5
Personal 83
Chapter Itemized Deductions
Highlights of 2010 Tax Changes
The mileage rate for medical is $.165 for 2010 (down from $.24 per mile in 2009). The mileage rate for
charitable contributions remains at $.14.
At the time the book went to press, the itemized deduction for general sales tax (in lieu of state and local
income taxes) had not been renewed for 2010. However, many believe it will be restored before the end
of 2010.
In 2010, the casualty and theft loss oor is $100 per event (down from $500 in 2009).
In 2010, there is no reduction in total itemized deductions for higher-income taxpayers. The reduction for
higher-income taxpayers is scheduled to return in 2011.
Teaching Suggestions
1. To help students understand the importance of AGI in determining the itemized deductions described in
Chapter 5, assist them in developing a list of the various AGI limitations imposed on these deductions. The
list should include:
Medical expenses
7.5%
Charitable contributions
50%, 30%, 20%
Casualty losses
10%
Miscellaneous itemized deductions (next chapter)
2%
2. As you go through each topic in Chapter 5, it might be useful to show a copy of Schedule A on an overhead,
or alternatively, have students open their books to Figure 5-1, where the Neals Schedule A is illustrated. Each
topic discussed in this chapter follows the organization of Schedule A. Having a copy of Schedule A handy
will make it easy to review each topic in order.
Solutions to Questions and Problems
1. 503.
Prescription drugs
$ 400
Doctors and insurance premiums
1,170
Other medical expenses:
Hearing aid
$525
Eyeglasses
130
655
$2,225
Less: 7.5% AGI ($24,000 7.5%)
( 1,800)
Medical and dental expense deduction
$ 425
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2. a.
Deductible
Amount
1.
Item
Health insurance premium
Deductible?
Yes
2.
Life insurance premium
No
0
3.
Accident insurance
No
0
4.
Acne cream
No
0
5.
Prescription drugs
Yes
300
6.
Vitamins
No
0
7.
Cosmetics
No
0
8.
Dr. Wall, DDS
Yes
120
9.
Health spa dues
No
0
10. X-ray examination
Yes
60
11. City Hospital
Yes
375
12. Eyeglasses
Yes
125
13. Cemetery plot
No
0
14. Medical: 1,000 miles $.165
Yes
165
15. Illegal drugs
No
0
16. Vacation
No
0
17. Dr. Root
Yes
350
18. Wheelchair
Yes
275
19. Dr. Spencer
Total
Yes
580
$2,736
$386
b. 503.
Unreimbursed medical and dental expenses
$2,736
Less: 7.5% AGI ($34,290 7.5%)
( 2,572)
Medical and dental expense deduction
$ 164
3. a. The $455 would offset the expenses paid in 20X2. 503.04.
b. The $455 is not taxable and would not be reported. 503.04.
c. The $455 must be included in gross income since the medical expenses deduction of $840 taken in the
prior year exceeds the reimbursement. 503.04.
d. $350 of the reimbursement would be included in income since that amount was deducted in the prior year.
The remaining $105 is not taxable. 503.04.
e. $380 ($455 $75) of the reimbursement would be subtracted by the employee from the medical expenses
paid in the current year. Since the taxpayer had paid the total cost of the medical insurance premium, the
excess reimbursement of $75 is not taxable and, therefore, would not be reported. 503.04.
f. $380 ($455 $75) would be subtracted by the employee from the medical expenses paid. Since the
employer had paid the total cost of the medical insurance plan and the cost of the premium was not included
in the gross income of the taxpayer, the excess reimbursement of $75 would be included in the gross income
of the taxpayer. 503.04.
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4. Yes. The amount paid by an employee for a periodic medical checkup required by an employer is deductible
as an employee business expense, subject to the 2% of AGI rule for certain miscellaneous deductions. The
7.5% of AGI rule for medical expenses does not apply. 503.03.
5. $4,500 ($7,500 $3,000). Since the purchase of the hot tub was prescribed by his doctor, Sparks can deduct
the excess of the hot tubs cost over the amount by which his home increased in value. 503.03.
