Unit 3 - Deductions and Credits Flashcards
Standard Deduction
A specific dollar amount that reduces the amount of income on which a taxpayer is taxed.
The standard deduction amounts are based on a taxpayer’s filing status and are adjusted every year for
inflation.
Additional Standard Deduction
Available to taxpayers who are:
- 65 or older, and/or
- Blind or partially blind
The standard deduction is $1,500 higher for joint filers who are over 65 and/or blind, and $1,850 higher for unmarried taxpayers (Single and head of household)
A taxpayer who is both blind and 65 or older may take the basic standard deduction, as well as additional standard deduction amounts for both age and blindness.
Blindness
The additional amount for blindness is allowed if the taxpayer is blind on the last day of the year, even if the taxpayer was not blind the rest of the year. In order to qualify, the taxpayer must obtain a statement from an eye doctor stating that their vision cannot be corrected to better than 20/200 with eyeglasses or that their peripheral vision is limited to 20 degrees.
Standard Deduction (Deceased)
The standard deduction for a deceased taxpayer is the same as if the taxpayer had lived the entire year, with one exception: if a taxpayer dies before their 65th birthday, the higher standard deduction for being 65 does not apply.
Standard Deduction for Dependents
In 2023, the standard deduction for dependents is limited to the greater of: (1) $1,250, or (2) their earned income plus $400 (but the total cannot be more than the basic standard deduction for their filing status)
The standard deduction amount can be higher if the dependent happens to be 65 or older and/or blind.
If a dependent must file an income tax return but cannot file due to age or any other reason, the parent, guardian, or other legally responsible person, must file the return for the child.
If a child cannot sign their own return, the parent or guardian must sign the child’s name followed by the words: “By (parent’s signature), parent for minor child.”
Itemized Deductions
Itemized deductions may be taken in lieu of the standard deduction; they allow taxpayers to reduce their taxable income based on specific personal expenses. In most cases, taxpayers may choose whether to claim itemized deductions or the standard deduction, depending on which is more beneficial.
Itemized deductions are reported on Schedule A, Form 1040. Nonresident aliens can also claim a limited amount of itemized deductions on Schedule A, Form 1040-NR.
Taxpayers who are Required to Itemize
- MFS filers whose spouses itemize
- Nonresident Aliens
- Short tax year
Taxpayers who are Required to Itemize - MFS FILERS WHOSE SPOUSES ITEMIZE
If both spouses are filing MFS, and one spouse itemizes, the other spouse also must itemize (or else deduct $0 as a standard deduction)
Taxpayers who are Required to Itemize - NONRESIDENT ALIENS
If the taxpayer is a nonresident alien or dual-status alien filing Form 1040-NR (who is not married to a U.S. citizen or resident, and electing to be treated as a U.S. resident)
Taxpayers who are Required to Itemize - SHORT TAX YEAR
If the taxpayer files a tax return for a period of less than twelve months due to a change in accounting methods (this scenario would be extremely rare for an individual taxpayer).
Medical and Dental Expenses
Medical and dental expenses (other than self-employed health insurance premiums) are deductible only if a taxpayer itemizes deductions.
Qualifying expenses must be primarily to alleviate or prevent a physical or mental defect or illness.
A taxpayer may only deduct medical expenses they paid during the year, regardless of when the services were provided.
Qualified medical expenses include expenses paid for the taxpayer, their
spouse, and their dependents.
Taxpayers can deduct only the amount of unreimbursed medical expenses that exceed 7.5% of adjusted gross income (AGI).
Deductible Medical Expenses
- Fees paid to doctors, in-patient hospital care or nursing home services, including the cost of meals and lodging charged by the hospital or nursing home, acupuncture treatments, lactation supplies (breastfeeding supplies).
- Treatment centers for alcohol or drug addiction, participation in smoking-cessation programs and prescription drugs to alleviate nicotine withdrawal, weight-loss programs prescribed by a
physician (but not diet food items, such as weight-loss shakes). - Insulin and prescription drugs (but prescription drugs brought in or shipped from a different country are generally not deductible)
- Admission and transportation to a medical conference relating to a chronic disease (but the costs of meals and lodging while attending the conference are not deductible)
- Veterinary care when it relates to the care of animals trained to assist persons who are visually impaired, hearing-impaired, or disabled.
Medical and Dental Expenses - Qualifying Costs
The IRS defined qualifying costs as:
* Medically necessary equipment, supplies, and diagnostic devices,
* Dental and vision care,
* Transportation to obtain medical care,
* Qualified health insurance and long-term care insurance.
