There are a variety of itemized deductions. Many itemized deductions are personal in nature but are allowed to subsidize desirable activities such as home ownership and chari- table giving. Other itemized deductions, such as medical expenses, provide relief for tax- payers whose ability to pay taxes has been involuntarily reduced. We discuss itemized deductions in the order they appear on the individual tax return, Form 1040, Schedule A.
LO 6-2
CHAPTER 6 Individual Deductions 6-11
Medical Expenses
The medical-expense deduction is designed to provide relief for taxpayers whose ability to pay taxes is seriously hindered by health-related circumstances. Qualified medical ex- penses include any payments for the care, prevention, diagnosis, or cure of injury, disease, or bodily function that are not reimbursed by health insurance or are not paid for through a
“flexible spending account.”16 Taxpayers may also deduct medical expenses incurred to treat their spouses and their dependents.17 Common medical expenses include:
• Prescription medication, insulin, and medical aids such as eyeglasses, contact lenses, and wheelchairs. Over-the-counter medicines are generally not deductible.
• Payments to medical care providers such as doctors, dentists, and nurses and medi- cal care facilities such as hospitals.
• Transportation for medical purposes.
• Long-term care facilities.
• Health insurance premiums (if not deducted for AGI by self-employed taxpayers) and insurance for long-term care services.18,19
16Taxpayers participating in flexible spending accounts are allowed to direct that a fixed amount of their sal- ary be placed in an account to pay for medical expenses. The salary paid into these accounts is excluded from gross income and used to pay for medical expenses. See the Compensation chapter.
17For the purpose of deducting medical expenses, a dependent need not meet the gross income test [§213(a)], and a child of divorced parents is considered a dependent of both parents [§213(d)(5)]. We discuss the general requirements for dependency in the Individual Income Tax Overview, Dependents, and Filing Status chapter.
18This includes the annual cost of Medicare and prescription insurance withheld from the Social Security recipient’s benefits checks.
19The portion of any premiums for health insurance purchased through an exchange and offset by a premium tax credit under §36B is not deductible as an itemized deduction.
Exemptions 6a Yourself. If someone can claim you as a dependent, do not check box 6a . . . . .
b Spouse . . . . . . . . . . . . . . . . . . . . . . . .}
c Dependents:
(1) First name Last name
(2) Dependent’s
social security number (3) Dependent’s relationship to you
(4) if child under age 17 qualifying for child tax credit
(see instructions) If more than four
dependents, see instructions and check here a
d Total number of exemptions claimed . . . . . . . . . . . . . . . . .
Boxes checked on 6a and 6b No. of children on 6c who:
• lived with you
• did not live with you due to divorce or separation (see instructions) Dependents on 6c not entered above Add numbers on lines above a
Income
Attach Form(s) W-2 here. Also attach Forms W-2G and 1099-R if tax was withheld.
If you did not get a W-2, see instructions.
7 Wages, salaries, tips, etc. Attach Form(s) W-2 . . . . . . . . . . . . 7 8a Taxable interest. Attach Schedule B if required . . . . . . . . . . . . 8a
b Tax-exempt interest. Do not include on line 8a . . . 8b
9 a Ordinary dividends. Attach Schedule B if required . . . . . . . . . . . 9a b Qualified dividends . . . . . . . . . . . 9b
10 Taxable refunds, credits, or offsets of state and local income taxes . . . . . . 10
11 Alimony received . . . . . . . . . . . . . . . . . . . . . 11
12 Business income or (loss). Attach Schedule C or C-EZ . . . . . . . . . . 12 13 Capital gain or (loss). Attach Schedule D if required. If not required, check here a 13 14 Other gains or (losses). Attach Form 4797 . . . . . . . . . . . . . . 14
15 a IRA distributions . 15a b Taxable amount . . . 15b
16 a Pensions and annuities 16a b Taxable amount . . . 16b
17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17 18 Farm income or (loss). Attach Schedule F . . . . . . . . . . . . . . 18
19 Unemployment compensation . . . . . . . . . . . . . . . . . 19
20 a Social security benefits 20a b Taxable amount . . . 20b
21 Other income. List type and amount 21
22 Combine the amounts in the far right column for lines 7 through 21. This is your total income a 22
