chapter 6 other itemized deductions - mid-state...

83

Chapter 6

Other Itemized Deductions

Teaching Suggestions

1. Most taxpayers do not have enough miscellaneous itemized deductions subject to the 2% of AGI rule.However, employees who are not reimbursed for their travel (such as sales people) should always keep goodrecords of these expenses, just in case.

2. Taxpayers might have their standard deduction within reasonable range of their itemized deductions.Taxpayers can minimize their tax liability by planning their payments to take the standard deduction in one yearand then to itemize deductions in the next year or vice versa.

Solutions to Questions and Problems1. The six elements include the (1) amount, (2) date, (3) place, (4) business purpose, (5) business

relationship, and (6) identity of the individuals.

2. a. When the reimbursement comes from an accountable reimbursement plan, the employee is not taxedon the reimbursement. Martin is entitled to deduct the amount by which his deductible car expenses(4,305 × $.485 = $2,087.93) exceed his $1,506.75 reimbursement. Martin would deduct this $581.18 asan employee business expense. The deduction is taken as a miscellaneous itemized deduction onSchedule A (subject to the 2% AGI rule). ¶602.01.

b. When the reimbursement is made from a nonaccountable reimbursement plan, the employee is taxedon the full amount of the reimbursement. Thus, the $1,506.75 would be included in Martin’s grossincome as additional taxable wages. Martin is allowed to deduct on Form 2106 the $2,087.93 that he cansubstantiate as deductible car expenses. This amount is then deducted as a miscellaneous itemizeddeduction (subject to the 2% AGI rule) on Schedule A. ¶602.01.

c. An accountable plan is one that both (1) requires employees to account for (turn in) adequatesubstantiation for their business expenses, and (2) return any excess reimbursements. Thus, anonaccountable plan would be one where the employer advances the employee amounts and does notrequire any excess to be returned. A nonaccountable plan also would be one where the employerreimburses employees without checking to see that proper documentation exists for the expense.¶602.01.

3. a. Under the standard mileage method, his deduction would be $2,692 [(12,400 × $.485) + $398 − (12,400× $.30)]. ¶602.03.

b. Under the actual mileage method, Estes’s car deduction would be $1,361 [($6,927 × 12,400/18,340 +$398 − (12,400 × $.30)]. ¶602.03.

c. Because the standard mileage method produces a larger deduction, Estes should use this method todeduct his car expenses in 2007. However, he can only use the standard mileage method if he has notused an accelerated depreciation method to deduct car expenses in a prior year with respect to thisvehicle. ¶602.03.

d. If Estes has used an accelerated method of depreciation in computing his car expenses with respect tothis car in a prior year, then he will be required to use the actual method to compute his car expensesfor all subsequent tax years involving this vehicle. ¶602.03.

4. a. Under the actual method, Plank’s car deduction would be $268 [($8,084 × 2,235/15,544 − (2,235 ×$.40)]. Under the standard mileage method, her deduction would be $190 [(2,235 × $.485) − (2,235 ×$.40)]. Since actual method produces a greater deduction, Plank would want to use the actual methodto deduct her car expenses. However, if she uses an accelerated depreciation method to deduct carexpenses this year, she will be precluded from using the standard mileage method to deduct car

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84 Essentials of Federal Income Taxation

expenses with respect to this automobile in all future tax years. This all assumes that Plank’smiscellaneous itemized deductions exceed 2% of her AGI. ¶602.03.

b. Since the reimbursement is made from an accountable plan, Plank is not taxed on the reimbursement.If she wants to deduct the excess of her car expenses over the reimbursed amount, she will report boththe business portion of her car expenses and the reimbursement on Form 2106. The excess amountwould then be deducted as a miscellaneous itemized deduction on Schedule A. ¶602.03.

5. a. Only Ricardo’s mileage between job one and job two is deductible. ¶602.02.

12 miles (distance from first to second job)

× 250 days

3,000 total deductible business miles

b. $1,455 (3,000 × $.485). ¶602.02.

6. a. Since Joshua’s domestic trip was primarily for business, all of the airfare is deductible. However, onlythe business portion (60% of the travel time) of the other expenses is deductible. ¶602.05.

