Deductions

September 03, 2024

749 / How are business expenses reported for income tax purposes?

<div class="Section1"> A deduction is permitted for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Examples of deductible business expenses include: (1) expenditures for reasonable salaries, (2) traveling expenses (within limits), and (3) certain rental expenses incurred for purposes of a trade or business.<a href="#_ftn1" name="_ftnref1">1</a> Illegal payments made in the course of business, such as bribes to government officials or illegal rebates (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="658">658</a>), are not deductible.<a href="#_ftn2" name="_ftnref2">2</a> Under the 2017 Tax Act, certain expenses paid to (or at the direction of) a government or government entity in relation to the violation of any law, or investigation into potential violations of the law, are not deductible.<a href="#_ftn3" name="_ftnref3">3</a> Further, amounts paid in relation to sexual harassment suits that are subject to a nondisclosure agreement are not deductible.<a href="#_ftn4" name="_ftnref4">4</a> <hr> Planning Point: The IRS released a memorandum addressing whether a lawsuit settlement could be deducted as an expense under IRC Section 162(a). It determined that the business itself was required to prove whether the payments were compensatory, and thus deductible, or punitive (such as a fine or penalty, and thus nondeductible). This was the case despite the fact that the settlement specifically provided that the payments were not to be construed as fines or penalties. A deductible payment under Section 162 is generally one meant to compensate another party or to ensure compliance with a law. In this case, the IRS required further factual analysis to determine the nature of the payments, highlighting the fact that a settlement agreement alone will not be controlling.<a href="#_ftn5" name="_ftnref5">5</a> <hr> In 2025, the business standard mileage rate is 70 cents per mile driven for business purposes up from 67 cents per mile in 2024, 65.5 cents in 2023, 58.5 cents per mile for the first half of 2022 and 62.5 cents for the second half of 2022.<a href="#_ftn6" name="_ftnref6">6</a> <hr> Planning Point: The IRS increased the business standard mileage rate in the second half of 2022 in response to rising gas prices. <hr> The amount of the deduction for expenses incurred in carrying on a trade or business depends upon whether the individual is an independent contractor or an employee. Typically, whether an insurance agent is considered an independent contractor or employee is determined on the basis of all the facts and circumstances involved; however, where an employer has the right to control the manner and the means by which services are performed, an employer-employee relationship will generally be found to exist.<a href="#_ftn7" name="_ftnref7">7</a> The IRS has ruled that a full-time life insurance salesperson is not an “employee” for purposes of IRC Sections 62 and 67, even though he is treated as a “statutory employee” for Social Security tax purposes.<a href="#_ftn8" name="_ftnref8">8</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3928">3928</a>. Furthermore, according to decisions from the Sixth and 11th Circuit Courts of Appeals, the fact that an insurance agent received certain employee benefits did not preclude his being considered an independent contractor, based on all the other facts and circumstances of the case.<a href="#_ftn9" name="_ftnref9">9</a> The IRS has determined, however, that a district manager of an insurance company was an employee of the company, and not an independent contractor.<a href="#_ftn10" name="_ftnref10">10</a> On the other hand, the IRS has determined that individuals who were regional and senior sales vice presidents of an insurance company (but who were not officers of the company) were independent contractors and not employees of the insurance company.<a href="#_ftn11" name="_ftnref11">11</a> <hr> Planning Point: The Sixth Circuit Court of Appeals confirmed in 2019 that life insurance agents were properly classified as independent contractors, rather than employees. The case involved eligibility for benefits under ERISA, and a district court, using the traditional Darden factors for determining classification status, had ruled in 2017 that the agents were employees who were eligible for ERISA benefits. In reversing the lower court, the Sixth Circuit gave weight to the fact that both parties had expressed their intent that an independent contractor relationship would apply. The case also opens the possibility that the weight given to the various Darden factors should vary based upon the context of the case—for example, in this case, financial benefits were at issue, so the court gave more weight to the financial structure of the relationship.<a href="#_ftn12" name="_ftnref12">12</a> <hr> Independent contractors may deduct all allowable business expenses from gross income (i.e., “above-the-line”) to arrive at adjusted gross income.<a href="#_ftn13" name="_ftnref13">13</a> Prior to 2018, the business expenses of an employee were deductible from adjusted gross income (i.e., “below-the-line”) if he or she itemized instead of taking the standard deduction, but only to the extent that they exceeded 2 percent of adjusted gross income when aggregated with other “miscellaneous itemized deductions.” All miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025. Industrial agents (or “debit agents”) are treated as employees for tax purposes.<a href="#_ftn14" name="_ftnref14">14</a> Thus, as in the case of any employee, a debit agent can deduct transportation and away-from-home traveling expenses from adjusted gross income if he itemizes, only to the extent that the aggregate of these and other miscellaneous itemized deductions exceed 2 percent of adjusted gross income (prior to 2018 and, presumably, after 2025).<a href="#_ftn15" name="_ftnref15">15</a> Self-employed taxpayers are permitted a deduction equal to one-half of their self-employment (i.e., Social Security) taxes for the taxable year. This deduction is treated as attributable to a trade or business that does not consist of the performance of services by the taxpayer as an employee; thus it is taken “above-the line.”<a href="#_ftn16" name="_ftnref16">16</a> In Allemeier v. Commissioner,<a href="#_ftn17" name="_ftnref17">17</a> the Tax Court held that the taxpayer could deduct his expenses ($15,745) incurred in earning a master’s degree in business administration to the extent those expenses were substantiated and education-related. The court based its decision on the fact that the taxpayer’s MBA did not satisfy a minimum education requirement of his employer, nor did the MBA qualify the taxpayer to perform a new trade or business. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a discussion of the business expense deduction for meals and entertainment, including a discussion of how the IRS has interpreted the changes imposed post-tax reform. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 162(a). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 162(c). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 162(f). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 162(q). <a href="#_ftnref5" name="_ftn5">5</a>. ILM 201825027. <a href="#_ftnref6" name="_ftn6">6</a>. Notice 2022-03, A-2022-13, Notice 2024-08, Notice 2025-05. <a href="#_ftnref7" name="_ftn7">7</a>. Butts v. Commissioner, TC Memo 1993-478, aff’d, 49 F.3d 713 (11th Cir. 1995); Let. Rul. 9306029. <a href="#_ftnref8" name="_ftn8">8</a>. Rev. Rul. 90-93, 1990-2 CB 33. <a href="#_ftnref9" name="_ftn9">9</a>. Ware v. U.S., 67 F.3d 574 (6th Cir. 1995); Butts v. Commissioner, above. <a href="#_ftnref10" name="_ftn10">10</a>. TAM 9342001. <a href="#_ftnref11" name="_ftn11">11</a>. TAM 9736002. <a href="#_ftnref12" name="_ftn12">12</a>. Jammal v. American Family Life Insurance Co., 2019 U.S. App. LEXIS 2905 (6th Cir. 2019). <a href="#_ftnref13" name="_ftn13">13</a>. IRC § 62(a)(1). <a href="#_ftnref14" name="_ftn14">14</a>. Rev. Rul. 58-175, 1958-1 CB 28. <a href="#_ftnref15" name="_ftn15">15</a>. IRC § 67. <a href="#_ftnref16" name="_ftn16">16</a>. IRC § 164(f). <a href="#_ftnref17" name="_ftn17">17</a>.  TC Memo 2005-207. </div></div>

