Deductions & Credits

Itemized deductions are reported to the IRS on Schedule A. The main types of itemized deductions include:

• Medical and Dental – Doctors, hospitals, dentists, eyeglasses, contacts, prescription drugs and mileage
• Taxes - State and local income taxes, real estate (property) taxes, vehicle registration and others. For more information about deducting property taxes in the greater Phoenix area, please refer to the website for the Maricopa County Treasurer.
• Sales Tax - Sales tax paid on the purchase of a new vehicle and/or building materials may be deductible. An additional amount of estimated sales tax paid on general merchandise can also be added to these amounts to arrive at the potential deductible amount. The estimated sales tax amount is obtained from an IRS table. If electing to deduct sales tax paid then this deduction replaces the deduction for state income tax paid.
• Interest - Home mortgage interest and points, investment interest
• Charity - Cash and non-cash donations (clothes, furniture, etc.)
• Casualty and Theft Losses - Unusual circumstances such as flood, fire, theft, or other disasters
• Employee Business Expenses - Non-reimbursed expenses required for your job
• Miscellaneous Deductions - Safety deposit box rental, investment expenses, tax return preparation fees
• Job Search Expenses - Resume preparation, travel, postage, stationary, etc.

For your information, the tables below shows some interesting statistics:

AVERAGE ITEMIZED DEDUCTIONS -- 2006 TAX RETURNS

AVERAGE ITEMIZED DEDUCTIONS -- 2007 TAX RETURNS

For most taxpayers the answer is no! The IRS has established the following criteria to qualify for exclusion of gain on a personal residence:

• Taxpayer must have owned and used the home as a principal residence for at least two out of the five years prior to the sale.
• The amount of gain that can be excluded is limited to $500,000 for a married couple (who must file a joint return) or $250,000 for a single taxpayer.

You may recall old tax law that required the taxpayer to "roll" the unrecognized gain from one home into the next home purchased. Under current law this is no longer required.

Interest paid on "acquisition indebtedness" is potentially deductible. Acquisition indebtedness is defined as any debt that is incurred in acquiring, constructing, or substantially improving any qualified residence. The debt also has to be secured by a qualified residence. The total amount that can be treated as acquisition indebtedness for a principal and a second residence is $1,000,000 ($500,000 for a married person filing a separate return). Any interest on debt that exceeds $1,000,000 would be non-deductible personal interest or perhaps can qualify as home equity indebtedness which is discussed later.

The total amount of acquisition indebtedness also cannot exceed the cost of the residence plus improvements. Therefore debt later taken out based on the appreciation of the property may not qualify as acquisition indebtedness. It may qualify as home equity indebtedness which is discussed later.

Interest on refinanced acquisition indebtedness is only deductible to the extent of the remaining balance of the original acquisition indebtedness immediately prior to the refinancing (unless the added debt is used to improve the property). This means that if you had previously paid down your loan and then refinance to the original loan amount, or more, only the interest on the amount of the loan prior to the refinance would be deductible as acquisition indebtedness. Therefore, taking out more equity during a refinance may not qualify as acquisition indebtedness. It may qualify as home equity indebtedness which is discussed later.

EXAMPLE: Sally purchases a principal residence for $250,000, using $40,000 of her own funds and a $210,000 mortgage that is secured by the residence. Sally refinances the debt when the balance due on the original mortgage is $205,000, borrowing $230,000 secured by the principal residence. Since $205,000 of the new loan proceeds is disbursed directly to repay the remaining balance of the earlier loan, $205,000 of the $230,000 loan is treated as acquisition indebtedness.

Interest paid on home equity indebtedness may be deductible. Home equity indebtedness is any debt secured by a qualified residence that is not acquisition indebtedness. The amount of home equity indebtedness may not exceed $100,000 ($50,000 for a married person filing a separate return) and may not exceed the difference between the fair market value of the residence and the amount of acquisition indebtedness. This debt can be used for any purposes, even personal purposes, and does not have to be used for home improvements.

The additional $100,000 of home equity indebtedness or acquisition indebtedness is not deductible for Alternative Minimum Tax (AMT) purposes.

