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Classification of deductible expenses
Deductions for adjusted gross income
Standard deduction and itemized deductions
Personal and dependency exemptions
Phaseout of exemptions
Reduction of itemized deductions
Classification of Deductible Expenses
Key Learning ObjectivesKey Learning Objectives
Allowable deductions of individual taxpayersAllowable deductions of individual taxpayers Order of deductionsOrder of deductions Relationship of deductionsRelationship of deductions
For AGI andFor AGI and From AGIFrom AGI
AGI & Deductions From AGI
Itemized deductions reduced by AGIItemized deductions reduced by AGI Medical--7.5%Medical--7.5% Miscellaneous--2%Miscellaneous--2% Casualty--10%Casualty--10%
Charitable--total deduction limited by AGICharitable--total deduction limited by AGI
§162 Trade or Business Expenses
Generally deductibleGenerally deductible Must be Must be
OrdinaryOrdinary NecessaryNecessary ReasonableReasonable
§162 Trade or Business Expenses
If self-employedIf self-employed Deductible for AGIDeductible for AGI
If employeeIf employee Deductible from AGI if unreimbursed Deductible from AGI if unreimbursed Reimbursed--non-accountable planReimbursed--non-accountable plan Subject to 2% floorSubject to 2% floor
§212 Expenses forProduction of Income
Generally deductibleGenerally deductible Must be Must be
OrdinaryOrdinary NecessaryNecessary ReasonableReasonable
§212 Expenses forProduction of Income
For production/collection of incomeFor production/collection of income For property held for production of incomeFor property held for production of income
Management/conservation/maintenanceManagement/conservation/maintenance
Determination/collection/refund Determination/collection/refund of any taxof any tax
§212 Expenses forProduction of Income
For AGIFor AGI Rental and royalty expenses on Sch ERental and royalty expenses on Sch E
From AGI From AGI Most investment related itemsMost investment related items Except taxes, interest expenseExcept taxes, interest expense Miscellaneous 2%Miscellaneous 2%
§262 Personal Expenses
Generally not deductibleGenerally not deductible Exceptions for certain itemized deductionsExceptions for certain itemized deductions
Deductions for Personal Items“Otherwise Allowable”
Interest expenseInterest expense Charitable contributionsCharitable contributions TaxesTaxes Medical expensesMedical expenses Casualty lossesCasualty losses
AGI Limitations
Medical--7.5% AGI offsetMedical--7.5% AGI offset Misc..-- 2% - 2% AGI offsetMisc..-- 2% - 2% AGI offset Overall--3% AGI offsetOverall--3% AGI offset
AMT Add-Backs
100% of taxes 100% of taxes 100% of misc.... 2%100% of misc.... 2% Additional 2.5% AGI offset on medicalAdditional 2.5% AGI offset on medical Equity interest expenseEquity interest expense
Deductions for Adjusted Gross Income Key Learning Objectives
Introduction to deductions for AGI Moving expenses--covered in Mod 25Moving expenses--covered in Mod 25 Alimony payments covered in Mod 25Alimony payments covered in Mod 25 Penalty on early withdrawal of savingsPenalty on early withdrawal of savings Health insurance costs for self-employed Health insurance costs for self-employed
taxpayerstaxpayers Interest on certain student loansInterest on certain student loans
Standard & Itemized Deductions
Key Learning Objectives (1)
Standard deduction Itemized deductions
Medical expensesMedical expenses TaxesTaxes
Standard Deduction 2000
Married, Joint--------------- 7,350Married, Joint--------------- 7,350 Married, Separate-----------3,675Married, Separate-----------3,675 Head of Household---------6,450Head of Household---------6,450 Single-------------------------4,400Single-------------------------4,400 If dependent-- at least 700 increased byIf dependent-- at least 700 increased by
earned income plus 250 earned income plus 250 but not to exceed 4,400 but not to exceed 4,400
Note: several special rules for this groupNote: several special rules for this group
Standard Deduction Add On
Blind and/or over 65Blind and/or over 65 Taxpayer and/or spouse onlyTaxpayer and/or spouse only
Could be 4 add-ons per married, joint returnCould be 4 add-ons per married, joint return 2000 amounts2000 amounts
Married -- $850Married -- $850 Single and head of household -- $1,100Single and head of household -- $1,100
Medical Expenses
Qualified expenses paid in tax yearQualified expenses paid in tax year For self, spouse, dependents For self, spouse, dependents Also for would be dependentAlso for would be dependent
Who has too much gross incomeWho has too much gross income
Qualified Medical Expenses