March 13, 2024

742 / What value of property contributed to charity can be taken into account for purposes of the charitable deduction if the gift is comprised of tangible personal property?

<div class="Section1">The treatment of a contribution of appreciated tangible personal property (i.e., property which, if sold, would generate long-term capital gain) depends on whether the use of the property is related or unrelated to the purpose or function of the (public or governmental) organization. If the property is related use property (e.g., a contribution of a painting to a museum), generally the full fair market value is deductible, up to 30 percent of the individual’s adjusted gross income; however, if the property is unrelated use property, the deduction is generally limited to the donor’s adjusted basis.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 170(e)(1)(B), 170(b)(1)(C); Treas. Reg. § 1.170A-4(b). </div>

March 13, 2024

739 / What is the maximum annual limit on the income tax deduction allowable for charitable contributions?

<div class="Section1">An individual who itemizes may take a deduction for certain contributions “to” or “for the use of” charitable organizations. The amount that may be deducted by an individual in any one year is subject to the income percentage limitations as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="740">740</a>.The value that may be taken into account for various gifts of property depends on the type of property and the type of charity to which it is contributed. These rules are explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="741">741</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="743">743</a>.<div class="Section1"> For an explanation of the deduction for charitable gifts of life insurance, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="120">120</a>. In the case of a gift of S corporation stock, special rules (similar to those relating to the treatment of unrealized receivables and inventory items under IRC Section 751) apply in determining whether gain on such stock is long-term capital gain for purposes of determining the amount of a charitable contribution.<a href="#_ftn1" name="_ftnref1">1</a> A contribution of a partial interest in property is deductible only if the donee receives an undivided portion of the donor’s entire interest in the property. Such a contribution was upheld even where the donee did not take possession of the property during the tax year.<a href="#_ftn2" name="_ftnref2">2</a> Generally, a deduction is denied for the mere use of property or for any interest which is less than the donor’s entire interest in the property, unless the deduction would have been allowable if the transfer had been in trust. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 170(e)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Winokur v. Commissioner, 90 TC 733 (1988), acq. 1989-1 CB 1. </div></div>

March 13, 2024

745 / What are the limits on the medical expense deduction?

