I. Classification and Limitations of Employee Expenses
A. Nature of the Employment Relationships
1.) Significant tax consequences flow from the characterization of a taxpayer as an employee vs. self-employed (independent contractors)
Ex : A self-employed individual will be responsible for self-employment tax which is much higher than an employee’s hare of social security tax.
2.) A taxpayer is considered an employee where the employer has the right to direct and control both the end result and the way the result is accomplished.
B. Limitations on Un-reimbursed employee expenses.
1.) Un-reimbursed employee expenses are classified as misc: Itemized deductions. The total of miscellaneous itemized deductions is reduced by 2%, of AGI before any tax benefit is reached.
2.) Therefore, un-reimbursed employee business expenses may provide not tax benefit if total misc. itemized deductions do not exceed 2% of AGI, or if total itemized deductions do not exceed the standard deduction. These expenses may also be affected by the phase-out of itemized deductions for certain high-income taxpayers.
III. Travel Expenses
A. Deductibility of travel expenses : Dependent on the nature of the expenditure and whether the employee is reimbursed.
1.) Travel expenses for self-employed individuals and fully-reimbursed employee travel expenses are deducted for AGI
2.) Un-reimbursed employee travel expenses (whether insufficient reimbursement or no reimbursement occurs) are deducted as a misc. itemized deduction subject to the 2% non-deductible floor.
B. Definition of Travel Expenses
1.) Includes transportation, meals and lodging related to a trade, business, or employee status incurred while away from the taxpayer’s tax home.
2.) The deductible amount of travel expenses may be reduced if actual expenses are lavish or extravagant.
C. General Qualification Requirements
1.) Travel expenses related to a trade, business, or employee status are deductible if incurred while away from the taxpayer’s home.
2.) Transportation costs for day trips are deductible, even if the taxpayer does not stay away from home overnight.
D. Business versus Pleasure
1.) Travel expenses in combination business/ personal trips will be only partially deductible
2.) If a domestic trip is primarily business, travel expenses to and from the business destination are deductible even though there is some personal time during the trip. Expenses for personal days will not be deductible.
3.) No deduction is allowed for the travel expenses of a companion unless the companion is also an employee and the travel is business-related and otherwise deductible.
E. Foreign Travel
1.) Even more stringent allocation rules apply to the deductibility of travel expenses on foreign business/personal trips.
2.) Deductions for foreign conventions are only allowed for “directly related” activities for which the taxpayers can proved that a meeting held outside North American is reasonable.
F. Additional Limitations on Travel Expenses
1.) Additional limitations on deductions for travel expenses exist for educational travel, certain conventions and seminars, luxury water travel and charitable travel.
III. Transportation Expenses
A. Commuting cost are generally non-deductible personal expenses.
B. Commuting expenses between multiple jobs for the same taxpayers will be deductible
C. Transportation costs from an employee’s regular place of work to a temporary work site are deductible.
D. If a taxpayer has a regular place of business, commuting costs between home and temporary work sites are deductible.
E. Treatment of Automobile Expenses.
1.) Actual business auto expenses can be deducted or a standard can mileage rate (48.5 cents/mile – effective 1/1/2007)
2.) For newer cars, the deduction for actual expenses will generally exceed the standard mileage deduction.
IV. Entertainment Expenses
A. 50% disallowance for meal and entertainment expenses
1.) Deductions for business-related meals and entertainment are limited to 50% of incurred cost.
2.) Self-employed individuals and employees who are fully reimbursed may deduct entertainment expenses for AGI.
Monday, October 22, 2007
Wednesday, October 17, 2007
Ch. 8 Notes
I. Transactions that may result in losses. Realization is a prerequisite for loss.
Ex. If a taxpayer holds tock that had a $25,000 fair market value at the beginning of the tax year and a $15,000 fair market value at the end of the tax year, no loss is recognized for tax purposes, even though the value of the stock has decreased by $10,000.
A. Sale or Exchange of Property
1.) In a sale or exchange, the amount of the loss is the excess of the property’s adjusted over the amount realized.
Ex. If the taxpayers realizes $10,000 from the sale of an asset with an adjusted basis of $18,000, the realized loss is $8,000 (10,000 – 18,000)
2.) Losses incurred on the sale of personal use property are not deductible.
