After you have figured your adjusted gross income, you are ready to subtract the deductions used to figure taxable income. You can subtract either the standard deduction or itemized deductions. Itemized deductions are deductions for certain expenses that are listed on Schedule A (Form 1040). The ten chapters in this part discuss the standard deduction, each itemized deduction, and the limit on some of your itemized deductions if your adjusted gross income exceeds certain amounts. See chapter 20 for the factors to consider when deciding whether to subtract the standard deduction or itemized deductions.
Increase in standard deduction. The standard deduction for most taxpayers who do not itemize their deductions on Schedule A of Form 1040 is higher in 2007 than it was in 2006. The amount depends on your filing status. There are tables at the end of this chapter to help you figure your standard deduction for 2007.
This chapter discusses the following topics.
Most taxpayers have a choice of either taking a standard deduction or itemizing their deductions. The standard deduction is a dollar amount that reduces the amount of income on which you are taxed.
The standard deduction is a benefit that eliminates the need for many taxpayers to itemize actual deductions, such as medical expenses, charitable contributions, and taxes, on Schedule A of Form 1040. The standard deduction is higher for taxpayers who are 65 or older or blind. If you have a choice, you can use the method that gives you the lower tax.
Tip: You benefit from the standard deduction if your standard deduction is more than the total of your allowable itemized deductions.
Persons not eligible for the standard deduction. Your standard deduction is zero and you should itemize any deductions you have if:
Note. If you are a nonresident alien who is married to a U.S. citizen or resident alien at the end of the year, you can choose to be treated as a U.S. resident. (See Publication 519, U.S. Tax Guide for Aliens.) If you make this choice, you can take the standard deduction.
Caution: If an exemption for you can be claimed on another person's return (such as your parents' return), your standard deduction may be limited. See Standard Deduction for Dependents, later.
The standard deduction amount depends on your filing status, whether you are 65 or older or blind, and whether an exemption can be claimed for you by another taxpayer. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amounts for most taxpayers for 2007 are shown in Table 20-1.
Decedent's final return. The amount of the standard deduction for a decedent's final tax return is the same as it would have been had the decedent was not 65 or older at the time of death, the higher standard deduction for age cannot be claimed.
Higher Standard Deduction for Age (65 or Older)
If you do not itemize deductions, you are entitled to a higher standard deduction if you are age 65 or older at the end of the year. You are considered 65 on the day before your 65th birthday. Therefore, you can take a higher standard deduction for 2007 if you were born before January 2, 1943.
Use Table 20-2 to figure the standard deduction amount.
Higher Standard Deduction for Blindness
If you are blind on the last day of the year and you do not itemize deductions, you are entitled to a higher standard deduction as shown in Table 20-2. You qualify for this benefit if you are totally or partly blind.
Partly blind. If you are partly blind, you must get a certified statement from an eye doctor or registered optometrist that:
If your eye condition will never improve beyond these limits, the statement should include this fact. You must keep the statement in your records.
If your vision can be corrected beyond these limits only by contact lenses that you can wear only briefly because of pain, infection, or ulcers, you can take the higher standard deduction for blindness if you otherwise qualify.
Spouse 65 or Older or Blind
You can take the higher standard deduction if your spouse is age 65 or older or blind and:
Caution: You cannot claim the higher standard deduction for an individual other than yourself and your spouse.
Examples
The following examples illustrate how to determine your standard deduction using Tables 20-1 and 20-2.
Example 1. Larry, 46, and Donna, 33, are filing a joint return for 2007. Neither is blind. They decide not to itemize their deductions. They use Table 20-1. Their standard deduction is $10,700.
Example 2. Assume the same facts as in Example 1, except that Larry is blind at the end of 2007. Larry and Donna use Table 20-2. Their standard deduction is $11,750.
Example 3. Bill, 72, and Terry, 66, are filing a joint return for 2007. Neither is blind. They decide not to itemize their deductions. They use Table 20-2. Their standard deduction is $12,800.
The standard deduction for an individual for whom an exemption can be claimed on another person's tax return is generally limited to the greater of:
However, if the individual is 65 or older or blind, the standard deduction may be higher.
If an exemption for you (or your spouse if you are filing jointly) can be claimed on someone else's return, use Table 20-3 to determine your standard deduction.
Earned income defined. Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work you actually perform.
For purposes of the standard deduction, earned income also includes any part of a scholarship or fellowship grant that you must include in your gross income. See Scholarships and Fellowships in chapter 1 of Publication 970 for more information on what qualifies as a scholarship or fellowship grant.
Example 1. Michael is single. His parents claim an exemption for him on their 2007 tax return. He has interest income of $780 and wages of $150. He has no itemized deductions. Michael uses Table 20-3 to find his standard deduction. He enters $150 (his earned income) on line 1, $450 ($150 plus $300) on line 3, $850 (the larger of $450 and $850) on line 5, and $5,350 on line 6. The amount of his standard deduction, on line 7a, is $850 (the smaller of $850 and $5,350).
Example 2. Joe, a 22-year-old full-time college student, is claimed on his parents' 2007 tax return. Joe is married and files a separate return. His wife does not itemize deductions on her separate return.
Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe finds his standard deduction by using Table 20-3. He enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,100 on line 3. On line 5 he enters $4,100, the larger of lines 3 and 4. Since Joe is married filing a separate return, he enters $5,350 on line 6. On line 7a he enters $4,100 as his standard deduction because it is smaller than $5,350, the amount on line 6.
Example 3. Amy, who is single, is claimed on her parents' 2007 tax return. She is 18 years old and blind. She has interest income of $1,300 and wages of $2,900. She has no itemized deductions. Amy uses Table 20-3 to find her standard deduction. She enters her wages of $2,900 on line 1. She adds lines 1 and 2 and enters $3,200 on line 3. On line 5 she enters $3,200, the larger of lines 3 and 4. Since she is single, Amy enters $5,350 on line 6. She enters $3,200 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked one box in the top part of the worksheet, she enters $1,300 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $4,500 on line 7c.
You should itemize deductions if your total deductions are more than the standard deduction amount. Also, you should itemize if you do not qualify for the standard deduction, as discussed earlier under Persons not eligible for the standard deduction.
You should first figure your itemized deductions and compare that amount to your standard deduction to make sure you are using the method that gives you the greater benefit.
Caution: You may be subject to a limit on some of your itemized deductions if your adjusted gross income (AGI) is more than $156,400 ($78,200 if you are married filing separately). See chapter 29 and the instructions for Schedule A (Form 1040), line 29, for more information on figuring the correct amount of your itemized deductions.
When to itemize. You may benefit from itemizing your deductions on Schedule A (Form 1040) if you:
These deductions are explained in chapters 21-28.
If you decide to itemize your deductions, complete Schedule A and attach it to your Form 1040. Enter the amount from Schedule A, line 29, on Form 1040, line 40.
Electing to itemize for state tax or other purposes. Even if your itemized deductions are less than the amount of your standard deduction, you can elect to itemize deductions on your federal return rather than take the standard deduction. You may want to do this, for example, if the tax benefit of being able to itemize your deductions on your state tax return is greater than the tax benefit you lose on your federal return by not taking the standard deduction. To make this election, you must check the box on line 30 of Schedule A.
Changing your mind. If you do not itemize your deductions and later find that you should have itemized -- or if you itemize your deductions and later find you should not have -- you can change your return by filing Form 1040X, Amended U.S. Individual Income Tax Return. See Amended Returns and Claims for Refund in chapter 1 for more information on amended returns.
Married persons who filed separate returns. You can change methods of taking deductions only if you and your spouse both make the same changes. Both of you must file a consent to assessment for any additional tax either one may owe as a result of the change.
You and your spouse can use the method that gives you the lower total tax, even though one of you may pay more tax than you would have paid by using the other method. You both must use the same method of claiming deductions. If one itemizes deductions, the other should itemize because he or she will not qualify for the standard deduction. See Persons not eligible for the standard deduction, earlier.
Caution: If you are married filling a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you cannot take the standard deduction even if you were born before January 2, 1943, or you are blind.
Table 20-1. Standard Deduction Chart for Most People*
------------------------------------------------------------- THEN your standard IF your filing status is... deduction is... ------------------------------------------------------------- single or married filing separately $ 5,350 ------------------------------------------------------------- married filing jointly or qualifying widow(er) with dependent child 10,700 ------------------------------------------------------------- head of household 7,850 ------------------------------------------------------------- * Do not use this chart if you were born before January 2, 1943, or you are blind, or if someone else can claim an exemption for you (or your spouse if married filing jointly). Use Table 20-2 or 20-3 instead. =============================================================
Table 20-2. Standard Deduction Chart for People Born Before January 2, 1943, or Who are Blind*
----------------------------------------------------------------- Check the correct number of boxes below. Then go to the chart. Born before You January 2, 1943 [] Blind [] Your spouse, if claiming Born before spouse's exemption January 2, 1943 [] Blind [] Total number of boxes you checked [] ----------------------------------------------------------------- THEN your AND the number standard IF your in the box above deduction filing status is... is... is... ----------------------------------------------------------------- single 1 $ 6,650 2 7,950 ----------------------------------------------------------------- married filing jointly or 1 11,750 qualifying widow(er) 2 12,800 with dependent child 3 13,850 4 14,900 ----------------------------------------------------------------- married filing 1 6,400 separately 2 7,450 3 8,500 4 9,550 ----------------------------------------------------------------- head of household 1 9,150 2 10,450 ----------------------------------------------------------------- * If someone can claim an exemption for you (or your spouse if married filing jointly), use Table 20-3, instead. =================================================================
Table 20-3. Standard Deduction Worksheet for Dependents
Use this worksheet only if someone else can claim an exemption for you (or your spouse if married filing jointly). ----------------------------------------------------------------- If you were born before January 2, 1943, or you are blind, check the correct number of boxes below. Then go to the worksheet. Born before You January 2, 1943 [] Blind [] Your spouse, if claiming Born before spouse's exemption January 2, 1943 [] Blind [] Total number of boxes you checked [] ----------------------------------------------------------------- 1. Enter your earned income (defined below). If none, enter -0-. 1. ________ ----------------------------------------------------------------- 2. Additional amount 2. $300 ----------------------------------------------------------------- 3. Add lines 1 and 2. 3. ________ ----------------------------------------------------------------- 4. Minimum standard deduction. 4. $850 ----------------------------------------------------------------- 5. Enter the larger of line 3 or line 4. 5. ________ ----------------------------------------------------------------- 6. Enter the amount shown below for your filing status. • Single or Married filing separately-- $5,350 6. ________ • Married filing jointly--$10,700 • Head of household--$7,850 ----------------------------------------------------------------- 7. Standard deduction. a. Enter the smaller of line 5 or line 6. If born after January 1, 1943, and not blind, stop here. This is your standard deduction. Otherwise, go on to line 7b. 7a. ________ b. If born before January 2, 1943, or blind, multiply $1,300 ($1,050 if married) by the number in the box above. 7b. ________ c. Add lines 7a and 7b. This is your standard deduction for 2007. 7c. ________ ----------------------------------------------------------------- Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services you performed. It also includes any amount received as a scholarship that you must include in your income. -----------------------------------------------------------------
Standard mileage rate. The standard mileage rate allowed for operating expenses for a car when you use it for medical reasons is 20 cents per mile. See Transportation under What Medical Expenses Are Includible.
Retired public safety officers. If you are a retired public safety officer, do not include as medical expenses any health or long-term care insurance premiums that you elected to have paid with tax-free distributions from a retirement plan. This applies only to distributions that would otherwise be included in income. For more information, see Insurance Premiums for Retired Public Safety Officers in Publication 575.
Health coverage tax credit. There is a credit for health insurance premiums paid by certain workers who are displaced by foreign trade or who are receiving a pension from the Pension Benefit Guaranty Corporation. For more information, see Health Coverage Tax Credit in chapter 37.
This chapter will help you determine the following.
Useful Items
You may want to see:
Publications
Form (and Instructions)
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes. They also include dental expenses.
Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. Do not include expenses that are merely beneficial to general health, such as vitamins or a vacation.
Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.
You can include only the medical and dental expenses you paid this year, regardless of when the services were provided. If you pay medical expenses by check, the day you mail or deliver the check generally is the date of payment. If you use a "pay-by-phone" or "online" account to pay your medical expenses, the date reported on the statement of the financial institution showing when payment was made is the date of payment. If you use a credit card, include medical expenses you charge to your credit card in the year the charge is made, not when you actually pay the amount charged.
Separate returns. If you and your spouse live in a noncommunity property state and file separate returns, each of you can include only the medical expenses you actually paid. Any medical expenses paid out of a joint checking account in which you and your spouse have the same interest are considered to have been paid equally by each of you, unless you can show otherwise.
Community property states. If you and your spouse live in a community property state and file separate returns, any medical expenses paid out of community funds are divided equally. Each of you should include half the expenses. If medical expenses are paid out of the separate funds of one spouse, only the spouse who paid the medical expenses can include them. If you live in a community property state, are married, and file a separate return, see Publication 555, Community Property.
You can deduct only the amount of your medical and dental expenses that is more than 7.5% of your adjusted gross income (Form 1040, line 38).
In this chapter, the term "7.5% limit" is used to refer to 7.5% of your adjusted gross income. The phrase "subject to the 7.5% limit" is also used. This phrase means that you must subtract 7.5% (.075) of your adjusted gross income from your medical expenses to figure your medical expense deduction.
Example. Your adjusted gross income is $40,000, 7.5% of which is $3,000. You paid medical expenses of $2,500. You cannot deduct any of your medical expenses because they are not more than 7.5% of your adjusted gross income.
You can generally include medical expenses you pay for yourself as well as those you pay for someone who was your spouse or your dependent either when the services were provided or when you paid for them. There are different rules for decedents and for individuals who are the subject of multiple support agreements.
What if you are claimed as a dependent on someone else's return? Even if you, or your spouse if you are filing a joint return, are claimed as a dependent on someone else's tax return, you can include the medical expenses of any person you could have claimed as a dependent if you, or your spouse if filing jointly, were not being claimed as a dependent on someone else's return.
You can include medical expenses you paid for your spouse. To include these expenses, you must have been married either at the time your spouse received the medical services or at the time you paid the medical expenses.
Example 1. Mary received medical treatment before she married Bill. Bill paid for the treatment after they married. Bill can include these expenses in figuring his medical expense deduction even if Bill and Mary file separate returns.
If Mary had paid the expenses, Bill could not include Mary's expenses in his separate return. Mary would include the amounts she paid during the year in her separate return. If they filed a joint return, the medical expenses both paid during the year would be used to figure their medical expense deduction.
Example 2. This year, John paid medical expenses for his wife Louise, who died last year. John married Belle this year and they file a joint return. Because John was married to Louise when she received the medical services, he can include those expenses in figuring his medical deduction for this year.
You can include medical expenses you paid for your dependent. For you to include these expenses, the person must have been your dependent either at the time the medical services were provided or at the time you paid the expenses. A person generally qualifies as your dependent for purposes of the medical expense deduction if both of the following requirements are met.
Exception for adopted child. If you are a U.S. citizen or U.S. national and your adopted child lived with you as a member of your household for 2007, that child does not have to be a U.S. citizen or national or a resident of the United States, Canada, or Mexico.
Qualifying Child
A qualifying child is a child who:
Adopted child. A legally adopted child is treated as your own child. This includes a child lawfully placed with you for legal adoption.
You can include medical expenses that you paid for a child before adoption if the child qualified as your dependent when the medical services were provided or when the expenses were paid.
If you pay back an adoption agency or other persons for medical expenses they paid under an agreement with you, you are treated as having paid those expenses provided you clearly substantiate that the payment is directly attributable to the medical care of the child.
But if you pay the agency or other person for medical care that was provided and paid for before adoption negotiations began, you cannot include them as medical expenses.
Tip: You may be able to take an adoption credit for other expenses related to an adoption. See the Instructions for Form 8839, Qualified Adoption Expenses, for more information.
Child of divorced or separated parents. For purposes of the medical and dental expenses deduction, a child of divorced or separated parents can be treated as a dependent of both parents. Each parent can include the medical expenses he or she pays for the child, even if the other parent claims the child's dependency exemption, if:
This does not apply if the child's exemption is being claimed under a multiple support agreement.
Qualifying Relative
A qualifying relative is a person:
Support claimed under a multiple support agreement. If you are considered to have provided more than half of a qualifying relative's support under a multiple support agreement, you can include medical expenses you pay for that person. A multiple support agreement is used when two or more people provide more than half of a person's support, but no one alone provides more than half.
For rules regarding what expenses you can include this year, see What Expenses Can You Include This Year, earlier.
Any medical expenses paid by others who joined you in the agreement cannot be included as medical expenses by anyone. However, you can include the entire unreimbursed amount you paid for medical expenses.
Example. You and your three brothers each provide one-fourth of your mother's total support. Under a multiple support agreement, you treat your mother as your dependent. You paid all of her medical expenses. Your brothers reimbursed you for three-fourths of these expenses. In figuring your medical expense deduction, you can include only one-fourth of your mother's medical expenses. Your brothers cannot include any part of the expenses. However, if you and your brothers share the nonmedical support items and you separately pay all of your mother's medical expenses, you can include the unreimbursed amount you paid for her medical expenses in your medical expenses.
Medical expenses paid before death by the decedent are included in figuring any deduction for medical and dental expenses on the decedent's final income tax return. This includes expenses for the decedent's spouse and dependents as well as for the decedent.
The survivor or personal representative of a decedent can choose to treat certain expenses paid by the decedent's estate for the decedent's medical care as paid by the decedent at the time the medical services were provided. The expenses must be paid within the 1-year period beginning with the day after the date of death. If you are the survivor or personal representative making this choice, you must attach a statement to the decedent's Form 1040 (or the decedent's amended return, Form 1040X) saying that the expenses have not been and will not be claimed on the estate tax return.
Caution: Qualified medical expenses paid before death by the decedent are not deductible if paid with a tax-free distribution from any Archer MSA or health savings account.
Amended returns and claims for refund are discussed in chapter 1.
What if you pay medical expenses of a deceased spouse or dependent? If you paid medical expenses for your deceased spouse or dependent, include them as medical expenses on your Form 1040 in the year paid, whether they are paid before or after the decedent's death. The expenses can be included if the person was your spouse or dependent either at the time the medical services were provided or at the time you paid the expenses.
Use Table 21-1, later, as a guide to determine which medical and dental expenses you can include on Schedule A (Form 1040). See Publication 502 for information about other expenses you can include.
Table 21-1. Medical and Dental Expenses Checklist
---------------------------------------------------------------------- You can include: You cannot include: ---------------------------------------------------------------------- • Bandages • Baby sitting and childcare • Birth control pills prescribed • Bottled water by your doctor • Contributions to Archer MSAs • Capital expenses for (see Publication 969) equipment or improvements • Diaper service to your home needed for • Expenses for your general medical care (see health (even if following your Publication 502) doctor's advice) such as-- • Certain fertility --Health club dues enhancement procedures --Household help (even if (see Publication 502) recommended by a doctor) • Certain weight-loss --Social activities, such as expenses for obesity dancing or swimming lessons • Diagnostic devices --Trip for general health • Expenses of an organ improvement donor • Flexible spending account • Eye surgery--to promote reimbursements for medical the correct function of the expenses (if contributions eye were on a pre-tax basis) (see • Guide dogs or other Publication 502) animals aiding the blind, • Funeral, burial, or cremation deaf, and disabled expenses • Hospital services fees (lab • Health savings account work, therapy, nursing payments for medical services, surgery, etc.) expenses (see Publication 502) • Lead-based paint removal • Illegal operation or treatment (see Publication 502) • Life insurance or income • Legal abortion protection policies, or policies • Legal operation to prevent providing payment for loss of having children such as a life, limb, sight, etc. vasectomy or tubal ligation • Maternity clothes • Long-term care contracts, • Medical insurance included qualified (see Publication 502) in a car insurance policy • Meals and lodging provided covering all persons by a hospital during medical injured in or by your car treatment • Medicine you buy without a • Medical and hospital prescription insurance premiums • Nursing care for a healthy • Medical services fees (from baby doctors, dentists, surgeons, • Prescription drugs you specialists, and other brought in (or ordered medical practitioners) shipped) from another • Medicare Part D premiums country, in most cases • Oxygen equipment and (see Publication 502) oxygen • Nutritional supplements, • Part of life-care fee paid to vitamins, herbal retirement home designated supplements, "natural for medical care medicines," etc., unless • Prescription medicines recommended by a (prescribed by a doctor) and medical practitioner as a insulin treatment for a specific • Psychiatric and medical condition psychological treatment diagnosed by a physician • Social Security tax, • Surgery for purely Medicare tax, FUTA, and cosmetic reasons (see state employment tax for Publication 502) worker providing medical • Toothpaste, toiletries, care (see Wages for cosmetics, etc. nursing services, below) • Teeth whitening • Special items (artificial • Weight-loss expenses not limbs, false teeth, for the treatment of obesity eye-glasses, contact or other disease lenses, hearing aids, crutches, wheelchair, etc.) • Special education for mentally or physically disabled persons (see Publication 502) • Stop-smoking programs • Transportation for needed medical care • Treatment at a drug or alcohol center (includes meals and lodging provided by the center) • Wages for nursing services (see Publication 502) ----------------------------------------------------------------------
You can include in medical expenses insurance premiums you pay for policies that cover medical care. Policies can provide payment for:
If you have a policy that provides more than one kind of payment, you can include the premiums for the medical care part of the policy if the charge for the medical part is reasonable. The cost of the medical part must be separately stated in the insurance contract or given to you in a separate statement.
Note. When figuring the amount of insurance premiums you can deduct on Schedule A, do not include any health coverage tax credit advance payments shown in box 1 of Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments.
Employer-sponsored health insurance plan. Do not include in your medical and dental expenses any insurance premiums paid by an employer-sponsored health insurance plan unless the premiums are included in box 1 of your Form W-2. Also, do not include any other medical and dental expenses paid by the plan unless the amount paid is included in box 1 of your Form W-2.
Example. You are a federal employee participating in the premium conversion plan of the Federal Employee Health Benefits (FEHB) program. Your share of the FEHB premium is paid by making a pre-tax reduction in your salary. Because you are an employee whose insurance premiums are paid with money that is never included in your gross income, you cannot deduct the premiums paid with that money.
Long-term care services. Contributions made by your employer to provide coverage for qualified long-term care services under a flexible spending or similar arrangement must be included in your income. This amount will be reported as wages in box 1 of your Form W-2.
Health reimbursement arrangement (HRA). If you have medical expenses that are reimbursed by a health reimbursement arrangement, you cannot include those expenses in your medical expenses. This is because an HRA is funded solely by the employer.
Retired public safety officers. You cannot deduct any premiums you paid to the extent they were paid for with a tax-free distribution from your retirement plan.
Medicare A. If you are covered under social security (or if you are a government employee who paid Medicare tax), you are enrolled in Medicare A. The payroll tax paid for Medicare A is not a medical expense. If you are not covered under social security (or were not a government employee who paid Medicare tax), you can voluntarily enroll in Medicare A. In this situation you can include the premiums you paid for Medicare A as a medical expense.
Medicare B. Medicare B is supplemental medical insurance. Premiums you pay for Medicare B are a medical expense. If you applied for it at age 65 or after you became disabled, you can include in medical expenses the monthly premiums you paid. Check the information you received from the Social Security Administration to find out your premium.
Medicare D. Medicare D is a voluntary prescription drug insurance program for persons with Medicare A or B. You can include as a medical expense premiums you pay for Medicare D.
Prepaid insurance premiums. Premiums you pay before you are age 65 for insurance for medical care for yourself, your spouse, or your dependents after you reach age 65 are medical care expenses in the year paid if they are:
Unused sick leave used to pay premiums. You must include in gross income cash payments you receive at the time of retirement for unused sick leave. You also must include in gross income the value of unused sick leave that, at your option, your employer applies to the cost of your continuing participation in your employer's health plan after you retire. You can include this cost of continuing participation in the health plan as a medical expense.
If you participate in a health plan where your employer automatically applies the value of unused sick leave to the cost of your continuing participation in the health plan (and you do not have the option to receive cash), do not include the value of the unused sick leave in gross income. You cannot include this cost of continuing participation in that health plan as a medical expense.
You can include in medical expenses the cost of meals and lodging at a hospital or similar institution if a principal reason for being there is to get medical care. See Nursing home, later.
You may be able to include in medical expenses the cost of lodging not provided in a hospital or similar institution. You can include the cost of such lodging while away from home if all of the following requirements are met.
The amount you include in medical expenses for lodging cannot be more than $50 for each night for each person. You can include lodging for a person traveling with the person receiving the medical care. For example, if a parent is traveling with a sick child, up to $100 per night can be included as a medical expense for lodging. Meals are not included.
Nursing home. You can include in medical expenses the cost of medical care in a nursing home, home for the aged, or similar institution, for yourself, your spouse, or your dependents. This includes the cost of meals and lodging in the home if a principal reason for being there is to get medical care.
Do not include the cost of meals and lodging if the reason for being in the home is personal. You can, however, include in medical expenses the part of the cost that is for medical or nursing care.
You can include in medical expenses amounts paid for transportation primarily for, and essential to, medical care.
You can include:
Car expenses. You can include out-of-pocket expenses, such as the cost of gas and oil, when you use your car for medical reasons. You cannot include depreciation, insurance, general repair, or maintenance expenses.
If you do not want to use your actual expenses for 2007, you can use a standard rate of 20 cents a mile for use of a car for medical reasons.
You can also include parking fees and tolls. You can add these fees and tolls to your medical expenses whether you use actual expenses or use the standard mileage rate.
Example. Bill Jones drove 2,800 miles for medical reasons during the year. He spent $250 for gas, $5 for oil, and $50 for tolls and parking. He wants to figure the amount he can include in medical expenses both ways to see which gives him the greater deduction.
He figures the actual expenses first. He adds the $250 for gas, the $5 for oil, and the $50 for tolls and parking for a total of $305.
He then figures the standard mileage amount. He multiplies the 2,800 miles by 20 cents a mile for a total of $560. He then adds the $50 in tolls and parking for a total of $610.
Bill includes the $610 of car expenses with his other medical expenses for the year because the $610 is more than the $305 he figured using actual expenses.
Transportation expenses you cannot include. You cannot include in medical expenses the cost of transportation expenses in the following situations.
Disabled Dependent Care Expenses
Some disabled dependent care expenses may qualify as either:
You can choose to apply them either way as long as you do not use the same expenses to claim both a credit and a medical expense deduction.
You can include in medical expenses only those amounts paid during the taxable year for which you received no insurance or other reimbursement.
Insurance Reimbursement
You must reduce your total medical expenses for the year by all reimbursements for medical expenses that you receive from insurance or other sources during the year. This includes payments from Medicare.
Even if a policy provides reimbursement for only certain specific medical expenses, you must use amounts you receive from that policy to reduce your total medical expenses, including those it does not provide reimbursement for.
Example. You have insurance policies which cover your hospital and doctors' bills but not your nursing bills. The insurance you receive for the hospital and doctors' bills is more than their charges. In figuring your medical deduction, you must reduce the total amount you spent for medical care by the total amount of insurance you received even if the policies do not cover some of your medical expenses.
Health reimbursement arrangement (HRA). A health reimbursement arrangement is an employer-funded plan that reimburses employees for medical care expenses and allows unused amounts to be carried forward. An HRA is funded solely by the employer and the reimbursements for medical expenses, up to a maximum dollar amount for a coverage period, are not included in your income.
Other reimbursements. Generally, you do not reduce medical expenses by payments you receive for:
You must, however, reduce your medical expenses by any part of these payments that is designated for medical costs. See How Do You Figure and Report the Deduction on Your Tax Return, later.
For how to treat damages received for personal injury or sickness, see Damages for Personal Injuries, later.
You do not have a medical deduction if you are reimbursed for all of your medical expenses for the year.
Excess reimbursement. If you are reimbursed more than your medical expenses, you may have to include the excess in income. You may want to use Figure 21-A to help you decide if any of your reimbursement is taxable.
[The following graphic has not been reproduced:
Figure 21-A. Is Your Excess Medical Reimbursement Taxable?]
Premiums paid by you. If you pay the entire premium for your medical insurance or all of the costs of a plan similar to medical insurance and your insurance payments or other reimbursements are more than your total medical expenses for the year, you have an excess reimbursement. You generally do not include the excess reimbursement in your gross income.
Premiums paid by you and your employer. If both you and your employer contribute to your medical insurance plan and your employer's contributions are not included in your gross income, you must include in your gross income the part of your excess reimbursement that is from your employer's contribution.
See Publication 502 to figure the amount of the excess reimbursement you must include in gross income.
Reimbursement in a later year. If you are reimbursed in a later year for medical expenses you deducted in an earlier year, you generally must report the reimbursement as income up to the amount you previously deducted as medical expenses.
However, do not report as income the amount of reimbursement you received up to the amount of your medical deductions that did not reduce your tax for the earlier year. For more information about the recovery of an amount that you claimed as an itemized deduction in an earlier year, see Itemized Deduction Recoveries in chapter 12.
Medical expenses not deducted. If you did not deduct a medical expense in the year you paid it because your medical expenses were not more than 7.5% of your adjusted gross income, or because you did not itemize deductions, do not include the reimbursement up to the amount of the expense in income. However, if the reimbursement is more than the expense, see Excess reimbursement, earlier.
Example. Last year, you had medical expenses of $500. You cannot deduct the $500 because it is less than 7.5% of your adjusted gross income. If, in a later year, you are reimbursed for any of the $500 in medical expenses, you do not include the amount reimbursed in your gross income.
If you receive an amount in settlement of a personal injury suit, part of that award may be for medical expenses that you deducted in an earlier year. If it is, you must include that part in your income in the year you receive it to the extent it reduced your taxable income in the earlier year. See Reimbursement in a Later Year, discussed under How Do You Treat Reimbursements.
Future medical expenses. If you receive an amount in settlement of a damage suit for personal injuries, part of that award may be for future medical expenses. If it is, you must reduce any future medical expenses for these injuries until the amount you received has been completely used.
Once you have determined which medical care expenses you can include, you figure and report the deduction on your tax return.
What Tax Form Do You Use?
You figure your medical expense deduction on lines 1 -- 4 of Schedule A, Form 1040. You cannot claim medical expenses on Form 1040A, or Form 1040EZ. If you need more information on itemized deductions or you are not sure if you can itemize, see chapters 20 and 29.
Enter the amount you paid for medical and dental expenses on line 1, Schedule A (Form 1040). This should be your expenses that were not reimbursed by insurance or any other sources.
You can deduct only the amount of your medical and dental expenses that is more than 7.5% of your adjusted gross income shown on line 38, Form 1040. For an example, see the partial Schedule A, above.
If you are disabled, you can take a business deduction for expenses that are necessary for you to be able to work. If you take a business deduction for these impairment-related work expenses, they are not subject to the 7.5% limit that applies to medical expenses.
