Miscellaneous Itemized Deductions

Miscellaneous Itemized Deductions Learning Objective Know how to determine if other items can be deductible as miscellaneous itemized deductions. Miscellaneous deductions fall into two categories: those limited to the extent the total exceeds 2 percent of AGI, and those with no limitation. The following are some common miscellaneous deductions that are not subject to the 2 percent of AGI limitation: Handicapped “impairment related work expenses” Certain estate taxes Amortizable bond premiums (on bonds acquired before October 23, 1986) Terminated annuity payments Gambling losses to the extent of gambling winnings Common miscellaneous deductions that are subject to the 2 percent limitation include unreimbursed employee business expenses (in the absence of and within an accountable plan), investment expenses, and other general miscellaneous deductions (e.g., tax return preparation fees, union dues, job hunting expenses, and professional subscriptions). Investment expenses are deductible if directly related to taxable income or taxable income-producing property. Custodian fees are deductible, including fees for holding stocks and bonds, collecting and reinvesting cash dividends and interest, and record keeping and providing a statement of accounts. Fees paid to a broker or similar agent to collect taxable interest or dividends are deductible, but fees paid to a broker to acquire stocks or bonds are not deductible; they are added to the cost of the stocks or bonds. No deduction is allowed for investment expenses related to tax-exempt income. Tax return preparation fees are deductible in the year paid. For example, fees paid in 2008 for preparation of a taxpayer’s 2007 tax return are deductible on the 2008 tax return. Included in this deduction are all regular fees for tax advice and audit representation and such items as appraisal expenses to establish the amount of a casualty loss or the fair market value of donated property. Job hunting costs may be able to deductible, including travel and employment agency fees. To deduct job hunting expenses, the taxpayer must be seeking employment in a trade or business in which he or she is currently employed or, if unemployed, there can be no lack of continuity since the taxpayer’s last job. For example, the taxpayer cannot stop working, get a college degree, and then deduct the cost of job hunting after earning the degree. The deduction is allowed even if the attempt to obtain a new job is unsuccessful, but it is not allowed for first-time job seekers or taxpayers seeking employment in a new trade or business. Hobby expenses are deductible as a miscellaneous itemized deduction. If a taxpayer enters into an activity without a profit motive, the tax law limits the amount of tax deductions available. Under the hobby loss provisions, a taxpayer may not show a loss from an activity that is not engaged in for profit. An example of an activity that might cause an airline pilot problems is breeding race horses. The IRS might contend that the activity was for personal enjoyment and disallow any loss for tax purposes. Despite the limitation on losses, any profits from hobbies must be included in taxable income. Individual taxpayers (or S corporations) can avoid the hobby loss rules if they can show that the activity was conducted with the intent to earn a profit. To determine whether the activity was engaged in for profit, the IRS will look at these factors: Whether the activity is conducted like a business The expertise of the taxpayer The time and effort expended Previous success of the taxpayer in similar activities Income and loss history from the activity Relationship of income to losses in the activity Financial status of the taxpayer Elements of personal recreation in the activity Tax law provides a presumption that if an activity shows a profit for three of the five previous years (two of the seven previous years for activities involving horses) the activity is engaged in for profit. For example, if an activity shows a profit for three of the previous five years, it is presumed to be a trade or business, and the IRS must establish that it is a hobby. For an activity that is not a hobby, there is no limitation on the amount of expenses allocable to the activity. The business can incur a loss that is deductible on the tax return—typically a loss from self-employment, rental activities or farm activities (which is covered in Chapter 7). If an activity is a hobby, it is subject to the hobby loss rules and expenses may be allowed as deductions only to the extent of income from the activity. Expenses otherwise deductible on Schedule A, such as certain interest (e.g., home mortgage interest) and taxes may be allowed without regard to the nature of the activity. Therefore, a taxpayer could have a loss on a hobby to the extent the amount of otherwise deductible interest and taxes paid exceeds the amount of income from the activity. Other allowed expenses attributable to the hobby activity are considered miscellaneous itemized deductions, subject to the 2 percent of AGI limitation. Example Tony is the manager of an insurance agency. He decides that he wants to photograph wildlife all around the world (he was inspired by the Discovery Channel series, Planet Earth). His expenses for this activity include depreciation on cameras, $1,250; property tax on equipment, $600; printing costs, $450; and travel costs, $7,500. During the year, Tony sells several pictures for $1,900. If the activity is not a hobby, then Tony may take a $7,900 ($1,900 – 1,250 – 600 – 450 – 7,500) loss against his other income. However, if the activity is deemed to be a hobby, the deductions are limited to the income from the activity. Tony would be allowed to deduct the property taxes of $600, which would leave $1,300 ($1,900 income – $600 property tax). Only $1,300 of the depreciation, printing, and travel costs ($9,200 in total) can be deducted as miscellaneous itemized deductions, which then will be subject to the 2 percent limitation. Go to Publication 17 and read all of chapter 28, “Miscellaneous Deductions.” Questions and Problems Which of the following items is not deductible as a miscellaneous deduction on Schedule A? Investment expenses Gambling losses to the extent of gambling winnings Unreimbursed business expenses Subscriptions to professional publications Charitable contributions Which of the following is not deductible by the taxpayer? A subscription to The CPA Journal by a CPA A subscription to The Yale Medical Journal by a doctor A subscription to Financial Management by a chief financial officer A subscription to The Harvard Law Review by a lawyer All of the above are deductible. Ingrid quits her job as a restaurant chef. She decides to take an extended trip to France. After touring France and Europe for five months, Ingrid returns to look for a new job as a chef. Are her job hunting expenses deductible for this year? Explain. During the year, Matt paid for the following items: ItemAmount ($) Subscription to Income Investor newsletter150 Safety deposit box used to store investment account records35 Safety shoes and helmet worn on job-site inspections210 Tax return preparation fee260 Union dues345 Gambling losses (reported gambling income of $600 on line 21 of form 1040)980 Total1,980 Matt’s AGI for the year was $72,000. Complete the Job Expenses and Certain Miscellaneous Itemized Deductions and Other Miscellaneous Deductions section of Schedule A for Matt. What is the total itemized deductions Matt can claim? $__________ Meg is a high school teacher who raises German shepherds and sells puppies and, sometimes, adult dogs. During this tax year, she earned $3,700 from the sale of the dogs. She incurred and paid the following expenses: ItemAmount ($) Vet fees and medical supplies, etc.1,280 Stud fees600 Travel costs totally related to the business (only 50 percent of meal costs are included)1,800 Depreciation on kennel facilities420 Dog food1,040 American Kennel Club registration fees300 Total$5,440 If Meg’s dog-raising activities are not considered to be a profit-seeking business, what is the amount of expense she can deduct as a miscellaneous itemized deduction? $__________ If Meg’s dog-raising activities are considered to be a profit-seeking business, how would the income and expenses be treated (and where) on her tax return?__________________________________________________ Ross and Sandi are married and file a joint income tax return. Ross is an Emergency Medical Technician who spent $400 on uniforms during the year. His laundry expenses for the uniforms were $80 for this year, plus $60 for altering them. Sandi works as an order filler at the Amazon.com warehouse in Reno and is required by her employer to wear jeans and a work shirt on the job, which cost $160 this year. Her laundry costs were $60 for the work clothes. Sandi is also required to wear safety glasses and safety shoes when working, which cost a total of $105. How much is their total deduction on Schedule A for special clothing and uniforms (before limitations)? $__________