Itemized Deductions: A Comprehensive Guide for Taxpayers
Chapter 7: Itemized Deductions
This chapter delves into the intricacies of itemized deductions, providing a comprehensive guide for taxpayers seeking to minimize their tax liability. We will explore various categories of deductions, including medical expenses, taxes, interest, charitable contributions, and miscellaneous itemized deductions. Each section will provide detailed explanations, examples, and true/false questions to test your understanding.
Medical Expenses
Deductible Medical Expenses
To be deductible, medical expenses must meet specific criteria:
- Amounts Paid: Expenses must be incurred for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for a condition affecting the body’s structure or function. These expenses must be paid for the taxpayer, their spouse, or dependents.
- Dependency Status: The taxpayer’s spouse or dependent must have existed either at the time the medical services were rendered or at the time the expenses were paid. The gross income test and joint return test are waived for determining dependency status.
- Payment Timing: Medical expenses must be paid in the year the expense is claimed.
Deductions for Medicines and Drugs
Deductions for medicines and drugs are limited to expenditures for prescription drugs.
Capital Expenditures
Capital expenditures are deductible in part or in full, depending on their impact on the market value of the taxpayer’s home:
- No Market Value Impact: Expenditures that do not affect the market value of the taxpayer’s home are fully deductible (e.g., wheelchairs, crutches, eyeglasses).
- Market Value Impact: Expenditures that affect the market value of the taxpayer’s home (improvements or betterments) are deductible to the extent they exceed the increase in fair market value (e.g., swimming pool).
- Structural Barrier Removal: Expenditures for removing structural barriers for the handicapped are fully deductible (e.g., elevators, exit ramps, widening doorways).
- Maintenance Costs: Maintenance costs of the above capital expenditures are also deductible, as long as the medical reason for the capital expenditure continues to exist.
Note: These expenditures must have been incurred for necessary medical care of the taxpayer, their spouse, or dependents.
Travel Costs
Travel costs to seek medical treatment are deductible:
- Automobiles: Keep records of actual expenses or use the per diem rate of 23.5 cents per mile plus parking and tolls.
- Meals:
- Meals while en route to and from treatment are 50% deductible.
- 100% of meals while at the medical facility are deductible if the taxpayer is an inpatient.
- No deduction is allowed for meals at the medical facility for outpatients or those accompanying the patient.
- Lodging: Limited to $50 per night per person if:
- Travel is essential to medical care.
- Care is provided in a licensed hospital.
- There is no significant element of personal pleasure.
Institutional Costs
Costs of staying at an institution (tuition) are deductible if the patient is placed there on a doctor’s orders.
Health Insurance Premiums
- Employees: 100% deductible from adjusted gross income (AGI).
- Self-Employed: 100% deductible for AGI.
Long-Term Care
- Insurance Premiums: Deductible with limits (see footnote 8, page 7-5).
- Long-Term Care Expenditures: Deductible if”chronically il” for at least 90 days.
Deductibility Timing
- Year of Payment: Medical expenses are deductible only in the year they are actually paid (credit card payment is considered”pai”).
- Prepayments: Prepayments are not allowed as deductions unless the taxpayer is required to make the prepayment.
Deductible Amount
x = reduction in deduction
example— in 2014,diana day2n pays $2,000 interest on a qualified educ8on loan. diana & her husband file a joint return & report modified agi of $130,000. ? amount is deductible 4 agi?
classific8on of interest expense –
classific8on is determined by d use of d loan proceeds,nt d coll8ral used 2 obtain d loan.
general exception – home equity loans.
other exceptions –
1. funds held in bank accounts – d interest on d account is investment interest til d funds R drawn & used.
example— ruth borrows $100,000 on january 1 & deposits it in a separ8 account where it remains til april 1 wen she purchases an interest in a limited partnership 4 $20,000. on september 1,ruth purchases a new car 4 $30,000. interest expense attributable 2 d $100,000 is alloc8d in d following manner:
2. commingled funds – wen borrowed funds R deposited in d same account with personal funds,d 1st funds spent R deemed 2 b d borrowed funds.