Adjusted Gross Income
23 Educator expenses . . . . . . . . . . . 23 24 Certain business expenses of reservists, performing artists, and
fee-basis government officials. Attach Form 2106 or 2106-EZ 24 25 Health savings account deduction. Attach Form 8889 . 25 26 Moving expenses. Attach Form 3903 . . . . . . 26 27 Deductible part of self-employment tax. Attach Schedule SE . 27 28 Self-employed SEP, SIMPLE, and qualified plans . . 28 29 Self-employed health insurance deduction . . . . 29 30 Penalty on early withdrawal of savings . . . . . . 30
31 a Alimony paid b Recipient’s SSN a 31a
32 IRA deduction . . . . . . . . . . . . . 32 33 Student loan interest deduction . . . . . . . . 33 34 Reserved for future use . . . . . . . . . . 34 35 Domestic production activities deduction. Attach Form 8903 35
36 Add lines 23 through 35 . . . . . . . . . . . . . . . . . . . 36 37 Subtract line 36 from line 22. This is your adjusted gross income . . . . . a 37
For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see separate instructions. Cat. No. 11320B Form 1040 (2017) 142,800
321 500
700 700
420 20,000 18,000
5,000
187,241
241
241 187,000
EXHIBIT 6-7 Courtney’s AGI Computation on Form 1040, Page 1
Source: Form1040
20§213(d)(9)(A).
21The cost of travel for and essential to medical care, including lodging (with certain limitations) is also deductible if the expense is not extravagant and the travel has no significant element of personal pleasure. However, under
§213(d)(2) the deduction for the cost of lodging is limited to $50 per night per individual.
Medical expenses for cosmetic surgery or other similar procedures are not deductible un- less the surgery or procedure is necessary to ameliorate a deformity arising from, or di- rectly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or a disfiguring disease.20
TAXES IN THE REAL WORLD Are Discretionary Medical Expenses Deductible?
While cosmetic surgery is generally not deduct- ible, discretionary medical costs may be deducted where the procedure affects the structure or func- tion of the body. Take, for example, procedures that facilitate pregnancy by overcoming infertility.
In IRS Letter Ruling 200318017, the IRS ruled that egg donor fees and expenses related to obtaining a willing donor, paid by a taxpayer who could not conceive using her own eggs, qualified as deduct- ible medical expenses because they were in- curred in preparation of the taxpayer’s medical procedure (the implantation of a donated egg).
Deductible expenses included the donor’s fee for her time and expense in following the procedures to ensure successful egg retrieval, the agency’s
fee for procuring the donor and coordinating the transaction, expenses for medical and psychologi- cal testing and assistance of the donor before and after the procedure, and legal fees for preparing a contract between the taxpayer and the donor.
What about the same type of expenses paid by a single male to father a child through a sur- rogate? Are those expenses deductible? No, be- cause in that situation, the expenses are not related to an underlying medical condition or de- fect of the taxpayer, nor are they affecting any structure or function of his body. See William Magdalin, TC Memo 2008-293.
Source: William Magdalin, TC Memo 2008-293.
In April, Courtney broke her wrist in a mountain biking accident. She paid $2,000 for a visit to the hos- pital emergency room and follow-up visits with her doctor. While she recuperated, Courtney paid $300 for prescription medicine and $700 to a therapist for rehabilitation. Courtney’s insurance reimbursed her $1,840 for these expenses. What is the amount of Courtney’s qualified medical expenses?
Answer: $1,160, computed as follows:
Description Deduction
Emergency room and doctor visits $ 2,000
Prescription medication 300
Physical therapy 700
Total qualifying medical expenses $3,000
Less insurance reimbursement −1,840
Qualified medical expenses from the accident $1,160
Example 6-9
Transportation and Travel for Medical Purposes Taxpayers traveling for the primary purpose of receiving essential and deductible medical care may deduct the cost of lodging while away from home overnight (with certain restrictions) and transporta- tion.21 Taxpayers using personal automobiles for medical transportation purposes may deduct a standard mileage allowance in lieu of actual costs. For 2018, the mileage rate is 18 cents a mile.
