TAX-DEDUCTIBLE INDIVIDUAL EXPENSES
Insurance Premium paid with Pre-Tax Dollars. Do not claim on Schedule A any insurance premiums paid to an employer-sponsored health plan with pre-tax dollars.
Qualified Medial Expense and HSA. You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free distribution from your HSA.
Legal Liability to Deduct Mortgage Interest. A taxpayer must be legally liable for the loan to deduct interest on a home mortgage. Payments made on a loan in which the taxpayer is not directly liable are deductible only if the taxpayer is the legal or equitable owner of the real estate. For example, if you live in your mother’s home, are not listed on the house title or mortgage, and make mortgage payments for your mother, you cannot deduct the interest as home mortgage interest because you are not liable for the debt and are not a co-owner of the house.
Amortization of Bond Premium. You reduce the cost basis of the bond by the amount of the premium taken as a deduction. If you do not elect to amortize the premium on a taxable bond, you will realize a capital loss when the bond is redeemed at a par value or you sell it for less than you paid for it.
Deducting Work-related Education Costs
- The course must not meet minimum standards
- The course must maintain or improve your job or professional skills
- The course must not lead to qualification for a new profession
- The cost of MBA courses is deductible if the courses enhance the skills required in your current position, are not a minimum job requirement, and do not qualify you for a new business or profession
If you have qualifying work-related education costs, you should determine whether you can claim the Lifetime Learning Credit. Also you may be eligible for Tuition and Fees deduction. However, you cannot use the SAME educational expenses to claim both benefits (no “double benefit”).
Tuition Reimbursements as W-2 Wages. If your under-graduate/graduate school tuition is deductible and the reimbursements from your employer are included in your income as wages, you may take the expense as a miscellaneous itemized deduction on Form 1040 Schedule A, Itemized Deductions. You may also need to attach Form 2106, Employee Business Expenses. This deduction is subject to the 2% of adjusted-gross-income floor that applies to certain miscellaneous itemized deductions.
Student Loan Interest Deduction. In order for a taxpayer to claim a deduction for student loan interest, the loan must be incurred for the taxpayer, the taxpayer’s spouse, or a person who was the taxpayer’s dependent when the taxpayer took out the loan. Therefore, if you were not your parents’ dependent when they took out the student loan, the interest they paid on the loan does not qualify for the student loan interest deduction.
Recapture of Education Tax Credits. If you claim an education tax credit and after you file your tax return for that year you receive tax-free educational assistance for the prior year or receive a refund of an expense used to calculate the prior-year credit, you have to re-calculate the original credit. If the refund or assistance would have reduced the original credit, the amount of the reduction must be added to your tax liability for the year you receive the refund or assistance.
Recapture of Tuition and Fees Deduction. If you receive a refund of an expense used to calculate the qualified tuition and fees deduction, you recapture the deduction to the extent it gave you a tax benefit by reducing your tax. To the extent of the increase in tax liability, you must include the refunded amount in your income for the year you received it.
Off-the-Shelf Computer Software. Off-the-shelf computer software is eligible for IRC §179 depreciation through 2015.
A Rented Room Not a Separate Dwelling Unit. The Tax Court says that a rented room must be separate and distinct from the rest of the house the owner used in order to claim a rental-activity loss. If the house is a single dwelling unit shared by the owner and his tenant, the owner cannot claim a rental loss.
Rental Activities: Repairs and Improvements. Only maintenance and incidental repair costs are deductible against rental income. Improvements that add to the value or prolong the life of the property are capital depreciable capital improvements.
Repair examples: Painting, fixing floors, fixing leaks, replacing broken windows
Improvement examples: Paving a driveway, putting up a fence, new plumbing, new roof*
* if the roof replacement merely restored the property to leak-free condition and did not increase the value of the house, such a cost for a new roof is considered a repair.
Effective in 2013: Qualifying taxpayers can elect to expense improvements made to a building during the year in an amount equal to the lesser of $10,000 or 2% of the unadjusted basis of the building. The election is made annually on a building-by-building basis by including a statement on timely filed original tax return for the year the cost are incurred.
Foreign Earned Income Exclusion. Foreign earned income includes salaries, wages, commissions, professional fees, and bonuses for personal services performed while your tax home is in a foreign country and you meet either the foreign residence test or the physical presence test. Also the earned income includes allowances from your employer for housing.
Rental income is generally not earned income. However, if you perform personal services, 30% of your net rents may be earned income.
If you claim the foreign earned income exclusion, you may not (1) claim business deductions allocable to the excluded income; (2) make a deductible traditional IRA contribution or a Roth IRA contribution based on the excluded income; or (3) claim foreign taxes paid on excluded income as a credit or deduction.
For self-employed persons, if your business solely consists of services, all gross income is considered earned income. The excluded amount will reduce the individual’s regular income tax, but will not reduce the individual’s self-employment tax.
For SEP and qualified plans, net earnings from self-employment does not include items excluded from gross income other than foreign earned income and foreign housing cost amounts.