example— on oc2ber 1,ben borrowed $1,000 2 purchase a snowplow attachment 4 d front of his truck. he plans 2 make some extra m1y dis winter by plowing driveways & parking lots. ben deposited d $1,000 in his only checking account. on oc2ber 20,he bought d attachment 4 $1,500. prior 2 oc2ber 20,he wrote $700 in checks 4 groceries & other personal items. on ? loan amount may ben deduct interest?
tru/false
_____ 1. in 2014,t is audited by d irs as 2 a prior year’s income tax return. as a result of d audit,t pays a tax deficiency plus interest. n1 of d interest can qualify as a federal income tax deduction.
_____ 2. some investment expenses fall in2 d c8gory of other miscellaneous deductions & R subject 2 d 2% of agi floor.
_____ 3. investment interest which is disallowed in 1 tax year may b carried 4ward & tre8d as investment interest in succeeding years.
_____ 4. d interest on home equity loans can b deducted only if d loan funds R used 2 make home improvements.
iv. charitable contributions –
a. deduction requirements:
1. d contribution must b a gift of m1y or other property given 2 a qualified d1e.
2. qualifying d1es R organiz8ons,nt individuals.
b. if an individual directly or indirectly receives a benefit frm d charitable organiz8on,d gift is nt deductible.
c. if taxpayer purchases products or services @ a premium,only d excess over fmv of d purchase price is deductible as a charitable contribution.
d. only 80% of amounts paid 2 university athletic clubs R deductible.
e. there R 2 types of charities:
1. public charities – supported by don8ons.
2. priv8 found8ons – more than 1/3 of their support comes frm priv8 sources;membership fees,dues,etc.
a. priv8 oper8ng found8ons
b. priv8 non-oper8ng found8ons
f. limit8ons on charitable contribution deductions:
1. limit8ons depend on:
a. d nature of d charitable organiz8on.
b. d nature of d property given.
2. there R 3 limit8ons (c chart on d next page):
a. limit8on 1 – d limit8on within each individual cell.
b. limit8on 2 – d % limit8on given under d heading of each column.
c. limit8on 3 – an overall limit8on of 50% of agi 2tal deduction 4 d year.
charitable contribution deduction | ||||||
nature of property | public charities & priv8 oper8ng found8ons | priv8 non-oper8ng found8ons | ||||
50% | 30% | 20% | ||||
1.cash | fully deductible | fully deductible | n/a | |||
2.ordinary income property | basis | basis | n/a | |||
(inven2ry,stcg,loss property) | ||||||
exception: if basis > fmv | fmv | fmv | n/a | |||
3.capital gain property | taxpayer’s option: | n/a | basis | |||
1.basis (limited 2 50% of agi) | ||||||
2.fmv (limited 2 30% of agi) | ||||||
if tangible personalty is given | basis | n/a | basis | |||
& put 2 unrel8d use | ||||||
4.contribution of services | nt deductible ——————————————————————————————————–> | |||||
5.expenses rel8d 2 services | actual expenses deductible | |||||
transport8on limited 2 14 cents/mile | ||||||
6.free or bargain use property | nt deductible ——————————————————————————————————–> |
example–
a. U gave gamma co.s2ck worth $10,000 2 charity dat cost U $4,000 4 months ago. ? is yur charitable contribution deduction?(apply limit8on #1 only).
b. U give alpha co.s2ck 2 yur college. it cost U $5,000 several years ago & is worth $10,000 on d d8 of d gift. ? is yur 2013 deduction?(apply limit8on #1 only).
c. let’s say dat yur agi is $70,000 & dat during d year U made d following gifts: (1) $5,000 in cash 2 yur church,(2) securities 2 yur college dat cost U $5,000 many years ago but were worth $45,000 on d d8 of d gift,& (3) $10,000 in cash 2 a priv8 non-oper8ng found8on. how much can U deduct in 2013? (apply ol limit8ons).
tru/false
_____ 1. t purchases a banquet ticket @ a fund raising function 4 d omaha museum of natural his2ry. d ticket costs $250 & d normal cost of such a banquet is $50. t hs a charitable contribution deduction of $50.