22Taxpayers may deduct the cost of long-term care facilities if they are chronically ill under a prescribed plan of care. A taxpayer is deemed to be chronically ill, generally, if she or he cannot perform at least two daily living tasks (eating, bathing, dressing, toileting, transferring, continence) for 90 days or more. §7702B. Tax- payers may also deduct long-term care insurance premiums, which are limited annually based on the age of the taxpayer.
Example 6-10
Gram drove Courtney, in Courtney’s car, 110 miles back and forth from the doctor’s office and the physical therapist’s facility during the period Courtney was being treated for her broken wrist. What is the amount of Courtney’s qualifying medical expense for her trips to the doctor’s office?
Answer: $20 (110 × $0.18, rounded).
Example 6-11
Gram considered moving into a long-term care facility before she decided she would move in with Courtney. The facility was not primarily for medical care and would have cost Gram $36,000 a year.
During discussions with facility administrators, Gram learned that typically 20 percent of the total cost for the facility is allocable to medical care. If Gram were to stay in the facility for an entire year, what amount of the long-term care costs would qualify as a medical expense for Gram?
Answer: $7,200 ($36,000 × 20% allocable to medical care).
Hospitals and Long-Term Care Facilities Taxpayers may deduct the cost of meals and lodging at hospitals. However, the cost of meals and lodging at other types of facilities such as nursing homes are deductible only when the principal purpose for the stay is medical care rather than convenience.22 Of course, taxpayers may deduct the costs of actual medical care whether the care is provided at hospitals or other long-term care facilities.
Medical Expense Deduction Limitation The deduction for medical expenses is limited to the amount of unreimbursed qualified medical expenses paid during the year (no matter when the services were provided) reduced by 7.5 percent of the taxpayer’s AGI for 2017 and 2018 (and 10 percent thereafter). This restriction is called a floor limitation because it eliminates any deduction for amounts below the floor. The purpose of a floor limitation is to restrict a deduction to taxpayers with substantial qualified expenses. Because this floor limitation is set at a high percentage of AGI, unreimbursed medical expenses rarely produce tax benefits, especially for high-income taxpayers.
Example 6-12
This year Courtney incurred $2,400 in unreimbursed qualified medical expenses (including the
$1,160 of qualifying medical expenses associated with the accident [Example 6-9] and the $20 transportation deduction for mileage [Example 6-10]). Given that Courtney’s AGI is $187,000, what is the amount of Courtney’s itemized medical expense deduction?
Answer: $0, computed as follows:
Description Expense
Total unreimbursed qualified medical expenses $ 2,400 Minus: 7.5% of AGI ($187,000 × 7.5%) (14,025) Medical expense itemized deduction $ 0
(continued on page 6-14)
Taxes
Individuals may deduct as itemized deductions the payments they made during the year for the following taxes:
• State, local, and foreign income taxes, including state and local taxes paid during the year through employer withholding, estimated tax payments, and overpayments on the prior-year return that the taxpayer applies to the current year (the taxpayer asks the state to keep the overpayment rather than refund it).
• State and local real estate taxes on property held for personal or investment purposes.
• State and local personal property taxes that are assessed on the value of the specific property.23
Taxpayers may elect to deduct state and local sales taxes instead of deducting state and local income taxes. This election is particularly advantageous for taxpayers in states that don’t have an individual state income tax.24 For years after 2017, the total itemized deduction for taxes is limited to $10,000 ($5,000 for a taxpayer filing married separate).
23§164.
24The deduction can be based upon either the amount paid or the amount published in the IRS tables (IRS Publication 600) based upon the state of residence, income, and number of dependents. The states with no income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Tennessee and New Hampshire have no state income tax on wages but do impose a tax on unearned income.
During the year, Courtney paid $6,700 of state income taxes through withholding from her paycheck.
She also paid $2,700 of real estate taxes on her personal residence and $980 of real estate taxes on an investment property she owns in Oklahoma. Finally, Courtney paid $180 as a registration fee for her automobile (the fee is based on the year the automobile was manufactured, not its value). What amount of these payments can Courtney deduct as itemized deductions?
