2 Learning objectives Identify the common deductions necessary for calculating adjusted gross income AGI Describe the different types of itemized deductions available to individuals and compute itemized deductions ID: 661632
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Chapter 6
Individual DeductionsSlide2
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Learning objectives
Identify the common deductions necessary for calculating adjusted gross income (AGI)
Describe the different types of itemized deductions available to individuals and compute itemized deductions
Explain the operation of the standard deduction, determine the deduction for personal and dependency exemptions, and compute taxable incomeSlide3
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Deductions for AGI
Three categories of deductions for AGI
Directly related to business activities
Indirectly related to business activities
Deductions subsidizing specific activitiesSlide4
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Deductions for AGI
Directly Related to Business Activities
Taxpayers are allowed to deduct expenses incurred to generate business income
For tax purposes activities are either
profit-motivated or
motivated by personal objectives
Profit-motivated activities are classified as
business activities (called “trade or business”) or
investment activities Slide5
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Deductions for AGI
Although both are motivated primarily by profit, business activities are distinguished from investment activities:
Trade or Business activities require a relatively high involvement or effort from the taxpayer where as investment activities don’t require
Investment activities involve investing in property for appreciation or for income paymentsSlide6
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Deductions for AGISlide7
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Deductions for AGI
Trade or Business Expenses must be:
directly connected to the business activity
ordinary and necessary for the activity (e.g., appropriate and helpful for generating a profit)
reasonable in amount (not extravagant)
Expenses are claimed on Schedule C
Revenues from the same activity are also reported on the same Schedule C
The net income or loss from Schedule C is transferred to Form 1040 (page 1) on line 12Slide8
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Deductions for AGI
Rental & Royalty Expenses
Claimed above the line (for AGI)
Could either be an investment activity or a trade activity depending on facts
Taxpayers report expenses and revenue on Schedule E and transfer the net income or loss from Schedule E to Form 1040 (page 1), line 17
Flow-through Entities
Expenses and losses incurred by a flow-through entity pass through to the entity owners who typically report these amounts on Schedule E and Line 17Slide9
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Deductions for AGI
Losses
Taxpayers disposing of trade or business assets at a loss are allowed to deduct the loss for AGI
Losses from investment assets (called
capital assets
) are offset against capital gains
If capital losses exceed capital gains, this is called a
net capital loss
A net capital loss is deducted for AGI but limited to $3,000. Losses in excess of the $3,000 limit are carried forward indefinitely to subsequent years
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Deductions for AGI
Deductions
indirectly
Related to Business Activities
The cost of moving personal possessions is not a direct cost of doing business or being employed
Moving Expenses are deductible for AGI if the move meets two tests
A distance test
A business test associated with a moveSlide11
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Deductions for AGI
Distance test – the new job site must extend existing commute by 50 miles
A new job site is required, but a new employer is not essential
Business test - Taxpayer must be employed at least 39 of 52 weeks or be self-employed for 78 of the 104 weeks following the move
Taxpayers are allowed to deduct a mileage rate in lieu of the actual costs of driving their personal automobiles during the move (23 cents per mile in 2015)Slide12
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Deductions for AGI
Health Insurance deduction by Self-Employed Taxpayers
Deduction provides equity with employees who receive health insurance as a qualified fringe benefit
Insurance must be provided for taxpayer or dependents who are not eligible for employer-provided health insurance
Penalty for early withdrawals of savings
Reduces the taxpayer’s net interest income to the amount actually receivedSlide13
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Deductions for AGI
SE Tax Deduction
Employer and employees each pay the employee’s Social Security tax
Employers deduct the portion of Social Security taxes they pay for employees
Self-employed individuals are required to pay SE tax in lieu of Social Security tax
Self-employed tax payers are allowed to deduct the employer portion of the SE tax they pay to compensate for employers deducting their portion of Social SecuritySlide14
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Deductions for AGI
Alimony payments are deductible for AGI to maintain equity
Contributions to a qualified retirement account are deductible for AGI to encourage savings
Interest expense on qualified educational loans
Qualified educational expenses
(scheduled to expire after 2014)Slide15
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Deductions for AGI
Deduction for Interest expense on loans used to fund qualified educational expenses
Up to $2,500 of interest on education loans is deductible for AGI
The interest deduction is phased-out for taxpayers with AGI exceeding $65,000 ($130,000 filing joint)
The deduction is eliminated for taxpayers with AGI exceeding $80,000 ($160,000 filing joint)Slide16