3.) Losses on trade on business property and investment property are deductible
B. Expropriated , Seized or Confiscated Property
1.) Property expropriated, seized or confiscated by a foreign government gives rise to a deductible loss only if the property is used in a trade or business and is held for investment.
2.) Any allowable deduction must be taken in the year of actual seizure.
3.) Any gain realized on seizure would be treated under the involuntary conversion rules.
C. Abandoned Property
1.) Abandoned property used in a trade or business or held for investment gives rise to a deductible loss.
2.) The amount of the asset at the date of abandonment.
3.) The character of the loss is ordinary, since there is no sale or exchange.
D. Worthless Securities Treated as a capital loss on the last day of the tax year.
Ex. If a calendar year taxpayer owns securities which become worthless on march 15, the tax treatment is to recognize a capital loss on Dec. 31st.
E. Demolition of Property demolition costs are to be added to the basis of the underlying property.
II. Classifying the Loss on the Taxpayer’s tax return.
A. Ordinary versus capital loss
1.) Dependent on the types of property involved and the type of transaction involved.
2.) Losses on qualifying Sec. 1244 stock are treated as ordinary ($50,000 or $100,000 limitation) rather than capital offset capital gains plus $3,000 of ordinary income.
- To qualify as Sec. 1244 stock:
The stock must be owned and issued by and individual or partnership.
The corporation must be a domestic corporation.
The stock must be issued for cash or property and not for services.
The corporation may not have derived over 50% of its gross receipts from passive income sources during the immediately preceding 5 tax years. And at the time the stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1,000,000
B. Disallowance Possibilities
1.) Certain realized losses are disallowed in special situations, including related party transactions and wash sales.
2.) Other potential disallowance situation include transfer of property in exchange for tock. Sec. 351, like-kind exchanges and partnerships (both under the (at risk) limitation and the passive loss rules.)
III. Passive Losses
A.)
1.) Passive losses may only offset passive income, not portfolio or active income
2.) Portfolio income included non-business dividends, interest, royalties, annuities, and certain gains and losses on property
3.) Credits generated from passive activities are also limited. These credits may only offset tax liabilitiy generated by passive income.
B.) Carryovers
1. Un-utilized passive losses may be used against future income or on the disposition of the passive activity interest.
2. The carryover is unlimited in amount and duration.
C.) Definition of Passive Activity
1. Includes any rental activity and any trade, business, or investment activity in which the taxpayer does not materially participate.
2. Investments in limited partnerships generate passive losses due to the legal restrictions on limited partner’s involvement in he mgt of the partnership.
C. Taxpayers subject to passive loss rules
1.) Apply to individuals, estates, trust, closely-held C corp personal service corp. and certain publicly-traded partnerships.
2.) While the passive loss rules do not apply to partnerships and S-Corp. They do apply to the owners (partners & shareholders)
IV. Casualty and Theft Losses
• Casualty defined
o A casualty loss results from an identifiable event that was sudden, unexpected or unusual.
o Qualifying casualties included fire, flood, hurricane , tornados, hail, and cyclone.
• Theft Defined
o Generally, criminal intent and violation or a state law are required to meet the definition of theft.
o Theft for tax purposes includes robbery, blackmail, extortion and ransom.
• Deductible Amount of Casualty Loss
o For personal use property the deductible amount is the lesser of the reduction in FMV or adjusted basis.
o In the total destruction of business property the deductible amount is the property’s adjusted basis.
V. Bad Debts
• Bonda-Fide debtor Creditor Relationships
o Valid and enforceable obligations to pay a fixed or determinable sum of money
• Taxpayer’s Basis in the Debt.
o Creditor must have a basis in the debt for the bad debt to be deductible
• Debt Must be Worthless
VI. Tax Planning Consideration
• Bad Debts – Taxpayers should document their determination that a particular debt is worthless.
• Casualties
o Documentation of FVC is important to support a casualty loss deduction.
Ex. If a taxpayer holds tock that had a $25,000 fair market value at the beginning of the tax year and a $15,000 fair market value at the end of the tax year, no loss is recognized for tax purposes, even though the value of the stock has decreased by $10,000.
A. Sale or Exchange of Property
1.) In a sale or exchange, the amount of the loss is the excess of the property’s adjusted over the amount realized.
