With standard deduction allowances at their current levels, many taxpayers may find the standard deduction more advantageous than itemizing. However, taxpayers with a home mortgage or with substantial state income tax liability and others are likely to itemize. In addition, if your spouse is filing separately and is itemizing, you also must itemize.
Which is the better way? The answer depends on your circumstances; the only true test is to go through your deductions as if you were itemizing and add them up. If the total is more than the standard deduction for which you qualify, then itemize.
Itemized deductions look for 1990 much as they did for 1989 and are claimed on Schedule A. Here are some rules about the various types of itemized deductions.
You are entitled to deduct expenses -- net of any insurance reimbursement -- paid during the tax year for the medical care for yourself, your spouse or dependents, to the extent that such expenses exceed 7.5 percent of your Adjusted Gross Income (AGI). A "dependent" is anyone you claim as a dependent, or could claim but for the $2,050 income test.
Either divorced parent -- or both -- may claim medical expenses each paid for a child, regardless of which parent has custody or gets the dependency exemption.
You may deduct any of the following taxes:
State and local income taxes paid or withheld in 1990 -- whether more or less than your final tax bill for the year.
If you itemized in 1989 and during 1990 you received a refund of a part of your 1989 tax, claim the full amount paid this year, and determine how much of the refund to include in your income.
Personal property taxes paid in 1990, regardless of the year to which the tax applied. Real estate taxes paid in 1990 on your home or other nonbusiness property. Taxes paid on property you own and rent to others goes on Schedule E. If the institution that holds your mortgage pays the real estate tax, deduct only the amount paid on your behalf in 1990, as shown on the annual statement, not the monthly tax payment you made into an escrow account.
If you paid a tax late and were assessed a penalty and interest, don't add those amounts to your tax payment. You may not deduct the penalty amount. Any interest charged may be included in the next section of Schedule A under "Interest You Paid."
Be careful to distinguish assessments for local benefits such as streets, curbs and gutters and sewers, from real estate taxes. Even if paid over a period of years, these assessments are not deductible. Add the cost to your basis.
You may not deduct excise taxes, traffic fines, tax penalties, general sales tax, inheritance and estate taxes or real estate transfer taxes. You may deduct any foreign tax, determined on Form 1116, if you decide to take the deduction for such taxes rather than the foreign tax credit.
Interest expense is handled differently, depending on which of the following categories it comes under: qualified residential (mortgage), other personal, investment, business, or passive.
Most people will be able to deduct all of the mortgage interest they pay on loans secured by their main residence -- whether first or second mortgages, home equity mortgages or refinanced mortgages. Here are some guidelines:
If you took out either a new mortgage or an equity loan on your principal residence before Oct. 14, 1987, you may deduct all of the interest paid in 1990 on those loans.
If you took out either a new mortgage or an equity loan on your principal residence after Oct. 13, 1987, to buy, build or improve that home, and these loans plus the loans in Item A are less than $1 million ($500,000 for marrieds filing separately), you may deduct all of the interest paid with respect to these loans in 1990.
If you took out a loan on your principal residence after Oct. 13, 1987, for any reason other than to buy, build or improve that home, the principal amount on which the interest is deductible is $100,000 ($50,000 if married filing separately).
If you have a second home, the dollar limits in the two paragraphs above apply to the combined total of mortgages on both homes.
Generally, "points" or "loan origination fees" are deductible only over the term of the loan. However, points paid to obtain financing to buy or improve your principal residence can generally be deducted in the year of payment.
Keep in mind that, if you didn't pay the points in cash, but rather had the points subtracted from your loan proceeds, the points are only deductible over the term of the mortgage.
If you sold your residence, any points you paid to induce a lender to provide financing to the buyer are not interest but rather a selling expense, reducing the gain on your sale. There are special deferral and/or exclusion provisions to deal with the gain on sale of a principal residence; see Form 2119.
Points are not currently reported on Form 1098, the mortgage interest information return. The tax revision act of 1989 includes a provision requiring such reporting, starting with information returns for 1991.
Points are reported separately on line 10 of Schedule A.
Personal interest is interest that doesn't fall into one of the other categories, including interest on a car or personal loan, credit card interest and interest on income taxes.
The itemized deduction for personal interest is limited to 10 percent of the total. The other 90 percent is lost. Enter the appropriate numbers on lines 12a and 12b of Schedule A.