<div class="Section1">Editor’s Note: The 2021 year-end Consolidated Appropriations Act permanently reduced the medical expense deduction threshold from 10 percent to 7.5 percent.<div></div><div>A taxpayer who itemizes deductions can deduct unreimbursed expenses for “medical care” (the term “medical care” includes dental care) and expenses for prescribed drugs or insulin for himself, a spouse and dependents, to the extent that such expenses exceed 7.5 percent -of adjusted gross income. (On a joint return, the 7.5 percent floor amount is based on the combined adjusted gross income of both spouses.) The taxpayer first determines net unreimbursed expenses by subtracting all reimbursements received during the year from total expenses for medical care paid during the year. He or she must then subtract 7.5 percent of his adjusted gross income from net unreimbursed medical expenses; only the balance, if any, is deductible.<a href="#_ftn1" name="_ftnref1">1</a> The deduction for medical expenses is not subject to the phaseout in itemized deductions for certain upper income taxpayers that applied before 2018. (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="731">731</a>.)</div><div class="Section1"> Though the 7.5 percent threshold was temporarily increased to 10 percent in 2013-2016, the 7.5 percent threshold continued to apply through 2016 if the taxpayer or the taxpayer’s spouse turned age 65 before the end of the taxable year. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for examples of the types of expenses that can be deducted under the medical expense deduction. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 213. </div></div>

March 13, 2024

751 / Can a self-employed taxpayer deduct medical insurance costs?

<div class="Section1"> A sole proprietor who purchases health insurance in his individual name has established a plan providing medical care coverage with respect to his trade or business, and therefore may deduct the medical care insurance costs for himself, his spouse, and dependents under IRC Section 162(l), but only to the extent the cost of the insurance does not exceed the earned income derived by the sole proprietor from the specific trade or business with respect to which the insurance was purchased. A self-employed individual may deduct the medical care insurance costs for himself and his spouse and dependents under a health insurance plan established for his trade or business up to the net earnings of the specific trade or business with respect to which the plan is established, but a self-employed individual may not add the net profits from all his trades and businesses for purposes of determining the deduction limit under IRC Section 162(l)(2)(A). However, if a self-employed individual has more than one trade or business, he may deduct the medical care insurance costs of the self-employed individual and his spouse and dependents under each specific health insurance plan established under each specific business up to the net earnings of that specific trade or business.<a href="#_ftn1" name="_ftnref1">1</a> In a legal memorandum, the IRS ruled that a self-employed individual may not deduct the costs of health insurance on Schedule C. The deduction under IRC section 162(l) must be claimed as an adjustment to gross income on the front of Form 1040.<a href="#_ftn2" name="_ftnref2">2</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. CCA 200524001. <a href="#_ftnref2" name="_ftn2">2</a>. CCA 200623001. </div>

March 13, 2024

732 / What is the limitation on certain high-income taxpayers’ itemized deductions?

<div class="Section1">Editor’s Note: The limitation on itemized deductions that applied to certain high-income taxpayers was suspended for tax years beginning after December 31, 2017 and before January 1, 2026.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> There was no phaseout of itemized deductions based on adjusted gross income (AGI) in 2010-2012. Under the American Taxpayer Relief Act of 2012 (“ATRA”), the phaseout resumed for tax years beginning in 2013-2017, and was once again suspended for 2018-2025. Therefore, in 2017, the aggregate of most itemized deductions was reduced dollar-for-dollar by the lesser of: (1) 3 percent (but see Adjustments to Limit, below, for tax years beginning before 2010) of the amount of adjusted gross income that exceeds a certain income-based threshold amount, or (2) 80 percent of the amount of such itemized deductions otherwise allowable for the taxable year.<a href="#_ftn2" name="_ftnref2">2</a> In 2017, the thresholds were $261,500 for individual taxpayers, $313,800 for married taxpayers filing jointly, $287,650 for heads of households and $156,900 for married taxpayers filing separately.<a href="#_ftn3" name="_ftnref3">3</a> In 2016, the thresholds were $259,400 for individual taxpayers, $311,300 for married taxpayers filing jointly, $285,350 for heads of households and $155,650 for married taxpayers filing separately.<a href="#_ftn4" name="_ftnref4">4</a> In 2015, the thresholds were $258,250 for individual taxpayers, $309,900 in the case of a married taxpayer filing jointly, $285,050 for heads of household, and $154,950 for married taxpayers filing separately) The threshold income levels for determining the phaseout are adjusted annually for inflation.<a href="#_ftn5" name="_ftnref5">5</a> Adjustments to limit for 2005-2009 tax years. For taxable years beginning after 2005, the limitation on itemized deductions was gradually reduced until it was completely repealed in 2010. The amended limitation amount was calculated by multiplying the otherwise applicable limitation amount by the “applicable fraction.” The “applicable fraction” for each year was as follows: 66.6 percent (?) in 2006 and 2007; 33.3 percent (?) in 2008 and 2009; and 0 percent in 2010-2012.<a href="#_ftn6" name="_ftnref6">6</a> The limitation on itemized deductions is not applicable to medical expenses deductible under IRC Section 213, investment interest deductible under IRC Section 163(d), or certain casualty loss deductions.<a href="#_ftn7" name="_ftnref7">7</a> The limitation also is not applicable to estates and trusts.<a href="#_ftn8" name="_ftnref8">8</a> For purposes of certain other calculations, such as the limits on deduction of charitable contributions or the 2 percent floor on miscellaneous itemized deductions, the limitations on each separate category of deductions are applied before the overall ceiling on itemized deductions is applied.<a href="#_ftn9" name="_ftnref9">9</a> The deduction limitation is not taken into account in the calculation of the alternative minimum tax.<a href="#_ftn10" name="_ftnref10">10</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 68(f). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 68(a). <a href="#_ftnref3" name="_ftn3">3</a>. Rev. Proc. 2016-55. <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Proc. 2015-53. <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 68(b); as amended by ATRA, § 101(2)(b); Rev. Proc. 2008-66, 2008-45 IRB 1107. <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 68(f) (deleted by ATRA, § 101(2)(b)). <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 68(c). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 68(e). <a href="#_ftnref9" name="_ftn9">9</a>. IRC § 68(d). <a href="#_ftnref10" name="_ftn10">10</a>. IRC § 56(b)(1)(F). </div>

March 13, 2024

734 / Is interest deductible?

