Tax Deductions and Credits: A Comprehensive Guide
Chapter 6: Itemized Deductions
Medical Expense Deduction
The medical expense deduction is limited to the amount of unreimbursed and qualified medical expenses that exceed 7.5% of the taxpayer’s adjusted gross income (AGI).
State and Local Taxes (SALT)
The total itemized deduction for state and local taxes, including property taxes and income taxes, is limited to $10,000 ($5,000 for married filing separately). The deduction for foreign income taxes is not subject to this cap.
Charitable Contributions
When claiming deductions for charitable contributions, always choose the lower of the contribution amount or the applicable AGI limitation. For example, if you donate $10,600 to a church and your AGI is $30,000, the AGI limitation is 30%, which means you can only deduct $9,000 for the church donation.
Casualty and Theft Losses
Casualty and theft losses are reduced by a $100 floor per event and further reduced by 10% of the taxpayer’s AGI.
Chapter 7: Capital Gains and Losses
Net Capital Gains and Losses
Net capital gains or losses are calculated by offsetting capital gains and losses within the same holding period (short-term or long-term). Short-term capital gains are taxed at ordinary income tax rates, while long-term capital gains are subject to preferential tax rates (0%, 15%, or 20% depending on the taxpayer’s income).
Capital Loss Limitations
If capital losses exceed capital gains, the excess can be deducted against ordinary income up to $3,000 per year. Any remaining capital losses can be carried forward to future years.
Wash Sales
Wash sales occur when a taxpayer sells a security at a loss and then repurchases the same or a substantially identical security within 30 days before or after the sale. Losses from wash sales are not deductible in the current year but are added to the basis of the repurchased security.
Chapter 8: Other Taxes and Credits
Qualified Business Income Deduction (QBID)
The QBID allows eligible taxpayers to deduct up to 20% of their qualified business income from a sole proprietorship, partnership, or S corporation. The deduction is subject to limitations based on W-2 wages paid by the business and the taxpayer’s taxable income.
Self-Employment Taxes
Self-employed individuals are responsible for paying both the employee and employer portions of Social Security and Medicare taxes (12.4% for Social Security and 2.9% for Medicare). The Social Security tax has a wage base limit, while the Medicare tax does not.
Child and Dependent Care Credit
The child and dependent care credit provides a tax credit for expenses paid for the care of qualifying individuals to enable the taxpayer to work or look for work. The amount of the credit is based on the taxpayer’s earned income and the amount of eligible care expenses.
American Opportunity Tax Credit (AOTC)
The AOTC provides a tax credit for qualified education expenses paid for the first four years of post-secondary education. The maximum credit is $2,500 per eligible student.
Earned Income Credit (EIC)
The EIC is a refundable tax credit for low- to moderate-income working individuals and families. The amount of the credit varies depending on the taxpayer’s income and family size.
Estimated Taxes
Taxpayers who expect to owe more than $1,000 in taxes are generally required to make estimated tax payments throughout the year. Failure to make sufficient estimated tax payments can result in underpayment penalties.
Additional Notes
- The correct order of loss limitation rules is: (1) tax basis, (2) at-risk amount, (3) passive loss, and (4) excess business loss limitations.
- Rental activities are generally considered passive activities, unless the taxpayer is a professional real estate agent.
- Passive losses that exceed passive income are deferred until the taxpayer generates passive income to offset these losses.
- The Kiddie tax rule is designed to prevent high-income taxpayers from shifting unearned income to their children to reduce their tax liability.
- The 3.8% net investment income tax applies to certain investment income of high-income taxpayers.
- Independent contractors are not eligible for nontaxable fringe benefits, unlike employees.
- Business tax credits are generally carried back one year and carried forward 20 years.
- The lifetime learning credit applies to the taxpayer and not to the taxpayer’s dependents.