Archive for November, 2014|Monthly archive page

Back to Basics Part IV – Even More Sch. A

Originally published in the Cedar Street Times

November  28, 2014

In this issue, we are continuing our discussion on Schedule A – Itemized Deductions.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

The third section on Schedule A covers deductible interest you have paid.  For most people the big item here is the mortgage interest on their principal residence.  You can also deduct mortgage interest on one other personal residence as well.  A lot of people assume that if the interest shows up on a Form 1098 that it is deductible.  Contrary to popular belief, that does not determine deductibility.  People with rental and personal properties, for instance, that refinance and pull money out of one property and put it into another are especially at risk of having made a major mistake.

The home mortgage interest deduction requires the debt to be secured by a qualified home and have been used to acquire, construct, or improve the home up to $1,000,000 of debt and up to $100,000 of additional debt for any purpose.  Assume someone refinances a rental property and pulls $200,000 out of it to buy a personal residence.  The interest on the $200,000 is not a rental property deduction on Schedule E because the funds did not go into the rental property activity.  It is also not deductible on Schedule A as home mortgage interest because the debt is not secured by a qualified personal residence – it is secured by the rental property!  Oops – nondeductible personal interest!  There are some work-arounds to this, but they are not always easily accomplished, and the problem is more likely to be found in an audit when it is too late.

Another common problem crops up for people on personal residences who take out a second loan, open a line of credit, or do a cash-out refinance and do not use the cash to improve the home.  This portion is called home equity debt.  You can only deduct the interest on up to $100,000 of total home equity debt.  Anything beyond that becomes non-deductible personal interest, and would need to be tracked properly.  If you later refinance your primary loan and the home equity loan into one loan, the character of the debt remains the same.  This means you have to keep track of the portion of the debt that is home equity debt versus acquisition debt that comprises the one loan.

Other deductible interest would include points paid during a purchase or refinance.  Often these are not included on the 1098 and you must look to the escrow closing statement to pick them up.  New purchases allow 100% deduction of the points in the year purchased.  Refinances, require amortizing and taking a portion of the deduction each year over the life of the loan term.  Private Mortgage Insurance (PMI) used to be deductible as interest, subject to limitations, but is not currently slated for a deduction in 2014.  Investment interest is another item that falls into this section of Schedule A.  A simple example would be borrowing money to invest in the stock market – like a margin loan.  However, investment interest expense is only deductible to the extent that you have investment income (Form 4952).  So, if you paid $1,000 of interest, you better have made a $1,000 of investment income, otherwise the excess gets suspended and carried forward for the future.

The fourth section on Schedule A deals with gifts to charity.  Volumes have been written on this topic!  Gifts to charity must be made to qualifying organizations for U.S. tax purposes.  There is a 50 percent of your adjusted gross income limit each year regarding regular donations to charities.  There are also 30 percent and 20 percent limitations for donations to certain types of organizations and types of property donated.  So if you gave a very large gift, it could get suspended and carried over to the future.  There is generally a five-year carryover limit, at which point any remaining deductions would be lost.

All donations must have substantiation, no matter how small.  Cash donations under $250 must be substantiated with a properly worded letter from the organization, a cancelled check, a bank statement, or a credit card statement.  Cash donations over $250 require a letter from the organization.  Noncash donations have a lot of rules.  Every noncash donation requires a receipt from the organization.  Noncash donations over $500 require the filing of an 8283.  Noncash donations over $5,000 require a qualified appraisal as well.  It would be in your best interest to ensure you have properly planned when making (or anticipating to make) a donation over $5,000.  The $5,000 threshold is cumulative throughout the year for similar items.  This means that many trips throughout the year of donating to the local charitable thrift store of household goods would retroactively require an appraisal to claim over $5,000.  And it is hard to appraise items you no longer have!  As you can see there can be much to consider.

You can deduct out-of-pocket charitable volunteer expenses such as uniforms or gear necessary for the volunteer work.  If you travel on your own dime overnight, and you have substantial duties and very little personal activities, you may be able to deduct airline tickets, meals, lodging, etc.  Volunteer excursions that are not away from home overnight do not qualify for meal deductions.  If you use your vehicle for charitable purposes you can deduct the mileage at 14 cents per mile, or track gas and oil expenses.

A few things that are definitely not deductible but are commonly misunderstood by individuals as well as by small charitable organizations: 1) gifts to needy or worthy individuals –  even if you give to a qualified organization be sure you do not earmark your donation for a particular person or family, or your deduction is not legitimate ,  2) gifts of your time or services – like the artist trying to deduct a self-created painting at “fair market value” – you can only deduct hard costs such as the canvas and paint costs.  Since you never included in income and paid tax on your services, you cannot take a deduction for them,  3) charity raffles, bingo, lotteries  4) charitable auctions or other donations to the extent of the value you received in return – such as paying $75 in a charity silent auction, but you get a $100 gift certificate – no deduction allowed.  Or the local public radio station sends you a set of CDs they value at $100 in return for your $125 donation – you only get to deduct $25.

In two weeks we will continue our discussion regarding Schedule A.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Back to Basics Part III – More Sch. A

Originally published in the Cedar Street Times

November  14, 2014

Two weeks ago we discussed the purpose of schedules and forms in a tax return and then began a discussion on Schedule A – Itemized Deductions.  We discussed that itemizing deductions is an option if you have more than what the IRS allots as a standard deduction to everyone for things like medical expenses, taxes, charitable donations, and other miscellaneous deductions.  This week we are going to look more closely at the different types of deductions that you can itemize on Schedule A and how these deductions can get a shave and a haircut and look like less than when you started.

