exam 2 chapter 6
3. Investment Interest
"Investment Interest Expense": Interest paid on loans used to purchase investment assets such as stocks, bonds, or land. 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.
When a dependent files his/her own tax return, the basic standard deduction is the greater of:
$1,050 - OR - $350 + earned income *Note: The basic standard deduction chosen above cannot exceed the BSD available to all taxpayers (chart on previous slide). *ASD amounts for age and/or blindness are still available in addition to the BSD.
Mike paid $4,000 of interest on a qualified education loan that he used to pay for his dependent son's college education. How much of this payment can Mike deduct as a for AGI deduction if he files married-joint and reports modified AGI of $150,000?
$1,250 Since Mike files married-joint and reports a modified AGI of over $135,000, the maximum deduction of $2,500 is reduced to $1,250 calculated as follows: ($2,500 maximum deduction - ($2,500 × (($150,000 AGI - $135,000)/$30,000))) = $2,500 - ($2,500 × (15,000/$30,000)) = $1,250).
c. Lionel's AGI before deducting interest on higher-education loans is $90,000.
(90,000-65,000)/15,000 = over 100% 1530 * 100% = 1530 1530 - 1530 = 0 deduction
The deduction for qualified business income cannot exceed the greater of:
(i) 50 percent of the wages paid with respect to the qualified trade or businesses, or (ii) the sum of 25 of percent of the wages with respect to the qualified trade or businesses plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property in the qualified trade or businesses. However, the wage-based limits only apply to taxpayers with taxable income in excess of $157,500 ($315,000, in the case of a joint return)). Because Roquan's taxable income (before the deduction for qualified business income) is less than $157,500, the wage-based limits do not apply. Thus, Roquan may deduct $18,000 ($90,000 net business income x 20%) as a deduction for qualified business income. Note that because Roquan has no capital gains or qualified dividends and his taxable income ($100,000) is greater than his qualified business income ($90,000), the taxable income limitation does not apply.
Deduction is limited by a "cap" the depends on when the indebtedness originates (one of the tax reform changes):
- Interest on acquisition indebtedness of $1 million if incurred before December 15, 2017 - Interest on acquisition indebtedness of $750,000 if incurred on or after December 15, 2017
Simon lost $6,900 gambling this year on a trip to Las Vegas. In addition, he paid $2,340 to his broker for managing his $234,000 portfolio and $1,485 to his accountant for preparing his tax return. In addition, Simon incurred $3,200 in transportation costs commuting back and forth from his home to his employer's office, which were not reimbursed. Calculate the amount of these expenses that Simon is able to deduct (assuming he itemizes his deductions).
0 $0. Gambling losses are only deductible to the extent of gambling winnings. Thus, Simon cannot deduct any of the $6,900 gambling losses. Unfortunately, the investment expenses, tax return fees, and commuting expenses are also nondeductible.
a. Stephanie reported $1,450 of earnings from her babysitting.
1,800 Stephanie can claim a standard deduction of $1,800, the greater of the minimum standard deduction ($1,050) or $350 plus her earned income ($1,450).
c. Stephanie reported $19,645 of earnings from her babysitting.
12,000 Stephanie can claim a standard deduction of $12,000, the greater of the minimum standard deduction ($1,050) or $350 plus her earned income but limited to the maximum standard deduction for her filing status, (single is $12,000 for 2018).
b. Stephanie reported $2,580 of earnings from her babysitting.
2930 Stephanie can claim a standard deduction of $2,930, the greater of the minimum standard deduction ($1,050) or $350 plus her earned income ($2,580).
This year, Randy paid $28,450 of interest on his residence. (Randy borrowed $504,000 to buy his residence, which is currently worth $560,000.) Randy also paid $2,650 of interest on his car loan and $4,425 of margin interest to his stockbroker (investment interest expense). How much of this interest expense can Randy deduct as an itemized deduction under the following circumstances? a. Randy received $2,320 of interest this year and no other investment income or expenses. His AGI is $75,000.
30,770 28450 +2320 =30770 Randy can deduct $30,770. The interest on the car loan is nondeductible personal interest but Randy may deduct all $28,450 of his interest on the home loan as an itemized deduction. The $4,425 of investment interest expense is limited to net investment income. Because the $2,320 of interest income qualifies as investment income and Randy has no deductible investment expenses, the investment interest expense would be limited to his $2,320 in net investment income. Randy would carry forward $2,105 to next year.
b. Suppose that Simpson was reimbursed for $250 of the physician's charges and $1,200 for the hospital costs. Calculate the amount of medical expenses that will be included with Simpson's itemized deductions after any applicable limitations.
