2016 UPDATE: Can I Write That Off?

Non-Business Expenses and Your Federal Income Tax Return

About the Author:

Christopher Floss, a Chicago based attorney at Hoogendoorn & Talbot LLP, concentrates his practice on estate planning, tax planning and real estate transactions. For more information on the content of this article or on his practice, you may contact Christopher at cfloss@htlaw or by telephone at 312–786–2250.

NOTE: This article was originally published in 2015. I have updated its contents to reflect current information for tax year 2016.

Introduction

A common question arises as taxpayers begin to assemble information in preparation for annual tax filings: can I write this expense off? As most taxpayers know, the Internal Revenue Code (“Code”) allows for the deduction of certain non-business expenses from income earned in a given tax year. The manner and extent to which these deductions can be taken varies depending on the category of expense. The purpose of this article is to explore the following points: (a) whether to itemize your deductions or take the “standard deduction” and (b) the types and limits of deductions reported on Schedule A of IRS Form 1040.[1] Additionally, this article is written to provide a general introduction to these concepts. In no way does the material provided in this article attempt to cover all of the nuances that are related to the various types of deductions allowed by the Code. Taxpayers should consult a tax professional for any specific questions related to their particular circumstances.

The Standard Deduction

The “standard deduction” is a fixed amount that taxpayers are allowed to deduct from their adjusted gross income (“AGI”). The amount of the standard deduction is determined by Congress each year and varies based on the taxpayer’s filing status. For instance, the 2016 standard deduction for married filing jointly taxpayers is $12,600. For head of household filers, it is $9,300. Finally, for married filing separate and single taxpayers, it is $6,300. Also, current revenue procedures allow for the increase of these amounts if the taxpayer is over 65 and/or blind.

The analysis as to whether a taxpayer should itemize or take the allowed standard deduction is simple: if the itemized amount is higher, then itemize. If not, then use the standard deduction.

Itemized Deductions

The easiest way to determine what a taxpayer may itemize is to review the IRS Form Schedule A. This form lists the following seven categories of expenses: (1) medical and dental expenses; (2) taxes you paid; (3) interest you paid; (4) gifts to charity; (5) casualty and theft losses; (6) job expenses and certain miscellaneous deductions; and (7) other miscellaneous deductions. Each of these categories has its own limits and considerations, as summarized below.

(1) Medical and Dental Expenses. Taxpayers are allowed to deduct unreimbursed medical expenses paid during the tax year for the medical care of the taxpayer, the taxpayer’s spouse and any dependent(s) of the taxpayer. For taxpayers under 65, only such expenses that exceed 10% of the taxpayer’s AGI may be deducted. For taxpayers over 65, the threshold percentage is decreased to 7.5%. As such, this analysis hinges on whether the taxpayer’s unreimbursed medical expenses exceed the threshold amount. If they do, then the taxpayer is allowed to include the amount over that threshold as a deduction. For example, if a taxpayer’s AGI is $60,000 and he is under 65, the threshold amount would be $6,000. In this case, the taxpayer would be allowed to deduct any unreimbursed medical expenses over $6,000. As to what constitutes a medical expense, it is best to consult a tax professional or to review the IRS Instructions.[2]

(2) Taxes. This section of Schedule A lists various types of taxes that may be claimed as a deduction. Taxpayers may deduct either income or general sales tax generated at the state and local level. If the taxpayer lives in a state that does not have an income tax, he will most likely deduct any general sales taxes paid in the tax year. Since whether to deduct state and local income or general sales tax is elective, it benefits the taxpayer to choose the higher amount in most instances. Furthermore, real property taxes may be deducted by the person upon whom they are imposed. Real property taxes are those that are imposed on interests in real property and levied for the general public welfare.[3] Personal property taxes, on the other hand, must meet three criteria: (i) the tax must be based on the value of the personal property (i.e., ad valorem); (ii) the tax must be imposed on an annual basis; and (iii) the tax must be imposed with respect to personal property.[4]