Only prescription medicineOnly prescription medicine Limited weight lossLimited weight loss Not cosmetic surgery after 1990Not cosmetic surgery after 1990
Medical ExpensesCapital Expenditures
Qualified expense forQualified expense for Cost more than the increase in FMVCost more than the increase in FMV Meet strict requirements as to needMeet strict requirements as to need
Medical ExpensesInstitutionalized Care
Nursing home only if medical care is Nursing home only if medical care is primary purposeprimary purpose
Special schools--blind etc.... Special schools--blind etc.... If special facilities are If special facilities are
primary purposeprimary purpose
Medical ExpensesReductions to Amount Spent
Reduce by insurance proceedsReduce by insurance proceeds Reduce by 7.5% of AGIReduce by 7.5% of AGI Reimbursements generally not incomeReimbursements generally not income
Include in income if tax benefit in prior yearInclude in income if tax benefit in prior year
Income Taxes
All deductible All deductible Except U.S. FederalExcept U.S. Federal
Optional credit treatment for Optional credit treatment for foreign taxesforeign taxes
Property TaxesAd Valorem
Real estate taxes (RE)Real estate taxes (RE) Prorate RE tax when property soldProrate RE tax when property sold
Other taxes if assessed on valueOther taxes if assessed on value Not assessment for improvementsNot assessment for improvements
Standard Deductions and Itemized Deductions
Key Learning Objectives (2)
Itemized deductions Interest expenseInterest expense Charitable contributionsCharitable contributions Casualty and theft loss deductions Casualty and theft loss deductions
for personal use property--on last test onlyfor personal use property--on last test only Miscellaneous itemized deductionsMiscellaneous itemized deductions
Interest Expense Categories
Active T/BActive T/B Qualified residence interestQualified residence interest Investment interestInvestment interest Tax exempt investments--N/A Tax exempt investments--N/A Consumer interest--N/A after 1990 Consumer interest--N/A after 1990 Passive T/B--follow PAL rules Passive T/B--follow PAL rules
To carry passive investment To carry passive investment To run passive T/BTo run passive T/B
General Limitations on Interest Deduction
Payer must be obligated on debt Payer must be obligated on debt Can't deduct prepaid interest Can't deduct prepaid interest
Interest Expense“Follow the Money”
Must track borrowing to show how money Must track borrowing to show how money was used was used
Interest expense limitations based on how Interest expense limitations based on how funds spent funds spent
Interest Expense Limitations
Active T/B--no limits to deductibilityActive T/B--no limits to deductibility Investment interestInvestment interest
Current deduction limited Current deduction limited ToTo netnet investment income investment income Excess carries over indefinitelyExcess carries over indefinitely
Investment Income
Investment incomeInvestment income interestinterest dividendsdividends Overpaid, refundable taxes Overpaid, refundable taxes Interest on the refund Interest on the refund net capital gain net capital gain
if you give up special tax ratesif you give up special tax rates
Investment Expense
Investment expensesInvestment expenses all related expensesall related expenses
real estate taxes on investment propertyreal estate taxes on investment property management feesmanagement fees safety deposit box feessafety deposit box fees magazine subscriptionsmagazine subscriptions
if subject to 2% limit, only that left in if subject to 2% limit, only that left in excess of the limitationexcess of the limitation
Net Investment Income
the excess of investment income over the excess of investment income over investment expenses investment expenses
Example 1: Deductible investment interest expense
No deductions relating to investments
$20,000 of interest expense on funds borrowed to buy stock
Taxable income: $100,000 W2 wages $ 8,500 interest income
Example 1: Deductible investment interest expense
No deductions relating to investments
Investment income _______ Related expenses _______ Net investment income
_______ Investment interest deduction
_______
Example 1: Deductible investment interest expense
No deductions relating to
investments Investment income $8,500 Related expenses 0 Net investment income 8,500 Investment interest
Deduction 8,500 Carryover 11,500
Example 2: Deductible investment interest expense
Deductions relating to investments RE taxes of $2,000
$20,000 of interest expense on funds borrowed to buy stock
Taxable income: $100,000 W2 wages $ 8,500 interest income
