1. VITA: 01/17/09 Lesson 17: Adjustments to Income Winter 2008 Kristina Shroyer

2. Lesson 17: Adjustments to Income We've now gone over all the lines in the Income section of the Form 1040 except for Line 12 (Rental Income) We'll do that one at the end of today The total of all the income you reported in the Income Section of Form 1040 goes on Line 22 Below the Income Section is the Adjustments to Income Section Anything Reported one of the lines in the Adjustments to Income Section is subtracted from the Total Income on Line 22 All of the Adjustments to Income are totaled and Subtracted from Total Income to arrive at AGI (Adjusted Gross Income) AGI is an important number on the tax return because it is used to determine phase outs for some deductions on the return You will determine if the taxpayer can claim the various adjustments to income during their interview and based on the Interview Intake Form

3. Lesson 17: Adjustments to Income There are a lot of items in the Adjustments to Gross Income section of the 1040, many which are outside the scope of VITA What is in the scope of VITA for this topic? ½ of Self Employment Tax Penalty on Early Withdrawal of Savings Alimony Paid IRA Deduction Student Loan Interest Deduction Jury Duty Pay Turned Over to Taxpayer's Employer Any other adjustments to income the taxpayer may have are outside the scope of VITA Tab E in the Volunteer Resource Guide contains some charts/forms we will use for completing the Adjustments to Income Section

4. Lesson 17: Adjustments to Income ½ Self Employment Tax Adjustment This adjustment will only come into play for taxpayers who fill out Sch C (Sch C-EZ only for VITA) and as a result have to fill out Sch SE and pay self employment tax Half of this self employment tax can be subtracted as an adjustment to income Report ½ of the self-employment tax from line 6 of Schedule SE on Form 1040, line 27 TaxWise automatically does this for you for self employed taxpayers

5. Lesson 17: Adjustments to Income Penalties for Early Withdrawal Adjustment This adjustments lets a user subtract from income penalties they paid for withdrawing funds early from an deferred interest account ♦ Most common example – a CD, early withdrawal ♦ Form 1099-INT reports the penalty on line 2 The penalty amount is reported on line 30 of Form 1040

6. Lesson 17: Adjustments to Income Alimony Paid Adjustment Alimony Paid to an ex-spouse is subtracted from Income as an Adjustment provided it meets all of the requirements to be considered alimony The requirements for a payment to be considered Alimony are described in Tab E of the Volunteer Resource Guide Some points: ♦ The payments to the ex-spouse must be specified in the divorce or separation agreement and must be required. ♦ Child support is NOT considered alimony ♦ The spouses cannot file a joint return ♦ See Tab for more Information Needed for this Adjustment Ask the taxpayer to give you the exact amount and make sure it is required under a divorce or separation agreement Ask the taxpayer for the social security number of the recipient of the alimony (this is REQUIRED) How to Report this Adjustment Enter the Alimony Paid on line 31a Enter the Recipient's Social Security Number on line 31b Exercise page 17-4

7. Lesson 17: Adjustments to Income IRA Contribution Adjustment This adjustment is for traditional IRAs only traditional IRA When you ask the taxpayer if they contributed to an IRA make sure it is a traditional IRA they contributed to ♦ Only contributions to traditional IRAs (NOT Roths or SIMPLES) can be potentially subtracted from Income as an Adjustment What is a traditional IRA (Individual Retirement Account)? Features of a Traditional IRA Taxpayers may be able to deduct some or all of their traditional IRA contributions as an adjustment to income Contributions may be able for a credit called the Retirement Savings Credit Generally amounts in an IRA, including earnings and gains are not taxed until they are distributed

