Chapter 6 Individual Deductions - PowerPoint Presentation

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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