As in previous years, interest on money borrowed to purchase or carry tax-exempt bonds or a single-premium life insurance policy cannot be deducted.
Investment interest is interest incurred to buy or carry property held to produce interest, dividends, royalties and capital gains, to name a few. This includes, for example, margin interest on your brokerage account.
Investment interest is deductible only to the extent of investment income, plus 10 percent of the lesser of: $10,000 or the excess of investment interest over investment income. If your investment interest expense exceeds your investment income, use Form 4952 to determine the allowable deduction.
Interest expense associated with a business continues to be deductible in full on Schedule C or on Schedule F for a farm business.
Passive Activity Interest
Interest expense associated with limited partnerships, tax shelter investments, S corporation investments and other business activities in which you did not materially participate -- so-called passive activities -- come under the rules that restrict passive loss deductions. See the passive loss discussion in connection with Schedule E, above. The allowable amount of interest expense is calculated as part of passive activity losses on IRS Form 8582.
You may deduct contributions to a variety of tax-exempt organizations -- that is, a tax-exempt organization created and operated exclusively for religious, charitable, scientific, literary, educational or a few other purposes. Not included are political organizations, civic leagues operated for the promotion of social welfare, labor unions, trade associations, social clubs and individuals.
It is not always obvious whether contributions to a particular organization are deductible. To be sure, you can check with the IRS or the organization. The IRS also publishes a "Cumulative List of Organizations Described in Section 170 (c) of IRC of 1986" -- Publication 78 -- that lists all organizations that have obtained an IRS ruling recognizing their charitable status.
If you make a cash contribution but derive some direct benefit in return, no deduction is allowed for the portion of the contribution allocable to the benefit received. However, if the benefit received is worth not more than the lesser of $50 or 2 percent of your contribution or is a token item bearing the recipient's logo and costs less than $5.45, your entire contribution should be deductible.
You may also deduct gifts of property, in which case the deductible amount is often the fair market value of the property, but sometimes it is limited to something less than fair market value. For instance, contributions of business inventory or short-term capital assets are deductible only to the extent of your cost, or basis, for the property. Also, if you contribute an art object that the charity does not use in connection with its charitable function, your deduction is limited to your cost for the property. If your contribution would be limited to your cost, it may sometimes be better to sell the property and contribute the sales proceeds.
If the cumulative amount of your deduction for gifts of property exceeds $500, the contributions must be documented on IRS Form 8283.
A professional appraisal is required to support a claim for contributed property, other than publicly held securities, valued at $5,000 or more.
The appraisal fee itself may not be added to the value of the contribution, but may be claimed as a miscellaneous deduction, subject to the 2 percent floor explained below.
Some reimbursed expenses incurred while contributing your services to a qualifying organization are deductible, including postage and phone calls and the purchase and upkeep of special uniforms not for general wear. You may not deduct the value of contributed services even if you are normally paid for the same type of work.
You may deduct local transportation expenses. If you use your own car, claim either the actual out-of-pocket cost of operating the vehicle -- fuel and oil, but not depreciation or maintenance -- or the optional standard rate of 12 cents a mile, unchanged from last year. Add tolls and parking fees with either method. But meal expenses may only be claimed if you are traveling away from home at least overnight on behalf of the organization.
If you travel away from home on behalf of the qualifying organization, you may deduct non-reimbursed expenses, including meals and lodging, only if there was no significant element of personal pleasure, recreation or vacation associated with the trip.
Your deduction for contributions is limited, based generally on a percentage of adjusted gross income. Unless the amount of your charitable contributions is more than 20 percent of your AGI, you need not be concerned with these limitations.
Casualty Losses And Theft Losses
You may be eligible for a Schedule A deduction in the event of the destruction of or damage to nonbusiness property resulting from a sudden, unexpected or unusual occurrence.
Gradual deterioration, such as a termite infestation, doesn't qualify. Neither does preventive action such as removing a dead tree before it falls. The event must occur suddenly -- hurricane or tornado, earthquake or flood, fire, theft, vandalism or accident.
Only a non-reimbursed loss is deductible. Any amount recovered from an insurance company or from another individual must be subtracted from the total loss.
If you could have filed an insurance claim but didn't -- or failed to file on time, under the rules of your policy -- then you may not claim the loss on your tax return.