Ex. If the taxpayers realizes $10,000 from the sale of an asset with an adjusted basis of $18,000, the realized loss is $8,000 (10,000 – 18,000)
2.) Losses incurred on the sale of personal use property are not deductible.
3.) Losses on trade on business property and investment property are deductible
B. Expropriated , Seized or Confiscated Property
1.) Property expropriated, seized or confiscated by a foreign government gives rise to a deductible loss only if the property is used in a trade or business and is held for investment.
2.) Any allowable deduction must be taken in the year of actual seizure.
3.) Any gain realized on seizure would be treated under the involuntary conversion rules.
C. Abandoned Property
1.) Abandoned property used in a trade or business or held for investment gives rise to a deductible loss.
2.) The amount of the asset at the date of abandonment.
3.) The character of the loss is ordinary, since there is no sale or exchange.
D. Worthless Securities Treated as a capital loss on the last day of the tax year.
Ex. If a calendar year taxpayer owns securities which become worthless on march 15, the tax treatment is to recognize a capital loss on Dec. 31st.
E. Demolition of Property demolition costs are to be added to the basis of the underlying property.
II. Classifying the Loss on the Taxpayer’s tax return.
A. Ordinary versus capital loss
1.) Dependent on the types of property involved and the type of transaction involved.
2.) Losses on qualifying Sec. 1244 stock are treated as ordinary ($50,000 or $100,000 limitation) rather than capital offset capital gains plus $3,000 of ordinary income.
- To qualify as Sec. 1244 stock:
The stock must be owned and issued by and individual or partnership.
The corporation must be a domestic corporation.
The stock must be issued for cash or property and not for services.
The corporation may not have derived over 50% of its gross receipts from passive income sources during the immediately preceding 5 tax years. And at the time the stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1,000,000
B. Disallowance Possibilities
1.) Certain realized losses are disallowed in special situations, including related party transactions and wash sales.
2.) Other potential disallowance situation include transfer of property in exchange for tock. Sec. 351, like-kind exchanges and partnerships (both under the (at risk) limitation and the passive loss rules.)
III. Passive Losses
A.)
1.) Passive losses may only offset passive income, not portfolio or active income
2.) Portfolio income included non-business dividends, interest, royalties, annuities, and certain gains and losses on property
3.) Credits generated from passive activities are also limited. These credits may only offset tax liabilitiy generated by passive income.
B.) Carryovers
1. Un-utilized passive losses may be used against future income or on the disposition of the passive activity interest.
2. The carryover is unlimited in amount and duration.
C.) Definition of Passive Activity
1. Includes any rental activity and any trade, business, or investment activity in which the taxpayer does not materially participate.
2. Investments in limited partnerships generate passive losses due to the legal restrictions on limited partner’s involvement in he mgt of the partnership.
C. Taxpayers subject to passive loss rules
1.) Apply to individuals, estates, trust, closely-held C corp personal service corp. and certain publicly-traded partnerships.
2.) While the passive loss rules do not apply to partnerships and S-Corp. They do apply to the owners (partners & shareholders)
IV. Casualty and Theft Losses
• Casualty defined
o A casualty loss results from an identifiable event that was sudden, unexpected or unusual.
o Qualifying casualties included fire, flood, hurricane , tornados, hail, and cyclone.
• Theft Defined
o Generally, criminal intent and violation or a state law are required to meet the definition of theft.
o Theft for tax purposes includes robbery, blackmail, extortion and ransom.
• Deductible Amount of Casualty Loss
o For personal use property the deductible amount is the lesser of the reduction in FMV or adjusted basis.
o In the total destruction of business property the deductible amount is the property’s adjusted basis.
V. Bad Debts
• Bonda-Fide debtor Creditor Relationships
o Valid and enforceable obligations to pay a fixed or determinable sum of money
• Taxpayer’s Basis in the Debt.
o Creditor must have a basis in the debt for the bad debt to be deductible
• Debt Must be Worthless
VI. Tax Planning Consideration
• Bad Debts – Taxpayers should document their determination that a particular debt is worthless.
• Casualties
o Documentation of FVC is important to support a casualty loss deduction.
