Taking control of your taxes topic #83 - Be proactive about 2012 income tax - Deductions

Be proactive about 2012 income tax

How to compute Deductions

Now that you have computed 2012 estimated income (see my previous post #82), you are ready to compute your deductions (Schedule A). This is a long post, so start reading if you have at least 5 minutes of spare time.

If you don’t have enough deductions, then you can use the standard deduction (see the table below) and skip this post entirely.

Schedule A deductions

Should I Itemize? – You can use itemized deduction only if the total itemized deductions (including medical, tax, mortgage interest, charitable donations, casualty and loss, and miscellaneous deductions) exceed the following 2012 standard deduction amounts:

• Joint Returns and Surviving Spouses $11,900
• Head of Household $8,700
• Single Taxpayers $5,950
• Married Filing Separately $5,950
• Dependent $950 or $300 plus earned income, if greater
• Age 65 and Older or Blind - Single or HoH Additional $1,450 each
• Age 65 and Older or Blind - All Others Additional $1,150 each
• "Kiddie" Tax (children < 19 and dependent full-time students < 24) $1,900
• Personal Exemption Deduction ($3,800)

Medical and Dental Expenses - If, for a taxable year, you itemize your deductions on Schedule A, you may be able to deduct expenses you paid that year for medical and dental care for yourself, your spouse, and your dependents. You may deduct only the amount by which your total medical care expenses for the year exceed 7.5% of your adjusted gross income. For years beginning after December 31, 2012, you may deduct only the amount by which your total medical expenses exceed 10% of your adjusted gross income.

Deductible Taxes - There are five types of deductible non-business taxes:

• State, local and foreign income taxes
• State, local and foreign real estate taxes
• State, and local personal property taxes
• State and local sales taxes, and
• Qualified motor vehicle taxes

To be deductible, the tax must be imposed on you and must have been paid during your tax year.

Home Mortgage Points - The term "points" is used to describe certain charges paid to obtain a home mortgage. Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions on Schedule A. If you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.

Interest Expense - Interest is an amount you pay for the use of borrowed money. To deduct interest you paid on a debt you must be legally liable for the debt. There must be a true debtor-creditor relationship. Additionally, you generally must itemize your deductions, unless the interest is on rental or business property or on a student loan.

If you prepay interest, you must allocate the interest over the tax years to which it applies. You may deduct in each year only the interest that applies to that year. However, there is an exception that applies to points paid on a principal residence.

Types of interest you can deduct as itemized deductions on Schedule A include investment interest (limited to your net investment income) and qualified residence interest. You cannot deduct personal interest. Personal interest includes interest paid on a loan to purchase a car for personal use. Personal interest also includes credit card and installment interest incurred for personal expenses. Items you cannot deduct as interest include points (if you are a seller), service charges, credit investigation fees, and interest relating to tax-exempt income, such as interest to purchase or carry tax-exempt securities.

Charitable Contributions - To be deductible, charitable contributions must be made to qualified organizations. Payments to individuals are never deductible. SeePublication 526, Charitable Contributions.

If your contribution entitles you to merchandise, goods, or services, including admission to a charity ball, banquet, theatrical performance, or sporting event, you can deduct only the amount that exceeds the fair market value of the benefit received.

For a contribution of cash, check, or other monetary gift (regardless of amount), you must maintain as a record of the contribution a bank record or a written communication from the qualified organization containing the name of the organization, the date of the contribution, and the amount of the contribution. In addition to deducting your cash contributions, you generally can deduct the fair market value of any other property you donate to qualified organizations. See Publication 561, Determining the Value of Donated Property. For any contribution of $250 or more (including contributions of cash or property), you must obtain and keep in your records a contemporaneous written acknowledgment from the qualified organization indicating the amount of the cash and a description of any property contributed. The acknowledgment must say whether the organization provided any goods or services in exchange for the gift and, if so, must provide a description and a good faith estimate of the value of those goods or services. One document from the qualified organization may satisfy both the written communication requirement for monetary gifts and the contemporaneous written acknowledgment requirement for all contributions of $250 or more.

Miscellaneous Expenses - If you have expenses that qualify as miscellaneous itemized deductions, you can deduct the total amount of those expenses only to the extent that they exceed 2% of your adjusted gross income.

There are three types of expenses that are subject to the 2% limit. They are unreimbursed employee expenses, tax preparation fees and other expenses. For an explanation of deductible and nondeductible expenses refer to Publication 529, Miscellaneous Deductions.