There is what amounts to a deductible -- the first $100 of net loss from each separately identifiable event must be subtracted. Further, nonbusiness casualty losses are deductible only to the extent that the net total of all losses, after the $100-per-loss exclusion, exceeds 10 percent of your adjusted gross income.
Various expenses associated with the production of taxable income may qualify for a deduction on Schedule A. Most of these expenses, however, may only be deducted if the total exceeds 2 percent of adjusted gross income.
You may include such things as a fee paid for having your tax return prepared; tax or investment counseling during the year; travel to your advisers and to the IRS for forms and publications; and tax or investment books and periodicals -- but only the proportionate share for 1990 of a multi-year subscription.
Employee business expenses incurred other than in connection with an "accountable" expense allowance arrangement -- explained in a separate section below -- are subject to the 2 percent floor, but qualifying moving expenses -- also discussed later -- may be deducted in full with no adjusted gross income exclusion.
Similarly, gambling losses are deductible without regard to the 2 percent of adjusted gross income exclusion -- but only to the extent of gambling winnings reported as income.
Fees connected with any legal action undertaken with the intention of generating taxable income -- whether ultimately successful or not -- are deductible above the 2 percent floor.
Thus you may claim legal costs to collect unpaid alimony or wages, but expenses associated with a divorce proceeding are not deductible. A separately identified fee for tax or investment counseling in connection with a divorce is, however, a valid deduction.
Aside from the limit on investment interest, explained earlier, you may claim as a miscellaneous deduction, subject to the 2 percent floor, expenses related to your investments -- even if you lost money on those investments. These rules include: Fees for investment advisory services; the cost of a safe deposit box to hold papers that generate taxable income; transportation to your broker's or investment adviser's office, but not travel to attend a stockholders meeting even if you owned or contemplated buying shares in the company.
Reasonable expenses attributable directly to your investment activities -- a calculator, for example, or dedicated computer software even though the computer itself doesn't qualify; fees paid to your bank or broker for the collection of taxable interest on notes and bonds; a custodial fee on your IRA or Keogh account if you paid the fee in cash, but not if it was simply deducted from your account.
If you changed your principal residence during 1990 to work at a new location, for either the same or a different employer, you may deduct all or a part of the non-reimbursed expenses of the move. Moving expenses are deductible in full without regard to the 2 percent of adjusted gross income floor. However, if you don't itemize, you lose any deduction for a qualifying move.
To claim the deduction for moving expenses, you must meet both of the following requirements: The distance between your new place of employment and your old residence must be at least 35 miles greater than the distance between your former job location and that same (old) residence. The location of your new home is not a factor. You must work in the new area, though not necessarily for the same employer, for at least 39 weeks during the 12-month period after the move.
If you are self-employed, you must conduct your business full-time for at least 39 weeks in the first 12 months and a total of 78 weeks during the 24 months after the move. This time test is waived if termination of employment was due to death or disability, transfer for the employer's benefit or discharge other than for willful misconduct.
If you meet both tests, you may deduct on Schedule A several kinds of moving expenses. To start with, the cost of direct travel from the old to the new residence for you and your family -- transportation, meals and lodging -- may be deducted. But do not claim any expenses associated with sightseeing or side trips to visit family.
If you go by car, you may use either the out-of-pocket costs -- gas, oil and repairs, but not depreciation or normal maintenance -- or a flat 9 cents a mile. In either case, you may add tolls and parking.
The cost of moving your household goods -- including packing and crating, insurance and necessary storage -- is deductible. But charges for disconnecting or connecting appliances or refitting carpets or curtains may not be claimed.
Subject to specified dollar limits, you may deduct the cost of travel, meals and lodging for house-hunting trips before the move, but after being hired.
You may also include the cost of temporary lodging, meals and miscellaneous personal expenses for up to 30 days, or 90 days for an overseas move, at the new job location.
You may also count any costs associated with selling your old residence and buying a new home, such as broker commissions and legal fees -- but a loss on the sale may not be claimed.
If you rent, include any expenses associated with terminating an old lease or negotiating a new one -- but not a security deposit on either the home or any utility service.
Report your moving expenses on IRS Form 3903. If you were reimbursed by your employer, subtract that amount from your expenses. But if the reimbursement was reported as income on your Form W-2, claim total expenses without reduction. Your employer should give you Form 4782 with details of any reimbursements.