Wednesday, October 10, 2007
Ch. 7 Notes (Part I)
emized Deductions
Personal Deductible expenses: chapter 7 is principally concerned with expenses that are essentially personal in nature but which are deductible due to legislative grace
Business expenses versus itemized deductions. It is important to understand the differences between business expenses, expenses incurred for the production of income and itemized deductions.
a. Business expenses are deductible under Section 162 and are deductible for AGI. Individual taxpayers who are engaged in a trade or business deduct business expenses on schedule C of form 1040.
b. Generally, expenses incurred for the production of income are itemized deductions under Sec. 212 are reported on schedule A. however, expenses related to the production of rent or royalty income are deductions for AGI and are reported on schedule E.
c. Itemized deductions that are related to the production of income include, but are not limited to, medical expenses, state and local income and sales taxes home mortgages and investment interest, casualty losses, charitable contributions and miscellaneous itemized deductions.
Itemized Deductions versus Standard Deductions – Itemized deductions are deducted from AGI if they exceed the taxpayer’s standard deduction. If itemized deductions do not exceed the standard deduction, they are "lost because they do not produce a tax benefit.
Allowable Medical expenses.
d. Medical expenses include all preventative and diagnostic measures. Thus, the cost of an annual physical exam qualifies even though the taxpayer is in good health.
e. Cosmetic surgery (e.g. Face lifts, hair transplants for necessary cosmetic surgery in not deductible, Necessary cosmetic surgery includes procedures that ameliorate:
1. . a deformity arising from a congenital abnormality
2. a personal injury resulting from accident or trauma or
3. a disfiguring disease
c. nursing home expenses need not be performed by a nurse as long as the services are of a kind generally performed by a nurse.
5. Effect of physician recommendation: Although the recommendation of a doctor is important, it is not controlling as far as deductible expenditures are concerned. Suppose, for example a child psychiatric recommends a private school in order to alleviate the learning disorder of a taxpayer’s child, by itself this does not male the tuition paid to the private school a deductible medical expense.
further investigation is necessary, it the tax benefit the primary reason the child is in the school?
6. Deductible as a medical expense: A capital expenditure dictated by medical necessary can de deducted as a medical expense.
a) Capital expenditures for medical purposes are not capitalized and depreciated. The deduction is taken in the year the medical expense is incurred, even though the asset’s useful life may extend over a period of several years,
b) The measure of the deduction is the amount of the expenditure less the increase in value to the personal residence resulting from the expenditure. In addition, operating costs related to the capital expenditure are deductible.
C) certain qualifying home-related capital expenditures incurred to eliminate structural barriers to accommodate a physical handicap of the taxpayer, spouse, or dependent are deductible in full. Thus, in increase-in-value adjustment need not be made.
d) Past IRS pronouncement have allowed a medical expense deduction for capital modifications to cars, vans, and telephones owned by handicapped taxpayers.
Special Rule for Children of Divorced Parents. One issue mention in the text deals with a situation that can arise in the case of divorced parents with children.
Ex- Fred and Marge were divorced in 2006, and under the terms of the divorce, Marge is awarded custody of their one child Cindy. In addition to required child support payments of 3,600 during 2007, Fred pays 2,555 of Cindy’s medical expenses. Together, both Fred and Marge proved more than ½ of Cindy’s support.
Because either parent could have claimed the child as a dependent of 2007 could have claimed Cindy as a dependent if Marge has signed a waiver to this effect each parent may deduct the medical expenses he or she pay for the child. Thus, Fred can include the 2,500 that he paid for Cindy’s medical expense in computing his medical expense deduction
A) Neither the gross income nor the joint return test applies in determining dependency status for medical expense deductions.
8) Deductibility of Transportation Expenses: In connection with the deductibility of transportation expenses, consider the following:
Example: Jason living in NYC and had a circulatory condition that had resulted in several strokes in the past. Jason’s physician advises him that another winter in the northern climate could prove fatal. According, Jason travels to Florida where he and his family send the winter in a rented apartment.
Based on a classic Supreme Court case, Jason should be allowed to deduct his round-trip transportation costs between New York and Florida. However, the meals and lodging en-route any living expenses while in Florida, or expenses attributed to Jason’s family, would not be deducted.
On the other hand, a change of climate recommended by a physician or general improvement of health is not enough justification to allow the deduction of transportation expenses.
9) Transportation to and from the point of treatment. Payments for transportation to and from point of treatment for medical care are deductible as medical expenses
a) Such expenses include bus, taxi, train, or plane fare charges for ambulance service, and out of pocket expenses for the use of an automobile.
