US Income Tax/Personal Deductions

US Income Tax Introduction Income Gains and Losses Capital Gains Business Deductions Personal Deductions Tax Liability Tax Credits

This chapter deals with the deductions that apply to individual taxpayers. The first set of deductions covered are those that are above the line—subtracted from gross income to reach AGI. The other deductions for individuals are below the line—subtracted from AGI to reach taxable income. When calculating below the line deductions, the taxpayer can either use a standard deduction provided by law, or elect to take itemized deductions.

Above the line deductions

The main type of above the line deduction is for business and employment expenses, which are discussed in the chapter on Business Deductions. Several other deductions are allowed "above the line" even though they are not business-related. These deductions are listed in Section 62.

Property losses

Ordinary losses from the sale of property, as detailed in the chapter on Gains and Losses, are deductible "above the line." This makes them preferable to capital losses, as they can be applied directly against income rather than going through the complicated calculations for capital gains taxation.

Interest

Section 163 provides that interest payments are generally deductible. However, interest on "personal" loans, with the exception of home mortgages and student loans, is not deductible.

Interest is generally defined as "rent for borrowed money," so some payments labeled as "interest" may not be considered "interest" for tax purposes. Likewise, some payments are considered to be "interest" despite not being called by that name: "points" and loan origination fees, for instance, are deductible over the term of the loan. Rev. Rul. 69-188, 1969-1 C.B. 54.

"Investment interest," interest for property held for investment (e.g. stocks, bonds, and land) can only be deducted to the extent of net investment income; disallowed investment interest is carried forward and treated as investment interest the following year.

Some interest payments are nondeductible due to the passive activity loss limitation, described in the section on leveraged tax shelters in the previous chapter.

Educational expenses

Educational expenses are deductible if they maintain or improve skills used in a present trade or business, and if they do not qualify an individual for a new trade or business.

This means that the type of education does not determine deductibility: the circumstances of the education do. In Ruehmann v. Commr., T.C. Memo. 1971-157, a student who entered an LLM program after four months of employment as an attorney was allowed to deduct the cost of his degree. But in Wassenaar v. Commr., 72 T.C. 1195 (1979), a student who entered an LLM program immediately after law school was denied a deduction for its cost, on the grounds that he was not employed as an attorney at the time he paid for the classes.

One exception to this rule is when a person takes a job contingent upon completing an educational requirement, as is the case when teachers are hired subject to completing a required degree, or when law school graduates are hired subject to passing the bar exam. In these cases, the cost of their education is not deductible because it is considered a "minimum education requirement" that qualifies the individual for their trade or business.

Personal exemptions

As of 2005, the personal exemption is $3,500 for the taxpayer and each dependent.

Under Section 151(d)(3), personal exemptions "phase out" over a threshold income of $145,950 for single taxpayers and $218,950 for married couples (2005). They fall two percent for each $2,500 or fraction thereof over the threshold, reaching zero at income levels of $268,450 and $341,450 respectively.

A dependent is defined in Section 152 as someone who is reliant on the taxpayer for more than 50% of their support, and either living with or closely related to the taxpayer. Non-resident foreigners cannot be dependents unless they come from a country contiguous with the United States.

Itemized deductions

Medical expenses

Medical expenses can be deducted to the amount of those expenses which the tax payer has not been reimbursed for and that they exceed 7.5% of the taxpayers adjusted gross income (AGI). (i.e. 100 dollars of unreimbursed expenses for a person with an AGI of 1,000 can be deducted in the amount of 25 [100-1,000*.075]) These deductions are different when calculating Alternative Minimum Tax (AMT) and are subject to phaseout in higher income brackets. See IRS form 1040 Schedule A instructions for more details.

Casualty losses

Casualty losses include losses due to theft, accident, and other "sudden" incidents. A casualty loss may be the loss of an entire piece of property, or it may be in the form of damage to that property.

Casualty losses do not include:

• Losses compensated for by insurance. But a property owner may claim a casualty loss if their property is covered by insurance but no claim is pursued. Hills v. Commr., 691 F.2d 997 (11th Cir. 1982).
• Property confiscated under color of law.
• Losses due to the owner's gross negligence (e.g. setting a house on fire during a domestic dispute). However, loss due to the owner's ordinary negligence (e.g. dropping a diamond ring down the drain) is deductible as a casualty loss.
• Unrealized declines in property value. See, e.g., Chamales v. Commr., T.C. Memo. 2000-33 (2000) (neighbors of O.J. Simpson not allowed to claim casualty loss for decline in property value due to disorder in neighborhood following Simpson murders).
• Expenses incidental to the loss, such as legal expenses.

Each casualty loss is only deductible to the extent it exceeds $100, and total casualty losses are only deductible to the extent they exceed 10% of AGI.

Casualty loss can never exceed adjusted basis of the property. If casualty loss is taken for damage to property, the adjusted basis of that property is reduced by the amount of the loss.

Charitable contributions

Charitable contributions are deductible under Section 170. The section imposes a limit on deductible contributions of 50 percent of AGI for individuals (less in the case of certain organizations) and 10 percent of taxable income for corporations.

The donor must have a donative intent in order for the contribution to be deductible. The analysis of donative intent is similar to the analysis used in determining whether a payment is a gift: the purpose of the donation must be "detached and disinterested generosity." See Hernandez v. Commr., 490 U.S. 680 (1989) (payments to Church of Scientology for "auditing" sessions were non-deductible quid pro quo exchanges). If a good or service is provided in exchange for the contribution, the contribution is only deductible to the extent it exceeds the fair market value of that good or service. But a de minimis consideration, worth less than 2 percent of the contribution or $50, need not be subtracted from the donation.

When property is donated to a charity, the value of the donation is considered to be the fair market value of the property, not its adjusted basis. Because of this rule, many taxpayers choose to donate appreciated property to charity, rather than sell it and pay taxes on the gain.

Foreign, state and local taxes

Many non-federal taxes are deductible under Section 164. The main categories are foreign, state and local income taxes; foreign, state and local real property taxes; and state and local personal property taxes. Other types of taxes, such as sales taxes, are generally not deductible.