Income Taxation- Ch 6 Individual Deductions

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Defintion: Deductions for AGI

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Subtracted directly from Gross Income. aka Above the Line Deductions

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3 types of Deductions for AGI

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1. Directly related to business activities.
2. Indirectly related to business activities.
3. Deductions subsidizing specific activities.

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Deductions for AGI- Directly Related to Business Activities (3)

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1. Trade or Business Expenses
2. Rent and Royalty Expenses
3. Losses
*Flow through entities

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Deductions for AGI- Indirectly Related to Business Activities (4)

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1. Moving Expenses
2. Health Insurance Premiums
3. Self-Employment Tax
4. Penalty for early withdrawal of savings

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Deductions for AGI- Deductions subsidizing specific activities (4)

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1. Alimony payments
2. Contributions to retirement savings
3. Interest Expense on qualified education loans
4. Qualified Educational expenses

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for AGI-Directly related- Trade or Business Expenses Requirements

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- directly connected to the business activity
- must be ordinary and necessary
- claimed on Schedule C (then reported on line 12 on Form 1040)

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for AGI- indirectly related- moving expenses are deductible if..., tests (2)

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- expenses are deductible if individual moves and changes principal place of work
Distance Test
A business text

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for AGI- Trade or Business expenses must be... (2)

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1. directly connected to the business activity
2. must be ordinary and necessary

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for AGI- Losses

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net capital loss can deduct up to $3000 for AGI with the excess carried forward indefinitely

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for AGI- Flow through Entities

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any expenses and losses incurred by the entity pass through to the entity owners who typically treat them as deductions for AGI

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for AGI- Moving Expenses- Distance Test

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- new job site must extent existing commute by 50 miles

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for AGI- Moving Expenses- Business Test

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taxpayer must be employed at least 39 of 52 weeks or be self-employed for 78 of the 104 weeks after the move

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for AGI- Moving Expenses- Do you have to change employers? Examples

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- Do not have to change employers as long as they meet both tests
- Can qualify for moving expense deduction by:
>Starting a new job
>Starting a job after a prolonged absence from the workforce
>By changing locations with the same employer
- Reasons can be entirely personal

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for AGI- Moving Expenses- What are deductible moving expenses? (2)

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1. moving possessions and traveling to new residence
2. transportation and lodging
- cost of driving personal automobiles: deduct actual costs or use standard mileage rate (16.5 cents a mile)

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for AGI- Moving Expenses- What are nondeductible moving expenses? (2)

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1. Meals
2. Costs associated with house-hunting trips

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for AGI- Moving Expenses- Employer reimbursement or allowance rules

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- Taxpayers who are reimbursed EXCLUDE reimbursement from income and cannot deduct the reimbursed expenses
- Taxpayers who receive a flat amount as a moving allowance from their employers INCLUDE the allowance in income and CAN deduct their actual moving expenses

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for AGI- Health Insurance Premiums paid by...

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self-employed taxpayers

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for AGI- Self-employment tax

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is NOT a business expense
self-employed are allowed to deduct 1/2 of tax paid

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for AGI- Penalty for early withdrawal of savings

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- a deduction for AGI is allowed for any interest income an individual forfeits to a bank as a penalty for prematurely withdrawing a CD or similar deposit
- Reduces net interest income to the amount actually received

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Deductions for AGI- Deductions subsidizing specific activities- deduction for interest on qualified education loans

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- up to $2500 of interest on education loans is deductible for AGI
- deduction is phased out as AGI increases

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Deductions for AGI- Deductions subsidizing specific activities- deduction for qualified education expenses

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- tuition and fees required for enrollment
- up to $4000 of qualified education expenses can be deducted for AGI
- deduction is phased out as AGI increases

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Deductions from AGI: Itemized deductions

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- itemized deductions appear on Schedule A, line 40
- take the greater of: itemized deductions or the standard deduction

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Itemized Deductions (5)

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1. Medical Expenses
2. Taxes
3. Interest
4. Charitable Contributions
5. Casualty and Theft Losses on Personal Use Assets
5. Miscellaneous Itemized Deductions

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from AGI: Itemized- Medical Expenses... what qualifies?

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-qualified medical expenses are deductible to the extent they exceed 7.5% of AGI
> total amount of expenses is reduced by 7.5% of AGI
> this is called a floor limitation because it eliminates any deduction for amounts below the floor
- taxpayers may also deduct medical expenses of their spouses and dependents
> dependent does not have to meet the gross income test
> a child of divorced parents is considered a dependent of both parents

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from AGI: Itemized- Qualifying Medical Expenses

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-payments for care, prevention, diagnosis, or cure of injury, disease, or bodily function that are not reimbursed by health insurance or are not paid for through a "flexible spending account"

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Common deductible medical expenses

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- Prescription medication and medical aids (eyeglasses, wheel chairs)
- Payments to medical care providers
- Transportation for medical purpose
- Hospitals and long-term care facilities
- Health insurance premiums if not deducted for AGI

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from AGI: itemized- taxes

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- 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

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from AGI: itemized- interest (2 types)

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1. Home Mortgage Interest
> interest on acquisition indebtedness of $1 million
> interest on home equity debt of $100,000

2. Investment Interest Expense
>deduction is limited to net investment income
**cannot deduct interest on personal credit card debt or on personal automobile loans

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from AGI: itemized- Charitable Contributions

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- must be made to a qualified charity
- amount of deduction depends on type of property contributed:
1. Money- deduct amount paid
2. Capital Gain Property- deduct FMV
3. Ordinary income property- deduct lesser of FMV or adjusted bassis
- deduction for the year is limited to 50%, excess is carried forward for 5 yrs before it expires

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from AGI: itemized- def of casualty loss

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-loss arising from a sudden, unexpected, or unusual event
-
amount of loss from any specific casualty event (including theft) is the lesser of: 1. Decline in value of the property caused by the casualty or 2. Tax basis in the damaged or stolen asset

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Casualty Loss deduction floor limitations

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- casualty losses must exceed 2 separate floor limitations to qualify as itemized deductions
1. $100 for each casualty event during the year
2. 10% of AGI (applies to the sun of all casualty losses for the year after applying the $100 floor)

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What are Misc Itemized Deductions subject to?

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miscellaneous itemized deductions are lumped together at the end of the year and are only deductible ONLY to the extent their sum EXCEEDS 2% of AGI

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Misc Itemized Deductions subject to the 2% Floor (4)

Misc Itemized NOT subject to the 2% Floor (1)

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1. Employee business expenses
2. Investment expenses
3. Tax preparation fees
4. Hobby losses

No Floor- 1. Gambling losses

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Misc Itemized Deductions- Employee Business Expenses

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- dues, uniforms, subscriptinos
- costs of education if maintains or improves skill in the business
- travel and transportation- must have a business purpose (commuting is personal)
- unreimbursed employee business expenses

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Misc Itemized Deductions- Investment Expenses

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- expenses associated with investment income or property
- investment advisory fees
- safety deposit box fees
- subscriptions to investment-rated publications

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Misc Itemized Deductions- Hobby Losses

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- hobby expenses are deductible only to extent of hobby income
- hobby: primarily for personal enjoyment
business: primarily to make a profit
- if generates a profit in 3 out of 5 consecutive interest= business
- hobby revenue included in gross income
- can DEDUCT to the extent of hobby income as misc itemized deductions subject to 2% floor

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Standard Deduction for a Dependent

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Standard Deduction is greater of: $950 or $300 + earned income limited to regular standard deduction (5700)

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Personal and Dependency Exemption

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$3,650 * number of exemptions

*personal exemptions allowed for taxpayer and spouse