Chapter 10   Deductions and Losses:   Certain Itemized Deductions   Individual Income Taxes© 2013 Cengage Learning. All Ri...
The Big Picture (slide 1 of 3)• John and Susan Williamson have been  renting an apartment since they were  married.  – The...
The Big Picture (slide 2 of 3)• After months of house hunting, they have found the perfect  home, but they fear it may be ...
The Big Picture (slide 3 of 3)• Alternatively, if they use investments to secure  financing, they could qualify for a lowe...
Itemized Deductions                       (slide 1 of 2)• Personal expenditures that are deductible from  AGI as itemized ...
Itemized Deductions                    (slide 2 of 2)• Itemized deductions provide a tax benefit only  to extent that, in ...
The Big Picture - Example 1      Allowable Itemized Deductions• Return to the facts of The Big Picture on p. 10-1.• With t...
Medical Expenses                    (slide 1 of 6)• Medical expenses are deductible to the extent  unreimbursed medical ex...
Medical Expenses                      (slide 2 of 6)• Example of medical expense deduction  limitation:  – Amy has AGI of ...
Medical Expenses                      (slide 3 of 6)• Example of medical expense deduction  limitation:  – Bob has AGI of ...
Medical Expenses                      (slide 4 of 6)• Expenditures for:  – The diagnosis, cure, mitigation, treatment,    ...
Medical Expenses                        (slide 5 of 6)• Does not include the cost of items such as :  – Unnecessary cosmet...
Medical Expenses                     (slide 6 of 6)• Medical expenditures are deductible in year  paid  – Includes payment...
The Big Picture - Example 2                 Medical Expenses• Return to the facts of The Big Picture on p. 10-1.• The Will...
Nursing Home Expenditures• If primary reason for being in nursing home is  medical, costs (including meals and lodging)  q...
Special School Expenditures• Medical expense deduction may include the  expenses of a special school for a mentally or  ph...
Capital Medical Expenditures• May include a pool, air conditioners if they do not  become permanent improvements, dust eli...
Capital Improvement to Home• Deductible medical expense only to extent cost  exceeds increase in value of home  – Appraisa...
Medical Care for Spouse           and Dependents• Taxpayer may deduct cost of medical care for  spouse and dependents  – D...
Medical Transportation               and Lodging• Transportation costs to and from medical care are  deductible   – Mileag...
The Big Picture - Example 9                          Medical Expenses•   Return to the facts of The Big Picture on p. 10-1...
Medical Insurance Premiums                        (slide 1 of 2)• Premiums paid for medical care insurance are  deductible...
Medical Insurance Premiums                           (slide 2 of 2)• For self-employed, 100% of insurance premiums are  de...
Reimbursement by               Medical Insurance• If reimbursed in same year as expense paid:   – Reimbursement offsets me...
Example of Medical Reimbursements                      (slide 1 of 2)• In 2012, taxpayer paid medical expenses =  $1,200; ...
Example of Medical Reimbursements                       (slide 2 of 2)• In 2012, taxpayer paid medical expenses of  $1,200...
Health Savings Accounts• Used in conjunction with a high deductible medical  insurance policy   – Employee contributions t...
Taxes                         (slide 1 of 4)• State, local, and foreign income and real  property taxes are deductible in ...
Taxes                      (slide 2 of 4)• Other taxes such as FICA, excise, etc., are not  deductible  – May be deductibl...
Taxes                      (slide 3 of 4)• Real estate taxes for year property is sold must  be apportioned between the bu...
Taxes                               (slide 4 of 4)• Can elect to deduct either state & local income taxes  or sales/use ta...
The Big Picture - Example 16          Deductible Property Taxes• Return to the facts of The Big Picture on p. 10-1.• If th...
Interest Expense• Deduction of interest expense is limited to:  –   Interest on qualified student loans  –   Investment in...
Interest on Qualified              Student Loans• Deductible for AGI, subject to limits  – Maximum deduction is $2,500 per...
Qualified Residence Interest                    (slide 1 of 4)• Interest on indebtedness secured by the  principal residen...
Qualified Residence Interest                      (slide 2 of 4)• Acquisition indebtedness: amounts incurred to  acquire, ...
Qualified Residence Interest                      (slide 3 of 4)• Home equity indebtedness: loans secured by  qualified re...
