Chapter 5
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CHAPTER 5. Itemized Deductions and Other Incentives. Objective. Understand the nature and treatment of itemized deductions. Itemized Deductions (Schedule A). Itemized deductions are generally personal expenses If itemized deductions exceed standard deductions, use that number

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Chapter 5


Itemized Deductions and Other Incentives



Understand the nature and treatment of itemized deductions

Itemized deductions schedule a

Itemized Deductions (Schedule A)

  • Itemized deductions are generally personal expenses

    • If itemized deductions exceed standard deductions, use that number

    • Itemized deductions are phased out if AGI is over threshold amounts

  • Types of itemized deductions (Separate sections of of Schedule A)

  • Medical Expenses Charitable Contributions

  • Taxes Employee Employee Business Expenses

  • Interest Other

  • Casualty/Theft

Medical expenses

Medical Expenses

  • Taxpayers are allowed deductions for medical expenses for spouse, self and dependents (in excess of reimbursements) but only if the total exceeds 7.5% of AGI

    • Prepaids are generally not deductible but credit card charges are deductible in year charged

    • Prescription medication is allowed

    • $.13/mile transport for medical care and $50/night lodging for each individual (person needing attention plus one caregiver)

  • Capital purchases deductible all in one year (only in excess of value increase of home, for example wheelchair ramps and bathroom fixtures)

Medical expenses continued

Medical Expenses (continued)

  • Health, dental and optical insurance premiums

    • Health insurance for self employed is split:

      • 70% is deductible for AGI

      • 30% is deductible on Schedule A

    • Long term care insurance premiums also deductible

    • Medicare A premiums not deductible, but Medicare B (supplemental) are deductible (SS Statement designates)

  • Psychiatric care, drug/alcohol treatment deductible, but not marriage counseling or smoking cessation

  • Nursing home costs (if entirely for medical benefit) deductible

Medical savings accounts msa

Medical Savings Accounts(MSA)

  • MSAs are designed to help employees of small businesses with high deductible health insurance plans meet uncovered costs

    • Also available to self-employed taxpayers

  • Employees can contribute 65% of annual deductible (if single) or 75% (family) as a deduction for AGI

    • “High deductible” plan means deductible of $1,650-$2,500 for individual or $3,300-$4,950 for family

      • Out of pocket expenses cannot exceed $3,300 ($6,500 for a family)

    • If employer contributes to MSA, not includable in income

    • Earnings and distributions from MSA are then nontaxable if used for medical expenses (15% penalty if used for other purposes)



  • Taxes are imposed by a government to raise revenue for general public purposes; a fee is a charge with a direct benefit to the person paying.

    • Taxes are deductible, fees not deductible.

  • Examples of deductible taxes

    • State and local income taxes

    • Real estate taxes

    • Personal property taxes

  • Example of nondeductible taxes

    • Sales tax

    • Estate tax

    • Social Security taxes

    • Any federal tax

State income tax deductibility

State Income Tax Deductibility

  • Amount paid in current year is deductible. For example: What is deductible in following scenario?

    • Amend 2001 state tax return and pay additional $843 ($93 in penalties/interest + $750 tax)

    • State Income Tax (SIT) withholding for the current year is $660

    • Paid quarterly SIT estimates as follows:

      • 4/15, 6/15, and 9/15 of current year and 1/15 of next year ($200/each)

      • 1/15 of current year paid fourth quarterly estimate from prior year of $155

  • Answer: Deductible amount is $750 + $660 + $200 + $200 + $200 + $155 = $2,165

  • If taxpayer receives refund of SIT that was deducted in prior year, that refund is taxable income in year it is received.