Answer: $10,000 ($6,700 state taxes + $2,700 real estate taxes on residence + $980 real estate taxes on investment property, limited to $10,000). Courtney is not allowed to deduct the registration fee for her car because the fee is not based on the value of the automobile.
What if: Suppose that on April 1, 2018, Courtney filed her 2017 state tax return and was due a refund from the state in the amount of $420. However, Courtney elected to have the state keep the overpay- ment and apply it to her 2018 tax payments. Assume that Courtney also had the $6,700 of state in- come tax withholding but only had $1,500 of real estate taxes in total. What amount of income taxes is Courtney allowed to deduct as an itemized deduction in 2018?
Answer: $8,620 ($6,700 withholding + $420 overpayment applied to 2018 + $1,500 real estate taxes). The treatment of the overpayment is the same as if Courtney had received the refund in 2018 and then remitted it to the state as payment of 2018 taxes. Because she paid the tax in 2018, she is allowed to deduct the tax in 2018. Recall that under the tax benefit rule (see the Gross Income and Exclusions chapter), Courtney was required to include the $420 in her 2018 gross income.
Example 6-13
What if: What amount of medical expenses would Courtney be allowed to deduct if her AGI was
$20,000?
Answer: $900, computed as follows:
Description Expense
Total unreimbursed qualified medical expenses $ 2,400 Minus: 7.5% of AGI ($20,000 × 7.5%) (1,500) Medical expense itemized deduction $ 900
Interest
There are two itemized deductions for interest expense.25 First, subject to limitations de- scribed in more detail in the Tax Consequences of Home Ownership chapter, individuals can deduct interest paid on acquisition indebtedness secured by a qualified residence (the taxpayer’s principal residence and one other residence).26 Acquisition indebtedness is any debt secured by a qualified residence that is incurred in acquiring, constructing, or sub- stantially improving the residence.27
The home mortgage interest deduction is limited by a cap on acquisition indebted- ness that varies based upon when the indebtedness originated. For acquisition indebt- edness incurred after December 15, 2017, taxpayers may only deduct mortgage interest on up to $750,000 of acquisition indebtedness ($375,000 if married filing separately).
For acquisition indebtedness incurred before December 16, 2017, the limitation on ac- quisition indebtedness is $1,000,000 ($500,000 if filing married separate), even if the debt is refinanced after December 15, 2017. When a taxpayer has both acquisition in- debtedness incurred before December 16, 2017, and after December 15, 2017, the
$750,000 ($375,000) limit is reduced (not below zero) by the acquisition indebtedness incurred before December 16, 2017.
As we discuss in more detail in the Investments chapter, individuals can also deduct in- terest paid on loans used to purchase investment assets such as stocks, bonds, or land (invest- ment interest expense). The deduction of investment interest is limited to a taxpayer’s net investment income.28 Any investment interest in excess of the net investment income limita- tion carries forward to the subsequent year. Taxpayers are not allowed to deduct interest on personal credit card debt or on loans to acquire (and secured by) personal-use automobiles.
25Interest paid on loans where the proceeds are used in a trade or business is fully deductible as a business ex- pense deduction for AGI.
26Prior to 2018, taxpayers could deduct mortgage interest on up to $100,000 of home-equity indebtedness ($50,000 if married filing separately). Prior to 2018, taxpayers could also deduct premiums paid or accrued on mortgage insurance (insurance premiums paid by the borrower to protect the lender against the borrower defaulting on the loan) as qualified residence interest expense. At press time, the deduction for mortgage in- surance premiums has not been extended to 2018.
27Subject to rules discussed in the Tax Consequences of Home Ownership chapter, points paid on indebtedness incurred in acquiring a home are also generally deductible as mortgage interest expense in the year the loan originates and points to refinance a home mortgage are typically amortized and deducted over the life of the loan (but see research memo in the Tax Compliance, the IRS, and Tax Authorities chapter for an exception).
28§163(d). Net investment income is defined as investment income minus investment expenses. Because in- vestment expenses are no longer deductible as itemized deductions, the investment interest expense deduc- tion is effectively limited to the taxpayer’s investment income.
