The American Taxpayer Relief Act of 2012 President Obama signed into law in January 2013, included many tax law changes that will affect your itemized deductions for 2013.
- Bunching allows you to maximize your itemized deductions in one year and take the standard deduction in the next.
- The medical expense threshold for deductibility has been increased to 10% of AGI for individuals under the age of 65.
- You have the option of deducting the larger of: (a) State and local income tax paid, or (b) state and local sales tax paid during the year.
- Charitable contributions generally require substantiation (no more deduction for unsubstantiated cash in the kettle or the collection plate).
- Documented gambling losses are deductible to the extent of gambling winnings.
- Home (and second home) mortgage interest is deductible up to the acquisition debt and equity debt limits.
- Overall itemized deduction limitation applies in 2013 and later years for higher-income filers.
As you plan for your tax year, keep in mind that you benefit from itemizing your tax deductions if they exceed the standard deduction, and sometimes when you are subject to the alternative minimum tax (AMT), it is beneficial to itemize even if the result is less than the standard deduction. The following is a run-down on itemizing your deductions.
• Bunching Deductions — If your itemized deductions exceed the standard deduction, you will want to itemize them. Itemized deductions consist of five basic categories, each with its own limitations and special considerations. If your deductions only marginally exceed the standard deduction, consider “bunching” your deductions in one year. You can bunch your deductions by pre-paying some of your expenses in one year, such as your church contribution. This allows you to produce higher than normal itemized deductions that year and then take the standard deduction the other year. Also consider pre-paying your state’s January estimated tax payment in December, or paying your property tax in full rather than in installments carrying over to the next year.
• Medical Expenses — Deductible medical expenses are limited to unreimbursed expenses for you, your spouse if married, and dependents that exceed 10% (7½% if age 65 or older) of your adjusted gross income (AGI) for the year. If you are 65 or older, for AMT purposes, your medical deduction will be less because only the excess of unreimbursed expenses above 10% of your AGI is deductible.
Expenses most frequently thought of as deductible medical expenses include medical and dental insurance premiums, charges by doctors and dentists, and the cost of prescription medication. Medical insurance premiums and other expenses paid with pre-tax dollars (e.g., through an employer’s cafeteria plan) cannot be included. Some less common deductions include the following:
- The cost of weight-loss program (not including food) for the treatment of a specific disease or diseases (including obesity) diagnosed by a physician.
- Medicare-B- premium payments and Medicare-D premiums for drug coverage.
- Participation in smoking-cessation programs and for prescribed drugs (but not non-prescription items such as gum or patches) designed to alleviate nicotine withdrawal.
- Elder Care, generally including the entire cost of nursing homes, homes for the aged and assisted living facilities. Long-term care insurance premiums are deductible, but with an additional limitation on the allowed amount based on the insured’s age. See the table below for the annual limit per insured individual.
- Medical dependent: For medical purposes, an individual may be a dependent even if his gross income precludes a dependency exemption, thus enabling you to deduct the individual’s medical expenses that you paid.
- A child of divorced parents may considered a dependent of both parents for medical expenses purposes (so that each parent may deduct the medical expenses he or she pays for the child.)
Generally, travel costs (not including meals) may be a deductible expense if the trip is primarily for medical purposes. Cosmetic surgeries are generally not deductible.
• Taxes — Deductible taxes primarily consist of real property taxes, state and local income taxes, and personal property taxes. Planning tip: Since taxes are not deductible for AMT purposes, you should attempt to minimize the payment of taxes in a year you are subject to the AMT if you can avoid late payment penalties for the tax payments. Where property taxes were paid on unimproved and unproductive real estate, you can annually elect to capitalize the taxes in lieu of deducting them (add the amount paid to your cost basis for the property).
For 2013, you have the option of deducting on Schedule A as part of your itemized deductions the LARGER of: (1) State and local income tax paid, or (2) State and local sales tax you paid during the year.
• Interest — The only interest that is deductible as an itemized deduction is home mortgage interest and investment interest. Although this category does not have an AGI limitation, each interest type has special limitations. Home mortgage interest is limited to the interest paid on acquisition debt that does not exceed $1 million and home equity debt (not exceeding $100,000) on your main home and a designated second home. In addition, the interest on most equity debt is not deductible against the AMT. Note: Home acquisition debt is the original debt (current balance) incurred to purchase or substantially improve the home and is not increased by refinanced debt.
Taxpayers can elect to treat any debt secured by the home as unsecured. The election is irrevocable without IRS consent. By making the election, the interest on the loan can be allocated to use of the proceeds, except none of the interest can be allocated back to the home itself. This election is for income tax purposes only and does not change how the loan is secured with the lender. If made, the election applies for both regular tax and AMT purposes, and it applies for the year the election is made and all future years. There is no specific IRS form to use to make the election. Instead, attach a statement to your return (timely filed) for the year the election is to be effective, stating the election is to apply.
