1. © Kristina Shroyer 2011 VITA: Winter 2011 Lesson 20: Itemized Deductions Winter 2011 Kristina Shroyer

2. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Blank Forms for this Lesson As we go through this lesson you'll want to use some of the blank forms in Publication 4491-W for reference (blank forms start on Page 229) Form 1040 (page 229) ♦ Look at Line 40 Schedule A (page 254) Have Publication 17 handy for when we talk about mortgage interest

3. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions What is an Itemized Deduction? Most taxpayers have a choice between taking the standard deduction or itemized deductions whichever is better for them ♦ ONE OR THE OTHER NOT BOTH! Itemized Deductions like the Standard Deduction are subtracted from a taxpayers AGI. ♦ However, itemized deductions are based on specific personal expenses of the taxpayer  will be different for each taxpayer based on a number of factors  taxpayer must keep records of these personal expenses  Require more bookkeeping and records from the taxpayer To determine if a taxpayer MUST Itemize use the Interview tips in Tab F (Page F-1) of your Volunteer Resource Guide ♦ Certain married filing separate taxpayers must itemize as well as dual status and non resident aliens Read the tip on page 20-2 If you think a taxpayer may benefit from itemizing Enter the qualified expense in the TaxWise software ♦ Taxwise will automatically select the larger of the standard deduction and the itemized deduction for the taxpayer's return You can also use the interview tips on Page F-3 and F-4 of your Volunteer Resource Guide Usually only taxpayers with mortgage interest on their principle residence or a large amount of unreimbursed medical expenses/unreimbursed work expenses (NOT self employed) end up being able to itemize How are Itemized Deductions Determined/Reported? Using Schedule A (Page 239 Pub 4491-W) Once the Itemized Deductions are calculated (if greater than the standard deduction) they go on line 40 of Form 1040 Let's take a look at Schedule A and the different categories of expenses

4. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions What expenses to Itemized Deductions Include? Medical and Dental Expenses Certain Taxes the Taxpayer Paid Mortgage Interest and certain Investment Interest Gifts to Charity Casualty and Theft Losses (out of scope) Other Miscellaneous Deductions (unreimbursed employment expenses are included here) Medical and Dental Expenses (Sch A lines 1-4) Taxpayers can deduct on Schedule A only the amount of deductible medical and dental expenses that EXCEED 7.5% of their AGI (remember AGI is line 37 of Form 1040 – Income Less Adjustments to Income) ♦ So multiply the taxpayer's AGI by.075 and only medical expenses in excess of this are deductible ♦ Let's say a taxpayer had AGI of $200,000 and medical expenses of $10,000 - None would be deductible Which Medical Expenses are Deductible? Whose Expenses are covered? (see page 20-2) ♦ Expenses paid by the taxpayer for: the taxpayer, the taxpayer's spouse, any dependents claimed at the time the medical services were provided or paid for, or individuals who would have been dependents if not for one of the three conditions listed on page 20-2 ♦ Look at the second tip on page 20-2 regarding child of divorced/separated parents, read example at the top of page 20-3 What type of Expenses are covered? ♦ Unreimbursed medical and dental expenses and eligible Long Term care premiums ♦ the expenses can NOT be paid with pre-tax dollars or reimbursed by an insurance company ♦ See Publication 17 Page 142 for a general checklist Look at Exercise page 20-3

5. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible Look at page145-150 of Publication 17 for more info on these Real Estate Taxes (line 6) state, foreign, or local based on the assessed value of the taxpayer's real property To claim real estate taxes, the taxpayer must be legally liable for the taxes and must pay them during the year ♦ This means if the person who paid the real estate taxes is also not legally liable for them they are not deductible These are either reported on Form 1098 or can be found on a taxpayers yearly property tax assessment (Let's take a quick look at Form 1098) ♦ Make sure the taxpayer has a record of what they actually PAID during the year, just because the taxes were assessed doesn't mean they were paid

6. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible Look at page145-150 of Publication 17 for more info on these State and Local Taxes (line 5) The taxpayer must elect to deduct EITHER State and Local Income Taxes OR General Sales Taxes – NOT BOTH ♦ See the box they need to Check on Schedule A If they choose to deduct State and Local Income Taxes (they will check Box a under line 5): The taxes that can be deducted for this are: ♦ state and local tax withheld on a W-2 (CA State W/H and CA SDI) ♦ other state or local tax withheld ♦ estimated state or local tax payments and state tax paid this year for an earlier year, state tax payments made with an extension The key it is it is state and local taxes PAID this year Question: Where do you find state taxes and SDI paid on Form W-2? Question: Where do you find information for State Tax Estimates and amounts paid with state extensions? ♦ 2010 Form 540-ES and 2009 Form 3519 and/or taxpayer's canceled checks or records DO NOT INCLUDE ANY PENALTIES OR INTEREST

7. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible (continued) General Sales Taxes instead of State and Local Income Taxes (line 5 continued) this is not in the book because the change was made at the last minute, it is explained in the Schedule A instructions I downloaded from the IRS website We were just talking about deducting State and Local Income taxes on line 5 In 2010 a taxpayer can elect to deduct state and local general SALES taxes instead of state and local income taxes This would only be done if state and local sales taxes results in a higher deduction for the taxpayer than state and local income taxes If the taxpayer makes this election Check box b on line 5 of Schedule A Get the amount of state and local sales taxes to enter on line 5 from 1. Actual receipts (provided by the taxpayer) 2. Optional Sales Tax Tables in the Schedule A instructions (page A-4) ♦ Get these from the IRS website www.irs.gov - Page A-12 through A-14www.irs.gov  First find CA in the first optional table, and based on the taxpayer's filing status and exemptions find an amount  Some states and localities get to use optional tables to add additional taxes to the amount from the first table - For Los Angeles County you will use one of the Optional Tables, Table A - Add this amount to what you calculated from the first table There is a worksheet to do this with on page A-4 of the Schedule A instructions

8. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible (continued) General Sales Taxes instead of State and Local Income Taxes (continued) The best source for this material right now is the Schedule A instructions that you can download from the IRS website How to compute Sales Tax using the Optional Sales Tax Tables instead of actual receipts Optional Sales Tax Tables in the Schedule A instructions ♦ Get these from the IRS website www.irs.gov - Page A-12 through A-13www.irs.gov General Idea on how it works (there's a little more to it in the worksheet but just follow the instructions): 1. First find CA in the first optional table, and based on the taxpayer's filing status and exemptions find an amount 2. Some states and localities get to use optional tables to add additional taxes to the amount from the first table  For Los Angeles County you will use one of the Optional Tables, Table A  Add this amount to what you calculated from the first table There is a worksheet to do this with on page A-4 of the Schedule A instructions In TaxWise, the program will do most of the calculation TaxWise will determine which is better, state and local income tax paid or general state and local sales taxes Just make sure and enter all of the necessary information ♦ Generally a program will just ask you for the taxpayer's county of residence and will get the rest of the information from the exemptions you entered and tables in the program

9. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible (continued) Look at page145-150 of Publication 17 for more info on these Motor Vehicle Taxes – WON'T BE COMMON IN 2010 (line 7) There is a deduction for state and local sales and excise taxes paid on the purchase of new cars, light trucks, motor homes and motorcycles You will calculate sales and excise taxes on these vehicles on the Schedule A, New Motor Vehicle Tax Deduction worksheet, this is page 2 of the Schedule A (the Schedule A used to be one page) ♦ you will calculate the amount following the instructions and the calculated amount on line 11 of the worksheet will be transferred to line 7 of Schedule A General Rules on the Deduction: ♦ Only applies to qualified passenger vehicles purchased after February 16, 2009 and before January 1, 2010 – this means for this to apply in 2010 the taxpayer needs to have PAID the sales taxes for a vehicle purchased in 2009 in 2010 (won't be common)  The rules for what is a qualified vehicle are on page A-6 in the Schedule A instructions at the bottom of column 1 (note the vehicle use must begin with the taxpayer so it cannot be a USED vehicle) ♦ For states with no sales taxes (doesn't apply to us) certain fees on the purchase of a qualified vehicle may be deductible (see A-6 of Sch A instructions column 1) ♦ Deduction is limited to taxes paid on a qualified new car, light truck, motor home or motorcycle with a purchase price of up to $49,500  If price is over 49,500 taxpayer can only deduct tax on 49,500 of the price ♦ The amount of the deduction is phased out based on AGI  $125,000 -135,000 phase out for single taxpayers  $250,000 – 260,000 phase out for married filing jointly If you think someone qualifies for this really double check and make sure, no vehicle purchased in 2010 is eligible for this IF you're sure they are the exception to the rule and qualify the worksheet to fill out is page 2 of Schedule A Note that taxpayers who deducted sales tax instead of state and local tax (checked box 5b) also are not eligible for this

10. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Taxes that May be Deductible (continued) Look at page145-150 of Publication 17 for more info on these Personal Property Taxes (line 8) Payments based on the value of personal property and charged on a yearly basis Most common one – property tax paid with the DMV registration…you can only deduct the property tax portion (the part paid based on the value) Note that only part of the DMV fee the taxpayer paid in CA is property tax and therefore deductible ♦ The deductible part is labeled the VLF fee on the form the taxpayer gets from the DMV Foreign Income taxes Paid (line 8) The general rule on this is that income taxes paid to a foreign country can be taken as an Itemized Deduction on Schedule A OR AS A CREDIT ♦ The credit is generally BETTER and should be taken, make sure and pay attention to this when we go over the Foreign Tax Credit Chapter 25 Sometimes these will show up on a 1099-DIV or a 1099-INT Box 6 ♦ This means that foreign taxes have been paid on their behalf by the issuer of the document ♦ Let's look at the 1099-DIV and 1099-INT to see where these would be reported ♦ The amounts are usually quite small….often less than $300 There are actually two ways to deal with Foreign Income Taxes Paid on a Individual Tax Return ♦ As a Credit or as the Deduction on Schedule A  You want the taxpayer to take the better of the two which may vary depending on situation so you want to compare the two and do what results in the lowest tax (USUALLY THE CREDIT!!!) ♦ We'll talk about Credits next Taxes and Fees you Cannot Deduct (publication 17 page 149-150) There are a lot but I want to point out two in particular ♦ Social Security and Medicare Taxes ♦ Penalties and Fines ♦ Homeowner Association Fees Exercises page 20-5 (#2 and #3)

11. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Interest (Schedule A: Lines 10-15) Interest is the amount you pay for the use of borrowed money Certain types of interest are deductible as itemized deductions Types of Interest that are deductible (lines 10-15) Home Mortgage Interest Points (paid in the form of interest) ♦ Points are simply charges paid by a borrower and/or seller to secure a loan (maybe a certain rate on that loan) Certain Types of Investment Interest ♦ This is outside the scope of VITA and taxpayers with this should be referred to a professional tax preparer Home mortgage interest is normally reported on Form 1098 Form 1098 shows the amount of mortgage interest paid (may or may not be fully deductible) by the taxpayer to that lender during the year Lets look at a Form 1098 (Mortgage Interest Paid is in Box 1) Points paid in connection with the purchase of a home are also normally reported on Form 1098 (Box 2) Points paid with a refinance are often shown on the closing statement for the refinance Only taxpayers legally liable for the debt can deduct the mortgage interest in the year it was paid Taxpayers may have multiple mortgages and may have refinanced one or more times during the year They will get a 1098 for each mortgage and from each lender Make sure you ask and have all the Form 1098s and closing papers if needed

12. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Interest (continued) - (Home Mortgage Interest (continued)) For mortgage interest to be fully deductible it must fit into one of the categories on page 150 of Publication 17 (look in the third column under "Fully Deductible Interest" - let's read these out loud) Fully deductible mortgage interest - If all the taxpayers mortgage interest (from all mortgages) fits into one of these three categories during the year they can deduct all of their mortgage interest…so all mortgage interest that fits into one of these three categories is deductible in full (the different mortgages the taxpayer has can fall in different individual categories) 1. Mortgages taken out on or before October 13,1987 2. Mortgages taken out after October 13, 1987 to buy, build, or improve the taxpayer's home (called home acquisition debt) BUT only if ♦ throughout 2010 these mortgages plus any mortgages that fall into category 1 above total $1 million or less ($500,000 or less if married filing separate) 3. Mortgages taken out after October 13, 1987 that were for things OTHER than to buy build or improve the taxpayer's home (called home equity debt) BUT only if  These mortgages totaled $100,000 or less AND  totaled no more than the Fair Market Value of the taxpayer's home reduced by the mortgages in #1 and #2 above There is a flow chart that you can use on page 151 also Now look at the example on page 20-6 (let's read through it)

13. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Interest (continued) - (Home Mortgage Interest (continued)) The deductible mortgage interest reported on Form 1098 goes on line 10 of Schedule A If the mortgage interest is not reported on form 1098 it goes on line 11 ♦ You will need to input information about who the interest was paid to – this does not happen very often A taxpayer may be able to deduct interest paid on a main home AND a second home Make sure the interest meets all the requirements to be fully deductible that we just discussed A home doesn't have to be a traditional house ♦ Can be a house, apartment condo, mobile home, house trailer, or houseboat as long as the houseboat has sleeping, cooking and toilet facilities Special Mortgage Interest Situations See Publication 17, page 151-152 if you have some sort of interest you are unsure if it's deductible or even mortgage interest ♦ One that used to come up a lot for me was Mortgage Prepayment Penalty  Let's read that one If you're unsure of something look it up – DON'T GUESS!

14. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Interest (continued) What about points? Points describe certain charges paid or treated as paid by a borrower to obtain a mortgage (so they are essentially prepaid interest). ♦ A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. Points go by different names (you'll see them listed as such on closing statements) See list on page 20-6 ♦ Most common ones I see are: Loan Origination Fees and Prepaid Interest Only points paid as a form of interest (for the use of money) can be deducted on Sch A The general rule of the deductibility of points is: Since points are really prepaid interest the taxpayer cannot deduct the full amount in the year paid ♦ Instead, the taxpayer to deduct them ratably over the life of the loan However there are certain conditions that allow the taxpayer to deduct all of their points in the year paid Points paid on a loan to buy or build a taxpayers main home may be fully deductible in the year paid Open Publication 17 to page 152 and look at the tests the taxpayer must meet to deduct all the points in the year paid (taxpayer must meet ALL the tests listed) ♦ In particular look at rules #1 and #7 Use flow chart in Publication 17 – Page 154 to determine if the taxpayer meets all the tests and can deduct all the points in the year paid Points paid for specific services such as appraisal fees, preparation fees etc. are not interest and are not deductible In almost all cases, points paid for a refinance or any reason other than the above must be deducted over the live of the mortgage (usually 15-30 years) Points reported on form 1098 Box 2 Usually meet the tests to be deductible in the year paid ♦ These type of points go on line 12 of Schedule A

15. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Interest (continued) Qualified Mortgage Insurance Premiums Also called PMI – Private Mortgage Insurance Taxpayers can deduct PMI premiums paid or accrued during the tax year on line 13 of Sch A The qualifications for PMI to be deductible are on page 20-7 ♦ Let's read through them What type of interest is not deductible No Personal Interest can be deducted! See list on page 20-8 Exercise Page 20-8

16. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Gifts To Charity (lines 16-19 – Sch A) A charitable contribution is a donation or gift to a qualified organization (NOT an individual) Only taxpayers who itemize can deduct charitable contributions Taxpayers can deduct charitable contributions to qualifying organizations that meet one of the qualifications shown at the top of page 20-9 Let's read through them Right below qualifying organizations on Page 20-9 it shows deductible items in regard to charity Read through that list For cash donations the deduction is the amount of the contribution For non-cash donations such as furniture and clothing the deduction amount is generally the Fair Market Value (FMV) of the item on the date donated Form 1098-C contributions of Motor Vehicles, Boats and Airplanes is out of scope Organizations that are NOT qualified (bottom of page 20-9) Some that come up a lot – taxpayers think they can deduct and cannot ♦ Political Donations ♦ Social Clubs ♦ Business Organizations Items that are NOT deductible (top of page 20-10) Something you cot a personal benefit for ♦ Girl Scout Cookies! (You received a cookie so you can't deduct the value of the cookie, only the amount attributable to charity) ♦ The dinner part of a charity dinner ♦ Homeowners dues (comes up again!, only time these are deductible is for a RENTAL) Let's read through the others Look at page 158 of publication 17 – look the table at the top of the page for a good list of deductible and non deductible charitable contributions

17. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Gifts To Charity (lines 16-19 – Sch A - continued) What limits apply to Charitable Donations? If a taxpayer's charitable contributions are more than 20% of their AGI the deduction will be limited, the limited amount can be carried forward for a possible deduction in future years If you enter the contributions correctly in TaxWise it should apply this limitation for you ♦ Non Cash and Cash contributions should be entered separately to calculate this correctly Individuals affected by these limits should be referred to a professional tax preparer What records should be kept for cash donations? Taxpayers MUST keep records to prove the amount of cash and non-cash charitable donations they made If a taxpayer did not keep records they cannot deduct the charitable contribution regardless of amount They should keep one of the following types of records for EACH CASH donation: ♦ A bank record such as a canceled check or a bank statement showing the name, date, and amount of the check ♦ A written communication from the charity which must include: the charity's name, the date of the contribution, and the amount of the contribution What records must be kept for out of pocket charitable expenses? This is talking about unreimbursed expenses related to donated services The taxpayer must have: ♦ Adequate Records of the Expenses ♦ The organization's written acknowledgement of the volunteer services ♦ The value of someone's TIME can NOT be deducted ♦ Only expenses directly related to the donated services can be deducted

18. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Gifts To Charity (lines 16-19 – Sch A - continued) What records must be kept non-cash charitable contributions? There are different records required for non-cash donations that are ♦ less than $250 ♦ non-cash donations that are $250 or more but not more than $500 and ♦ non-cash donations of more than $500 Records must be kept for each donation Required records for non cash donations less that $250 (top of page 20-10) ♦ Receipt or written communication from the charity is required and must show the information listed on page 20-10 ♦ Deductions are not allowed for charitable contributions of clothing and household items if the items are not in good used condition or better Required records for non cash donations of at least $250 but not more than $500 ♦ Taxpayer needs all the records required for donations less than $250 AND ♦ The organizations written acknowledgement must state whether the taxpayer received any goods or services in return for the donation as well as a good faith estimate of the value of the donation Non-cash donations exceeding $500 must be referred to a professional tax preparer Other types of charitable contributions outside the scope of VITA Donations of capital gain property (such as stock) Do Exercise page 20-10

19. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Casualty and Theft Losses (Outside the scope of VITA) Miscellaneous Deductions (Lines 21-27) Miscellaneous Deductions are expenses a taxpayer pays in order to ♦ Produce or Collect Income (such as unreimbursed job expenses and job hunting expenses) ♦ Manage, conserve, or maintain property held for producing income (such as investment management fees) ♦ Determine, contest, pay or claim a refund for any tax Two Types of Miscellaneous Deductions Those subject to the 2% AGI limit Those not subject to the 2% limit Deductions Subject to 2% limit (let's read the list on page 20-11) Notice a lot of these are unreimbursed professional or job related expenses ♦ We'll talk more about unreimbursed business expenses in the next section ♦ There are some unreimbursed business expenses that can't be deducted directly on Schedule A without filling out a special form (Form 2106)

20. © Kristina Shroyer 2011 Lesson 20: Itemized Deductions Casualty and Theft Losses (Outside the scope of VITA) Miscellaneous Deductions (Lines 21-27) - CONTINUED Miscellaneous Deductions are expenses a taxpayer pays in order to ♦ Produce or Collect Income (such as unreimbursed job expenses and job hunting expenses) ♦ Manage, conserve, or maintain property held for producing income (such as investment management fees) ♦ Determine, contest, pay or claim a refund for any tax Deductions NOT subject to the 2% limit NOT very many! Gambling losses to the extent of winnings (NOT IN EXCESS OF WINNINGS!) ♦ Taxpayer MUST have a record of their losses ♦ NOTE: if you don't itemize and have gambling winnings you get NO DEDUCTION even to the extent of winnings Work related expenses for individuals with a disability that enable them to work Miscellaneous Expenses that are not deductible (see list on page 20-12) Let's take a look at the Miscellaneous Deductions section of the Schedule A to see where these deductions will be entered and how it will work Note a lot of these expenses refer you to special rules in publication 17 – make sure you read the special rules before giving the taxpayer the deduction In the interview I would just let the taxpayer know the expense may be deductible and you will have to check the specifics Once you have all the sections of the Schedule A completed add them together and transfer line 29 to Line 40 of Form 1040 (the income limitation mentioned should not apply to VITA clients)