Chapter 4
Gross Income Exclusions and Adjustments to Income
Gross Income Exclusions
" Bequest and inheritance
o Basis FMV at date of death
o Holding period is long-term
" Damages for personal physical injury or sickness
o Slander\libel\back pay damages are taxable
" Dividends, tax-exempt - return of basis
" Foreign-earned income exclusion - up to $91,400 for 2009
" Gifts
o Basis & holding period same as giftor
o Giftor may have to pay gift tax
" Exception - $13,000 (for 2009 & 2010)
" Income of minors - taxable to child
" Insurance, proceeds from life policy
o Interest can be taxable
" Interest, tax-exempt [Muni (municipal) Interest]
o Taxable for California
o Exception - California Muni interest
" Scholarship and fellowship grants
o No room or board
" Social security benefits - income limitations
" Workers' compensation benefits
" Coverdell Education IRAs & Series EE & I Savings Bonds if used for education
" Qualified state tuition programs - IRC 529
Fringe Benefits
" Accident & health and insurance plans *
" Adoption expenses * - $12,150 - AGI limitations
" Cafeteria Plans - IRC 125
" Dependent care * - Lesser of $5,000 or earned income of spouse with lesser earnings
" De minimis - turkey, copies, etc
" Educational assistance * - $5,250
" Employee discounts * - limited
" Group-term life insurance* - Under $50,000
" Incentive stock option - not taxable until sold
" Lodging - required for employment
" Meals for the convenience of the employer
" Moving reimbursement for allowable costs
" No-additional-cost services *
" Transportation/parking - $120/$230 per month
" Tuition Reduction - college/university employees
" Retirement plans
o Usually not taxable when it is contributed; but, taxable when it is distributed
" Working condition
Roth Individual Retirement Accounts
" Who can contribute?
o Individuals up to the lesser of $5,000 per year or 100% of earned income, if over 49 an additional $1,000 can be contributed
o Amount is phased out at higher income levels, see page 4-14 for equation
Unmarried $105,000 - $120,000
MFJ $166,000 - $176,000
MFS $0 - $10,000, if you lived with your spouse anytime during the year; otherwise, use unmarried limits
" No deduction on the tax return
" Must be contributed by April 15th for the prior tax year
" Roth 401(k) - Contributions are made with post-tax wages up to $16,500 + $5,500 if over 49-no AGI limits
Roth IRAs Distributions
Taxpayers may take withdrawals tax and penalty free (10%) if made after a five-year waiting period and any of the folowing conditions is met:
" The distribution is made after the taxpayer attains age 59½
" The distribution is made to a beneficiary as a result of the taxpayer's death
" The distribution is made on account of the taxpayer's disability
" The distribution is used to pay first-time homebuyer expenses ($10,000 lifetime limit, no ownership in prior 2 year)
Other Non-deductible Education Programs
" Coverdell Education Savings Accounts
o Up to $2,000 per child, per year
o Contribution limit phased out if you make too much money and is nondeductible
o Distributions not taxable if used for education
" 529 Plans
o Treated as a gift & subject to annual gift tax limit
o Distributions not taxable
o If not used by beneficiary, can be transferred to another beneficiary or reverts to donor (income then is taxable)
" No double dipping
Deductions for AGI
A Form 1040 filer can deduct a number of adjustments to income including:
Line #:
23. Educator expenses
24. Certain business expenses of reservists, (starving) performing artists, and fee-based government officials - Mainly travel expenses
25. Health savings account deduction
26. Moving expenses
27. One-half of self-employment tax
28. Keogh and self-employed SEP and SIMPLE plans - Chapter 7
29. Self-employed health insurance deduction
30. Penalty on early withdrawal of savings - Form 1099-INT
31. Alimony paid - Chapter 3
32. Traditional IRA deduction
33. Student loan interest deduction
34. Tuition and fees deduction
35. Domestic production activities deduction
36. Jury duty pay that an employee transfers to an employer for regular pay
36. Attorney fees paid for certain discrimination claims to the extent of gross income
Educator Expenses
" Eligible Educators - K through 12
o Teachers, instructors, counselors, principal or aide for at least 900 hours during the school year
" May deduct up to $250 of qualified expenses
o Books, supplies, equipment, materials used in classroom
" Exceptions - home schooling & non-athletic supplies for health or PE classes
" Reduce by reimbursements
" Not deductible for California
Health Savings Account (HSA) Deduction (Form 8889)
" Basically Individual Retirement Account (IRA) for medical expenses
" Must be self-employed or employee of an employer who maintains a high deductible health plan($1,150/$2,300)