Qualified Residence Interest                     (slide 4 of 4)• Thus, maximum loans on qualified residences  that will pr...
The Big Picture - Example 22               Acquisition Indebtedness•   Return to the facts of The Big Picture on p. 10-1.•...
Interest Paid For Services                       (slide 1 of 2)• “Points” paid for the use or forbearance of  money qualif...
Interest Paid For Services                      (slide 2 of 2)• Exception: Points paid in the acquisition or  improvement ...
Mortgage Insurance Payments• Mortgage insurance premiums are deductible  as interest if they relate to a qualified residen...
Investment Interest• Investment interest on loans whose proceeds  are used to purchase investment property may  be deducti...
Classification of Interest Expense• Whether interest is deductible for AGI or as an itemized  deduction (from AGI) depends...
Charitable Contributions                      (slide 1 of 2)• Individuals and corporations may deduct  contributions made ...
Charitable Contributions                       (slide 2 of 2)• Exception to tangible benefit rule  – Allows deduction of 8...
Contribution of Services• No deduction is allowed for the contribution of  services  – Unreimbursed expenses related to th...
Nondeductible Items• The following items may not be deducted as  charitable contributions:   – Dues, fees, or bills paid t...
Qualified Organizations• To be deductible, contributions must be to a  qualified domestic nonprofit organization or  state...
Record-Keeping Requirements• No deduction is allowed for charitable  contributions unless the taxpayer has  appropriate do...
Ordinary Income Property• Defined: assets that would produce ordinary  income or short-term capital gain if sold• Contribu...
Capital Gain Property• Defined: assets that would produce long-term  capital gain or Section 1231 gain if sold• Contributi...
Exceptions to FMV Deduction    of Capital Gain Property (slide 1 of 3)• Private nonoperating foundations  – Deduction for ...
Exceptions to FMV Deduction    of Capital Gain Property (slide 2 of 3)• For contributions of tangible personalty  – The ch...
Exceptions to FMV Deduction     of Capital Gain Property (slide 3 of 3)• For contributions of certain types of  intellectu...
Example of Contributions         of Tangible Personalty• Taxpayer contributes painting to local charity:  FMV $100,000 and...
Charitable Contribution             Limitations (slide 1 of 4)• 50% limit  – In no case can the charitable contribution de...
Charitable Contribution            Limitations (slide 2 of 4)• 30% limit  – Charitable contribution deduction for certain ...
Charitable Contribution            Limitations (slide 3 of 4)• 30% limit  – Taxpayer can elect to treat capital gain prope...
Charitable Contribution            Limitations (slide 4 of 4)• 20% limit  – Certain contributions of capital gain property...
Charitable Contributions Carryover• Contributions that cannot be taken in current  year due to limitations may be carried ...
Example of Charitable Contribution             AGI Limits• Taxpayer, AGI $100,000, contributed $40,000  cash and long-term...
Miscellaneous Itemized Deductions• Some expenditures are deductible only to the extent  they exceed 2% of AGI• Examples in...
Misc. Itemized Deductions Not Subject          to 2% of AGI Floor• Examples include:  – Gambling losses to the extent of g...
Refocus On The Big Picture (slide 1 of 2)•   Because qualified residence interest and real estate taxes are deductible, th...
Refocus On The Big Picture (slide 2 of 2)• What if the Williamsons choose to finance the purchase of  their home using the...