Airfare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,500

Lodging (60% × $1,250) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

Meals (60% × $500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300

Entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

$430

Less: 50% × $430 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (215) 215

Total miscellaneous deduction (subject to the 2% AGI rule) . . . . . . . . . . . . . . . . . $2,465

b. Since the personal portion of the foreign travel exceeded 25%, Joshua must allocate his airfare betweenbusiness and pleasure. The other expenses are deductible as in part a. ¶602.05.

Airfare (60% × $1,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $900

Lodging (60% × $1,250) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750

Meals (60% × $500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300

Entertainment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

$430

Less: 50% × $430 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (215) 215

Total miscellaneous deduction (subject to the 2% AGI rule) . . . . . . . . . . . . . . . . . $1,865

7. a. $1,340. Since her trip was not primarily for business, she is only allowed to deduct the business portionof her lodging and meals. She cannot deduct any of the costs of traveling to and from the convention.Her business deduction is $1,340 [($200 × 6 nights) + (50% × $40 × 7)]. ¶602.05.

b. $1,755. If her travels are outside of the U.S., she can prorate all of her expenses between business andpersonal days. This would allow her to deduct an additional $415 ($830 × 7/14) for her airfare andtransportation to and from the airport. ¶602.05.

c. $2,170. If Barnes were to reduce her personal days by one, her six personal days would be 50% or lessof her 13 total days gone. She would then be allowed to deduct the full $830 of her costs of getting toand from her destination. ¶602.05.

d. $1,787. Her deductible airfare and transportation to and from the airport would increase to $447 ($830 ×7/13). This would increase her total deduction by $32 ($447 − $415). ¶602.05.

8. Fitch can deduct $125 ($250 × 50%) for the concert tickets. It is not necessary that she attend the concertwith the customer to claim the deduction. Because she did not dine with the other customer, she cannot

Chapter 6 ©2007 CCH. All Rights Reserved.

85Textbook Solutions

deduct any of the $210. She reports the $125 on Form 2106 along with any other employee businessexpenses she has for the year. She then deducts the total of her unreimbursed employee businessexpenses as a miscellaneous deduction (subject to the 2% AGI rule) on Schedule A. ¶602.06.

9. a. Yes. Expenses incurred to meet a state’s CPE requirements to perform as a CPA would qualify asdeductible education expenses. The $525 would be deductible from AGI on Schedule A, as supportedby Form 2106. ¶602.07.

b. No. Seeking a degree is considered to be a personal expense. It is regarded as a qualification for a newjob or career. ¶602.07.

c. Yes. The $2,700 of education expenses are deductible from AGI as itemized deductions subject to the2% rule to the extent not reimbursed. The expenses are deductible since the teacher must complete acertain amount of continuing education to renew her teaching certificate. Without incurring theseexpenses, the teacher would not be able to retain the teaching position. ¶602.07.

d. Yes. Having already been promoted to an executive management position, obtaining an MBA is not theminimum education requirement, nor will it qualify him for a new career. Expenses incurred toimprove business skills are deductible. To the extent not reimbursed, the $8,000 of expenses aredeductible from AGI as itemized deductions subject to the 2% rule. ¶602.07.

10. If Patel is currently employed as a manager, he can deduct the $1,700 as a miscellaneous itemizeddeduction (subject to the 2% AGI rule), regardless of whether his efforts result in a new position. If Patel isnot currently employed as a manager, his job hunting expenses are not deductible. Therefore, in Parts a.and b. the deduction will be allowed; it Parts c. and d. it will not. ¶602.07.

11.

Item Answer

a. State inheritance taxes (¶504) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

b. Transportation between home and work(¶602.03) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

c. Rental of safe-deposit box(¶603) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B

d. Fee to register for the CPA examination(¶602.07) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

e. Federal income tax penalty(¶504) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

f. Fee to accountant for property tax return on rental property(¶105.01) . . . . . . . . . . . . . . A

g. Loss in operating bookstore(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

h. Auto registration for business automobile(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

12.

