Individual Deductions Chapter 6 Individual Deductions

Deductions Know difference between “FOR” (above the line) and “FROM” (below the line) AGI

Deductions for AGI Three categories of deductions for AGI Directly related to business activities Indirectly related to business activities Subsidizing specific activities

Deductions for AGI (2) 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”) Investment activities

Deductions for AGI (3) 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 whereas investment activities do not Investment activities involve investing in property for appreciation or for income payments

Deductions for AGI (4)

Deductions for AGI (5) 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), line 12

Deductions for AGI (6) Rental and 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 17

Deductions for AGI (7) 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

Deductions for AGI (8) Deductions Indirectly Related to Business Activities The cost of moving personal possessions is not a direct cost of doing business or being employed (Goes away under 2018 tax law) Moving expenses are deductible for AGI if the move meets two tests A distance test A time test associated with the move

Deductions for AGI (9) 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 Time 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 (17 cents per mile in 2017)

Deductions for AGI (10) 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 Withdrawal of Savings Reduces the taxpayer’s net interest income to the amount actually received

Deductions for AGI (11) 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 taxpayers are allowed to deduct the employer portion of the SE tax they pay to compensate for employers deducting their portion of Social Security

Deductions for AGI (12) Alimony payments are deductible for AGI to maintain equity (not in 2018) Contributions to a qualified retirement account are deductible for AGI to encourage savings Interest expense on qualified educational loans Qualified educational expenses

Deductions for AGI (13) 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 ($135,000 filing jointly) The deduction is eliminated for taxpayers with AGI exceeding $80,000 ($165,000 filing jointly)

Deductions for AGI (14)

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 (17 cents per mile in 2017) in lieu of actual costs

Deductions from AGI: Itemized Deductions (2) 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 Expense Deduction Limitation It is limited to the amount of unreimbursed qualifying medical expenses paid during the year which is reduced by 7.5% through 2018 of the taxpayer’s AGI

Deductions from AGI: Itemized Deductions (3) Taxes Individuals may deduct itemized deductions payments for the following taxes: State, local, and foreign income taxes Real estate taxes on property held for personal or investment purposes (changes in 2018) 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

Deductions from AGI: Itemized Deductions (4) 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 $1 million (new law $750K) Interest on home equity debt of $100K (goes away under new law)

Deductions from AGI: Itemized Deductions (5) 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 Deductions (6) 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% limit.

Deductions from AGI: Itemized Deductions (7)

Deductions from AGI: Itemized Deductions (8) Casualty and Theft Losses on Personal-Use Assets (goes away) 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 asset

Deductions from AGI: Itemized Deductions (9) 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 AGI

Deductions from AGI: Itemized Deductions (10) Miscellaneous Itemized Deductions Subject to AGI Floor (goes away) 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 limit

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 deductions

The Standard Deduction Standard deduction amounts for 2017 Filing status Standard deduction Additional standard deduction (age and blindness) Married filing jointly $12,700 $1,250 Head of household 9,350 1,550 Single 6,350 Married filing separately 1,250

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 year

Standard Deductions & Exemptions (2) Deduction for Personal and Dependency Exemptions (goes away) $4,050 for the taxpayer $4,050 for the taxpayer’s spouse $4,050 for each dependent Subject to phase-out for high income taxpayers