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DEDUCTIONS A. Personal Deductions i. Above the Line Deductions (SS62) a. These are best thought of as inputs into the income production, so that gross income minus these deductions gets you net income. Also a few other things, like alimony, retirement savings and student loan interest payments. Other deductions are more about policy goals. b. Trade and business Deductions not conducted as an employee (SS62(a)(1)): c. Reimbursed employee expenses (SS62(a)(2)): d. Other stuff we didn't cover, including: certain expenses of performing artists; Certain expenses of school teachers; Certain expenses of armed forces members; losses from sale or exchange of property; rents and royalty on income-producing property; depreciation for life tenancies in property; pension and annuity plans; retirement savings; penalties from early withdrawal from CD or other account; moving expenses; higher ed loan interest; costs involving discrimination suits; health savings accounts; e. Higher education expenses (SS222) f. Requirements for reimbursement expenses under SS62(d) o Employee must be required to substantiate the expense ii. Standard Deduction (SS63) a. Most people take standard deduction (about 2/3 of filers). For 2011 it is $5,800 for single or married-filing-separately; $11,600 for married couple, $8,500 for HOH. b. Includes basic SD + additional SD (aged and blind) + disaster loss deduction and motor vehicle sales tax deduction c. SS63(c)(5) limits amount of standard deduction available to individuals who are claimed by others as dependents. iii. Itemized Deductions a. Taken from AGI as an alternative to standard deductions. Itemized deductions include all allowable deductions other than SS62 "above the line deductions" and personal exemptions. b. These are the itemized deductions that SS67 lists as NOT miscellaneous: Interest (163), Taxes (164), Property Losses (165), Charitable contributions (170 and 642), Medical (213), Impairment-related work expenses, Estate tax (691), personal property short sale, claim of right restoration (1341), certain annuity payment issues (72b3), amortizable bond premia (171), housing co-ops (216). c. Most important itemized deductions are charitable contributions, certain interest payments, certain state and local taxes, casualty losses, medical expenses and miscellaneous. d. Miscellaneous Itemized Deductions---a subset of itemized deductions o Only allowed to the extent that they exceed 2% of AGI o Everything other than the enumerated non-misc itemized in
o Practically, the main ones are expenses associate w/
investment activities (e.g., advice, safe-deposit boxes); expenses associated w/ preparing tax returns and defending them; unreimbursed employee business expenses (e.g., journal subscriptions) e. Reduction of Itemized Deductions (SS68(a)) o Note: temporarily suspended through 2012 o If taxpayer's AGI exceeds $166,800 threshold (adjusted for inflation), then the amount of itemized deductions is reduced by the lesser of (80% of the itemized deductions), or (3% of the amount by which AGI exceeds the threshold). o **Note, since most high-income taxpayers have substantial amounts of itemized deductions (at least taxes paid and mortgage interest), the real effect of this is to increase the marginal effective tax rate by 3%. Because each extra dollar of income by which you exceed the threshold effectively knocks 3 cents off of how much you can deduct, so you only keep .97*(1-marginal tax rate). So if you're in 25% tax bracket and have AGI above threshold, this effectively raises your marginal rate to 25.75%, assuming you have some itemized iv. Charitable Contributions a. Overview: o Not miscellaneous itemized deductions---not subject to 2%
floor (SS67) o To be deductible, donation must be a gift (cannot receive anything in value in return) to a qualified donee b. Return Benefit (Rev Ruling 67-246): You can only deduct the excess of the gift over the FMV of any return benefit. So if you give $100 to PBS and get tote bag worth $15, its an $85 deduction. c. Qualified Donee: (SS170(c)): include federal, state, local governments, or a corporation, trust, or community chest, fund, or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals. o Qualification is unrelated to the tax treatment of the donee organization (i.e., whether it is a SS501(c)(3)). o BUT organizations that do political stuff (watch out for words like "advocacy group") are not eligible (SS170(c)(2) (D)): groups that are disqualified for tax exemption under
SS501(c)(3) for attempting to influence legislation, or participating, or intervening in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. d. Appreciated Property: If you donate appreciated property (e.g., real estate or stock), neither donor nor donee pays capital gains on
appreciation. The amount of the deduction is the FMV of the property (SS1.170A-1(c)(1)). o Conditions (SS170(e)): Only get basis, not FMV, if these three not met:
? Must have been eligible for long-term gain. If it would have been short-term gain had he sold it, only gets basis deduction.