You are disabled if you have:
Impairment-related expenses defined. Impairment-related expenses are those ordinary and necessary business expenses that are:
[The following graphic has not been reproduced:
2007 Jones' Example Schedule A&B (Form 1040), Schedule A--Itemized
Deductions]
Where to report. If you are self-employed, deduct the business expenses on the appropriate form (Schedule C, C-EZ, E, or F) used to report your business income and expenses.
If you are an employee, complete Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. Enter on Schedule A (Form 1040), line 28, that part of the amount on Form 2106, line 10, or Form 2106-EZ, line 6, that is related to your impairment. Enter the amount that is unrelated to your impairment on Schedule A (Form 1040), line 21. Your impairment-related work expenses are not subject to the 2%-of-adjusted-gross-income limit that applies to other employee business expenses.
Example. You are blind. You must use a reader to do your work. You use the reader both during your regular working hours at your place of work and outside your regular working hours away from your place of work. The reader's services are only for your work. You can deduct your expenses for the reader as business expenses.
If you were self-employed and had a net profit for the year, were a general partner (or a limited partner receiving guaranteed payments), or received wages from an S corporation in which you were a more than 2% shareholder (who is treated as a partner), you may be able to deduct, as an adjustment to income, all of the amount paid for medical and qualified long-term care insurance on behalf of yourself, your spouse, and dependents.
The insurance plan must be established under your trade or business, and you cannot take this deduction to the extent that the amount of the deduction is more than your earned income from that trade or business.
You cannot take this deduction for any month in which you were eligible to participate in any subsidized health plan maintained by your employer or your spouse's employer. This rule is applied separately to plans that provide long-term care insurance and plans that do not provide long-term care insurance.
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet in the Form 1040 instructions to figure the amount you can deduct. But if any of the following applies, do not use the worksheet.
If you cannot use the worksheet in the Form 1040 instructions, use the worksheet in Publication 535, Business Expenses, to figure your deduction.
Note. When figuring the amount you can deduct for insurance premiums, do not include any advance payments shown in box 1 of Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments. Also, if you are claiming the health coverage tax credit, subtract the amount shown on Form 8885, line 4, from the total insurance premiums you paid.
Also, do not include amounts paid for health insurance coverage with retirement plan distributions that were tax-free because you are a retired public safety officer.
Where to report. You take this deduction on Form 1040, line 29. If you itemize your deductions and do not claim 100% of your self-employed health insurance on line 29, include any remaining premiums with all other medical care expenses on Schedule A (Form 1040), subject to the 7.5% limit. See chapter 6 of Publication 535, Business Expenses, for more information.
Limit on itemized deductions. The amount of adjusted gross income allowed without limiting your itemized deductions has increased. For 2007, if your adjusted gross income is more than $156,400 ($78,200 if you are married filing separately), you may have to reduce the amount of certain itemized deductions, including most miscellaneous deductions. For more information and a worksheet, see the instructions for Schedule A (Form 1040), line 29.
Deduction for general sales taxes extended. The deduction for state and local general sales taxes that you can elect to take as an itemized deduction on Schedule A (Form 1040) instead of state and local income taxes was extended through 2007.
This chapter discusses which taxes you can deduct if you itemize deductions on Schedule A (Form 1040). It also explains which taxes you can deduct on other schedules or forms and which taxes you cannot deduct.
This chapter covers the following topics.
Use Table 22-1 as a guide to determine which taxes you can deduct.
The end of the chapter contains a section that explains which forms you use to deduct the different types of taxes.
Business taxes. You can deduct certain taxes only if they are ordinary and necessary expenses of your trade or business or of producing income. For information on these taxes, see Publication 535, Business Expenses.
State or local taxes. These are taxes imposed by the 50 states, U.S. possessions, or any of their political subdivisions (such as a county or city), or by the District of Columbia.
Indian tribal government. An Indian tribal government that is recognized by the Secretary of the Treasury as performing substantial government functions will be treated as a state for purposes of claiming a deduction for taxes. Income taxes, real estate taxes, and personal property taxes imposed by that Indian tribal government (or by any of its subdivisions that are treated as political subdivisions of a state) are deductible.
General sales taxes. These are taxes imposed at one rate on retail sales of a broad range of classes of items.
Foreign taxes. These are taxes imposed by a foreign country or any of its political subdivisions.
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Form (and Instructions)
The following two tests must be met for any tax to be deductible by you.
The tax must be imposed on you. Generally, you can deduct only taxes that are imposed on you.
Generally, you can deduct property taxes only if you are an owner of the property. If your spouse owns the property and pays real estate taxes on it, the taxes are deductible on your spouse's separate return or on your joint return.
You must pay the tax during your tax year. If you are a cash basis taxpayer, you can deduct only those taxes you actually paid during your tax year. If you pay your taxes by check, the day you mail or deliver the check is the date of payment, provided the check is honored by the financial institution. If you use a pay-by-phone account, the date reported on the statement of the financial institution showing when payment was made is the date of payment. If you contest a tax liability and are a cash basis taxpayer, you can deduct the tax only in the year you actually pay it (or transfer money or other property to provide for satisfaction of the contested liability). See Publication 538, Accounting Periods and Methods, for details.
If you use an accrual method of accounting, see Publication 538, for more information.
This section discusses the deductibility of state and local income taxes (including employee contributions to state benefit funds), and foreign income taxes.
You can deduct state and local income taxes. However, you can elect to deduct state and local general sales taxes instead of state and local income taxes. But you cannot deduct both taxes in the same year.
Exception. You cannot deduct state and local income taxes you pay on income that is exempt from federal income tax, unless the exempt income is interest income. For example, you cannot deduct the part of a state's income tax that is on a cost-of-living allowance that is exempt from federal income tax.
What To Deduct
Your deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows.
Withheld taxes. You can deduct state and local income taxes withheld from your salary in the year they are withheld. For 2007, these taxes will be shown in boxes 17 and 19 of your Form W-2. You may also have state or local income tax withheld on Form W-2G (box 14), Form 1099-MISC (box 16), or Form 1099-R (boxes 10 and 13).
Estimated tax payments. You can deduct estimated tax payments you made during the year to a state or local government. However, you must have a reasonable basis for making the estimated tax payments. Any estimated state or local tax payments you make that are not reasonably determined in good faith at the time of payment are not deductible. For example, you made an estimated state income tax payment. However, the estimate of your state tax liability shows that you will get a refund of the full amount of your estimated payment. You had no reasonable basis to believe you had any additional liability for state income taxes and you cannot deduct the estimated tax payment.
Refund applied to taxes. You can deduct any part of a refund of prior-year state or local income taxes that you chose to have credited to your 2007 estimated state or local income taxes.
Do not reduce your deduction by either of the following items.
However, part or all of this refund (or credit) may be taxable. See Refund (or credit) of state or local income taxes, later.
Separate federal returns. If you and your spouse file separate state, local, and federal income tax returns, you each can deduct on your federal return only the amount of your own state and local income tax that you paid during the tax year.
Joint state and local returns. If you and your spouse file joint state and local returns and separate federal returns, each of you can deduct on your separate federal return a part of the total state and local income taxes paid during the tax year. You can deduct only the amount of the total taxes that is proportionate to your gross income compared to the combined gross income of you and your spouse. However, you cannot deduct more than the amount you actually paid during the year. You can avoid this calculation if you and your spouse are jointly and individually liable for the full amount of the state and local income taxes. If so, you and your spouse can deduct on your separate federal returns the amount you each actually paid.
Joint federal return. If you file a joint federal return, you can deduct the total of the state and local income taxes both of you paid.
Contributions to state benefit funds. As an employee, you can deduct mandatory contributions to state benefit funds withheld from your wages that provide protection against loss of wages. For example, certain states require employees to make contributions to state funds providing disability or unemployment insurance benefits. Mandatory payments made to the following state benefit funds are deductible as state income taxes on Schedule A (Form 1040), line 5.
Caution: Employee contributions to private or voluntary disability plans are not deductible.
Refund (or credit) of state or local income taxes. If you receive a refund of (or credit for) state or local income taxes in a year after the year in which you paid them, you may have to include the refund in income on Form 1040, line 10, in the year you receive it. This includes refunds resulting from taxes that were overwithheld, applied from a prior year return, not figured correctly, or figured again because of an amended return. If you did not itemize your deductions in the previous year, do not include the refund in income. If you deducted the taxes in the previous year, include all or part of the refund on Form 1040, line 10, in the year you receive the refund. For a discussion of how much to include, see Recoveries in chapter 12.
Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession. However, you cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. For information on these exclusions, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. For information on the foreign tax credit, see Publication 514.
You can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction on Schedule A (Form 1040), line 5. Generally, you can use either your actual expenses or the state and local sales tax tables to figure your sales tax deduction.
Actual expenses. Generally, you can deduct the actual state and local general sales taxes (including compensating use taxes) if the tax rate was the same as the general sales tax rate. However, sales taxes on food, clothing, medical supplies, and motor vehicles are deductible as a general sales tax even if the tax rate was less than the general sales tax rate. If you paid sales tax on a motor vehicle at a rate higher than the general sales tax rate, you can deduct only the amount of tax that you would have paid at the general sales tax rate on that vehicle. If you use the actual expenses method, you must have receipts to show the general sales taxes paid.
Optional sales tax tables. Instead of using your actual expenses, you can figure your state and local general sales tax deduction using the state and local sales tax tables in the Instructions for Schedule A (Form 1040). You may also be able to add the state and local general sales taxes paid on certain specified items, such as motor vehicles (purchased or leased), aircraft, boats, homes (including mobile and prefabricated homes) and home building materials.
Your applicable table amount is based on the state where you live, your income, and the number of exemptions claimed on your tax return. Your income is your adjusted gross income plus any nontaxable items such as the following.
If you lived in different states during the same tax year, you must prorate your applicable table amount for each state based on the days you lived in each state. See the instructions for Schedule A (Form 1040), line 5, for details.
Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare. You can deduct these taxes only if they are based on the assessed value of the real property and charged uniformly against all property under the jurisdiction of the taxing authority.
Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property. They also do not include itemized charges for services (such as trash collection) assessed against specific property or certain people, even if the charge is paid to the taxing authority. For more information about taxes and charges that are not deductible, see Real Estate-Related Items You Cannot Deduct, later.
Tenant-shareholders in a cooperative housing corporation. Generally, if you are a tenant-stockholder in a cooperative housing corporation, you can deduct the amount paid to the corporation that represents your share of the real estate taxes the corporation paid or incurred for your dwelling unit. The corporation should provide you with a statement showing your share of the taxes. For more information, see Special Rules for Cooperatives in Publication 530.
Division of real estate taxes between buyers and sellers. If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller.
The buyer and the seller must divide the real estate taxes according to the number of days in the real property tax year (the period to which the tax imposed relates) that each owned the property. The seller is treated as paying the taxes up to, but not including, the date of sale. The buyer is treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this information is included on the settlement statement provided at the closing.
If you (the seller) cannot deduct taxes until they are paid because you use the cash method of accounting, and the buyer of your property is personally liable for the tax, you are considered to have paid your part of the tax at the time of the sale. This lets you deduct the part of the tax to the date of sale even though you did not actually pay it. However, you must also include the amount of that tax in the selling price of the property. The buyer must include the same amount in his or her cost of the property.
You figure your deduction for taxes on each property bought or sold during the real property tax year as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction
Keep for Your Records 1. Enter the total real estate taxes for the real property tax year ______ 2. Enter the number of days in the real property tax year that you owned the property ______ 3. Divide line 2 by 365 (for leap years, divide line 2 by 366) . 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6 ====== Note. Repeat steps 1 through 4 for each property you bought or sold during the real property tax year. Your total deduction is the sum of the line 4 amounts for all of the properties.
Real estate taxes for prior years. Do not divide delinquent taxes between the buyer and seller if the taxes are for any real property tax year before the one in which the property is sold. Even if the buyer agrees to pay the delinquent taxes, the buyer cannot deduct them. The buyer must add them to the cost of the property. The seller can deduct these taxes paid by the buyer. However, the seller must include them in the selling price.
Examples. The following examples illustrate how real estate taxes are divided between buyer and seller.
Example 1. Dennis and Beth White's real property tax year for both their old home and their new home is the calendar year, with payment due August 1. The tax on their old home, sold on May 7, was $620. The tax on their new home, bought on May 3, was $732. Dennis and Beth are considered to have paid a proportionate share of the real estate taxes on the old home even though they did not actually pay them to the taxing authority. On the other hand, they can claim only a proportionate share of the taxes they paid on their new property even though they paid the entire amount.
Dennis and Beth owned their old home during the real property tax year for 126 days (January 1 to May 6, the day before the sale). They figure their deduction for taxes on their old home as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on Old Home
1. Enter the total real estate taxes for the real property tax year $620 2. Enter the number of days in the real property tax year that you owned the property 126 3. Divide line 2 by 365 (for leap years, divide line 2 by 366) .345 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6 $214 ======
Since the buyers of their old home paid all of the taxes, Dennis and Beth also include the $214 in the selling price of the old home. (The buyers add the $214 to their cost of the home.)
Dennis and Beth owned their new home during the real property tax year for 243 days (May 3 to December 31, including their date of purchase). They figure their deduction for taxes on their new home as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on New Home
1. Enter the total real estate taxes for the real property tax year $732 2. Enter the number of days in the real property tax year that you owned the property 243 3. Divide line 2 by 365 (for leap years, divide line 2 by 366) .666 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6 $488 ======
Since Dennis and Beth paid all of the taxes on the new home, they add $244 ($732 paid less $488 deduction) to their cost of the new home. (The sellers add this $244 to their selling price and deduct the $244 as a real estate tax.)
Dennis and Beth's real estate tax deduction for their old and new homes is the sum of $214 and $488, or $702. They will enter this amount on Schedule A (Form 1040), line 6.
Example 2. George and Helen Brown bought a new home on May 3, 2007. Their real property tax year for the new home is the calendar year. Real estate taxes for 2006 were assessed in their state on January 1, 2007. The taxes became due on May 31, 2007, and October 31, 2007.
The Browns agreed to pay all taxes due after the date of purchase. Real estate taxes for 2006 were $680. They paid $340 on May 31, 2007, and $340 on October 31, 2007. These taxes were for the 2006 real property tax year. The Browns cannot deduct them since they did not own the property until 2007. Instead, they must add $680 to the cost of their new home.
In January 2008, the Browns receive their 2007 property tax statement for $752, which they will pay in 2008. The Browns owned their new home during the 2007 real property tax year for 243 days (May 3 to December 31). They will figure their 2008 deduction for taxes as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on New Home
1. Enter the total real estate taxes for the real property tax year $752 2. Enter the number of days in the real property tax year that you owned the property 243 3. Divide line 2 by 365 (for leap years, divide line 2 by 366) .666 4. Multiply line 1 by line 3. This is your deduction. Claim it on Schedule A (Form 1040), line 6 $501 ======
The remaining $251 ($752 paid less $501 deduction) of taxes paid in 2008, along with the $680 paid in 2007, is added to the cost of their new home.
Because the taxes up to the date of sale are considered paid by the seller on the date of sale, the seller is entitled to a 2007 tax deduction of $931. This is the sum of the $680 for 2006 and the $251 for the 122 days the seller owned the home in 2007. The seller must also include the $931 in the selling price when he or she figures the gain or loss on the sale. The seller should contact the Browns in January 2008 to find out how much real estate tax is due for 2007.
Form 1099-S. For certain sales or exchanges of real estate, the person responsible for closing the sale (generally the settlement agent) prepares Form 1099-S, Proceeds From Real Estate Transactions, to report certain information to the IRS and to the seller of the property. Box 2 of the form is for the gross proceeds from the sale and should include the portion of the seller's real estate tax liability that the buyer will pay after the date of sale. The buyer includes these taxes in the cost basis of the property, and the seller both deducts this amount as a tax paid and includes it in the sales price of the property.
For a real estate transaction that involves a home, any real estate tax the seller paid in advance but that is the liability of the buyer appears on Form 1099-S, box 5. The buyer deducts this amount as a real estate tax, and the seller reduces his or her real estate tax deduction (or includes it in income) by the same amount. See Refund (or rebate), later.
Taxes placed in escrow. If your monthly mortgage payment includes an amount placed in escrow (put in the care of a third party) for real estate taxes, you may not be able to deduct the total amount placed in escrow. You can deduct only the real estate tax that the third party actually paid to the taxing authority. If the third party does not notify you of the amount of real estate tax that was paid for you, contact the third party or the taxing authority to find the proper amount to show on your return.
Tenants by the entirety. If you and your spouse held property as tenants by the entirety and you file separate federal returns, each of you can deduct only the taxes each of you paid on the property.
Divorced individuals. If your divorce or separation agreement states that you must pay the real estate taxes for a home owned by you and your spouse, part of your payments may be deductible as alimony and part as real estate taxes. See Taxes and insurance in chapter 18 for more information.
Ministers' and military housing allowances. If you are a minister or a member of the uniformed services and receive a housing allowance that you can exclude from income, you still can deduct all of the real estate taxes you pay on your home.
Refund (or rebate). If you received a refund or rebate in 2007 of real estate taxes you paid in 2007, you must reduce your deduction by the amount refunded to you. If you received a refund or rebate in 2007 of real estate taxes you deducted in an earlier year, you generally must include the refund or rebate in income in the year you receive it. However, the amount you include in income is limited to the amount of the deduction that reduced your tax in the earlier year. For more information, see Recoveries in chapter 12.
Tip: If you did not itemize deductions in the year you paid the tax, do not report the refund as income.
Real Estate-Related Items You Cannot Deduct
Payments for the following items generally are not deductible as real estate taxes.
Taxes for local benefits. Deductible real estate taxes generally do not include taxes charged for local benefits and improvements tending to increase the value of your property. These include assessments for streets, sidewalks, water mains, sewer lines, public parking facilities, and similar improvements. You should increase the basis of your property by the amount of the assessment.
Local benefit taxes are deductible only if they are for maintenance, repair, or interest charges related to those benefits. If only a part of the taxes is for maintenance, repair, or interest, you must be able to show the amount of that part to claim the deduction. If you cannot determine what part of the tax is for maintenance, repair, or interest, none of it is deductible.
Taxes for local benefits may be included in your real estate tax bill. If your taxing authority (or mortgage lender) does not furnish you a copy of your real estate tax bill, ask for it. You should use the rules above to determine if the local benefit tax is deductible.
Itemized charges for services. An itemized charge for services assessed against specific property or certain people is not a tax, even if the charge is paid to the taxing authority. For example, you cannot deduct the charge as a real estate tax if it is:
Caution: You must look at your real estate tax bill to determine if any nondeductible itemized charges, such as those listed above, are included in the bill. If your taxing authority (or mortgage lender) does not furnish you a copy of your real estate tax bill, ask for it.
Exception. Service charges used to maintain or improve services (such as trash collection or police and fire protection) are deductible as real estate taxes if:
Transfer taxes (or stamp taxes). Transfer taxes and similar taxes and charges on the sale of a personal home are not deductible. If they are paid by the seller, they are expenses of the sale and reduce the amount realized on the sale. If paid by the buyer, they are included in the cost basis of the property.
Rent increase due to higher real estate taxes. If your landlord increases your rent in the form of a tax surcharge because of increased real estate taxes, you cannot deduct the increase as taxes.
Homeowners' association charges. These charges are not deductible because they are imposed by the homeowners' association, rather than the state or local government.
Personal property tax is deductible if it is a state or local tax that is:
A tax that meets the above requirements can be considered charged on personal property even if it is for the exercise of a privilege. For example, a yearly tax based on value qualifies as a personal property tax even if it is called a registration fee and is for the privilege of registering motor vehicles or using them on the highways.
If the tax is partly based on value and partly based on other criteria, it may qualify in part.
Example. Your state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight. You paid $32 based on the value ($1,500) and weight (3,400 lbs.) of your car. You can deduct $15 (1% × $1,500) as a personal property tax because it is based on the value. The remaining $17 ($.50 × 34), based on the weight, is not deductible.
Many federal, state, and local government taxes are not deductible because they do not fall within the categories discussed earlier. Other taxes and fees, such as federal income taxes, are not deductible because the tax law specifically prohibits a deduction for them. See Table 22-1.
Table 22-1. Which Taxes Can You Deduct?
---------------------------------------------------------------------- Type of Tax You Can Deduct You Cannot Deduct ---------------------------------------------------------------------- Fees and Fees and charges that are Fees and charges that are Charges expenses of your trade or not expenses of your business or of producing trade or business or of income. producing income, such as fees for driver's licenses, car inspections, parking, or charges for water bills (see Taxes and Fees You Cannot Deduct). Fines and penalties. ---------------------------------------------------------------------- General State and local general State and local income Sales Taxes sales taxes, including taxes if you choose to compensating use taxes. deduct state and local general sales taxes. ---------------------------------------------------------------------- Income Taxes State and local income Federal income taxes. taxes. Employee contributions to Foreign income taxes. private or voluntary Employee contributions to disability plans. state funds listed under State and local general Contributions to state sales taxes if you choose benefit funds. to deduct state and local income taxes. ---------------------------------------------------------------------- Other Taxes Taxes that are expenses of Federal excise taxes, your trade or business. such as tax on gasoline, Taxes on property producing that are not expenses of rent or royalty income. your trade or business or Occupational taxes. See of producing income. chapter 28. Per capita taxes. One-half of self-employment tax paid. ---------------------------------------------------------------------- Personal State and local personal Customs duties that are Property property taxes. not expenses of your Taxes trade or business or of producing income. ---------------------------------------------------------------------- Real Estate State and local real estate Real estate taxes that Taxes taxes. are treated as imposed on Foreign real estate taxes. someone else (see Tenant's share of real Division of real estate estate taxes paid by taxes between buyers and cooperative housing sellers). corporation. Taxes for local benefits (with exceptions). See Real Estate-Related Items You Cannot Deduct. Trash and garbage pickup fees (with exceptions). See Real Estate-Related Items You Cannot Deduct. Rent increase due to higher real estate taxes. Homeowners' association charges. ----------------------------------------------------------------------
Taxes and fees that are generally not deductible include the following items.
Many taxes and fees other than those listed above are also nondeductible, unless they are ordinary and necessary expenses of a business or income producing activity. For other nondeductible items, see Real Estate-Related Items You Cannot Deduct, earlier.
You deduct taxes on the following schedules.
State and local income taxes. These taxes are deducted on Schedule A (Form 1040), line 5, even if your only source of income is from business, rents, or royalties. Check box a on line 5 to indicate income taxes.
General sales taxes. Sales taxes are deducted on Schedule A (Form 1040), line 5. You must check box b on line 5. If you elect to deduct sales taxes, you cannot deduct state and local income taxes.
Foreign income taxes. Generally, income taxes you pay to a foreign country or U.S. possession can be claimed as an itemized deduction on Schedule A (Form 1040), line 8, or as a credit against your U.S. income tax on Form 1040, line 51. To claim the credit, you may have to complete and attach Form 1116. For more information, see chapter 37, the Form 1040 instructions, or Publication 514.
Real estate taxes and personal property taxes. These taxes are deducted on Schedule A (Form 1040), lines 6 and 7, respectively, unless they are paid on property used in your business, in which case they are deducted on Schedule C, Schedule C-EZ, or Schedule F (Form 1040). Taxes on property that produces rent or royalty income are deducted on Schedule E (Form 1040).
Self-employment tax. Deduct one-half of your self-employment tax on Form 1040, line 27.
Other taxes. All other deductible taxes are deducted on Schedule A (Form 1040), line 8.
Mortgage insurance premiums. You may be able to treat mortgage insurance premiums paid in connection with home acquisition debt as home mortgage interest. See Mortgage Insurance Premiums under Home Mortgage Interest.
Limit on itemized deductions. If your adjusted gross income is more than $156,400 ($78,200 if you are married filing separately), the overall amount of your itemized deductions may be limited. See chapter 29 for more information about this limit.
This chapter discusses interest. Interest is the amount you pay for the use of borrowed money.
The following are types of interest you can deduct as itemized deductions on Schedule A (Form 1040).
This chapter explains these deductions. It also explains where to deduct other types of interest and lists some types of interest you cannot deduct.
Use Table 23-1 to find out where to get more information on various types of interest, including investment interest.
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Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.
You can deduct home mortgage interest only if you meet all the following conditions.
In most cases, you will be able to deduct all of your home mortgage interest. Whether it is all deductible depends on the date you took out the mortgage, the amount of the mortgage, and your use of its proceeds.
Fully deductible interest. If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.)
The three categories are as follows:
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
See Part II of Publication 936 for more detailed definitions of grandfathered, home acquisition, and home equity debt.
You can use Figure 23-A to check whether your home mortgage interest is fully deductible.
[The following graphic has not been reproduced:
Figure 23-A. Is My Home Mortgage Interest Fully Deductible?]
Limits on deduction. You cannot fully deduct interest on a mortgage that does not fit into any of the three categories listed above. If this applies to you, see Part II of Publication 936 to figure the amount of interest you can deduct.
Special Situations
This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special situations that may affect your deduction.
Late payment charge on mortgage payment. You can deduct as home mortgage interest a late payment charge if it was not for a specific service performed in connection with your mortgage loan.
Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.
Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of sale.
Example. John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).
Prepaid interest. If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception that applies to points, discussed later.
Mortgage interest credit. You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. Figure the credit on Form 8396, Mortgage Interest Credit. If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit.
For more information on the credit, see chapter 37.
Ministers' and military housing allowance. If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home mortgage interest.
Mortgage assistance payments. If you qualify for mortgage assistance payments for lower-income families under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. You cannot deduct the interest that is paid for you.
No other effect on taxes. Do not include these mortgage assistance payments in your income. Also, do not use these payments to reduce other deductions, such as real estate taxes.
Divorced or separated individuals. If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony. See the discussion of Payments for jointly-owned home in chapter 18.
Redeemable ground rents. If you make annual or periodic rental payments on a redeemable ground rent, you can deduct them as mortgage interest.
Payments made to end the lease and to buy the lessor's entire interest in the land are not ground rents. You cannot deduct them. For more information, see Publication 936.
Nonredeemable ground rents. Payments on a nonredeemable ground rent are not mortgage interest. You can deduct them as rent if they are a business expense or if they are for rental property.
Rental payments. If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest. This is true even if the settlement papers call them interest. You cannot deduct these payments as home mortgage interest.
Mortgage proceeds invested in tax-exempt securities. You cannot deduct the home mortgage interest on grandfathered debt or home equity debt if you used the proceeds of the mortgage to buy securities or certificates that produce tax-free income. "Grandfathered debt" and "home equity debt" are defined earlier under Amount Deductible.
Refunds of interest. If you receive a refund of interest in the same tax year you paid it, you must reduce your interest expense by the amount refunded to you. If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage.
If you received a refund of interest you overpaid in an earlier year, you generally will receive a Form 1098, Mortgage Interest Statement, showing the refund in box 3. For information about Form 1098, see Form 1098, Mortgage Interest Statement, later.
For more information on how to treat refunds of interest deducted in earlier years, see Recoveries in chapter 12.
The term "points" is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See Points paid by the seller, later.
General Rule
You generally cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally deduct them ratably over the life (term) of the mortgage. See Deduction Allowed Ratably, later.
For exceptions to the general rule, see Deduction Allowed in Year Paid, next.
Deduction Allowed in Year Paid
You can fully deduct points in the year paid if you meet all the following tests. (You can use Figure 23-B as a quick guide to see whether your points are fully deductible in the year paid.)
[The following graphic has not been reproduced:
Figure 23-B. Are My Points Fully Deductible This Year?]
Note. If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan.
Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if tests (1) through (6) are met.
Caution: Second home. You cannot fully deduct in the year paid points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.
Refinancing. Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first 6 tests listed under Deduction Allowed in Year Paid, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. You can deduct the rest of the points over the life of the loan.
Example 1. In 1994, Bill Fields got a mortgage to buy a home. In 2007, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2007 and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it was not for the purchase or improvement of that home. He cannot deduct all of the points in 2007. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) × 6 payments] of the points in 2007. The other point ($1,000) was a fee for services and is not deductible.
Example 2. The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in 2007. His deduction is $500 ($2,000 × 25%).
Bill also deducts the ratable part of the remaining $1,500 ($2,000 - $500) that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) × 6 payments] in 2007. The total amount Bill deducts in 2007 is $550 ($500 + $50).
Deduction Allowed Ratably
If you do not meet the tests listed under Deduction Allowed in Year Paid, earlier, the loan is not a home improvement loan, or you choose not to deduct your points in full in the year paid, you can deduct the points ratably (equally) over the life of the loan if you meet all the following tests.
Special Situations
This section describes certain special situations that may affect your deduction of points.
Original issue discount. If you do not qualify to either deduct the points in the year paid or deduct them ratably over the life of the loan, or if you choose not to use either of these methods, the points reduce the issue price of the loan. This reduction results in original issue discount, which is discussed in chapter 4 of Publication 535.
Amounts charged for services. Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:
You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.
Points paid by the seller. The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer.
Treatment by seller. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the amount realized by the seller. See chapter 15 for information on selling your home.
Treatment by buyer. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests under Deduction Allowed in Year Paid, earlier, are met, the buyer can deduct the points in the year paid. If any of those tests are not met, the buyer deducts the points over the life of the loan.
For information about basis, see chapter 13.
Funds provided are less than points. If you meet all the tests in Deduction Allowed in Year Paid, earlier, except that the funds you provided were less than the points charged to you (test (6)), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.
Example 1. When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.
Example 2. The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You spread the remaining $250 over the life of the mortgage. You must reduce the basis of your home by the $1,000 paid by the seller.
Excess points. If you meet all the tests in Deduction Allowed in Year Paid, earlier, except that the points paid were more than generally paid in your area (test (3)), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.
Mortgage ending early. If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.
A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example. Dan paid $3,000 in points in 1997 that he had to spread out over the 15-year life of the mortgage. He had deducted $2,000 of these points through 2006.
Dan prepaid his mortgage in full in 2007. He can deduct the remaining $1,000 of points in 2007.
Limits on deduction. You cannot fully deduct points paid on a mortgage unless the mortgage fits into one of the categories listed earlier under Fully deductible interest. See Publication 936 for details.
Mortgage Insurance Premiums
You can treat amounts you paid during 2007 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt, the insurance contract must have been issued after 2006, and you must have paid the premiums before 2008 for coverage in effect during 2007.
Qualified mortgage insurance. Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006).
Mortgage insurance provided by the Department of Veterans Affairs is commonly known as a funding fee. If provided by the Rural Housing Service, it is commonly known as a guarantee fee. These fees can be deducted fully in 2007 if the mortgage insurance contract was issued in 2007. Contact the mortgage insurance issuer to determine the deductible amount if it is not reported in box 4 of Form 1098.
Special rules for prepaid mortgage insurance. If you paid premiums for qualified mortgage insurance that are allocable to periods after 2007, such premiums are treated as paid in the period to which they are allocated. No deduction is allowed for the unamortized balance if the mortgage is satisfied before its term. The preceding two sentences do not apply to qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Service.