_____ 2. 4 ol of 2014,t allows d salv8on army 2 use a building he owns rent-free. if d building normally rents 4 $18,000 a year,t will b allowed a charitable contribution deduction 4 2014 of $18,000.
_____ 3. a taxpayer pays tuition 2 a parochial school run by his church in order 2 enable his children 2 attend. since d church is a qualified charity,d tuition payments can b claimed as a charitable contribution.
_____ 4. t mails a check 4 $600 2 his church on 12/31/14. d check is nt received by his church til 1/2/15. d $600 qualifies as a charitable contribution by t 4 2014.
_____ 5. in order 2 dissuade his pas2r frm resigning & taking a position with a larger church,t,an ardent leader of d congreg8on,gives d pas2r a new car. d cost of d car is deductible by t as a charitable contribution.
_____ 6. contributions 2 public charities in excess of 50% of agi may b carried 4ward 5 years.
_____ 7. in applying d percentage limit8ons,carryovers must b claimed 1st be4 current charitable contributions R considered.
_____ 8. t don8s art 2 a qualified museum. in order 2 ascertain & 2 support d value of d assets don8d,t pays $1,200 2 an independent appraiser. d $1,200 is nt deductible as a charitable contribution but can b claimed by t as a miscellaneous itemized deduction & is subject 2 d 2% of agi limit8on.
v. miscellaneous itemized deductions –
a. those only deductible in excess of 2% of agi:
- expenses rel8d 2 §212 activities (except 4 rents/royalties).
- unreimbursed employee business expenses (e.g.,professional dues,subscriptions,specialized work clothing,union dues).
- costs of tax advice (including tax prep.fees.,appraisals 4 charitable contributions,legal fees incurred in est8 planning)
- job hunting expenses (if same trade or business–nt allowed 4 1st job)
- hobby expenses (tier 2 & tier 3 expenses)
- deductible home office expenses (basic cost of 1 teleph1 nt deductible)
- deductible educ8onal expenses
b. those fully deductible:
- gambling losses (nt in excess of gambling winnings).
vi. overall limit8on (phase-out) 4 id’s
agi thresholds: $305,050 (mfj)
$279,650 (hh)
$254,200 (s)
$152,525 (mfs)
reduction: lesser of:
1.3% of excess agi (above threshold);or,
2.80% of ids (nt counting medical expenses,investment interest,casualty losses,& gambling losses)
reduction applied after taking in2 account d other limit8ons on id’s (e.g.,2% of agi limit8on).
practice questions:
_____ 1. in 2014,r (a single tp) purchases 4 pleasure a boat 4 $110,000. in order 2 obtain financing 4 d purchase,r issues a lien on his personal residence in d amount of $110,000. @ d time d loan is obtained,d residence hs a fmv of $500,000 & is encumbered with a 1st mortgage of $420,000. 4 d boat loan,r may claim as qualified residence interest d interest on:
a. $0.
b. $80,000.
c. $100,000.
d. $110,000.
e. n1 of d above.
_____ 2. m suffers frm a rare b1 disorder & decides 2 seek treatment @ a special clinic. m’s granddaughter,k,takes m 2 d clinic coz m is unable 2 travel al1. it takes dem 3 days 2 drive d 900 miles 2 d clinic & 3 days 2 return home. @ d clinic,m is tre8d on an outp8ent basis 4 6 days. m & k share a motel room during d entire trip & incur d following expenses:
motel en route 2 & frm clinic:
$75 per night 4 6 nights
motel while @ d clinic:
$80 per night 4 6 nights
meals en route 2 & frm d clinic:
m $90
k $105
meals while @ d clinic:
m $110
k $125
m may deduct d following expenses (be4 agi limit8ons):
a. $1,522.
b. $1,397.
c. $1,287.
d. $1,248.
e. n1 of d above.