<div class="Section1">Editor’s Note: The 2017 Tax Act limited the mortgage interest deduction to $750,000, so that from 2018-2025, only interest on up to $750,000 of new mortgage debt may be deducted. This limit applies to debt incurred after December 31, 2017 and before January 1, 2026.<a href="#_ftn1" name="_ftnref1">1</a> After December 31, 2025, absent Congressional action to extend the current rules, the $1 million mortgage interest deduction will be reinstated and will apply regardless of when the taxpayer incurred the relevant debt (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>).<a href="#_ftn2" name="_ftnref2">2</a> Modifications to the deductibility of business interest are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>.<div class="Section1"> Editor’s Note: Late in 2015, Congress acted to extend the treatment of certain mortgage insurance premiums as qualified residence interest, as discussed below, through 2016. This treatment was extended through 2017 by the Bipartisan Budget Act of 2018, again through 2020 by the SECURE Act and through 2021 by CAA 2021 as of the date of this publication. The deductibility of interest depends on its classification, as described below. Furthermore, interest expense that is deductible under the rules below may be subject to the additional limitation on itemized deductions (unless it is investment interest, which is not subject to that provision). Interest must be classified and is deductible within the following limitations: (1) Investment interest. This includes any interest expense on indebtedness properly allocable to property held for investment.<a href="#_ftn3" name="_ftnref3">3</a> Generally, investment interest is deductible only to the extent of investment income; however, investment interest in excess of investment income may be carried over to succeeding tax years. For purposes of this calculation, net long-term capital gain income is included in investment income if the taxpayer foregoes the reduced tax rate (0 percent/15 percent/20 percent) that applies to such income. Under JGTRRA 2003, as extended by ATRA, certain dividends are taxable at the lower capital gains rates rather than at higher ordinary income tax rates. A dividend will be treated as investment income for purposes of determining the amount of deductible investment interest income only if the taxpayer elects to treat the dividend as not being eligible for the reduced rates.<a href="#_ftn4" name="_ftnref4">4</a> For the temporary regulations relating to an election that may be made by noncorporate taxpayers to treat qualified dividend income as investment income for purposes of calculating the deduction for investment interest, see Treasury Regulation Section 1.163(d)-1.<a href="#_ftn5" name="_ftnref5">5</a> Note that the 2017 tax reform legislation placed limitations on the deductibility of business interest, which specifically excludes investment interest. (2) Trade or business interest. This includes any interest incurred in the conduct of a trade or business. Generally, such interest was deductible as a business expense prior to 2018. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a discussion of the treatment of corporate business interest under the 2017 tax reform legislation. Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> outline the new rules as they apply to pass-through entities.<a href="#_ftn6" name="_ftnref6">6</a> (3) Qualified residence (mortgage) interest. Qualified residence interest is interest paid or accrued during the taxable year on debt that is secured by the taxpayer’s qualified residence and that is either (a) “acquisition indebtedness” (that is, debt incurred to acquire, construct or substantially improve the qualified residence, or any refinancing of such debt), or (b) “home equity indebtedness” (any other indebtedness secured by the qualified residence). There is a limitation of $1,000,000 ($750,000 for 2018-2025) on the aggregate amount of debt that may be treated as acquisition indebtedness, but the amount of refinanced debt that may be treated as acquisition indebtedness is limited to the amount of debt being refinanced. Prior to 2018, a deduction was generally allowed for home equity indebtedness. The aggregate amount that could be treated as “home equity indebtedness” (that is, borrowing against the fair market value of the home less the acquisition indebtedness, or refinancing to borrow against the “equity” in the home) was $100,000.<a href="#_ftn7" name="_ftnref7">7</a> Indebtedness incurred on or before October 13, 1987 (and limited refinancing of it) that is secured by a qualified residence is considered acquisition indebtedness. This pre-October 14, 1987 indebtedness is not subject to the $750,000 (2018-2025) aggregate limit, but is included in the aggregate limit as it applies to indebtedness incurred after October 13, 1987.<a href="#_ftn8" name="_ftnref8">8</a> (For 2007 through 2021, certain mortgage insurance premiums are treated as qualified residence interest.)<a href="#_ftn9" name="_ftnref9">9</a> <hr> Planning Point: Although interest on home equity indebtedness is technically no longer deductible under the terms of the 2017 tax reform legislation, the IRS has released guidance on situations where this interest may continue to be deducted. Pursuant to the guidance, interest on home equity loans that are used to buy, build or substantially improve the taxpayer’s home continue to be deductible to the extent that they (when combined with other relevant loans) do not exceed the $750,000 limit. However, home equity loan interest is not deductible to the extent that the loan proceeds are used for expenditures not related to buying, building or substantially improving a home (i.e., if the proceeds are used for personal living expenses or to purchase a new car, the related interest is not deductible). The home equity loan must be secured by the home in order for the interest to be deductible in any case. <hr> A “qualified residence” is the taxpayer’s principal residence and one other residence that the taxpayer (a) used during the year for personal purposes more than fourteen days or, if greater, more than 10 percent of the number of days it was rented at a fair rental value, or (b) used as a residence but did not rent during the year.