Prof Myles Bassell
Individual Deductions
Learning objectives
1.
2.
3.
Identify the common deductions necessary
for calculating adjusted gross income (AGI)
Describe the different types of itemized
deductions available to individuals and
compute itemized deductions
Explain the operation of the standard
deduction, determine the deduction for
personal and dependency exemptions, and
compute taxable income
6-2
Deductions for AGI
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Three categories of deductions for AGI
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Directly related to business activities
Indirectly related to business activities
Deductions subsidizing specific activities
6-3
Deductions for AGI
Directly Related to Business Activities
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Taxpayers are allowed to deduct expenses
incurred to generate business income
For tax purposes activities are either
profit-motivated or
motivated by personal objectives
Profit-motivated activities are classified as
1.
2.
business activities (called “trade or business”) or
investment activities
6-4
Deductions for AGI

Although both are motivated primarily by profit,
business activities are distinguished from
investment activities:
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
Trade or Business activities require a relatively high
involvement or effort from the taxpayer where as
investment activities don’t require
Investment activities involve investing in property for
appreciation or for income payments
6-5
Deductions for AGI
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Trade or Business Expenses must be:
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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
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Revenues from the same activity are also reported on
the same Schedule C
The net income or loss from Schedule C is transferred
to Form 1040 (page 1) on line 12
6-6
Deductions for AGI

Rental & Royalty Expenses
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Claimed above the line (for AGI)
Could either be an investment activity or a trade
activity depending on facts
Taxpayers report expenses and revenue on Schedule
E and transfer the net income or loss from Schedule E
to Form 1040 (page 1), line 17
Flow-through Entities

Expenses and losses incurred by a flow-through entity
pass through to the entity owners who typically report
these amounts on Schedule E and Line 17
6-7
Deductions for AGI

Losses
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Taxpayers disposing of trade or business assets at a
loss 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 a
net capital loss
A net capital loss is deducted for AGI but limited to
$3,000. Losses in excess of the $3,000 limit are
carried forward indefinitely to subsequent years
6-8
Deductions for AGI
Deductions indirectly Related to Business
Activities
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The cost of moving personal possessions is not
a direct cost of doing business or being
employed
Moving Expenses are deductible for AGI if the
move meets two tests
1.
2.
A distance test
A business test associated with a move
6-9
Deductions for AGI

Distance test – the new job site must extend existing
commute by 50 miles

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A new job site is required, but a new employer is not
essential
Business test - Taxpayer must be employed at least
39 of 52 weeks or be self-employed for 78 of the 104
weeks following the move
Taxpayers are allowed to deduct a mileage rate in lieu
of the actual costs of driving their personal
automobiles during the move (19 cents per mile in
2011)
6-10
Deductions for AGI
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Health Insurance deduction by Self-Employed
Taxpayers
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Deduction provides equity with employees who
receive health insurance as a qualified fringe benefit
Insurance must be provided for taxpayer or
dependents who are not eligible for employerprovided health insurance
Penalty for early withdrawals of savings

Reduces the taxpayer’s net interest income to the
amount actually received
6-11
Deductions for AGI
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SE Tax Deduction
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Employer and employees each pay one-half of
employee’s Social Security tax
Employers deduct the portion of Social Security taxes
they pay for employees
Self-employed individuals are required to pay SE tax
in lieu of Social Security tax
Self-employed tax payers are allowed to deduct onehalf of the SE tax they pay to compensate for
employers deducting their portion of Social Security
6-12
Deductions for AGI
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Alimony payments are deductible for AGI to
maintain equity
Contributions to a qualified retirement
account are deductible for AGI to encourage
savings
Interest expense on qualified educational
loans
Qualified educational expenses
6-13
Deductions for AGI

Deduction for Interest expense on loans used to
fund qualified educational expenses
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Up to $2,500 of interest on education loans is
deductible for AGI
The interest deduction is phased-out for taxpayers
with AGI exceeding $60,000 ($120,000 filing joint)
The deduction is eliminated for taxpayers with AGI
exceeding $75,000 ($150,000 filing joint)
6-14
Deductions from AGI: Itemized
Deductions
Medical Expenses
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Taxpayers may deduct medical expenses incurred to
treat themselves, their spouse, and their dependents
Qualifying medical expenses include unreimbursed
payments for care, prevention, diagnosis or cure of
injury, disease, or bodily function
Taxpayers using personal automobiles for medical
transportation purposes may deduct a standard
mileage allowance (19 cents per mile in 2011) in lieu
of actual costs
6-15
Deductions from AGI: Itemized
Deductions

Hospitals and Long-term Care Facilities
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Taxpayers may deduct the costs of actual medical
care whether the care is provided at hospitals or other
long-term care facilities
Medical Expenses Deduction Limitation

It is limited to the amount of unreimbursed qualifying
medical expenses paid during the year which is
reduced by 7.5% of the taxpayers AGI
6-16
Deductions from AGI: Itemized
Deductions
Taxes

Individuals may deduct itemized deductions
payments for following taxes
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State, local, and foreign income taxes
Real estate taxes on property held for personal or
investment purposes
Personal property taxes that are assessed on the value
of the specific property
Sales Tax deduction

State and local sales taxes can be deducted in lieu of
state and local income taxes
6-17
Deductions from AGI: Itemized
Deductions

Interest

Two itemized deductions for interest expense:


Deduction of investment interest is limited to a
taxpayer’s net investment income
Any investment interest in excess of the net
investment income limitation carries forward to the
subsequent year
Home mortgage interest
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Interest on acquisition indebtedness of $1million
Interest on home equity debt of $100K
6-18
Deductions from AGI: Itemized
Deductions
Charitable Contributions
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Contribution of money or property must be made
to a qualified charity

Special rules apply to charitable contributions of
property depending on the type of property:
 Capital gain property
 Ordinary income property
6-19
Deductions from AGI: Itemized
Deductions
Casualty and theft losses on personal-use
assets
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The amount of the tax loss from any specific
casualty event (including theft) is the lesser of
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decline in value of the property caused by the
casualty or
taxpayer’s tax basis in the damaged or stolen asset
6-20
Deductions from AGI: Itemized
Deductions
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Casualty Loss Deduction Floor Limitations

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It must exceed two separate floor limitations to
qualify as itemized deductions
 $100 for each casualty during the year
 10 percent of AGI floor limit applied to the sum of
all casualty losses for the year (after applying the
$100 floor)
In other words, the itemized deduction is the
aggregate amount of casualty losses that exceeds 10
percent of AGI
6-21
Deductions from AGI: Itemized
Deductions

Miscellaneous Itemized Deductions Subject
to AGI Floor
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Employee Business Expenses
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Travel and transportation
Employee expense reimbursements
Investment Expenses
Tax Preparation Fees
Hobby losses
Total miscellaneous itemized deductions are
subject to a 2 percent of AGI floor limit
6-22
Itemized Deductions and the
Standard Deduction
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Miscellaneous Itemized Deductions Not
Subject to AGI Floor
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Individuals include all gambling winnings for the
year in gross income and deduct gambling losses
to the extent of gambling winnings for the year
Standard Deductions

Taxpayers generally deduct the greater of their
standard deduction or their itemized deductions
6-23
Standard Deductions & Exemptions
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Bunching Itemized Deductions
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Tax benefit can be gained by implementing simple
timing tax-planning strategy
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Taxpayers with itemized deductions that fall just short
of the standard deduction amount
These itemized deductions do not produce any tax
benefit
Rather than deduct the standard deduction every
year time deductions (when possible) to bunch
together in one year
6-24