1. Individual Deductions
Chapter 6
Individual Deductions

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

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

4. 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

5. 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

6. Deductions for AGI (4)

7. 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

8. 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

9. 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

10. 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

11. 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)

12. 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

13. 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

14. 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

15. 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)

16. Deductions for AGI (14)

17. 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

18. 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

19. 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

20. 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)

21. 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

22. 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.

23. Deductions from AGI: Itemized Deductions (7)

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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