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CHAPTER 6 DEDUCTIONS AND LOSSES: IN GENERAL LECTURE NOTES CLASSIFICATION OF DEDUCTIBLE EXPENSES 1. Section 61 provides an “all inclusive” definition of income, but deductions are allowed only by statute or legislative grace . 2. An introductory preview of what expenses are deductible for adjusted gross income and from adjusted gross income is important because a deduction for AGI is more beneficial than a deduction from AGI. a. A deduction for AGI is more valuable in several ways (see a partial list on page 6-4 in the text ). (1) A deduction from AGI can be lost if the taxpayer does not itemize; note that the standard deduction is increased each year for inflation. (2) Deductions for AGI reduce AGI and increase several itemized deductions that are subject to a floor based on AGI. Examples are: (a) Personal casualty losses (subject to a reduction of 10% of AGI ). (b) Only medical expenses in excess of 7 1/2% of AGI can be deducted. The taxpayer has to be poor (low AGI) as well as sick (high expenses) to get any deduction. (c) Miscellaneous itemized deductions can be deducted only to the extent that they exceed 2% of AGI . (3) Many states that “piggyback ” onto the Federal income tax start with Federal AGI. Deductions for AGI can reduce state income taxes, often significantly. 6-1
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6-2 2009 Comprehensive Volume/Instructor’s Guide with Lecture Notes b. Increases or decreases in AGI can work in the opposite direction for charitable contributions . (i.e., the larger the AGI, the higher the ceiling on the charitable contribution deduction).` (1) Such deductions are subject to a ceiling of 20%, 30% or 50%. These limits are discussed in Chapter 10. DEDUCTIONS FOR ADJUSTED GROSS INCOME 3. The various allowable deductions for adjusted gross income are categorized as follows: a. Trade and business deductions available to all taxpayers, including individuals, corporations, etc. b. Reimbursed employee business expenses . An employee is considered to be in the trade or business of being an employee for purposes of reimbursed employment related expenses. c. The capital loss deduction , and other losses on the sale or exchange of property other than personal use property (e.g., casualty losses on business property). d. Section 212 deductions are allowed for adjusted gross income only if attributable to rent and royalty income ; (1) All other § 212 deductions are deducted from adjusted gross income. (2) Section 212 allows deductions for expenses related to the production of income, for the management of assets held for the production of income, or in connection with the determination, collection, or refund of any tax. e. Alimony payments . f. Certain contributions to pension , profit-sharing , and annuity plans of self- employed individuals (e.g., Keogh plan). g. Deduction for certain retirement savings such as traditional IRA’s .
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