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P pt ch 10

  1. 1. Chapter 10 Deductions and Losses: Certain Itemized Deductions Individual Income Taxes© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1
  2. 2. The Big Picture (slide 1 of 3)• John and Susan Williamson have been renting an apartment since they were married. – They now want to purchase their own home.• Their current monthly rent is $2,000. – They are willing to spend $2,500 per month on an after-tax basis if necessary to purchase their first home. 2
  3. 3. The Big Picture (slide 2 of 3)• After months of house hunting, they have found the perfect home, but they fear it may be too expensive.• Using a standard mortgage to finance the purchase, the total cash outlay during the first year of ownership would be as follows. Principal payments $ 2,000 Interest payments 37,000 Real estate taxes 3,000 Total cash outlay $42,000 Monthly cost ($42,000 ÷ 12) = $ 3,500 3
  4. 4. The Big Picture (slide 3 of 3)• Alternatively, if they use investments to secure financing, they could qualify for a lower interest rate. – Reduces the interest charge from $37,000 to $35,000.• Their Federal taxable income will be between $160,000 and $185,000 for the year.• They do not itemized their deductions.• The state they live in imposes an income tax at a flat rate of 6%.• Can John and Susan Williamson afford to pursue their dream of home ownership? – Read the chapter and formulate your response. 4
  5. 5. Itemized Deductions (slide 1 of 2)• Personal expenditures that are deductible from AGI as itemized deductions include: – Medical expenses – Certain taxes – Mortgage and investment interest – Charitable Contributions – Miscellaneous itemized deductions 5
  6. 6. Itemized Deductions (slide 2 of 2)• Itemized deductions provide a tax benefit only to extent that, in total, they exceed the standard deduction amount for the taxpayer 6
  7. 7. The Big Picture - Example 1 Allowable Itemized Deductions• Return to the facts of The Big Picture on p. 10-1.• With the purchase of a home, John and Susan will be able to itemize their deductions for the first time instead of claiming the standard deduction. – Assuming the home mortgage interest expense and real estate taxes meet the requirements discussed in this chapter, they will be deducted from AGI. – Their total itemized deductions will exceed the amount of their allowable standard deduction.• Further, other qualifying expenditures (e.g., state income taxes and charitable contributions) likewise will be deductible as itemized deductions, providing an explicit tax benefit to the Williamsons. 7
  8. 8. Medical Expenses (slide 1 of 6)• Medical expenses are deductible to the extent unreimbursed medical expenses, in total, exceed 7.5% of AGI 8
  9. 9. Medical Expenses (slide 2 of 6)• Example of medical expense deduction limitation: – Amy has AGI of $10,000 and medical expenses of $1,000 – Amy’s medical expense deduction = $250 [$1,000 – ($10,000 × 7.5%)] 9
  10. 10. Medical Expenses (slide 3 of 6)• Example of medical expense deduction limitation: – Bob has AGI of $4,000 and medical expenses of $1,000 – Bob’s medical expense deduction = $700 [$1,000 – ($4,000 × 7.5%)] 10
  11. 11. Medical Expenses (slide 4 of 6)• Expenditures for: – The diagnosis, cure, mitigation, treatment, prevention of disease, or – The purpose of affecting any structure or function of the body of the taxpayer, spouse, or dependents – Includes prescription drugs and insulin 11
  12. 12. Medical Expenses (slide 5 of 6)• Does not include the cost of items such as : – Unnecessary cosmetic surgery – General health items – Nonprescription drugs• If cosmetic surgery is deemed necessary, it is deductible as a medical expense – Cosmetic surgery is necessary when it ameliorates • A deformity arising from a congenital abnormality • A personal injury, or • A disfiguring disease 12
  13. 13. Medical Expenses (slide 6 of 6)• Medical expenditures are deductible in year paid – Includes payment by check or credit card 13
  14. 14. The Big Picture - Example 2 Medical Expenses• Return to the facts of The Big Picture on p. 10-1.• The Williamsons had medical expenses of $20,000. – $3,000 of medical expenses were reimbursed by their insurance company.• With AGI of $200,000, the itemized deduction for medical expenses is limited to $2,000. – [($20,000 − $3,000) – (7.5% × $200,000)] – Note: the Williamsons will not receive a tax benefit from their medical expenses unless: • Unreimbursed medical expenses exceed $15,000, and • They itemize their deductions. 14
  15. 15. Nursing Home Expenditures• If primary reason for being in nursing home is medical, costs (including meals and lodging) qualify• If primary purpose of placement in home is personal, only specific medical costs qualify (no meals or lodging) 15