Medical and Dental Expenses - Dependent
The dependent must generally have been a dependent at the time the
medical services were provided or at the time the expenses were paid.
A parent can also deduct medical expenses paid on behalf of an adopted child, even before the adoption becomes final.
If a child of divorced or separated parents is claimed as a dependent on either parent’s return, each parent can deduct medical expenses they individually paid for the child. This is true even if the other parent claims the child’s dependency exemption. Basically, it does not matter which parent claims the child—the medical expenses are deductible for the parent who pays them.
A taxpayer can deduct medical expenses paid for a dependent parent. All the standard rules for a dependency exemption apply, so the dependent parent does not have to live with the taxpayer to qualify.
Medical Insurance
When a taxpayer receives insurance reimbursement for medical expenses,
they cannot deduct those amounts.
Only insurance premiums paid with after-tax dollars for medical and long-term care insurance can be considered as qualifying medical expenses.
Medical expenses reimbursed out of a health savings account (HSA) are not deductible, but contributions to HSAs may be deducted as an adjustment to gross income, and withdrawals from an HSA are tax-free as long as they are used to pay for qualifying medical costs.
Long-Term Care Premiums
A taxpayer may include amounts paid for qualified long-term care services and insurance premiums in his medical expense deductions.
The deductibility of costs of qualified long-term care premiums is limited by the age of the taxpayer.
The expenses generally cannot include costs that would be reimbursed under Medicare.
Long-term Care Services
Long-term care services include
necessary diagnostic, preventive, therapeutic, rehabilitative, maintenance, and personal care services that are required by a chronically ill individual and provided under a plan of care by a licensed doctor.
Other Medical Expenses
If a taxpayer or a dependent is in a nursing home, and the primary
reason for being there is medically related, the entire cost, including meals and lodging, is a medical
expense.
A taxpayer can deduct any legal fees necessary to authorize treatment for mental illness.
However, legal fees for the management of a guardianship estate or for conducting the affairs of a
person being treated are not deductible as medical expenses.
Medical Expenses of Deceased Taxpayers
In addition to expenses paid before a taxpayer’s death, a deceased taxpayer’s executor (or personal representative) can elect to treat medical expenses paid by the estate within one year after his death as if the taxpayer had paid when the medical services were provided.
In other words, an executor can elect to treat medical expenses as if they were paid at the time they were incurred, even if the expenses are paid the year after the taxpayer’s death
Cosmetic Surgery
Cosmetic surgery is only deductible if it is used to correct a defect or disease.
A cosmetic procedure simply for the enhancement of someone’s physical appearance is not a deductible medical expense.
Medically Related Transportation
Vehicle mileage may be deducted if
transportation is for medical reasons, such as trips to and from doctors’ appointments.
If a taxpayer uses his own car for medical transportation, he can deduct actual out-of-pocket expenses for gas and other expenses, or he can deduct the standard mileage rate for medical expenses.
A taxpayer can also deduct the costs of taxis, buses, trains, planes, or ambulances, as well as tolls
and parking fees.
Medically Related Meals and Lodging
A taxpayer can deduct the cost of meals and lodging at a hospital or similar institution if the principal reason for being there is to receive medical care.
The amount for lodging cannot be
more than $50 for each night for each person, although the taxpayer can include lodging for a person traveling with the person receiving the medical care, up to $100. The cost of meals is not included.
Capital Improvements for Medical Reasons
Capital improvements such as home improvements are usually not deductible.
However, a home improvement may qualify as a deductible expense if its
main purpose is to provide medical care to the taxpayer (or to family members).
The amount that can
be deducted for capital improvements is limited to the difference between the cost of the improvements and the corresponding rise in the home’s fair market value.
Tenants can deduct the entire cost of disability-related improvements, even if they are not the owners of the property.
Qualifying Home/Capital Improvements
Home improvements that qualify as deductible medical expenses may include:
* Wheelchair ramps
* Lowering of kitchen cabinets
* Railings and support bars
* Elevators
* Special lift equipment
State and Local Income Taxes (SALT)
Taxpayers can deduct certain taxes if they itemize deductions. In order to be deductible, a tax must have been imposed on the taxpayer and paid by the taxpayer during the tax year.
Deductible taxes include:
- State, local, and foreign income taxes,
- State and local sales taxes,
- Real estate taxes (but not for foreign real estate),
- Personal property taxes (such as the portion of DMV fees based on the value of the car).
The Tax Cuts and Jobs Act instituted a temporary cap on state and local taxes (also called the “SALT cap”). This deduction is capped at $10,000 ($5,000 for MFS filers) until 2025.