6. a. $3,550. Sanchez can deduct the state and local income taxes he paid during the year. This would be the
$450 he paid to the state with his 2009 tax return and the $3,100 of state income taxes withheld from his
paycheck during the year. Federal income taxes are not deductible. 504.01.
b. Sanchez will include $120 in gross income in 2011. Since Sanchezs total itemized deductions of $6,550
exceed his standard deduction amount of $5,700, he will itemize deductions on his 2010 tax return. When he
receives a $120 from the state government in 2011, he will be required to include that amount in gross income
on his 2011 tax return. The federal refund is not taxable. Because federal income taxes are not deductible, no
tax benet was ever received. 504.01.
c. None of the refund is taxable. Since Sanchezs total itemized deductions of $4,550 do not exceed his
standard deduction amount of $5,700, he will deduct the standard deduction on his 2010 tax return. Because
no tax benet was derived from the additional $210 of state income taxes paid in 2010, when he receives the
refund from the state government in 2011, it is not included in his gross income. As with Part b., the federal
refund is never taxable. 504.01.
7. $1,125. Ivy deducts on Schedule A all state and local income taxes paid during 2010. This includes estimated
payments totaling $1,125 ($250 + $300 + $300 + $275). The $300 refund from the state government that she
received in 2010 is included in her 2010 gross income to the extent she received a benet from deducting
state income taxes on her 2009 tax return. The $650 paid to the state government in 2011 will be deductible
on her 2011 tax return. 504.01.
8. Ad valorem property taxes are deductible as itemized deductions. Adams will be allowed to deduct $405.
Reed will not be allowed to deduct any of the $55 she pays to renew her license tags. 504.03.
9. a. $31,773. The tax laws allow the Hemphills to deduct the interest associated with up to $1 million of
acquisition indebtedness on their principal residence and one other residence. They will deduct the $8,330
plus the $23,443 interest on the Tampa residence. 505.01.
b. $23,443. The Hemphills would only be allowed to deduct the interest paid on one of their vacation homes.
Each year they should the one that has the highest interest expense. 505.01.
10. a. All of the interest will be deductible. The tax laws allow the Stephens to deduct the interest associated with
up to $1 million of acquisition indebtedness on their principal residence and one other residence. Their total
acquisition indebtedness includes the $800,000 on their principal residence and $295,000 on their second
residence. Since this amount exceeds $1 million, they will be able to deduct the interest on the rst $1 million
of this indebtedness. The $95,000 excess qualies as home equity indebtedness. Thus, the Stephens will be
allowed to deduct the interest associated with the entire amount of indebtedness. 505.01.
b. The interest on $40,000 of the nancing will not be deductible. The rest will be deducted as home mortgage
interest on Schedule A. Because the additional $140,000 of nancing was not used to buy or improve their
principal residence, it cannot count as acquisition indebtedness. The Stephens acquisition indebtedness equals
$955,000 ($660,000 + $295,000). Their total indebtedness of $1,095,000 exceeds this amount by $140,000.
Since the interest on home equity indebtedness is limited to $100,000 of indebtedness, the interest associated
with $40,000 of the total debt will be disallowed. 505.01.
c. Same result as Part b. The tax laws do not restrict the use of the proceeds from a home equity loan in order
to deduct the interest. 505.01.
11. a. Lee must allocate the points on the bank loan to buy the land over the life of the loan. Therefore, during
2010, interest is deductible in the amount of $4.50 per month ($540 120 mo.) for 10 months for a total of
$45. An exception to the general rule of spreading points over the life of the loan applies to Lees loan for
her principal residence. The exception will allow Lee to deduct the entire $480 in 2010 as qualied residence
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interest, which she paid in points on the loan for her principal residence. Thus, Lee may deduct a total of $525
($45 + $480) during 2010 as interest in the form of points paid. 505.02.
b. The remaining $495 ($540 $45) in the form of points paid on the bank loan will be deductible at the
rate of $4.50 per month over the remaining 9 years and 2 months of the loan as investment interest expense.
505.02.