Example 2: Deductible investment interest expense
RE taxes are fully deductible on Schedule A, so
Investment income _______ Related expenses _______ Net investment income _______ Investment interest deduction
_______
Example 2: Deductible investment interest expense
Investment income $8,500 Related expenses 2,000 Net investment income 6,500 Investment interest
Deduction 6,500 Carryover 13,500
Example 3: Deductible investment interest expense
Deductions relating to investments Management fees of $2,000
$20,000 of interest expense on funds borrowed to buy stock
Taxable income: $100,000 W2 wages $ 8,500 interest income
Example 3: Deductible investment interest expense
Mgt fees are deductible only if in excess of 2% of AGI
Here AGI = $108,500 2% = $2,170 Since mgt fee was only $2,000
and no other misc 2% deductions, deduction = 0
Example 3: Deductible investment interest expense
Investment income _______ Related expenses _______ Net investment income _______ Investment interest
deduction _______
Example 3: Deductible investment interest expense
Investment income $8,500 Related expenses 0 Net investment income 8,500 Investment interest
Deduction 8,500 Carryover 11,500
Example 4: Deductible investment interest expense
Deductions relating to investments Management fees of $8,000
$20,000 of interest expense on funds borrowed to buy stock
Taxable income: $100,000 W2 wages $ 8,500 interest income
Example 4: Deductible investment interest expense
Management fees are deductible only if in excess of 2% of AGI
Here AGI = $108,500 2% = $2,170 Since management fee is $8,000
and no other misc 2% deductions, deduction = $5,830
Example 4: Deductible investment interest expense
Investment income _______ Related expenses _______ Net investment income _______ Investment interest
deduction _______
Example 4: Deductible investment interest expense
Investment income $8,500 Related expenses 5,830 Net investment income 2,670 Investment interest
Deduction 2,670 Carryover 17,330
Special Rules for Qualified Residence Interest
(QRI)
Only 2 principal residences Only 2 principal residences 1 million total acquisition indebtedness 1 million total acquisition indebtedness Plus 100,000 equity indebtedness Plus 100,000 equity indebtedness
Acquisition Indebtedness (ACQ)
Loan secured by property Loan secured by property Funds used to build/improve etc....Funds used to build/improve etc.... Limited to 1 million if after Limited to 1 million if after 10/16/8910/16/89
Outstanding loans at 10/17/89 Outstanding loans at 10/17/89 Grandfathered-in as QRI Grandfathered-in as QRI No limit as long as secured by propertyNo limit as long as secured by property
Equity indebtednessEquity indebtedness
Excess of FMV over ACQ debtExcess of FMV over ACQ debt Funds can use for anything Funds can use for anything Must be secured by property Must be secured by property Limited to 100,000 debtLimited to 100,000 debt AMT add back AMT add back
Points Paid
Points on acquisition of debt deductible if Points on acquisition of debt deductible if Purchase of principal personal residence Purchase of principal personal residence Not borrowed from lender Not borrowed from lender OK if paid by sellerOK if paid by seller
Points N/D if rental or if refinancing Points N/D if rental or if refinancing Amortize over life of loan Amortize over life of loan
Charitable Contributions
To qualified charitable organizationTo qualified charitable organization Not individualNot individual Not foreignNot foreign Not political organizationNot political organization
Charitable Contributions
MoneyMoney Not value of services Not value of services Related out of pocket costs OKRelated out of pocket costs OK
Charitable ContributionsGifts of Property
Ordinary income property Ordinary income property InventoryInventory Other held < 1 yearOther held < 1 year
Deduction limited to adjusted basisDeduction limited to adjusted basis Unless FMV is smallerUnless FMV is smaller
Generally subject to 50% of AGI limitGenerally subject to 50% of AGI limit
Charitable ContributionsGifts of Property
Long term capital gain property (CG) Long term capital gain property (CG) Deduction generally FMV if > basisDeduction generally FMV if > basis Gift of tangible property limited to basis ifGift of tangible property limited to basis if
Unrelated use by charitable organizationUnrelated use by charitable organization Contributed to nonoperating private foundationContributed to nonoperating private foundation
Can deduct basis to avoid 30% limitCan deduct basis to avoid 30% limit
Check List for Gift of Appreciated Property
Ordinary income or “capital gains” property?