? For tangible personal property, the property is related to the charity's tax-exempt purpose, and
? e.g., antique furniture deductible at FMV to furniture museum, but only at basis to an elementary school o Policy: maybe encourages donations. e. Limits (SS170(b)): o Individuals:
? Cash: can only claim deductions for cash contributions up to 50% of AGI (or up to 30% if to private foundation) SS170(b)
? Appreciated property: Gifts of art, stock, etc, only up to 30% of AGI (or 20% if given to private foundations).
? There's a carryover provision in SS170(d)(1) o Corporations (SS170(b)(2)): deductions cannot exceed 10%
of taxable income. But the excess can be carried forward for 15 years
? Taxable income is computed without regard to donations, or Part VIII (p. 253 in supplement) corporate special deductions. o Donation of services: Are never tax-deductible (Reg.
? Lary v Untied States (11th Cir 1968, p 368): Taxpayer tried to claim deduction for donating blood. Court says not deductible. Need not decide whether property or services. Services never deductible. If property, could only deduct adjusted basis ($0). o Partial property interests: A contribution of less than the taxpayer's entire interest in property is allowable as deduction only to the extent that the value of that interest would be allowable if it had been transferred in trust. f. Substantiation (SS170(f)(8)): Deductions for $250 or more require a substantiation acknowledgment statement, unless the donee reports the contribution on its return. o Appraisal: Special appraisal for donated property with claimed value of more than $5,000. (SS170(f)(11)(C)). Goal is to prevent fraudulent claims of really high donations.
g. Hernandez v Commissioner (US 1989, p 449): Church of Scientology offers courses to help ppl become auditors, charges tuition (church members who register early get 5% discount). o Court: not deductible charitable contributions b/c there's a quid pro quo. Discount was indicium of transactional, rather than philanthropic nature of price. o O'Connor dissent now cited as binding. Religion is different from everything else. B/c he's receiving a spiritual benefit and b/c there is no similar course offered in the market based on which you could determine FMV of return benefit, you can't separate out the gift from the return benefit.
? SS170(f)(8)(B)(iii): Statement from organization that benefit consists solely of intangible religious benefits counts as substantiation. v. Medical Expenses (SS213) a. In general: Taxpayer can deduct medical expenses incurred for himself, spouse, or dependent within the tax year and not reimbursed by insurance or otherwise, to the extent that such expenses exceed 7.5% of AGI. This does not count toward 2%
floor for miscellaneous itemized. o Covers only expenses Paid during that year, regardless of when the bill was incurred (Reg. SS1.213-1(a)(1)). b. Covered expenses: o Include diagnosis, cure, mitigation, treatment, or prevention of disease, "or for the purpose for affecting any structure or function of the body," transportation, qualified long-term care, and insurance. o Includes both mental and physical health (unlike excludable damages for personal injury) o Does not include cosmetic surgery "unless the surgery or procedure is necessary to ameliorate a deformity arising form, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease." (SS213(d)(9)).
? Defines cosmetic surgery as any procedure directed at improving the patient's appearance and does not meaningfully promote the proper function of the body or prevent or treat illness or disease.
? Note: movie stars cannot deduct cosmetic surgery as a business expense---too hard to separate out which part is personal vs for producing income. o Does not include an expenditure which is merely beneficial to the general health of an individual, such as expenditure for a vacation (Reg SS1.213-1(e)(1)). o Can never deduct non-prescription drugs c. Transportation; If "primarily for and essential to" covered medical care (SS213(d)(1)(B)).
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