8. Lesson 17: Adjustments to Income IRA Contribution Adjustment (continued) Who can make an traditional IRA contribution for 2008? (Eligibility – Taxpayer must meet ALL of these requirements) 1. Taxpayer must by less than age 70 ½ years at the end of the tax year ♦ For 2008 this means the taxpayer must be born on or after July 1, 1938 2. Taxpayer must have taxable compensation ♦ Wages, self employment income, alimony, commissions, taxable scholarships or fellowships  No unearned income 3. Contributions must be made by the due date of the tax return NOT including extensions ♦ You can file the return before the taxpayer makes the IRA contribution and take the adjustment (if the contribution is qualified) as long as the taxpayer makes the contribution by the due date of the return  This means for some of the people filing a return they might want to make a traditional IRA contribution and you can figure out if they can, how much, and if its deductible  If the taxpayer forgets to make the contribution by the deadline the return must be amended Example Page 17-5

9. Lesson 17: Adjustments to Income IRA Contribution Adjustment (continued) How much can a taxpayer contribute to a IRA? The total contribution (to ALL TYPES of IRAs including ROTH IRAs) cannot be more than the smaller of: $5,000 ($6,000 for a person age 50 or older at the end of the tax year) The individuals taxable compensation What do they mean by compensation? Generally it is the amount of income the taxpayer has earned from working but can include other forms of income So no unearned income can count as compensation Alimony is considered earned income/compensation

10. Lesson 17: Adjustments to Income IRA Contribution Adjustment (continued) Spousal IRA Contribution A spouse with no compensation may be able to make a spousal IRA contribution to their traditional IRA In order to make a spousal IRA Contribution a Joint Return must be filed So they can't be MFS ($ How much can be contributed to a spousal IRA? The lesser of: $5,000 ($6,000 if the individual is 50 or older) The total compensation includible in gross income for BOTH spouses during the year This must be reduced by: 1. Traditional IRA contributions for the spouse with the greater compensarion 2. Contributions to Roth IRAs for the spouse with the greater compensation Look at Exercises on 17-6

11. Lesson 17: Adjustments to Income HERO ACT – Special Rules for Military Personnel Allows members of the armed forces to qualify for additional retirement benefits Taxpayers can count tax free combat pay when determining whether or not they can contribute to IRAs (both traditional and Roth) Armed Forces members serving in Iraq, Afghanistan or other combat zones can contribute to IRAs (both traditional and Roth) even if they tax free combat pay Military personnel who received tax free combat pay in 2004 or 2005 can amend their tax return for these years to make IRA contributions (Form 1040X) When can IRA contributions be deducted? So we started talking about all of these due to the adjustment allowed on the tax return for traditional IRA contributions ♦ Make sure your taxpayer is talking only about traditional IRA contributions when you are figuring out this adjustment to income Just because a taxpayer is eligible to make a traditional IRA contribution and does make one, does NOT mean that IRA contribution is deductible IRA contributions may be fully deductible, partially deductible or non-deductible ♦ Any portion of an IRA contribution that is non-deductible must be reported on an Form 8606 (this is very important) ♦ Form 8606 is beyond the scope of VITA – any taxpayer needing to fill out this form should be referred to a professional tax preparer

12. Lesson 17: Adjustments to Income How to determine if an IRA contribution is deductible (determining the deduction amount) If neither the taxpayer or the taxpayer's spouse are covered by a retirement plan at work any traditional IRA contributions are fully deductible regardless of income Ask the taxpayer first if they or their spouse are covered at work, if the answer is NO, the IRA contribution is fully deductible and you're done with this part The factors that can affect the deductibility of a traditional IRA contribution are listed at the bottom of page 17-7 (the requirements are a bit complicated so we'll use a worksheet to figure it out ) 1. If either the taxpayer or spouse is covered by a retirement plan at work 2. The taxpayer's Modified Adjusted Gross Income before taking the IRA deduction There are some charts in Tab E of the Volunteer resource guide and a worksheet we will use to determine if a taxpayer's IRA contributions are fully deductible Looking at the charts shows you there are several factors in determining the amount of a taxpayer's deductible traditional IRA contribution

