November 19, 2014
Make the Most of Your Deductions
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On December 22, 2017, The Tax Cuts and Jobs Act was signed into law. The information in this article predates the tax reform legislation and may not apply to tax returns starting in the 2018 tax year. You may wish to speak to your tax advisor about the latest tax law. This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
As you plan for your tax year, keep in mind that some tax deductions are “above-the-line” and are available whether deductions are itemized or not. In addition to the educational “above-the-line” deductions, the following deductions are noteworthy.
- Health Savings Accounts - A Health Savings Account is a trust account into which tax-deductible contributions may be made by qualified taxpayers who have high deductible medical insurance plans. Interest earned on the HSA balance is tax-free. The funds from these accounts are then used to pay qualified medical expenses not covered by the medical insurance for an eligible individual. If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used as a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize deductions to take advantage of this tax break. High deductible plans are defined as those with the following deductible amounts for 2017: Self-only coverage with an annual deductible of $1,300 (same as 2016) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $6,550 (same as 2016); or Family coverage with an annual deductible of $2,600 (same as 2016) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $13,100 (same as 2016). The deductibles and maximum out of pocket limits are inflation adjusted annually, so please call for amounts for years other than 2016 or 2017.
- Itemized Deductions - A taxpayer with deductible expenses exceeding the standard deduction amount will want to itemize their deductions. Itemized deductions consist of five basic categories, each with its own limitations and special considerations. If your deductions only marginally exceed the standard deduction, consider “bunching” your deductions in one year. This allows you to produce higher than normal itemized deductions that year and then take the standard deduction the other year. The following is an overview of the itemized deductions
- Medical Expenses - Deductible medical expenses are limited to unreimbursed expenses for the taxpayer, his or her spouse and dependents that exceed 10% (7-1/2% if age 65 or older) of the taxpayer's AGI for the year.
Expenses most frequently thought of as deductible medical expenses include medical and dental insurance premiums, charges by doctors and dentists and the cost of prescription medication. Medical insurance premiums and other expenses paid with pre-tax dollars (e.g., through an employer's cafeteria plan) cannot be included. Generally, travel costs (not including meals) may be a deductible expense if the trip is primarily for medical purposes. Cosmetic surgeries are generally not deductible. Some less common deductions include the following:
- The cost of a weight loss program (not including food) for the treatment of a specific disease or diseases (including obesity) diagnosed by a physician.
- Medicare-B premium payments and Medicare-D premiums for drug coverage.
- Participation in smoking-cessation programs and for prescribed drugs (but not nonprescription items such as gum or patches) designed to alleviate nicotine withdrawal.
- Elder Care, generally including the entire cost of nursing homes, homes for the aged and assisted living facilities.
- Medical dependent - For medical purposes, an individual may be a dependent even if his gross income precludes a dependency exemption, thus enabling the taxpayer to deduct the individual’s medical expenses that the taxpayer paid. A child of divorced parents is considered a dependent of both parents for medical expenses purposes (so that each parent may deduct the medical expenses he or she pays for the child.)
- Long-term care insurance - Amounts paid for long-term care services and certain premiums paid on long-term care insurance are includible as medical expenses. The maximum amount of long-term care premiums treated as medical expenses depends on the insured’s age and is inflation-indexed annually. For values for years other than 2016 or 2017 please call this office.
Deductio LimiLong-Term Care Insurance Age40 or less41 to 5051 to 6061 to 7071 & OlderLimit20162017$390$410$730$770$1,460$1,530$3,900$4,090$4,870$5,110
o Taxes - Deductible taxes primarily consist of real property taxes, state and local income taxes and personal property taxes. Planning tip: Since taxes are not deductible for AMT purposes, taxpayers should attempt to minimize the payment of taxes in a year they are subject to the AMT if they can avoid late payment penalties for the tax payments. Where property taxes were paid on unimproved and unproductive real estate, a taxpayer can annually elect to capitalize the taxes in lieu of deducting them.
o Interest - The only interest that is deductible as an itemized deduction is home mortgage interest and investment interest. Although this category does not have an AGI limitation, each interest type has special limitations. Home mortgage interest is limited to the interest paid on acquisition debt that does not exceed $1 million and home equity debt (not exceeding $100,000) on the taxpayer’s main home and a designated second home. In addition, the interest on most equity debt is not deductible against the AMT. Note: Home acquisition debt is the current balance of the original debt that was incurred to purchase or substantially improve the home and is not increased by refinanced debt.