(3) Interest. The Code generally disallows deductions for personal interest. However, there are certain exceptions, such as the home mortgage interest deduction. Taxpayers are allowed to deduct mortgage interest paid on acquisition and home equity indebtedness. Acquisition indebtedness is generally described as debt incurred in acquiring, constructing, or substantially improving a qualified residence and is secured by the residence.[5] Home equity indebtedness is debt that is secured by a qualified principal residence that does not exceed the fair market value of the home reduced by the amount of acquisition indebtedness.[6] There are statutory limitations for both types of indebtedness. Mortgage interest paid on acquisition indebtedness over $1,000,000 ($500,000 for married filing separately) is not deductible. Similarly, any mortgage interest paid on home equity indebtedness over $100,000 ($50,000 for married filing separately) cannot be deducted.

(4) Gifts to Charity. Contributions to charitable organizations defined as such by the IRS are deductible to the extent they do not exceed the taxpayer’s contribution base. Any amounts that are not allowed in a given year may be carried forward and deducted in subsequent years. Substantiation of donations is very critical when claiming charitable contributions. Taxpayers are required to keep records of all types of donations. Additionally, donations over certain dollar amounts require specific types of substantiation. It is important to review the IRS guidelines regarding the type of substantiation required.[7]

(5) Casualty and Theft Losses. Taxpayers are allowed to deduct certain unreimbursed amounts related to the loss or destruction of nonbusiness property as a result of fire, storm, shipwreck, other casualty or theft. Generally, each amount of unreimbursed loss must exceed $100. Similar to medical expenses, only net unreimbursed loss amounts that exceed 10% of the taxpayer’s AGI can be deducted. IRS Publication 547 provides further guidance as to the parameters of this deduction.[8]

(6) Job Expenses and Certain Miscellaneous Deductions. The expenses listed in this section cover unreimbursed employee expenses, tax preparation fees, certain investment expenses, save deposit box fees and other expenses. Any expenses falling under this category are subject to the “2% floor,” which means that taxpayers are only allowed to deduct the net value of such expenses that exceeds 2% of the taxpayer’s AGI.

(7) Other Miscellaneous Deductions. Generally, taxpayers use this section if they have incurred gambling losses in excess of winnings, federal estate tax on income with respect to a decedent and other not so common expenses that do not fit the above-mentioned categories. For further guidance as to the use of this section, see IRS Publication 529.[9]

Finally, changes to the Code in the past few years have provided limitations on the net amount of itemized deductions allowed to be taken on the taxpayer’s Form 1040. Phaseouts in itemized deductions are based on the taxpayer’s filing status and AGI, as follows: for married filing jointly filers, the AGI threshold is $311,300; for head of household filers, the AGI threshold is $285,350; for single filers, the AGI threshold is $259,400; for married filing seperate taxpayers, the AGI threshold is $155,650. These amounts are specific to 2016 tax filings and are subject to inflation in subsequent tax years.

Conclusion

As stated in the introduction, the purpose of this article is to provide an overview of the federal tax principles governing the standard deduction and various common itemized deductions reported on Schedule A of IRS Form 1040. As this brief article highlights, this area of tax law is very detailed and complex. Taxpayers are strongly advised to consult the materials cited in this article, the publications listed on the IRS website and competent tax professionals for further guidance on this topic.

[1] Schedule A is the form that a taxpayer would file if he were to itemize his deductions.

[2] See this link: http://www.irs.gov/instructions/i1040sca/

[3] Treas. Reg. § 1.164–3(b).

[4] Treas. Reg. § 1.164–3(c).

[5] I.R.C. § 163(h)(3)(B).

[6] Id. at (C).

[7] See the link to the IRS Instructions for Schedule A, cited above: http://www.irs.gov/instructions/i1040sca/

[8] See this link: http://www.irs.gov/pub/irs-pdf/p547.pdf

[9] See this link: http://www.irs.gov/pub/irs-pdf/p529.pdf