13. Lesson 17: Adjustments to Income How to determine if an IRA contribution is deductible (determining the deduction amount) If a taxpayer has already made a traditional IRA contribution for the year and it is not fully deductible it is outside the scope of VITA because the non-deductible part of the contribution must be reported on Form 8606 In the situation where a traditional IRA contribution has already been made the first step is to figure out whether or not it is fully deductible and in the scope of VITA However remember we also said that an IRA contribution doesn't have to be made until the due date of the tax return (not including extensions) In this case you can figure out what DEDUCTIBLE traditional IRA contribution the taxpayer can make by 04/15/09 ♦ As long as the taxpayer only wants to make deductible traditional IRA contributions this in within the scope of VITA

14. Lesson 17: Adjustments to Income Using the IRA Deduction Worksheet Use this worksheet to determine what amount of traditional IRA contribution a taxpayer can make for 2008 The worksheet is: On Page 238-239 in Appendix C of your Publication 4491-W ♦ This is the best one to use and is the one I'm using It is also in the Form 1040 Instructions Let's read through the worksheet step by step for a possibly limited deduction Line 1 Answer is found on taxpayer's W-2, box 13 will be checked If the answer is NO for the taxpayer or spouse the traditional IRA contribution deduction may be limited and go on to step 2 Line 2 If you look at Tab E again in your Volunteer Resource Guide (E-2) remember the deduction limitations for IRA contributions are based on filing status – line 2 is determining the correct amount for each filing status to use in determining deductibility of a traditional IRA contribution ♦ Note that the number in Step 2 may be different for each spouse in the case of MFJ depending on who is covered by a retirement plan Lines 3-5: these steps compute MAGI…follow the directions carefully You don't need to understand MAGI, just how to find the information the worksheet asks for Line 6: This step determines if the taxpayer's MAGI is low enough they can take the full deduction, if the taxpayer's MAGI is too high for any deduction or if a limited deduction must be completed ♦ If line 6 is NO the taxpayer's MAGI is greater than income limits and they have no deduction…explain why and refer them to a professional tax preparer ♦ If line 6 is YES, read the directions very carefully to figure out what to put on line 7 or if you should go to line 7 and make a calculation Line 7 This line represents the maximum allowable deduction for the taxpayer (7a for the taxpayer and 7b for the spouse – the amounts may be different for taxpayer and spouse) Line 8-10 Determine the amount of compensation for the taxpayer and spouse (if applicable) Line 11 Enter the total contributions MADE or that WILL BE MADE by 04/15/09 Line 12 – Deductible IRA contribution (this will go in the adjustments section of the 1040) If the taxpayer makes a contribution greater than this (and is eligible to do so) they will have to fill out a Form 8606 and be referred to a professional tax preparer

15. Lesson 17: Adjustments to Income Using the IRA Deduction Worksheet (continued) Use this worksheet to determine what amount of traditional IRA contribution a taxpayer can make for 2008 The worksheet is: On Page 238-239 in Appendix C of your Publication 4491-W ♦ This is the best one to use and is the one I'm using It is also in the Form 1040 Instructions Let's read through the worksheet step by step for a unlimited deduction Line 1 Answer is found on taxpayer's W-2, box 13 will be checked If the answer is YES for the taxpayer is eligible to deduct their maximum contribution they are entitled to make (go to line 7) Line 7 This line represents the maximum allowable deduction for the taxpayer (7a for the taxpayer and 7b for the spouse – the amounts may be different for taxpayer and spouse) In this case it's $5,000 if the taxpayer is under 50 at the end of the year and $6,000 otherwise Line 8-10 Determine the amount of compensation for the taxpayer and spouse (if applicable) Line 11 Enter the total contributions MADE or that WILL BE MADE by 04/15/09 Line 12 – Deductible IRA contribution (this will go in the adjustments section of the 1040) This will just be the amount up to the maximum on line 7 the taxpayer or spouse chose to contribute to their traditional IRA