Limit on deduction. If your adjusted gross income on Form 1040, line 38, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated. See Line 13 in the instructions for Schedule A (Form 1040) and complete the Qualified Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can deduct. If your adjusted gross income is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums.
Form 1098, Mortgage Interest Statement
If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement from the mortgage holder. You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. A governmental unit is a person for purposes of furnishing the statement.
The statement for each year should be sent to you by January 31 of the following year. A copy of this form will also be sent to the IRS.
The statement will show the total interest you paid during the year, any mortgage insurance premiums you paid, and if you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.
As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See Points, earlier, to determine whether you can deduct points not shown on Form 1098.
Prepaid interest on Form 1098. If you prepaid interest in 2007 that accrued in full by January 15, 2008, this prepaid interest may be included in box 1 of Form 1098. However, you cannot deduct the prepaid amount for January 2008 in 2007. (See Prepaid interest, earlier.) You will have to figure the interest that accrued for 2008 and subtract it from the amount in box 1. You will include the interest for January 2008 with the other interest you pay for 2008. See How To Report, later.
Refunded interest. If you received a refund of mortgage interest you overpaid in an earlier year, you generally will receive a Form 1098 showing the refund in box 3. See Refunds of interest, earlier.
Mortgage insurance premiums. The amount of mortgage insurance premiums you paid during 2007 may be shown in box 4 of Form 1098. See Mortgage Insurance Premiums, earlier.
This section discusses interest expenses you may be able to deduct as an investor.
If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest subject to the limit discussed later. However, you cannot deduct interest you incurred to produce tax-exempt income. Nor can you deduct interest expenses on straddles.
Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity.
Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).
Partners, shareholders, and beneficiaries. To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest.
Allocation of Interest Expense
If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. The allocation is not affected by the use of property that secures the debt.
Generally, your deduction for investment interest expense is limited to the amount of your net investment income.
You can carry over the amount of investment interest that you could not deduct because of this limit to the next tax year. The interest carried over is treated as investment interest paid or accrued in that next year.
You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued.
Net Investment Income
Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income.
Investment income. This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Investment income does not include Alaska Permanent Fund dividends. It also does not include qualified dividends or net capital gain unless you choose to include them.
Choosing to include qualified dividends. Investment income generally does not include qualified dividends, discussed in chapter 8. However, you can choose to include all or part of your qualified dividends in investment income.
You make this choice by completing Form 4952, line 4g, according to its instructions.
If you choose to include any amount of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount.
Choosing to include net capital gain. Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). However, you can choose to include all or part of your net capital gain in investment income.
You make this choice by completing Form 4952, line 4g, according to its instructions.
If you choose to include any amount of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount.
Tip: Before making either choice, consider the overall effect on your tax liability. Compare your tax if you make one or both of these choices with your tax if you do not.
Investment income of child reported on parent's return. Investment income includes the part of your child's interest and dividend income that you choose to report on your return. If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814, Parents' Election To Report Child's Interest and Dividends.
Child's qualified dividends. If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends, earlier.
Your investment income also includes the amount on Form 8814, line 12, (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends).
Child's Alaska Permanent Fund dividends. If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. Subtract the result from the amount on Form 8814, line 12.
Child's capital gain distributions. If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D, line 13, or Form 1040, line 13) generally does not count as investment income. However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain, earlier.
Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends, earlier).
Investment expenses. Investment expenses include all income-producing expenses (other than interest expense) relating to investment property that are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Use the smaller of:
Losses from passive activities. Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). See Publication 925, Passive Activity and At-Risk Rules, for information about passive activities.
Form 4952
Use Form 4952, Investment Interest Expense Deduction, to figure your deduction for investment interest.
Exception to use of Form 4952. You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests.
If you meet all of these tests, you can deduct all of your investment interest.
More Information
For more information on investment interest, see Interest Expenses in chapter 3 of Publication 550.
Some interest payments are not deductible. Certain expenses similar to interest also are not deductible. Nondeductible expenses include the following items.
Penalties. You cannot deduct fines and penalties paid to a government for violations of law, regardless of their nature.
Personal interest is not deductible. Personal interest is any interest that is not home mortgage interest, investment interest, business interest, or other deductible interest. It includes the following items.
Tip: You may be able to deduct interest you pay on a qualified student loan. For details, see Publication 970, Tax Benefits for Education.
If you use the proceeds of a loan for more than one purpose (for example, personal and business), you must allocate the interest on the loan to each use. However, you do not have to allocate home mortgage interest if it is fully deductible, regardless of how the funds are used.
You allocate interest (other than fully deductible home mortgage interest) on a loan in the same way as the loan itself is allocated. You do this by tracing disbursements of the debt proceeds to specific uses. For details on how to do this, see chapter 4 of Publication 535.
You must file Form 1040 to deduct any home mortgage interest expense on your tax return. Where you deduct your interest expense generally depends on how you use the loan proceeds. See Table 23-1 for a summary of where to deduct your interest expense.
Table 23-1. Where To Deduct Your Interest Expense
---------------------------------------------------------------------- AND for more IF you have... THEN deduct it on... information go to... ---------------------------------------------------------------------- deductible student Form 1040, line 33, or Publication 970. loan interest Form 1040A, line 18 ---------------------------------------------------------------------- deductible home Schedule A (Form 1040), Publication 936. mortgage interest line 10 and points reported on Form 1098 ---------------------------------------------------------------------- deductible home Schedule A (Form 1040), Publication 936. mortgage interest not line 11 reported on Form 1098 ---------------------------------------------------------------------- deductible points not Schedule A (Form 1040), Publication 936. reported on Form 1098 line 12 ---------------------------------------------------------------------- deductible mortgage Schedule A (Form 1040), Publication 936. insurance premiums line 13 ---------------------------------------------------------------------- deductible investment Schedule A (Form 1040), Publication 550. interest (other than line 14 incurred to produce rents or royalties) ---------------------------------------------------------------------- deductible business Schedule C or Publication 535. interest (non-farm) C-EZ (Form 1040) ---------------------------------------------------------------------- deductible farm Schedule F (Form 1040) Publications 225 business interest and 535. ---------------------------------------------------------------------- deductible interest Schedule E (Form 1040) Publications 527 incurred to produce and 535. rents or royalties ---------------------------------------------------------------------- personal interest not deductible. ----------------------------------------------------------------------
Home mortgage interest and points. Deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 10. If you paid more deductible interest to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Attach a statement explaining the difference and print "See attached" next to line 10.
Deduct home mortgage interest that was not reported to you on Form 1098 on Schedule A (Form 1040), line 11. If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and taxpayer identification number (TIN) on the dotted lines next to line 11. The seller must give you this number and you must give the seller your TIN. A Form W-9, Request for Taxpayer Identification Number and Certification, can be used for this purpose. Failure to meet any of these requirements may result in a $50 penalty for each failure. The TIN can be either a social security number, an individual taxpayer identification number (issued by the Internal Revenue Service), or an employer identification number. See Social Security Number in chapter 1 for more information about TINs.
If you can take a deduction for points that were not reported to you on Form 1098, deduct those points on Schedule A (Form 1040), line 12.
Deduct mortgage insurance premiums on Schedule A (Form 1040), line 13.
More than one borrower. If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share of the interest on Schedule A (Form 1040), line 11, and print "See attached" next to the line. Also, deduct your share of any qualified mortgage insurance premiums on Schedule A (Form 1040), line 13.
Similarly, if you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. You should let each of the other borrowers know what his or her share is.
Mortgage proceeds used for business or investment. If your home mortgage interest deduction is limited but all or part of the mortgage proceeds were used for business, investment, or other deductible activities, see Table 23-1. It shows where to deduct the part of your excess interest that is for those activities.
Investment interest. Deduct investment interest, subject to certain limits discussed in Publication 550, on Schedule A (Form 1040), line 14.
Amortization of bond premium. There are various ways to treat the premium you pay to buy taxable bonds. See Bond Premium Amortization in Publication 550.
Income-producing rental or royalty interest. Deduct interest on a loan for income-producing rental or royalty property that is not used in your business in Part I of Schedule E (Form 1040).
Example. You rent out part of your home and borrow money to make repairs. You can deduct only the interest payment for the rented part in Part I of Schedule E (Form 1040). Deduct the rest of the interest payment on Schedule A (Form 1040) if it is deductible home mortgage interest.
New recordkeeping requirements for cash contributions. You cannot deduct a cash contribution, regardless of the amount, unless you keep as a record of the contribution a bank record (such as a canceled check, a bank copy of a canceled check, or a bank statement containing the name of the charity, the date, and the amount) or a written communication from the charity. The written communication must include the name of the charity, date of the contribution, and amount of the contribution. See Records To Keep, later.
Contributions of cars, boats, and airplanes. If you donate a car, boat, or airplane to a qualified organization, your deduction generally is limited to the gross proceeds from its sale by the organization. This rule applies if the claimed value of the donated vehicle is more than $500.
For exceptions and more information, see Cars, boats, and airplanes under Contributions of Property.
Limit on itemized deductions. If your adjusted gross income is more than $156,400 ($78,200 if you are married filing separately), the overall amount of your itemized deductions may be limited. See chapter 29 for more information about this limit.
This chapter explains how to claim a deduction for your charitable contributions. It discusses the following topics.
A charitable contribution is a donation or gift to, or for the use of, a qualified organization. It is voluntary and is made without getting, or expecting to get, anything of equal value.
Form 1040 required. To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A. The amount of your deduction may be limited if certain rules and limits explained in this chapter apply to you.
Useful Items
You may want to see:
Publication
Form (and Instructions)
You can deduct your contributions only if you make them to a qualified organization. To become a qualified organization, most organizations other than churches and governments, as described below, must apply to the IRS.
Tip: You can ask any organization whether it is a qualified organization, and most will be able to tell you. Or you can check IRS Publication 78, which lists most qualified organizations. You may find Publication 78 in your local library's reference section, or on the Internet at www.irs.gov. You can also call the IRS Tax Exempt/Government Entities Customer Service at 1-877-829-5500 to find out if an organization is qualified.
Types of Qualified Organizations
Generally, only the five following types of organizations can be qualified organizations.
Certain organizations that foster national or international amateur sports competition also qualify.
Note. Your contribution to this type of organization is deductible only if it is to be used solely for charitable, religious, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.
Note. Your contribution to this type of organization is not deductible if it can be used for the care of a specific lot or mausoleum crypt.
Note. To be deductible, your contribution to this type of organization must be made solely for public purposes.
Examples. Qualified organizations include:
Certain foreign charitable organizations. Under income tax treaties with Canada, Israel, and Mexico, you may be able to deduct contributions to certain Canadian, Israeli, or Mexican charitable organizations. Generally, you must have income from sources in that country. For additional information on the deduction of contributions to Canadian charities, see Publication 597, Information on the United States -- Canada Income Tax Treaty. If you need more information on how to figure your contribution to Mexican and Israeli charities, see Publication 526.
Generally, you can deduct your contributions of money or property that you make to, or for the use of, a qualified organization. A gift or contribution is "for the use of" a qualified organization when it is held in a legally enforceable trust for the qualified organization or in a similar legal arrangement.
If you give property to a qualified organization, you generally can deduct the fair market value of the property at the time of the contribution. See Contributions of Property, later in this chapter.
Your deduction for charitable contributions is generally limited to 50% of your adjusted gross income, but in some cases 20% and 30% limits may apply. See Limits on Deductions, later.
Table 24-1 lists some examples of contributions you can deduct and some that you cannot deduct.
Table 24-1. Examples of Charitable Contributions--A Quick Check
---------------------------------------------------------------------- Use the following lists for a quick check of contributions you can or cannot deduct. See the rest of this chapter for more information and additional rules and limits that may apply. ---------------------------------------------------------------------- Deductible As Not Deductible Charitable Contributions As Charitable Contributions Money or property you give to: Money or property you give to: • Churches, synagogues, temples, • Civic leagues, social and mosques, and other religious sports clubs, labor unions, organizations and chambers of commerce • Federal, state, and local • Foreign organizations governments, if your contribution (except certain Canadian, is solely for public purposes (for Israeli, and Mexican example, a gift to reduce the charities) public debt) • Groups that are run for • Nonprofit schools and hospitals personal profit • Public parks and recreation • Groups whose purpose is to facilities (but not entry or usage lobby for law changes fees) • Homeowners' associations • Salvation Army, Red Cross, CARE, Goodwill Industries, United Way, • Individuals Boy Scouts, Girl Scouts, Boys and Girls Clubs of America, etc. • Political groups or candidates for public • War veterans groups office • Charitable organizations listed in Publication 78 Costs you pay for a student living Noncharitable payments to with you, sponsored by a qualified federal, state, and local organization governments Out-of-pocket expenses when you serve Cost of raffle, bingo, or a qualified organization as a lottery tickets volunteer Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups Tuition Value of your time or services Value of blood given to a blood bank ----------------------------------------------------------------------
Contributions From Which You Benefit
If you receive a benefit as a result of making a contribution to a qualified organization, you can deduct only the amount of your contribution that is more than the value of the benefit you receive.
If you pay more than fair market value to a qualified organization for merchandise, goods, or services, the amount you pay that is more than the value of the item can be a charitable contribution. For the excess amount to qualify, you must pay it with the intent to make a charitable contribution.
Example 1. You pay $65 for a ticket to a dinner-dance at a church. All of the proceeds of the function go to the church. The ticket to the dinner-dance has a fair market value of $25. When you buy your ticket, you know that its value is less than your payment. To figure the amount of your charitable contribution, you subtract the value of the benefit you receive ($25) from your total payment ($65). You can deduct $40 as a contribution to the church.
Example 2. At a fund-raising auction conducted by a charity, you pay $600 for a week's stay at a beach house. The amount you pay is no more than the fair rental value. You have not made a deductible charitable contribution.
Athletic events. If you make a payment to, or for the benefit of, a college or university and, as a result, you receive the right to buy tickets to an athletic event in the athletic stadium of the college or university, you can deduct 80% of the payment as a charitable contribution.
If any part of your payment is for tickets (rather than the right to buy tickets), that part is not deductible. In that case, subtract the price of the tickets from your payment. 80% of the remaining amount is a charitable contribution.
Example 1. You pay $300 a year for membership in an athletic scholarship program maintained by a university (a qualified organization). The only benefit of membership is that you have the right to buy one season ticket for a seat in a designated area of the stadium at the university's home football games. You can deduct $240 (80% of $300) as a charitable contribution.
Example 2. The facts are the same as in Example 1 except that your $300 payment included the purchase of one season ticket for the stated ticket price of $120. You must subtract the usual price of a ticket ($120) from your $300 payment. The result is $180. Your deductible charitable contribution is $144 (80% of $180).
Charity benefit events. If you pay a qualified organization more than fair market value for the right to attend a charity ball, banquet, show, sporting event, or other benefit event, you can deduct only the amount that is more than the value of the privileges or other benefits you receive.
If there is an established charge for the event, that charge is the value of your benefit. If there is no established charge, your contribution is that part of your payment that is more than the reasonable value of the right to attend the event. Whether you use the tickets or other privileges has no effect on the amount you can deduct. However, if you return the ticket to the qualified organization for resale, you can deduct the entire amount you paid for the ticket.
Caution: Even if the ticket or other evidence of payment indicates that the payment is a "contribution," this does not mean you can deduct the entire amount. If the ticket shows the price of admission and the amount of the contribution, you can deduct the contribution amount.
Example. You pay $40 to see a special showing of a movie for the benefit of a qualified organization. Printed on the ticket is "Contribution -- $40." If the regular price for the movie is $8, your contribution is $32 ($40 payment - $8 regular price).
Membership fees or dues. You may be able to deduct membership fees or dues you pay to a qualified organization. However, you can deduct only the amount that is more than the value of the benefits you receive. You cannot deduct dues, fees, or assessments paid to country clubs and other social organizations. They are not qualified organizations.
Certain membership benefits can be disregarded. Both you and the organization can disregard certain membership benefits you get in return for an annual payment of $75 or less to the qualified organization. You can pay more than $75 to the organization if the organization does not require a larger payment for you to get the benefits. The following benefits are covered under this rule.
Token items. You can deduct your entire payment to a qualified organization as a charitable contribution if both of the following are true.
Written statement. A qualified organization must give you a written statement if you make a payment to it that is more than $75 and is partly a contribution and partly for goods or services. The statement must tell you that you can deduct only the amount of your payment that is more than the value of the goods or services you received. It must also give you a good faith estimate of the value of those goods or services.
The organization can give you the statement either when it solicits or when it receives the payment from you.
Exception. An organization will not have to give you this statement if one of the following is true.
Expenses Paid for Student Living With You
You may be able to deduct some expenses of having a student live with you. You can deduct qualifying expenses for a foreign or American student who:
Tip: You can deduct up to $50 a month for each full calendar month the student lives with you. Any month when conditions (1) through (3) above are met for 15 days or more counts as a full month.
For additional information, see Expenses Paid for Student Living With You in Publication 526.
Mutual exchange program. You cannot deduct the costs of a foreign student living in your home under a mutual exchange program through which your child will live with a family in a foreign country.
Out-of-Pocket Expenses in Giving Services
You may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be:
Table 24-2 contains questions and answers that apply to some individuals who volunteer their services.
Table 24-2. Volunteers' Questions and Answers
---------------------------------------------------------------------- If you do volunteer work for a qualified organization, the following questions and answers may apply to you. All of the rules explained in this chapter also apply. See, in particular, Out-of-Pocket Expenses in Giving Services. ---------------------------------------------------------------------- Question Answer ---------------------------------------------------------------------- I do volunteer work 6 hours a week in No, you cannot deduct the the office of a qualified value of your time or organization. The receptionist is paid services. $10 an hour to do the same work I do. Can I deduct $60 a week for my time? The office is 30 miles from my home. Yes, you can deduct the costs Can I deduct any of my car of gas and oil that are expenses for these trips? directly related to getting to and from the place where you are a volunteer. If you don't want to figure your actual costs, you can deduct 14 cents for each mile. ---------------------------------------------------------------------- I volunteer as a Red Cross nurse's Yes, you can deduct the cost aide at a hospital. Can I deduct of buying and cleaning your the cost of uniforms that I must uniforms if the hospital is wear? a qualified organization, the uniforms are not suitable for everyday use, and you must wear them when volunteering. ---------------------------------------------------------------------- I pay a babysitter to watch my No, you cannot deduct children while I do volunteer work payments for child care for a qualified organization. Can I expenses as a charitable deduct these costs? contribution, even if they are necessary so you can do volunteer work for a qualified organization. (If you have child care expenses so you can work for pay, see chapter 32.) ----------------------------------------------------------------------
Conventions. If you are a chosen representative attending a convention of a qualified organization, you can deduct actual unreimbursed expenses for travel and transportation, including a reasonable amount for meals and lodging, while away from home overnight in connection with the convention. However, see Travel, later.
You cannot deduct personal expenses for sightseeing, fishing parties, theater tickets, or nightclubs. You also cannot deduct travel, meals and lodging, and other expenses for your spouse or children.
You cannot deduct your expenses in attending a church convention if you go only as a member of your church rather than as a chosen representative. You can deduct unreimbursed expenses that are directly connected with giving services for your church during the convention.
Uniforms. You can deduct the cost and upkeep of uniforms that are not suitable for everyday use and that you must wear while performing donated services for a charitable organization.
Foster parents. You may be able to deduct as a charitable contribution some of the costs of being a foster parent (foster care provider) if you have no profit motive in providing the foster care and are not, in fact, making a profit. A qualified organization must designate the individuals you take into your home for foster care.
You can deduct expenses that meet both of the following requirements.
Unreimbursed expenses that you cannot deduct as charitable contributions may be considered support provided by you in determining whether you can claim the foster child as a dependent. For details, see chapter 3.
Example. You cared for a foster child because you wanted to adopt her, not to benefit the agency that placed her in your home. Your unreimbursed expenses are not deductible as charitable contributions.
Car expenses. You can deduct unreimbursed out-of-pocket expenses, such as the cost of gas and oil, that are directly related to the use of your car in giving services to a charitable organization. You cannot deduct general repair and maintenance expenses, depreciation, registration fees, or the costs of tires or insurance.
If you do not want to deduct your actual expenses, you can use a standard mileage rate of 14 cents a mile to figure your contribution.
You can deduct parking fees and tolls whether you use your actual expenses or the standard mileage rate.
You must keep reliable written records of your car expenses. For more information, see Car expenses under Records To Keep, later.
Travel. Generally, you can claim a charitable contribution deduction for travel expenses necessarily incurred while you are away from home performing services for a charitable organization only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable organization and the organization pays for your travel expenses.
The deduction for travel expenses will not be denied simply because you enjoy providing services to the charitable organization. Even if you enjoy the trip, you can take a charitable contribution deduction for your travel expenses if you are on duty in a genuine and substantial sense throughout the trip. However, if you have only nominal duties, or if for significant parts of the trip you do not have any duties, you cannot deduct your travel expenses.
Example 1. You are a troop leader for a tax-exempt youth group and you help take the group on a camping trip. You are responsible for overseeing the setup of the camp and for providing adult supervision for other activities during the entire trip. You participate in the activities of the group and really enjoy your time with them. You oversee the breaking of camp and you help transport the group home. You can deduct your travel expenses.
Example 2. You sail from one island to another and spend 8 hours a day counting whales and other forms of marine life. The project is sponsored by a charitable organization. In most circumstances, you cannot deduct your expenses.
Example 3. You work for several hours each morning on an archaeological dig sponsored by a charitable organization. The rest of the day is free for recreation and sightseeing. You cannot take a charitable contribution deduction even though you work very hard during those few hours.
Example 4. You spend the entire day attending a charitable organization's regional meeting as a chosen representative. In the evening you go to the theater. You can claim your travel expenses as charitable contributions, but you cannot claim the cost of your evening at the theater.
Daily allowance (per diem). If you provide services for a charitable organization and receive a daily allowance to cover reasonable travel expenses, including meals and lodging while away from home overnight, you must include in income the amount of the allowance that is more than your deductible travel expenses. You can deduct your necessary travel expenses that are more than the allowance.
Deductible travel expenses. These include:
Because these travel expenses are not business-related, they are not subject to the same limits as business-related expenses. For information on business travel expenses, see Travel Expenses in chapter 26.
There are some contributions you cannot deduct, such as those made to specific individuals and those made to nonqualified organizations. (See Contributions to Individuals and Contributions to Nonqualified Organizations, next.) There are others you can deduct only part of, as discussed later under Contributions From Which You Benefit.
You cannot deduct contributions to specific individuals, including the following.
Example. Your son does missionary work. You pay his expenses. You cannot claim a deduction for your son's unreimbursed expenses related to his contribution of services.
Contributions to Nonqualified Organizations
You cannot deduct contributions to organizations that are not qualified to receive tax-deductible contributions, including the following.
Contributions From Which You Benefit
If you receive or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, you cannot deduct the part of the contribution that represents the value of the benefit you receive. These contributions include the following.
You cannot deduct the value of your time or services, including:
You cannot deduct personal, living, or family expenses, such as:
You also may be able to claim an exemption for the child. See Adopted child in chapter 3.
Fees that you pay to find the fair market value of donated property are not deductible as contributions (but see chapter 28).
If you contribute property to a qualified organization, the amount of your charitable contribution is generally the fair market value of the property at the time of the contribution. However, if the property has increased in value, you may have to make some adjustments to the amount of your deduction. See Giving Property That Has Increased in Value, later.
For information about the records you must keep and the information you must furnish with your return if you donate property, see Records To Keep and How To Report, later.
Clothing and household items. You cannot take a deduction for clothing or household items you donate unless the clothing or household items are in good used condition or better.
Household items. Household items include:
Household items do not include:
Appraisal for items more than $500. You can take a deduction for a contribution of an item of clothing or household item that is not in good used condition or better if you deduct more than $500 for it and include a qualified appraisal of it with your return.
Cars, boats, and airplanes. The following rules apply to any donation of a qualified vehicle.
A qualified vehicle is:
Deduction more than $500. If you donate a qualified vehicle to a qualified organization and you claim a deduction of more than $500, you can deduct the smaller of:
Form 1098-C. You must attach to your return the copy of the Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, (or other statement containing the same information as Form 1098-C) you received from the organization. The Form 1098-C (or other statement) will show the gross proceeds from the sale of the vehicle.
If you do not attach Form 1098-C (or other statement), you cannot deduct your contribution. You must get Form 1098-C (or other statement) within 30 days of the sale of the vehicle. But if exception 1 or 2 (described next) applies, you must get Form 1098-C (or other statement) within 30 days of your donation.
Exceptions. There are two exceptions to the rules just described for deductions of more than $500.
Exception 1 -- vehicle used or improved by organization. If the qualified organization makes a significant intervening use of or material improvement to the vehicle before transferring it, and you claim a deduction of more than $500, you generally can deduct the vehicle's fair market value at the time of the contribution. But if the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value, later. The Form 1098-C (or other statement) will show whether this exception applies.
Exception 2 -- vehicle given or sold to needy individual. If the qualified organization will give the vehicle, or sell it for a price well below fair market value, to a needy individual to further the organization's charitable purpose, and you claim a deduction of more than $500, you generally can deduct the vehicle's fair market value at the time of the contribution. But if the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value, later. The Form 1098-C (or other statement) will show whether this exception applies.
This exception does not apply if the organization sells the vehicle at auction. In that case, you cannot deduct the vehicle's fair market value.
Example. Anita donates a used car to a qualified organization. She bought it 3 years ago for $9,000. A used car guide shows the fair market value for this type of car is $6,000. However, Anita gets a Form 1098-C from the organization showing the car was sold for $2,900. Neither exception 1 nor exception 2 applies. If Anita itemizes her deductions, she can deduct $2,900 for her donation. She must attach Form 1098-C and Form 8283 to her return.
Deduction $500 or less. If the qualified organization sells the vehicle for $500 or less and exceptions 1 and 2 do not apply, you can deduct the smaller of:
If the vehicle's fair market value is at least $250 but not more than $500, you must have a written statement from the qualified organization acknowledging your donation. The statement must contain the information and meet the tests for an acknowledgment described under Deductions of At Least $250 But Not More Than $500 under Records To Keep, later.
Partial interest in property. Generally, you cannot deduct a charitable contribution of less than your entire interest in property.
Right to use property. A contribution of the right to use property is a contribution of less than your entire interest in that property and is not deductible. For exceptions and more information, see Partial Interest in Property Not in Trust in Publication 561.
Future interests in tangible personal property. You can deduct the value of a charitable contribution of a future interest in tangible personal property only after all intervening interests in and rights to the actual possession or enjoyment of the property have either expired or been turned over to someone other than yourself, a related person, or a related organization.
Tangible personal property. This is any property, other than land or buildings, that can be seen or touched. It includes furniture, books, jewelry, paintings, and cars.
Future interest. This is any interest that is to begin at some future time, regardless of whether it is designated as a future interest under state law.
This section discusses general guidelines for determining the fair market value of various types of donated property.
Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Publication 561 contains a more complete discussion.
Used clothing and household items. Generally, the fair market value of used clothing and household goods is far less than its original cost.
For used clothing, you should claim as the value the price that buyers of used items actually pay in used clothing stores, such as consignment or thrift shops. See Household Goods in Publication 561 for information on the valuation of household goods, such as furniture, appliances, and linens.
Example. Dawn Greene donated a coat to a thrift store operated by her church. She paid $300 for the coat 3 years ago. Similar coats in the thrift store sell for $50. The fair market value of the coat is reasonably determined to be $50. Dawn's donation is limited to $50.
Cars, boats, and aircraft. If you contribute a car, boat, or aircraft to a charitable organization, you must determine its fair market value. Certain commercial firms and trade organizations publish used car pricing guides, commonly called "blue books," containing complete dealer sale prices or dealer average prices for recent model years. The guides may be published monthly or seasonally and for different regions of the country. These guides also provide estimates for adjusting for unusual equipment, unusual mileage, and physical condition. The prices are not "official" and these publications are not considered an appraisal of any specific donated property. But they do provide clues for making an appraisal and suggest relative prices for comparison with current sales and offerings in your area.
Example. You donate a used car in poor condition to a local high school for use by students studying car repair. A used car guide shows the dealer retail value for this type of car in poor condition is $1,600. However, the guide shows the price for a private party sale of the car is only $750. The fair market value of the car is considered to be $750.
Large quantities. If you contribute a large number of the same item, fair market value is the price at which comparable numbers of the item are being sold.
Giving Property That Has Decreased in Value
If you contribute property with a fair market value that is less than your basis in it, your deduction is limited to its fair market value. You cannot claim a deduction for the difference between the property's basis and its fair market value.
Giving Property That Has Increased in Value
If you contribute property with a fair market value that is more than your basis in it, you may have to reduce the fair market value by the amount of appreciation (increase in value) when you figure your deduction.
Your basis in property is generally what you paid for it. See chapter 13 if you need more information about basis.
Different rules apply to figuring your deduction, depending on whether the property is:
Ordinary income property. Property is ordinary income property if its sale at fair market value on the date it was contributed would have resulted in ordinary income or in short-term capital gain. Examples of ordinary income property are inventory, works of art created by the donor, manuscripts prepared by the donor, and capital assets held 1 year or less.
Amount of deduction. The amount you can deduct for a contribution of ordinary income property is its fair market value minus the amount that would be ordinary income or short-term capital gain if you sold the property for its fair market value. Generally, this rule limits the deduction to your basis in the property.
Example. You donate stock that you held for 5 months to your church. The fair market value of the stock on the day you donate it is $1,000, but you paid only $800 (your basis). Because the $200 of appreciation would be short-term capital gain if you sold the stock, your deduction is limited to $800 (fair market value minus the appreciation).
Capital gain property. Property is capital gain property if its sale at fair market value on the date of the contribution would have resulted in long-term capital gain. It includes capital assets held more than 1 year, as well as certain real property and depreciable property used in your trade or business and, generally, held more than 1 year.
Amount of deduction -- general rule. When figuring your deduction for a gift of capital gain property, you usually can use the fair market value of the gift.
Exceptions. In certain situations, you must reduce the fair market value by any amount that would have been long-term capital gain if you had sold the property for its fair market value. Generally, this means reducing the fair market value to the property's cost or other basis.
Bargain sales. A bargain sale of property to a qualified organization (a sale or exchange for less than the property's fair market value) is partly a charitable contribution and partly a sale or exchange. A bargain sale may result in a taxable gain.
More information. For more information on donated appreciated property, see Giving Property That Has Increased in Value in Publication 526.
You can deduct your contributions only in the year you actually make them in cash or other property (or in a later carryover year, as explained later under Carryovers). This applies whether you use the cash or an accrual method of accounting.
Time of making contribution. Usually, you make a contribution at the time of its unconditional delivery.
Checks. A check that you mail to a charity is considered delivered on the date you mail it.
Credit card. Contributions charged on your credit card are deductible in the year you make the charge.
