McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter 06Individual Deductions
6-2Learning objectives1. Identify the common deductions necessaryfor calculating adjusted gross income (AGI)2. Describe th...
6-3Deductions for AGI Three categories of deductions for AGI Directly related to business activities Indirectly related...
6-4Deductions for AGI Directly Related to Business Activities Taxpayers are allowed to deduct expensesincurred to genera...
6-5Deductions for AGI Although both are motivated primarily by profit,business activities are distinguished frominvestmen...
6-6Deductions for AGI Trade or Business Expenses must be: directly connected to the business activity ordinary and nece...
6-7Deductions for AGI Rental & Royalty Expenses Claimed above the line (for AGI) Could either be an investment activity...
6-8Deductions for AGI Losses Taxpayers disposing of trade or business assets at aloss are allowed to deduct the loss for...
6-9Deductions for AGI Deductions indirectly Related to BusinessActivities The cost of moving personal possessions is not...
6-10Deductions for AGI Distance test – the new job site must extend existingcommute by 50 miles A new job site is requir...
6-11Deductions for AGI Health Insurance deduction by Self-EmployedTaxpayers Deduction provides equity with employees who...
6-12Deductions for AGI SE Tax Deduction Employer and employees each pay one-half ofemployee’s Social Security tax Emplo...
6-13Deductions for AGI Alimony payments are deductible for AGI tomaintain equity Contributions to a qualified retirement...
6-14Deductions for AGI Deduction for Interest expense on loans used tofund qualified educational expenses Up to $2,500 o...
6-15Deductions from AGI: ItemizedDeductions Medical Expenses Taxpayers may deduct medical expenses incurred totreat them...
6-16Deductions from AGI: ItemizedDeductions Hospitals and Long-term Care Facilities Taxpayers may deduct the costs of ac...
6-17 Taxes Individuals may deduct itemized deductionspayments for following taxes State, local, and foreign income taxe...
6-18Deductions from AGI: ItemizedDeductions Interest Two itemized deductions for interest expense: Deduction of investm...
6-19 Charitable Contributions Contribution of money or property must be madeto a qualified charity Special rules apply ...
6-20Deductions from AGI: ItemizedDeductions Casualty and theft losses on personal-useassets The amount of the tax loss f...
6-21Deductions from AGI: ItemizedDeductions Casualty Loss Deduction Floor Limitations It must exceed two separate floor ...
6-22Deductions from AGI: ItemizedDeductions Miscellaneous Itemized Deductions Subjectto AGI Floor Employee Business Expe...
6-23Itemized Deductions and theStandard Deduction Miscellaneous Itemized Deductions NotSubject to AGI Floor Individuals ...
6-24Standard Deductions & Exemptions Bunching Itemized Deductions Tax benefit can be gained by implementingsimple timing...
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Chap006