29§170(c). The IRS Exempt Organizations Select Check (https://www.irs.gov/charities-non-profits/exempt- organizations-select-check) lists the organizations that the IRS has determined to be qualified charities.
Example 6-14
Courtney acquired her home in Kansas City in January of this year for $300,000 (also its value through- out the year). She purchased it by paying $40,000 as a down payment and borrowing $260,000 from a credit union. Her home is the collateral for the loan. During the year, Courtney paid $15,800 in inter- est on the loan. How much of this interest may Courtney deduct?
Answer: $15,800. Because Courtney’s home mortgage is secured by her home, she is allowed to deduct the interest expense on the home as an itemized deduction.
Charitable Contributions
Congress encourages donations to charities by allowing taxpayers to deduct contributions of money and other property to qualified domestic charitable organizations. Qualified charitable organizations include organizations that engage in educational, religious, sci- entific, governmental, and other public activities.29 Political and campaign contributions are not deductible even though they arguably indirectly support the government (contri- butions to which are generally deductible).
This year Courtney donated $1,700 to the American Red Cross. She also gave $200 in cash to various homeless people she met on the streets during the year. What amount of these donations is Courtney allowed to deduct as a charitable contribution?
Answer: $1,700. Because the American Red Cross is a public charity recognized by the IRS, Courtney may deduct her $1,700 charitable contribution to it as an itemized deduction. However, despite Court- ney’s charitable intent, her donations to the homeless are not deductible as charitable contributions because individuals do not qualify as charitable organizations.
What if: Suppose that instead of transferring cash to homeless people on the streets, Courtney do- nated $200 cash to a local food bank that is listed in the IRS Exempt Organizations Select Check as a qualified charity. The food bank provides meals to those in need. Would Courtney be allowed to de- duct this contribution?
Answer: Yes, because the food bank is a qualified charity.
Example 6-15
The amount of the charitable contribution deduction depends on whether the tax- payer contributes money or other property to the charity. Note that in virtually all cir- cumstances, donations are deductible only if the contribution is substantiated by written records.30
Contributions of Money Cash contributions are deductible in the year paid, includ- ing donations of cash or by check, electronic funds transfers, credit card charges, and payroll deductions.31 Taxpayers are also considered as making monetary contributions for the cost of transportation and travel for charitable purposes if there is no significant ele- ment of pleasure or entertainment in the travel. When taxpayers use their personal vehi- cles for charitable transportation purposes, they may deduct, as a cash contribution, a standard mileage allowance for each mile driven (14 cents a mile in 2018). While taxpay- ers are allowed to deduct their transportation costs and other out-of-pocket costs of pro- viding services for charities, they are not allowed to deduct the value of the services they provide for charities.
30For example, to deduct monetary donations, taxpayers must keep a bank record or a written communica- tion from the charity showing the name of the charity and the date and amount of the contribution. In addi- tion, to deduct charitable contributions for cash or noncash contributions of $250 or more, a taxpayer must receive a written acknowledgment from the charity that shows the amount of cash and a description of any property contributed. The acknowledgment must also state whether the donee organization provided any goods or services to the donor for the contribution and if so, either include a description and estimate of the value of the goods or services provided by the donee organization or, if applicable, a statement that the goods or services provided by the donee organization consist entirely of intangible religious benefits. See Publication 526 for more information.
31When individual taxpayers mail a contribution, they are allowed to deduct the contribution when they place the payment in the mail. When they pay via credit card, they are allowed to deduct the contribution on the day of the charge. Rev. Rul. 78-38, 1978-1 CB 67.
Once a month, Courtney does volunteer work at a Goodwill Industries outlet about 20 miles from her home. Altogether, Courtney traveled 500 miles during the year driving to and from the Goodwill outlet. Courtney has determined that the services she provided during the year are reasonably valued at $1,500. What amount is Courtney allowed to deduct for her volunteer work with Goodwill Industries?
Answer: $70. Courtney is not allowed to deduct the value of the services she provides to Goodwill.
However, she is allowed to deduct the $70 cost of her transportation to and from the Goodwill outlet (500 miles × 14 cents per mile).
Example 6-16