5,125 Same as a. except Simpson's medical expenses are first reduced by reimbursements $11,765 less $1,450 then reduced by the floor limit $5,190 (7.5 percent × 69,200) = $5,125 and this amount is included with Simpson's other itemized deductions.
Simpson, age 45, is a single individual who is employed full-time by Duff Corporation. This year Simpson reports AGI of $69,200 and has incurred the following medical expenses: Dentist charges 1,600 Physician charges 2,450 Optical charges 875 Cost of eyeglasses 715 Hospital charges 4,350 Prescription drugs 575 Over-the-counter drugs 820 Medical insurance premiums 1,200 a. Calculate the amount of medical expenses that will be included with Simpson's itemized deductions after any applicable limitations.
6,575 All expenses are qualified medical expenses except for the over-the-counter drugs. Hence, Simpson's medical expense deduction is $11,765 less $5,190 (7.5 percent × 69,200) = $6,575 and this amount is included with Simpson's other itemized deductions.
b. Lionel's AGI before deducting interest on higher-education loans is $74,000.
Agi of 74,000 amount of interest paid up to 2,500 * phase out percentage =x amount paid - x 1530 * 60% [(74,000 - 65,000) / 15,000] = 918 1530 - 918 = 612
6. Penalty for Early Withdrawal of Savings
Allowed a deduction "for" AGI for any interest income an individual forfeits to a bank as a penalty for prematurely withdrawing a certificate of deposit.
Standard Deduction of Someone Being Claimed as a Dependent
An individual who is claimed as a dependent on another person's tax return can still file his/her own tax return.
4. Capital Losses
As discussed in Chapter 4, net capital losses are deducted "for" AGI, but limited to $3,000 per tax year. Net capital losses in excess of the $3,000 limit are carried-forward indefinitely to subsequent years. Reported on Schedule D.
The beauty parlor salaries and expenses are deductible on Schedule C as business expenses and the depreciation and real estate taxes for the apartment building are deductible for AGI as rental/royalty related deductions. The interest income is included in AGI, and the alimony expense is deductible for AGI. Note that this solution assumes that the apartment building amounts represent Betty's interest and not the total. The residential real estate taxes and the charitable contributions are itemized deductions.
Betty would owe $2,596 in self-employment tax ($18,370 salon income × 92.35% × 15.3% = $2,596). Of the $2,596, $1,298 ($18,370 × 92.35% × 7.65%) would be deductible as a for AGI deduction
Taxpayers may also deduct the cost of transportation for charitable purposes. When taxpayers use their personal vehicle for charitable transportation purposes, they are allowed to deduct a standard mileage allowance for each mile driven (14 cents per mile for 2018). Taxpayers are NOT allowed to deduct the value of the services they provide for charities.
Charitable contributions of cash (including cost of transportation, above) to qualified public charities and private operating foundations is limited to a 60 % of AGI "ceiling". If contributions exceed AGI ceiling limitation for the year, excess contributions can be carried-forward for 5 years. In the subsequent years, current year contributions must be used first, then carry forward amounts are used on a FIFO basis (oldest first) until the AGI ceiling is reached.
5. Charitable Contributions
Contribution of money or property must be made to a qualified charity. Usually include organizations that engage in educational, religious, scientific, or other public activities/service. Note: Political and campaign contributions are NOT deductible.
8. Alimony Payments
Deductible "for" AGI by the payor, if the criteria outlined in Chapter 5 are met. For divorce decrees executed before 2019 (see details we discussed in Chapter 5).
c. Clem paid self-employment tax of $21,200 (the employer portion is $10,600), and Wanda had $4,600 of Social Security taxes withheld from her pay.
Deductible amount for AGI= 10600 $10,600 − The employer portion of the self-employment tax is deductible for AGI but the Social Security tax is not deductible.
b. Clem and Wanda own a garage downtown that they rent to a local business for storage. This year they incurred expenses of $1,590 in utilities and $905 in depreciation.
Deductible amount for AGI= 2495 $2,495 − The utilities and depreciation are deductible for AGI (rental activity).
a. Clem is self-employed and this year he incurred $875 in expenses for tools and supplies related to his job. Since neither were covered by a qualified health plan, Wanda paid health insurance premiums of $3,660 to provide coverage for herself and Clem (not through an exchange).
Deductible amount for AGI= 4535 $4,535 − The tools and supplies and the health insurance are deductible for AGI.
