Marcus (ssn 397-73-8399) and Debra Cross own three homes. Information regarding
ID: 2613606 • Letter: M
Question
Marcus (ssn 397-73-8399) and Debra Cross own three homes. Information regarding the amount of acquisition indebtedness, as well as interest and taxes paid on each home during the year is as follows.
During 2012 the crosses made cash gifts totaling $12,000 to various qualified public charities. The Crosses gifted 150 shares of stock to their church during 2012. They purchased 100 shares of the stock for $10 a share in 2008. The other 50 shares were purchased earlier in 2012 for $18 a share. At the times the shares were donated to the church, their fair market value was $24 a share. The Crosses only other itemized deductions for 2012 were $4,240 that their employers withheld from their paychecks for state income taxes. The Crosses AGI for 2012 is $216,952. Compute the Crosses total itemized deductions and prepare their schedule A.
Acquisition Debt Interest paid Taxes paid Main home $240,000 $18,330 $2,400 Vacation home #1 300,000 18,583 2,800 Vacation home #2 350,000 19,044 3,400Explanation / Answer
Itemized deductions from adjusted gross income will be allowed for specific activities, catastrophic losses, or other taxes paid under the federal individual income tax system (Internal Revenue Code, Section 63). Taxpayers compute their total itemized deductions, compare this total to the standard deduction allowed for their filing status, and subtract the greater amount from adjusted gross income. While the standard deduction simply provides a threshold for taxation, itemized deductions are targeted at individual circumstances or specific policies (Goode 1976: 147).
Itemized deductions have been allowed under the federal income tax law for many years. However, they have been altered over time; some have been disallowed, some have been added, the computations have changed, and so forth. Taxpayers with income over a threshold amount are subject to a limitation on their total itemized deductions. In 1997, the threshold was $121,200 ($60,600 for married filing separately). For taxpayers with adjusted gross income over the threshold, allowable itemized deductions (other than medical, investment interest, casualty, theft, or wagering losses) are reduced by 3 percent of the excess, to a maximum reduction of 80 percent of total allowable deductions (excluding medical, investment interest, casualty, theft, or wagering losses) (Commerce Clearing House 1996: 281). Taxpayers must use tax form 1040 if they itemize their deductions.
In 1993, approximately 28 percent of all federal individual income tax returns filed used itemized rather than standard deductions. Of the 43 states and the District of Columbia that have an income tax, 38 allow some itemized deductions in the calculation of taxable income (Advisory Commission on Intergovernmental Relations 1994: 68-69). The majority of these states have adopted most of the same itemized deductions that are allowed by the federal government. The purpose of itemized deductions is fourfold: to ease the burden of catastrophic expenditures that affect a taxpaying unit’s ability to pay tax, to encourage certain types of activities such as home ownership and charitable contributions, to ease the burden of taxes paid to state and local governments, and to allow taxpayers to deduct the cost of legitimate business expenses (Pitchmen 1987: 92-97). Under current law, there are seven main classes of itemized deductions. Medical and dental expenses are justified on the grounds that catastrophic medical expenses alter a taxpayer’s ability to pay taxes (Pechman 1987: 92). A taxpayer may deduct non-reimbursed medical and dental expenses that exceed 7.5 percent of adjusted gross income. This relatively high floor precludes many taxpayers from taking this deduction; in 1993, only 4.7 percent of total filers used it. An individual may deduct payment of the following taxes: state and local government income taxes, real estate taxes, personal property taxes, income taxes paid to a foreign country, war profits or excess profits taxes, generation-skipping transfer taxes, and environmental taxes (Commerce Clearing House 1996: 284). Previously, federal excise taxes (e.g., gasoline) and state and local sales taxes were also allowed as deductions, along with some other minor state and local taxes, but these were removed by the mid-1980s. The federal deduction of state and local government taxes effectively reduces the price of state and local taxes. If taxpayers itemize and deduct the allowed state and local government taxes, the federal income tax bill is reduced by their deduction times their federal marginal tax rate. Consider the following example: A taxpayer pays $100 in state income and property taxes and faces a federal marginal tax rate of 28 percent. An itemizer would deduct the $100 of state taxes and reduce the federal tax liability bill by $28. In effect, $100 in state taxes cost only $72 ($100 - $28), because of the federal income tax saving received. There is debate about this deduction. Certain other miscellaneous deductions that may be itemized include moving expenses incurred in an earlier period, gambling losses that offset gambling winnings, federal estate tax on income in respect of a decedent (income received but which was also included in the valuation of a decedent’s estate for estate tax purposes), and impairment related work expenses of a disabled person (Commerce Clearing House 1996: 280). These deductions are not subject to any floor. The data in table 1 summarize the use of itemized deductions for tax year 1993. This information shows that itemized deductions have a significant impact on federal individual income tax revenue. In fact, the tax expenditure estimate of the main itemized deductions for 1996 is well over $100 billion’s almost 17 percent of expected federal individual income tax revenue for 1996.
Summary of Itemized Deductions, 1993 Number of Returns Amount ($ millions) Total Itemized Deductions after Limitation 32,694,192 $ 480,356 Medical and Dental Expenses Deduction 5,408,223 25,932 Taxes Paid Deduction 32,155,955 167,882 Interest Paid Deduction 27,359,989 194,976 Contributions Deduction 29,717,271 67,166 Moving Expense Deduction 804,919 3,897 Net Miscellaneous Deductions after Limitation 7,717,250 27,877 Other Miscellaneous Deductions 729,192 2,718 Total Returns 114,626,932 Total Adjusted Gross Income Reported $3,724,124 Source: Internal Revenue Service (1995).