  16. 16. Special School Expenditures• Medical expense deduction may include the expenses of a special school for a mentally or physically handicapped individual – Deduction is allowed if a principal reason for sending the individual to the school is the school’s special resources for alleviating the infirmities – In this case, the cost of meals and lodging, in addition to the tuition, is a proper medical expense deduction 16
  17. 17. Capital Medical Expenditures• May include a pool, air conditioners if they do not become permanent improvements, dust elimination systems, elevators, etc.• Must be medical necessity, advised by a physician, used primarily by patient, and expense is reasonable• Full amount of cost is medical expense in year paid• Maintenance on capital expenditures also medical expense 17
  18. 18. Capital Improvement to Home• Deductible medical expense only to extent cost exceeds increase in value of home – Appraisal costs related to capital improvements are also deductible, but not as medical expenses• Exception: removal of structural barriers to home of handicapped are deemed to add no value to home – Thus, full amount is a medical expense 18
  19. 19. Medical Care for Spouse and Dependents• Taxpayer may deduct cost of medical care for spouse and dependents – Dependents need not meet gross income or joint return tests – Medical expenses of children of divorced parents can be deducted by non-custodial parent even though child is claimed as dependent of custodial parent 19
  20. 20. Medical Transportation and Lodging• Transportation costs to and from medical care are deductible – Mileage allowance of 23 cents per mile (in 2012) may be used instead of actual out-of-pocket automobile expenses• Lodging while away from home for medical care – Allowable amount is $50 per person per night• If parent and/or aide needs to accompany patient, their expenses are also deductible 20
  21. 21. The Big Picture - Example 9 Medical Expenses• Return to the facts of The Big Picture on p. 10-1.• Because of her disabilities, John’s mother, Martha, moves in with them. – She becomes their dependent.• The family physician advises them that Martha needs specialized treatment for her heart condition. – John and Martha fly to Cleveland, Ohio, where Martha receives therapy• Expenses in connection with the trip are as follows: – Round-trip airfare ($250 each) $500 – Lodging in Cleveland for two nights ($120 each per night) $480• Assuming that the Williamsons itemize their deductions, the medical expense deduction is as follows: – Transportation $500 – Lodging ($50 per night per person) $200 • Because Martha is disabled, it is assumed that John’s accompanying her is justified. 21
  22. 22. Medical Insurance Premiums (slide 1 of 2)• Premiums paid for medical care insurance are deductible medical expenses – If employer pays all or part of taxpayer’s medical insurance premiums the amount paid by employer is • Not included in gross income by employee • Not deductible by the employee as medical expense 22
  23. 23. Medical Insurance Premiums (slide 2 of 2)• For self-employed, 100% of insurance premiums are deductible for AGI – Includes amounts paid for taxpayer’s spouse and dependents – Not allowed if taxpayer is eligible to participate in a subsidized health plan maintained by any employer of the taxpayer or the taxpayer’s spouse• Premiums paid for qualified long-term care insurance are deductible medical expenses – Subject to limitations based on age of the insured 23
  24. 24. Reimbursement by Medical Insurance• If reimbursed in same year as expense paid: – Reimbursement offsets medical expense – Amount deductible is excess of expenses over reimbursement• If reimbursed in the year after medical expenses were paid: – Reimbursement is income only to extent medical deduction decreased taxable income in the earlier year (tax benefit rule) – If standard deduction was taken in year expenses were paid, none of the reimbursement is included in income 24
  25. 25. Example of Medical Reimbursements (slide 1 of 2)• In 2012, taxpayer paid medical expenses = $1,200; In 2012, reimbursed $800 by insurance company – For 2012, deductible medical expense is $400 – (7.5% × AGI) 25
  26. 26. Example of Medical Reimbursements (slide 2 of 2)• In 2012, taxpayer paid medical expenses of $1,200; In 2013, reimbursed $800 by insurance company – For 2012, deductible medical expense is $1,200 – (7.5% × AGI) – For 2013, reimbursement is income to extent taxpayer received a tax benefit from medical expense deduction in 2012 26
  27. 27. Health Savings Accounts• Used in conjunction with a high deductible medical insurance policy – Employee contributions to HSA are deductible for AGI and earnings on funds in account are not taxable – Deductible contributions are limited to the sum of the monthly limitations. The monthly deductible amount is limited to the lesser of one twelfth of: • The annual deductible under a high deductible plan or • $3,100 for self-only ($6,250 for family coverage) in 2012 – Withdrawals from HSA are excludible to the extent used for qualified medical expenses 27