    • Report on Form 1040

Real estate taxes

Real Estate Taxes

  • Property taxes on real estate are deductible (even on second home); however, rental property real estate taxes are reported on Schedule E

    • If paid into escrow, taxes are deductible when paid

    • If taxpayer pays real estate taxes twice per year, doesn’t matter which year it pertains to - deduct using cash method

  • When selling property, need to allocate based on number of days each owned; this is reported on closing documents

    • Seller deducts taxes paid up to, but not including, date of sale

  • Assessments add to basis of property and are not deductible

Personal property taxes

Personal Property Taxes

  • Tax on personal property (such as autos, boats, trailer, etc.) are deductible, but only if ad valorem (amount that is based on the property’s value)



  • Examples of deductible interest include

    • Qualified residence interest and points

    • Amortized points on refinanced mortgage

    • Investment interest, such as margin interest

    • Student loan interest

      • up to $2,500 per year

      • this deduction phases out when AGI > $50,000 (S) and when AGI > $100,000 (MFJ)

      • Loan must be used for qualified expenses including tuition, room and board, and related expenses.

Mortgage interest

Mortgage Interest

  • Qualified residence interest is interest on debt used to secure/construct principal and second residence

    • limited to acquisition indebtedness (up to $1,000,000)

    • home equity loans (even if loan is for personal use) up to $100,000

  • Loan origination fees and discount points (these are quoted as a percentage of principal)

    • Refinancing points must be capitalized & amortized (deducted) over life of loan (reported on 4562 and carries to A or E)

    • Other closing costs such as appraisal, title search, etc. are nondeductible, but are added to the property’s basis

Interest limitations

Interest Limitations

  • To be deductible, interest paid or accrued within tax year must result from true debtor-creditor relationship

    • Promissory note, market rate of interest

  • Investment interest (debt to purchase investment property, such as margin interest, but not if belongs on C or E)

    • Can only deduct up to the amount of net investment income

      • carry forward to next year on 4952 any unused investment interest expense

  • Not allowed to deduct

    • Investment interest on tax-exempt securities

    • Interest on loans to pay life insurance premiums

    • Consumer interest or prepaid interest

Charitable contributions

Charitable Contributions

  • Deductions limited by type of donee organization and type of contribution made

  • Example of organizations that qualify for 50% AGI deductions:

    • Churches and educational institutions

    • Hospital and medical research organizations

    • Private operating foundations (defined as receiving 1/3 or more of operating funds from grants)

    • Private non-operating foundations if all contributions distributed to public charities in the same year

  • Examples of organizations that qualify for 30% AGI deductions:

    • Private non-operating foundations

    • War veterans’ associations and fraternal societies

Charitable contributions continued

Charitable Contributions (continued)

  • Can contribute cash or property

  • If contribute appreciated long term capital gain (LTCG) property (such as appreciated stock)

    • To a 50% organization

      • can deduct appreciated value, but subject to 30% AGI limitation, or deduct the basis instead and then can take up to 50% AGI

    • to a 30% organization

      • can deduct appreciated value but subject to 20% AGI limitation, or deduct the basis instead and then can take up to 30% AGI

  • If the LTCG property donated is tangible personal property that is used for unrelated purpose, can only deduct FMV less potential LTCG

Charitable contributions continued1

Charitable Contributions (continued)

50% Organization

STCG or ordinary

income property. Can deduct FMV less amount of gain that would’ve been recognized (i.e., the basis), then limited to 50% of AGI



see rules on

prior screen



Charitable contributions continued2

Charitable Contributions (continued)

30% Organization





see rules on

prior screen

STCG or ordinary income property, can deduct FMV less amount of gain that would’ve been recognized, then limited to 30% of AGI

Charitable contributions continued3

Charitable Contributions (continued)

  • Order of charitable contribution deductions:

  • 1. Deduct 50% contributions

  • 2. Deduct 30% contributions

  • 3. Deduct 20% contributions

  • 4. Any contributions not currently

  • deductible, can carry over for 5 years,

  • subject to the same ceilings

Total of all 3 types

of deductions still

limited to AGI x 50%

Charitable contributions continued4

Charitable Contributions (continued)

  • Allowed $.14/miles for mileage deduction

  • If purchase event tickets, can only deduct amount paid in excess of value of event

  • Can’t deduct

    • If influences legislation

    • Free use of property (for example, donate use of ski condo to church youth group)