12. $878. The Devons have been amortizing the $24,000 of points they paid on the purchase of their vacation
home over the life of the loan. They have been deducting $66.67 each month ($24,000/360 month loan). In the
current year, they will amortize $533.33 ($66.67 8 months). As of the time of the renancing, $18,000 of the
points is still unamortized. They add this amount to the points they paid as part of the renancing. Thus, after
the renancing, the Devons total unamortized points equal $31,000 ($18,000 + $13,000). They will amortize
these points over the life of the new loan. For the current year, the Devons will deduct points totaling $878
($533.33 from the original loan + $344.44 from the new loan ($31,000/360 + 4 months)). 505.02.
13. The Edlins have two choices. First, they can choose to include the qualied dividends and net capital gains
in the calculation of net investment income and forgo the lower tax rates associated with these items. They
instead would be taxed at the Edlins normal (ordinary) tax rates. However, this option will make their net
investment income equal to $10,700 ($5,000 + $2,400 + $3,300) and allow them to deduct $10,700 of their
investment interest expense in 2010. They would carry over the $1,200 excess to 2011. If they elect to not
include their qualied dividends and net capital gain in the calculation of net investment income, they will
pay a maximum 15% tax rate on the $8,300. However, they will only be allowed to deduct $2,400 of their
investment interest (limited to $2,400 of net investment income) in 2010. They would carry over the $9,500
excess to 2011. 505.04.
14. 505.
Item
Deductible
a. Als home equity loan interest, $1,750
Nondeductible
X
b. Bettys credit card interest
X
c. Charles interest on loan to buy muni-bonds
X
d. Davids mortgage interest
X
e. Eds interest on state tax deciency
X
f. Freds textbook loan interest
X
g. Gabes investment interest
X
15. 505.
Home mortgage interest ($6,300 + $7,200 + $13,080)
$26,580
Points ($5,700/120 months 8 months during the year)
380
Investment interest expense
543
Total interest deduction on Schedule A
$27,503
Although the renancing was for more than the original loan balance, the excess qualies as home equity
indebtedness.
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Textbook Solutions
16. 506.
Gift or Expenditure
a. Red a
But Cross
Deductible
Deductible,
as Not as a
Not
Contribution Contribution Deductible
X
b. Pledge
X1
c. Auto expenses (employee)
X
d. Girl Scouts
X
e. Land
X2
f. Political
X
g. Public library
X
h. Salvation Army
X
i. Stock
X2
j. Local university
X
k. Bonds
X2
l. Service
X
m. Auto expenses (volunteer)
X
3
1
Deductible when paid.
2
The FMV is deductible on capital gain property.
3
Deductible at the standard rate of $.14 per mile.
17. 506.02.
a. Clarke may not deduct any amount as a charitable contribution on her income tax return. The fair market
value of the admission charge is $32, which is what she paid per ticket.
b. The answer to (a) would be the same. To be deductible, there must be a gift.
c. The contribution would be the difference between the payment of $32 and the fair market value of $20
for each ticket.
18. First, the taxpayer adds all the cash contributions. The noncash contributions are deducted at their lower FMV.
Political contributions are never deductible. The gift given directly to a homeless person is not a qualied
contribution. 506.
Cash contributions
$5,200
Noncash contributions:
Clothing
Camping equipment
Charitable contribution deduction
$100
300
400
$5,600
19. a. The taxpayer can deduct the full $190,000 FMV of the land and apply the 30% AGI limit ($389,200 30%
= $116,760). The $73,240 excess ($190,000 $116,760) can be carried over for 5 years (subject to the 30%
AGI limit in those years). The taxpayer could elect to deduct only the $72,000 adjusted basis in the land and
use the 50% AGI limit. However, this would result in a lower deduction. 506.04.
b. $72,000. Since tangible, personal property would be put to unrelated use, the taxpayers deduction would
be limited to its $72,000 basis. 506.02.
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20. a. $14,700. Because the stock had been held for more than one year and was contributed to a qualied
charitable organization, the taxpayer may treat $15,000 (FMV) as a contribution. However, only $14,700
(30% $49,000) may be claimed as an itemized deduction in the current year. The remaining $300 may be
carried forward for up to ve years. 506.04.
b. $3,575. The deduction for property held short-term is its adjusted basis. 506.02.
21. $176. Bortz can deduct her out-of-pocket expenses, which includes the $160 for supplies and $16.10 for
mileage (115 miles $.14). No deduction is allowed for the value of services rendered to qualied charitable
organizations. 506.02.