Certain unreimbursed employee expenses are deductible as miscellaneous itemized deductions on Schedule A. To be deductible, the expense must be:

• Paid or incurred in the tax year
• For carrying on your trade or business of being an employee, and
• Ordinary and necessary

You can deduct other expenses subject to the 2% limit that you pay to:

• Produce or collect taxable income
• Manage, conserve, or maintain property held for producing such income, or
• Determine, contest, pay, or claim a refund of any tax

Employee Business Expenses - If you are an employee, you may be able to deduct your work-related expenses as an itemized deduction (subject to limitations) on Schedule A.

Although commuting costs are not deductible, some local transportation expenses are. Deductible local transportation expenses include the ordinary and necessary expenses of going from one workplace (away from the residence) to another. If you have an office in your home that you use as your principal place of business for your employer, you may deduct the cost of traveling between your home office and work places associated with your employment. Refer to Topic 509 for information on home offices. You may deduct the cost of going between your residence and a temporary work location outside of the metropolitan area where you live and normally work. If you have one or more regular work locations away from your residence, you may also deduct the cost of going between your residence and a temporary work location in the same trade or business within your metropolitan area. Business entertainment expenses and business gift expenses may be deductible, but subject to certain limits.

Casualty, Disaster, and Theft Losses - A casualty loss can result from the damage, destruction or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake or even volcanic eruption. A casualty does not include normal wear and tear or progressive deterioration.

A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking must be illegal under the law of the state where it occurred and it must have been done with criminal intent.

If your property is personal-use property or is not completely destroyed, the amount of your casualty or theft loss is the lesser of:

• The adjusted basis of your property, or
• The decrease in fair market value of your property as a result of the casualty or theft

Schedule C deductions

 

Business Use of Home- To deduct expenses for business use of the home, part of your home must be used regularly and exclusively as one of the following:

1. The principal place of business for your trade or business
2. The place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; or
3. A separate structure used in connection with your trade or business that is not attached to your home

When the exclusive-use requirement applies, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business-use-of-your-home expenses. Further, under the principal-place-of-business test, you must determine that your home is the principal place of your trade or business after considering where your most important activities are performed and most of your time is spent, in order to deduct expenses for the business use of your home. Additionally, a portion of your home may qualify as your principal place of business if you use it for the administrative or management activities of your trade or business and you have no other fixed location where you conduct substantial administrative and management activities for that trade or business. An employee may only deduct business-use-of-the-home expenses when the business part of the home is used regularly and exclusively and for the employer's convenience.

Deductions also may be taken for business storage purposes when the dwelling unit is the sole fixed location of the business or for regular use of a residence for the provision of day care services; exclusive use is not required in these cases.

Business Use of Car- If you use your car in your job or business and you use it only for that purpose, you may deduct its entire cost of operation (subject to limits discussed later). However, if you use the car for both business and personal purposes, you may deduct only the cost of its business use.

You can generally figure the amount of your deductible car expense using one of two methods: the standard mileage rate method or the actual expense method. If you qualify to use both methods, before choosing a method, you may want to figure your deduction both ways to see which gives you a larger deduction. Please refer to Publication 463, Travel, Entertainment, Gift and Car Expenses, for the current standard mileage rate. If you use the standard mileage rate, you can add to your deduction any parking fees and tolls incurred for business purposes.

Business Travel Expenses - Travel expenses are the ordinary and necessary expenses of traveling away from home for your business, profession, or job. You cannot deduct expenses that are lavish or extravagant or that are for personal purposes.  You are traveling away from home if your duties require you to be away from the general area of your tax home for a period substantially longer than an ordinary day's work, and you need to get sleep or rest to meet the demands of your work while away.

 

Education deductions

Educational Expenses- You may be able to deduct work-related educational expenses paid during the year as an itemized deduction on Schedule A. To be deductible, your expenses must be for education that (1) maintains or improves your job skills, or (2) is required by your employer or by law to keep your salary, status or job. However, even if the education meets either of these tests, the education cannot be part of a program that will qualify you for a new trade or business, or needed to meet the minimal educational requirements of your trade or business.

Although the education must relate to your present work, educational expenses incurred during temporary absence from your job may be deductible. However, after your temporary absence, you must return to the same kind of work. Usually, absence from work for one year or less is considered temporary.

Expenses that can be deducted include:

• Tuition, books, supplies, lab fees, and similar items
• Certain transportation and travel costs, and
• Other educational expenses, such as the cost of research and typing

Next post will discuss tax credits