Ace ACC330 Test #2: Complete Notes
with Practice Questions and Answers
Deductions FOR AGI - There are three categories of deductions FOR AGI:
- Directly related to business activities
- Indirectly related to business activities
- Subsidizing specific activities
Directly related to business actitivities - • Taxpayers are allowed to deduct expenses
incurred togenerate business income.
• For tax purposes, activities are either profit-motivated ormotivated by personal
objectives.
• Profit-motivated activities are classified as
1. Business activities (called "trade or business")
2. Investment activities
Business activities - Although both are motivated primarily by profit,
businessactivities are distinguished from investment activities.
• Trade or business activities require a relatively high involvement or effort from the
taxpayer, whereas investment activities do not
• Investment activities involve investing in property forappreciation or for income
payments
Trade or business expenses - Trade or business expenses must be.
• Directly connected to the business activity.
• Ordinary and necessary for the activity (example, appropriateand helpful for
generating a profit).
• Reasonable in amount (not extravagant).
Expenses are claimed on Schedule C.
• Revenues from the same activity are also reported on thesame Schedule C
.• The net income or loss from Schedule C is transferred toSchedule 1, line 3, and
then combined with other items and included on Form 1040 (page 1), line 8.
Rent and Royalty Expenses - Rental and Royalty Expenses.
• Claimed above the line (for AGI).
• Could either be an investment activity or a trade activity dependingon facts.
• Taxpayers report expenses and revenue on Schedule E andtransfer the net income
or loss from Schedule E to Schedule 1, line5, and then combine with other items and
include on Form 1040(page 1), line 8.
Flow-Through Entities.
• Expenses and losses incurred by a flow-through entity passthrough to the entity
owners, who typically report these amounts onSchedule E, then Schedule 1, line 5,
and then combine with other items and include on Form 1040 (page 1), line 8.
Losses - Losses
• Taxpayers disposing of trade or business assets at a loss areallowed to deduct the
loss for AGI.
• Losses from investment assets (called capital assets) areoffset against capital
gains.
,• If capital losses exceed capital gains, this is called a netcapital loss.
• A net capital loss is deducted for AGI but limited to $3,000.
• Losses in excess of the $3,000 limit are carried forward indefinitely to subsequent
years.
Excess business loss limitation - Excess Business Loss Limitation
• Excess business loss is excess of aggregate businessdeductions over the sum of
aggregate business gross incomeor gain plus $305,000 ($610,000 for taxpayers
married filingjointly).
• Excess business loss is not deductible but is carried forward.10
Health Insurance Deduction by self-employed taxpayers - - Deduction provides
equity with employees who receive health insurance as a qualified fringe benefit.
• Self-employed taxpayers can claim personal health insurance premiums for the
taxpayer, the taxpayer's spouse, the taxpayer's dependents, and the taxpayer's
children underage 27 as deductions for AGI, but only to the extent of the self-
employment income derived from the specific trade or business.
Self-employment tax deduction - • Employers deduct the Social Security and
Medicare taxesthey pay on employee salaries.
• Self-employed individuals are required to pay self-employment tax in lieu of Social
Security tax. This taxrepresents both the employee's and the employer's share ofthe
Social Security and Medicare taxes.
• Self-employed taxpayers are allowed to deduct the employer portion of the self-
employment tax they pay to compensate for employers deducting their portion of
Social Security.
Deductions for individual retirement accounts - • Deductible contributions to
traditional IRA's are for AGIdeductions. Deduction amount depends on a number
offactors.
• Distributions from traditional IRA's are taxed as ordinaryincome and early
distributions (before age 59½) aregenerally subject to a 10 percent penalty.
• Nondeductible contributions can be made. On distribution, the taxpayer is taxed on
the earnings generated by nondeductible contributions but not on the actual
nondeductible contributions.
Deductions for health savings accounts - • Individuals covered by a high deductible
health plan with no other health coverage can set aside amounts for payment of
qualified medical and dental expenses for the taxpayer, spouse, and dependents
• For 2024, high deductible health plans have a minimum annual deductible of
$1,600 for self-only coverage ($3,200 for family coverage) and their maximum
annual deductible and other out-of-pocket expenses cannot exceed $8,050 for self-
only coverage($16,100 for family coverage)
• For 2024, individuals can contribute up to $4,150 for self-only coverage ($8,300 for
family coverage) to a HSA and deduct these contributions for AGI. Individuals age 55
or older at the end of the tax year may contribute and deduct an additional $1,000
annually.