22. a. $700. 507.
Cost or other basis
$73,000
FMV before casualty
$97,000
Less: FMV after casualty
(79,000)
Change in FMV
$18,000
Lesser of $18,000 or $73,000
$18,000
Less: Insurance reimbursement
(15,000)
Casualty loss
$ 3,000
(100)
Less: $100 oor
$ 2,900
Less: 10% of AGI
Deductible casualty loss
(2,200)
$
700
b. $900. Of the $5,700 (3 $1,900) received as a reimbursement for living expenses, the Wildes may exclude
the amount that represents a temporary increase in living expenses. This increase is $1,600 [($2,000 + $500)
$900] each month. Thus, the Wildes may exclude $4,800 ($1,600 3). The remaining $900 ($5,700 $4,800)
is taxable. 507.
23. a. Theft losses are deductible in the year in which they are discovered. For the Tavels, this would be 2010.
507.04.
b. Their theft loss deduction would be $3,100. 507.
Theft loss on TV (lesser of $4,000 FMV or $5,600 adjusted basis)
Theft loss on artwork (lesser of $22,500 FMV or $8,400 adjusted basis)
$4,000
8,400
Less: $100 oor
(100)
Less: 10% AGI
(9,200)
Theft loss deduction
$3,100
c. The theft loss would be $0. 507.
Theft loss on TV (lesser of $4,000 FMV or $5,600 adjusted basis)
$4,000
Theft loss on artwork (lesser of $22,500 FMV or $8,400 adjusted basis)
8,400
Less: Insurance reimbursement
(7,500)
Less: $100 oor
(500)
Less: 10% AGI
(9,200)
Theft loss deduction
$
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Textbook Solutions
24. $1,075. 507.
Item
Television set
Change in
Lesser of
Adjusted Fair Market Change in
Basis
Value (FMV) FMV or A.B.
$ 595
$ 375
$ 375
Microwave oven
575
400
400
VCR
850
700
700
2,200
2,500
2,200
Jewelry
Lesser of FMV or cost basis
$3,675
Less: Insurance proceeds
(500)
Less: $100 oor
(100)
(2,000)
Less: 10% $20,000 (AGI)
Theft loss deduction
$1,075
1
25. 503, 504.
Item
Yes
No
Line No.
a. Home-for-the-aged payments:
(1) Meals
X
1
(2) Lodging
X
1
(3) Nursing care
X
1
b. Interest paid to purchase municipal bonds
c. Supplementary Medicare insurance
X
X
1
d. Interest on credit card
X
e. Interest on student loan (deductible for AGI)
X
f. Foreign income taxes
X
6
g. Interest on delinquent income tax
X
h. Life insurance premiums
X
26. a. See lled-in Schedule A for Pido. 502.
Unreimbursed medical
$ 3,200
Less: 7.5% AGI
(12,941)
State and local income taxes withheld from wages
$ 3,583
Amount paid to the state with 2009 tax return
425
$0
4,008
Real estate taxes
6,898
Mortgage interest
11,880
Investment interest expense
12,000
Charitable contributions
Miscellaneous itemized deductions
Less: 2% AGI
Total itemized deductions
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5,000
$ 2,749
(3,451)
0
$39,786
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Essentials of Federal Income Taxation
Filled-in Schedule A for Pido.
Chapter 5
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Textbook Solutions
b. See lled-in Schedule A for the Moores. 502.
Unreimbursed medical
$15,800
Less: 7.5% AGI
(13,844)
State and local income taxes withheld from wages
$ 6,682
888
Amount paid to the state with 2009 tax return
$ 1,956
7,570
Real estate taxes
4,582
Mortgage interest
17,559
Investment interest expense (limited to NII)
1,800
Charitable contributions
Miscellaneous itemized deductions
Less: 2% AGI
Total itemized deductions
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13,540
$
749
(3,692)
0
$47,007
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Essentials of Federal Income Taxation
Filled-in Schedule A for the Moores.
Chapter 5
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93
27. According to page 2 of the Instructions to Form 4684, if the loss can be reasonably estimated, three options
may be available for recognizing the loss:
(1) Treat the loss as a casualty loss to personal property on Form 4684.
