Chapter 11-Part A Income Taxationof Individuals.Deductions For AGIItemized DeductionsFall, 2007
In 2007, Mr. and Ms. Jones have combined salaries of $60,000. Their only expenditures affecting the tax return are state income taxes of $6,000, mortgage interest of $5,000 and real estate taxes amounting to $1,000. They have two small children whom they support, and file a joint return. What is their taxable income for 2007?
Deductions For AGI • Discussed in previous chapters • Retirement plan contributions including IRAs • Moving expenses • 50% of self-employment taxes • Self-employed health insurance • Alimony paid
Deductions For AGI • Deductions discussed in this chapter • Educator expenses • Student loan interest expense • Tuition and fees deduction • Health savings accounts • Penalty on early withdrawals of savings • Other deductions for AGI
Educator Expenses • Kindergarten through 12th grade teachers may deduct up to $250 of unreimbursed expenses for books, supplies, computer equipment, software, and other supplemental materials used in the classroom
Student Loan Interest-1 • Deduction allowed for interest paid on qualified student loans incurred and used for tuition, fees, room, board, books, and supplies.
Student Loan Interest-2 • Deduction limit is $2,500 • Limit is phased out for modified AGI of $55,000 - $70,000 ($110,000 - $140,000 for married persons filing jointly)
Student Loan Interest-2 • Individuals claimed as dependents cannot take deduction on their own tax return. • Expenses paid by tax-exempt scholarships or subject to education credits must be excluded from loan amounts and related interest.
HW-19 Student Loan InterestCecilia is married and files a joint return with her husband, Steve. They have modified AGI of $120,000. Cecilia paid $2,700 in student loan interest this year. What is her interest deduction?
Tuition & Fees Deduction-1 • $4,000 deduction for 2005 for tuition & fees for taxpayer, spouse, and dependents • Income limits apply ($65,000 if single and $130,000 if married filing jointly)
Tuition & Fees Deduction-2 • Deduction reduced to $2,000 for singles with AGI $65,000 - $80,000 ($130,000 - $160,000 for joint filers) • Individuals who are claimed as dependents cannot take deduction on their own tax return • No double benefit - no deduction if expense is deductible under any other provision (including education credits)
Health Savings Accounts • Taxpayers covered by high-deductible medical insurance policies only may deduct amounts set aside in an HSA • Contributions and earnings on HSAs are not taxed when withdrawn to pay medical expenses • Distributions not spent on qualifying expenses are included in income and subject to a 10% penalty
Health Savings Accounts • To qualify for an HSA in 2006, individuals must have health insurance with deductibles of at least $1,100 ($2,200 for families) • Maximum contribution to HSA equal to lesser of $2,850 ($5,650 for families) or the annual policy deductible.
Medical Savings Accounts • MSAs are similar to HSAs but with different limits • Qualified policies are those with deductibles beteen $1,900 and $2,850 for individuals ($3,750 and $5,650 for families) in 2007 • Contributions to MSAs are limited to 65% of policy deductible for individuals (75% for families) • Distributions not spent on qualifying expenses are included in income and subject to a 15% penalty
HW-20 Health Savings AccountsAshley is single and owns a sole proprietorship. She pays $2,600 for high-deductible medical policy for herself --with a $2,300 deductible. How much can she set aside in an HSA?
HWA-20 Health Savings AccountsThe maximum Ashley can contribute to an HSA for 2007 is $2,850 ($3,650 if 55 or over).She can deduct the $2,850 for AGI if contributed to an HSA. She can deduct the $2,600 medical insurance premium only if she itemizes.
Penalty on Early Withdrawals • Penalties assessed on premature withdrawals from certificates of deposits or other savings accounts are deductible • Gross interest income, unreduced by the penalty, is included in taxable income • Deducting the penalty ensures that only net interest income is included in taxable income
Special Travel Deduction • For nonreimbursed travel expenses to attend National Guard or military reserve meetings more than 100 miles from home • Maximum deduction is general government per diem rate for the area • Excess expenses can be deducted as miscellaneous itemized deductions (subject to 2% of AGI floor)
Special Travel Deduction • Expenses of fee-basis government officials • Expenses of performing artists
Exemptions • Each taxpayer (who is not a dependent) is entitled to one personal exemption • Exemption deduction is $3,400 for 2007 • Additional exemptions allowed for each person who is considered a dependent • Anyone who is claimed as a dependent cannot claim a personal exemption • For purposes of the dependency exemption, a dependent is a qualifying child or qualifying relative
Qualifying Child Must meet four tests • Residency test - live with taxpayer more than 6 months • Relationship test - son, daughter, brother, sister, or descendant • Age test - under 19 (or under 24 if full-time student) • Support test - child cannot provide more than half his own support
Qualifying Relative If not a qualifying child, then three similar tests must be met: • Relationship test - must either be a qualifying relative of the taxpayer or a resident in the taxpayer’s household for the entire year • Gross income test - the qualifying relative's gross income from taxable sources must be less than the exemption amount ($3,400 for 2007) • Support test (provided by taxpayer)
Qualifying Relative Support Test • Taxpayer must provide more than 50% of the dependent's total support • Support includes amounts spent for food, clothing, shelter, medical care, education and capital expenditures such as a car • Value of services and scholarship funds are omitted in determining support received by a student • Dependent’s nontaxable income used for support must be included in support determination
HW-20 Dependency Exemptions-1Joseph provides $12,000 of support for his mother, Miriam, who lives in his house. Miriam is a U.S. citizen and single. Miriam’s only income is Social Security of $5,000 and taxable pension income of $4,000. Miriam uses the Social Security income for support but puts all of the pension income into her savings account.