" No other health insurance coverage except for accidents, disability, dental or vision care, long-term care or workers' compensation
" Maximum contribution is equal to the amount of the insurance deductible but not to exceed
o Individuals - $3,000 ($4,000 for individuals age 55 or older
o Families - $5,950 ($6,950 if age 55 or older)
" Pay for medical expenses out of the HSA - nontaxable
" California has somewhat conformed
Moving Expenses - Form 3903
" For employees & self-employed
" Moving Expenses
o Cost to move household goods
o Travel from old house to new
Actual or mileage (24 cents for 2009)
Lodging but no meals
o Reduced by employer moving expense reimbursements
" Tests for Deductibility
o Change in workplace
o Distance Test - 50 miles farther than the taxpayer's old principal residence than was the old job location
o Time Test - different rules for self-employed
Full-time employee for 39 weeks during 12 months post- arrival in new area
Full-time employee for 78 weeks during 24 months post-arrival in new area
Exceptions - Death or disability; involuntary separation from employment; re-transfer for the benefit of employer
" California has conformed
Half of Self-Employment Tax
" Self-Employed
o Self-employment tax = 15.3% of net earnings
o Allowed as a for AGI deduction = 1/2 of the self-employment tax imposed
" Must attach Schedule SE - Chapter 7
" California has conformed
Self-Employed Health Insurance Deduction
" 100% of self-employed health insurance payments, deductible for AGI
" Limitations:
o Taxpayers cannot take deduction for amount in excess of net earnings
o Taxpayer may not participate in any subsidized health plan maintained by an employer of taxpayer or spouse
" California allows a deduction for health insurance coverage for your registered domestic partner and their dependents
Individual-based Retirement Plans - IRAs -Contributions
" Two types of Individual Retirement Accounts (IRA)
o Roth - no deduction available
o Traditional
" Contribution must be made by April 15th for the prior year
" Traditional IRA
o 2009 Contribution dollar limitations is the lesser of
$4,000 ($5,000 if over 49 years old) per person OR
Earned income
o Also limited if you are an active participant in an employer plan and your AGI is at a certain level
Look on W-2 for participation
If you are limited because of AGI limitations, you can still make a non-deductible IRA contribution - See page 4-27
o Special rules apply to married taxpayers
If only one spouse is employed, and that spouse is not covered by an employer sponsored plan, then the working spouse and the nonworking spouse can contribute $4,000 each to an IRA
Distributions from a Traditional IRA
" Must start at 70½ years old; can start at 59½
" Fully taxable if funded with deductible contributions
" A portion is nontaxable if funded partially with nondeductible contributions
" No penalties (10% Federal; 2½% CA) for early withdrawal when the distribution is
o Due to death or disability
o Used by an unemployed person to buy health insurance
o Used to pay
Medical expenses in excess of 7.5% of AGI
Qualified higher education expenses
Qualified first-time homebuyer expenses ($10,000 lifetime limit)
Student Loan Interest
" Interest paid on student loans
" Higher education - must be going for a degree
" Expenses incurred attending a qualified educational institution
o Tuition
o Fees
o Room & Board
o Books & Supplies
o Reduced by nontaxable monies received
" Provisions and Limitations
o You must be liable for the debt
o Easy to document if you participated in federal student loan program. More documentation required if you went through a financial institution.
o Maximum deduction is $2,500 per year
MAGI (Modified AGI) limitation
Deduction reduced and eventually phased out when MAGI reaches $150,000 for MFJ or $75,000 for Single.
Tuition and Fees Deduction
" Qualified tuition and related expense paid for taxpayer, spouse, & dependent
" Required tuition and fees - no student health fees
o Reduced by any reimbursements or nontaxable education monies used
" Maximum deduction of $4,000
o No deduction if Modified AGI reaches $130,000 for MJF or $65,000 for Single.
" Deduction is not available to:
o MFS
o Anyone claimed as a dependent
o Anyone who claims a Hope or Lifetime learning credit (using same expenses)
" Not deductible for California
Domestic Production Activities
" 6% deduction of the LESSER of
o Qualified production activities income or
o Taxable income, then
o Limited to 50% of W-2 wages paid by taxpayer
" What domestic income qualifies for deduction?
o Manufacture, production, growth or extraction of tangible personal property, software development or sound recordings
o Qualified film - no porn
o Production of electricity, natural gas or potable water
o Construction/renovation of real property
" California did not conform
End of Chapter 4