B) Instead of the actual out of pocket expense for the use of an automobile, a mileage allowance of 20 cents per mile may be used in 2007. Related tolls and parking fees are also deductible.
C) Deduction for transportation of an accompanying parent, aide, or nurse is permitted.
10) Lodging for Medical Care
a) A deduction may be allowed for lodging while away from home for medical expenses.
b) To be a deductible, the following requirements are satisfied:
1) the lodging is primarily for and essential to medical care.
2) The medical care is provided by a doctor in a licensed hospital or a similar medical facility.
3) The lodging is not lavish or extravagant under the circumstances.
4) There is no significant element of person pleasure, recreation, or vacation in the travel away from home.
The ceiling on the lodging deduction is 50 per night for each person, including the patient and traveling companion.
11) Medical insurance premiums are included with other medical expenses subject to the 7.5% of AGI floor.
a) The deductible amount included premiums paid for the taxpayer, spouse, and dependents.
b) A self-employed taxpayer may deduct 100% of medical insurance premiums as a business expense.
Personal Deductible expenses: chapter 7 is principally concerned with expenses that are essentially personal in nature but which are deductible due to legislative grace
Business expenses versus itemized deductions. It is important to understand the differences between business expenses, expenses incurred for the production of income and itemized deductions.
a. Business expenses are deductible under Section 162 and are deductible for AGI. Individual taxpayers who are engaged in a trade or business deduct business expenses on schedule C of form 1040.
b. Generally, expenses incurred for the production of income are itemized deductions under Sec. 212 are reported on schedule A. however, expenses related to the production of rent or royalty income are deductions for AGI and are reported on schedule E.
c. Itemized deductions that are related to the production of income include, but are not limited to, medical expenses, state and local income and sales taxes home mortgages and investment interest, casualty losses, charitable contributions and miscellaneous itemized deductions.
Itemized Deductions versus Standard Deductions – Itemized deductions are deducted from AGI if they exceed the taxpayer’s standard deduction. If itemized deductions do not exceed the standard deduction, they are "lost because they do not produce a tax benefit.
Allowable Medical expenses.
d. Medical expenses include all preventative and diagnostic measures. Thus, the cost of an annual physical exam qualifies even though the taxpayer is in good health.
e. Cosmetic surgery (e.g. Face lifts, hair transplants for necessary cosmetic surgery in not deductible, Necessary cosmetic surgery includes procedures that ameliorate:
1. . a deformity arising from a congenital abnormality
2. a personal injury resulting from accident or trauma or
3. a disfiguring disease
c. nursing home expenses need not be performed by a nurse as long as the services are of a kind generally performed by a nurse.
5. Effect of physician recommendation: Although the recommendation of a doctor is important, it is not controlling as far as deductible expenditures are concerned. Suppose, for example a child psychiatric recommends a private school in order to alleviate the learning disorder of a taxpayer’s child, by itself this does not male the tuition paid to the private school a deductible medical expense.
further investigation is necessary, it the tax benefit the primary reason the child is in the school?
6. Deductible as a medical expense: A capital expenditure dictated by medical necessary can de deducted as a medical expense.
a) Capital expenditures for medical purposes are not capitalized and depreciated. The deduction is taken in the year the medical expense is incurred, even though the asset’s useful life may extend over a period of several years,
b) The measure of the deduction is the amount of the expenditure less the increase in value to the personal residence resulting from the expenditure. In addition, operating costs related to the capital expenditure are deductible.
C) certain qualifying home-related capital expenditures incurred to eliminate structural barriers to accommodate a physical handicap of the taxpayer, spouse, or dependent are deductible in full. Thus, in increase-in-value adjustment need not be made.
d) Past IRS pronouncement have allowed a medical expense deduction for capital modifications to cars, vans, and telephones owned by handicapped taxpayers.
Special Rule for Children of Divorced Parents. One issue mention in the text deals with a situation that can arise in the case of divorced parents with children.
Ex- Fred and Marge were divorced in 2006, and under the terms of the divorce, Marge is awarded custody of their one child Cindy. In addition to required child support payments of 3,600 during 2007, Fred pays 2,555 of Cindy’s medical expenses. Together, both Fred and Marge proved more than ½ of Cindy’s support.