If ordinary use lower of adjusted basis (AB) or FMV.
If capital gains property Is charity’s use “related?” If yes use higher of AB or FMV If no use AB unless < FMV.
Example 1: Gift of Appreciated Property
Artwork is given to the local boy scouts for annual auction. Cost $ 9,000 FMV $11,000
Held as investment since 1994 What is taxpayer’s deduction
Example 1: Gift of Appreciated Property
Here gift is for public auction, so can’t Here gift is for public auction, so can’t be related usebe related use
Deduct lower of AB and FMVDeduct lower of AB and FMV ANSWER: $9,000ANSWER: $9,000
Example 2: Gift of Appreciated Property
Boat is given to the local boy scouts for summer camp. Cost $ 9,000 FMV $11,000
Used personally since 1994 What is taxpayer’s deduction
Example 2: Gift of Appreciated Property
Here gift is for use in summer camp, so Here gift is for use in summer camp, so should be related useshould be related use
Deduct FMVDeduct FMV ANSWER: $11,000ANSWER: $11,000
Charitable ContributionsLimitations on Current Deduction
Overall--50% of AGIOverall--50% of AGI Appreciated CG propertyAppreciated CG property
30% of AGI if deduction is FMV 30% of AGI if deduction is FMV 50% if elect adjusted basis 50% if elect adjusted basis
To private foundation--20% AGITo private foundation--20% AGI
Charitable ContributionsExcess Contributions
Carry over for next 5 years Carry over for next 5 years Retain character as to AGI limitsRetain character as to AGI limits No carry back availableNo carry back available
Charitable ContributionsDocumentation for Cash
Over $250 charity must substantiateOver $250 charity must substantiate Charity must disclose value of Charity must disclose value of
goods/services received in exchange if goods/services received in exchange if FMV > $75FMV > $75
Charitable ContributionsDocumentation for Property
FMV > 500--attach Form 8283 FMV > 500--attach Form 8283 FMV > 5,000 need formal, written appraisalFMV > 5,000 need formal, written appraisal Cost of appraisal is misc..... 2% deduction Cost of appraisal is misc..... 2% deduction
Casualty and Theft Losses Sudden, Unexpected, Unusual
Loss on disposal of personal-use asset is Loss on disposal of personal-use asset is generally not allowedgenerally not allowed
Casualty loss is exception Casualty loss is exception Use lower of basis or decline in FMV to Use lower of basis or decline in FMV to
determine lossdetermine loss
Casualty and Theft LossesInsurance Claims
Adjust for actual or expected insurance Adjust for actual or expected insurance reimbursementreimbursement
Gain could result if insurance > basisGain could result if insurance > basis See involuntary conversion rulesSee involuntary conversion rules
Insurance claim must be filed to deduct loss Insurance claim must be filed to deduct loss
Casualty and Theft LossPersonal-Use Property
Each casualty loss reduced by $100Each casualty loss reduced by $100 Net casualty gains and lossesNet casualty gains and losses Net gain for the year is capital gainNet gain for the year is capital gain Net loss for the year is ordinary lossNet loss for the year is ordinary loss
Reduce by 10% of AGI floorReduce by 10% of AGI floor Deduction from AGIDeduction from AGI
Casualty and Theft EventsBusiness or Investment Asset
Return of capital doctrineReturn of capital doctrine Partial destruction Partial destruction
Use lower of basis or decline in FMV Use lower of basis or decline in FMV Complete destructionComplete destruction
Use basis Use basis Adjust for actual or expected insuranceAdjust for actual or expected insurance
Casualty and Theft Events Business or Investment Asset
Business losses deductible for AGI Business losses deductible for AGI Net loss for the year is ordinary lossNet loss for the year is ordinary loss
No 100 or 10% floorNo 100 or 10% floor Net gain for the year is Net gain for the year is
§1231 gain or §1231 gain or Ordinary gainOrdinary gain Depending on holding periodDepending on holding period