Deductions from health savings accounts - • Distributions from a HSA are tax free if
they pay for qualified medical expenses of the taxpayer, spouse, and dependents.
, Otherwise, distributions are taxed as ordinary income (and subject to an additional
20% tax unless the taxpayer is disabled, age 65 or older, or deceased).
Penalty for early withdrawal of savings
• Reduces the taxpayer's net interest income to the amount actually received
Extra examples of deductions for AGI - - - Alimony payments are deductible for AGI
to maintain equity if paid pursuant to a divorce or separation agreement executed
before 2019
- Contributions to a qualified retirement account are deductible for AGI to encourage
savings
Deduction for interest on qualified education loans - • Up to $2,500 of interest on
education loans is deductible for AGI
• The interest deduction is phased out for taxpayers with A GI exceeding $80,000
($165,000 filing jointly)
• The deduction is eliminated for taxpayers with A GI exceeding $95,000 ($195,000
filing jointly).
Phase-out percentage - Single or head of household --> (modified AGI -
$80,000)/$15,000
Married filing jointly --> (modified AGI - $165,000)/$30,000
** married taxpayers filing separately are ineligible for the deduction
Deductions from AGI - Now moving on to deductions FROM adjusted gross income;
itemized deductions
Medical expenses - • Taxpayers may deduct medical expenses incurred to
treatthemselves, their spouse, and their dependents
• Qualifying medical expenses include unreimbursedpayments for care, prevention,
diagnosis, or cure of injury,disease, or bodily function
• Taxpayers using personal automobiles for medical transportation purposes may
deduct a standard mileage allowance (21 cents per mile in 2024) in lieu of actual
costs
Hospitals and long-term care facilities - Hospitals and Long-Term Care Facilities
• Taxpayers may deduct the costs of actual medical carewhether the care is provided
at hospitals or other long-term care facilities
Medical Expense Deduction Limitation
• It is limited to the amount of unreimbursed qualified medical expenses paid during
the year (no matter when the services were provided) reduced by 7.5 percent of the
taxpayer's AGI
Taxes - Individuals may deduct itemized deductions payments for the followingtaxes:
• State, local, and foreign income taxes
• State and local real estate taxes on property held for personal orinvestment
purposes
• State and local personal property taxes that are assessed on thevalue of the
specific property
Sales tax deduction
• State and local sales taxes can be deducted in lieu of state andlocal income taxes.
with Practice Questions and Answers
Deductions FOR AGI - There are three categories of deductions FOR AGI:
- Directly related to business activities
- Indirectly related to business activities
- Subsidizing specific activities
Directly related to business actitivities - • Taxpayers are allowed to deduct expenses
incurred togenerate business income.
• For tax purposes, activities are either profit-motivated ormotivated by personal
objectives.
• Profit-motivated activities are classified as
1. Business activities (called "trade or business")
2. Investment activities
Business activities - Although both are motivated primarily by profit,
businessactivities are distinguished from investment activities.
• Trade or business activities require a relatively high involvement or effort from the
taxpayer, whereas investment activities do not
• Investment activities involve investing in property forappreciation or for income
payments
Trade or business expenses - Trade or business expenses must be.
• Directly connected to the business activity.
• Ordinary and necessary for the activity (example, appropriateand helpful for
generating a profit).
• Reasonable in amount (not extravagant).
Expenses are claimed on Schedule C.
• Revenues from the same activity are also reported on thesame Schedule C
.• The net income or loss from Schedule C is transferred toSchedule 1, line 3, and
then combined with other items and included on Form 1040 (page 1), line 8.
Rent and Royalty Expenses - Rental and Royalty Expenses.
• Claimed above the line (for AGI).
• Could either be an investment activity or a trade activity dependingon facts.
• Taxpayers report expenses and revenue on Schedule E andtransfer the net income
or loss from Schedule E to Schedule 1, line5, and then combine with other items and
include on Form 1040(page 1), line 8.
Flow-Through Entities.
• Expenses and losses incurred by a flow-through entity passthrough to the entity
owners, who typically report these amounts onSchedule E, then Schedule 1, line 5,
and then combine with other items and include on Form 1040 (page 1), line 8.
Losses - Losses
• Taxpayers disposing of trade or business assets at a loss areallowed to deduct the
loss for AGI.
• Losses from investment assets (called capital assets) areoffset against capital
gains.