Pre-payment penalties are deductible as mortgage interest.

The above are the rules for loans after 10/13/87. Loans prior to 10/13/87 have different rules.

A taxpayer can deduct mortgage interest on a second home in most cases (assuming that you itemize deductions). One exception is if the second or "vacation" home is rented out for part of the year. In that situation, the interest is only deductible if the taxpayer personally uses the home for more than a minimum number of days. This minimum number is the greater of 14 days or 10 percent of the rental days.

Generally speaking, the move must be due to working in a new location and the costs of moving must occur within one year of starting the new work. In addition, moving expenses are subject to several tests.

• The distance test says that the taxpayer's commute to his new work must be at least 50 miles farther than his prior commute had been.
• Another test states that the taxpayer must be employed full time for at least 39 weeks during the 12-month period following the move.
• Please be aware that some special rules apply for military and foreign moves.
• If an employer covers your moving costs, either by paying them directly or reimbursing the taxpayer, the amounts received is not income. Accordingly, any moving costs that are reimbursed are not deductible for taxes.
• Types of deductible moving costs include the costs of transporting household goods and the costs of traveling from the old residence to the new residence. This traveling may involve airfare, lodging during the move, and vehicle use at 16.5 cents per mile.
• Other moving related expenses that are not deductible are: meals during the move, temporary lodging and meals, expenses of buying or selling a home, and house-hunting trips.

The use of a vehicle results in a tax deduction in several situations. When using a car for business, the deduction is calculated either with the standard rate option at 51 cents per mile or using actual costs (NOTE: Both methods require you to keep a log of your mileage. Also, under the actual costs method, you would only deduct a percentage of the actual costs based on your ratio of business miles to total mileage for the year.)

For a taxpayer who is an employee, the deduction for business use of a personal vehicle is deductible on Schedule A, itemized deductions. The deduction is limited to the amount that exceeds 2% of the taxpayer's adjusted gross income.

If your employer reimbursed your vehicle costs using the 51 cents a mile standard rate, then as an employee you have no income to report and also no deduction. However, if your employer's reimbursement is less than your costs, you do have a potential deduction. 

The IRS has several special opportunities for this area:

Credits

• Two credits are available for tuition expenses paid These can be paid for the taxpayer, the taxpayer's spouse or a dependent.
• The first credit is called the Lifetime Learning Tax Credit and is calculated at 20% of tuition paid with a maximum credit of $2,000 based on $10,000 of tuition paid.  This credit is as the title states: available for a taxpayer's lifetime.  There is no limit or cap on the number of years this can credit can be claimed.
• The second credit is called the American Opportunity Tax Credit and is calculated at 100% of the first $2,000 of tuition paid and 25% of then next $2,000 of tuition paid.  The maximum credit is $2,500 and is potentially partially refundable.  This credit is limited to the first 4 years of college education and expires at 12/31/10.  This credit also requires the student to be in a degreed program and take at least 1/2 the normal full time workload.
• Unfortunately however, these two credits are subject to restrictions based on income. For the American Opportunity Tax Credit joint return filers with adjusted gross income between $160,000 and $180,000 will only receive a portion of the credit. Likewise, single return filers with adjusted gross income between $80,000 to $90,000 will only receive a portion of the credit. Taxpayers whose income is below the beginning of those income ranges will receive the full credit. Taxpayers filing married filing separate returns will not qualify for the credit. For this credit qualified expenses include tuition and course materials.
• For the American Opportunity Tax Credit joint return filers with adjusted gross income between $160,000 and $180,000 will only receive a portion of the credit. Likewise, single return filers with adjusted gross income between $80,000 to $90,000 will only receive a portion of the credit. Taxpayers whose income is below the beginning of those income ranges will receive the full credit. Taxpayers filing married filing separate returns will not qualify for the credit. For this credit qualified expenses include tuition and course materials.
• For the Lifetime Learning Tax Credit joint return filers with adjusted gross income between $100,000 and $120,000 will only receive a portion of the credit. Likewise, single return filers with adjusted gross income between $50,000 to $60,000 will only receive a portion of the credit. Taxpayers whose income is below the beginning of those income ranges will receive the full credit. Taxpayers filing married filing separate returns will not qualify for the credit. For this credit qualified expenses include tuition, books, supplies and equipment (if paid to the institution as a condition of enrollment or attendance).