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Chap006

  1. 1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter 06Individual Deductions
  2. 2. 6-2Learning objectives1. Identify the common deductions necessaryfor calculating adjusted gross income (AGI)2. Describe the different types of itemizeddeductions available to individuals andcompute itemized deductions3. Explain the operation of the standarddeduction, determine the deduction forpersonal and dependency exemptions, andcompute taxable income
  3. 3. 6-3Deductions for AGI Three categories of deductions for AGI Directly related to business activities Indirectly related to business activities Deductions subsidizing specific activities
  4. 4. 6-4Deductions for AGI Directly Related to Business Activities Taxpayers are allowed to deduct expensesincurred to generate business income For tax purposes activities are eitherprofit-motivated ormotivated by personal objectives Profit-motivated activities are classified as1. business activities (called “trade or business”) or2. investment activities
  5. 5. 6-5Deductions for AGI Although both are motivated primarily by profit,business activities are distinguished frominvestment activities: Trade or Business activities require a relatively highinvolvement or effort from the taxpayer where asinvestment activities don’t require Investment activities involve investing in property forappreciation or for income payments
  6. 6. 6-6Deductions for AGI Trade or Business Expenses must be: directly connected to the business activity ordinary and necessary for the activity (e.g.,appropriate and helpful for generating a profit) reasonable in amount (not extravagant) Expenses are claimed on Schedule C Revenues from the same activity are also reported onthe same Schedule C The net income or loss from Schedule C is transferredto Form 1040 (page 1) on line 12
  7. 7. 6-7Deductions for AGI Rental & Royalty Expenses Claimed above the line (for AGI) Could either be an investment activity or a tradeactivity depending on facts Taxpayers report expenses and revenue on ScheduleE and transfer the net income or loss from Schedule Eto Form 1040 (page 1), line 17 Flow-through Entities Expenses and losses incurred by a flow-through entitypass through to the entity owners who typically reportthese amounts on Schedule E and Line 17
  8. 8. 6-8Deductions for AGI Losses Taxpayers disposing of trade or business assets at aloss are allowed to deduct the loss for AGI Losses from investment assets (called capital assets)are offset against capital gains If capital losses exceed capital gains, this is called anet capital loss A net capital loss is deducted for AGI but limited to$3,000. Losses in excess of the $3,000 limit arecarried forward indefinitely to subsequent years
  9. 9. 6-9Deductions for AGI Deductions indirectly Related to BusinessActivities The cost of moving personal possessions is nota direct cost of doing business or beingemployed Moving Expenses are deductible for AGI if themove meets two tests1. A distance test2. A business test associated with a move
  10. 10. 6-10Deductions for AGI Distance test – the new job site must extend existingcommute by 50 miles A new job site is required, but a new employer is notessential Business test - Taxpayer must be employed at least39 of 52 weeks or be self-employed for 78 of the 104weeks following the move Taxpayers are allowed to deduct a mileage rate in lieuof the actual costs of driving their personalautomobiles during the move (19 cents per mile in2011)
  11. 11. 6-11Deductions for AGI Health Insurance deduction by Self-EmployedTaxpayers Deduction provides equity with employees whoreceive health insurance as a qualified fringe benefit Insurance must be provided for taxpayer ordependents who are not eligible for employer-provided health insurance Penalty for early withdrawals of savings Reduces the taxpayer’s net interest income to theamount actually received
  12. 12. 6-12Deductions for AGI SE Tax Deduction Employer and employees each pay one-half ofemployee’s Social Security tax Employers deduct the portion of Social Security taxesthey pay for employees Self-employed individuals are required to pay SE taxin lieu of Social Security tax Self-employed tax payers are allowed to deduct one-half of the SE tax they pay to compensate foremployers deducting their portion of Social Security
  13. 13. 6-13Deductions for AGI Alimony payments are deductible for AGI tomaintain equity Contributions to a qualified retirementaccount are deductible for AGI to encouragesavings Interest expense on qualified educationalloans Qualified educational expenses
  14. 14. 6-14Deductions for AGI Deduction for Interest expense on loans used tofund qualified educational expenses Up to $2,500 of interest on education loans isdeductible for AGI The interest deduction is phased-out for taxpayerswith AGI exceeding $60,000 ($120,000 filing joint) The deduction is eliminated for taxpayers with AGIexceeding $75,000 ($150,000 filing joint)
  15. 15. 6-15Deductions from AGI: ItemizedDeductions Medical Expenses Taxpayers may deduct medical expenses incurred totreat themselves, their spouse, and their dependents Qualifying medical expenses include unreimbursedpayments for care, prevention, diagnosis or cure ofinjury, disease, or bodily function Taxpayers using personal automobiles for medicaltransportation purposes may deduct a standardmileage allowance (19 cents per mile in 2011) in lieuof actual costs
  16. 16. 6-16Deductions from AGI: ItemizedDeductions Hospitals and Long-term Care Facilities Taxpayers may deduct the costs of actual medicalcare whether the care is provided at hospitals or otherlong-term care facilities Medical Expenses Deduction Limitation It is limited to the amount of unreimbursed qualifyingmedical expenses paid during the year which isreduced by 7.5% of the taxpayers AGI
  17. 17. 6-17 Taxes Individuals may deduct itemized deductionspayments for following taxes State, local, and foreign income taxes Real estate taxes on property held for personal orinvestment purposes Personal property taxes that are assessed on the valueof the specific property Sales Tax deduction State and local sales taxes can be deducted in lieuof state and local income taxesDeductions from AGI: ItemizedDeductions
  18. 18. 6-18Deductions from AGI: ItemizedDeductions Interest Two itemized deductions for interest expense: Deduction of investment interest is limited to ataxpayer’s net investment income Any investment interest in excess of the netinvestment income limitation carries forward to thesubsequent year Home mortgage interest Interest on acquisition indebtedness of $1million Interest on home equity debt of $100K
  19. 19. 6-19 Charitable Contributions Contribution of money or property must be madeto a qualified charity Special rules apply to charitable contributions ofproperty depending on the type of property: Capital gain property Ordinary income propertyDeductions from AGI: ItemizedDeductions
  20. 20. 6-20Deductions from AGI: ItemizedDeductions Casualty and theft losses on personal-useassets The amount of the tax loss from any specificcasualty event (including theft) is the lesser of decline in value of the property caused by thecasualty or taxpayer’s tax basis in the damaged or stolen asset
  21. 21. 6-21Deductions from AGI: ItemizedDeductions Casualty Loss Deduction Floor Limitations It must exceed two separate floor limitations toqualify as itemized deductions $100 for each casualty during the year 10 percent of AGI floor limit applied to the sum ofall casualty losses for the year (after applying the$100 floor) In other words, the itemized deduction is theaggregate amount of casualty losses that exceeds10 percent of AGI
  22. 22. 6-22Deductions from AGI: ItemizedDeductions Miscellaneous Itemized Deductions Subjectto AGI Floor Employee Business Expenses Travel and transportation Employee expense reimbursements Investment Expenses Tax Preparation Fees Hobby losses Total miscellaneous itemized deductions aresubject to a 2 percent of AGI floor limit
  23. 23. 6-23Itemized Deductions and theStandard Deduction Miscellaneous Itemized Deductions NotSubject to AGI Floor Individuals include all gambling winnings for theyear in gross income and deduct gambling lossesto the extent of gambling winnings for the year Standard Deductions Taxpayers generally deduct the greater of theirstandard deduction or their itemized deductions
  24. 24. 6-24Standard Deductions & Exemptions Bunching Itemized Deductions Tax benefit can be gained by implementingsimple timing tax-planning strategy Taxpayers with itemized deductions that fall just shortof the standard deduction amount These itemized deductions do not produce any taxbenefit Rather than deduct the standard deduction everyyear time deductions (when possible) to bunchtogether in one year

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