Because either parent could have claimed the child as a dependent of 2007 could have claimed Cindy as a dependent if Marge has signed a waiver to this effect each parent may deduct the medical expenses he or she pay for the child. Thus, Fred can include the 2,500 that he paid for Cindy’s medical expense in computing his medical expense deduction
A) Neither the gross income nor the joint return test applies in determining dependency status for medical expense deductions.
8) Deductibility of Transportation Expenses: In connection with the deductibility of transportation expenses, consider the following:
Example: Jason living in NYC and had a circulatory condition that had resulted in several strokes in the past. Jason’s physician advises him that another winter in the northern climate could prove fatal. According, Jason travels to Florida where he and his family send the winter in a rented apartment.
Based on a classic Supreme Court case, Jason should be allowed to deduct his round-trip transportation costs between New York and Florida. However, the meals and lodging en-route any living expenses while in Florida, or expenses attributed to Jason’s family, would not be deducted.
On the other hand, a change of climate recommended by a physician or general improvement of health is not enough justification to allow the deduction of transportation expenses.
9) Transportation to and from the point of treatment. Payments for transportation to and from point of treatment for medical care are deductible as medical expenses
a) Such expenses include bus, taxi, train, or plane fare charges for ambulance service, and out of pocket expenses for the use of an automobile.
B) Instead of the actual out of pocket expense for the use of an automobile, a mileage allowance of 20 cents per mile may be used in 2007. Related tolls and parking fees are also deductible.
C) Deduction for transportation of an accompanying parent, aide, or nurse is permitted.
10) Lodging for Medical Care
a) A deduction may be allowed for lodging while away from home for medical expenses.
b) To be a deductible, the following requirements are satisfied:
1) the lodging is primarily for and essential to medical care.
2) The medical care is provided by a doctor in a licensed hospital or a similar medical facility.
3) The lodging is not lavish or extravagant under the circumstances.
4) There is no significant element of person pleasure, recreation, or vacation in the travel away from home.
The ceiling on the lodging deduction is 50 per night for each person, including the patient and traveling companion.
11) Medical insurance premiums are included with other medical expenses subject to the 7.5% of AGI floor.
a) The deductible amount included premiums paid for the taxpayer, spouse, and dependents.
b) A self-employed taxpayer may deduct 100% of medical insurance premiums as a business expense.
Tax Notes CH. 7 Continued (part II)
Ch. 7
c. Tax Payers may also include premiums paid on qualified long-term care insurance contracts in medical expenses. For 2007, the per-person limits range from $290 for taxpayers age 40 and under to $3,680 for taxpayers over the age of 70 ( see IRS publication 502)
12. General Rule – Regardless of the taxpayer’s method of accounting, medical expenses are deductible only in the third year paid.
a. Exception for medical expenses of a decedent. An exception to this rule is contained in sec. 213 © Under this provision, the medical expenses of decedent may be deducted in the year incurred if paid by the estate or surviving spouse within one year of death.
i. Do not conclude, however that all such medical expenses can be deducted on a decedent’s final income tax return.
ii. Ex. Daniel a calendar year taxpayer, died on March, 10, 2007. At the time of his death, Daniel owed 4,200 of medical expenses incurred as follows: 1,200 in 2006 and 3,000 in 2007. If these expenses are paid (either by Daniel’s estate or Daniel’s surviving spouse) within one yea of March 10, 2007, $1,200 can be claimed on Daniel’s 2006 form 1040 and 3,000 on Daniel’s’ final 2007 1040 form.
b. Exception for future medical services. No deduction will be allowed for payment of medical care to be rendered in the future unless the taxpayer is under an obligation to make the payment.
i. Whether an obligation to make the payment exists depends upon the policy of the physician or the institution furnishing the medical care.
ii. The IRS does not allow a deduction for the portion of a lump-sum prepayment allocable to medical care made to a retirement home under a life care plan.