Lionel is an unmarried law student at State University Law School, a qualified educational institution. This year Lionel borrowed $25,500 from County Bank and paid interest of $1,530. Lionel used the loan proceeds to pay his law school tuition. Calculate the amounts Lionel can deduct for interest on higher-education loans under the following circumstances: a. Lionel's AGI before deducting interest on higher-education loans is $50,000.
Deductible interest expense = 1530 The maximum interest deduction is the amount paid up to $2,500. The deduction is phased out as AGI exceeds $65,000 (before applying the interest deduction). Consequently, because his AGI is below the trigger amount for the phase-out, Lionel can deduct $1,530, which is the lesser of (1) $2,500 or (2) $1,530 (the amount of interest expense he paid).
Dan has AGI of $50,000 and paid the following taxes during this tax year. State income tax withholding $ 1,175 State income tax estimated payments 640 Federal income tax withholding 2,975 Social Security tax withheld from wage 1,840 State excise tax on liquor 370 Automobile license (weight) 285 State sales tax paid 405 Calculate how much Dan can deduct for taxes as an itemized deduction this year.
Deductible taxes = $1,815 (only the state income taxes paid and withheld will be deductible). The $285 fee for the auto license is not deductible as property tax since the fee is based on weight, not value. Dan could opt to deduct state sales tax in lieu of state income taxes.
Calculate the Deduction for Qualified Business Income "QBI"
Deduction "from" AGI; this is allowed in addition to the taxpayer's itemized deductions or standard deduction. Deduction applies to taxpayers with qualified income from a partnership, S-corporation, or sole proprietorship. Deduction is limited to "qualified trade or business": Brand new deduction created with the recent tax law change
4. Home mortgage interest
Deduction is allowed for interest paid on acquisition indebtedness secured by a qualified residence (the taxpayer's principal residence and one other residence). Acquisition indebtedness is any debt secured by a qualified residence that is incurred in acquiring, constructing, or substantially improving the residence.
5. Health Insurance Deduction by Self- Employed Taxpayers
Deduction provides equity with employees who receive health insurance as a qualified fringe benefit. Deducted on Schedule 1, Line 29 (not Schedule C), but only to the extent of the self-employed net income. Insurance must be provided for taxpayer, spouse, and/or dependents who are not eligible for employer-provided health insurance.
7. Self-Employed Tax Deduction ("SE Tax")
Employer and employees each pay a portion of the employee's Social Security (SS) and Medicare tax on employee salaries. In turn, employers are able to deduct the portion of SS and Medicare taxes they pay for employees as a business expense. In contrast, because self-employed individuals do not have an employer, these individuals are required to pay SE tax (in lieu of SS and Medicare tax). This tax basically represents BOTH the employee's and the employer's share of the SS and Medicare taxes. Unfortunately, the SE tax is not considered a business expense. To provide some relief: Self-employed taxpayers are allowed to deduct the employer portion of the SE tax they pay, to provide fairness with how employers deduct their portion of SS and Medicare taxes.
Amount of standard deduction varies according to filing status, age, and eyesight. Taxpayers and spouses who are 65 or older and/or blind are entitled to additional standard deduction(s).
Example: MFJ couple with both spouses over age 65 and one spouse legally blind is entitled to a $27,900 standard deduction. ($24,000+$1,300+$1,300+$1,300)
3. Flow-Through Entities
Expenses and losses incurred by a flow-through entity (such as partnerships and S-corporations) pass through to the entity owners who typically report these amounts on page two of Schedule E.
The deduction for cash charitable contributions is limited to twenty-five percent of the taxpayer's AGI.
False Cash contributions are limited to 60% or 30% of AGI.
Consulting services are generally considered a qualified trade or business for purposes of the deduction for qualified business income.
False Consulting services is a specified service trade or business, and thus, generally is not a qualified trade or business.
The tax law specifically excludes "specified service trade or business" (SSTB) from taking this deduction. SSTB is any trade or business involving the performance of services in fields of health, law, consulting, athletics, financial services, or where the principal business is the reputation or skill of one or more of its employees/owners. *Architecture and engineering services (their services build things) are specifically excluded from the definition of SSTB.
For any year in which a taxpayer's taxable income (before the QBI deduction) is less than $157,500 ($315,000 MFJ returns), the exclusion above for SSTB will not apply. (In other words, the business will be deemed a qualified trade or business).
6. Miscellaneous Itemized Deductions
Gambling losses to the extent of gambling winnings for the year Unrecovered cost of a life annuity (if the taxpayer died before recovering the cost of the annuity; we discussed this with our annuity calculations in Chapter 5)
TJCA side note
If you are an employee (not self-employed) and incur unreimbursed employee business expenses, these expenses are not deductible for tax years beginning after 2017. Prior to 2018, unreimbursed employee business expenses were allowed as itemized deductions, subject to a 2% AGI floor.