Pay-by-phone account. If you use a pay-by-phone account, the date you make a contribution is the date the financial institution pays the amount. This date should be shown on the statement the financial institution sends to you.
Stock certificate. A gift to a charity of a properly endorsed stock certificate is completed on the date of mailing or other delivery to the charity or to the charity's agent. However, if you give a stock certificate to your agent or to the issuing corporation for transfer to the name of the charity, your gift is not completed until the date the stock is transferred on the books of the corporation.
Promissory note. If you issue and deliver a promissory note to a charitable organization as a contribution, it is not a contribution until you make the note payments.
Option. If you grant an option to buy real property at a bargain price to a charitable organization, you cannot take a deduction until the organization exercises the option.
Borrowed funds. If you make a contribution with borrowed funds, you can deduct the contribution in the year you make it, regardless of when you repay the loan.
If your total contributions for the year are 20% or less of your adjusted gross income, you do not need to read this section. The limits discussed here do not apply to you.
The amount of your deduction is limited to 50% of your adjusted gross income and may be limited to 30% or 20% of your adjusted gross income, depending on the type of property you give and the type of organization you give it to. These limits are described below.
If your contributions are more than any of the limits that apply, see Carryovers, later.
50% Limit
This limit applies to the total of all charitable contributions you make during the year. This means that your deduction for charitable contributions cannot be more than 50% of your adjusted gross income for the year.
Generally, the 50% limit is the only limit that applies to gifts to organizations listed below under 50% limit organizations. But there is one exception. A 30% limit also applies to these gifts if they are gifts of capital gain property for which you figure your deduction using fair market value without reduction for appreciation. (See Special 30% Limit for Capital Gain Property, later.)
50% limit organizations. You can ask any organization whether it is a 50% limit organization and most will be able to tell you. Or you can check IRS Publication 78 or call the IRS Tax Exempt/Government Entities Customer Service at the number listed earlier under Organizations that Qualify To Receive Deductible Contributions. The following is a partial list of the types of organizations that are 50% limit organizations.
30% Limit
A 30% limit applies to the following gifts.
However, if these gifts are of capital gain property, they are subject to the 20% limit, described later, rather than the 30% limit.
Student living with you. Amounts you spend on behalf of a student living with you are subject to the 30% limit. These amounts are considered a contribution for the use of a qualified organization. See Expenses Paid for Student Living With You, earlier.
Special 30% Limit for Capital Gain Property
A special 30% limit applies to gifts of capital gain property to 50% limit organizations. (For gifts of capital gain property to other organizations, see 20% Limit, later.) However, the special 30% limit does not apply when you choose to reduce the fair market value of the property by the amount that would have been long-term capital gain if you had sold the property. Instead, only the 50% limit applies.
Qualified conservation contribution. The special 30% limit does not apply to qualified conservation contributions (QCCs). Instead, a 50% limit applies. For qualified farmers and ranchers, QCCs are deductible up to 100% of adjusted gross income. See Publication 526 for details.
Two separate 30% limits. This special 30% limit for capital gain property is separate from the other 30% limit. Therefore, the deduction of a contribution subject to one 30% limit does not reduce the amount you can deduct for contributions subject to the other 30% limit. However, the total you deduct cannot be more than 50% of your adjusted gross income.
Example. Your adjusted gross income is $50,000. During the year, you gave capital gain property with a fair market value of $15,000 to a 50% limit organization. You do not choose to reduce the property's fair market value by its appreciation in value. You also gave $10,000 cash to a qualified organization that is not a 50% limit organization. The $15,000 gift of property is subject to the special 30% limit. The $10,000 cash gift is subject to the other 30% limit. Both gifts are fully deductible because neither is more than the 30% limit that applies ($15,000 in each case) and together they are not more than the 50% limit ($25,000).
For more information, see the rules for electing the 50% limit for capital gain property under How To Figure Your Deduction When Limits Apply in Publication 526.
20% Limit
This limit applies to all gifts of capital gain property to or for the use of qualified organizations (other than gifts of capital gain property to 50% limit organizations).
Carryovers
You can carry over your contributions that you are not able to deduct in the current year because they exceed your adjusted-gross-income limits. You can deduct the excess in each of the next 5 years until it is used up, but not beyond that time. For more information, see Carryovers in Publication 526.
You must keep records to prove the amount of the contributions you make during the year. The kind of records you must keep depends on the amount of your contributions and whether they are:
Note. An organization generally must give you a written statement if it receives a payment from you that is more than $75 and is partly a contribution and partly for goods or services. (See Contributions From Which You Benefit under Contributions You Can Deduct, earlier.) Keep the statement for your records. It may satisfy all or part of the recordkeeping requirements explained in the following discussions.
Cash Contributions
Cash contributions include those paid by cash, check, electronic funds transfer, credit card, or payroll deduction.
You cannot deduct a cash contribution, regardless of the amount, unless you keep one of the following.
Payroll deductions. If you make a contribution by payroll deduction, you must keep:
If your employer withheld $250 or more from a single paycheck, see Contributions of $250 or More, next.
Contributions of $250 or More
You can claim a deduction for a contribution of $250 or more only if you have an acknowledgment of your contribution from the qualified organization or certain payroll deduction records.
If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that lists each contribution and the date of each contribution and shows your total contributions.
Amount of contribution. In figuring whether your contribution is $250 or more, do not combine separate contributions. For example, if you gave your church $25 each week, your weekly payments do not have to be combined. Each payment is a separate contribution.
If contributions are made by payroll deduction, the deduction from each paycheck is treated as a separate contribution.
If you made a payment that is partly for goods and services, as described earlier under Contributions From Which You Benefit, your contribution is the amount of the payment that is more than the value of the goods and services.
Acknowledgment. The acknowledgment must meet these tests.
If the acknowledgment does not show the date of the contribution, you must also have a bank record or receipt, as described earlier, that does show the date of the contribution. If the acknowledgment does show the date of the contribution and meets the other tests just described, you do not need any other records.
Payroll deductions. If you make a contribution by payroll deduction and your employer withheld $250 or more from a single paycheck, you must keep:
A single pledge card may be kept for all contributions made by payroll deduction regardless of amount as long as it contains all the required information.
If the pay stub, Form W-2, pledge card, or other document does not show the date of the contribution, you must also have another document that does show the date of the contribution. If the pay stub, Form W-2, pledge card, or other document does show the date of the contribution, you do not need any other records except those just described in (1) and (2).
Noncash Contributions
For a contribution not made in cash, the records you must keep depend on whether your deduction for the contribution is:
Amount of deduction. In figuring whether your deduction is $500 or more, combine your claimed deductions for all similar items of property donated to any charitable organization during the year.
If you received goods or services in return, as described earlier in Contributions From Which You Benefit, reduce your contribution by the value of those goods or services. If you figure your deduction by reducing the fair market value of the donated property by its appreciation, as described earlier in Giving Property That Has Increased in Value, your contribution is the reduced amount.
Deductions of Less Than $250
If you make any noncash contribution, you must get and keep a receipt from the charitable organization showing:
Tip: A letter or other written communication from the charitable organization acknowledging receipt of the contribution and containing the information in (1), (2), and (3) will serve as a receipt.
You are not required to have a receipt where it is impractical to get one (for example, if you leave property at a charity's unattended drop site).
Additional records. You must also keep reliable written records for each item of donated property. Your written records must include the following information.
Deductions of At Least $250 But Not More Than $500
If you claim a deduction of at least $250 but not more than $500 for a noncash charitable contribution, you must get and keep an acknowledgment of your contribution from the qualified organization. If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that shows your total contribution.
The acknowledgment must contain the information in items (1) through (3) listed under Deductions of Less Than $250, earlier, and your written records must include the information listed in that discussion under Additional records.
The acknowledgment must also meet these tests.
Deductions Over $500
You are required to give additional information if you claim a deduction over $500 for noncash charitable contributions. See Records To Keep in Publication 526 for more information.
Qualified Conservation Contribution
If the gift was a qualified conservation contribution, your records must also include the fair market value of the underlying property before and after the gift and the conservation purpose furthered by the gift. See Qualified conservation contribution in Publication 526 for more information.
Out-of-Pocket Expenses
If you render services to a qualified organization and have unreimbursed out-of-pocket expenses related to those services, the following three rules apply.
Car expenses. If you claim expenses directly related to use of your car in giving services to a qualified organization, you must keep reliable written records of your expenses. Whether your records are considered reliable depends on all the facts and circumstances. Generally, they may be considered reliable if you made them regularly and at or near the time you had the expenses.
Your records must show the name of the organization you were serving and the date each time you used your car for a charitable purpose. If you use the standard mileage rate of 14 cents a mile, your records must show the miles you drove your car for the charitable purpose. If you deduct your actual expenses, your records must show the costs of operating the car that are directly related to a charitable purpose.
See Car expenses under Out-of-Pocket Expenses in Giving Services, earlier, for the expenses you can deduct.
Report your charitable contributions on Schedule A (Form 1040).
If your total deduction for all noncash contributions for the year is over $500, you must also file Form 8283. See How To Report in Publication 526 for more information.
This chapter explains the tax treatment of personal (not business related) casualty losses, theft losses, and losses on deposits.
The chapter also explains the following topics.
Forms to file. When you have a casualty or theft, you have to file Form 4684. You will also have to file one or both of the following forms.
Condemnations. For information on condemnations of property, see Involuntary Conversions in chapter 1 of Publication 544.
Workbook for casualties and thefts. Publication 584 is available to help you make a list of your stolen or damaged personal-use property and figure your loss. It includes schedules to help you figure the loss on your home, its contents, and your motor vehicles.
Other sources of information. For information on a casualty or theft loss of business or income-producing property, see Publication 547.
Useful Items
You may want to see:
Publication
Form (and Instructions)
A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.
Deductible losses. Deductible casualty losses can result from a number of different causes, including the following.
Nondeductible losses. A casualty loss is not deductible if the damage or destruction is caused by the following.
Family pet. Loss of property due to damage by a family pet is not deductible as a casualty loss unless the requirements discussed earlier under Casualty are met.
Example. Your antique oriental rug was damaged by your new puppy before it was housebroken. Because the damage was not unexpected and unusual, the loss is not deductible as a casualty loss.
Progressive deterioration. Loss of property due to progressive deterioration is not deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. The following are examples of damage due to progressive deterioration.
A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the laws of the state where it occurred and it must have been done with criminal intent.
Theft includes the taking of money or property by the following means.
The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.
Decline in market value of stock. You cannot deduct as a theft loss the decline in market value of stock acquired on the open market for investment if the decline is caused by disclosure of accounting fraud or other illegal misconduct by the officers or directors of the corporation that issued the stock. However, you can deduct as a capital loss the loss you sustain when you sell or exchange the stock or the stock becomes completely worthless. You report a capital loss on Schedule D (Form 1040). For more information about stock sales, worthless stock, and capital losses, see chapter 4 of Publication 550.
Mislaid or lost property. The simple disappearance of money or property is not a theft. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual. Sudden, unexpected, and unusual events are defined earlier.
Example. A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.
A loss on deposits can occur when a bank, credit union, or other financial institution becomes insolvent or bankrupt. If you incurred this type of loss, you can choose one of the following ways to deduct the loss.
Casualty loss or ordinary loss. You can choose to deduct a loss on deposits as a casualty loss or as an ordinary loss for any year in which you can reasonably estimate how much of your deposits you have lost in an insolvent or bankrupt financial institution. The choice is generally made on the return you file for that year and applies to all your losses on deposits for the year in that particular financial institution. If you treat the loss as a casualty or ordinary loss, you cannot treat the same amount of the loss as a nonbusiness bad debt when it actually becomes worthless. However, you can take a nonbusiness bad debt deduction for any amount of loss that is more than the estimated amount you deducted as a casualty or ordinary loss. Once you make this choice, you cannot change it without permission from the Internal Revenue Service.
If you claim an ordinary loss, report it as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23. The maximum amount you can claim is $20,000 ($10,000 if you are married filing separately) reduced by any expected state insurance proceeds. Your loss is subject to the 2%-of-adjusted-gross-income limit. You cannot choose to claim an ordinary loss if any part of the deposit is federally insured.
Nonbusiness bad debt. If you do not choose to deduct the loss as a casualty loss or as an ordinary loss, you must wait until the year the actual loss is determined and deduct the loss as a nonbusiness bad debt in that year.
How to report. The kind of deduction you choose for your loss on deposits determines how you report your loss. If you choose:
More information. For more information, see Special Treatment for Losses on Deposits in Insolvent or Bankrupt Financial Institutions in the Instructions for Form 4684 or Deposit in Insolvent or Bankrupt Financial Institution in Publication 550.
To deduct a casualty or theft loss, you must be able to prove that you had a casualty or theft. You must be able to support the amount you claim for the loss as discussed next.
Casualty loss proof. For a casualty loss, your records should show all the following.
Theft loss proof. For a theft loss, your records should show all the following.
Records: It is important that you have records that will prove your deduction. If you do not have the actual records to support your deduction, you can use other satisfactory evidence to support it.
Figure the amount of your loss using the following steps.
For personal-use property and property used in performing services as an employee, apply the deduction limits, discussed later, to determine the amount of your deductible loss.
Leased property. If you are liable for casualty damage to property you lease, your loss is the amount you must pay to repair the property minus any insurance or other reimbursement you receive or expect to receive.
Fair market value (FMV) is the price for which you could sell your property to a willing buyer when neither of you has to sell or buy and both of you know all the relevant facts.
The decrease in FMV used to figure the amount of a casualty or theft loss is the difference between the property's fair market value immediately before and immediately after the casualty or theft.
FMV of stolen property. The FMV of property immediately after a theft is considered to be zero, since you no longer have the property.
Example. Several years ago, you purchased silver dollars at face value for $150. This is your adjusted basis in the property. Your silver dollars were stolen this year. The FMV of the coins was $1,000 just before they were stolen, and insurance did not cover them. Your theft loss is $150.
Recovered stolen property. Recovered stolen property is your property that was stolen and later returned to you. If you recovered property after you had already taken a theft loss deduction, you must refigure your loss using the smaller of the property's adjusted basis (explained later) or the decrease in FMV from the time just before it was stolen until the time it was recovered. Use this amount to refigure your total loss for the year in which the loss was deducted.
If your refigured loss is less than the loss you deducted, you generally have to report the difference as income in the recovery year. But report the difference only up to the amount of the loss that reduced your tax. For more information on the amount to report, see Recoveries in chapter 12.
Figuring Decrease in FMV-- Items To Consider
To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. But other measures can also be used to establish certain decreases.
Appraisal. An appraisal to determine the difference between the FMV of the property immediately before a casualty or theft and immediately afterward should be made by a competent appraiser. The appraiser must recognize the effects of any general market decline that may occur along with the casualty. This information is needed to limit any deduction to the actual loss resulting from damage to the property.
Several factors are important in evaluating the accuracy of an appraisal, including the following.
Cost of cleaning up or making repairs. The cost of repairing damaged property is not part of a casualty loss. Neither is the cost of cleaning up after a casualty. But you can use the cost of cleaning up or making repairs after a casualty as a measure of the decrease in FMV if you meet all the following conditions.
Landscaping. The cost of restoring landscaping to its original condition after a casualty may indicate the decrease in FMV. You may be able to measure your loss by what you spend on the following.
Car value. Books issued by various automobile organizations that list your car may be useful in figuring the value of your car. You can use the book's retail values and modify them by such factors as mileage and the condition of your car to figure its value. The prices are not official, but they may be useful in determining value and suggesting relative prices for comparison with current sales and offerings in your area. If your car is not listed in the books, determine its value from other sources. A dealer's offer for your car as a trade-in on a new car is not usually a measure of its true value.
Figuring Decrease in FMV-- Items Not To Consider
You generally should not consider the following items when attempting to establish the decrease in FMV of your property.
Cost of protection. The cost of protecting your property against a casualty or theft is not part of a casualty or theft loss. The amount you spend on insurance or to board up your house against a storm is not part of your loss.
If you make permanent improvements to your property to protect it against a casualty or theft, add the cost of these improvements to your basis in the property. An example would be the cost of a dike to prevent flooding.
Exception. You cannot increase your basis in the property by, or deduct as a business expense, any expenditures you made with respect to qualified disaster mitigation payments. See Disaster Area Losses in Publication 547.
Related expenses. Any incidental expenses you have due to a casualty or theft, such as expenses for the treatment of personal injuries, for temporary housing, or for a rental car, are not part of your casualty or theft loss.
Replacement cost. The cost of replacing stolen or destroyed property is not part of a casualty or theft loss.
Sentimental value. Do not consider sentimental value when determining your loss. If a family portrait, heirloom, or keepsake is damaged, destroyed, or stolen, you must base your loss on its FMV.
Decline in market value of property in or near casualty area. A decrease in the value of your property because it is in or near an area that suffered a casualty, or that might again suffer a casualty, is not to be taken into consideration. You have a loss only for actual casualty damage to your property. However, if your home is in a federally declared disaster area, see Disaster Area Losses in Publication 547.
Costs of photographs and appraisals. Photographs taken after a casualty will be helpful in establishing the condition and value of the property after it was damaged. Photographs showing the condition of the property after it was repaired, restored, or replaced may also be helpful.
Appraisals are used to figure the decrease in FMV because of a casualty or theft. See Appraisal, earlier, under Figuring Decrease in FMV -- Items To Consider, for information about appraisals.
The costs of photographs and appraisals used as evidence of the value and condition of property damaged as a result of a casualty are not a part of the loss. You can claim these costs as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit on Schedule A (Form 1040). For information about miscellaneous deductions, see chapter 28.
Adjusted basis is your basis in the property (usually cost) increased or decreased by various events, such as improvements and casualty losses. For more information, see chapter 13.
Insurance and Other Reimbursements
If you receive an insurance payment or other type of reimbursement, you must subtract the reimbursement when you figure your loss. You do not have a casualty or theft loss to the extent you are reimbursed.
If you expect to be reimbursed for part or all of your loss, you must subtract the expected reimbursement when you figure your loss. You must reduce your loss even if you do not receive payment until a later tax year. See Reimbursement Received After Deducting Loss, later.
Failure to file a claim for reimbursement. If your property is covered by insurance, you must file a timely insurance claim for reimbursement of your loss. Otherwise, you cannot deduct this loss as a casualty or theft loss. However, this rule does not apply to the portion of the loss not covered by insurance (for example, a deductible).
Example. You have a car insurance policy with a $500 deductible. Because your insurance did not cover the first $500 of an auto collision, the $500 would be deductible (subject to the deduction limits discussed later). This is true even if you do not file an insurance claim, because your insurance policy would never have reimbursed you for the deductible.
Gain from reimbursement. If your reimbursement is more than your adjusted basis in the property, you have a gain. This is true even if the decrease in the FMV of the property is smaller than your adjusted basis. If you have a gain, you may have to pay tax on it, or you may be able to postpone reporting the gain. See Publication 547 for more information on how to treat a gain from a reimbursement for a casualty or theft.
Types of Reimbursements
The most common type of reimbursement is an insurance payment for your stolen or damaged property. Other types of reimbursements are discussed next. Also see the Instructions for Form 4684.
Employer's emergency disaster fund. If you receive money from your employer's emergency disaster fund and you must use that money to rehabilitate or replace property on which you are claiming a casualty loss deduction, you must take that money into consideration in computing the casualty loss deduction. Take into consideration only the amount you used to replace your destroyed or damaged property.
Example. Your home was extensively damaged by a tornado. Your loss after reimbursement from your insurance company was $10,000. Your employer set up a disaster relief fund for its employees. Employees receiving money from the fund had to use it to rehabilitate or replace their damaged or destroyed property. You received $4,000 from the fund and spent the entire amount on repairs to your home. In figuring your casualty loss, you must reduce your unreimbursed loss ($10,000) by the $4,000 you received from your employer's fund. Your casualty loss before applying the deduction limits discussed later is $6,000.
Cash gifts. If you receive excludable cash gifts as a disaster victim and there are no limits on how you can use the money, you do not reduce your casualty loss by these excludable cash gifts. This applies even if you use the money to pay for repairs to property damaged in the disaster.
Example. Your home was damaged by a hurricane. Relatives and neighbors made cash gifts to you that were excludable from your income. You used part of the cash gifts to pay for repairs to your home. There were no limits or restrictions on how you could use the cash gifts. Because it was an excludable gift, the money you received and used to pay for repairs to your home does not reduce your casualty loss on the damaged home.
Insurance payments for living expenses. You do not reduce your casualty loss by insurance payments you receive to cover living expenses in either of the following situations.
Inclusion in income. If these insurance payments are more than the temporary increase in your living expenses, you must include the excess in your income. Report this amount on Form 1040, line 21. However, if the casualty occurs in a Presidentially declared disaster area, none of the insurance payments are taxable. See Qualified disaster relief payments, under Disaster Area Losses in Publication 547.
A temporary increase in your living expenses is the difference between the actual living expenses you and your family incurred during the period you could not use your home and your normal living expenses for that period. Actual living expenses are the reasonable and necessary expenses incurred because of the loss of your main home. Generally, these expenses include the amounts you pay for the following.
Normal living expenses consist of these same expenses that you would have incurred but did not because of the casualty or the threat of one.
Example. As a result of a fire, you vacated your apartment for a month and moved to a motel. You normally pay $525 a month for rent. None was charged for the month the apartment was vacated. Your motel rent for this month was $1,200. You normally pay $200 a month for food. Your food expenses for the month you lived in the motel were $400. You received $1,100 from your insurance company to cover your living expenses. You determine the payment you must include in income as follows.
1) Insurance payment for living expenses $1,100 2) Actual expenses during the month you are unable to use your home because of fire 1,600 3) Normal living expenses 725 ------ 4) Temporary increase in living expenses: Subtract line 3 from line 2 875 ------ 5) Amount of payment includible in income: Subtract line 4 from line 1 $ 225 ======
Tax year of inclusion. You include the taxable part of the insurance payment in income for the year you regain the use of your main home or, if later, for the year you receive the taxable part of the insurance payment.
Example. Your main home was destroyed by a tornado in August 2005. You regained use of your home in November 2006. The insurance payments you received in 2005 and 2006 were $1,500 more than the temporary increase in your living expenses during those years. You include this amount in income on your 2006 Form 1040. If, in 2007, you receive further payments to cover the living expenses you had in 2005 and 2006, you must include those payments in income on your 2007 Form 1040.
Disaster relief. Food, medical supplies, and other forms of assistance you receive do not reduce your casualty loss unless they are replacements for lost or destroyed property.
Tip: Qualified disaster relief payments you receive for expenses you incurred as a result of a Presidentially declared disaster are not taxable income to you. For more information, see Disaster Area Losses in Publication 547.
Disaster unemployment assistance payments are unemployment benefits that are taxable.
Generally, disaster relief grants and qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) are not includible in your income. See Disaster Area Losses in Publication 547.
Reimbursement Received After Deducting Loss
If you figured your casualty or theft loss using your expected reimbursement, you may have to adjust your tax return for the tax year in which you receive your actual reimbursement. This section explains the adjustment you may have to make.
Actual reimbursement less than expected. If you later receive less reimbursement than you expected, include that difference as a loss with your other losses (if any) on your return for the year in which you can reasonably expect no more reimbursement.
Example. Your personal car had an FMV of $2,000 when it was destroyed in a collision with another car in 2006. The accident was due to the negligence of the other driver. At the end of 2006, there was a reasonable prospect that the owner of the other car would reimburse you in full. You did not have a deductible loss in 2006.
In January 2007, the court awarded you a judgment of $2,000. However, in July it became apparent that you will be unable to collect any amount from the other driver. You can deduct the loss in 2007 subject to the limits discussed later.
Actual reimbursement more than expected. If you later receive more reimbursement than you expected after you claimed a deduction for the loss, you may have to include the extra reimbursement in your income for the year you receive it. However, if any part of the original deduction did not reduce your tax for the earlier year, do not include that part of the reimbursement in your income. You do not refigure your tax for the year you claimed the deduction. For more information, see Recoveries in chapter 12.
Caution: If the total of all the reimbursements you receive is more than your adjusted basis in the destroyed or stolen property, you will have a gain on the casualty or theft. If you have already taken a deduction for a loss and you receive the reimbursement in a later year, you may have to include the gain in your income for the later year. Include the gain as ordinary income up to the amount of your deduction that reduced your tax for the earlier year. See Publication 547 for more information on how to treat a gain from the reimbursement of a casualty or theft.
Actual reimbursement same as expected. If you receive exactly the reimbursement you expected to receive, you do not have to include any of the reimbursement in your income and you cannot deduct any additional loss.
Example. In December 2007, you had a collision while driving your personal car. Repairs to the car cost $950. You had $100 deductible collision insurance. Your insurance company agreed to reimburse you for the rest of the damage. Because you expected a reimbursement from the insurance company, you did not have a casualty loss deduction in 2007.
Due to the $100 rule (discussed later under Deduction Limits), you cannot deduct the $100 you paid as the deductible. When you receive the $850 from the insurance company in 2008, do not report it as income.
Single Casualty on Multiple Properties
Personal property. Personal property is any property that is not real property. If your personal property is stolen or is damaged or destroyed by a casualty, you must figure your loss separately for each item of property. Then combine these separate losses to determine your total loss from that casualty or theft.
Example. A fire in your home destroyed an upholstered chair, an oriental rug, and an antique table. You did not have fire insurance to cover your loss. (This was the only casualty or theft you had during the year.) You paid $750 for the chair and you established that it had an FMV of $500 just before the fire. The rug cost $3,000 and had an FMV of $2,500 just before the fire. You bought the table at an auction for $100 before discovering it was an antique. It had been appraised at $900 before the fire. You figure your loss on each of these items as follows:
Chair Rug Table 1) Basis (cost) $750 $3,000 $100 ===== ====== ====== 2) FMV before fire $500 $2,500 $900 3) FMV after fire -0- -0- -0- ----- ------ ------ 4) Decrease in FMV $500 $2,500 $900 ===== ====== ====== 5) Loss (smaller of (1) or (4)) $500 $2,500 $100 ===== ====== ====== 6) Total loss $3,100 ======
Real property. In figuring a casualty loss on personal-use real property, treat the entire property (including any improvements, such as buildings, trees, and shrubs) as one item. Figure the loss using the smaller of the adjusted basis or the decrease in FMV of the entire property.
Example. You bought your home a few years ago. You paid $160,000 ($20,000 for the land and $140,000 for the house). You also spent $2,000 for landscaping. This year a fire destroyed your home. The fire also damaged the shrubbery and trees in your yard. The fire was your only casualty or theft loss this year. Competent appraisers valued the property as a whole at $200,000 before the fire, but only $30,000 after the fire. (The loss to your household furnishings is not shown in this example. It would be figured separately on each item, as explained earlier under Personal property.) Shortly after the fire, the insurance company paid you $155,000 for the loss. You figure your casualty loss as follows:
1) Adjusted basis of the entire property (land, building, and landscaping) $162,000 ========= 2) FMV of entire property before fire $200,000 3) FMV of entire property after fire 30,000 --------- 4) Decrease in FMV of entire property $170,000 ========= 5) Loss (smaller of (1) or (4)) $162,000 6) Subtract insurance 155,000 --------- 7) Amount of loss after reimbursement $7,000 =========
After you have figured your casualty or theft loss, you must figure how much of the loss you can deduct. If the loss was to property for your personal use or your family's use, there are two limits on the amount you can deduct for your casualty or theft loss.
You make these reductions on Form 4684.
These rules are explained next and Table 25-1 summarizes how to apply the $100 rule and the 10% rule in various situations. For more detailed explanations and examples, see Publication 547.
Table 25-1. How To Apply the Deduction Limits for Personal-Use Property
---------------------------------------------------------------------- $100 Rule 10% Rule ---------------------------------------------------------------------- General Application You must reduce each You must reduce your casualty or theft total casualty or loss by $100 when theft loss by 10% of figuring your your adjusted gross deduction. Apply income. Apply this this rule after you rule after you have figured the reduce each loss by amount of your loss. $100 (the $100 rule). ---------------------------------------------------------------------- Single Event Apply this rule only Apply this rule only once, even if many once, even if many pieces of property pieces of property are affected. are affected. ---------------------------------------------------------------------- More Than One Event Apply to the loss Apply to the total from each event. of all your losses from all events. ---------------------------------------------------------------------- More Than One Person-- Apply separately to Apply separately to With Loss From the each person. each person. Same Event (other than a married couple filing jointly) ---------------------------------------------------------------------- Married Filing Jointly Apply as if you were Apply as if you were Couple-- one person. one person. With Loss ---------------------------------------------------------- From the Filing Apply separately to Apply separately to Same Event Separately each spouse. each spouse. ---------------------------------------------------------------------- More Than One Owner Apply separately to Apply separately to (other than a married each owner of each owner of couple filing jointly) jointly owned jointly owned property. property. ----------------------------------------------------------------------
Property used partly for business and partly for personal purposes. When property is used partly for personal purposes and partly for business or income-producing purposes, the casualty or theft loss deduction must be figured separately for the personal-use part and for the business or income-producing part. You must figure each loss separately because the $100 rule and the 10% rule apply only to the loss on the personal-use part of the property.
After you have figured your casualty or theft loss on personal-use property, you must reduce that loss by $100. This reduction applies to each total casualty or theft loss. It does not matter how many pieces of property are involved in an event. Only a single $100 reduction applies.
Example. A hailstorm damages your home and your car. Determine the amount of loss, as discussed earlier, for each of these items. Since the losses are due to a single event, you combine the losses and reduce the combined amount by $100.
Single event. Generally, events closely related in origin cause a single casualty. It is a single casualty when the damage is from two or more closely related causes, such as wind and flood damage caused by the same storm.
You must reduce the total of all your casualty or theft losses on personal-use property by 10% of your adjusted gross income. Apply this rule after you reduce each loss by $100. If you have both gains and losses from casualties or thefts, see Gains and losses, later in this discussion.
Example 1. In June, you discovered that your house had been burglarized. Your loss after insurance reimbursement was $2,000. Your adjusted gross income for the year you discovered the theft is $29,500. You first apply the $100 rule and then the 10% rule. Figure your theft loss deduction as follows.
1) Loss after insurance $2,000 2) Subtract $100 100 ------ 3) Loss after $100 rule $1,900 4) Subtract 10% × $29,500 AGI 2,950 ------ 5) Theft loss deduction -0- ======
You do not have a theft loss deduction because your loss after you apply the $100 rule ($1,900) is less than 10% of your adjusted gross income ($2,950).
Example 2. In March, you had a car accident that totally destroyed your car. You did not have collision insurance on your car, so you did not receive any insurance reimbursement. Your loss on the car was $1,200. In November, a fire damaged your basement and totally destroyed the furniture, washer, dryer, and other items stored there. Your loss on the basement items after reimbursement was $1,700. Your adjusted gross income for the year that the accident and fire occurred is $25,000. You figure your casualty loss deduction as follows.