16. Lesson 17: Adjustments to Income How to Report the IRA contribution deduction If the taxpayer decides to make a traditional IRA deduction and the amount they contribute (or have contributed) is all deductible it is in the VITA scope Report the Amount on line 32 of Form 1040 What if the taxpayer makes excess IRA contributions? If the taxpayer contributes more than the maximum allowed (this is the maximum allowed not the maximum deductible) they have made and excess IRA contribution See definition of an excess IRA contribution on page 17-9 Sometimes the taxpayer may not realize they've made an excess contribution until the tax return is filed ♦ In this situation the taxpayer MUST withdrawal the excess contribution by the due date of the return (including extensions)  If the excess is not withdrawn by this date a penalty will be assessed on the excess amount (this will be discussed in a later lesson)

17. Lesson 17: Adjustments to Income Student Loan Interest Adjustment The taxpayer may be able to subtract the interest they paid on their student loan from Income as an Adjustment The student loan interest deduction: Is generally the small of $2,500 or the interest paid for the year May be reduced or eliminated based on a taxpayer's MAGI (we'll have another worksheet to figure this out) ♦ See Tab E, page E-3 of the Volunteer Student Resource Guide ♦ See Examples and look at chart What type of interest qualifies? The interest must be paid during the year on a loan for qualified higher education expenses The loan must meet ALL three conditions shown on page 17-10 ♦ The loan was for the taxpayer, the taxpayer's spouse or a person who was the taxpayer's dependent at the time the loan was obtained ♦ The loan was paid within a reasonable time after obtaining it ♦ The loan was for an eligible student Exercise page 17-10

18. Lesson 17: Adjustments to Income Student Loan Interest Adjustment (continued) Who Can take the deduction? See page 17-10 The taxpayer can take the student loan interest deduction ONLY if all the conditions listed are met (let's read through them) Let's look in particular at these two points (points 3 and 4): ♦ To be eligible for the deduction, the taxpayer must 1. have a primary obligation to repay the debt AND 2. actually make interest payments during the year Loan Made By Loan Repaid By Is it Deductible? Parent Yes StudentNo Student ParentNo StudentYes

19. Lesson 17: Adjustments to Income Student Loan Interest Adjustment (continued) Who Can take the deduction? (continued) Point 5: The loan must be for qualified higher education expenses What are qualified higher education expenses? ♦ tuition and fees, room and board, books, supplies and equipment and other necessary expenses such as transportation to school The education must be obtained at an eligible education institution ♦ See Page 17-11 Point 7: The expenses paid must be incurred by an eligible student What is an eligible student? ♦ Someone enrolled at least half time in a program leading to a degree, certificate or other educational credential Where to get the information on student loan interest paid? Form 1089-E (let's look at one)

20. Lesson 17: Adjustments to Income Student Loan Interest Adjustment (continued) How to Compute the Deduction? Use the worksheet – this is in your 1040 Instruction booklet (page 33) We will be using TaxWise software which will automatically link up to this worksheet and the other ones you need. Let's look at the worksheet on the screen. Lines 2-4 are computing MAGI to compute the possible reduction of the deduction…just follow the directions The deduction is the final result on line 9 Where to report it? Form 1040 line 33

21. Lesson 17: Adjustments to Income Jury Duty Adjustment You learned last week that jury duty pay should be included on form 1040 line 21 (Other Income) Some employees still receive regular wages while on jury duty ♦ Sometimes employees must turn their jury duty pay over to their employers  A taxpayer required to do this may deduct the amount they turned into their employer as an adjustment to income This adjustment is reported on line 36 of Form 1040 (DIFFERENT THAN BOOK – there has been a change see page 26 of the supplement, you write this deduction in) Other Adjustments In general these are beyond the scope of VITA – refer to a professional taxpayer There are a couple more adjustments in the supplement we will go over

22. Lesson 17: Adjustments to Income Adjusted Gross Income We are determining all of these adjustments to be able to compute the Adjusted Gross Income (AGI) on the taxpayer's return ♦ AGI is very important in other calculations and that's why this deductions leading to AGI are in a separate section of the return from other deductions we will compute later How to compute AGI (let's look at form 1040 on the screen and page17-13) ♦ Let's read through each of the three steps TaxWise will compute AGI for you based on your entries regarding adjustments to income