Item Answer

a. Cost of uniforms suitable for street wear(¶602.07) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

b. Insurance on personal residence(¶604.03) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

c. Union dues paid by employee(¶602.07) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B

d. Travel expense by employee, no reimbursement(¶602.05) . . . . . . . . . . . . . . . . . . . . . . . B

e. Mortgage interest on rental property(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

f. Loss of trees due to storm(¶507) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B1

g. Loss on sale of personal automobile(¶117.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

h. Car damage paid to X, taxpayer’s fault(¶507.03) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

1 After adjusting for $ 100 deductible and 10% of adjusted income.

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13.

Item Answer

a. Loss on sale of stock(¶117.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

b. Interest on loan for vacation(¶505) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C

c. Entertainment expense for outside salesperson(¶601) . . . . . . . . . . . . . . . . . . . . . . . . . . . A

d. Depreciation on rental property(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

e. Charitable contribution to university(¶506) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B

f. Cost of seminar for sole proprietor(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

g. Storm damage to rental property(¶105.01) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A

14. a. A hobby is an activity from which a taxpayer does not expect to make a profit. The question of whethera profit motive exists arises in cases where an activity has elements of both personal pleasure andprofit. Some of the factors considered in determining whether an activity is a business or a hobbyinclude:

(1) The taxpayer’s past success with other activities.

(2) Whether separate books and records were kept for the activity.

(3) Whether there have been both profits and losses in prior years.

(4) The relative amount of pleasure derived from the activity.

(5) The extent of dependency on the activity for financial support.

(6) The amount of time and effort devoted to the activity.

(7) The taxpayer’s expertise in the area.

(8) The amount of the occasional profits from the activity.

(9) The expectation that the property used in the activity will rise in value.

The taxpayer must show that the activity is being pursued for profit but does not need to justify that theexpectation of profit is necessarily reasonable. The taxpayer does not need to show a profit each year. Ifthe activity shows a profit in any three of five consecutive years (two years out of seven for activitiesinvolving horses), the burden of proof shifts to the IRS. The IRS then must prove the activity is ahobby. ¶603.01.

b. No. However, if the activity shows a profit in any three of five consecutive years, the burden of proof ison the IRS to prove that the activity is a hobby. The taxpayer may also exercise an election to postponeany IRS challenge until five years of business activity have been completed. ¶603.01.

15. a. Expenses of painting activity treated as a business:

Allocated expenses of the home:

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,600

Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,400

Heat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,900

Total general household expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,900

Business use percentage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . × 12 %

Portion of general expenses related to the painting activity . . . . . . . . . . . . . . . . . . . . . $1,068

Expenses related directly to the painting activity:

Interest on loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

Painting supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,750

Total expenses for the painting activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,958



If Long’s painting activity is treated as a business, he reports an above the line deduction for the loss of$658, computed as follows:

Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,300

Less: Total expenses (from above) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ( 2,958 )

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ ( 658 )

Long could deduct the loss on the assumption that the painting activity is a business, and expects toreport a profit in three of the first five years of the business. ¶603.01.

b. If Long cannot justify the activity as a business, then he is required to report the $2,300 of revenue fromthe sale of the paintings as income. He is allowed to deduct expenses up to the amount of the revenue(as a miscellaneous itemized deduction subject to the 2% AGI rule) when an activity is a hobby, butexcess expenses would not be deductible. Thus, if the painting activity is treated as a hobby, Longwould report revenues and expenses as follows. ¶603.01.

Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,300

Less: Total expenses ($2,958, but limited to hobby income) . . . . . . . . . . . . . . . . . . . . ( 2,300 )

The allowable expenses ($2,300) are deductible as follows:

(1) $432 (12% × $3,600) is deductible as property tax (line 6).

(2) $1,868 (remainder) is deductible only to the extent that miscellaneous itemized deductionsexceed 2% of AGI.

c. Long might support his claim that the painting activity is a business by arranging for regular displays ofhis paintings in galleries and by making every effort to earn a profit in three of five consecutive years. Ifhe has discretionary expenses related to the activity, such as subscriptions to art magazines, he mightbe able to postpone payments until early in the next year in order to show a profit in a given year tohelp meet the three-out-of-five-year profit rule. The timing of the payment of property taxes andelectricity bills might also support the opportunity to show a profit in certain years. ¶603.01.

