Advanced Individual Income Tax

Accounting 811: Spring, 1998

Week 7: Losses; Itemized Deductions

 Outline (c) 1997-98 Robert H. Daniels

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1. "Itemized" deductions

Individual deductions not costs of Y

 2. Concept of "Tax Expenditure"

A tax subsidy

Treating foregone revenue as the equivalent of spending
Departure from a "normative" tax code
Equivalent of off-budget spending

History and evolution:

Concept developed in late 1960's
Since mid-1970's a tax expenditure chart is required part of budget
New proposals are scored as tax expenditure equivalents
Need to reaise counterbalancing revenues

Large tax expenditures today: over $10 BB each

3. Code and form structure for itemized deductions

Sec. 62: Concept of AGI

Text gives some of the legislative history
Now increasingly arbitrary and subject to ad hoc overrides
"Modified" AGI as the starting point for many pahseouts

Definition: gross Y minus some deductions

These are the Schedule C, D, E and 1040 p.1 "Adjustments" to income

T/B expenses of proprietor, partner, non-employee
Employee under reimbursement arrangement:
Defined in 62(c) See Regs: a pass-thru
Losses from property if allowed (Sec. 165, 1211)
Rents and Royalty expenses
Retirement Savings, P/P/S
Alimony paid
Eff 1/98 student loan interest (w/ an annual maximum)
Various other small stuff

Functions of AGI:

deductions taken to arrive at AGI have no standard alternative
these deductions not hit by % phaseout over $120K
AGI used to calculate threshholds: Medical, Cas, Misc.

Effect:

Costs of being an employee or non-landlord investor are itemized, even tho they are costs of income

"Modified AGI"

Congress sought threshholds on some AGI items:

Rental Losses of Active Landlords
Social Security Benefits
IRA deductions if also covered by employer
The new student loan interest provision

Need to do a worksheet calculation of tentative AGI

4. Taxable Y: Sec. 63.

Y minus deductions allowed by "chapter"

63(b)- (f): standard deduction or itemize

Itemized means: all deductions not for AGI

Deduct exemption for dependents: Sec. 151-152

Ordinary Y and Loss: Sec 64 and 65:

gain that is not capital or 1231

loss that is not capital

5. Medical: Sec. 213

7.5% threshhold is the big screen

Tax expenditure here $3.5 bb/ yr. That for employer insurance is $60 bb

Mechanics:

Taxpayer, spouse, Sec. 152 dependent
  note: need not be a "deductible" dependent
throwback rule for decedents: Sec. 213(c)

definition of "medical"

Key case law question Sec. 213(d)(1)

Recent code expansion:: medical includes nursing home care

 

6. Taxes:

What does it cover?

Sec. 164: S/L/ Foreign Y and real estate; s/l pers property

And other taxes if w/in 162 or 212

1/2 of self-employment tax : 164(f): to =ize SE w/ e'er

This is adjustment to income: rest are itemized

Deduction limits:

capitalized cost of property: 164(a) last sentence

No deduction for benefit assessments: 164(c)
No deduction for Y taxes themselves: Sec. 275

Property tax prorations: Sec. 164(d)

In effect, place parties on accrual in year of sale
The balancing credit or debit is a price adjustment

Who get the deduction: Cramer case

Taxes only deductible by person on whom imposed: the owner.
(Note that California law is different: beneficial owner liable)

Prorations example:

In effect, part of the selling price was B reimbursing her for taxes paid, which B now deducts

 

7. Interest: Sec. 163

Peculiar structure

due to 1986 change. Also much complexity,

163(a)  grants deduction.

163(d) limits it for investment interest.

163(h) disallows interest for noncorporates for "personal interest"

"personal interest" is residual. 163(h)(2): all but...:

Investment interest:

163(d) : deduct it up to Net Invest Y

Peculiar definition

Debt allocable to property held for investment
But not qualified residence or passive activity

Held for investment

X-Ref to "producing Y described in" 469(e)(1)
  469(e)(1)(A)(i) int, div, annuity, nonbiz royalites

469(e)(1)(A)(ii) g/l from disposition of property producing
  (i) Y or held for investment. (not passive activity)

And "an interest in a business which is not passive but Tp doesn't materially participate"

Probably to pick up oil and gas working interests: 469(c)(3)

Reported as itemized: cost of being an investor

Sched A: along w/ home mortgage
indefinite carryforward of excess

Net Capital Gains

are "investment income" only to extent Tp waives the capital gains tax break

Home mortgage interest: Sec. 163(h)(3)

Acquisition debt.

Acquire/improve, secured by residence
or a Refinancing of acquisition debt

Aggregate limit $1 mm

Home equity debt.

Secured by residence, max $100K

Grandfather rule:

debt in place 10/13/87

Qualified residence: primary and 1 secondary

construction and take-out financing:

Notice 88-74: 90 day window for borrowing: and take out may replace expenses made in prior 24 months

Tracing: outside the home mortgage area:

Regs. 1.163-8T

Extremely complex and not used as often as it could be

Account by account

 interest follows the debt
compounding follows the debt its compounded on

Within an account

       Temp. Regs. Sec.1.163-8T (c)(4)

Debt spent before non-debt
First Debt Spent first

      Alternatively, 15 day specific identification

Partial Payments

When debt paid, if multi use, pay off least deductible 1st: -8T(d)(1)
If expenditure was asset, reallocate when asset sold

Special Rules

Replacement Debt (refinancings)-8T(e)
Ancillary debt (borrow to pay interest)-8T(c)(6)

How to cope:

know the rules
after borrowing, write personal checks last
create separate accounts to hold borrowed funds
Borrow to run business, use business income for personal expenses

 

8. Charity

In General

What’s a charitable organization?

501(c)(3): subclass of nonprofit tax exempt

What’s the tax break?

No tax on organization income (all nonprofits)

Sec. 170 deduction for gifts

Limits on the deduction:

50% of current year AGI w/ 4 year carryforward

Sub-limit of 30% for gifts to private nonoperating foundations
Or for certain "capital gains" gifts

What’s the valuation of gifts

Cash:

fact of contribution: note substantiation rule for over $250
Question of the quid pro quo

Non cash is generally Lower of cost or market

If appreciated

need to ask if LT capital, if tangible, if charity will use in its exempt function

if so: charitable loophole: deduct market: untaxed gain

If LT capital, are further sublimits of 30% of AGI generally and 20% for private foundations

Charitable issues: Hernandez case

 

9. Casualty Losses: personal use property

 defined

Fire storm, shipwreck, other casualty or theft

accident? probably (diamond ring misplaced?)
slow deterioration not a casualty: termites
disaster loss treated as tho in prior year: Sec 165(i)

Measurement

generally: lesser of basis (tax cost) or FMV

less available insurance recovery
can't deduct unrealized gains
cost of repair if auto is measure of loss

Mechanics

    personal use property: deduct unreimbursed loss

    limits: $100 per casualty event; sum events, subtract 10% AGI

Note re investment property (eg stock and bonds): special rules

  

10. Moving expenses

Reimbursement may create income

50 mile distance test for "job related" move

only milage, lodging, household effect move are deductible

 11. Miscellaneous.

most 212's (not rents or royalties); 162's of employees

key is the 2% threshhold

Misc not subject to 2%: gambling, estate tax paid on IRD

  

Gwailo