  • Non-cash contributions

    • If more than $250 - need written acknowledgement

    • If more than $500, complete 8283 Section A

    • If more than $5,000, complete 8283 Section B and need appraisal

Casualty and theft

Casualty and Theft

Fill out Form 4684, then

Personal or Business

  • To be classified as casualty loss, needs to be “sudden”

    • if theft, need to prove (for example, by police report)

  • Either business or non-business casualty loss can result in NOL

  • Business casualty losses are fully deductible on 4684 Section B

  • Personal casualty losses are subject to $100 floor per event and then only if total exceeds 10% of AGI

To Schedule C

To Schedule A

Casualty and theft continued

Casualty and Theft (continued)

  • Amount to deduct on 4684 is

    lesser of: Difference in FMV before and after casualty, or Adjusted basis

    Minus:Any reimbursement

  • Casualty gains can occur if reimbursed more than decrease in FMV

Miscellaneous deductions

Miscellaneous Deductions

  • Category 1: limited to total amount over 2% AGI

    • unreimbursed employee expenses (Form 2106)

    • union dues

    • tax prep fees

    • safety deposit box

    • journals/subscriptions

    • investment expenses

    • job hunting fees

Miscellaneous deductions1

Miscellaneous Deductions

  • Category 2: no AGI limitations

    • Handicapped individual’s attendant care cost

    • Estate tax on income of decedent

    • Gambling losses to extent of gambling winnings

    • Terminated annuity payments



Understand the special rules applicable to moving expenses

Moving expenses

Moving Expenses

  • Can use if employee or self employed

  • To qualify for deductible moving expense

    • Travel from new job site to old residence must be longer by at least 50 miles than distance from old job site to old residence

    • Must work 39 weeks in the next 12 months; if self-employed, must work 78 weeks in the next 24 months

    • Must change job sites.

      • Move can be with new or existing company

  • Deduct expenses of moving self and family, if related to starting work in new location

    • Cost of moving personal goods

    • Travel and lodging included, but not meals

    • .13/mile for personal car



Know the factors used to determine whether an activity is a hobby, and understand the tax treatment of hobby losses

Hobby losses

Hobby Losses

  • Must show business intent to be able to deduct all losses

    • IRS will look at the facts of each case

  • If a “hobby”, can only deduct hobby expenses as miscellaneous itemized deductions

    • No expenses in excess of hobby income, i.e., cannot create a loss

    • Must deduct in specific order:

      • Expenses otherwise deductible on Schedule A (home mortgage interest, taxes, etc.)

      • Other expenses

  • Income reported on 1040 “other income”



Know the tax implications of using educational savings accounts and qualified tuition programs

Qualified tuition programs section 529 plans

Qualified Tuition Programs (Section 529 plans)

  • Allow taxpayer to

    • Buy in-kind tuition credits or certificates to cover higher education expenses

    • Contribute to an account established to meet qualified higher education expenses

  • Distributions are generally not taxed if funds used for higher education (tuition, fees, books, supplies, equipment)

    • Reasonable amount can be used for room and board

  • If not used for higher education, distributions are taxable

  • No limit on contribution amount, but contribution is not deductible

    • 10% penalty if funds not used for qualified expenses or early withdrawal

Educational iras education savings accounts

Educational IRAs (Education Savings Accounts)

  • An educational IRA is a trust or custodial account created to pay qualified higher education expenses

  • Can contribute until beneficiary reaches 18

    • $2,000/year per child non-deductible contribution

    • Becomes tax free distribution if used for higher education

  • Income phase-outs begin at $190,000 for joint filers and $95,000 for single

  • Can roll over from one child to another

Higher education expense deduction

Higher Education Expense Deduction

  • Allowed deduction for qualified tuition and related expenses incurred during tax year.

    • Limited to $3,000 and phased out for AGI > $65,000 (S); $130,000 (MFJ)

    • Must be enrolled at an institution of higher education

    • Taken in year paid

  • Reduce by

    • Interest excluded from education savings bonds

    • Excluded distributions from state tuition plans

    • Excluded distributions from Education Savings Accounts (IRAs)

End of chapter 5

End of Chapter 5

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