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Deductions for AGISlide17
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Deductions from AGI: Itemized Deductions
Medical Expenses
Taxpayers may deduct medical expenses incurred to treat themselves, their spouse, and their dependents
Qualifying medical expenses include unreimbursed payments for care, prevention, diagnosis or cure of injury, disease, or bodily function
Taxpayers using personal automobiles for medical transportation purposes may deduct a standard mileage allowance (23 cents per mile in 2015) in lieu of actual costsSlide18
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Deductions from AGI: Itemized Deductions
Hospitals and Long-term Care Facilities
Taxpayers may deduct the costs of actual medical care whether the care is provided at hospitals or other long-term care facilities
Medical Expenses Deduction Limitation
It is limited to the amount of unreimbursed qualifying medical expenses paid during the year which is reduced by 10% (7.5% for a taxpayer or spouse age 65 or older) of the taxpayer’s AGISlide19
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Taxes
Individuals may deduct itemized deductions payments for following taxes
State, local, and foreign income taxes
Real estate taxes on property held for personal or investment purposes
Personal property taxes that are assessed on the value of the specific property
Sales Tax deduction
State and local sales taxes can be deducted
in lieu
of state and local income taxes
(scheduled to expire after
2014)
Deductions from AGI: Itemized DeductionsSlide20
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Deductions from AGI: Itemized Deductions
Interest
Two itemized deductions for interest expense:
Deduction of investment interest is limited to a taxpayer’s net investment income
Any investment interest in excess of the net investment income limitation carries forward to the subsequent year
Home mortgage interest
Interest on acquisition indebtedness of $1million
Interest on home equity debt of $100KSlide21
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Charitable Contributions
Contribution of money or property must be made to a qualified charity
Special rules apply to charitable contributions of property depending on the type of property:
Capital gain property
Ordinary income property
Deductions from AGI: Itemized DeductionsSlide22
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Deductions from AGI: Itemized Deductions
Charitable Contribution Deduction Limitations for property donations
Apply the AGI limitations in the following sequence
Step 1
:
Determine limitation for the 50% contributions
Step 2: Apply limitation to 30% contributions, which is the
lesser
of (a) AGI × 30% or (b) AGI × 50% minus the contributions subject to 50% limit
Step 3: Apply limitation to 20% contributions, which is the
lesser
of (a) AGI × 20% , (b) AGI × 30% minus the contributions subject to 30% limit, or (c) AGI x 50% minus the contributions subject to the 50% limit and the contributions subject to the 30% limitSlide23
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Deductions from AGI: Itemized DeductionsSlide24
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Deductions from AGI: Itemized Deductions
Casualty and theft losses on personal-use assets
The amount of the tax loss from any specific casualty event (including theft) is the lesser of
decline in value of the property caused by the casualty or
taxpayer’s tax basis in the damaged or stolen assetSlide25
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Deductions from AGI: Itemized Deductions
Casualty Loss Deduction Floor Limitations
It must exceed two separate floor limitations to qualify as itemized deductions
$100 for each casualty during the year
10 percent of AGI floor limit applied to the sum of all casualty losses for the year (after applying the $100 floor)
In other words, the itemized deduction is the aggregate amount of casualty losses that exceeds 10 percent of AGISlide26
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Deductions from AGI: Itemized Deductions
Miscellaneous Itemized Deductions Subject to AGI Floor
Employee Business Expenses
Travel and transportation
Employee expense reimbursements
Investment Expenses
Tax Preparation Fees
Hobby losses
Total miscellaneous itemized deductions are subject to a 2 percent of AGI floor limitSlide27
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Itemized Deductions and the Standard Deduction
Miscellaneous Itemized Deductions Not Subject to AGI Floor
Individuals include all gambling winnings for the year in gross income and deduct gambling losses to the extent of gambling winnings for the year
Standard Deductions
Taxpayers generally deduct the greater of their standard deduction or their itemized deductions
High income taxpayers are subject to a phase out of certain itemized deductionsSlide28
The Standard Deduction
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Standard
deduction amounts for
2015
Filing
status
Standard
deduction
Additional
standard deduction (age and
blindness)
Married filing jointly
$
12,600
$1,250
Head of household
9,250
1,550
Single
6,300
1,550
Married filing separately
6,300
1,250Slide29
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Standard Deductions & Exemptions
Bunching Itemized Deductions
Tax benefit can be gained by implementing simple timing tax-planning strategy
Taxpayers with itemized deductions that fall just short of the standard deduction amount
These itemized deductions do not produce any tax benefit
Rather than deduct the standard deduction every year time deductions (when possible) to bunch together in one yearSlide30
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Standard Deductions & Exemptions
Deduction for Personal and Dependency Exemptions
$4,000 for the taxpayer
$4,000 for the taxpayer’s spouse
$4,000 for each dependent
Subject to phase-out for high income taxpayers