Investment interest is interest on debts incurred to acquire investments such as securities or land. The investment interest deduction is limited to net investment income (investment income less investment expenses), and any excess not deductible in the current year is carried over to future years. Interest on debt to acquire tax-free investment income is not deductible. You can elect to treat capital gains as investment income in order to increase the amount of deductible investment interest. However, the same capital gains are then not eligible for the lower capital gains tax rate. Qualified dividends taxed at the reduced capital gains tax rates are not treated as investment income for the investment interest deduction calculation.
• Charitable Contributions — You may, within certain limits, deduct charitable contributions of cash and property to qualified organizations to the extent you receive no personal benefit from the donations. All cash contributions regardless of the amount must be documented with a written verification from the charity or a bank record. Non-receipted cash contributions are not deductible. Non-cash contributions also require an acknowledgement of the contribution from the qualified charitable organization except for donations of $250 or less left at unmanned drop points. For non-cash contributions of more than $5,000 (except for publicly-traded securities), you are generally required to have a qualified appraisal of the property donated. Please call this office for further details. Charitable deductions are limited by a percent of income depending upon the type of contribution. Contributions in excess of the AGI limitation may be carried forward for five years. Although there are 20% and 30% of AGI limitations, generally, contributions to qualified organizations are deductible to the extent they don’t exceed 50% of your AGI. One notable exception is the 30% limitation for gifts of capital gains property, where the contribution is based on the fair market value of the property.
Frequently overlooked contributions include those made to governmental organizations such as schools, police and fire departments, parks and recreation, etc. Uniforms, travel expenses, and out-of-pocket expenses for a charity are also deductible, but not the value of your time or the cost of equipment such as computers, phones, etc., if you retain ownership.
Congress imposed some tough rules that substantially limit the deduction for the popular charitable car donation. If the claimed value of the vehicle exceeds $500, the deduction will generally be limited to the gross proceeds from the charity’s sale of the vehicle. The IRS provides Form 1098-C that incorporates all of the required acknowledgement elements for the charitable organization to complete. The donor is required to attach copy B of the 1098-C to his or her federal tax return when claiming a deduction for contribution of a motor vehicle, boat, or airplane.
There is an exception to the rules for donated vehicles that the charity retains for its own use “to substantially further the organization’s regularly conducted activities or provides to a needy family.” Please call this office for more information.
For 2013, if you are age 70½ and over you are allowed to make direct distributions (up to $100,000 per year) from your Traditional or Roth IRA account to a charity. The distribution is tax-free, but there is no charitable deduction. The distribution counts toward your required minimum distribution. This provision can be very beneficial if you have Social Security income and/or do not itemize your deductions.
• Miscellaneous Deductions — Miscellaneous deductions fall into two basic categories: those that are reduced by 2% of your AGI and those that are not.
– Those Subject to the 2% Reduction—This category generally includes your investment expenses, costs of having your tax return prepared, and employee business expenses.
– Those NOT Subject to the 2% Reduction—This category includes gambling losses (but cannot exceed the amount reported as gambling income), personal casualty losses (after first reducing each loss by $100 and the total loss for the year by 10% of your AGI), repayments of income (over $3,000) reported in prior years, and estate tax deductions. The estate tax deduction is considered by many to be the most overlooked deduction in taxes. It is a deduction based on the additional taxes paid as a result of the same income being taxed to both the estate and to the beneficiaries of the estate. Only certain types of income are doubly taxed. As an example, if the decedent had a Traditional IRA account, the value of the IRA would be included in the decedent’s estate and also would be taxable to the beneficiary. If the estate paid any tax at all (on Form 706), the beneficiary in this example would have an estate tax deduction equal to the portion of the estate tax paid attributable to the IRA.
• Overall Itemized Deduction Limitation — If your 2013 adjusted gross income exceeds $300,000 for joint filers and a surviving spouse, $275,000 for heads of household, $250,000 for single filers, and $150,000 for married taxpayers filing separately, your total itemized deductions will be limited, adding another factor to consider for planning purposes. This overall limitation had been reduced or suspended for the last few years. If the limitation applies to you, the total amount of your itemized deductions is reduced by 3% of the amount by which your AGI exceeds the threshold amounts listed above, with the reduction not to exceed 80% of your otherwise allowable itemized deductions. The threshold amounts are inflation-adjusted for tax years after 2013.
Tax Topics, Itemized Deductions, from the IRS.gov website.
Frequently Asked Questions Regarding Itemized Medical Deductions at the IRS.gov website.
If you have questions related to maximizing your itemized deductions, please give Bressler & Company a call at 559.924.1225.