Car Basement 1) Loss $1,200 $1,700 2) Subtract $100 per incident 100 100 ------ ------ 3) Loss after $100 rule $1,100 $1,600 ====== ======= 4) Total loss $2,700 5) Subtract 10% × $25,000 AGI 2,500 ------- 6) Casualty loss deduction $200 =======
Gains and losses. If you had both gains and losses from casualties or thefts to personal-use property, you must compare your total gains to your total losses. Do this after you have reduced each loss by any reimbursements and by $100, but before you have reduced the losses by 10% of your adjusted gross income.
Caution: Casualty or theft gains do not include gains you choose to postpone. See Publication 547 for information on the postponement of gain.
Losses more than gains. If your losses are more than your recognized gains, subtract your gains from your losses and reduce the result by 10% of your adjusted gross income. The rest, if any, is your deductible loss.
Gains more than losses. If your recognized gains are more than your losses, subtract your losses from your gains. The difference is treated as capital gain and must be reported on Schedule D (Form 1040). The 10% rule does not apply to your gains.
Gains. If you receive an insurance or other reimbursement that is more than your adjusted basis in the destroyed or stolen property, you have a gain from the casualty or theft. You must include this gain in your income in the year you receive the reimbursement, unless you choose to postpone reporting the gain as explained in Publication 547.
If you have a loss, see Table 25-2.
Table 25-2. When To Deduct a Loss
---------------------------------------------------------------------- IF you have a loss... THEN deduct it in the year... ---------------------------------------------------------------------- from a casualty, the loss occurred. ---------------------------------------------------------------------- in a Presidentially declared the disaster occurred or the year disaster area, immediately before the disaster. ---------------------------------------------------------------------- from a theft, the theft was discovered. ---------------------------------------------------------------------- on a deposit treated as a: ---------------------------------------------------------------------- • casualty, • a reasonable estimate can be made. ---------------------------------------------------------------------- • bad debt, • deposits are totally worthless. ---------------------------------------------------------------------- • ordinary loss, • a reasonable estimate can be made. ----------------------------------------------------------------------
Losses. Generally, you can deduct a casualty loss that is not reimbursable only in the tax year in which the casualty occurred. This is true even if you do not repair or replace the damaged property until a later year.
You can deduct theft losses that are not reimbursable only in the year you discover your property was stolen.
If you are not sure whether part of your casualty or theft loss will be reimbursed, do not deduct that part until the tax year when you become reasonably certain that it will not be reimbursed.
Loss on deposits. If your loss is a loss on deposits in an insolvent or bankrupt financial institution, see Loss on Deposits, earlier.
You generally must deduct a casualty loss in the year it occurred. However, if you have a casualty loss from a disaster that occurred in an area warranting public or individual assistance (or both), you can choose to deduct the loss on your tax return or amended return for either of the following years.
Gains. Special rules apply if you choose to postpone reporting gain on property damaged or destroyed in a Presidentially declared disaster area. For those special rules, see Publication 547.
Postponed tax deadlines. The IRS may postpone for up to 1 year certain tax deadlines of taxpayers who are affected by a Presidentially declared disaster. The tax deadlines the IRS may postpone include those for filing income and employment tax returns, paying income and employment taxes, and making contributions to a traditional IRA or Roth IRA.
If any tax deadline is postponed, the IRS will publicize the postponement in your area by publishing a news release, revenue ruling, revenue procedure, notice, announcement, or other guidance in the Internal Revenue Bulletin (IRB).
Who is eligible. If the IRS postpones a tax deadline, the following taxpayers are eligible for the postponement.
Covered disaster area. This is an area of a Presidentially declared disaster in which the IRS has decided to postpone tax deadlines for up to 1 year.
Abatement of interest and penalties. The IRS may abate the interest and penalties on underpaid income tax for the length of any postponement of tax deadlines.
More information. For more information, see Disaster Area Losses in Publication 547.
Use Form 4684 to report a gain or a deductible loss from a casualty or theft. If you have more than one casualty or theft, use a separate Form 4684 to determine your gain or loss for each event. Combine the gains and losses on one Form 4684. Follow the form instructions as to which lines to fill out. In addition, you must use the appropriate schedule to report a gain or loss. The schedule you use depends on whether you have a gain or loss.
If you have a: Report it on: Gain Schedule D (Form 1040) Loss Schedule A (Form 1040)
Adjustments to basis. If you have a casualty or theft loss, you must decrease your basis in the property by any insurance or other reimbursement you receive, and by any deductible loss. Amounts you spend to restore your property after a casualty increase your adjusted basis. See Adjusted Basis in chapter 13 for more information.
Net operating loss (NOL). If your casualty or theft loss deduction is more than your income, you may have an NOL. You can use an NOL to lower your tax in an earlier year, allowing you to get a refund for tax you have already paid. Or, you can use it to lower your tax in a later year. You do not have to be in business to have an NOL from a casualty or theft loss. For more information, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.
Standard mileage rate. For 2007, the standard mileage rate for the cost of operating your car for business use is 48 1/2 cents per mile.
Car expenses and use of the standard mileage rate are explained under Transportation Expenses, later.
You may be able to deduct the ordinary and necessary business-related expenses you have for:
An ordinary expense is one that is common and accepted in your field of trade, business, or profession. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be required to be considered necessary.
This chapter explains the following.
Who does not need to use this chapter. If you are an employee, you will not need to read this chapter if all of the following are true.
If you meet all of these conditions, there is no need to show the expenses or the reimbursements on your return. See Reimbursements, later, if you would like more information on reimbursements and accounting to your employer.
Tip: If you meet these conditions and your employer included reimbursements on your Form W-2 in error, ask your employer for a corrected Form W-2.
Useful Items
You may want to see:
Publication
Form (and Instructions)
If you temporarily travel away from your tax home, you can use this section to determine if you have deductible travel expenses. This section discusses:
It also discusses the standard meal allowance, rules for travel inside and outside the United States, and deductible convention expenses.
Travel expenses defined. For tax purposes, travel expenses are the ordinary and necessary expenses (defined earlier) of traveling away from home for your business, profession, or job.
You will find examples of deductible travel expenses in Table 26-1.
Table 26-1. Travel Expenses You Can Deduct
This chart summarizes expenses you can deduct when you travel away from home for business purposes. ---------------------------------------------------------------------- IF you have expenses for... THEN you can deduct the cost of... ---------------------------------------------------------------------- transportation travel by airplane, train, bus, or car between your home and your business destination. If you were provided with a ticket or you are riding free as a result of a frequent traveler or similar program, your cost is zero. If you travel by ship, see Luxury Water Travel and Cruise ships (under Conventions) in Publication 463 for additional rules and limits. ---------------------------------------------------------------------- taxi, commuter fares for these and other types of transportation bus, and airport that take you between: limousine • The airport or station and your hotel, and • The hotel and the work location of your customers or clients, your business meeting place, or your temporary work location. ---------------------------------------------------------------------- baggage and sending baggage and sample or display material shipping between your regular and temporary work locations. ---------------------------------------------------------------------- car operating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard mileage rate as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses. ---------------------------------------------------------------------- lodging and meals your lodging and meals if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. Meals include amounts spent for food, beverages, taxes, and related tips. See Meals and Incidental Expenses for additional rules and limits. ---------------------------------------------------------------------- cleaning dry cleaning and laundry. ---------------------------------------------------------------------- telephone business calls while on your business trip. This includes business communication by fax machine or other communication devices. ---------------------------------------------------------------------- tips tips you pay for any expenses in this chart. ---------------------------------------------------------------------- other other similar ordinary and necessary expenses related to your business travel. These expenses might include transportation to or from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer. ----------------------------------------------------------------------
Traveling Away From Home
You are traveling away from home if:
This rest requirement is not satisfied by merely napping in your car. You do not have to be away from your tax home for a whole day or from dusk to dawn as long as your relief from duty is long enough to get necessary sleep or rest.
Example 1. You are a railroad conductor. You leave your home terminal on a regularly scheduled round-trip run between two cities and return home 16 hours later. During the run, you have 6 hours off at your turnaround point where you eat two meals and rent a hotel room to get necessary sleep before starting the return trip. You are considered to be away from home.
Example 2. You are a truck driver. You leave your terminal and return to it later the same day. You get an hour off at your turnaround point to eat. Because you are not off to get necessary sleep and the brief time off is not an adequate rest period, you are not traveling away from home.
Members of the Armed Forces. If you are a member of the U.S. Armed Forces on a permanent duty assignment overseas, you are not traveling away from home. You cannot deduct your expenses for meals and lodging. You cannot deduct these expenses even if you have to maintain a home in the United States for your family members who are not allowed to accompany you overseas. If you are transferred from one permanent duty station to another, you may have deductible moving expenses, which are explained in Publication 521, Moving Expenses.
A naval officer assigned to permanent duty aboard a ship that has regular eating and living facilities has a tax home aboard ship for travel expense purposes.
To determine whether you are traveling away from home, you must first determine the location of your tax home.
Generally, your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. It includes the entire city or general area in which your business or work is located.
If you have more than one regular place of business, your tax home is your main place of business. See Main place of business or work, later.
If you do not have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you regularly live. See No main place of business or work, later.
If you do not have a regular place of business or post of duty and there is no place where you regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel expense deduction because you are never considered to be traveling away from home.
Main place of business or work. If you have more than one place of business or work, consider the following when determining which one is your main place of business or work.
Example. You live in Cincinnati where you have a seasonal job for 8 months each year and earn $40,000. You work the other 4 months in Miami, also at a seasonal job, and earn $15,000. Cincinnati is your main place of work because you spend most of your time there and earn most of your income there.
No main place of business or work. You may have a tax home even if you do not have a regular or main place of business or work. Your tax home may be the home where you regularly live.
Factors used to determine tax home. If you do not have a regular or main place of business or work, use the following three factors to determine where your tax home is.
If you satisfy all three factors, your tax home is the home where you regularly live. If you satisfy only two factors, you may have a tax home depending on all the facts and circumstances. If you satisfy only one factor, you are an itinerant; your tax home is wherever you work and you cannot deduct travel expenses.
Example. You are single and live in Boston in an apartment you rent. You have worked for your employer in Boston for a number of years. Your employer enrolls you in a 12-month executive training program. You do not expect to return to work in Boston after you complete your training.
During your training, you do not do any work in Boston. Instead, you receive classroom and on-the-job training throughout the United States. You keep your apartment in Boston and return to it frequently. You use your apartment to conduct your personal business. You also keep up your community contacts in Boston. When you complete your training, you are transferred to Los Angeles.
You do not satisfy factor (1) because you did not work in Boston. You satisfy factor (2) because you had duplicate living expenses. You also satisfy factor (3) because you did not abandon your apartment in Boston as your main home, you kept your community contacts, and you frequently returned to live in your apartment. You have a tax home in Boston.
Tax home different from family home. If you (and your family) do not live at your tax home (defined earlier), you cannot deduct the cost of traveling between your tax home and your family home. You also cannot deduct the cost of meals and lodging while at your tax home. See Example 1 that follows.
If you are working temporarily in the same city where you and your family live, you may be considered as traveling away from home. See Example 2, below.
Example 1. You are a truck driver and you and your family live in Tucson. You are employed by a trucking firm that has its terminal in Phoenix. At the end of your long runs, you return to your home terminal in Phoenix and spend one night there before returning home. You cannot deduct any expenses you have for meals and lodging in Phoenix or the cost of traveling from Phoenix to Tucson. This is because Phoenix is your tax home.
Example 2. Your family home is in Pittsburgh, where you work 12 weeks a year. The rest of the year you work for the same employer in Baltimore. In Baltimore, you eat in restaurants and sleep in a rooming house. Your salary is the same whether you are in Pittsburgh or Baltimore.
Because you spend most of your working time and earn most of your salary in Baltimore, that city is your tax home. You cannot deduct any expenses you have for meals and lodging there. However, when you return to work in Pittsburgh, you are away from your tax home even though you stay at your family home. You can deduct the cost of your round trip between Baltimore and Pittsburgh. You can also deduct your part of your family's living expenses for meals and lodging while you are living and working in Pittsburgh.
You may regularly work at your tax home and also work at another location. It may not be practical to return to your tax home from this other location at the end of each work day.
Temporary assignment vs. indefinite assignment. If your assignment or job away from your main place of work is temporary, your tax home does not change. You are considered to be away from home for the whole period you are away from your main place of work. You can deduct your travel expenses if they otherwise qualify for deduction. Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less.
However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than 1 year, whether or not it actually lasts for more than 1 year.
If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are called travel allowances and you account to your employer for them. You may be able to deduct the cost of relocating to your new tax home as a moving expense. See Publication 521 for more information.
Exception for federal crime investigations or prosecutions. If you are a federal employee participating in a federal crime investigation or prosecution, you are not subject to the 1-year rule. This means you may be able to deduct travel expenses even if you are away from your tax home for more than 1 year, provided you meet the other requirements for deductibility.
For you to qualify, the Attorney General (or his or her designee) must certify that you are traveling:
Determining temporary or indefinite. You must determine whether your assignment is temporary or indefinite when you start work. If you expect an assignment or job to last for 1 year or less, it is temporary unless there are facts and circumstances that indicate otherwise. An assignment or job that is initially temporary may become indefinite due to changed circumstances. A series of assignments to the same location, all for short periods but that together cover a long period, may be considered an indefinite assignment.
Going home on days off. If you go back to your tax home from a temporary assignment on your days off, you are not considered away from home while you are in your hometown. You cannot deduct the cost of your meals and lodging there. However, you can deduct your travel expenses, including meals and lodging, while traveling between your temporary place of work and your tax home. You can claim these expenses up to the amount it would have cost you to stay at your temporary place of work.
If you keep your hotel room during your visit home, you can deduct the cost of your hotel room. In addition, you can deduct your expenses of returning home up to the amount you would have spent for meals had you stayed at your temporary place of work.
Probationary work period. If you take a job that requires you to move, with the understanding that you will keep the job if your work is satisfactory during a probationary period, the job is indefinite. You cannot deduct any of your expenses for meals and lodging during the probationary period.
What Travel Expenses Are Deductible?
Once you have determined that you are traveling away from your tax home, you can determine what travel expenses are deductible.
You can deduct ordinary and necessary expenses you have when you travel away from home on business. The type of expense you can deduct depends on the facts and your circumstances.
Table 26-1 summarizes travel expenses you may be able to deduct. You may have other deductible travel expenses that are not covered there, depending on the facts and your circumstances.
Records: When you travel away from home on business, you should keep records of all the expenses you have and any advances you receive from your employer. You can use a log, diary, notebook, or any other written record to keep track of your expenses. The types of expenses you need to record, along with supporting documentation, are described in Table 26-2, later.
Separating costs. If you have one expense that includes the costs of meals, entertainment, and other services (such as lodging or transportation), you must allocate that expense between the cost of meals and entertainment and the cost of other services. You must have a reasonable basis for making this allocation. For example, you must allocate your expenses if a hotel includes one or more meals in its room charge.
Travel expenses for another individual. If a spouse, dependent, or other individual goes with you (or your employee) on a business trip or to a business convention, you generally cannot deduct his or her travel expenses.
Employee. You can deduct the travel expenses of someone who goes with you if that person:
Business associate. If a business associate travels with you and meets the conditions in (2) and (3) above, you can deduct the travel expenses you have for that person. A business associate is someone with whom you could reasonably expect to actively conduct business. A business associate can be a current or prospective (likely to become) customer, client, supplier, employee, agent, partner, or professional advisor.
Bona fide business purpose. A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as typing notes or assisting in entertaining customers, are not enough to make the expenses deductible.
Example. Jerry drives to Chicago on business and takes his wife, Linda, with him. Linda is not Jerry's employee. Linda occasionally types notes, performs similar services, and accompanies Jerry to luncheons and dinners. The performance of these services does not establish that her presence on the trip is necessary to the conduct of Jerry's business. Her expenses are not deductible.
Jerry pays $199 a day for a double room. A single room costs $149 a day. He can deduct the total cost of driving his car to and from Chicago, but only $149 a day for his hotel room. If he uses public transportation, he can deduct only his fare.
You can deduct the cost of meals in either of the following situations.
Business-related entertainment is discussed under Entertainment Expenses, later. The following discussion deals only with meals (and incidental expenses) that are not business-related entertainment.
Lavish or extravagant. You cannot deduct expenses for meals that are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable based on the facts and circumstances. Expenses will not be disallowed merely because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.
50% limit on meals. You can figure your meal expenses using either of the following methods.
Both of these methods are explained below. But, regardless of the method you use, you generally can deduct only 50% of the unreimbursed cost of your meals.
If you are reimbursed for the cost of your meals, how you apply the 50% limit depends on whether your employer's reimbursement plan was accountable or nonaccountable. If you are not reimbursed, the 50% limit applies whether the unreimbursed meal expense is for business travel or business entertainment. The 50% limit is explained later under Entertainment Expenses. Accountable and nonaccountable plans are discussed later under Reimbursements.
Actual cost. You can use the actual cost of your meals to figure the amount of your expense before reimbursement and application of the 50% deduction limit. If you use this method, you must keep records of your actual cost.
Standard meal allowance. Generally, you can use the "standard meal allowance" method as an alternative to the actual cost method. It allows you to use a set amount for your daily meals and incidental expenses (M&IE), instead of keeping records of your actual costs. The set amount varies depending on where and when you travel. In this chapter, "standard meal allowance" refers to the federal rate for M&IE, discussed later under Amount of standard meal allowance. If you use the standard meal allowance, you still must keep records to prove the time, place, and business purpose of your travel. See Recordkeeping, later.
Incidental expenses. The term "incidental expenses" means:
Incidental expenses do not include expenses for laundry, cleaning and pressing of clothing, lodging taxes, or the costs of telegrams or telephone calls.
Incidental expenses only method. You can use an optional method (instead of actual cost) for deducting incidental expenses only. The amount of the deduction is $3 a day for incidental expenses paid or incurred for travel away from home in 2007. You can use this method only if you did not pay or incur any meal expenses. You cannot use this method on any day that you use the standard meal allowance.
Caution: Federal employees should refer to the Federal Travel Regulations at www.gsa.gov. Click on "Federal Travel Regulation (FTR)" for changes affecting claims for reimbursement of these expenses.
50% limit may apply. If you use the standard meal allowance method for meal expenses and you are not reimbursed or you are reimbursed under a nonaccountable plan, you can generally deduct only 50% of the standard meal allowance. If you are reimbursed under an accountable plan and you are deducting amounts that are more than your reimbursements, you can deduct only 50% of the excess amount. The 50% limit is explained later under Entertainment Expenses. Accountable and nonaccountable plans are discussed later under Reimbursements.
Caution: There is no optional standard lodging amount similar to the standard meal allowance. Your allowable lodging expense deduction is your actual cost.
Who can use the standard meal allowance. You can use the standard meal allowance whether you are an employee or self-employed, and whether or not you are reimbursed for your traveling expenses.
Use of the standard meal allowance for other travel. You can use the standard meal allowance to figure your meal expenses when you travel in connection with investment and other income-producing property. You can also use it to figure your meal expenses when you travel for qualifying educational purposes. You cannot use the standard meal allowance to figure the cost of your meals when you travel for medical or charitable purposes.
Amount of standard meal allowance. The standard meal allowance is the federal M&IE rate. For travel in 2007, the rate for most small localities in the United States is $39 a day from January 1 through December 31, 2007.
Most major cities and many other localities in the United States are designated as high-cost areas, qualifying for higher standard meal allowances. Locations qualifying for these rates are listed in Publication 1542 which is available on the Internet at www.irs.gov.
You can also find this information (organized by state) on the Internet at www.gsa.gov. Click on "Per Diem Rates," then select "2007" for the period January 1, 2007 - September 30, 2007, and select "2008" for the period October 1, 2007 - December 31, 2007. However, you can apply the rates in effect before October 1, 2007, for expenses of all travel within the United States for 2007 instead of the updated rates. You must consistently use either the rates for the first 9 months for all of 2007 or the updated rates for the period of October 1, 2007, through December 31, 2007.
If you travel to more than one location in one day, use the rate in effect for the area where you stop for sleep or rest. If you work in the transportation industry, however, see Special rate for transportation workers, later.
Standard meal allowance for areas outside the continental United States. The standard meal allowance rates above do not apply to travel in Alaska, Hawaii, or any other location outside the continental United States. The Department of Defense establishes per diem rates for Alaska, Hawaii, Puerto Rico, American Samoa, Guam, Midway, the Northern Mariana Islands, the U.S. Virgin Islands, Wake Island and other non-foreign areas outside the continental United States. The Department of State establishes per diem rates for all other foreign areas.
You can access per diem rates for non-foreign areas outside the continental United States at: http://perdiem.hqda.pentagon.mil/perdiem/perdiemrates.html. You can access all other foreign per diem rates at: www.state.gov/travelandbusiness.
Special rate for transportation workers. You can use a special standard meal allowance if you work in the transportation industry. You are in the transportation industry if your work:
If this applies to you, you can claim a standard meal allowance of $52 a day ($58 for travel outside the continental United States) from January 1 through December 31, 2007.
Using the special rate for transportation workers eliminates the need for you to determine the standard meal allowance for every area where you stop for sleep or rest. If you choose to use the special rate for any trip, you must use the special rate (and not use the regular standard meal allowance rates) for all trips you take that year.
Travel for days you depart and return. For both the day you depart for and the day you return from a business trip, you must prorate the standard meal allowance (figure a reduced amount for each day). You can do so by one of two methods.
Example. Jen is employed in New Orleans as a convention planner. In March, her employer sent her on a 3-day trip to Washington, DC, to attend a planning seminar. She left her home in New Orleans at 10 a.m. on Wednesday and arrived in Washington, DC, at 5:30 p.m. After spending two nights there, she flew back to New Orleans on Friday and arrived back home at 8:00 p.m. Jen's employer gave her a flat amount to cover her expenses and included it with her wages.
Under Method 1, Jen can claim 2 1/2 days of the standard meal allowance for Washington, DC: 3/4 of the daily rate for Wednesday and Friday (the days she departed and returned), and the full daily rate for Thursday.
Under Method 2, Jen could also use any method that she applies consistently and that is in accordance with reasonable business practice. For example, she could claim 3 days of the standard meal allowance even though a federal employee would have to use method 1 and be limited to only 2 1/2 days.
The following discussion applies to travel in the United States. For this purpose, the United States includes the 50 states and the District of Columbia. The treatment of your travel expenses depends on how much of your trip was business related and on how much of your trip occurred within the United States. See Part of Trip Outside the United States, later.
Trip Primarily for Business
You can deduct all your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.
Example. You work in Atlanta and take a business trip to New Orleans. On your way home, you stop in Mobile to visit your parents. You spend $1,070 for the 9 days you are away from home for travel, meals, lodging, and other travel expenses. If you had not stopped in Mobile, you would have been gone only 6 days, and your total cost would have been $920. You can deduct $920 for your trip, including the cost of round-trip transportation to and from New Orleans. The deduction for your meals is subject to the 50% limit on meals mentioned earlier.
Trip Primarily for Personal Reasons
If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.
A trip to a resort or on a cruise ship may be a vacation even if the promoter advertises that it is primarily for business. The scheduling of incidental business activities during a trip, such as viewing videotapes or attending lectures dealing with general subjects, will not change what is really a vacation into a business trip.
Part of Trip Outside the United States
If part of your trip is outside the United States, use the rules described later under Travel Outside the United States for that part of the trip. For the part of your trip that is inside the United States, use the rules for travel in the United States. Travel outside the United States does not include travel from one point in the United States to another point in the United States. The following discussion can help you determine whether your trip was entirely within the United States.
Public transportation. If you travel by public transportation, any place in the United States where that vehicle makes a scheduled stop is a point in the United States. Once the vehicle leaves the last scheduled stop in the United States on its way to a point outside the United States, you apply the rules under Travel Outside the United States.
Example. You fly from New York to Puerto Rico with a scheduled stop in Miami. You return to New York nonstop. The flight from New York to Miami is in the United States, so only the flight from Miami to Puerto Rico is outside the United States. Because there are no scheduled stops return trip is outside the United States.
Private car. Travel by private car in the United States is travel between points in the United States, even when you are on your way to a destination outside the United States.
Example. You travel by car from Denver to Mexico City and return. Your travel from Denver to the border and from the border back to Denver is travel in the United States, and the rules in this section apply. The rules under Travel Outside the United States apply to your trip from the border to Mexico City and back to the border.
Travel Outside the United States
If any part of your business travel is outside the United States, some of your deductions for the cost of getting to and from your destination may be limited. For this purpose, the United States includes the 50 states and the District of Columbia.
How much of your travel expenses you can deduct depends in part upon how much of your trip outside the United States was business related.
See chapter 1 of Publication 463 for information on luxury water travel.
Travel Entirely for Business or Considered Entirely for Business
You can deduct all your travel expenses of getting to and from your business destination if your trip is entirely for business or considered entirely for business.
Travel entirely for business. If you travel outside the United States and you spend the entire time on business activities, you can deduct all of your travel expenses.
Travel considered entirely for business. Even if you did not spend your entire time on business activities, your trip is considered entirely for business if you meet at least one of the following four exceptions.
Exception 1 - No substantial control. Your trip is considered entirely for business if you did not have substantial control over arranging the trip. The fact that you control the timing of your trip does not, by itself, mean that you have substantial control over arranging your trip.
You do not have substantial control over your trip if you:
"Related to your employer" is defined later in this chapter under Per Diem and Car Allowances.
A "managing executive" is an employee who has the authority and responsibility, without being subject to the veto of another, to decide on the need for the business travel.
A self-employed person generally has substantial control over arranging business trips.
Exception 2 - Outside United States no more than a week. Your trip is considered entirely for business if you were outside the United States for a week or less, combining business and nonbusiness activities. One week means seven consecutive days. In counting the days, do not count the day you leave the United States, but do count the day you return to the United States.
Exception 3 - Less than 25% of time on personal activities. Your trip is considered entirely for business if:
For this purpose, count both the day your trip began and the day it ended.
Exception 4 - Vacation not a major consideration. Your trip is considered entirely for business if you can establish that a personal vacation was not a major consideration, even if you have substantial control over arranging the trip.
Travel Primarily for Business
If you travel outside the United States primarily for business but spend some of your time on nonbusiness activities, you generally cannot deduct all of your travel expenses. You can only deduct the business portion of your cost of getting to and from your destination. You must allocate the costs between your business and nonbusiness activities to determine your deductible amount. These travel allocation rules are discussed in chapter 1 of Publication 463.
Tip: You do not have to allocate your travel expense deduction if you meet one of the four exceptions listed earlier under Travel considered entirely for business. In those cases, you can deduct the total cost of getting to and from your destination.
Travel Primarily for Personal Reasons
If you travel outside the United States primarily for vacation or for investment purposes, the entire cost of the trip is a nondeductible personal expense. If you spend some time attending brief professional seminars or a continuing education program, you can deduct your registration fees and other expenses you have that are directly related to your business.
Conventions
You can deduct your travel expenses when you attend a convention if you can show that your attendance benefits your trade or business. You cannot deduct the travel expenses for your family.
If the convention is for investment, political, social, or other purposes unrelated to your trade or business, you cannot deduct the expenses.
Caution: Your appointment or election as a delegate does not, in itself, determine whether you can deduct travel expenses. You can deduct your travel expenses only if your attendance is connected to your own trade or business.
Convention agenda. The convention agenda or program generally shows the purpose of the convention. You can show your attendance at the convention benefits your trade or business by comparing the agenda with the official duties and responsibilities of your position. The agenda does not have to deal specifically with your official duties and responsibilities; it will be enough if the agenda is so related to your position that it shows your attendance was for business purposes.
Conventions held outside the North American area. See chapter 1 of Publication 463 for information on conventions held outside the North American area.
You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee.
You can deduct entertainment expenses only if they are both ordinary and necessary (defined earlier in the Introduction) and meet one of the following tests.
Both of these tests are explained in chapter 2 of Publication 463.
Caution: The amount you can deduct for entertainment expenses may be limited. Generally, you can deduct only 50% of your unreimbursed entertainment expenses. This limit is discussed next.
50% Limit
In general, you can deduct only 50% of your business-related meal and entertainment expenses. (If you are subject to the Department of Transportation's "hours of service" limits, you can deduct a higher percentage. See Individuals subject to "hours of service" limits, later.)
The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed.
Figure 26-A summarizes the general rules explained in this section.
The 50% limit applies to business meals or entertainment expenses you have while:
[The following graphic has not been reproduced:
Figure 26-A. Does the 50% Limit Apply to Your Expenses?]
Included expenses. Expenses subject to the 50% limit include:
However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.
Application of 50% limit. The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions discussed later in this section.
The 50% limit also applies to certain meal and entertainment expenses that are not business-related. It applies to meal and entertainment expenses incurred for the production of income, including rental or royalty income. It also applies to the cost of meals included in deductible educational expenses.
When to apply the 50% limit. You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. You first have to determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this chapter.
Example 1. You spend $200 for a business-related meal. If $110 of that amount is not allowable because it is lavish and extravagant, the remaining $90 is subject to the 50% limit. Your deduction cannot be more than $45 (.50 × $90).
Example 2. You purchase two tickets to a concert and give them to a client. You purchased the tickets through a ticket agent. You paid $200 for the two tickets, which had a face value of $80 each ($160 total). Your deduction cannot be more than $80 (.50 × $160).
Exceptions to the 50% Limit
Generally, business-related meal and entertainment expenses are subject to the 50% limit. Figure 26-A can help you determine if the 50% limit applies to you.
Your meal or entertainment expense is not subject to the 50% limit if the expense meets one of the following exceptions.
Employee's reimbursed expenses. If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan. Accountable plans are discussed later under Reimbursements.
Individuals subject to "hours of service" limits. You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any period subject to the Department of Transportation's "hours of service" limits. The percentage is 75% for 2007.
Individuals subject to the Department of Transportation's "hours of service" limits include the following persons.
Other exceptions. There are also exceptions for the self-employed, advertising expenses, selling meals or entertainment, and charitable sports events. These are discussed in Publication 463.
What Entertainment Expenses Are Deductible?
This section explains different types of entertainment expenses that you my be able to deduct.
Entertainment. Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips.
A meal as a form of entertainment. Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. A meal expense includes the cost of food, beverages, taxes, and tips for the meal. To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided.
Caution: You cannot claim the cost of your meal both as an entertainment expense and as a travel expense.
Separating costs. If you have one expense that includes the costs of entertainment, and other services (such as lodging or transportation), you must allocate that expense between the cost of entertainment and the cost of other services. You must have a reasonable basis for making this allocation. For example, you must allocate your expenses if a hotel includes entertainment in its lounge on the same bill with your room charge.
Taking turns paying for meals or entertainment. If a group of business acquaintances take turns picking up each others' meal or entertainment checks without regard to whether any business purposes are served, no member of the group can deduct any part of the expense.
Lavish or extravagant expenses. You cannot deduct expenses for entertainment that are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.