Miscellaneous Itemized Deductions
Employee business expensesEmployee business expenses §212 expenses §212 expenses exceptexcept
RentsRents RoyaltiesRoyalties
Total is reduced by 2% of AGITotal is reduced by 2% of AGI
Employee Business Expenses
Being an employee (em’e) is a recognized Being an employee (em’e) is a recognized T/BT/B T/B not that of job, but being em'eT/B not that of job, but being em'e
Must distinguish between personal and T/B Must distinguish between personal and T/B expensesexpenses
Statutory em'e--expenses for AGIStatutory em'e--expenses for AGI Performing artist--may be for AGIPerforming artist--may be for AGI
Employee Business Expenses
All others--deductions from AGI All others--deductions from AGI Included with other misc..... 2% items Included with other misc..... 2% items Exception if em’e reimbursed ANDException if em’e reimbursed AND Em'e accounts to em'rEm'e accounts to em'r
Then em'r does not report in W2 Then em'r does not report in W2 Em’e does not report on tax returnEm’e does not report on tax return
Miscellaneous Itemized Deductions
Add togetherAdd together Meals & entertainment--reduced by 50%Meals & entertainment--reduced by 50% Other employee business expensesOther employee business expenses All §212 expenses except rent/royaltyAll §212 expenses except rent/royalty
Reduce by 2% of AGIReduce by 2% of AGI This is the amount deduct from AGIThis is the amount deduct from AGI
If itemized > standard deductionIf itemized > standard deduction
In Class Exercise: Calculate the Miscellaneous 2% Amount
Valid business entertainment Valid business entertainment 8,000 8,000 Employee business expensesEmployee business expenses 7,500 7,500 Tax Preparation fee Tax Preparation fee 250 250 Management fee onManagement fee on
mutual stock fundmutual stock fund 1,900 1,900 TotalTotal 17,65017,650 Calculate final deduction if Calculate final deduction if
AGI = 100,000 OR 500,000AGI = 100,000 OR 500,000
Solution: In Class Exercise: The Miscellaneous 2% Amount
If AGI = 100,000If AGI = 100,000 Final deduction = 11,650Final deduction = 11,650 Reduce entertainment by 50%Reduce entertainment by 50% Deductions before 2% = 13,650Deductions before 2% = 13,650 2% of AGI = 2,0002% of AGI = 2,000 13,650 reduced to 11,65013,650 reduced to 11,650
In Class Exercise: Calculate the Miscellaneous 2% Amount
If AGI = 500,000 If AGI = 500,000 Final deduction = 3,650Final deduction = 3,650 2% of AGI = 10,0002% of AGI = 10,000
Reduce entertainment by 50%Reduce entertainment by 50% Deductions before 2% = 13,650Deductions before 2% = 13,650
13,650 reduced to 3,65013,650 reduced to 3,650 Use standard deduction if no other deductions Use standard deduction if no other deductions
from AGIfrom AGI
Personal and Dependency Exemptions
Key Learning Objectives
Personal exemptions Dependency exemptions
Personal Exemptions
2,800 per allowance--2000--for2,800 per allowance--2000--for Taxpayer Taxpayer And spouse if joint returnAnd spouse if joint return N/A if dependent on another's returnN/A if dependent on another's return
Dependency Exemptions
2,800 per allowance -- 20002,800 per allowance -- 2000 Meet all of 5 of following testsMeet all of 5 of following tests
SupportSupport Gross incomeGross income RelationshipRelationship Joint return testJoint return test Citizenship/residencyCitizenship/residency
Multiple Support AgreementsNo One Provides > 50% Support
Group, not individual, gives >50% of total Group, not individual, gives >50% of total supportsupport
Group can decide who gets exemptionGroup can decide who gets exemption Taxpayer getting deduction must have Taxpayer getting deduction must have
contributed at least 10% of total supportcontributed at least 10% of total support
Multiple Support AgreementsNo One Provides > 50% Support
Individual being claimed must not Individual being claimed must not Have too much gross income orHave too much gross income or Fail to meet Fail to meet