<a href="#_ftn10" name="_ftnref10">10</a> Subject to the above limitations, qualified residence interest is deductible. If indebtedness used to purchase a residence is secured by property other than the residence, the interest incurred on it is not residential interest but is personal interest.<a href="#_ftn11" name="_ftnref11">11</a> The Tax Court denied a deduction for mortgage interest to individuals renting a home under a lease with an option to purchase the property. Although the house was their principal residence, they did not have legal or equitable title to the home and the earnest money did not provide ownership status.<a href="#_ftn12" name="_ftnref12">12</a> An individual member of a homeowner’s association was denied a deduction for interest paid by the association on a common building because the member was not the party primarily responsible for repaying the loan and the member’s principal residence was not the specific security for the loan.<a href="#_ftn13" name="_ftnref13">13</a> Assuming that the loan was otherwise a bona fide debt, a taxpayer could deduct interest paid on a mortgage loan from his qualified plan, even though the amount by which the loan exceeded the $50,000 limit of IRC Section 72(p) was deemed to be a taxable distribution.<a href="#_ftn14" name="_ftnref14">14</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a more detailed discussion of how the mortgage interest deduction was changed by the 2017 tax reform legislation. (4) Interest taken into account in computing income or loss from a passive activity. A passive activity is generally an activity that involves the conduct of a trade or business but in which the taxpayer does not materially participate, or any rental activity.<a href="#_ftn15" name="_ftnref15">15</a> (5) Interest on extended payments of estate tax. Generally, this interest is deductible. (6) Interest on education loans. An above-the-line deduction is available to certain taxpayers for interest paid on a “qualified education loan.”<a href="#_ftn16" name="_ftnref16">16</a> The deduction is subject to a limitation of $2,500 in 2015-2024. The deduction is phased out for 2015-2018, ratably for taxpayers with modified AGI between $65,000 and $80,000 ($135,000 and $165,000 (joint returns) in 2017-2018).<a href="#_ftn17" name="_ftnref17">17</a> Certain other requirements must be met for the deduction to be available.<a href="#_ftn18" name="_ftnref18">18</a> In 2019-2021, the phaseout range is $70,000 and $85,000 for single filers and $140,000 and $170,000 for joint returns.<a href="#_ftn19" name="_ftnref19">19</a> In 2022, the phaseout range is $70,000 and $85,000 for single filers and $145,000 and $175,000 for joint returns.<a href="#_ftn20" name="_ftnref20">20</a> In 2023, the phaseout range is $75,000 and $90,000 for single filers and $155,000 and $185,000 for joint returns.<a href="#_ftn21" name="_ftnref21">21</a> In 2024, the phaseout range is $80,000 and $95,000 for single filers and $165,000 and $195,000 for joint returns.<a href="#_ftn22" name="_ftnref22">22</a> In 2025, the phaseout range is $85,000 to $100,000 for single filers and $170,000 to $200,000 for joint returns.<a href="#_ftn23" name="_ftnref23">23</a> (7) Personal interest. This is any interest expense not described in (1) through (6) above and is often referred to as “consumer” interest.<a href="#_ftn24" name="_ftnref24">24</a> Personal interest includes interest on indebtedness properly allocable to the purchase of consumer items and interest on tax deficiencies. Personal interest is not deductible.<a href="#_ftn25" name="_ftnref25">25</a> The proper allocation of interest generally depends on the use to which the loan proceeds are put, except in the case of qualified residence interest (excluding home equity interest, where the use is relevant for 2018-2025). Detailed rules for classifying interest by tracing the use of loan proceeds are contained in temporary regulations.<a href="#_ftn26" name="_ftnref26">26</a> The interest allocation rules apply to interest expense that would otherwise be deductible.<a href="#_ftn26" name="_ftnref26">27</a> Various provisions in the Code may prohibit or delay the deduction of certain types of interest expense. For example, no deduction is allowed for interest paid on a loan used to buy or carry tax-exempt securities or, under certain conditions, for interest on a loan used to purchase or carry a life insurance or annuity contract (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3">3</a>). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 163(h)(3)(F). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 163(h)(3)(F)(ii). <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 163(d)(3). <a href="#_ftnref4" name="_ftn4">4</a>.   IRC §§ 1(h)(11)(D)(i), as amended by ATRA, 163(d)(4)(B). <a href="#_ftnref5" name="_ftn5">5</a>.   69 Fed. Reg. 47364 (8-5-2004). See also 70 Fed. Reg. 13100 (3-18-2005). <a href="#_ftnref6" name="_ftn6">6</a>.   IRC § 162. <a href="#_ftnref7" name="_ftn7">7</a>.   IRC § 163(h)(3). <a href="#_ftnref8" name="_ftn8">8</a>.   IRC § 163(h)(3)(D). <a href="#_ftnref9" name="_ftn9">9</a>.   IRC § 163(h)(3)(E), as amended by ATRA. <a href="#_ftnref10" name="_ftn10">10</a>. IRC § 163(h)(4)(A). See, e.g., FSA 200137033. <a href="#_ftnref11" name="_ftn11">11</a>. Let. Ruls. 8743063 and 8742025. <a href="#_ftnref12" name="_ftn12">12</a>. Blanche v. Commissioner, TC Memo 2001-63, aff’d without opinion, 2002 U.S. App. LEXIS 6379 (5th Cir. 2002). <a href="#_ftnref13" name="_ftn13">13</a>. Let. Rul 200029018. <a href="#_ftnref14" name="_ftn14">14</a>. FSA 200047022. <a href="#_ftnref15" name="_ftn15">15</a>. IRC §§ 163(d), 469(c). <a href="#_ftnref16" name="_ftn16">16</a>. IRC §§ 163(h)(2)(F), 221. <a href="#_ftnref17" name="_ftn17">17</a>. IRC § 221(b); Rev. Proc. 2016-55, Rev. Proc. 2017-58. <a href="#_ftnref18" name="_ftn18">18</a>. IRC § 221; Treas. Reg. § 1.221-1. <a href="#_ftnref19" name="_ftn19">19</a> Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45. <a href="#_ftnref20" name="_ftn20">20</a> Rev. Proc. 2021-45. <a href="#_ftnref21" name="_ftn21">21</a> Rev. Proc. 2022-38. <a href="#_ftnref22" name="_ftn22">22</a> Rev. Proc. 2023-34. <a href="#_ftnref23" name="_ftn23">23</a>. Rev. Proc. 2024-40. <a href="#_ftnref24" name="_ftn24">24</a>. IRC § 163(h)(2). <a href="#_ftnref25" name="_ftn25">25</a>. IRC § 163(h)(1). <a href="#_ftnref26" name="_ftn26">26</a>.  Temp. Treas. Reg. § 1.163-8T. <a href="#_ftnref26" name="_ftn26">27</a>. Temp. Treas. Reg. § 1.163-8T(m)(2). </div></div>