State and Local Taxes
Taxpayers are allowed to deduct either sales/use taxes or state and local
income taxes, depending on which provides the larger deduction, but not both.
Income taxes paid include taxes withheld from salaries and wages, amounts paid for prior years, and estimated tax payments.
Real Estate Taxes
State and local real estate taxes, based on the assessed value of the taxpayer’s
real property (such as a house or land), are deductible.
If the taxes are paid from a mortgage escrow account, the taxpayer can deduct only the amount actually paid out of the escrow account during the
year to the taxing authority.
Some real estate taxes are not deductible, including taxes imposed to finance improvements of property, such as assessments for streets, sidewalks, and sewer lines. In addition, itemized charges for services and homeowner’s association fees are not deductible.
Personal Property Taxes (including DMV Fees)
Personal property taxes for individuals are deductible if they are:
- Charged on personal property, including cars, motorcycles and boats;
- Based on the value of the property; and
- Charged on a yearly basis, even if collected more than once a year.
Escrow accounts
If a portion of the taxpayer’s monthly mortgage payment goes into an escrow account, and periodically the lender pays the real estate taxes out of the account to the local government, the taxpayer is only allowed to deduct the amount that was actually paid out of the escrow account during the year to the taxing authority.
Foreign Income Taxes
Generally, a taxpayer can choose between claiming the Foreign Tax Credit or claiming an itemized deduction on Schedule A for income taxes paid to a foreign country, depending on which option results in the lowest tax.
Foreign income taxes are not subject to the “SALT cap.”
Deductible Interest
Taxpayers are allowed to deduct certain types of interest. Qualified interest payments are deductible as itemized deductions on Form 1040, Schedule A. Deductible interest includes:
- Home mortgage interest,
- Late fees on a mortgage loan,
- Points on a mortgage loan,
- Investment interest expense.
Home Mortgage Interest
A taxpayer is allowed to deduct the mortgage interest related to a primary residence and a second home. The loan must be secured by the taxpayer’s home, in order for the interest to be deductible. The loan may be a mortgage, a second mortgage, a home equity loan, or a line of credit.
The maximum amount of qualified acquisition Indebtedness secured by a qualified primary or secondary residence to allow a full deduction for home mortgage interest is $750,000 in 2023 ($375,000 for MFS).
Interest paid on debt related to a primary and secondary residence is only tax deductible if the proceeds from the loan were used to acquire, build, or significantly enhance the main home. For instance, if a taxpayer takes out a $250,000 home equity line of credit and uses all of it towards
improving their home, the entire amount would qualify for the mortgage interest deduction. This
dollar limit also applies to construction debt, such as home renovations.
Late fees and pre-payment penalties incurred on a mortgage loan are also deductible as mortgage interest on Schedule A.
A second home can include any other residence a taxpayer owns and treats as a home, but the taxpayer does not have to actually use the second home during the year to deduct the mortgage interest paid on the related loan.
Home Mortgage Interest - Vacant Land
A vacant piece of land is not eligible for the mortgage interest deduction. However, if a taxpayer constructs a house that meets the requirements of a qualified home once it is ready to be lived in, they can deduct mortgage interest for a period of up to 24 months from when construction begins.
Mortgage Insurance Premiums (PMI)
Taxpayers can no longer claim the deduction for 2023 and going forward.
Mortgage insurance premiums paid during the year are reported to the taxpayer on Form 1098, Mortgage Interest Statement, by the bank or financial institution that received the payments.
Points and Prepaid Mortgage Interest
Points are interest charges a borrower pays up-front to obtain a loan.
Points generally represent prepaid interest a borrower pays at closing to obtain a lower interest rate. Points may also be called loan origination fees, including VA and FHA fees, maximum loan charges, premium charges, loan discount points, or prepaid interest.
Loan fees paid for specific services, such as home appraisal fees, document preparation fees, or notary fees are not interest and are not deductible.
Point Deduction Requirements
In order to deduct points, the following requirements must be met:
- The mortgage must be secured by the taxpayer’s main home, and the mortgage must have been used to buy, build, or improve the home.
- The points must not be an excessive or unusual amount.
- The points paid must not be more than the amount of unborrowed funds.
- The points must be computed as a percentage of the loan principal, and they must be listed on the settlement statement (the HUD-1).
If all these requirements are met, the taxpayer can deduct points in connection with the acquisition
or construction of the home either in the year paid or over the life of the loan.
Tax law treats “purchase” mortgage points differently from “refinance” mortgage points. Points paid to refinance a mortgage are generally not fully deductible in the year paid and must be deducted over the life of the loan unless the proceeds are used to improve a main home.