Joint return testJoint return test Citizenship/residency testCitizenship/residency test
Multiple Support AgreementsNo One Provides > 50% Support
Members of groups must meet relationship Members of groups must meet relationship testtest Relative orRelative or Non-relative dependent lives withNon-relative dependent lives with
In Class Exercise: Who Can Claim D? (1)
D, age 15, parents deceased, lives with D, age 15, parents deceased, lives with Grandparents Grandparents
D's support this year was provided as follows:D's support this year was provided as follows: Interest income--D’s accountInterest income--D’s account 1,000 1,000 Social security survivor's benefitsSocial security survivor's benefits 2,000 2,000 GrandparentsGrandparents 3,0003,000
6,0006,000
Solution--In Class Exercise: Who Can Claim D? (1)
D would claim self since no one provides D would claim self since no one provides more than 50 of D’s supportmore than 50 of D’s support
Note that most of D’s exemption is wasted Note that most of D’s exemption is wasted since D’s income is only 1,000since D’s income is only 1,000
Grandparents would have to spend an extra Grandparents would have to spend an extra dollar to claim Ddollar to claim D
In Class Exercise Who Can Claim D? (2)
D, age 15, parents deceased, lives with D, age 15, parents deceased, lives with Grandparents. D's support this year was Grandparents. D's support this year was provided as follows:provided as follows:
Interest income D’s accountInterest income D’s account 1,000 1,000 Social security survivor's benefitsSocial security survivor's benefits 2,000 2,000 Contributions by mother’s friend Contributions by mother’s friend 500 500 GrandparentsGrandparents 3,000 3,000
6,5006,500
Solution--In Class Exercise: Who Can Claim D? (2)
D would claim self since no one provides D would claim self since no one provides more than 50% of D’s supportmore than 50% of D’s support
Since D lives with grandparents, friend Since D lives with grandparents, friend cannot meet relationship test, so not part of cannot meet relationship test, so not part of groupgroup
Grandparents now need to spend $501 to Grandparents now need to spend $501 to get exemption get exemption
In Class Exercise Who Can Claim D? (3)
D, age 15, parents deceased, lives with D, age 15, parents deceased, lives with Grandparents. D's support this year was Grandparents. D's support this year was provided as follows:provided as follows:
Interest income D’s accountInterest income D’s account 1,000 1,000 Social security survivor's benefitsSocial security survivor's benefits 2,000 2,000 Uncle JoeUncle Joe 500 500 GrandparentsGrandparents 3,000 3,000
6,5006,500
Solution--In Class Exercise: Who Can Claim D? (3)
Only the grandparentsOnly the grandparents Grandparents and Uncle Joe are group since Grandparents and Uncle Joe are group since
they meet relationship testthey meet relationship test Uncle Joe doesn’t meet the 10% testUncle Joe doesn’t meet the 10% test
In Class Exercise Who Can Claim D? (4)
D, age 15, parents deceased, lives with D, age 15, parents deceased, lives with Grandparents. D's support this year was Grandparents. D's support this year was provided as follows:provided as follows:
Interest income, D’s accountInterest income, D’s account 3,000 3,000 Uncle JoeUncle Joe 1,000 1,000 GrandparentsGrandparents 3,000 3,000
7,0007,000
Solution--In Class Exercise: Who Can Claim D? (4)
Now either grandparents or Uncle JoeNow either grandparents or Uncle Joe Group must decide who gets exemptionGroup must decide who gets exemption The other members of the group must sign The other members of the group must sign
written waiver agreeing to not take written waiver agreeing to not take exemptionexemption Form 2120Form 2120
Phaseout of Exemptions and Reduction of Itemized Deductions
Key Learning Objectives
Phaseout of exemptions Reduction of itemized deductions