March 13, 2024

740 / What are the income percentage limits that apply to charitable contributions?

<div class="Section1">Editor’s Note 1: The 2017 tax reform legislation increased the 50 percent AGI limit on contributions to public charities and certain private foundations to 60 percent for tax years beginning after 2017 and before 2026.<div></div><div>Editor’s Note 2: The 2020 CARES Act made several changes designed to encourage charitable giving during the COVID-19 outbreak. For the 2020 and 2021 tax years, the CARES Act amended IRC Section 62(a), allowing taxpayers to reduce adjusted gross income (AGI) by $300 worth of charitable contributions made in 2020 and 2021 even if they do not itemize.<a href="#_ftn1" name="_ftnref1">1</a> The year-end stimulus package passed in December 2020 extended this temporary relief through 2021.</div><div class="Section1"> The CARES Act also lifted the 60 percent AGI limit for 2020. This relief was also extended through 2021. Cash contributions to public charities and certain private foundations in 2020 were not subject to the AGI limit (contributions to donor advised funds, supporting organizations and private grant-making organizations remained subject to the usual AGI limits). Individual taxpayers can offset their income for 2020 up to the full amount of their AGI, and additional charitable contributions can be carried over to offset income in a later year (the amounts are not refundable). The corporate AGI limit was raised from 10 percent to 25 percent (excess contributions also carry over to subsequent tax years). Taxpayers must elect this treatment.<a href="#_ftn2" name="_ftnref2">2</a> Fifty percent limit (60 percent for tax years 2018-2025). An individual is allowed a charitable deduction of up to 50 (or 60) percent of his adjusted gross income for a charitable contribution to: churches; schools; hospitals or medical research organizations; organizations that normally receive a substantial part of their support from federal, state, or local governments or from the general public and that aid any of the above organizations; federal, state, and local governments. Also included in this list is a limited category of private foundations (i.e., private operating foundations and conduit foundations<a href="#_ftn3" name="_ftnref3">3</a>) that generally direct their support to public charities.<a href="#_ftn4" name="_ftnref4">4</a> The above organizations are often referred to as “50 (or 60) percent-type charitable organizations.” Thirty percent limit. The deduction for contributions of most long-term capital gain property to the above organizations, contributions for the use of any of the above organizations, as well as contributions (other than long-term capital gain property, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="741">741</a>) to or for the use of any other types of charitable organizations (i.e., most private foundations, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="743">743</a>) is limited to the lesser of (a) 30 percent of the taxpayer’s adjusted gross income, or (b) 50 percent of adjusted gross income minus the amount of charitable contributions allowed for contributions to the 50 (or 60) percent-type charities.<a href="#_ftn5" name="_ftnref5">5</a> Twenty percent limit. The deduction for contributions of long-term capital gain property to most private foundations (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="741">741</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="743">743</a>) is limited to the lesser of (a) 20 percent of the taxpayer’s adjusted gross income, or (b) 30 percent of adjusted gross income minus the amount of charitable contributions allowed for contributions to the 30 percent-type charities.<a href="#_ftn6" name="_ftnref6">6</a> Deductions denied because of the 50 (or 60) percent, 30 percent or 20 percent limits may be carried over and deducted over the next five years, retaining their character as 50 (or 60) percent, 30 percent or 20 percent type deductions.<a href="#_ftn7" name="_ftnref7">7</a> Gifts are “to” a charitable organization if made directly to the organization. “For the use of” applies to indirect contributions to a charitable organization (e.g., an income interest in property, but not the property itself).<a href="#_ftn8" name="_ftnref8">8</a> The term “for the use of” does not refer to a gift of the right to use property. Such a gift would generally be a nondeductible gift of less than the donor’s entire interest. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 62(a)(22), added by the 2020 CARES Act. <a href="#_ftnref2" name="_ftn2">2</a>. CARES Act § 2205. <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 170(b)(1)(E). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 170(b)(1)(A). <a href="#_ftnref5" name="_ftn5">5</a>. IRC §§ 170(b)(1)(B), 170(b)(1)(C). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 170(b)(1)(D). <a href="#_ftnref7" name="_ftn7">7</a>. IRC §§ 170(d)(1), 170(b)(1)(D)(ii). <a href="#_ftnref8" name="_ftn8">8</a>. Treas. Reg. § 1.170A-8(a)(2). </div></div>