Trade association meetings. You can deduct entertainment expenses that are directly related to, and necessary for, attending business meetings or conventions of certain exempt organizations if the expenses of your attendance are related to your active trade or business. These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and professional associations.
Entertainment tickets. Generally, you cannot deduct more than the face value of an entertainment ticket, even if you paid a higher price. For example, you cannot deduct service fees you pay to ticket agencies or brokers or any amount over the face value of the tickets you pay to scalpers.
What Entertainment Expenses Are Not Deductible?
This section explains different types of entertainment expenses that you generally may not be able to deduct.
Club dues and membership fees. You cannot deduct dues (including initiation fees) for membership in any club organized for:
This rule applies to any membership organization if one of its principal purposes is either:
The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. You cannot deduct dues paid to:
Entertainment facilities. Generally, you cannot deduct any expense for the use of an entertainment facility. This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection.
An entertainment facility is any property you own, rent, or use for entertainment. Examples include a yacht, hunting lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a vacation resort.
Out-of-pocket expenses. You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and fishing bait, that you provided during entertainment at a facility. These are not expenses for the use of an entertainment facility. However, these expenses are subject to the directly-related and associated tests and to the 50% limit discussed earlier.
Additional information. For more information on entertainment expenses, including discussions of the directly-related and associated tests, see chapter 2 of Publication 463.
If you give gifts in the course of your trade or business, you can deduct all or part of the cost. This section explains the limits and rules for deducting the costs of gifts.
$25 limit. You can deduct no more than $25 for business gifts you give directly or indirectly to each person during your tax year. A gift to a company that is intended for the eventual personal use or benefit of a particular person or a limited class of people will be considered an indirect gift to that particular person or to the individuals within that class of people who receive the gift.
If you give a gift to a member of a customer's family, the gift is generally considered to be an indirect gift to the customer. This rule does not apply if you have a bona fide, independent business connection with that family member and the gift is not intended for the customer's eventual use.
If you and your spouse both give gifts, both of you are treated as one taxpayer. It does not matter whether you have separate businesses, are separately employed, or whether each of you has an independent connection with the recipient. If a partnership gives gifts, the partnership and the partners are treated as one taxpayer.
Incidental costs. Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit.
A cost is incidental only if it does not add substantial value to the gift. For example, the cost of gift wrapping is an incidental cost. However, the purchase of an ornamental basket for packaging fruit is not an incidental cost if the value of the basket is substantial compared to the value of the fruit.
Exceptions. The following items are not considered gifts for purposes of the $25 limit.
Gift or entertainment. Any item that might be considered either a gift or entertainment generally will be considered entertainment. However, if you give a customer packaged food or beverages that you intend the customer to use at a later date, treat it as a gift.
If you give a customer tickets to a theater performance or sporting event and you do not go with the customer to the performance or event, you have a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is to your advantage.
If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. You cannot choose, in this case, to treat the cost of the tickets as a gift expense.
This section discusses expenses you can deduct for business transportation when you are not traveling away from home as defined earlier under Travel Expenses. These expenses include the cost of transportation by air, rail, bus, taxi, etc., and the cost of driving and maintaining your car.
Transportation expenses include the ordinary and necessary costs of all of the following.
Transportation expenses do not include expenses you have while traveling away from home overnight. Those expenses are travel expenses, which are discussed earlier. However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense deduction. See Car Expenses, later.
Illustration of transportation expenses. Figure 26-B illustrates the rules for when you can deduct transportation expenses when you have a regular or main job away from your home. You may want to refer to it when deciding whether you can deduct your transportation expenses.
[The following graphic has not been reproduced:
Figure 26-B. When Are Transportation Expenses Deductible?]
Temporary work location. If you have one or more regular work locations away from your home and you commute to a temporary work location in the same trade or business, you can deduct the expenses of the daily round-trip transportation between your home and the temporary location, regardless of distance.
If your employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary unless there are facts and circumstances that would indicate otherwise.
If your employment at a work location is realistically expected to last for more than 1 year or if there is no realistic expectation that the employment will last for 1 year or less, the employment is not temporary, regardless of whether it actually lasts for more than 1 year.
If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is realistically expected to last more than 1 year, that employment will be treated as temporary (unless there are facts and circumstances that would indicate otherwise) until your expectation changes. It will not be treated as temporary after the date you determine it will last more than 1 year.
If the temporary work location is beyond the general area of your regular place of work and you stay overnight, you are traveling away from home. You may have deductible travel expenses as discussed earlier in this chapter.
No regular place of work. If you have no regular place of work but ordinarily work in the metropolitan area where you live, you can deduct daily transportation costs between home and a temporary work site outside that metropolitan area.
Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that metropolitan area.
You cannot deduct daily transportation costs between your home and temporary work sites within your metropolitan area. These are nondeductible commuting expenses.
Two places of work. If you work at two places in one day, whether or not for the same employer, you can deduct the expense of getting from one workplace to the other. However, if for some personal reason you do not go directly from one location to the other, you cannot deduct more than the amount it would have cost you to go directly from the first location to the second.
Transportation expenses you have in going between home and a part-time job on a day off from your main job are commuting expenses. You cannot deduct them.
Armed Forces reservists. A meeting of an Armed Forces reserve unit is a second place of business if the meeting is held on a day on which you work at your regular job. You can deduct the expense of getting from one workplace to the other as just discussed under Two places of work.
You usually cannot deduct the expense if the reserve meeting is held on a day on which you do not work at your regular job. In this case, your transportation generally is a nondeductible commuting expense. However, you can deduct your transportation expenses if the location of the meeting is temporary and you have one or more regular places of work.
If you ordinarily work in a particular metropolitan area but not at any specific location and the reserve meeting is held at a temporary location outside that metropolitan area, you can deduct your transportation expenses.
If you travel away from home overnight to attend a guard or reserve meeting, you can deduct your travel expenses. These expenses are discussed earlier under Travel Expenses.
If you travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you may be able to deduct some of your reserve-related travel costs as an adjustment to income rather than as an itemized deduction. See Armed Forces reservists traveling more than 100 miles from home under Special Rules, later.
Commuting expenses. You cannot deduct the costs of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of work. These costs are personal commuting expenses. You cannot deduct commuting expenses no matter how far your home is from your regular place of work. You cannot deduct commuting expenses even if you work during the commuting trip.
Example. You had a telephone installed in your car. You sometimes use that telephone to make business calls while commuting to and from work. Sometimes business associates ride with you to and from work, and you have a business discussion in the car. These activities do not change the trip from personal to business. You cannot deduct your commuting expenses.
Parking fees. Fees you pay to park your car at your place of business are nondeductible commuting expenses. You can, however, deduct business-related parking fees when visiting a customer or client.
Advertising display on car. Putting display material that advertises your business on your car does not change the use of your car from personal use to business use. If you use this car for commuting or other personal uses, you still cannot deduct your expenses for those uses.
Car pools. You cannot deduct the cost of using your car in a nonprofit car pool. Do not include payments you receive from the passengers in your income. These payments are considered reimbursements of your expenses. However, if you operate a car pool for a profit, you must include payments from passengers in your income. You can then deduct your car expenses (using the rules in this chapter).
Hauling tools or instruments. Hauling tools or instruments in your car while commuting to and from work does not make your car expenses deductible. However, you can deduct any additional costs you have for hauling tools or instruments (such as for renting a trailer you tow with your car).
Union members' trips from a union hall. If you get your work assignments at a union hall and then go to your place of work, the costs of getting from the union hall to your place of work are nondeductible commuting expenses. Although you need the union to get your work assignments, you are employed where you work, not where the union hall is located.
Office in the home. If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business. (See chapter 28 for information on determining if your home office qualifies as a principal place of business.)
Examples of deductible transportation. The following examples show when you can deduct transportation expenses based on the location of your work and your home.
Example 1. You regularly work in an office in the city where you live. Your employer sends you to a one-week training session at a different office in the same city. You travel directly from your home to the training location and return each day. You can deduct the cost of your daily round-trip transportation between your home and the training location.
Example 2. Your principal place of business is in your home. You can deduct the cost of round-trip transportation between your qualifying home office and your client's or customer's place of business.
Example 3. You have no regular office, and you do not have an office in your home. In this case, the location of your first business contact is considered your office. Transportation expenses between your home and this first contact are nondeductible commuting expenses. Transportation expenses between your last business contact and your home are also nondeductible commuting expenses. Although you cannot deduct the costs of these first and last trips, you can deduct the costs of going from one client or customer to another.
Car Expenses
If you use your car for business purposes, you may be able to deduct car expenses. You generally can use one of the two following methods to figure your deductible expenses.
If you use actual car expenses to figure your deduction for a car you lease, there are rules that affect the amount of your lease payments that you can deduct. See Leasing a car under Actual Car Expenses, later.
In this chapter, "car" includes a van, pickup, or panel truck.
Tip: You may be entitled to a tax credit for an alternative motor vehicle that you place in service during the year. The vehicle must meet certain requirements, and you do not have to use it in your business to qualify for the credit. For more information, see chapter 37.
Rural mail carriers. If you are a rural mail carrier, you may be able to treat the amount of qualified reimbursement you received as the amount of your allowable expense. Because the qualified reimbursement is treated as paid under an accountable plan, your employer should not include the amount of reimbursement in your income.
If your vehicle expenses are more than the amount of your reimbursement, you can deduct the unreimbursed expenses as an itemized deduction on Schedule A (Form 1040). You must complete Form 2106 and attach it to your Form 1040.
A "qualified reimbursement" is the reimbursement you receive that meets both of the following conditions.
See your employer for information on your reimbursement.
Caution: If you are a rural mail carrier and received a qualified reimbursement, you cannot use the standard mileage rate.
Standard Mileage Rate
You may be able to use the standard mileage rate to figure the deductible costs of operating your car for business purposes. For 2007, the standard mileage rate for each mile of business use is 48 1/2 cents per mile.
Caution: If you use the standard mileage rate for a year, you cannot deduct your actual car expenses for that year, but see Parking fees and tolls, later.
You generally can use the standard mileage rate whether or not you are reimbursed and whether or not any reimbursement is more or less than the amount figured using the standard mileage rate. See Reimbursements under How To Report, later.
Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use either the standard mileage rate or actual expenses.
If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. For leases that began on or before December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals) that is after 1997.
You must make the choice to use the standard mileage rate by the due date (including extensions) of your return. You cannot revoke the choice. However, in a later year, you can switch from the standard mileage rate to the actual expenses method. If you change to the actual expense method in a later year, but before your car is fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation.
For more information about depreciation included in the standard mileage rate, see the exception in Methods of depreciation under Depreciation Deduction in chapter 4 of Publication 463.
Standard mileage rate not allowed. You cannot use the standard mileage rate if you:
Five or more cars. If you own or lease five or more cars that are used for business at the same time, you cannot use the standard mileage rate for the business use of any car. However, you may be able to deduct your actual expenses for operating each of the cars in your business. See Actual Car Expenses in chapter 4 of Publication 463 for information on how to figure your deduction.
You are not using five or more cars for business at the same time if you alternate using (use at different times) the cars for business.
Parking fees and tolls. In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees that you pay to park your car at your place of work are nondeductible commuting expenses.)
Actual Car Expenses
If you do not use the standard mileage rate, you may be able to deduct your actual car expenses.
Tip: If you qualify to use both methods, you may want to figure your deduction both ways to see which gives you a larger deduction.
Actual car expenses include:
Depreciation Lease Registration payments fees Garage rent Licenses Repairs Gas Oil Tires Insurance Parking fees Tolls
Business and personal use. If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expense based on the miles driven for each purpose.
Example. You are a contractor and drive your car 20,000 miles during the year: 12,000 miles for business use and 8,000 miles for personal use. You can claim only 60% (12,000 ÷ 20,000) of the cost of operating your car as a business expense.
Interest on car loans. If you are an employee, you cannot deduct any interest paid on a car loan. This interest is treated as personal interest and is not deductible. However, if you are self-employed and use your car in that business, see chapter 4 of Publication 535.
Tip: If you use a home equity loan to purchase your car, you may be able to deduct the interest. See chapter 23 for more information.
Taxes paid on your car. If you are an employee, you can deduct personal property taxes paid on your car if you itemize deductions. Enter the amount paid on line 7 of Schedule A (Form 1040). (See chapter 22 for more information on taxes.) If you are not an employee, see your form instructions for information on how to deduct personal property taxes paid on your car.
Sales taxes. Generally, sales taxes on your car are part of your car's basis and are recovered through depreciation, discussed later. However, to the extent the car is not used in your trade or business, you can choose to deduct the nonbusiness part of the sales tax deduction on Schedule A (Form 1040). You can only choose to deduct state and local sales taxes as an itemized deduction if you choose not to deduct state and local income taxes.
Fines and collateral. You cannot deduct fines you pay and forfeited collateral for traffic violations.
Depreciation and section 179 deductions. Generally, the cost of a car, plus sales tax and improvements, is a capital expense. Because the benefits last longer than 1 year, you generally cannot deduct a capital expense. However, you can recover this cost through the section 179 deduction (the deduction allowed by section 179 of the Internal Revenue Code), and depreciation deductions. Depreciation allows you to recover the cost over more than 1 year by deducting part of it each year. The section 179 deduction and the depreciation deduction are discussed in more detail in chapter 4 of Publication 463.
Generally, there are limits on these deductions. Special rules apply if you use your car 50% or less in your work or business.
Leasing a car. If you lease a car, truck, or van that you use in your business, you can use the standard mileage rate or actual expenses to figure your deductible car expense.
Deductible payments. If you choose to use actual expenses, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for personal use of the car, such as commuting.
You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car, even if the payments are called lease payments.
If you lease a car for 30 days or more, you may have to reduce your lease payment deduction by an "inclusion amount." For information on reporting lease inclusion amounts, see Leasing a Car in chapter 4 of Publication 463.
Sale, Trade-In, or Other Disposition
If you sell, trade in, or otherwise dispose of your car, you may have a taxable gain or a deductible loss. This is true whether you used the standard mileage rate or actual car expenses to deduct the business use of your car. Publication 544 has information on sales of property used in a trade or business, and details on how to report the disposition.
If you deduct travel, entertainment, gift, or transportation expenses, you must be able to prove (substantiate) certain elements of the expense. This section discusses the records you need to keep to prove these expenses.
Records: If you keep timely and accurate records, you will have support to show the IRS if your tax return is ever examined. You will also have proof of expenses that your employer may require if you are reimbursed under an accountable plan. These plans are discussed later under Reimbursements.
How To Prove Expenses
Table 26-2 is a summary of records you need to prove each expense discussed in this chapter. You must be able to prove the elements listed across the top portion of the chart. You prove them by having the information and receipts (where needed) for the expenses listed in the first column.
Table 26-2. How To Prove Certain Business Expenses
---------------------------------------------------------------------- THEN you must keep records that show details of the following elements... ---------------------------------------------------------------------- IF you have Place or expenses for... Amount Time Description ---------------------------------------------------------------------- Travel Cost of each separate Dates you left Destination or expense for travel, and returned area of your lodging, and meals. for each trip travel (name Incidental expenses and number of of city, town, may be totaled in days spent on or other reasonable categories business. designation). such as taxis, fees and tips, etc. ---------------------------------------------------------------------- Entertainment Cost of each separate Date of Name and expense. Incidental entertainment. address or expenses such as (Also see location of taxis, telephones, Business place of etc., may be totaled Purpose.) entertainment. on a daily basis. Type of entertainment if not otherwise apparent. (Also see Business Purpose.) ---------------------------------------------------------------------- Gifts Cost of the gift. Date of the Description of gift. the gift. ---------------------------------------------------------------------- Transportation Cost of each separate Date of the Your business expense. For car expense. For destination. expenses, the cost of car expenses, the car and any the date of improvements, the the use of the date you started car. using it for business, the mileage for each business use, and the total miles for the year. ---------------------------------------------------------------------- [Table Continued] ---------------------------------------------------------------------- THEN you must keep records that show details of the following elements... ---------------------------------------------------------------------- IF you have Business Purpose and expenses for... Business Relationship ---------------------------------------------------------------------- Travel Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. Relationship: N/A ---------------------------------------------------------------------- Entertainment Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. For entertainment, the nature of the business discussion or activity. If the entertainment was directly before or after a business discussion: the date, place, nature, and duration of the business discussion, and the identities of the persons who took part in both the business discussion and the entertainment activity. Gifts Relationship: Occupations or other information (such as names, titles, or other designations) about the recipients that shows their business relationship to you. For entertainment, you must also prove that you or your employee was present if the entertainment was a business meal. ---------------------------------------------------------------------- Transportation Purpose: Business purpose for the expense. Relationship: N/A ----------------------------------------------------------------------
Caution: You cannot deduct amounts that you approximate or estimate.
You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You must generally prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if you prepare a record in a computer memory device with the aid of a logging program, it is considered an adequate record.
What Are Adequate Records?
You should keep the proof you need in an account book, diary, statement of expense, or similar record. You should also keep documentary evidence that, together with your records, will support each element of an expense.
Documentary evidence. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.
Exception. Documentary evidence is not needed if any of the following conditions apply.
Adequate evidence. Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense.
For example, a hotel receipt is enough to support expenses for business travel if it has all of the following information.
A restaurant receipt is enough to prove an expense for a business meal if it has all of the following information.
If a charge is made for items other than food and beverages, the receipt must show that this is the case.
Canceled check. A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose.
Duplicate information. You do not have to record information in your account book or other record that duplicates information shown on a receipt as long as your records and receipts complement each other in an orderly manner.
You do not have to record amounts your employer pays directly for any ticket or other travel item. However, if you charge these items to your employer, through a credit card or otherwise, you must keep a record of the amounts you spend.
Timely-kept records. You should record the elements of an expense or of a business use at or near the time of the expense or use and support it with sufficient documentary evidence. A timely-kept record has more value than a statement prepared later when generally there is a lack of accurate recall.
You do not need to write down the elements of every expense on the day of the expense. If you maintain a log on a weekly basis which accounts for use during the week, the log is considered a timely-kept record.
If you give your employer, client, or customer an expense account statement, it can also be considered a timely-kept record. This is true if you copy it from your account book, diary, statement of expense, or similar record.
Proving business purpose. You must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, then you do not need to give a written explanation.
Confidential information. You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the expense and have it available to fully prove that element of the expense.
What If I Have Incomplete Records?
If you do not have complete records to prove an element of an expense, then you must prove the element with:
Destroyed records. If you cannot produce a receipt because of reasons beyond your control, you can prove a deduction by reconstructing your records or expenses. Reasons beyond your control include fire, flood, and other casualty.
Separating and Combining Expenses
This section explains when expenses must be kept separate and when expenses can be combined.
Separating expenses. Each separate payment is generally considered a separate expense. For example, if you entertain a customer or client at dinner and then go to the theater, the dinner expense and the cost of the theater tickets are two separate expenses. You must record them separately in your records.
Combining items. You can make one daily expenses. Examples are taxi fares, telephone calls, or other incidental travel costs. Meals should be in a separate category. You can include tips for meal-related services with the costs of the meals.
Expenses of a similar nature occurring during the course of a single event are considered a single expense. For example, if during entertainment at a cocktail lounge, you pay separately for each serving of refreshments, the total expense for the refreshments is treated as a single expense.
Allocating total cost. If you can prove the total cost of travel or entertainment but you cannot prove how much it cost for each person who participated in the event, you may have to allocate the total cost among you and your guests on a pro rata basis. An allocation would be needed, for example, if you did not have a business relationship with all of your guests.
If your return is examined. If your return is examined, you may have to provide additional information to the IRS. This information could be needed to clarify or to establish the accuracy or reliability of information contained in your records, statements, testimony, or documentary evidence before a deduction is allowed.
How Long To Keep Records and Receipts
You must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep your records that support your deduction (or an item of income) for 3 years from the date you file the income tax return on which the deduction is claimed. A return filed early is considered filed on the due date. For a more complete explanation, get Publication 583, Starting a Business and Keeping Records.
Reimbursed for expenses. Employees who give their records and documentation to their employers and are reimbursed for their expenses generally do not have to keep copies of this information. However, you may have to prove your expenses if any of the following conditions apply.
See the next section, How To Report, for a discussion of reimbursements, adequate accounting, and nonaccountable plans.
Additional information. Chapter 5 of Publication 463 has more information on recordkeeping, including examples.
This section explains where and how to report the expenses discussed in this chapter. It discusses reimbursements and how to treat them under accountable and nonaccountable plans. It also explains rules for independent contractors and clients, fee-basis officials, certain performing artists, Armed Forces reservists, and certain disabled employees. This section ends with an illustration of how to report travel, entertainment, gift, and car expenses on Form 2106-EZ.
Self-employed. You must report your income and expenses on Schedule C or C-EZ (Form 1040) if you are a sole proprietor, or on Schedule F (Form 1040) if you are a farmer. You do not use Form 2106 or 2106-EZ. See your form instructions for information on how to complete your tax return. You can also find information in Publication 535 if you are a sole proprietor, or in Publication 225, Farmer's Tax Guide, if you are a farmer.
Both self-employed and an employee. If you are both self-employed and an employee, you must keep separate records for each business activity. Report your business expenses for self-employment on Schedule C, C-EZ, or F (Form 1040), as discussed earlier. Report your business expenses for your work as an employee on Form 2106 or 2106-EZ, as discussed next.
Employees. If you are an employee, you generally must complete Form 2106 to deduct your travel, transportation, and entertainment expenses. However, you can use the shorter Form 2106-EZ instead of Form 2106 if you meet all of the following conditions.
For more information on how to report your expenses on Forms 2106 and 2106-EZ, see Completing Forms 2106 and 2106-EZ, later.
Gifts. If you did not receive any reimbursements (or the reimbursements were all included in box 1 of your Form W-2), the only business expense you are claiming is for gifts, and the rules for certain individuals (such as performing artists) discussed later under Special Rules do not apply to you, do not complete Form 2106 or 2106-EZ. Instead, claim the amount of your deductible gifts directly on line 21 of Schedule A (Form 1040).
Statutory employees. If you received a Form W-2 and the "Statutory employee" box in box 13 was checked, report your income and expenses related to that income on Schedule C or C-EZ (Form 1040). Do not complete Form 2106 or 2106-EZ.
Statutory employees include full-time life insurance salespersons, certain agent or commission drivers, traveling salespersons, and certain homeworkers.
Caution: If you are entitled to a reimbursement from your employer but you do not claim it, you cannot claim a deduction for the expenses to which that unclaimed reimbursement applies.
Reimbursement for personal expenses. If your employer reimburses you for nondeductible personal expenses, such as for vacation trips, your employer must report the reimbursement as wage income in box 1 of your Form W-2. You cannot deduct personal expenses.
This section explains what to do when you receive an advance or are reimbursed for any of the employee business expenses discussed in this chapter.
If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a nonaccountable plan.
This section explains the two types of plans, how per diem and car allowances simplify proving the amount of your expenses, and the tax treatment of your reimbursements and expenses.
No reimbursement. You are not reimbursed or given an allowance for your expenses if you are paid a salary or commission with the understanding that you will pay your own expenses. In this situation, you have no reimbursement or allowance arrangement, and you do not have to read this section on reimbursements. Instead, see Completing Forms 2106 and 2106-EZ, later, for information on completing your tax return.
Reimbursement, allowance, or advance. A reimbursement or other expense allowance arrangement is a system or plan that an employer uses to pay, substantiate, and recover the expenses, advances, reimbursements, and amounts charged to the employer for employee business expenses. Arrangements include per diem and car allowances.
A per diem allowance is a fixed amount of daily reimbursement your employer gives you for your lodging, meal, and incidental expenses when you are away from home on business. (The term "incidental expenses" is defined earlier under Meals and Incidental Expenses.) A car allowance is an amount your employer gives you for the business use of your car.
Your employer should tell you what method of reimbursement is used and what records you must provide.
Accountable Plans
To be an accountable plan, your employer's reimbursement or allowance arrangement must include all of the following rules.
See Adequate Accounting and Returning Excess Reimbursements, later.
An excess reimbursement or allowance is any amount you are paid that is more than the business-related expenses that you adequately accounted for to your employer.
The definition of reasonable period of time depends on the facts and circumstances of your situation. However, regardless of the facts and circumstances of your situation, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time.
Employee meets accountable plan rules. If you meet the three rules for accountable plans, your employer should not include any reimbursements in your income in box 1 of your Form W-2. If your expenses equal your reimbursement, you do not complete Form 2106. You have no deduction since your expenses and reimbursement are equal.
Tip: If your employer included reimbursements in box 1 of your Form W-2 and you meet all the rules for accountable plans, ask your employer for a corrected Form W-2.
Accountable plan rules not met. Even though you are reimbursed under an accountable plan, some of your expenses may not meet all the rules. Those expenses that fail to meet all three rules for accountable plans are treated as having been reimbursed under a nonaccountable plan (discussed later).
Reimbursement of nondeductible expenses. You may be reimbursed under your employer's accountable plan for expenses related to that employer's business, some of which are deductible as employee business expenses and some of which are not deductible. The reimbursements you receive for the nondeductible expenses do not meet rule (1) for accountable plans, and they are treated as paid under a nonaccountable plan.
Example. Your employer's plan reimburses you for travel expenses while away from home on business and also for meals when you work late at the office, even though you are not away from home. The part of the arrangement that reimburses you for the nondeductible meals when you work late at the office is treated as paid under a nonaccountable plan.
Tip: The employer makes the decision whether to reimburse employees under an accountable plan or a nonaccountable plan. If you are an employee who receives payments under a nonaccountable plan, you cannot convert these amounts to payments under an accountable plan by voluntarily accounting to your employer for the expenses and voluntarily returning excess reimbursements to the employer.
Adequate Accounting
One of the rules for an accountable plan is that you must adequately account to your employer for your expenses. You adequately account by giving your employer a statement of expense, an account book, a diary, or a similar record in which you entered each expense at or near the time you had it, along with documentary evidence (such as receipts) of your travel, mileage, and other employee business expenses. (See Table 26-2, earlier, for details you need to enter in your record and documents you need to prove certain expenses.) A per diem or car allowance satisfies the adequate accounting requirement under certain conditions. See Per Diem and Car Allowances, later.
You must account for all amounts you received from your employer during the year as advances, reimbursements, or allowances. This includes amounts you charged to your employer by credit card or other method. You must give your employer the same type of records and supporting information that you would have to give to the IRS if the IRS questioned a deduction on your return. You must pay back the amount of any reimbursement or other expense allowance for which you do not adequately account or that is more than the amount for which you accounted.
Per Diem and Car Allowances
If your employer reimburses you for your expenses using a per diem or car allowance, you can generally use the allowance as proof of the amount of your expenses. A per diem or car allowance satisfies the adequate accounting requirements for the amount of your expenses only if all of the following conditions apply.
If the IRS finds that an employer's travel allowance practices are not based on reasonably accurate estimates of travel costs (including recognition of cost differences in different areas for per diem amounts), you will not be considered to have accounted to your employer. In this case, you must be able to prove your expenses to the IRS.
Related to employer. You are related to your employer if:
You may be considered to indirectly own stock, for purposes of (2), if you have an interest in a corporation, partnership, estate, or trust that owns the stock or if a member of your family or your partner owns the stock.
The federal rate. The federal rate can be figured using any one of the following methods.
Regular federal per diem rate. The regular federal per diem rate is the highest amount that the federal government will pay to its employees for lodging, meal, and incidental expenses (or meal and incidental expenses only) while they are traveling away from home in a particular area. The rates are different for different locations. Your employer should have these rates available. (Employers can get Publication 1542 on the Internet, which gives the rates in the continental United States for the current year.)
The standard meal allowance. The standard meal allowance (discussed earlier) is the federal rate for meals and incidental expenses (M&IE). The rate for most small localities in the United States is $39 a day from January 1 through December 31, 2007. Most major cities and many other localities qualify for higher rates. The rates for all localities within the continental United States are listed in Publication 1542. You can also find this information on the Internet at www.gsa.gov.
You receive an allowance only for meals and incidental expenses when your employer does one of the following.
High-low rate. This is a simplified method of computing the federal per diem rate for travel within the continental United States. It eliminates the need to keep a current list of the per diem rate for each city.
Under the high-low method, the per diem amount for travel during January through September of 2007 is $246 (including $58 for M&IE) for certain high-cost locations. All other areas have a per diem amount of $148 (including $45 for M&IE). (Employers can get Publication 1542 which gives the areas eligible for the $246 per diem amount under the high-low method for all or part of this period.)
Caution: Effective October 1, 2007, the per diem rate under this method for certain high-cost locations decreased to $237 (including $58 for M&IE). The rate for all other locations increased to $152 (including $45 for M&IE). However, an employer can continue to use the rates described in the preceding paragraph for the remainder of 2007 if those rates and locations are used consistently during October, November, and December for all employees. Employers who did not use the high-low method during the first 9 months of 2007 cannot begin to use it before 2008. See Revenue Procedure 2007-63 for more information. Also see Publication 1542 on the Internet at www.irs.gov.
Prorating the standard meal allowance on partial days of travel. The standard meal allowance is for a full 24-hour day of travel. If you travel for part of a day, such as on the days you depart and return, you must prorate the full-day M&IE rate. This rule also applies if your employer uses the regular federal per diem rate or the high-low rate.
You can use either of the following methods to figure the federal M&IE for that day.
The standard mileage rate. This is a set rate per mile that you can use to compute your deductible car expenses. For 2007, the standard mileage rate for the cost of operating your car is 48 1/2 cents per mile.
Fixed and variable rate (FAVR). This is an allowance your employer may use to reimburse your car expenses. Under this method, your employer pays an allowance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your variable operating costs (such as gas, oil, etc.) plus a flat amount to cover your fixed costs (such as depreciation (or lease payments), insurance, etc.). If your employer chooses to use this method, your employer will request the necessary records from you.
Reporting your expenses with a per diem or car allowance. If your reimbursement is in the form of an allowance received under an accountable plan, the following facts affect your reporting.
The following discussions explain where to report your expenses depending upon how the amount of your allowance compares to the federal rate.
Allowance less than or equal to the federal rate. If your allowance is less than or equal to the federal rate, the allowance will not be included in box 1 of your Form W-2. You do not need to report the related expenses or the allowance on your return if your expenses are equal to or less than the allowance.
However, if your actual expenses are more than your allowance, you can complete Form 2106 and deduct the excess amount on Schedule A (Form 1040). If you are using actual expenses, you must be able to prove to the IRS the total amount of your expenses and reimbursements for the entire year. If you are using the standard meal allowance or the standard mileage rate, you do not have to prove that amount.
Example. Nicole drives 10,000 miles a year for business. Under her employer's accountable plan, she accounts for the time (dates), place, and business purpose of each trip. Her employer pays her a mileage allowance of 35 cents a mile.
Since Nicole's $4,850 expenses computed under the standard mileage rate (10,000 miles × 48 1/2 cents) are more than her $3,500 reimbursement (10,000 miles × 35 cents), she itemizes her deductions to claim the excess expenses. Nicole completes Form 2106 (showing all of her expenses and reimbursements) and enters $1,350 ($4,850 - $3,500) as an itemized deduction.