  28. 28. Taxes (slide 1 of 4)• State, local, and foreign income and real property taxes are deductible in the year paid – Real property taxes do not include taxes assessed for local benefits • e.g., Special assessments for streets, sidewalks, curbing, and other similar improvements• State and local personal property taxes based on value (ad valorem) are deductible in the year paid 28
  29. 29. Taxes (slide 2 of 4)• Other taxes such as FICA, excise, etc., are not deductible – May be deductible if incurred in business or production of income activity• Fees are not deductible as tax 29
  30. 30. Taxes (slide 3 of 4)• Real estate taxes for year property is sold must be apportioned between the buyer and the seller – Failure to correctly apportion requires offsetting adjustments to seller’s amount realized and buyer’s adjusted basis 30
  31. 31. Taxes (slide 4 of 4)• Can elect to deduct either state & local income taxes or sales/use taxes – For state and local income taxes, deduct amounts paid during year: • Amounts withheld • Estimated tax payments • Amounts paid in current year for prior year’s liability – For sales/use taxes, deduct either: • Actual sales/use tax payments or • Amount from an IRS table – Table amount may be increased by sales tax paid on certain specific items (e.g., purchase of motor vehicles, boats, etc.) 31
  32. 32. The Big Picture - Example 16 Deductible Property Taxes• Return to the facts of The Big Picture on p. 10-1.• If the Williamsons purchase their home, the real estate taxes they pay will be deductible from AGI as an itemized deduction.• If they also pay personal property tax on their car, the payment may be only partially deductible. – In their state, the motor vehicle registration tax is 4% of the value of the vehicle plus 40 cents per hundredweight. – The Williamsons car is valued at $20,000 and weighs 3,000 lbs. – Their annual registration fee is $812. • $800 (4% of $20,000) is deductible as a personal property tax. • The remaining $12, based on the weight of the car, is not deductible. 32
  33. 33. Interest Expense• Deduction of interest expense is limited to: – Interest on qualified student loans – Investment interest – Qualified residence (home mortgage) interest – Business interest• Personal interest expense is not deductible 33
  34. 34. Interest on Qualified Student Loans• Deductible for AGI, subject to limits – Maximum deduction is $2,500 per year – Deduction is phased out for taxpayers with modified AGI (MAGI) between $60,000 and $75,000 ($120,000 and $150,000 on joint returns) – Not allowed for those claimed as a dependent or for married filing separate returns 34
  35. 35. Qualified Residence Interest (slide 1 of 4)• Interest on indebtedness secured by the principal residence and one other residence (qualified residences)• Interest must be on acquisition indebtedness or home equity loans 35
  36. 36. Qualified Residence Interest (slide 2 of 4)• Acquisition indebtedness: amounts incurred to acquire, construct, or substantially improve the qualified residences – Interest paid on aggregate acquisition indebtedness of $1 million or less ($500,000 for married, filing separately) is deductible as qualified residence interest 36
  37. 37. Qualified Residence Interest (slide 3 of 4)• Home equity indebtedness: loans secured by qualified residences• Interest is deductible only on portion of home equity loan that does not exceed the lesser of: – $100,000 ($50,000 for married, filing separate), or – FMV of home – acquisition indebtedness 37
  38. 38. Qualified Residence Interest (slide 4 of 4)• Thus, maximum loans on qualified residences that will produce qualified residence interest is $1.1 million• Interest on mortgage debt exceeding $1.1 million or on mortgage debt relating to nonqualified residence (e.g., second vacation home) is nondeductible personal interest 38
  39. 39. The Big Picture - Example 22 Acquisition Indebtedness• Return to the facts of The Big Picture on p. 10-1.• John and Susan will need to borrow at least a portion of the purchase price of their new home – A standard mortgage likely will qualify as acquisition indebtedness. – However, the interest on the acquisition indebtedness will be fully deductible only if • The amount of the mortgage is $1 million or less (assuming they file a joint return), and • The mortgage is secured by the home.• Recall that they are also considering what appears to be a less expensive route of using their investments to secure the debt. – If they choose this alternative, the interest will not be deductible as qualified residence interest because the loan would not be acquisition indebtedness. 39
  40. 40. Interest Paid For Services (slide 1 of 2)• “Points” paid for the use or forbearance of money qualify as deductible interest – Cannot be a service charge if they are to qualify as deductible interest• Points generally must be capitalized and amortized over the life of loan 40