Phase Out of Exemptions The Steps To Follow
Calculate AGI, if < threshold stopCalculate AGI, if < threshold stop Calculate excess AGI Calculate excess AGI
AGI - ThresholdAGI - Threshold Divide by 2,500 Divide by 2,500
Round up for Round up for anyany fraction fraction
Multiply by 2%--this is the amount Multiply by 2%--this is the amount lostlost 1 - % = amount of exemptions allowed1 - % = amount of exemptions allowed
Threshold Amounts 2000
SingleSingle 128,950128,950 Head of householdHead of household 161,150 161,150 Married, jointMarried, joint 193,400 193,400 Married, separateMarried, separate 96,700 96,700
In Class Exercise: Phaseout of Exemptions
Part 1: Calculate AGI
W2 W2 170,000 170,000 Bank interest Bank interest 5,900 5,900 State bond interestState bond interest 4,500 4,500 Alimony Alimony paidpaid 5,0005,000
Solution--In Class ExercisePart 1: Calculate AGI
AGI = 170,900 [170,000 + 5,900 - 5,000]AGI = 170,900 [170,000 + 5,900 - 5,000] State bond interest excludedState bond interest excluded Alimony paid is deduction for AGIAlimony paid is deduction for AGI Now calculate taxable income IFNow calculate taxable income IF
SingleSingle Married, jointMarried, joint Head of HouseholdHead of Household
In each case, taxpayer gets two exemptionsIn each case, taxpayer gets two exemptions
Solution: In Class ExerciseSingle, Exemption Phaseout
AGIAGI 170,900170,900 THRESHOLDTHRESHOLD (128,950)(128,950) EXCESSEXCESS 41,950 41,950 ÷2,500÷2,500 16.78 -> 1716.78 -> 17 17 times 2% = loss amount (34%)17 times 2% = loss amount (34%) 1 - .34 = deduction amount (66%)1 - .34 = deduction amount (66%) Exemptions = 2,800 x 2 x .66 = 3,696Exemptions = 2,800 x 2 x .66 = 3,696
Solution: In Class ExerciseSingle, Taxable Income
AGI 170,900AGI 170,900 SD (4,400)SD (4,400) EXS EXS (3,696) (3,696) 2,800 x 2 x .662,800 x 2 x .66
TI TI 162,804162,804
Solution: In Class Exercise Married, Exemption Phaseout
AGIAGI 170,900 170,900 THRESHOLDTHRESHOLD (193,400)(193,400) EXCESSEXCESS N/A N/A
Exemptions = 2,800 x 2 = 5,600Exemptions = 2,800 x 2 = 5,600
Solution: In Class ExerciseMarried, Taxable Income
AGIAGI 170,900 170,900 SDSD (7,350) (7,350) EXSEXS (5,600 (5,600)) 2,800 x 2 2,800 x 2
TITI 157,950157,950
Solution: In Class Exercise Head, Exemption Phaseout
AGIAGI 170,900 170,900 THRESHOLDTHRESHOLD (161,150)(161,150) EXCESSEXCESS 9,750 9,750 ÷ 2,500÷ 2,500 3.9 = 43.9 = 4 4 times 2% = loss amount ( 8%)4 times 2% = loss amount ( 8%) 1 - .08= deduction amount (92%)1 - .08= deduction amount (92%) Exemptions = 2,800 x 2 x .92 = 5,152Exemptions = 2,800 x 2 x .92 = 5,152
Solution: In Class Exercise Head, Taxable Income
AGIAGI 170,900 170,900 STDSTD (6,450) (6,450) EXSEXS (5,152) (5,152) 2,800 x 2 x .922,800 x 2 x .92
TITI 159,298159,298
3% of AGI ReductionAll Itemized Deductions Except
MedicalMedical CasualtyCasualty Investment interest expenseInvestment interest expense Gambling lossesGambling losses
3% of AGI Reduction
Threshold is same as the exemption Threshold is same as the exemption phaseout for single filersphaseout for single filers
For 2000, threshold is 128,950For 2000, threshold is 128,950 Know which deduction it applies toKnow which deduction it applies to Know how to calculateKnow how to calculate
3% ReductionNever Reduces to Zero
Taxpayer always gets the largest ofTaxpayer always gets the largest of
(1) Limited - offset + unlimited(1) Limited - offset + unlimited
(2) 20% of limited + unlimited(2) 20% of limited + unlimited
(3) Standard deduction(3) Standard deduction
In Class Exercise: Itemized Deduction Phaseout (1) AGI 200,000 AGI 200,000 Mortgage interest paid = 10,000Mortgage interest paid = 10,000 What is the deduction from AGI?What is the deduction from AGI? Apply all other limits firstApply all other limits first
Reduce entertainment by 50% of costReduce entertainment by 50% of cost Reduce medical by 7.5% of AGIReduce medical by 7.5% of AGI Reduce miscellaneous by 2% of AGIReduce miscellaneous by 2% of AGI Reduce casualty loss by 10% of AGIReduce casualty loss by 10% of AGI