Limitation: There are wage-based limits for taxpayers with taxable income in excess of $157,500 ($315,000 MFJ returns).
In this case, the deduction for QBI cannot exceed the greater of 1) 50% of the wages paid with respect to the QBI - OR - 2) 25% of the wages paid with respect to the QBI + 2.5% of the unadjusted basis of all qualified property in the qualified trade or business.
Interest income =14,045 Salon revenue 88,160 salaries paid (46,210) beauty salon supplies (23,580) Operating income from salon =18,370 Apartment building revenue 34,460 Less: Depreciation on apartment building (13,800) Less: Real estate taxes paid on apartment building (11,820) Apartment building income =8840 Less: Alimony = (6,900) Less: Self-employment tax =(1298) AGI = 33,057
Interest income =14,045 +Operating income from salon =18,370 +Apartment building income =8840 -Alimony = (6,900) -Self-employment tax =(1298) AGI = 33,057
This year, Major Healy paid $33,750 of interest on a mortgage on his home (he borrowed $675,000 to buy the residence in 2015; $775,000 original purchase price and value at purchase), $5,250 of interest on a $105,000 home equity loan on his home (loan proceeds were used to buy antique cars), and $6,250 of interest on a mortgage on his vacation home (borrowed $125,000 to purchase the home in 2010; home purchased for $312,500). Major Healy's AGI is $220,000. How much interest expense can Major Healy deduct as an itemized deduction?
Major Healy's acquisition debt on his home and vacation home does not exceed $1,000,000 (the applicable limit on acquisition indebtedness incurred before December 15, 2017 so he can deduct 33,750 +$6,250 of mortgage interest on his vacation home =40,000 interest deductible
IRS Exempt Organizations Select Check is a website that lists the organizations the IRS has determined to be qualified charities
Must be a qualified charity; not just a person in need. Cash contributions are deductible in the year paid including cash, check, EFT, credit card charges, payroll deductions.
. Trade or Business Expenses (Schedule C)
Profit-motivated activity Self-employed business expenses Directly connected to the business activity Ordinary and necessary for the activity (e.g., appropriate and helpful for generating a profit), and Reasonable in amount (not extravagant). Revenue and expenses are reported on Schedule C.
b. Randy had no investment income this year, and his AGI is $75,000.
Randy may deduct all $28,450 of his interest on the home loan as an itemized deduction. Randy has no net investment income. Hence, the investment interest would not be deductible this year and would carry forward to next year.
b. Suppose that Jack also reported income of $10,750 from a half share of profits from a partnership. Disregard any potential self-employment taxes on this income. What AGI would Jack report under these circumstances?
Salary = 168,000 + partenrship 10,750 - alimony 28,800 = modified agi 149,950 - student loan interest deduction 1254 =Agi 148,696 AGI is $148,696. Jack's modified AGI calculated without adjustment for educational interest expense is 149,950. The moving expense is not deductible. He is allowed to deduct part of his student loan interest because his modified AGI is not above $165,000. Jack's maximum deduction before the phase-out is $2,500 (the amount of interest paid up to $2,500). The maximum deduction of $2,500 is phased-out ratably over a $30,000 range beginning with modified AGI over $135,000. Consequently, Jack's education interest expense deduction is $1,254 = ($2,500 − $2,500 × [($149,950 − 135,000)/30,000]). Jack's AGI is computed as follows:
a. What is Jack's adjusted gross income?
Salary and gross income Less: Alimony = modified agi -Student loan interest deduction =agi AGI is $137,050. Jack's modified AGI calculated without adjustment for educational interest expense is 139,200. The moving expense is not deductible. He is allowed to deduct part of his student loan interest because his modified AGI is not above $165,000. Jack's maximum deduction before the phase-out is $2,500 (the amount of interest paid up to $2,500). The maximum deduction of $2,500 is phased-out ratably over a $30,000 range beginning with modified AGI over $135,000. Consequently, Jack's education interest expense deduction is $2,150 = ($2,500 − $2,500 × [($139,200 − 135,000) / 30,000]). Jack's AGI is computed as follows:
The Standard Deduction
Standard deduction = Basic Std Deduction + Additional Std Deduction
Individuals may deduct itemized deductions payments for the following taxes:
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:
1. Medical Expenses
Taxpayers may deduct medical expenses incurred to treat themselves, their spouse, and/or 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 (18 cents per mile in 2018) in lieu of actual costs.