Taxpayers can elect to treat any debt secured by the home as unsecured. The election is irrevocable without IRS consent. By making the election, the interest on the loan can be allocated to use of the proceeds, except none of the interest can be allocated back to the home itself. This election is for income tax purposes only and does not change how the loan is secured with the lender. If made, the election applies for both regular tax and AMT purposes, and it applies for the year the election is made and all future years. There is no specific IRS form to use to make the election. Instead, the taxpayer should attach a statement to their return (timely filed) for the year the election is to be effective stating the election is to apply.
Investment interest is interest on debts incurred to acquire investments such as securities or land. The investment interest deduction is limited to net investment income (investment income less investment expenses), and any excess not deductible in the current year is carried over to future years. Interest on debt to acquire tax-free investment income is not deductible. A taxpayer can elect to treat qualified dividends and long-term capital gains as investment income in order to increase the amount of deductible investment interest. However, the same capital gains and qualified dividends are then not eligible for the lower capital gains/qualified dividends tax rate.
o Charitable Contributions - A taxpayer may, within certain limits, deduct charitable contributions of cash and property to qualified organizations to the extent he or she receives no personal benefit from the donations. All cash contributions regardless of the amount must be documented with a written verification from the charity or a bank record. Non-receipted cash contributions are not deductible. Non-cash contributions also require an acknowledgement of the contribution from the qualified charitable organization except for donations of $250 or less left at unmanned drop points. For non-cash contributions of more than $5,000 (except for publicly-traded securities), a taxpayer is generally required to have a qualified appraisal of the property that was donated. Please call this office for further details. Charitable deductions are limited by a percent of income depending upon the type of contribution. Contributions in excess of the AGI limitation may be carried forward for five years. Although there are 20% and 30% of AGI limitations, generally, contributions to qualified organizations are deductible to the extent they don’t exceed 50% of the taxpayer’s Adjusted Gross Income. One notable exception is the 30% limitation for gifts of capital gains property, where the contribution is based on the fair market value of the property.
Frequently overlooked contributions include those made to governmental organizations such as schools, police and fire departments, parks and recreation, etc. Uniforms, travel expenses and out-of-pocket expenses for a charity are also deductible, but not the value of your time or the cost of equipment such as computers, phones, etc., if you retain ownership.
Congress imposed some tough rules that substantially limit the deduction for the popular charitable car donation. If the claimed value of the vehicle exceeds $500, the deduction will generally be limited to the gross proceeds from the charity’s sale of the vehicle. The IRS provides Form 1098-C that incorporates all of the required acknowledgement elements for the donee (charitable organization) to complete. The donor is required to attach copy B of the 1098-C to his or her federal tax return when claiming a deduction for contribution of a motor vehicle, boat or airplane.
There is an exception to the rules for donated vehicles that the charity retains for its own use “to substantially further the organization's regularly conducted activities or provides to a needy family.” Please call this office for more information.
Taxpayers age 70½ and over are allowed to make direct distributions (up to $100,000 per year) from their Traditional or Roth IRA account to a charity. The distribution is tax-free, and counts toward the taxpayer’s required minimum distribution for the year, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have Social Security income and/or do not itemize their deductions.
- Miscellaneous Deductions - Miscellaneous deductions fall into two basic categories: those that are reduced by 2% of a taxpayer's AGI and those that are not.
- Those Subject to the 2% Reduction - This category generally includes your investment expenses, costs of having your tax return prepared, and employee business expenses.
- Those NOT Subject to the 2% Reduction - This category includes gambling losses (but cannot exceed the amount reported as gambling income), personal casualty losses (after first reducing each loss by $100 and the total loss for the year by 10% of your AGI), repayments of income (over $3,000) reported in prior years and estate tax deductions. The estate tax deduction is considered by many to be the most overlooked deduction in taxes. It is a deduction based on the additional taxes paid as a result of the same income being taxed to both the estate and to the beneficiaries of the estate. Only certain types of income are doubly taxed. As an example, if the decedent had a Traditional IRA account, the value of the IRA would be included in the decedent’s estate and also would be taxable to the beneficiary. If the estate paid any tax at all (on Form 706), the beneficiary in this example would have an estate tax deduction equal to the portion of the estate tax paid attributable to the IRA.
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