Charitable Contributions. Charitable contributions can be tax deductible, but you must have the proper records to support your deduction. Due to the Pension Protection Act of 2006 the rules on recordkeeping for charitable contributions became a little more strict beginning in January 2007. For 2007 and later years, generally all cash and non-cash contributions require verification.
Under the new substantiation rule, the IRS can easily audit charitable contributions. If you don’t have appropriate records, your contribution deductions will be disallowed.
To deduct a charitable cash donation, regardless of the amount, you must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. Acceptable bank records would include canceled checks or bank or credit union statements containing the name of the charity, the date and the amount of the contribution.
To deduct a non-cash donation, you must receive and keep a receipt from the charity. The required information is slightly different, depending on the amount of deduction:
Receive Timely Written Acknowledgement. IRS disallows deductions for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization.
A written acknowledgment is contemporaneous if it is obtained by the taxpayer on or before the earlier of:
(1) the date the taxpayer files the original return for the taxable year of the contribution or
(2) the due date (including extensions) for filing the original return for the year.
If IRS Asks Your Canceled Checks as Evidence. What happens when the IRS conducts an examination and asks for a canceled check to substantiate payment of an expense? Usually, the IRS accepts a copy of the canceled check. So taxpayers must take extra care to protect the copies of checks that may accompany their bank statements. The bank normally has quick access to copies of these checks. In rare instances where the IRS demands more than the copy of the canceled check included in the bank statement, taxpayers can request a substitute check from the bank. A substitute check is legally the same as the original check if it accurately represents the information on the original check and includes the following statement: “This is a legal copy of your check. You can use it the same way you would use the original check.”
TAX-DEDUCTIBLE BUSINESS EXPENSES
According to the IRS, the operating costs of running your business are deductible if they’re “ordinary and necessary.” The IRS defines “ordinary” as expenses that are common and accepted in your field of business. “Necessary expenses” are those that are appropriate and helpful for your business. Following are some of the business expenses you may be able to deduct.
Equipment purchases. Under IRS Code Section 179, business owners can fully deduct from taxable income a limited amount of the cost of new business equipment in a year rather than depreciating the cost over several years. In 2019, the maximum federal allowance is $1 million, while the limit on equipment purchases remains at $2.5 million. For more information, get a copy of IRS Publication 946, How to Depreciate Property, and read “Electing The Section 179 Deduction.”
Business expenses. Some common business expenses for which you can take a deduction include advertising expenses, employee benefit programs, insurance, legal and professional services, telephone and utilities costs, rent, office supplies, employee wages, membership dues to professional associations, and business publication subscriptions.
Auto expenses. If you use your car for business purposes, the IRS allows you to either deduct your actual business-related expenses or claim the standard mileage rate, which is a specified amount of money you can deduct for each business mile you drive. To calculate your deduction, multiply your business miles by the standard mileage rate for the year. For tax purposes, be sure to keep a log of your business miles, as well as the costs of business-related parking fees and tolls, because you can deduct these expenses.
While using the standard mileage rate is easier for record-keeping, you may receive a larger deduction using the actual cost method. If you qualify to use both methods, the IRS recommends figuring your deduction both ways to see which gives you a larger deduction, as long as you have kept detailed records to substantiate the actual cost method. For more details on using a car for business, see IRS Publications 334 (Tax Guide for Small Business) and 463 (Travel, Entertainment, Gift and Car Expenses).
Meals and Entertainment. As a first time business owner you may have some questions about how your taxes will be files and what kind of things you need to be aware of. To earn a deduction for business entertainment, it must be either directly related to your business or associated with it. To be deductible, meals and entertainment must be “ordinary and necessary” and not “lavish” or “extravagant.” The deduction is limited to 50 percent of the cost of qualifying meals and entertainment.
To prove expenses are directly related to your business, you must show there was more than a general expectation of gaining some business benefit other than goodwill, that you conducted business during the entertainment, and conducting business was your main purpose.
To meet the “associated” with your business test, the entertainment must directly precede or come after a substantial business discussion. In addition, you must have had a clear business purpose when you took on the expense.
Be sure to maintain receipts for any entertainment or meal that costs $75 or more, and record all your expenses in an account book. Record the business reason for the expense, amount spent, dates, location, type of entertainment, and the name, title, and occupation of the people you entertained.
Update: Due to the TCJA passed at the end of the year 2017, the entertainment expenses are not longer deductible.
Travel expenses. You can deduct ordinary and necessary expenses you incur while traveling on business. Your records should show the amount of each expense for items such as transportation, meals and lodging. Be sure to record the date of departure and return for each trip, the number of days you spent on business, the name of the city, and the business reason for the travel or the business benefits you expect to achieve. Keep track of your cleaning and laundry expenses while traveling because these are deductible, as is the cost of telephone, fax, and modem usage.
IRS CIRCULAR 230 DISCLOSURE: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code.