Allowance more than the federal rate. If your allowance is more than the federal rate, your employer must include the allowance amount up to the federal rate in box 12 of your Form W-2. This amount is not taxable. However, the excess allowance will be included in box 1 of your Form W-2. You must report this part of your allowance as if it were wage income.
If your actual expenses are less than or equal to the federal rate, you do not complete Form 2106 or claim any of your expenses on your return.
However, if your actual expenses are more than the federal rate, you can complete Form 2106 and deduct those excess expenses. You must report on Form 2106 your reimbursements up to the federal rate (as shown in box 12 of your Form W-2) and all your expenses. You should be able to prove these amounts to the IRS.
Example. Joe lives and works in Austin. In May his employer sent him to San Diego for 4 days and paid the hotel directly for Joe's hotel bill. The employer reimbursed Joe $75 a day for his meals and incidental expenses. The federal rate for San Diego is $64 a day.
Joe can prove that his actual meal expenses totaled $380. His employer's accountable plan will not pay more than $75 a day for travel to San Diego, so Joe does not give his employer the records that prove that he actually spent $380. However, he does account for the time, place, and business purpose of the trip. This is Joe's only business trip this year.
Joe was reimbursed $300 ($75 × 4 days), which is $44 more than the federal rate of $256 ($64 × 4 days). His employer includes the $44 as income on Joe's Form W-2 in box 1. His employer also enters $256 in box 12 of Joe's Form W-2.
Joe completes Form 2106 to figure his deductible expenses. He enters the total of his actual expenses for the year ($380) on Form 2106. He also enters the reimbursements that were not included in his income ($256). His total deductible expense, before the 50% limit, is $124. After he figures the 50% limit on his unreimbursed meals and entertainment, he will include the balance, $62, as an itemized deduction on Schedule A (Form 1040).
Returning Excess Reimbursements
Under an accountable plan, you are required to return any excess reimbursement or other expense allowances for your business expenses to the person paying the reimbursement or allowance. Excess reimbursement means any amount for which you did not adequately account within a reasonable period of time. For example, if you received a travel advance and you did not spend all the money on business-related expenses, or you do not have proof of all your expenses, you have an excess reimbursement.
"Adequate accounting" and "reasonable period of time" were discussed earlier in this chapter.
Travel advance. You receive a travel advance if your employer provides you with an expense allowance before you actually have the expense, and the allowance is reasonably expected to be no more than your expense. Under an accountable plan, you are required to adequately account to your employer for this advance and to return any excess within a reasonable period of time.
If you do not adequately account for or do not return any excess advance within a reasonable period of time, the amount you do not account for or return will be treated as having been paid under a nonaccountable plan (discussed later).
Unproven amounts. If you do not prove that you actually traveled on each day for which you received a per diem or car allowance (proving the elements described in Table 26-2), you must return this unproved amount of the travel advance within a reasonable period of time. If you do not do this, the unproved amount will be considered paid under a nonaccountable plan (discussed later).
Per diem allowance more than federal rate. If your employer's accountable plan pays you an allowance that is higher than the federal rate, you do not have to return the difference between the two rates for the period you can prove business-related travel expenses. However, the difference will be reported as wages on your Form W-2. This excess amount is considered paid under a nonaccountable plan (discussed later).
Example. Your employer sends you on a 5-day business trip to Phoenix in March 2007 and gives you a $400 ($80 × 5 days) advance to cover your meals and incidental expenses. The federal per diem for meals and incidental expenses for Phoenix is $59. Your trip lasts only 3 days. Under your employer's accountable plan, you must return the $160 ($80 × 2 days) advance for the 2 days you did not travel. You do not have to return the $63 difference between the allowance you received and the federal rate for Phoenix (($80 - $59) × 3 days). However, the $63 will be reported on your Form W-2 as wages.
Nonaccountable Plans
A nonaccountable plan is a reimbursement or expense allowance arrangement that does not meet one or more of the three rules listed earlier under Accountable Plans.
In addition, even if your employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan.
If you are not sure if the reimbursement or expense allowance arrangement is an accountable or nonaccountable plan, ask your employer.
Reporting your expenses under a nonaccountable plan. Your employer will combine the amount of any reimbursement or other expense allowance paid to you under a nonaccountable plan with your wages, salary, or other pay. Your employer will report the total in box 1 of your Form W-2.
You must complete Form 2106 or 2106-EZ and itemize your deductions to deduct your expenses for travel, transportation, meals, or entertainment. Your meal and entertainment expenses will be subject to the 50% limit discussed earlier under Entertainment Expenses. Also, your total expenses will be subject to the 2%-of-adjusted-gross-income limit that applies to most miscellaneous itemized deductions on Schedule A (Form 1040).
Example. Kim's employer gives her $1,000 a month ($12,000 for the year) for her business expenses. Kim does not have to provide any proof of her expenses to her employer, and Kim can keep any funds that she does not spend.
Kim is being reimbursed under a nonaccountable plan. Her employer will include the $12,000 on Kim's Form W-2 as if it were wages. If Kim wants to deduct her business expenses, she must complete Form 2106 or 2106-EZ and itemize her deductions.
Completing Forms 2106 and 2106-EZ
This section briefly describes how employees complete Forms 2106 and 2106-EZ. Table 26-3 explains what the employer reports on Form W-2 and what the employee reports on Form 2106. The instructions for the forms have more information on completing them.
Table 26-3. Reporting Travel, Entertainment, Gift, and Car Expenses and Reimbursements
---------------------------------------------------------------------- IF the type of reimbursement (or THEN the employer AND the employee other expense allowance) reports on reports on arrangement is under: Form W-2: Form 2106:* ---------------------------------------------------------------------- An accountable plan with: ---------------------------------------------------------------------- Actual expense reimbursement: No amount. No amount. Adequate accounting made and excess returned. ---------------------------------------------------------------------- Actual expense reimbursement: The excess amount No amount. Adequate accounting and return as wages in box 1. of excess both required but excess not returned. ---------------------------------------------------------------------- Per diem or mileage allowance up No amount. All expenses and to the federal rate: reimbursements Adequate accounting made and only if excess excess returned. expenses are claimed. Otherwise, form is not filed. ---------------------------------------------------------------------- Per diem or mileage allowance up The excess amount No amount. to the federal rate: as wages in box 1. Adequate accounting and return The amount up to of excess both required but the federal rate excess not returned. is reported only in box 12--it is not reported in box 1. ---------------------------------------------------------------------- Per diem or mileage allowance The excess amount All expenses exceeds the federal rate: as wages in box 1. (and Adequate accounting up to the The amount up to reimbursement federal rate only and excess the federal rate reported on not returned. is reported only Form W-2, in box 12--it is box 12) not reported in only if expenses box 1. in excess of the federal rate are claimed. Otherwise, form is not required. ---------------------------------------------------------------------- A nonaccountable plan with: ---------------------------------------------------------------------- Either adequate accounting or The entire amount All expenses. return of excess, or both, not as wages in box 1. required by plan ---------------------------------------------------------------------- No reimbursement plan: The entire amount All expenses. as wages in box 1. ---------------------------------------------------------------------- * You may be able to use Form 2106-EZ. See Completing Forms 2106 and 2106-EZ. ======================================================================
Caution: If you are self-employed, do not file Form 2106 or 2106-EZ. Report your expenses on Schedule C, C-EZ, or F (Form 1040). See the instructions for the form that you must file.
Form 2106-EZ. You may be able to use the shorter Form 2106-EZ to claim your employee business expenses. You can use this form if you meet all of the following conditions.
Car expenses. If you used a car to perform your job as an employee, you may be able to deduct certain car expenses. These are generally figured on Form 2106, Part II, and then claimed on Form 2106, Part I, line 1, Column A. Car expenses using the standard mileage rate can also be figured on Form 2106-EZ by completing Part II and Part I, line 1.
Transportation expenses. Show your transportation expenses that did not involve overnight travel on Form 2106, line 2, Column A, or on Form 2106-EZ, Part I, line 2. Also include on this line business expenses you have for parking fees and tolls. Do not include expenses of operating your car or expenses of commuting between your home and work.
Employee business expenses other than meals and entertainment. Show your other employee business expenses on Form 2106, lines 3 and 4, Column A, or Form 2106-EZ, lines 3 and 4. Do not include expenses for meals and entertainment on those lines. Line 4 is for expenses such as gifts, educational expenses (tuition and books), office-in-the-home expenses, and trade and professional publications.
Tip: If line 4 expenses are the only ones you are claiming, you received no reimbursements (or the reimbursements were all included in box 1 of your Form W-2), and the Special Rules discussed later do not apply to you, do not complete Form 2106 or 2106-EZ. Claim these amounts directly on Schedule A (Form 1040), line 21. List the type and amount of each expense on the dotted lines and include the total on line 21.
Meal and entertainment expenses. Show the full amount of your expenses for business-related meals and entertainment on Form 2106, line 5, Column B. Include meals while away from your tax home overnight and other business meals and entertainment. Enter 50% of the line 8, column B, meal and entertainment expenses on line 9, Column B.
If you file Form 2106-EZ, enter the full amount of your meals and entertainment on the line to the left of line 5 and multiply the total by 50%. Enter the result on line 5.
Hours of service limits. If you are subject to the Department of Transportation's "hours of service" limits, use 75% instead of 50% for meals while away from your tax home.
Reimbursements. Enter on Form 2106, line 7, the amounts your employer (or third party) reimbursed you that were not included in box 1 of your Form W-2. (You cannot use Form 2106-EZ.) This includes any reimbursement reported under code L in box 12 of Form W-2.
Allocating your reimbursement. If you were reimbursed under an accountable plan and want to deduct excess expenses that were not reimbursed, you may have to allocate your reimbursement. This is necessary if your employer pays your reimbursement in the following manner:
You must allocate that single payment so that you know how much to enter on Form 2106, line 7, Column A and Column B.
Example. Rob's employer paid him an expense allowance of $12,000 this year under an accountable plan. The $12,000 payment consisted of $5,000 for airfare and $7,000 for entertainment and car expenses. Rob's employer did not clearly show how much of the $7,000 was for the cost of deductible entertainment. Rob actually spent $14,000 during the year ($5,500 for airfare, $4,500 for entertainment, and $4,000 for car expenses).
Since the airfare allowance was clearly identified, Rob knows that $5,200 of the payment goes in Column A, line 7 of Form 2106. To allocate the remaining $7,000, Rob uses the worksheet from the instructions for Form 2106. His completed worksheet follows.
1. Enter the total amount of reimbursements your employer gave you that were not reported to you in box 1 of Form W-2 $7,000 2. Enter the total amount of your expenses for the periods covered by this reimbursement 8,500 3. Of the amount on line 2, enter your total expense for meals and entertainment 4,500 4. Divide line 3 by line 2. Enter the result as a decimal (rounded to at least three places) .529 5. Multiply line 1 by line 4. Enter the result here and in Column B, line 7 3,703 6. Subtract line 5 from line 1. Enter the result here and in Column A, line 7 $3,297
On line 7 of Form 2106, Rob enters $8,297 ($5,000 airfare and $3,297 of the $7,000) in Column A and $3,703 (of the $7,000) in Column B.
After you complete the form. After you have completed your Form 2106 or 2106-EZ, follow the directions on that form to deduct your expenses on the appropriate line of your tax return. For most taxpayers, this is line 21 of Schedule A (Form 1040). However, if you are a government official paid on a fee basis, a performing artist, an Armed Forces reservist, or a disabled employee with impairment-related work expenses, see Special Rules, later.
Limits on employee business expenses. Your employee business expenses may be subject to any of the three limits described next. These limits are figured in the following order on the specified form.
Special Rules
This section discusses special rules that apply to Armed Forces reservists, government officials who are paid on a fee basis, performing artists, and disabled employees with impairment-related work expenses.
Armed Forces reservists traveling more than 100 miles from home. If you are a member of a reserve component of the Armed Forces of the United States and you travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you can deduct your travel expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. The amount of expenses you can deduct as an adjustment to gross income is limited to the regular federal per diem rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and tolls. The federal rate is explained earlier under Per Diem and Car Allowances. Any expenses in excess of these amounts can be claimed only as a miscellaneous itemized deduction subject to the 2% limit.
Member of a reserve component. You are a member of a reserve component of the Armed Forces of the United States if you are in the Army, Navy, Marine Corps, Air Force, or Coast Guard Reserve, the Army National Guard of the United States, the Air National Guard of the United States, or the Reserve Corps of the Public Health Service.
How to report. If you have reserve-related travel that takes you more than 100 miles from home, you should first complete Form 2106 or Form 2106-EZ. Then include your expenses for reserve travel over 100 miles from home, up to the federal rate, from Form 2106, line 10, or Form 2106-EZ, line 6, in the total on Form 1040, line 24. Subtract this amount from the total on Form 2106, line 10, or Form 2106-EZ, line 6, and deduct the balance as an itemized deduction on Schedule A (Form 1040), line 21.
You cannot deduct expenses of travel that does not take you more than 100 miles from home as an adjustment to gross income. Instead, you must complete Form 2106 or 2106-EZ and deduct those expenses as an itemized deduction on Schedule A (Form 1040), line 21.
Officials paid on a fee basis. Certain fee-basis officials can claim their employee business expenses whether or not they itemize their other deductions on Schedule A (Form 1040).
Fee-basis officials are persons who are employed by a state or local government and who are paid in whole or in part on a fee basis. They can deduct their business expenses in performing services in that job as an adjustment to gross income rather than as a miscellaneous itemized deduction.
If you are a fee-basis official, include your employee business expenses from Form 2106, line 10, or Form 2106-EZ, line 6, on Form 1040, line 24.
Expenses of certain performing artists. If you are a performing artist, you may qualify to deduct your employee business expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. To qualify, you must meet all of the following requirements.
Special rules for married persons. If you are married, you must file a joint return unless you lived apart from your spouse at all times during the tax year.
If you file a joint return, you must figure requirements (1), (2), and (3) separately for both you and your spouse. However, requirement (4) applies to your and your spouse's combined adjusted gross income.
Where to report. If you meet all of the above requirements, you should first complete Form 2106 or 2106-EZ. Then you include your performing-arts-related expenses from line 10 of Form 2106 or line 6 of Form 2106-EZ in the total on line 24 of Form 1040.
If you do not meet all of the above requirements, you do not qualify to deduct your expenses as an adjustment to gross income. Instead, you must complete Form 2106 or 2106-EZ and deduct your employee business expenses as an itemized deduction on Schedule A (Form 1040), line 21.
Impairment-related work expenses of disabled employees. If you are an employee with a physical or mental disability, your impairment-related work expenses are not subject to the 2%-of-adjusted-gross-income limit that applies to most other employee business expenses. After you complete Form 2106 or 2106-EZ, enter your impairment-related work expenses from Form 2106, line 10, or Form 2106-EZ, line 6, on Schedule A (Form 1040), line 28, and identify the type and amount of this expense on the dotted line next to line 28. Enter your employee business expenses that are unrelated to your disability from Form 2106, line 10, or Form 2106-EZ, line 6, on Schedule A, line 21.
Impairment-related work expenses are your allowable expenses for attendant care at your workplace and other expenses you have in connection with your workplace that are necessary for you to be able to work. For more information, see chapter 21.
Illustrated Example
Bill Wilson is an employee of Fashion Clothing Co. in Manhattan, NY. In a typical travel week, Bill leaves his home on Long Island on Monday morning and drives to Albany to exhibit the Fashion line for 3 days to prospective customers. Then he drives to Troy to show Fashion's new line of merchandise to Town Department Store, an old customer. While in Troy, he talks with Tom Brown, purchasing agent for Town Department Store, to discuss the new line. He later takes John Smith of Attire Co. out to dinner to discuss Attire Co.'s buying Fashion's new line of clothing.
Bill purchased his car on January 3, 2004. He uses the standard mileage rate for car expense purposes. He records his total mileage, business mileage, parking fees, and tolls for the year. Bill records his expenses and other pertinent information in a travel expense log (not shown). He obtains receipts for his expenses for lodging and for any other expenses of $75 or more.
During the year, Bill drove a total of 25,000 miles of which 20,000 miles were for business. He answers all the questions in Part II of Form 2106-EZ and figures his car expense to be $9,700 (20,000 × 48 1/2 cents per mile).
His total employee business expenses are shown in the following table.
Type of Expense Amount Parking fees and tolls $ 520 Car expenses 9,700 Meals 3,861 Lodging, laundry, dry cleaning 18,318 Entertainment 3,250 Gifts, education, etc. 650 -------- Total $36,299 ========
Bill received an allowance of $33,000 ($2,750 per month) to help offset his expenses. Bill did not have to account to his employer for the reimbursement, and the $33,000 was included as income in box 1 of his Form W-2.
Because Bill's reimbursement was included in his income and he is using the standard mileage rate for his car expenses, he files Form 2106-EZ with his tax return. His filled-in form is shown on the next page.
[The following graphic has not been reproduced:
2007 Wilsons' Example Form 2106-EZ, Unreimbursed Employee Business Expenses]
Standard mileage rate. Generally, if you claim a business deduction for work-related education and you drive your car to and from school, the amount you can deduct for miles driven during 2007 is 48 1/2 cents a mile. This is up from 44 1/2 cents a mile in 2006. See Transportation Expenses under What Expenses Can Be Deducted, for more information.
Limit on itemized deductions. If your adjusted gross income for 2007 is more than $156,400 ($78,200 if you are married filing separately), your itemized deductions may be limited. See chapter 29 for more information about this limit.
This chapter discusses work-related education expenses that you may be able to deduct as business expenses.
To claim such a deduction, you must:
If you are an employee and able to itemize your deductions, you may be able to claim a deduction for the expenses you pay for your work-related education. Your deduction will be the amount by which your qualifying work-related education expenses plus other job and certain miscellaneous expenses is greater than 2% of your adjusted gross income. See chapter 28.
If you are self-employed, you deduct your expenses for qualifying work-related education directly from your self-employment income.
Your work-related education expenses may also qualify you for other tax benefits, such as the tuition and fees deduction (see chapter 19) and the Hope and lifetime learning credits (see chapter 35). You may qualify for these other benefits even if you do not meet the requirements listed earlier.
Also, keep in mind that your work-related education expenses may qualify you to claim more than one tax benefit. Generally, you may claim any number of benefits as long as you use different expenses to figure each one.
Tip: When you figure your taxes, you may want to compare these tax benefits so you can choose the method(s) that give you the lowest tax liability. First, figure your taxes using the expenses as business deductions. Then, figure your taxes again using any of the other deductions and credits for which you qualify. You may find that a combination of credit(s) and deduction(s) gives you the lowest tax.
Useful Items
You may want to see:
Publication
Form (and Instructions)
You can deduct the costs of qualifying work-related education as business expenses. This is education that meets at least one of the following two tests.
However, even if the education meets one or both of the above tests, it is not qualifying work-related education if it:
You can deduct the costs of qualifying work-related education as a business expense even if the education could lead to a degree.
Use Figure 27-A, later, as a quick check to see if your education qualifies.
[The following graphic has not been reproduced:
Figure 27-A. Does Your Work-Related Education Qualify?]
Education Required by Employer or by Law
Once you have met the minimum educational requirements for your job, your employer or the law may require you to get more education. This additional education is qualifying work-related education if all three of the following requirements are met.
When you get more education than your employer or the law requires, the additional education can be qualifying work-related education only if it maintains or improves skills required in your present work. See Education To Maintain or Improve Skills, below.
Example. You are a teacher who has satisfied the minimum requirements for teaching. Your employer requires you to take an additional college course each year to keep your teaching job. If the courses will not qualify you for a new trade or business, they are qualifying work-related education even if you eventually receive a master's degree and an increase in salary because of this extra education.
Education To Maintain or Improve Skills
If your education is not required by your employer or the law, it can be qualifying work-related education only if it maintains or improves skills needed in your present work. This could include refresher courses, courses on current developments, and academic or vocational courses.
Example. You repair televisions, radios, and stereo systems for XYZ Store. To keep up with the latest changes, you take special courses in radio and stereo service. These courses maintain and improve skills required in your work.
Maintaining skills vs. qualifying for new job. Education to maintain or improve skills needed in your present work is not qualifying education if it will also qualify you for a new trade or business.
Temporary absence. If you stop working for a year or less in order to get education to maintain or improve skills needed in your present work and then return to the same general type of work, your absence is considered temporary. Education that you get during a temporary absence is qualifying work-related education if it maintains or improves skills needed in your present work.
Example. You quit your biology research job to become a full-time biology graduate student for one year. If you return to work in biology research after completing the courses, the education is related to your present work even if you do not go back to work with the same employer.
Indefinite absence. If you stop work for more than a year, your absence from your job is considered indefinite. Education during an indefinite absence, even if it maintains or improves skills needed in the work from which you are absent, is considered to qualify you for a new trade or business. Therefore, it is not qualifying work-related education.
Education To Meet Minimum Requirements
Education you need to meet the minimum educational requirements for your present trade or business is not qualifying work-related education. The minimum educational requirements are determined by:
Once you have met the minimum educational requirements that were in effect when you were hired, you do not have to meet any new minimum educational requirements. This means that if the minimum requirements change after you were hired, any education you need to meet the new requirements can be qualifying education.
Caution: You have not necessarily met the minimum educational requirements of your trade or business simply because you are already doing the work.
Example 1. You are a full-time engineering student. Although you have not received your degree or certification, you work part time as an engineer for a firm that will employ you as a full-time engineer after you finish college. Although your college engineering courses improve your skills in your present job, they are also needed to meet the minimum job requirements for a full-time engineer. The education is not qualifying work-related education.
Example 2. You are an accountant and you have met the minimum educational requirements of your employer. Your employer later changes the minimum educational requirements and requires you to take college courses to keep your job. These additional courses can be qualifying work-related education because you have already satisfied the minimum requirements that were in effect when you were hired.
Requirements for Teachers
States or school districts usually set the minimum educational requirements for teachers. The requirement is the college degree or the minimum number of college hours usually required of a person hired for that position.
If there are no requirements, you will have met the minimum educational requirements when you become a faculty member. You generally will be considered a faculty member when one or more of the following occurs.
Example 1. The law in your state requires beginning secondary school teachers to have a bachelor's degree, including 10 professional education courses. In addition, to keep the job, a teacher must complete a fifth year of training within 10 years from the date of hire. If the employing school certifies to the state Department of Education that qualified teachers cannot be found, the school can hire persons with only 3 years of college. However, to keep their jobs, these teachers must get a bachelor's degree and the required professional education courses within 3 years.
Under these facts, the bachelor's degree, whether or not it includes the 10 professional education courses, is considered the minimum educational requirement for qualification as a teacher in your state.
If you have all the required education except the fifth year, you have met the minimum educational requirements. The fifth year of training is qualifying work-related education unless it is part of a program of study that will qualify you for a new trade or business.
Example 2. Assume the same facts as in Example 1 except that you have a bachelor's degree and only six professional education courses. The additional four education courses can be qualifying work-related education. Although you do not have all the required courses, you have already met the minimum educational requirements.
Example 3. Assume the same facts as in Example 1 except that you are hired with only 3 years of college. The courses you take that lead to a bachelor's degree (including those in education) are not qualifying work-related education. They are needed to meet the minimum educational requirements for employment as a teacher.
Example 4. You have a bachelor's degree and you work as a temporary instructor at a university. At the same time, you take graduate courses toward an advanced degree. The rules of the university state that you can become a faculty member only if you get a graduate degree. Also, you can keep your job as an instructor only as long as you show satisfactory progress toward getting this degree. You have not met the minimum educational requirements to qualify you as a faculty member. The graduate courses are not qualifying work-related education.
Certification in a new state. Once you have met the minimum educational requirements for teachers for your state, you are considered to have met the minimum educational requirements in all states. This is true even if you must get additional education to be certified in another state. Any additional education you need is qualifying work-related education. You have already met the minimum requirements for teaching. Teaching in another state is not a new trade or business.
Example. You hold a permanent teaching certificate in State A and are employed as a teacher in that state for several years. You move to State B and are promptly hired as a teacher. You are required, however, to complete certain prescribed courses to get a permanent teaching certificate in State B. These additional courses are qualifying work-related education because the teaching position in State B involves the same general kind of work for which you were qualified in State A.
Education That Qualifies You for a New Trade or Business
Education that is part of a program of study that will qualify you for a new trade or business is not qualifying work-related education. This is true even if you do not plan to enter that trade or business.
If you are an employee, a change of duties that involves the same general kind of work is not a new trade or business.
Example 1. You are an accountant. Your employer requires you to get a law degree at your own expense. You register at a law school for the regular curriculum that leads to a law degree. Even if you do not intend to become a lawyer, the education is not qualifying because the law degree will qualify you for a new trade or business.
Example 2. You are a general practitioner of medicine. You take a 2-week course to review developments in several specialized fields of medicine. The course does not qualify you for a new profession. It is qualifying work-related education because it maintains or improves skills required in your present profession.
Example 3. While working in the private practice of psychiatry, you enter a program to study and train at an accredited psychoanalytic institute. The program will lead to qualifying you to practice psychoanalysis. The psychoanalytic training does not qualify you for a new profession. It is qualifying work-related education because it maintains or improves skills required in your present profession.
Bar or CPA Review Course
Review courses to prepare for the bar examination or the certified public accountant (CPA) examination are not qualifying work-related education. They are part of a program of study that can qualify you for a new profession.
Teaching and Related Duties
All teaching and related duties are considered the same general kind of work. A change in duties in any of the following ways is not considered a change to a new business.
If your education meets the requirements described earlier under Qualifying Work-Related Education, you can generally deduct your education expenses as business expenses. If you are not self-employed, you can deduct business expenses only if you itemize your deductions.
You cannot deduct expenses related to tax-exempt and excluded income.
Deductible expenses. The following education expenses can be deducted.
Nondeductible expenses. You cannot deduct personal or capital expenses. For example, you cannot deduct the dollar value of vacation time or annual leave you take to attend classes. This amount is a personal expense.
Unclaimed reimbursement. If you do not claim reimbursement that you are entitled to receive from your employer, you cannot deduct the expenses that apply to the reimbursement.
Example. Your employer agrees to pay your education expenses if you file a voucher showing your expenses. You do not file a voucher, and you do not get reimbursed. Because you did not file a voucher, you cannot deduct the expenses on your tax return.
If your education qualifies, you can deduct local transportation costs of going directly from work to school. If you are regularly employed and go to school on a temporary basis, you can also deduct the costs of returning from school to home.
Attendance on a temporary basis. You go to school on a temporary basis if either of the following situations applies to you.
Note. If you are in either situation (1) or (2) above, your attendance is not temporary if facts and circumstances indicate otherwise.
Attendance not on a temporary basis. You do not go to school on a temporary basis if either of the following situations apply to you.
Deductible Transportation Expenses
If you are regularly employed and go directly from home to school on a temporary basis, you can deduct the round-trip costs of transportation between your home and school. This is true regardless of the location of the school, the distance traveled, or whether you attend school on nonwork days.
Transportation expenses include the actual costs of bus, subway, cab, or other fares, as well as the costs of using your car. Transportation expenses do not include amounts spent for travel, meals, or lodging while you are away from home overnight.
Example 1. You regularly work in a nearby town, and go directly from work to home. You also attend school every work night for 3 months to take a course that improves your job skills. Since you are attending school on a temporary basis, you can deduct your daily round-trip transportation expenses in going between home and school. This is true regardless of the distance traveled.
Example 2. Assume the same facts as in Example 1 except that on certain nights you go directly from work to school and then home. You can deduct your transportation expenses from your regular work site to school and then home.
Example 3. Assume the same facts as in Example 1 except that you attend the school for 9 months on Saturdays, nonwork days. Since you are attending school on a temporary basis, you can deduct your round-trip transportation expenses in going between home and school.
Example 4. Assume the same facts as in Example 1 except that you attend classes twice a week for 15 months. Since your attendance in school is not considered temporary, you cannot deduct your transportation expenses in going between home and school. If you go directly from work to school, you can deduct the one-way transportation expenses of going from work to school. If you go from work to home to school and return home, your transportation expenses cannot be more than if you had gone directly from work to school.
Using your car. If you use your car (whether you own or lease it) for transportation to school, you can deduct your actual expenses or use the standard mileage rate to figure the amount you can deduct. The standard mileage rate for miles driven during 2007 is 48 1/2 cents a mile. Whichever method you use, you can also deduct parking fees and tolls. See chapter 26 for information on deducting your actual expenses of using a car.
You can deduct expenses for travel, meals (see 50% limit on meals, later), and lodging if you travel overnight mainly to obtain qualifying work-related education.
Travel expenses for qualifying work-related education are treated the same as travel expenses for other employee business purposes. For more information, see chapter 26.
Caution: You cannot deduct expenses for personal activities, such as sightseeing, visiting, or entertaining.
Mainly personal travel. If your travel away from home is mainly personal, you cannot deduct all of your expenses for travel, meals, and lodging. You can deduct only your expenses for lodging and 50% of your expenses for meals during the time you attend the qualified educational activities.
Whether a trip's purpose is mainly personal or educational depends upon the facts and circumstances. An important factor is the comparison of time spent on personal activities with time spent on educational activities. If you spend more time on personal activities, the trip is considered mainly educational only if you can show a substantial nonpersonal reason for traveling to a particular location.
Example 1. John works in Newark, New Jersey. He traveled to Chicago to take a deductible 1-week course at the request of his employer. His main reason for going to Chicago was to take the course.
While there, he took a sightseeing trip, entertained some friends, and took a side trip to Pleasantville for a day.
Since the trip was mainly for business, John can deduct his round-trip airfare to Chicago. He cannot deduct his transportation expenses of going to Pleasantville. He can deduct only the meals (subject to the 50% limit) and lodging connected with his educational activities.
Example 2. Sue works in Boston. She went to a university in Michigan to take a course for work. The course is qualifying work-related education.
She took one course, which is one-fourth of a full course load of study. She spent the rest of the time on personal activities. Her reasons for taking the course in Michigan were all personal.
Sue's trip is mainly personal because three-fourths of her time is considered personal time. She cannot deduct the cost of her round-trip train ticket to Michigan. She can deduct one-fourth of the meals (subject to the 50% limit) and lodging costs for the time she attended the university.
Example 3. Dave works in Nashville and recently traveled to California to take a 2-week seminar. The seminar is qualifying work-related education.
While there, he spent an extra 8 weeks on personal activities. The facts, including the extra 8-week stay, show that his main purpose was to take a vacation.
Dave cannot deduct his round-trip airfare or his meals and lodging for the 8 weeks. He can deduct only his expenses for meals (subject to the 50% limit) and lodging for the 2 weeks he attended the seminar.
Cruises and conventions. Certain cruises and conventions offer seminars or courses as part of their itinerary. Even if the seminars or courses are work related, your deduction for travel may be limited. This applies to:
For a discussion of the limits on travel expense deductions that apply to cruises and conventions, see Luxury Water Travel and Conventions in Publication 463.