March 13, 2024

747 / What is income in respect of a decedent and how is it taxed?

<div class="Section1">“Income in respect of a decedent” (IRD) refers to those amounts to which a decedent was entitled as gross income, but that were not includable in his taxable income for the year of his death.<a href="#_ftn1" name="_ftnref1">1</a> It can include, for example: renewal commissions of a sales representative; payment for services rendered before death or under a deferred compensation agreement; and proceeds from sales on the installment method (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="667">667</a>). Generally, if stock is acquired in an S corporation from a decedent, the pro rata share of any income of the corporation that would have been IRD if that item had been acquired directly from the decedent is IRD.<a href="#_ftn2" name="_ftnref2">2</a><div></div><div>The IRS has determined that a distribution from a qualified plan of the balance as of the employee’s death is IRD.<a href="#_ftn3" name="_ftnref3">3</a> The Service has also privately ruled that a distribution from a 403(b) tax sheltered annuity is IRD.<a href="#_ftn4" name="_ftnref4">4</a> The Service has also concluded that a death benefit paid to beneficiaries from a deferred variable annuity would be IRD to the extent that the death benefit exceeded the owner’s investment in the contract.<a href="#_ftn5" name="_ftnref5">5</a> In addition, the Service has determined that distributions from a decedent’s individual retirement account were IRD, including those parts of the distributions used to satisfy the decedent’s estate tax obligation, since the individual retirement account was found to have automatically vested in the beneficiaries.<a href="#_ftn6" name="_ftnref6">6</a></div><div class="Section1"> However, a rollover of funds from a decedent’s IRA to a marital trust and then to the surviving spouse’s IRA was not IRD, according to the Service, where the surviving spouse was the sole trustee and sole beneficiary of the trust.<a href="#_ftn7" name="_ftnref7">7</a> The Service also ruled that designation of a QTIP trust as the beneficiary of a decedent’s account balance in a qualified profit sharing plan would not result in the acceleration of IRD at the time the assets from the plan passed into the trust. Consequently, the taxpayer would include the amounts of IRD in the plan in the taxpayer’s gross income only when the taxpayer received a distribution (or distributions) from the trust.<a href="#_ftn8" name="_ftnref8">8</a> Gain realized upon the cancellation at death of a note payable to a decedent has been held to be IRD to the decedent’s estate.<a href="#_ftn9" name="_ftnref9">9</a> The unreported increase in value reflected in the redemption value of savings bonds as of the date of a decedent’s death constitutes income in respect of a decedent.<a href="#_ftn10" name="_ftnref10">10</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7688">7688</a>. If savings bonds on which the increases in value have not been reported are inherited, or the subject of a bequest, the reporting of such amounts may be delayed until the bonds are redeemed or disposed of by the legatee, or reach maturity, whichever is first.<a href="#_ftn11" name="_ftnref11">11</a> However, to the extent savings bonds are distributed by an estate or trust to satisfy pecuniary obligations or legacies, the estate or trust is required to recognize the unreported incremental increase in the redemption price of Series E bonds as income in respect of a decedent.<a href="#_ftn12" name="_ftnref12">12</a> The Service determined that in the case of a taxpayer who dies before a short sale of stock is closed, any income that may result from the closing of the short sale is not IRD, and the basis of any stock held on the date of the taxpayer’s death will be stepped up.<a href="#_ftn13" name="_ftnref13">13</a> The Service also privately ruled that in the case of a sales contract entered into before the decedent’s death, where an economically material contingency existed at the time of the decedent’s death that might have disrupted the sale of the real property, any gain realized from the sale of the real property after the decedent’s death did not constitute IRD.<a href="#_ftn14" name="_ftnref14">14</a> The Court of Appeals for the 10th Circuit has held that an alimony arrearage paid to the estate of a former spouse was IRD and thus, taxable to the recipient beneficiaries as ordinary income.<a href="#_ftn15" name="_ftnref15">15</a> The Tax Court determined that because a signed withdrawal request from the decedent constituted an effective exercise of the decedent’s right to a lump-sum distribution during his lifetime, the lump-sum distribution from TIAA-CREF was therefore income to the decedent and properly includable in the decedent’s income. Accordingly, the court held, the lump sum payment received by the decedent’s son was not a death benefits payment and, thus, was not includable in the son’s gross income as IRD.<a href="#_ftn16" name="_ftnref16">16</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 691(a). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 1367(b). <a href="#_ftnref3" name="_ftn3">3</a>.   Rev. Rul. 69-297, 1969-1 CB 131; Rev. Rul. 75-125, 1975-1 CB 254. <a href="#_ftnref4" name="_ftn4">4</a>.   Let. Rul. 9031046. <a href="#_ftnref5" name="_ftn5">5</a>.   Let. Rul. 200041018. <a href="#_ftnref6" name="_ftn6">6</a>.   Let. Rul. 9132021. See Rev. Rul. 92-47, 1992-1 CB 198. See also Let. Rul. 200336020. <a href="#_ftnref7" name="_ftn7">7</a>.   Let. Rul. 200023030. <a href="#_ftnref8" name="_ftn8">8</a>.   Let. Rul. 200702007. <a href="#_ftnref9" name="_ftn9">9</a>.   Estate of Frane v. Commissioner, 998 F.2d 567 (8th Cir. 1993). <a href="#_ftnref10" name="_ftn10">10</a>. Rev. Rul. 64-104, 1964-1 CB 223. <a href="#_ftnref11" name="_ftn11">11</a>. Let. Ruls. 9845026, 9507008, 9024016. <a href="#_ftnref12" name="_ftn12">12</a>. Let. Rul. 9507008. <a href="#_ftnref13" name="_ftn13">13</a>. Let. Rul. 9436017. See IRC § 1014. <a href="#_ftnref14" name="_ftn14">14</a>. Let. Rul. 200744001. <a href="#_ftnref15" name="_ftn15">15</a>. Kitch v. Commissioner, 103 F. 3d 104, 97-1 USTC ¶ 50,124 (10th Cir. 1996). <a href="#_ftnref16" name="_ftn16">16</a>.  Eberly v. Commissioner, TC Summary Op. 2006-45. </div></div>