13. Points to Emphasize
a. Expense and reimbursement in same tax year. If the medical expense and its reimbursement occur in the same tax year, the reimbursement must be taken in account in arriving at the medical expense deduction for that year.
b. Anticipated reimbursement. Unlike casualty insurance recoveries, medical expense reimbursements do not have to be anticipated. Consequently though a taxpayer is positive that the medical expense will be reimbursed, the reimbursement is not considered until received.
c. Reimbursement received in subsequent tax year. If the reimbursement is received in a subsequent year, much taxpayer confusion exists as to the proper tax treatment.
i. Undoubtedly, many taxpayers will honestly regard the reimbursement as being devoid of tax consequences. The rationalization might be: “I merely got back what I paid so why should it be taxed?”
ii. Another erroneous approach would be to offset the reimbursement against the medical expenses for the year of reimbursement.
d. Taxpayer Compliance. – Due to the likelihood of taxpayer error, the IRS has for many years urged Congress to require information reporting (e.g. Form 1099) on insurance companies that offer medical coverage.
e. Tax Benefit Rule/ The proper way to handle a subsequent-year reimbursement is to apply the tax benefit rule.
HEALTH SAVINGS ACCOUNTANTS (HSA’s)
14. Certain employees and self-employed taxpayers may deduct payments to HSA’s as deductions for AGI. The HAS must be used in connection with high deductible policies. The purpose of this provision is to assist in the control of health costs.
a. High Deductible policies for tax years beginning in 2007 are those with deductibles not less that $1,100 (In 2006 $1,050) for self-only coverage or @2,200 deducting and other out-of-pocket costs (excluding premiums) under the plan does not exceed $5,500 for self-only coverage ($11,000 for family coverage).
b. HAS distributions are not taxable if used by the recipient to pay for amounts not covered by a high deductible plan, but distributions used for other purposes are included in gross income and are subject to an additional 10% penalty if made before age 65, death or disability. Earnings on HSAs are not subject to taxation unless distributed. Distributions made by reason of death or disability and distribution made after the beneficiary becomes eligible for Medicare are taxed but not penalized.
c. The deductible amount for HAS contributions is subject to limitations.
i. The amount of the monthly limitation for self-only coverage in 2007 is the lesser of one-twelfth of the annual deductible under the high-deductible plan or @,850. For family coverage in 2007, the annual deduction is limited to the lesser of one-twelfth of the annual deductible under the high-deductible plan or $5,650. For an eligible taxpayer who has attained age 55 by the end of the tax year, the limit on annual contributions in 2007 is increased by $800 ($900 in 2008 and $1,000 after 2008)
d. An HAS is portable. Taxpayers who switch jobs can take their HSAs with them.
TAXES
15. A Tax versus a Fee.
a. A fee for personal use is not deductible as a tax under Sec. 164
b. Thus, fees for god licenses, automobile inspection, automobile titles and registration, hunting and fishing licenses, parking meter deposits, postage, etc. are not deductible unless incurred as a business expense under Sec. 162 or for the production of income under sec. 212.
16. Examples of Deductible and nondeductible Taxes
a. The following are examples of deductible taxes: state and local income or state and local sales, personal property, real estate and intangible property taxes.
b. Examples of nondeductible taxes: Social Security, Federal income and estate and inheritance taxes.
c. Taxes incurred in connection with trade or business or production of income activities are deductible, even if the same tax is not deductible as an itemized deduction.
PROPERTY TAXES
17. Timing of Deduction and by Whom.
a. Taxes on real and personal property are generally deductible only by the person against whom the tax imposed.
b. Cash basis taxpayers may deduct these taxes in the year of actual payment, and accrual basis taxpayers may deduct them in the year when economic performance has occurred.
c. Assessments on real property (e.g. for streets, sidewalks, curbing) are not deductible but added to the adjusted basis of the property.
c. Tax Payers may also include premiums paid on qualified long-term care insurance contracts in medical expenses. For 2007, the per-person limits range from $290 for taxpayers age 40 and under to $3,680 for taxpayers over the age of 70 ( see IRS publication 502)
12. General Rule – Regardless of the taxpayer’s method of accounting, medical expenses are deductible only in the third year paid.
a. Exception for medical expenses of a decedent. An exception to this rule is contained in sec. 213 © Under this provision, the medical expenses of decedent may be deducted in the year incurred if paid by the estate or surviving spouse within one year of death.
i. Do not conclude, however that all such medical expenses can be deducted on a decedent’s final income tax return.
ii. Ex. Daniel a calendar year taxpayer, died on March, 10, 2007. At the time of his death, Daniel owed 4,200 of medical expenses incurred as follows: 1,200 in 2006 and 3,000 in 2007. If these expenses are paid (either by Daniel’s estate or Daniel’s surviving spouse) within one yea of March 10, 2007, $1,200 can be claimed on Daniel’s 2006 form 1040 and 3,000 on Daniel’s’ final 2007 1040 form.
b. Exception for future medical services. No deduction will be allowed for payment of medical care to be rendered in the future unless the taxpayer is under an obligation to make the payment.
i. Whether an obligation to make the payment exists depends upon the policy of the physician or the institution furnishing the medical care.
ii. The IRS does not allow a deduction for the portion of a lump-sum prepayment allocable to medical care made to a retirement home under a life care plan.