Solution: In Class Exercise: Itemized Deduction Phaseout (1)(1) Calculate the 3% Reduction
AGIAGI 200,000200,000 ThresholdThreshold 128,950 -128,950 --> same for all -> same for all ExcessExcess 71,05071,050 x .03x .03 ReductionReduction 2,132 2,132
Solution: In Class Exercise: Itemized Deduction Phaseout (1)
(2) Compare the 3 Limits Taxpayer gets the largest ofTaxpayer gets the largest of
((1) 10,000 - 1) 10,000 - 2,1322,132 7,868 7,868
(2) 20% of 10,000 (2) 20% of 10,000 2,000 2,000
(3) Standard deduction (3) Standard deduction 7,8687,868 > all standard deductions, so all filers > all standard deductions, so all filers
would use 7,868would use 7,868
In Class Exercise: Itemized Deduction Phaseout (2)
AGI 200,000 AGI 200,000 Medical expenses paid 20,000Medical expenses paid 20,000 What is the deduction from AGI?What is the deduction from AGI? Remember to apply all other limits before Remember to apply all other limits before
3% reduction3% reduction Medical reduced by 7.5% of AGIMedical reduced by 7.5% of AGI
Solution: In Class Exercise: Itemized Deduction Phaseout (2)(1) Calculate the 7.5% Reduction
Reduction = 200,000 x 0.075 = 15,000Reduction = 200,000 x 0.075 = 15,000
Medical Medical 20,000 20,000 Reduction Reduction (15,000)(15,000) Deductible Deductible 5,000 5,000
Solution: In Class Exercise: Itemized Deduction Phaseout (2)(2) Calculate the 3% Reduction
Medical is not 3% limited, SOMedical is not 3% limited, SO Taxpayer gets > Taxpayer gets >
(1) 5,000 (1) 5,000
(2) Standard deduction (2) Standard deduction Only single/married separate use 5,000Only single/married separate use 5,000 Others would use standard deduction Others would use standard deduction
In Class Exercise: Itemized Deduction Phaseout (3) AGI 200,000 AGI 200,000 Medical expenses paidMedical expenses paid 20,00020,000 Mortgage interest paidMortgage interest paid 10,000 10,000 What is the deduction from AGI?What is the deduction from AGI? Remember to apply all other limits before Remember to apply all other limits before
3% reduction3% reduction Medical reduced by 7.5% of AGIMedical reduced by 7.5% of AGI
Solution: In Class Exercise: Itemized Deduction Phaseout (3)
This is a combination of first two cases. This is a combination of first two cases. Here taxpayer gets largest ofHere taxpayer gets largest of
(1) 7,868 + 5,000 = 12,868(1) 7,868 + 5,000 = 12,868
(2) 2,000 + 5,000 = 7,000(2) 2,000 + 5,000 = 7,000
(3) Standard deduction (3) Standard deduction 12 ,868 > all standard deductions12 ,868 > all standard deductions All filers would use 12 ,868All filers would use 12 ,868
In Class Exercise: Itemized Deduction Phaseout (4)
AGI 200,000 AGI 200,000 Business Entertainment 52,000Business Entertainment 52,000 What is the deduction from AGI ?What is the deduction from AGI ? Remember to apply all other limits before 3% Remember to apply all other limits before 3%
reductionreduction Entertainment reduced by Entertainment reduced by
50% of each dollar50% of each dollar 2% of AGI2% of AGI
Solution: In Class Exercise: Itemized Deduction Phaseout (4)(1) Reduce Entertainment by Limits
Reduce entertainment by 50% Reduce entertainment by 50% 52,000 x .5 = 26,00052,000 x .5 = 26,000
Reduced entertainment by 2% of AGIReduced entertainment by 2% of AGI26,000 - [200,000 x .02] = 22,000 26,000 - [200,000 x .02] = 22,000
Solution: In Class Exercise: Itemized Deduction Phaseout (4)
(2) Apply 3% Offset Rules 3% reduction is still 2,1323% reduction is still 2,132
Taxpayer gets the largest ofTaxpayer gets the largest of
(1) 22,000 - (1) 22,000 - 2,1322,132 = 19,868 = 19,868
(2) 22,000 x .20 = 4,400(2) 22,000 x .20 = 4,400
(3) Standard deduction (3) Standard deduction 19,868 is > all standard deductionsAll filers 19,868 is > all standard deductionsAll filers
would use 19,868would use 19,868