Ben is employed as a carpenter and his wife, Marilyn, is a self-employed consultant. Besides Ben's salary, Ben and Marilyn own a condominium that they rent to tourists and do not use personally. This year they paid $2,200 for utilities in the condo. Marilyn also paid self-employment tax of $4,200 and Ben had $3,000 of Social Security taxes withheld from his pay. Which of the following is a true statement?
The cost of the utilities is deductible for AGI. The entire cost of the utilities would be a for AGI deduction assuming no personal use of the condo. The employer portion of Marilyn's self-employment tax would be deductible as well.
2. Taxes
The total deduction for taxes is limited to $10,000 ($5,000 married filing separate). This $10,000 limit is new for tax years beginning 2018.
9. Qualified Education Loan Interest (Student Loan Interest)
Up to $2,500 of interest on education loans is deductible for AGI. The interest deduction is phased out for taxpayers with AGI exceeding $65,000 for single, HOH, or QW ($135,000 filing jointly). See next slide... The deduction is eliminated for taxpayers with AGI exceeding $80,000 for single, HOH, or QW ($165,000 filing jointly). Married taxpayers filing separately (MFS) are ineligible for this deduction.
2. Rental and Royalty Expenses (Schedule E)
Usually considered to be investment activities Schedule E is used to report rental income and deductions related to real property (condo, apartments, houses, land, etc.) Schedule E is also used to report royalty income and deductions.
Roquan is an attorney and practices as a sole proprietor. This year, Roquan, who is single, had net business income of $90,000 from his law practice. Assume that Roquan pays $40,000 wages to his employees, he has $10,000 of property (unadjusted basis of equipment he purchased last year), has no capital gains or qualified dividends, and his taxable income before the deduction for qualified business income is $100,000 Assume the same facts as earlier, except Roquan's taxable income before the deduction for qualified business income is $300,000.
a. Legal services fall within the definition of specific service or trade businesses, which are deemed not to be "qualified trade or businesses" for purposes of the deduction for qualified business income. However, because Roquan's taxable income (before the 20 percent deduction for qualified business income) is less than $157,500, the exclusion for specified service trades or business will not apply (the business will be deemed a qualified trade or business). Hence, Roquan is eligible for the deduction. 90,000 * 20% = 18,000
Assume the same facts as earlier, except Roquan's taxable income before the deduction for qualified business income is $300,000Assume the same facts as earlier, except Roquan's taxable income before the deduction for qualified business income is $300,000
b. If Roquan has taxable income (before the deduction for qualified business income) of $300,000, his law practice would be considered a specified service or trade business. Thus, he would not be eligible for the deduction for qualified business income.
b. Timothy, a plumber employed by ACE Plumbing, spent $129 for small tools to be used on his job, but he was not reimbursed by ACE.
deductible for agi: 0 deductible from agi: 0 not deductible: 129 Not deductible. The unreimbursed employee business expenses of $129 are not deductible.
a. Fran spent $166 for uniforms for use on her job. Her employer reimbursed her for $129 of this amount under an accountable plan (and did not report the reimbursement as wages).
deductible for agi: 0 deductible from agi: 0 not deductible: 37 Not deductible. The unreimbursed employee business expenses of $37 are not deductible. Income and expenses associated with the $129 reimbursement from an accountable plan completely offset each other and are ignored. Note that the accountable plan only reimburses deductible expenses.
c. Jake is a perfume salesperson. Because of his high pay, he receives no allowance or reimbursement from his employer for advertising expenses even though his position requires him to advertise frequently. During the year, he spent $4,560 on legitimate business advertisements.
deductible for agi: 0 deductible from agi: 0 not deductible: 4560 Not deductible. The unreimbursed employee business expenses of $4,560 are not deductible.
e. Mary, a professor at a community college, spent $745 for magazine subscriptions. The magazines were helpful for her research activities, but she was not reimbursed for the expenditures.
deductible for agi: 0 deductible from agi: 0 not deductible: 745 Not deductible. The unreimbursed employee business expenses of $745 are not deductible.
f. Wayne lost $405 on the bets he made at the race track, but he won $140 playing slot machines.
deductible for agi: 0 deductible from agi: 140 not deductible: 265 $140 from AGI as a miscellaneous itemized deduction. Wayne's gambling loss deduction is limited to his winnings. The remaining $265 is not deductible
d. Trey is a self-employed, special-duty nurse. He spent $525 for uniforms.
deductible for agi: 525 deductible from agi: 0 not deductible: 0 $525 for AGI as trade expense assuming that the special duty uniforms cannot be adapted to normal use.