50% limit on meals. You can deduct only 50% of the cost of your meals while traveling away from home to obtain qualifying work-related education. You cannot have been reimbursed for the meals.
Employees must use Form 2106 or Form 2106-EZ to apply the 50% limit.
You cannot deduct the cost of travel as a form of education even if it is directly related to your duties in your work or business.
Example. You are a French language teacher. While on sabbatical leave granted for travel, you traveled through France to improve your knowledge of the French language. You chose your itinerary and most of your activities to improve your French language skills. You cannot deduct your travel expenses as education expenses. This is true even if you spent most of your time learning French by visiting French schools and families, attending movies or plays, and engaging in similar activities.
No Double Benefit Allowed
You cannot do either of the following.
Adjustments to Qualifying Work-Related Education Expenses
If you pay qualifying work-related education expenses with certain tax-free funds, you cannot claim a deduction for those amounts. You must reduce the qualifying expenses by the amount of any tax-free educational assistance you received.
Tax-free educational assistance includes:
Amounts that do not reduce qualifying work-related education expenses. Do not reduce the qualifying work-related education expenses by amounts paid with funds the student receives as:
Also, do not reduce the qualifying work-related education expenses by any scholarship or fellowship reported as income on the student's return or any scholarship which, by its terms, cannot be applied to qualifying work-related education expenses.
How you treat reimbursements depends on the arrangement you have with your employer.
There are two basic types of reimbursement arrangements -- accountable plans and nonaccountable plans. You can tell the type of plan you are reimbursed under by the way the reimbursement is reported on your Form W-2.
For information about how to treat reimbursements under both accountable and nonaccountable plans, see Reimbursements in chapter 26.
Self-employed persons and employees report business expenses differently.
The following information explains what forms you must use to deduct the cost of your qualifying work-related education as a business expense.
Self-Employed Persons
If you are self-employed, you must report the cost of your qualifying work-related education on the appropriate form used to report your business income and expenses (generally Schedule C, C-EZ, or F). If your educational expenses include expenses for a car or truck, travel, or meals, report those expenses the same way you report other business expenses for those items. See the instructions for the form you file for information on how to complete it.
Employees
If you are an employee, you can deduct the cost of qualifying work-related education only if you:
If either (1) or (2) applies, you can deduct the total qualifying cost. If (3) applies, you can deduct only the qualifying costs that were more than your reimbursement.
In order to deduct the cost of your qualifying work-related education as a business expense, include the amount with your deduction for any other employee business expenses on Schedule A (Form 1040), line 21. (Special rules for expenses of certain performing artists and fee-basis officials and for impairment-related work expenses are explained later.)
This deduction is subject to the 2%-of-adjusted-gross-income limit that applies to most miscellaneous itemized deductions. See chapter 28.
Form 2106 or 2106-EZ. To figure your deduction for employee business expenses, including qualifying work-related education, you generally must complete Form 2106 or Form 2106-EZ.
Form not required. Do not complete either Form 2106 or Form 2106-EZ if:
If you meet both of these requirements, enter the expenses directly on Schedule A (Form 1040), line 21. (Special rules for expenses of certain performing artists and fee-basis officials and for impairment-related work expenses are explained below.)
Using Form 2106-EZ. This form is shorter and easier to use than Form 2106. Generally, you can use this form if:
If you do not meet both of these requirements, use Form 2106.
Performing Artists and Fee-Basis Officials
If you are a qualified performing artist, or a state (or local) government official who is paid in whole or in part on a fee basis, you can deduct the cost of your qualifying work-related education as an adjustment to gross income rather than as an itemized deduction.
Include the cost of your qualifying work-related education with any other employee business expenses on Form 1040, line 24. You do not have to itemize your deductions on Schedule A (Form 1040), and, therefore, the deduction is not subject to the 2%-of-adjusted-gross-income limit. You must complete Form 2106 or 2106-EZ to figure your deduction, even if you meet the requirements described earlier under Form not required.
For more information on qualified performing artists, see Publication 463.
Impairment-Related Work Expenses
If you are disabled and have impairment-related work expenses that are necessary for you to be able to get qualifying work-related education, you can deduct these expenses on Schedule A (Form 1040), line 28. They are not subject to the 2%-of-adjusted-gross-income limit. To deduct these expenses, you must complete Form 2106 or 2106-EZ, even if you meet the requirements, described earlier under Form not required.
For more information on impairment-related work expenses, see Publication 463.
Records: You must keep records as proof of any deduction claimed on your tax return. Generally, you should keep your records for 3 years from the date of filing the tax return and claiming the deduction.
For specific information about keeping records of business expenses, see Recordkeeping in chapter 26.
Limit on itemized deductions. The amount of adjusted gross income allowed without limiting your itemized deductions has increased. For 2007, if your adjusted gross income is more than $156,400 ($78,200 if you are married filing separately), you may have to reduce the amount of certain itemized deductions, including most miscellaneous deductions. For more information and a worksheet, see the instructions for Schedule A (Form 1040), line 29, or chapter 29.
This chapter explains which expenses you can claim as miscellaneous itemized deductions on Schedule A (Form 1040). You must reduce the total of most miscellaneous itemized deductions by 2% of your adjusted gross income. This chapter covers the following topics.
Records: You must keep records to verify your deductions. You should keep receipts, canceled checks, substitute checks, financial account statements, and other documentary evidence. For more information on recordkeeping, get Publication 552, Recordkeeping for Individuals.
Useful Items
You may want to see:
Publication
Form (and Instructions)
You can deduct certain expenses as miscellaneous itemized deductions on Schedule A (Form 1040). You can claim the amount of expenses that is more than 2% of your adjusted gross income. You figure your deduction on Schedule A by subtracting 2% of your adjusted gross income from the total amount of these expenses. Your adjusted gross income is the amount on Form 1040, line 38.
Generally, you apply the 2% limit after you apply any other deduction limit. For example, you apply the 50% (or 75%) limit on business-related meals and entertainment (discussed in chapter 26) before you apply the 2% limit.
Deductions subject to the 2% limit are discussed in the three categories in which you report them on Schedule A.
Unreimbursed Employee Expenses (Line 21)
You can deduct only unreimbursed employee expenses that are:
An expense is ordinary if it is common and accepted in your trade, business, or profession. An expense is necessary if it is appropriate and helpful to your business. An expense does not have to be required to be considered necessary.
Examples of unreimbursed employee expenses are listed next. The list is followed by discussions of additional unreimbursed employee expenses.
You can deduct insurance premiums you paid for protection against personal liability for wrongful acts on the job.
Damages for Breach of Employment Contract
If you break an employment contract, you can deduct damages you pay your former employer that are attributable to the pay you received from that employer.
Depreciation on Computers or Cell Phones
You can claim a depreciation deduction for a computer or cell phone that you use in your work as an employee if its use is:
For more information about the rules and exceptions to the rules affecting the allowable deductions for a home computer or cell phone, see Publication 529.
Dues to Chambers of Commerce and Professional Societies
You may be able to deduct dues paid to professional organizations (such as bar associations and medical associations) and to chambers of commerce and similar organizations, if membership helps you carry out the duties of your job. Similar organizations include:
You cannot deduct dues paid to an organization if one of its main purposes is to:
Dues paid to airline, hotel, and luncheon clubs are not deductible. See Club Dues under Nondeductible Expenses, later.
Lobbying and political activities. You may not be able to deduct that part of your dues that is for certain lobbying and political activities. See Dues used for lobbying under Lobbying Expenses, later.
Educator Expenses over Limit
If you were an eligible educator in 2007, and you had qualified educator expenses that you cannot take as an adjustment to gross income, you can deduct the rest of those expenses that are ordinary and necessary as an itemized deduction subject to the 2% limit. For information on educator expenses that you can take as an adjustment to gross income, see chapter 26.
If you use a part of your home regularly and exclusively for business purposes, you may be able to deduct a part of the operating expenses and depreciation of your home.
You can claim this deduction for the business use of a part of your home only if you use that part of your home regularly and exclusively:
The regular and exclusive business use must be for the convenience of your employer and not just appropriate and helpful in your job. Get Publication 587 for more detailed information and a worksheet.
You can deduct certain expenses you have in looking for a new job in your present occupation, even if you do not get a new job. You cannot deduct these expenses if:
Employment and outplacement agency fees. You can deduct employment and outplacement agency fees you pay in looking for a new job in your present occupation.
Employer pays you back. If, in a later year, your employer pays you back for employment agency fees, you must include the amount you receive in your gross income up to the amount of your tax benefit in the earlier year. (See Recoveries in chapter 12.)
Employer pays the employment agency. If your employer pays the fees directly to the employment agency and you are not responsible for them, you do not include them in your gross income.
Résumé. You can deduct amounts you spend for preparing and mailing copies of a résumé to prospective employers if you are looking for a new job in your present occupation.
Travel and transportation expenses. If you travel to an area and, while there, you look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area. You can deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend in looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.
Even if you cannot deduct the travel expenses to and from an area, you can deduct the expenses of looking for a new job in your present occupation while in the area.
You can choose to use the standard mileage rate to figure your car expenses. The rate for business use of a vehicle is 48 1/2 cents per mile. See chapter 26 for more information.
Licenses and Regulatory Fees
You can deduct the amount you pay each year to state or local governments for licenses and regulatory fees for your trade, business, or profession.
Occupational Taxes
You can deduct an occupational tax charged at a flat rate by a locality for the privilege of working or conducting a business in the locality. If you are an employee, you can claim occupational taxes only as a miscellaneous deduction subject to the 2% limit; you cannot claim them as a deduction for taxes elsewhere on your return.
Repayment of Income Aid Payment
An "income aid payment" is one that is received under an employer's plan to aid employees who lose their jobs because of lack of work. If you repay a lump-sum income aid payment that you received and included in income in an earlier year, you can deduct the repayment.
Research Expenses of a College Professor
If you are a college professor, you can deduct research expenses, including travel expenses, for teaching, lecturing, or writing and publishing on subjects that relate directly to your teaching duties. You must have undertaken the research as a means of carrying out the duties expected of a professor and without expectation of profit apart from salary. However, you cannot deduct the cost of travel as a form of education.
Tools Used in Your Work
Generally, you can deduct amounts you spend for tools used in your work if the tools wear out and are thrown away within 1 year from the date of purchase. You can depreciate the cost of tools that have a useful life substantially beyond the tax year. For more information about depreciation, see Publication 946.
You can deduct dues and initiation fees you pay for union membership.
You can also deduct assessments for benefit payments to unemployed union members. However, you cannot deduct the part of the assessments or contributions that provides funds for the payment of sick, accident, or death benefits. Also, you cannot deduct contributions to a pension fund, even if the union requires you to make the contributions.
You may not be able to deduct amounts you pay to the union that are related to certain lobbying and political activities. See Lobbying Expenses under Nondeductible Expenses, later.
You can deduct the cost and upkeep of work clothes if the following two requirements are met.
Caution: It is not enough that you wear distinctive clothing. The clothing must be specifically required by your employer. Nor is it enough that you do not, in fact, wear your work clothes away from work. The clothing must not be suitable for taking the place of your regular clothing.
Examples of workers who may be able to deduct the cost and upkeep of work clothes are: delivery workers, firefighters, health care workers, law enforcement officers, letter carriers, professional athletes, and transportation workers (air, rail, bus, etc.).
Musicians and entertainers can deduct the cost of theatrical clothing and accessories that are not suitable for everyday wear.
However, work clothing consisting of white cap, white shirt or white jacket, white bib overalls, and standard work shoes, which a painter is required by his union to wear on the job, is not distinctive in character or in the nature of a uniform. Similarly, the costs of buying and maintaining blue work clothes worn by a welder at the request of a foreman are not deductible.
Protective clothing. You can deduct the cost of protective clothing required in your work, such as safety shoes or boots, safety glasses, hard hats, and work gloves.
Examples of workers who may be required to wear safety items are: carpenters, cement workers, chemical workers, electricians, fishing boat crew members, machinists, oil field workers, pipe fitters, steamfitters, and truck drivers.
Military uniforms. You generally cannot deduct the cost of your uniforms if you are on full-time active duty in the armed forces. However, if you are an armed forces reservist, you can deduct the unreimbursed cost of your uniform if military regulations restrict you from wearing it except while on duty as a reservist. In figuring the deduction, you must reduce the cost by any nontaxable allowance you receive for these expenses.
If local military rules do not allow you to wear fatigue uniforms when you are off duty, you can deduct the amount by which the cost of buying and keeping up these uniforms is more than the uniform allowance you receive.
You can deduct the cost of your uniforms if you are a civilian faculty or staff member of a military school.
Tax Preparation Fees (Line 22)
You can usually deduct tax preparation fees in the year you pay them. Thus, on your 2007 return, you can deduct fees paid in 2007 for preparing your 2006 return. These fees include the cost of tax preparation software programs and tax publications. They also include any fee you paid for electronic filing of your return. However, if you paid your tax by credit card, you cannot deduct the convenience fee you were charged.
You can deduct certain other expenses as miscellaneous itemized deductions subject to the 2% limit. These are expenses you pay:
You can deduct expenses you pay for the purposes in (1) and (2) above only if they are reasonably and closely related to these purposes. Some of these other expenses are explained in the following discussions.
If the expenses you pay produce income that is only partially taxable, see Tax-Exempt Income Expenses, later, under Nondeductible Expenses.
You can deduct appraisal fees if you pay them to figure a casualty loss or the fair market value of donated property.
Certain Casualty and Theft Losses
You can deduct a casualty or theft loss as a miscellaneous itemized deduction subject to the 2% limit if you used the damaged or stolen property in performing services as an employee. First report the loss in Section B of Form 4684, Casualties and Thefts. You may also have to include the loss on Form 4797, Sales of Business Property, if you are otherwise required to file that form. To figure your deduction, add all casualty or theft losses from this type of property included on Form 4684, lines 32 and 38b, or Form 4797, line 18a. For other casualty and theft losses, see chapter 25.
Clerical Help and Office Rent
You can deduct office expenses, such as rent and clerical help, that you have in connection with your investments and collecting the taxable income on them.
You can deduct depreciation on your home computer if you use it to produce income (for example, to manage your investments that produce taxable income). You generally must depreciate the computer using the straight line method over the Alternative Depreciation System (ADS) recovery period. But if you work as an employee and also use the computer in that work, see Publication 946.
Excess Deductions of an Estate
If an estate's total deductions in its last tax year are more than its gross income for that year, the beneficiaries succeeding to the estate's property can deduct the excess. Do not include deductions for the estate's personal exemption and charitable contributions when figuring the estate's total deductions. The beneficiaries can claim the deduction only for the tax year in which, or with which, the estate terminates, whether the year of termination is a normal year or a short tax year. For more information, see Termination of Estate in Publication 559, Survivors, Executors, and Administrators.
Fees to Collect Interest and Dividends
You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect your taxable bond interest or dividends on shares of stock. But you cannot deduct a fee you pay to a broker to buy investment property, such as stocks or bonds. You must add the fee to the cost of the property.
You cannot deduct the fee you pay to a broker to sell securities. You can use the fee only to figure gain or loss from the sale. See the instructions for Schedule D (Form 1040), columns (d) and (e), for information on how to report the fee.
Hobby Expenses
You can generally deduct hobby expenses, but only up to the amount of hobby income. A hobby is not a business because it is not carried on to make a profit. See Activity not for profit in chapter 12 under Other Income.
Indirect Deductions of Pass-Through Entities
Pass-through entities include partnerships, S corporations, and mutual funds that are not publicly offered. Deductions of pass-through entities are passed through to the partners or shareholders. The partners or shareholders can deduct their share of passed-through deductions for investment expenses as miscellaneous itemized deductions subject to the 2% limit.
Example. You are a member of an investment club that is formed solely to invest in securities. The club is treated as a partnership. The partnership's income is solely from taxable dividends, interest, and gains from sales of securities. In this case, you can deduct your share of the partnership's operating expenses as miscellaneous itemized deductions subject to the 2% limit. However, if the investment club partnership has investments that also produce nontaxable income, you cannot deduct your share of the partnership's expenses that produce the nontaxable income.
Publicly offered mutual funds. Publicly offered mutual funds do not pass deductions for investment expenses through to shareholders. A mutual fund is "publicly offered" if it is:
A publicly offered mutual fund will send you a Form 1099-DIV, Dividends and Distributions, or a substitute form, showing the net amount of dividend income (gross dividends minus investment expenses). This net figure is the amount you report on your return as income. You cannot deduct investment expenses.
Information returns. You should receive information returns from pass-through entities.
Partnerships and S corporations. These entities issue Schedule K-1, which lists the items and amounts you must report and identifies the tax return schedules and lines to use.
Nonpublicly offered mutual funds. These funds will send you a Form 1099-DIV, or a substitute form, showing your share of gross income and investment expenses. You can claim the expenses only as a miscellaneous itemized deduction subject to the 2% limit.
Investment Fees and Expenses
You can deduct investment fees, custodial fees, trust administration fees, and other expenses you paid for managing your investments that produce taxable income.
Legal Expenses
You can usually deduct legal expenses that you incur in attempting to produce or collect taxable income or that you pay in connection with the determination, collection, or refund of any tax.
You can also deduct legal expenses that are:
You can deduct expenses of resolving tax issues relating to profit or loss from business (Schedule C or C-EZ), rentals or royalties (Schedule E), or farm income and expenses (Schedule F) on the appropriate schedule. You deduct expenses of resolving nonbusiness tax issues on Schedule A (Form 1040). See Tax Preparation Fees, earlier.
Loss on Deposits
For information on whether, and if so, how, you may deduct a loss on your deposit in a qualified financial institution, see Loss on Deposits in chapter 25.
If you had to repay an amount that you included in income in an earlier year, you may be able to deduct the amount you repaid. If the amount you had to repay was ordinary income of $3,000 or less, the deduction is subject to the 2% limit. If it was more than $3,000, see Repayments Under Claim of Right under Deductions Not Subject to the 2% Limit, later.
Repayments of Social Security Benefits
For information on how to deduct your repayments of certain social security benefits, see Repayments More Than Gross Benefits in chapter 11.
Safe Deposit Box Rent
You can deduct safe deposit box rent if you use the box to store taxable income-producing stocks, bonds, or investment-related papers and documents. You cannot deduct the rent if you use the box only for jewelry, other personal items, or tax-exempt securities.
Service Charges on Dividend Reinvestment Plans
You can deduct service charges you pay as a subscriber in a dividend reinvestment plan. These service charges include payments for:
Trustee's Administrative Fees for IRA
Trustee's administrative fees that are billed separately and paid by you in connection with your individual retirement arrangement (IRA) are deductible (if they are ordinary and necessary) as a miscellaneous itemized deduction subject to the 2% limit. For more information about IRAs, see chapter 17.
You can deduct the items listed below as miscellaneous itemized deductions. They are not subject to the 2% limit. Report these items on Schedule A (Form 1040), line 28.
List of Deductions
Each of the following items is discussed in detail after the list.
Amortizable Premium on Taxable Bonds
In general, if the amount you pay for a bond is greater than its stated principal amount, the excess is bond premium. You can elect to amortize the premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item.
Part of the premium on some bonds may be a miscellaneous deduction not subject to the 2% limit. For more information, see Amortizable Premium on Taxable Bonds in Publication 529, and Bond Premium Amortization in chapter 3 of Publication 550, Investment Income and Expenses.
Certain Casualty and Theft Losses
You can deduct a casualty or theft loss as a miscellaneous itemized deduction not subject to the 2% limit if the damaged or stolen property was income-producing property (property held for investment, such as stocks, notes, bonds, gold, silver, vacant lots, and works of art). First, report the loss in Form 4684, Section B. You may also have to include the loss on Form 4797 if you are otherwise required to file that form. To figure your deduction, add all casualty or theft losses from this type of property included on Form 4684, lines 32 and 38b, or Form 4797, line 18a. For more information on casualty and theft losses, see chapter 25.
Federal Estate Tax on Income in Respect of a Decedent
You can deduct the federal estate tax attributable to income in respect of a decedent that you as a beneficiary include in your gross income. Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. See Publication 559 for more information.
Gambling Losses Up to the Amount of Gambling Winnings
You must report the full amount of your gambling winnings for the year on Form 1040, line 21. You deduct your gambling losses for the year on Schedule A (Form 1040), line 28. You cannot deduct gambling losses that are more than your winnings.
Caution: You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately from your losses.
Records: Diary of winnings and losses. You must keep an accurate diary or similar record of your losses and winnings. Your diary should contain at least the following information.
See Publication 529 for more information.
Impairment-Related Work Expenses
If you have a physical or mental disability that limits your being employed, or substantially limits one or more of your major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, you can deduct your impairment-related work expenses.
Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at your place of work and for other expenses in connection with your place of work that are necessary for you to be able to work.
Self-employed. If you are self-employed, enter your impairment-related work expenses on the appropriate form (Schedule C, C-EZ, E, or F) used to report your business income and expenses.
Loss From Other Activities From Schedule K-1 (Form 1065-B), Box 2
If the amount reported in Schedule K-1 (Form 1065-B), box 2, is a loss, report it on Schedule A (Form 1040), line 28. It is not subject to the passive activity limitations.
Repayments Under Claim of Right
If you had to repay more than $3,000 that you included in your income in an earlier year because at the time you thought you had an unrestricted right to it, you may be able to deduct the amount you repaid or take a credit against your tax. See Repayments in chapter 12 for more information.
Unrecovered Investment in Annuity
A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final income tax return. See chapter 10 for more information about the tax treatment of pensions and annuities.
Examples of nondeductible expenses are listed next. The list is followed by discussions of additional nondeductible expenses.
List of Nondeductible Expenses
Adoption Expenses
You cannot deduct the expenses of adopting a child, but you may be able to take a credit for those expenses. See chapter 37.
Campaign Expenses
You cannot deduct campaign expenses of a candidate for any office, even if the candidate is running for reelection to the office. These include qualification and registration fees for primary elections.
Legal fees. You cannot deduct legal fees paid to defend charges that arise from participation in a political campaign.
Check-Writing Fees on Personal Account
If you have a personal checking account, you cannot deduct fees charged by the bank for the privilege of writing checks, even if the account pays interest.
Generally, you cannot deduct the cost of membership in any club organized for business, pleasure, recreation, or other social purpose. This includes business, social, athletic, luncheon, sporting, airline, hotel, golf, and country clubs.
Commuting Expenses
You cannot deduct commuting expenses (the cost of transportation between your home and your main or regular place of work). If you haul tools, instruments, or other items, in your car to and from work, you can deduct only the additional cost of hauling the items such as the rent on a trailer to carry the items.
You cannot deduct fines or penalties you pay to a governmental unit for violating a law. This includes an amount paid in settlement of your actual or potential liability for a fine or penalty (civil or criminal). Fines or penalties include parking tickets, tax penalties, and penalties deducted from teachers' paychecks after an illegal strike.
Health Spa Expenses
You cannot deduct health spa expenses, even if there is a job requirement to stay in excellent physical condition, such as might be required of a law enforcement officer.
Home Security System
You cannot deduct the cost of a home security system as a miscellaneous deduction. However, you may be able to claim a deduction for a home security system as a business expense if you have a home office. See Home Office under Unreimbursed Employee Expenses, earlier, and Security System under Deducting Expenses in Publication 587.
Investment-Related Seminars
You cannot deduct any expenses for attending a convention, seminar, or similar meeting for investment purposes.
You cannot deduct premiums you pay on your life insurance. You may be able to deduct, as alimony, premiums you pay on life insurance policies assigned to your former spouse. See chapter 18 for information on alimony.
You generally cannot deduct amounts paid or incurred for lobbying expenses. These include expenses to:
Lobbying expenses also include any amounts paid or incurred for research, preparation, planning, or coordination of any of these activities.
Dues used for lobbying. If a tax-exempt organization notifies you that part of the dues or other amounts you pay to the organization are used to pay nondeductible lobbying expenses, you cannot deduct that part. See Lobbying Expenses in Publication 529 for information on exceptions.
Lost or Mislaid Cash or Property
You cannot deduct a loss based on the mere disappearance of money or property. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual. See chapter 25.
Example. A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.
Lunches with Co-workers
You cannot deduct the expenses of lunches with co-workers, except while traveling away from home on business. See chapter 26 for information on deductible expenses while traveling away from home.
Meals While Working Late
You cannot deduct the cost of meals while working late. However, you may be able to claim a deduction if the cost of meals is a deductible entertainment expense, or if you are traveling away from home. See chapter 26 for information on deductible entertainment expenses and expenses while traveling away from home.
Personal Legal Expenses
You cannot deduct personal legal expenses such as those for the following.
You cannot deduct these expenses even if a result of the legal proceeding is the loss of income-producing property.
Political Contributions
You cannot deduct contributions made to a political candidate, a campaign committee, or a newsletter fund. Advertisements in convention bulletins and admissions to dinners or programs that benefit a political party or political candidate are not deductible.
Professional Accreditation Fees
You cannot deduct professional accreditation fees such as the following.
Professional Reputation
You cannot deduct expenses of radio and TV appearances to increase your personal prestige or establish your professional reputation.
Relief Fund Contributions
You cannot deduct contributions paid to a private plan that pays benefits to any covered employee who cannot work because of any injury or illness not related to the job.
Residential Telephone Service
You cannot deduct any charge (including taxes) for basic local telephone service for the first telephone line to your residence, even if it is used in a trade or business.
Stockholders' Meetings
You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you own stock but have no other interest. You cannot deduct these expenses even if you are attending the meeting to get information that would be useful in making further investments.
You cannot deduct expenses to produce tax-exempt income. You cannot deduct interest on a debt incurred or continued to buy or carry tax-exempt securities.
If you have expenses to produce both taxable and tax-exempt income, but you cannot identify the expenses that produce each type of income, you must divide the expenses based on the amount of each type of income to determine the amount that you can deduct.
Example. During the year, you received taxable interest of $4,800 and tax-exempt interest of $1,200. In earning this income, you had total expenses of $500 during the year. You cannot identify the amount of each expense item that is for each income item. Therefore, 80% ($4,800/$6,000) of the expense is for the taxable interest and 20% ($1,200/$6,000) is for the tax-exempt interest. You can deduct, subject to the 2% limit, expenses of $400 (80% of $500).
Travel Expenses for Another Individual
You generally cannot deduct travel expenses you pay or incur for a spouse, dependent, or other individual who accompanies you (or your employee) on business or personal travel. See chapter 26 for more information on deductible travel expenses.
Voluntary Unemployment Benefit Fund Contributions
You cannot deduct voluntary unemployment benefit fund contributions you make to a union fund or a private fund. However, you can deduct contributions as taxes if state law requires you to make them to a state unemployment fund that covers you for the loss of wages from unemployment caused by business conditions.
Wristwatches
You cannot deduct the cost of a wristwatch, even if there is a job requirement that you know the correct time to properly perform your duties.
This chapter discusses the overall limit on itemized deductions on Schedule A (Form 1040). The following topics are included.
Useful Items
You may want to see:
Form (and Instructions)
You are subject to the limit on certain itemized deductions if your adjusted gross income (AGI) is more than $156,400 ($78,200 if you are married filing separately). Your AGI is the amount on Form 1040, line 38.
The following Schedule A (Form 1040) deductions are subject to the overall limit on itemized deductions.
The following Schedule A (Form 1040) deductions are not subject to the overall limit on itemized deductions. However, they are still subject to other applicable limits.
If your itemized deductions are subject to the limit, the total of all your itemized deductions is reduced by the smaller of the following reduced by one-third:
Before you figure the overall limit on itemized deductions, you first must complete Schedule A (Form 1040), lines 1 through 28, including any related forms (such as Form 2106, Form 4684, etc.).
The overall limit on itemized deductions is figured after you have applied any other limit on the allowance of any itemized deduction. These other limits include charitable contribution limits (chapter 24), the limit on certain meal and entertainment expenses (chapter 26), and the 2%-of-adjusted-gross-income limit on certain miscellaneous deductions (chapter 28).
Itemized Deductions Worksheet. After you have completed Schedule A (Form 1040) through line 28, you can use the Itemized Deductions Worksheet in the Instructions for Schedule A (Form 1040) to figure your limit. Enter the result on Schedule A (Form 1040), line 29. Keep the worksheet for your records.
Tip: You should compare the amount of your standard deduction to the amount of your itemized deductions after applying the limit. Use the greater amount when completing Form 1040, line 40. See chapter 20 for information on how to figure your standard deduction.
Example
For tax year 2007, Bill and Terry Willow are filing a joint return on Form 1040. Their adjusted gross income on line 38 is $259,600. Their Schedule A itemized deductions are as follows:
Taxes paid--line 9 $ 17,900 Interest paid--lines 10, 11, 12, and 13 45,000 Investment interest expense--line 14 41,000 Gifts to charity--line 19 21,000 Job expenses--line 27 17,240 -------- Total $142,140 ========
The Willows' investment interest expense deduction ($41,000 from Schedule A (Form 1040), line 14) is not subject to the overall limit on itemized deductions.
The Willows use the Itemized Deductions Worksheet in the Schedule A (Form 1040) instructions to figure their overall limit. Their completed worksheet is shown as Table 29-1.
Table 29-1. Itemized Deductions Worksheet--Line 28
---------------------------------------------------------------------- 1. Enter the total of the amounts from Schedule A, lines 4, 9, 15, 19, 20, 27, and 28 1. 142,140 2. Enter the total of the amounts from Schedule A, lines 4, 14, and 20, plus any gambling and casualty or theft losses included on line 28 2. 41,000 --------------------------------------------------- Caution: Be sure your total gambling and casualty or theft losses are clearly identified on the dotted lines next to line 28. --------------------------------------------------- 3. Is the amount on line 2 less than the amount on line 1? [ ] No. STOP Your deduction is not limited. Enter the amount from line 1 above on Schedule A, line 29. [x] Yes. Subtract line 2 from line 1 3. 101,140 4. Multiply line 3 by 80% (.80) 4. 80,912 5. Enter the amount from Form 1040, line 38 5. 259,600 6. Enter: $156,400 ($78,200 if married filing separately) 6. 156,400 7. Is the amount on line 6 less than the amount on line 5? [ ] No. STOP Your deduction is not limited. Enter the amount from line 1 above on Schedule A, line 29. [x] Yes. Subtract line 6 from line 5 7. 103,200 8. Multiply line 7 by 3% (.03) 8. 3,096 9. Enter the smaller of line 4 or line 8 9. 3,096 10. Divide line 9 by 3.0 10. 1,032 11. Subtract line 10 from line 9 11. 2,064 12. Total itemized deductions. Subtract line 11 from line 1. Enter the result here and on Schedule A, line 29 12. 140,076 ----------------------------------------------------------------------
Of their $142,140 total itemized deductions, the Willows can deduct only $140,076 ($142,140 - $2,064). They enter $140,076 on Schedule A (Form 1040), line 29.
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