16. a. $321.40. Wendy Rogers can include as itemized deductions $116.40 for transportation expenses (240 ×$.485) plus $205 [(50% × $120) + $110 + $35] for meeting expenses, union dues, and her license.¶603.01.

b. These expenses would be combined with other 2% miscellaneous itemized expenses such as safe-deposit box rents, subscriptions, and tax return preparation fees; this total can be deducted to theextent that it exceeds 2% of adjusted gross income. ¶603.01.

17. a. Downing should report $1,400 of the gains and $1,400 of the losses on his income tax return. Allgambling winnings are included in gross income, but gambling losses are deductible only to the extentof gambling income. Gambling losses are not subject to the 2% limitation. ¶604.01.

b. The $1,400 of the gains is entered as “Other Income� on Form 1040. Only $1,400 of the losses can beentered on Schedule A as a miscellaneous deduction not subject to the 2% of AGI limitation. Deductionsfrom AGI must be itemized in order for any gambling losses to be deductible. ¶604.01.

18. See filled-in Form 2106 for Lopez. Since PSI included the $9,000 reimbursement on Lopez’s W-2, noamount is shown on Form 2106 (line 9). ¶602.08.

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Filled-in Form 2106 for Lopez, page 1.



Filled-in Form 2106 for Lopez, page 2.

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19. Taxpayers may deduct only the price of nonluxury box seats when they entertain clients in a luxury skyboxrented for more than one event. Thus, Alpha-Beta may consider only $4,800 as its entertainment cost forthe rental of the skybox. This amount represents the cost of 96 seats (12 seats for 8 games) at $50 per seat.It should also be pointed out that only 50% of the $4,800 is actually deductible ($2,400).

See also pages 12 and 13 of Publication 463.



Page 12 of Publication 463.

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Page 13 of Publication 463.



20. a. False. Statutory employees report travel expenses on Schedule C. ¶602.05.

b. True. ¶602.01.

c. False. Only one-half is deductible. ¶602.06.

d. False. Self-employed taxpayers deduct education expenses for AGI on Schedule C. ¶602.07.

21. ¶603, ¶604.

1. Unreimbursed employee expenses, $1,044

[$376 + $115 + ($256 × 50%) + $340 + $85]

2. Tax preparation fees, $175

3. Other expenses subject to the 2% rule, $165 ($45 + $120)

4. Total expenses, $1,384

5. Less: 2% of AGI, $948 ($47,400 × .02)

6. Deductible expenses, $436

7. Other miscellaneous expenses, $65 (limited to winnings)

22. See filled-in Schedule A for the Churches. ¶605.

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Filled-in Schedule A for the Churches.



23. a. See filled-in Schedule A for the Gomezes. The Gomezes have ample net investment income to deductthe $2,000 of investment interest expense. ¶605.

Reduction in Itemized Deductions (lesser of):

Itemized deductions subject to the limitation:

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,500

Mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000

Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000

Total subject to limitation . . . . . . . . . . . . . . . . . . . . . . . . . . $17,500

× 80 %

Net 80% of deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,000

OR

2% of AGI in excess of $156,400:

($181,050 − $156,400) × 2% . . . . . . . . . . . . . . . . . . . . . . . . . $ 493

b.

Adjusted gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $181,050

Less: Itemized deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,007)

$162,043

Less: Personal exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,200)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $151,843

c. In computing the Gomezes’ tax liability, the $11,630 of qualified dividends will be taxed at a 15% taxrate. The rest of their taxable income ($151,843 − $11,630 = $140,213) will be taxed using tax rateschedule Y-1 for married filing jointly taxpayers. This amount of taxable income falls in the 28% taxbracket. The itemized deduction limitation resulted in a $493 reduction in the amount of allowableitemized deductions [see part a. above]. With a marginal tax rate of 28%, this would increase the taxliability by $138 ($493 × 28%).

Chapter 6

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