A second home or vacation home would not qualify for this exception.
Investment Interest Expense
Investment interest expense is defined as any interest paid on loans used to purchase taxable investments.
If a taxpayer takes out a loan to purchase investment property, such as stocks, the interest paid on that loan can be considered as investment interest expense and may be eligible for deduction. The deductible amount is limited to the net investment income earned in a given year, but any unused
portion can be carried over to the following year.
The deductible amount of investment interest expense and any disallowed amount that may be carried over to the following year are calculated on Form 4952, Investment Interest Expense Deduction.
A taxpayer cannot deduct interest related to passive activities or incurred to produce tax-exempt income (such as state and local bonds that generate tax-exempt interest income) as investment interest expense.
Nondeductible Interest and Investment Expenses
The following expenses cannot be deducted as investment interest:
- Interest on personal loans, such as car loans
- Fees for credit cards and finance charges for nonbusiness credit card purchases
- Loan fees for services needed to get a loan
- Interest on debt the taxpayer is not legally obligated to pay
- Service charges (such as monthly account fees, ATM fees, and foreign transaction fees).
- Interest to purchase or carry tax-exempt securities
- Late payment charges paid to a public utility
- Expenses relating to stockholders’ meetings or investment-related seminars
- Interest expenses from single-premium life insurance and annuity contracts
- Interest incurred from borrowing against a life insurance policy
- Fines and penalties paid to any government entity for violations of the law
Charitable Contributions
For the tax years 2023 and 2024,
individuals can deduct up to 60% of their adjusted gross income in cash contributions.
Different AGI limits apply to contributions of property
A donation can only be deducted in the year it was actually made.
Charity Contribution Limits
In 2023, taxpayers can elect to deduct cash contributions up to 60% of adjusted gross income. The 60%-of-AGI limit applies to cash contributions only—not real estate, not stocks, not furniture, or any other type of noncash donations.
A property contribution may be limited to 50%, 30%, or 20% of AGI, depending on the type of property donated and the type of organization the donor gives it to.
Charitable contributions cannot generate a net operating loss. Excess contributions that exceed a
taxpayer’s AGI may be carried over and deducted over a 5-year period. Carryovers are subject to the same percentage limits in the year to which they are carried.
60% Limit
In 2023, a 60%-of-AGI limit applies to cash contributions to a public charity,
specifically, 501(c)(3) organizations. These are called “qualified cash contributions.”
Contributions of noncash property do not qualify for this limit.
The 60%-of-AGI contribution limit applies to cash contributions made to 501(c)(3) charities, including:
- Churches, mosques, synagogues, and similar religious organizations,
- Hospitals, and most schools and colleges,
- State or federal government entities,
- Nonprofits organized solely for charitable, religious, educational, scientific, or literary purposes
or for the prevention of cruelty to children or animals, - Organizations that foster youth sports, or national or international amateur sports competitions (examples include: Little League Baseball, the Olympics, Special Olympics, and the Paralympic Games).
50% Limit
This limit applies to most noncash contributions to public charities. Examples of noncash contributions include furniture, clothing, and housewares. This limit also applies to
gifts of inventory and depreciable property, such as machinery and vehicles. This limit also applies to most conservation easements.
30% Limit
This limit applies to donations of most appreciated capital gain property
(property that would have resulted in a long-term capital gain if sold instead of donated) where the donor can claim the FMV as a deduction. Common examples include stock, cryptocurrency, land, or other real estate that has appreciated in value.
The 30% limit applies to organizations that include the following:
- Certain private nonoperating foundations,
- Veterans’ organizations and fraternal benefit societies (such as the Knights of Columbus, Odd
Fellows, and the Shriners), - Nonprofit cemeteries.
In addition, a separate 30% limit applies in the following cases:
- Gifts for use by the charitable organization (such as the donation of a vehicle the organization
uses for itself), - Gifts of appreciated capital gain property.
20% Limit
This limit applies specifically to gifts of appreciated capital gain property to
most private nonoperating foundations and certain other non-public charities.
The 20% limit applies to contributions of capital gain property to organizations subject to the 30%
limit (such as most private nonoperating foundations).
Charity Contribution Carryovers
To the extent a taxpayer’s deductions for contributions are limited; they may be carried over to subsequent years. The carryover period is generally limited to five years.
Any carryover amounts that
cannot be deducted within five years due to AGI limits are lost.
Any contributions made by the taxpayer and carried over to future years retain their original character. For example, contributions made to a 30% organization continue to be subject to the 30%-of-AGI limit in future years.