_____ 3. during 2014,j,who is a security officer,is shot while on d job. as a result,j suffers frm a leg injury & must spend most of his time in a wheelchair. j’s physician prescribes dat he install a whirlpool bath in his home 4 therapy. during d year,j makes d following expenditures:
wheelchair $700
whirlpool bath $1,800
maintenance of whirlpool $280
handicap entrance ramp $3,800
a professional appraiser tells j dat d whirlpool hs increased d value of his home by $800 & d ramp increased d value of d home by $280. j’s deductible expenses,be4 agi limit8ons,4 2014 will b
a. $6,580.
b. $5,780.
c. $5,500.
d. $5,700.
e. n1 of d above.
_____ 4. during 2013,d,a single taxpayer who is age 40,reports d following items of income & expense:
agi $40,000
qualified medical expenses 4,000
other i.d.’s 3,500
in 2014,d receives a reimbursement 4 medical expenses of $1,200. as a result,d must
a. include $800 in gross income in 2014.
b. include $800 in gross income in 2013.
c. include $3,000 in gross income in 2014.
d. include $3,000 in gross income in 2013.
e. n1 of d above.
_____ 5. g hs agi of $40,000. g incurs d following expenses in g’s hardware business:
-$300 sales tax.
-$300 vehicle registr8on.
-$20 vehicle inspection report.
-$200 unemployment taxes 4 employees.
-$100 st8 income taxes.
how much will g b able 2 deduct as business expenses under §162?
a. $920.
b. $820.
c. $620.
d. $0.
e. n1 of d above.
_____ 6. on september 1,2013,a,a cash basis taxpayer,sells his farm 2 b,also a cash basis taxpayer 4 $100,000. a’s basis in d farm is $65,000. d real property tax year is d calendar year. real est8 taxes on d property 4 d year R $1,800 & R payable on april 1 of d following year. d sales agreement does nt provide 4 apportionment of real est8 taxes btwn d buyer & d seller. assume b pays ol of d real est8 taxes in 2014. d effects of dis sales structure will b
a. $602 of taxes 2 a,$1,198 of taxes 2 b,increase a’s gain by $602.
b. $1,198 of taxes 2 a,$602 of taxes 2 b,increase a’s gain by $1,198.
c. $0 of taxes 2 a,$1,800 of taxes 2 b,no effect on a’s gain.
d. $1,198 of taxes 2 a,$0 of taxes 2 b,increase a’s gain by $1,198.
e. $1,198 of taxes 2 a,$602 of taxes 2 b,increase a’s gain by $602.
_____ 7. sam’s records 4 2014 contain d following in4m8on:
don8d s2ck having fmv of $1,000 2 a qualified charitable organiz8on. he acquired d s2ck 5 months ago 4 $800.
paid $3,000 2 a church school as a requirement 4 d enrollment of his daughter.
paid $200 4 annual homeowner’s associ8on dues.
drove 300 miles in his personal au2. d travel was directly rel8d 2 services he per4med 4 his church (actual costs unavailable).
? is sam’s charitable contribution deduction 4 2014 if his agi is $25,000?
a. $842.
b. $1,032.
c. $4,032.
d. $4,072.
e. n1 of d above.
_____ 8. t incurred d following expenses 4 her dependent son during d year:
payment of son’s au2 loan $8,000
interest on above loan 1,000
payment of son’s medical expenses 2,000
payment of son’s property taxes 1,200
how much may t consider in computing her i.d.’s?
a. $0.
b. $2,000.
c. $2,200.
d. $3,000.
e. n1 of d above.