HW-21 Dependency Exemptions-2Joseph also provides $6,000 of support for his 22-year-old son, Mike, who is a full-time student attending college on a basketball scholarship. The balance of Mike’s support comes from a scholarship that pays Mike's $10,000 tuition and fees for the year. How many dependents can Joseph claim on his tax return?
HWA-21 Dependency ExemptionsOne. Miriam’s taxable income ($4,000) is above the allowable $3,400 limit so she does not pass the gross income test. Mike is a qualifying child so he qualifies as a dependent.
Multiple Support Agreement • Multiple support agreements allow one member of group of support providers to claim the exemption when • Together the group meets the support test • All other dependency tests are met • Member who claims exemption must provide more than 10% of the total support and other members providing more than 10% support agree to exemption
Phaseout of Exemptions • Both personal and dependency exemptions are phased out at a rate of 2% (4% for MFS) for each $2,500 (or fraction thereof) of AGI above thresholds for 2007 of • $156,400 if single • $195,500 if head of household • $234,600 if married filing jointly • $117,300 if married filing separately
Exemption Phaseout • (AGI – threshold AGI)/$2,500 = Phaseout Factor (always round up to next whole number) • Phaseout Factor x 2 = Phaseout Percentage • Phaseout Percentage x Exemption Amount x 2/3 = Exemption Reduction • Exemption Amount – Exemption Reduction = Allowable Exemption Deduction • Once AGI exceeds the threshold AGI by more than $122,500 ($61,250 for MFS), only 1/3 of exemption deduction remains
HW-26 Phaseout of ExemptionsWhat is the total deduction for personal and dependency exemptions for the following taxpayers in 2007?a. Married filing jointly with two dependents and AGI of $300,000b. Single with no dependents and AGI of $200,000
HWA-26 Phaseout of Exemptions-1a. $8,704. Their exemptions before phaseout are $13,600 ($3,400 x 4).($300,000 - $234,600)/$2,500 = 26.16 (round up to 27)27 x 2 = 54% phaseout percentage 54% x $13,600 x 2/3 phaseout reduction = $4,896.$13,600 - $4,896 = $8,704
HWA-26 Phaseout of Exemptions-2b. $2,584. His exemption before phaseout is $3,400 for one personal exemption.($200,000 - $156,400)/$2,500 = 17.44 (round up to 18) 18 x 2 = 36% phaseout percentage36% x $3,400 x 2/3 phaseout reduction = $816 $3,400 - $816 = $2,584.
Filing Status • Taxpayer’s filing status determines standard deduction and tax rate schedule • Marital status determined on the last day of the tax year • Separated spouses are considered married until divorce becomes final
Filing Status - Married • Can file jointly if both spouses are US citizens or US residents (or if nonresident alien agrees to be taxed on worldwide income) • If the couple files separately, both must itemize deductions or both must use the standard deduction
Surviving Spouse • Marital status is determined at the date of death so a joint return can be filed for the year in which a spouse dies • A surviving spouse may continue to use the tax rates and standard deduction for married persons filing jointly for the next 2 years only if a dependent child lives with the taxpayer
Filing Status – Unmarried • Unmarried taxpayers file as • Head of household - an unmarried person who provides more than half of the cost of maintaining a home in which a qualifying child or other qualifying relative lives for more than half the year • Single
Head of Household • Claimed if taxpayer is unmarried (and not a surviving spouse) • Taxpayer pays more than half the cost of maintaining home which is the principal residence for more than half the year of • A qualifying child • An individual for whom the taxpayer may claim a dependency exemption • A parent is not required to live with the taxpayer
Abandoned Spouse • A taxpayer who is married but whose spouse did not live with him or her at any time during the last six months of the tax year and who provides more than half the cost of maintaining the home in which a dependent child lives • A qualifying abandoned spouse uses head of household tax rates and standard deduction