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J.K. LASSER'STM

1001 DEDUCTIONS
AND TAX BREAKS
2018

Your Complete Guide
to Everything Deductible

Barbara Weltman

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Introduction

Discussions about tax reform has got people talking about taxes. But say the word “taxes” and most people groan. There are good reasons for this response: First of all, the cost of paying your taxes annually can be a financial burden. You may feel taken to the cleaners every time you view your paycheck after withholding for federal income taxes (not to mention state income taxes as well as Social Security and Medicare taxes). And taxes are time consuming—costing individuals 8.9 billion hours annually to file their returns.

Second, you may not even have to deal personally with taxes, other than paying them. The IRS says that nearly 60% of taxpayers use paid preparers for their returns.

Third, the tax law is very complicated and changing all the time. According to the Tax Foundation, the Internal Revenue Code (Tax Code) has about 2.4 million words. There were only 11,400 words in the Tax Code in 1914, one year after the constitutional amendment authorizing the levy of an income tax. Between 2001 and 2012, there were 4,600 changes (which works out to more than one a day). Today the Tax Code is twice as long as it was in 1985. There have been major changes in the tax law nearly every year over the past 50 years—and this year is no exception! In addition, new court decisions and IRS rulings appear each day, providing guidance on how to interpret the law. The Tax Foundation says taxpayers spend more than $409 billion each year complying with federal tax rules.

Fourth, you have to know what the tax rules are and can't claim ignorance to avoid taxes and penalties. Even if you use a tax professional or tax preparation software to prepare your return, you remain responsible for your taxes. The Tax Court has noted that using software is not an automatic excuse to avoid underpayment penalties.

How can you combat the feeling of dread when it comes to taxes? It helps to know that the tax law is peppered with many, many tax breaks to which you may be entitled. These breaks allow you to not report certain economic benefits you enjoy or to subtract certain expenses from your income or even directly from your tax bill. As the famous jurist Judge Learned Hand once stated (in the 1934 case of Helvering v. Gregory in the Court of Appeals for the Second Circuit):

Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike, and all do right, for nobody owes any public duty to pay more than the law demands.

So get your tax affairs in order and reduce what you pay each year to Uncle Sam!

In getting a handle on how to do this by taking advantage of every tax break you may be entitled to without running afoul of the Internal Revenue Service (IRS), there are some simple rules to keep in mind. They include:

Whether you prepare your return by hand (as 6% of filers do), use computer software or an online solution (39%), or rely on a professional (55%), this book is designed to tell you how to get every tax edge you're entitled to. Knowing what to look out for will help you plan ahead and organize your activities in such a way that you'll share less of your hard-earned money with Uncle Sam.

Tax-Favored Items

There are 5 types of tax-advantaged items receiving preferential or favorable treatment under the tax law:

  1. Tax-free income—income you can receive without any current or future tax concerns. Tax-free income may be in the form of exclusions or exemptions from tax. In many cases, tax-free items do not even have to be reported in any way on your return.

  2. Capital gains—profits on the sale or exchange of property held for more than one year (long-term). Long-term capital gains are subject to lower tax rates than the rates on other income, such as salary and interest income, and may even be tax free in some cases. Ordinary dividends on stocks and capital gain distributions from stock mutual funds are taxed at the same low rates as long-term capital gains.

  3. Tax-deferred income—income that isn't currently taxed. Since the income builds up without any reduction for current tax, you may accumulate more over time. However, at some point the income becomes taxable.

  4. Deductions—items you can subtract from your income to reduce the amount of income subject to tax. There are 2 classes of deductions: those “above the line,” which are subtracted directly from gross income, and those “below the line,” which can be claimed only if you itemize deductions instead of claiming the standard deduction (explained later).

  5. Credits—items you can use to offset your tax on a dollar-for-dollar basis. There are 2 types of tax credits: one that can be used only to offset tax liability (called a “nonrefundable” credit) and one that can be claimed even if it exceeds tax liability and you receive a refund (called a “refundable” credit). Usually you must complete a special tax form for each credit you claim.

This book focuses on different types of tax-favored items: exclusions (tax-free income), above-the-line deductions that don't require itemizing, itemized deductions, tax credits, and other benefits, such as subtractions that reduce income. At the end of this Introduction you'll see symbols used to easily identify the type of benefit being explained.

Limits on Qualifying for Tax-Favored Items

In many cases, eligibility for a tax benefit, or the extent to which it can be claimed, depends on adjusted gross income (AGI) or modified adjusted gross income (MAGI).

Adjusted gross income is gross income (all the income you are required to report) minus certain deductions (called “adjustments to gross income”). Adjustments or subtractions you can make to your gross income to arrive at your adjusted gross income are limited to the following items:

Figuring AGI may sound complicated, but in reality it's merely a number taken from a line on your tax return. For example, AGI is the figure you enter on line 37 of the 2017 Form 1040, line 21 of the 2017 Form 1040A, or line 4 of 2017 Form 1040EZ.

Modified adjusted gross income is merely AGI increased by certain items that are excludable from income and/or certain adjustments to gross income. Which items are added back varies for different tax breaks. For example, the MAGI limit on eligibility to claim the student loan interest deduction is AGI (disregarding the student loan interest deduction) increased by the tuition and fees deduction as well as the exclusion for foreign earned income and certain other foreign income or expenses. All of these items are explained in this book.