March 13, 2024

744 / What substantiation requirements apply in order for a taxpayer to take an income tax deduction for charitable contributions?

<div class="Section1">No charitable deduction is allowed for a contribution of cash, check, or other monetary gift unless the donor maintains either a bank record or a written communication from the donee showing the name of the organization and the date and the amount of the contribution.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> Charitable contributions of $250 or more (whether in cash or property) must be substantiated by a contemporaneous written acknowledgment of the contribution supplied by the charitable organization. (An organization can provide the acknowledgement electronically, such as via an e-mail addressed to the donor.)<a href="#_ftn2" name="_ftnref2">2</a> In prior years, substantiation was not required if certain information was reported on a return filed by the charitable organization (this exception was repealed by the 2017 Tax Act for tax years beginning after December 31, 2016).<a href="#_ftn3" name="_ftnref3">3</a> Special rules apply to the substantiation and disclosure of quid pro quo contributions and contributions made by payroll deduction.<a href="#_ftn4" name="_ftnref4">4</a> A qualified appraisal is generally required for contributions of nonreadily valued property for which a deduction of more than $5,000 is claimed.<a href="#_ftn5" name="_ftnref5">5</a> No charitable deduction is allowed for a contribution of clothing or a household item unless the property is in good or used condition. Regulations may deny a deduction for a contribution of clothing or a household item which has minimal monetary value. These rules do not apply to a contribution of a single item if a deduction of more than $500 is claimed and a qualified appraisal is included with the return. Household items include furniture, furnishings, electronics, linens, appliances, and similar items; but not food, art, jewelry, and collections.<a href="#_ftn6" name="_ftnref6">6</a> Special rules apply to certain types of gifts, including charitable donations of patents and intellectual property, and for donations of used motor vehicles, boats, and airplanes.<a href="#_ftn7" name="_ftnref7">7</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 170(f)(17). <a href="#_ftnref2" name="_ftn2">2</a>. IRS Pub. 1771 (March 2016), p. 5. <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 170(f)(8) (repealed by Pub. Law. No. 115-97). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. §§ 1.170A-13(f), 1.6115-1. <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 170(f)(11). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 170(f)(16). <a href="#_ftnref7" name="_ftn7">7</a>. IRC §§ 170(e)(1)(B), 170(f)(11), 170(f)(12), 170(m); Notice 2005-44, 2005-25 IRB 1287. </div>