  41. 41. Interest Paid For Services (slide 2 of 2)• Exception: Points paid in the acquisition or improvement of principal residence – Entire amount of such points are deductible in the year paid – Points paid to refinance an existing home mortgage must be capitalized and amortized over the life of the new loan 41
  42. 42. Mortgage Insurance Payments• Mortgage insurance premiums are deductible as interest if they relate to a qualified residence of the taxpayer – The deduction begins to phase out for taxpayers with AGI in excess of $100,000 ($50,000 for married taxpayers filing separately) 42
  43. 43. Investment Interest• Investment interest on loans whose proceeds are used to purchase investment property may be deductible – e.g., Investment property may include stock, bonds, and land held for investment• Deduction of investment interest expense is limited to net investment income 43
  44. 44. Classification of Interest Expense• Whether interest is deductible for AGI or as an itemized deduction (from AGI) depends on purpose of indebtedness – If related to a business or the production of rent or royalty income • Interest is deductible for AGI – If incurred for personal use, such as qualified residence interest • Deduction is reported on Schedule A, Form 1040 if taxpayer itemizes • However, interest on a student loan is a deduction for AGI – If the taxpayer incurs debt in relation to his or her employment • Interest is considered to be personal, or consumer, interest 44
  45. 45. Charitable Contributions (slide 1 of 2)• Individuals and corporations may deduct contributions made to qualified domestic organizations• Contributor must have donative intent and expect nothing in return – If contributor receives tangible benefit, the FMV of such benefit reduces the amount of the charitable contribution deduction 45
  46. 46. Charitable Contributions (slide 2 of 2)• Exception to tangible benefit rule – Allows deduction of 80% of amount paid for the right to purchase athletic tickets from colleges and universities 46
  47. 47. Contribution of Services• No deduction is allowed for the contribution of services – Unreimbursed expenses related to the services are deductible – Out-of-pocket transportation costs or a standard mileage rate of 14 cents per mile are deductible – Deductions are also permitted for transportation, reasonable expenses for lodging, and the cost of meals while away from home incurred in performing the donated services 47
  48. 48. Nondeductible Items• The following items may not be deducted as charitable contributions: – Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups – Cost of raffle, bingo, or lottery tickets – Cost of tuition – Value of blood given to a blood bank – Donations to homeowners associations – Gifts to individuals – Rental value of property used by a qualified charity 48
  49. 49. Qualified Organizations• To be deductible, contributions must be to a qualified domestic nonprofit organization or state or possession of U.S. or any subdivisions thereof – Many (but not all) qualified domestic charities are listed in IRS Publication #78 49
  50. 50. Record-Keeping Requirements• No deduction is allowed for charitable contributions unless the taxpayer has appropriate documentation and substantiation – The specific type of documentation required depends on the amount of the contribution and whether the contribution is made in cash or noncash property – Special rules may apply to gifts of certain types of property (e.g., used automobiles) where Congress has noted taxpayer abuse in the past 50
  51. 51. Ordinary Income Property• Defined: assets that would produce ordinary income or short-term capital gain if sold• Contribution amount – FMV of asset less ordinary income (or STCG) potential; generally the lower of adjusted basis or FMV 51
  52. 52. Capital Gain Property• Defined: assets that would produce long-term capital gain or Section 1231 gain if sold• Contribution amount – Generally FMV of asset 52
  53. 53. Exceptions to FMV Deduction of Capital Gain Property (slide 1 of 3)• Private nonoperating foundations – Deduction for contributions to private nonoperating foundations must be reduced by the amount of capital gain potential – Thus, the contribution deduction is limited to the adjusted basis 53
  54. 54. Exceptions to FMV Deduction of Capital Gain Property (slide 2 of 3)• For contributions of tangible personalty – The charitable deduction may limited to the adjusted basis if the asset contributed is not used in charity’s exempt function – This reduction generally does not apply if • The property is, in fact, not put to an unrelated use, or • At the time of the contribution, it was reasonable to anticipate that the property would not be put to an unrelated use by the donee 54
  55. 55. Exceptions to FMV Deduction of Capital Gain Property (slide 3 of 3)• For contributions of certain types of intellectual property – Contribution deduction is limited to the lesser of the taxpayer’s basis in the property or the property’s fair market value – Includes patents, certain copyrights, trademarks, trade names, trade secrets, know-how, and some software 55