The first section on Schedule A covers out-of-pocket medical expenses (not reimbursed by insurance).  Things like doctors, dentists, chiropractors, Christian Science practitioners, hospital bills, prescription drugs (not over the counter), eyeglasses, contacts, copays, etc. all fit into this category.  Health insurance is also deductible here unless it is for self-employed people, in which case it can get potentially better treatment as an adjustment to income on page one of the 1040 instead.  Health insurance would include your Medicare payments which most people see deducted from their Social Security checks.

Sometimes people are surprised to learn that substantial expenditures on your home can be deductible if done to improve accessibility – such as widening doors and bathrooms, installing ramps, hand rails, etc. (there are a number of rules to be aware of, however).  You can also deduct medical related miles at 23.5 cents per mile and even deduct overnight travel expenses if you must drive to a hospital that is not local, for instance. The problem with medical expense deductions is that for the vast majority of people, none of the expenses even make it towards counting as an itemized deduction. 

You have to have in excess of 10 percent of your adjusted gross income (the bottom number on page one of your 1040) in medical expenses before a single dollar counts.  So, if your adjusted gross income is $100,000, and you have $10,500 of out-of-pocket medical expenses, only $500 counts towards your itemized deductions.  If you or your spouse are over 65 you have a 7.5 percent threshold through 2016, and then you will jump to ten percent as well.  A really nice planning opportunity around this dilemma is having a health savings account in connection with a high deductible plan.  It has the ability to effectively convert some or all of your nondeductible medical expenses to deductible expenses.  Ask your tax preparer or insurance agent about this.

The second section on Schedule A covers deductible taxes you have paid. This includes state income taxes you paid during the year, SDI withholdings from your CA paycheck, real estate taxes on your personal residence(s), personal property taxes assessed on value such as annual vehicle taxes (license fee on your CA DMV renewal), boat, aircraft, etc.  Remember, as a cash basis taxpayer, these (as with generally all income and expenses on your tax returns) count in the year you actually pay them (or charge them in the case of a credit card), so it doesn’t matter what year they are supposed to cover – just look at when they were paid.  There has been an option in past years to deduct sales taxes you paid during the year if they were greater than the state income taxes you paid, but that is currently not an option for 2014, unless Congress takes action.

In two weeks we will continue our discussion regarding Schedule A.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Back to Basics Part II – Schedule A

Originally published in the Cedar Street Times

October 31, 2014

Two weeks ago we discussed a general overview of the Form 1040 – a personal income tax return.  The 1040 can be thought of as a two-page summary of your taxes in a nutshell.  (I should mention also there are two other shorter forms that could be filed instead: a 1040A and a 1040EZ.  These are for simpler returns and have income limits and other restrictions.  In practice, however, anyone using tax software does not really have to decide which form to use and the software will generally optimize as appropriate.  For our discussion we will focus on the 1040.)

The details for many of the items on the Form 1040 are actually determined on subsequent Schedules and Forms.   Schedules are labeled with letters of the alphabet and additional forms are generally four digit numbers.  Schedules are generally more major topical areas.  For instance, Schedule C – Profit or Loss from Business, which is a summary of all the activity of a sole proprietorship.  It may in turn have subsequent forms that support it.  Forms are often more narrowly focused and would generally support other schedules or forms.  For instance Form 4572 Depreciation, could support the calculation of depreciation expense for a business on Schedule C, a rental property on Schedule E, a farm on Schedule F, etc.  I have not counted them all, but I have read the IRS has over 800 forms and schedules.  The reality is that most people are covered by 30 or 40 of those 800!

Let’s start at the beginning of the alphabet – Schedule A.  (I am sure this saddens you, but we will not be going through all 800 in this series of articles, but we will hit on a number of the most common ones!)  Schedule A is for itemized deductions.  You probably hear lots of people justify expenses by tossing around the phrase, “it’s deductible.”  However, just because something may be deductible, does not mean it will benefit you. This is easily seen with Schedule A.  Schedule A covers a host of “expenses” that most people have that our tax code has graced as good behavior and therefore allows a deduction for it.  Medical expenses, state and local taxes, real estate taxes, mortgage interest, charitable deductions, unreimbursed employee business expenses, my favorite – tax preparation fees, investment expenses, etc.

Since Congress realized that everyone had some of this, and it would be a pain for people to track it, they decided to allow as an option a “standard deduction” for everyone in lieu of tracking and itemizing all those deductions.  The standard deduction was created to generally cover what many people would have on the average anyway.  For 2014 this standard deduction is $6,200 if you file as Single or Married Filing Separate, $12,400 if you file Married Filing Jointly or Qualifying Widow(er), and $9,100 if you are filing Head of Household status.  If you believe you would have more than this, then you would itemize the deductions using Schedule A.

Mortgage interest and real estate taxes are the two areas that push most Californians into the itemizing zone.  In other words, if you do not own a home, there is a good chance you won’t be itemizing.  This is not always true: sometimes people don’t own a home, but make a lot of money and pay a lot of deductible state income taxes which would push them over the standard deduction, or maybe they work in sales jobs where they have lots of unreimbursed employee business expenses, or have major unreimbursed medical expenditures, or are perhaps like you dear reader, and have a heart of gold giving away buckets of money to charitable organizations each year!  Or it could be a combination of things – paid some income taxes, have a stingy boss that won’t reimburse, and maybe you have a heart of bronze.

Next week we will discuss more specifically the deductions on Schedule A and how they can come out looking a little thin after running the Schedule A gauntlet.

Prior articles are republished on my website at www.tlongcpa.com/blog.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.