13. Points to Emphasize
a. Expense and reimbursement in same tax year. If the medical expense and its reimbursement occur in the same tax year, the reimbursement must be taken in account in arriving at the medical expense deduction for that year.
b. Anticipated reimbursement. Unlike casualty insurance recoveries, medical expense reimbursements do not have to be anticipated. Consequently though a taxpayer is positive that the medical expense will be reimbursed, the reimbursement is not considered until received.
c. Reimbursement received in subsequent tax year. If the reimbursement is received in a subsequent year, much taxpayer confusion exists as to the proper tax treatment.
i. Undoubtedly, many taxpayers will honestly regard the reimbursement as being devoid of tax consequences. The rationalization might be: “I merely got back what I paid so why should it be taxed?”
ii. Another erroneous approach would be to offset the reimbursement against the medical expenses for the year of reimbursement.
d. Taxpayer Compliance. – Due to the likelihood of taxpayer error, the IRS has for many years urged Congress to require information reporting (e.g. Form 1099) on insurance companies that offer medical coverage.
e. Tax Benefit Rule/ The proper way to handle a subsequent-year reimbursement is to apply the tax benefit rule.
HEALTH SAVINGS ACCOUNTANTS (HSA’s)
14. Certain employees and self-employed taxpayers may deduct payments to HSA’s as deductions for AGI. The HAS must be used in connection with high deductible policies. The purpose of this provision is to assist in the control of health costs.
a. High Deductible policies for tax years beginning in 2007 are those with deductibles not less that $1,100 (In 2006 $1,050) for self-only coverage or @2,200 deducting and other out-of-pocket costs (excluding premiums) under the plan does not exceed $5,500 for self-only coverage ($11,000 for family coverage).
b. HAS distributions are not taxable if used by the recipient to pay for amounts not covered by a high deductible plan, but distributions used for other purposes are included in gross income and are subject to an additional 10% penalty if made before age 65, death or disability. Earnings on HSAs are not subject to taxation unless distributed. Distributions made by reason of death or disability and distribution made after the beneficiary becomes eligible for Medicare are taxed but not penalized.
c. The deductible amount for HAS contributions is subject to limitations.
i. The amount of the monthly limitation for self-only coverage in 2007 is the lesser of one-twelfth of the annual deductible under the high-deductible plan or @,850. For family coverage in 2007, the annual deduction is limited to the lesser of one-twelfth of the annual deductible under the high-deductible plan or $5,650. For an eligible taxpayer who has attained age 55 by the end of the tax year, the limit on annual contributions in 2007 is increased by $800 ($900 in 2008 and $1,000 after 2008)
d. An HAS is portable. Taxpayers who switch jobs can take their HSAs with them.
TAXES
15. A Tax versus a Fee.
a. A fee for personal use is not deductible as a tax under Sec. 164
b. Thus, fees for god licenses, automobile inspection, automobile titles and registration, hunting and fishing licenses, parking meter deposits, postage, etc. are not deductible unless incurred as a business expense under Sec. 162 or for the production of income under sec. 212.
16. Examples of Deductible and nondeductible Taxes
a. The following are examples of deductible taxes: state and local income or state and local sales, personal property, real estate and intangible property taxes.
b. Examples of nondeductible taxes: Social Security, Federal income and estate and inheritance taxes.
c. Taxes incurred in connection with trade or business or production of income activities are deductible, even if the same tax is not deductible as an itemized deduction.
PROPERTY TAXES
17. Timing of Deduction and by Whom.
a. Taxes on real and personal property are generally deductible only by the person against whom the tax imposed.
b. Cash basis taxpayers may deduct these taxes in the year of actual payment, and accrual basis taxpayers may deduct them in the year when economic performance has occurred.
c. Assessments on real property (e.g. for streets, sidewalks, curbing) are not deductible but added to the adjusted basis of the property.
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