  56. 56. Example of Contributions of Tangible Personalty• Taxpayer contributes painting to local charity: FMV $100,000 and adjusted basis $10,000 – If charitable organization is a local museum that hangs the painting for patrons to view, taxpayer has $100,000 contribution deduction – If charitable organization is a local church that sells the painting immediately to obtain funds for its operation, taxpayer has $10,000 contribution 56
  57. 57. Charitable Contribution Limitations (slide 1 of 4)• 50% limit – In no case can the charitable contribution deduction for a year exceed 50% of the taxpayer’s AGI – Contributions of cash, ordinary income property, and certain capital gain property (where the contribution amount is adjusted basis) are subject to the 50% limit (50% assets) – Generally, applies to contributions to public charities • e.g., Churches, schools, hospitals, and Federal, state, or local governmental units • Also applies to private operating foundations and certain private nonoperating foundations 57
  58. 58. Charitable Contribution Limitations (slide 2 of 4)• 30% limit – Charitable contribution deduction for certain assets cannot exceed 30% of the taxpayer’s AGI • Applies to 30% assets which are: – Capital gain property for which the contribution amount is FMV – Certain contributions to private nonoperating foundations 58
  59. 59. Charitable Contribution Limitations (slide 3 of 4)• 30% limit – Taxpayer can elect to treat capital gain property as 50% assets by limiting the amount of such contributions to their adjusted bases – Referred to as the reduced deduction election • Enables the taxpayer to move from the 30% limitation to the 50% limitation 59
  60. 60. Charitable Contribution Limitations (slide 4 of 4)• 20% limit – Certain contributions of capital gain property to private nonoperating foundations 60
  61. 61. Charitable Contributions Carryover• Contributions that cannot be taken in current year due to limitations may be carried forward for 5 years – Contributions carried forward retain their classification • e.g., If the contribution originally involved 30% property, the carryover will continue to be classified as 30% property in the carryover year – When using carryovers, current contributions are used first, then carryovers used on a FIFO basis 61
  62. 62. Example of Charitable Contribution AGI Limits• Taxpayer, AGI $100,000, contributed $40,000 cash and long-term stocks with a FMV of $35,000 and a basis of $8,000 to a University• 50% limit = $50,000 30% limit = $30,000 – Amount of deduction = $50,000 (40,000 cash + 10,000 stock) – Contribution carryforward = $25,000 stock (as 30% asset) 62
  63. 63. Miscellaneous Itemized Deductions• Some expenditures are deductible only to the extent they exceed 2% of AGI• Examples include: – Professional dues – Uniforms – Tax return prep fees – Job-hunting costs – Certain investment expenses – Hobby losses – Unreimbursed employee expenses 63
  64. 64. Misc. Itemized Deductions Not Subject to 2% of AGI Floor• Examples include: – Gambling losses to the extent of gambling winnings – Impairment-related work expenses of a handicapped person – Deduction for repayment of amounts under a claim of right if more than $3,000 – Unrecovered investment in an annuity contract when annuity ceases by reason of death 64
  65. 65. Refocus On The Big Picture (slide 1 of 2)• Because qualified residence interest and real estate taxes are deductible, the after- tax cost of a home purchase is reduced by the tax savings associated with these itemized tax deductions.• Given the Williamsons’ projected taxable income, they are in the 28% Federal and 6% state tax brackets for an aggregate marginal tax bracket of 34%. – As a result, the after-tax cost of financing the purchase of the home will be: Nondeductible principal payments $ 2,000 Deductible qualified residence interest and real estate taxes [($37,000 + $3,000) X (1- .34)] 26,400 Total $28,400 After-tax monthly cost ($28,400 ÷ 12) $ 2,367• Because the Williamsons will be able to itemize their deductions if they purchase a new home and will be able to deduct most of their monthly house payment, the home purchase will be affordable. 65
  66. 66. Refocus On The Big Picture (slide 2 of 2)• What if the Williamsons choose to finance the purchase of their home using their investments as security for the loan? – What may appear to be a cost-effective approach ends up being more costly on an after-tax basis.• With this approach, the interest expense is not deductible. – It is not qualified residence interest or investment interest.• Therefore, the after-tax cost of financing the home using this approach makes the home unaffordable. Nondeductible principal and interest payments $37,000 Deductible real estate taxes [$3,000 X (1 - .34)] 1,980 Total $38,980 After-tax monthly cost ($38,980 ÷ 12) $ 3,248 66
  67. 67. If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 67
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