Employee Business Expenses
Employee business expenses paid or incurred by a taxpayer under a reimbursement allowance arrangement with an employer are not to be reported as income; they shouldn't be on your W-2. By the same token, the reimbursed expenses are not to be deducted.
An arrangement is not a reimbursement or expense allowance arrangement unless it requires the employee to substantiate the covered expenses to the employer and to return to the employer any amounts received in excess of the substantiated expenses.
Any qualifying employee business expenses not covered by a reimbursement allowance arrangement may be taken only as miscellaneous itemized deductions, subject to the 2 percent of adjusted gross income floor that applies to other miscellaneous deductions, even though any reimbursement is includable in your income in full.
Some authorized employee business expenses are:
Travel, transportation, meals and entertainment expenses. Use Form 2106 if you have any of these.
Union dues, safety equipment, specialized uniforms, protective clothing.
Dues to professional organizations, subscriptions to professional journals.
Business gifts, up to $25 per person.
If you have a handicap or disability, you can deduct necessary expenses that enabled you to work, such as the cost of a reader or a special attendant at your place of employment. This deduction may be claimed in full, not subject to the 2 percent of adjusted gross income floor.
Only 80 percent of expenses for business meals and entertainment is deductible, and the amount that meets the 80 percent limit is further subject to the 2 percent-of-AGI floor on miscellaneous deductions.
Expenses for education undertaken to maintain or improve a skill required in connection with your employment or business are redeductible. Your employer also may have explicit educational requirements, and in some instances there are legally imposed requirements, for you to retain your job or position. Educational costs incurred to meet these requirements are deductible.
Transportation between your place of employment and school is deductible, but if you travel to school from your home on a nonworking day, it is considered personal commuting and is not deductible.
Education expenses to qualify for a job in a new career field, or in many instances to qualify for a more responsible position in your current career field (particularly where such new position requires a new level of certification), or for your own pleasure, do not qualify. IRS Publication 508 has more information.
Remember that good record keeping for transportation, travel, meals and entertainment and business gifts is not just a desirable business practice, but required. You must keep adequate records or sufficient evidence to support your deductions; estimates and approximations alone no longer can be used to justify these deductions.
Expenses related to a job search -- preparation and mailing of resumes, fees paid to an employment agency, long-distance phone calls and travel expenses for an interview -- may be deducted if the job applied for was in the same trade or business, even if the search was unsuccessful.
Office at Home
Deductions for the business use of your personal residence can be claimed, but only for that portion of your residence that is used exclusively and on a regular basis as: the principal place of business of your trade or business, or a place of business for meeting customers, patients or clients.
The portion devoted to business may be a separate room or just part of a room, as long as that part is used solely for business purposes.
The business you are conducting at home need not be your principal occupation. The deduction may qualify even if the space was used for a secondary or part-time business. However, it must be conducted with the idea of making a profit, not as a hobby. The IRS looks at all the circumstances, but generally you should show a profit in at least three years out of any five to stay clear of the hobby loss rule.
If you are an employee claiming an office at home, the rules are more stringent: Use of space in your home must be for the convenience of your employer, not for your own convenience.
If the space qualifies, you may deduct two kinds of expenses: costs directly attributable to the business use, such as a desk, filing cabinet, stationery; and a proportionate share of the general expenses of the home, such as utilities, insurance or rent; or depreciation if you own the home. The fraction to be used may be derived either from the number of rooms in the home or the square footage of the space used.
Finally, as mentioned before, the deduction for an office in the home may not be used to shelter other income from tax. After subtracting the allowable portion of property taxes and mortgage interest -- both of which could be claimed elsewhere on Schedule A -- the deduction for the remaining expenses is limited to your net income from the business activity for which the deduction is claimed.
You may claim an appropriate depreciation cost -- using one of several depreciation methods -- for equipment purchased for the business. As an alternative, as much as $10,000 worth of business property may be "expensed" -- that is, written off in full in the year of purchase instead of being depreciated. The amount of such deductions that may be claimed is limited to your taxable income for the business -- that is, you can't create or increase a business loss by claiming this first year write-off. The $10,000 ceiling also is phased out, dollar-for-dollar, for investment in tangible personal property in excess of $200,000 in any one year.
If the property purchased is not used more than 50 percent for business, you must use straight-line depreciation over the useful life of the property for that part of the total cost that corresponds to the percentage of business use.