Household income is a term in tax law used to determine eligibility for the premium tax credit under the Affordable Care Act, as well as whether a penalty applies to individuals who don't have minimum essential health coverage for 2017 and are not exempt from this requirement. Household income is explained further in this book in connection with these tax rules.

Standard Deduction versus Itemized Deductions

Every taxpayer, other than someone who can be claimed as a dependent on another taxpayer's return, is entitled to a standard deduction. This is a subtraction from your income, and the amount you claim is based on your filing status. Table I.1 shows the standard deduction amounts for 2017. In 2015, 70.5% of all filers used the standard deduction.

Table I.1 Standard Deduction Amounts for 2017

Filing Status

Standard Deduction

Married filing jointly

$12,700

Head of household

9,350

Single (unmarried)

6,350

Qualifying widow(er) (surviving spouse)

12,700

Married filing separately

6,350

In addition to the basic standard deduction, certain taxpayers can increase these amounts. An additional standard deduction amount applies to those age 65 and older and for blindness. For 2017, the additional amount is $1,550 for individuals who are not married and are not a surviving spouse and $1,250 for those who are married or a surviving spouse.

Instead of claiming the standard deduction, you can opt to list certain deductions separately (i.e., itemize them). Itemized deductions include:

You cannot claim any additional standard deduction that applies to those 65 or older and/or blind if you choose to itemize deductions in lieu of claiming the basic standard deduction amount.

Generally, claim the standard deduction when it is greater than the total of your itemized deductions. However, it may save overall taxes to itemize, even when total deductions are less than the standard deduction, if you are subject to the alternative minimum tax (AMT). The reason: The standard deduction cannot be used to reduce income subject to the AMT, but certain itemized deductions can.

If a married couple files separate returns and one spouse itemizes deduction, the other must also itemize and cannot claim a standard deduction.

Overall Limit on Itemized Deductions

High-income taxpayers have an overall limit on the total amount of itemized deductions they can claim. Itemized deductions are reduced by the lesser of 3% of the amount that adjusted gross income (AGI) exceeds the applicable threshold amount (see Table I.2) or 80% of itemized deductions subject to the phaseout. Thus you cannot lose more than 80% of itemized deductions subject to the phaseout.

Table I.2 2017 Thresholds for the Itemized Deduction Phaseout

Filing Status

MAGI Start of Phaseout

Married filing jointly

$313,800

Head of household

287,650

Single (unmarried)

261,500

Qualifying widow(er) (surviving spouse)

313,800

Married filing separately

156,900

Itemized deductions subject to the phaseout include taxes, interest (other than investment interest), charitable contributions, and miscellaneous itemized deductions not subject to the 2%-of-adjusted-gross-income limit (other than gambling losses). Itemized deductions not subject to the phaseout are medical expenses, investment interest, casualty and theft losses, and gambling losses. These itemized deductions are already subject to special limitations.

Impact of Deductions on Your Chances of Being Audited

Did you know that the IRS collects statistics from taxpayers to create profiles of average deductions? If you claim more than the average for your income range, the computer may select your return for further examination.

Table I.3 shows the average itemized deductions for taxpayers in various adjusted gross income ranges.

Table I.3 Average Itemized Deductions for 2015*

AGI

Medical

Taxes

Interest

Donations

Under $15,000

$8,210 $3,667 $6,397 $1,533
$15,000 ≤ 30,000 8,646 5,497 6,572 2,483
$30,000 ≤ 50,000 8,761 4,027 6,357 2,812
$50,000 ≤ 100,000 9,426 6,323 7,382 3,244
$100,000 ≤ 200,000 11,305 11,052 8,905 4,155
$200,000 ≤ 250,000 17,625 17,711 11,370 5,779
$250,000 and over 37,032 51,906 16,580 21,769

*The latest year for which statistics are available.

Tax experts agree that you should claim every deduction you are entitled to, even if your write-offs exceed these statistical ranges. Just make sure to have the necessary proof of your eligibility and other records you are required to keep in case your return is examined.

How to Use This Book

The chapters in this book are organized by subject matter so you can browse through them to find the subjects that apply to you or those in which you have an interest.

Each tax benefit is denoted by an icon to help you spot the type of benefit involved:

For each tax benefit you will find an explanation of what it is, starting with the maximum benefit or benefits you can claim if you meet all eligibility requirements. You'll learn the conditions or eligibility requirements for claiming or qualifying for the benefit. You'll find both planning tips to help you make the most of the benefit opportunity as well as pitfalls to help you avoid problems that can prevent your eligibility. You'll see where to claim the benefit (if reporting is required) on your tax return and what records you must retain to support your tax position.

You'll find hundreds of examples to show you how other taxpayers have successfully taken advantage of the benefit. Over the years, taxpayers have been able to write off literally thousands of items; not every one is listed here because space does not allow it. And you'll learn what isn't allowed even though you might otherwise think so. There are references to free IRS publications on a variety of tax topics that you can download from the IRS website (www.irs.gov) or obtain free of charge by calling 800-829-1040.

In the appendices, you'll find a listing of items that can be adjusted each year to reflect cost-of-living changes so you can plan ahead, as well as a checklist of items that are tax free, and a checklist of items that are not deductible.

Throughout the book you will find alerts to possible changes to come. For a free update on tax developments, look for the Supplement to this book in February 2018, by going to www.jklasser.com, as well as to my website, www.barbaraweltman.com.