(2) Treat the loss as an ordinary loss (miscellaneous itemized deduction) on Schedule A (Form 1040), line
23. The maximum amount than can be claimed is $20,000 ($10,000 for marrieds ling separately). The
reduction is reduced by any expected state insurance proceeds and is subject to the 2% limit.
(3) Wait until the year of nal determination of the actual loss and treat the amount as a nonbusiness bad
debt. A nonbusiness bad debt is deducted on Schedule D (Form 1040) as a short-term capital loss.
However, if the taxpayer is an ofcer of the nancial institution or owns 1% or more of the institution, or
is related to such an owner or ofcer, the loss cannot be deducted as either a casualty loss or as an ordinary
loss.
If any part of the deposits related to the loss is federally insured, the taxpayer cannot choose the ordinary loss
deduction.
If, in a later year, some of the loss is recovered, the recovered amount is income to the extent a tax benet
resulted from the loss deduction.
28. a. If the taxpayers itemized deductions are near in amount to his or her standard deduction, a control of the
timing of the payments of certain itemized deductions can help maximize the total standard deduction and
itemized deductions in alternate tax years. By timing the payment of expenses eligible as itemized deductions,
the taxpayer can minimize the tax liability by bunching itemized deductions in one year so that the total is at a
higher level than the standard deduction. Then, in the next year, when expenses eligible as itemized deductions
are lower in total than the standard deduction, the taxpayer can use the higher standard deduction.
b. Certain itemized deductions are exible as to the year in which they are paid. These deductions include
medical expenses incurred near year-end, state income taxes paid on a quarterly basis, certain real estate
taxes, and charitable contributions.
If these payments are bunched in December 2010, for example, the taxpayer can deduct a higher amount
of itemized deductions than the eligible standard deduction amount. In 2011, the standard deduction would
be used, and the taxpayer would postpone paying certain medical expenses, charitable contributions, and
fourth-quarter state income taxes until January 2012. In this way, the taxpayer would have higher itemized
deductions in 2010 and maximize the use of itemized deductions and the standard deduction over a series of
years. This will work only if the amounts of both deductions are similar and the timing of the payments can
be controlled.
29. a. The company may deduct $35,000 (10% $350,000) currently and carry the remaining $15,000 forward
for ve years. 1402.06.
b. If the company uses the cash basis of accounting, the donation must take place before the end of the tax
year. If the company uses the accrual basis of accounting, it may accrue and deduct the contribution in the
current year as long as payment is made within 2 months after its year ends. 1402.06.
c. An S corporation receives no deduction for charitable contributions when calculating ordinary income.
Instead, the deduction passes through to the shareholders who deduct it on their tax returns. 1507.02.
d. The tax implications for a partnership are the same as those for the S corporation discussed in c. above.
The deduction passes through to the partners. 1502.04.
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Essentials of Federal Income Taxation
30. a. See lled-in Schedule A for the Crosses. 502.
Home mortgage interest ($18,330 + $19,044)
$37,374
State income taxes paid
4,240
Real estate taxes ($2,400 + $2,800 + $3,400)
8,600
Charitable contributionscash
$12,000
Charitable contributionsnoncash
1
Total itemized deductions
3,300
15,300
$65,514
(100 shares held long-term $24 a share) + (50 shares held short-term $18 a share)
1
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Filled-in Schedule A for the Crosses.
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Essentials of Federal Income Taxation
b. See lled-in Schedule A for Prior. 502.
State income taxes paid ($3,967 + $800 + ($1,200 3))
Real estate taxes
$8,367
3,290
Personal property taxes
296
Home mortgage interest
16,940
Charitable contributions
1,500
Total itemized deductions
Chapter 5
$30,393
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Filled-in Schedule A for Prior.
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Essentials of Federal Income Taxation
c. See lled-in Schedule A for the Saads. 502.
Medical expenses [$14,743 (7.5% $167,900)]
$ 2,150
Taxes [$4,400 + $4,800]
9,200
Mortgage interest
5,200
Investment interest (limited to net investment income)
3,700
Contributions
6,400
Total itemized deductions
Chapter 5
$26,650
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Filled-in Schedule A for the Saads.
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Chapter 5