Deductions

• Tuition and Fees Deduction.  The maximum allowable deduction for 2010 is $4,000. Unfortunately however, this deduction is subject to restrictions based on income. Single return filers with adjusted gross income of $65,000 -$80,000 and joint return filers with adjusted gross income of $130,000 - $160,000 are only eligible to deduct $2,000. If adjusted gross income is over $80,000 (single) or $130,000 (joint) no deduction is allowed.
• Education expenses are also deductible expense under IRS regulations if they are either (a) paid to meet the express requirements of your employer or (b) the education maintains or improves a skill required in your occupation. This deduction would appear on schedule A as a miscellaneous itemized deduction.
• The tax law defines personal education expense as any that either (1) qualify the taxpayer for a new occupation or (2) are needed for the taxpayer to meet the minimum educational requirements for their current occupation.

Tax law provides that parents who pay child and dependent care expenses to allow the taxpayer (and spouse if married) to work can take a credit if they qualify.

To qualify, the expenses must be paid for a qualifying individual, defined as either:

• A dependent under age 13 for whom the taxpayer is entitled to claim an exemption
• A dependent who is physically or mentally incapable of self-care (regardless of age)
• A spouse who is physically or mentally incapable of self-care

Yes! An Arizona tax law provides the opportunity for two tax credits for donations to benefit schools. Credits result in a direct dollar for dollar decrease in tax due. Therefore credits are much better than deductions.

• The first is for donations made to public schools to fund extracurricular activities. The maximum amount of the credit in 2010 is $400 for married couples filing jointly or $200 for single taxpayers.
• The second credit available is for donations to a school tuition organization that provides scholarships or grants to qualified schools. The maximum amount of the credit in 2010 is $1000 for married couples filing jointly or $500 for single taxpayers.

To claim these credits, the donation must be made by December 31st. The donor is not required to have a child or relative attending school.

For 2010 the child tax credit is $1,000. To take this credit the taxpayer must have a child who is a U.S. citizen under the age of 17 for whom they qualify to claim as a dependent. This credit reduces your tax due (or increases your refund) by the dollar amount of the credit.

The child tax credit is usually nonrefundable. However, for some taxpayers part or all of the credit may be refundable. This occurs when a taxpayer's tax due is less than the credit and they have earned income greater than $3,000.

One word of caution – this credit is limited for higher income taxpayers. Specifically, when your "AGI" (adjusted gross income - income before most deductions) reaches $110,000 for married filing joint taxpayers or $75,000 for single taxpayers the credit begins to be reduced and it is ultimately eliminated at the following points:

Generally speaking, money received as an inheritance is income tax free to the person receiving it. In the situation of real or personal property, the value to the person receiving it is the amount it is worth on the date of death. This value is called "basis".

For example, let's say your uncle leaves you a piece of land in his will. The amount he paid to purchase it many years ago is $5,000. On the date of his death the land's value is $100,000. However, you keep it for some time until it appreciates further and sell it for $120,000. In this situation, the tax basis in the land is $100,000. This results in a $20,000 gain for tax purposes at the time sold. The good news is no tax is paid on the $95,000 increase in value during your uncle's ownership!

Please note that when income-producing assets are inherited, such as stocks or bonds, the dividends or interest they earn will be taxable income.

Here are some IRS audit statistics for 2008:

Personal Tax Returns -

• Overall audit rate = 1.00%.
• Audit rate for income of $100,000 or more = 3.80%

Personal Tax Returns with Business -

• Audit rate for income less than $25,000 = 1.20%
• Audit rate for income of $25,000 - $99,999 = 1.90%
• Audit rate for income of $100,000 - $199,999 = 3.80%
• Audit rate for income of $200,000 or more = 3.10%