,• If capital losses exceed capital gains, this is called a netcapital loss.
• A net capital loss is deducted for AGI but limited to $3,000.
• Losses in excess of the $3,000 limit are carried forward indefinitely to subsequent
years.
Excess business loss limitation - Excess Business Loss Limitation
• Excess business loss is excess of aggregate businessdeductions over the sum of
aggregate business gross incomeor gain plus $305,000 ($610,000 for taxpayers
married filingjointly).
• Excess business loss is not deductible but is carried forward.10
Health Insurance Deduction by self-employed taxpayers - - Deduction provides
equity with employees who receive health insurance as a qualified fringe benefit.
• Self-employed taxpayers can claim personal health insurance premiums for the
taxpayer, the taxpayer's spouse, the taxpayer's dependents, and the taxpayer's
children underage 27 as deductions for AGI, but only to the extent of the self-
employment income derived from the specific trade or business.
Self-employment tax deduction - • Employers deduct the Social Security and
Medicare taxesthey pay on employee salaries.
• Self-employed individuals are required to pay self-employment tax in lieu of Social
Security tax. This taxrepresents both the employee's and the employer's share ofthe
Social Security and Medicare taxes.
• Self-employed taxpayers are allowed to deduct the employer portion of the self-
employment tax they pay to compensate for employers deducting their portion of
Social Security.
Deductions for individual retirement accounts - • Deductible contributions to
traditional IRA's are for AGIdeductions. Deduction amount depends on a number
offactors.
• Distributions from traditional IRA's are taxed as ordinaryincome and early
distributions (before age 59½) aregenerally subject to a 10 percent penalty.
• Nondeductible contributions can be made. On distribution, the taxpayer is taxed on
the earnings generated by nondeductible contributions but not on the actual
nondeductible contributions.
Deductions for health savings accounts - • Individuals covered by a high deductible
health plan with no other health coverage can set aside amounts for payment of
qualified medical and dental expenses for the taxpayer, spouse, and dependents
• For 2024, high deductible health plans have a minimum annual deductible of
$1,600 for self-only coverage ($3,200 for family coverage) and their maximum
annual deductible and other out-of-pocket expenses cannot exceed $8,050 for self-
only coverage($16,100 for family coverage)
• For 2024, individuals can contribute up to $4,150 for self-only coverage ($8,300 for
family coverage) to a HSA and deduct these contributions for AGI. Individuals age 55
or older at the end of the tax year may contribute and deduct an additional $1,000
annually.
Deductions from health savings accounts - • Distributions from a HSA are tax free if
they pay for qualified medical expenses of the taxpayer, spouse, and dependents.
, Otherwise, distributions are taxed as ordinary income (and subject to an additional
20% tax unless the taxpayer is disabled, age 65 or older, or deceased).
Penalty for early withdrawal of savings
• Reduces the taxpayer's net interest income to the amount actually received
Extra examples of deductions for AGI - - - Alimony payments are deductible for AGI
to maintain equity if paid pursuant to a divorce or separation agreement executed
before 2019
- Contributions to a qualified retirement account are deductible for AGI to encourage
savings
Deduction for interest on qualified education loans - • Up to $2,500 of interest on
education loans is deductible for AGI
• The interest deduction is phased out for taxpayers with A GI exceeding $80,000
($165,000 filing jointly)
• The deduction is eliminated for taxpayers with A GI exceeding $95,000 ($195,000
filing jointly).
Phase-out percentage - Single or head of household --> (modified AGI -
$80,000)/$15,000
Married filing jointly --> (modified AGI - $165,000)/$30,000
** married taxpayers filing separately are ineligible for the deduction
Deductions from AGI - Now moving on to deductions FROM adjusted gross income;
itemized deductions
Medical expenses - • Taxpayers may deduct medical expenses incurred to
treatthemselves, their spouse, and their dependents
• Qualifying medical expenses include unreimbursedpayments for care, prevention,
diagnosis, or cure of injury,disease, or bodily function
• Taxpayers using personal automobiles for medical transportation purposes may
deduct a standard mileage allowance (21 cents per mile in 2024) in lieu of actual
costs
Hospitals and long-term care facilities - Hospitals and Long-Term Care Facilities
• Taxpayers may deduct the costs of actual medical carewhether the care is provided
at hospitals or other long-term care facilities
Medical Expense Deduction Limitation
• It is limited to the amount of unreimbursed qualified medical expenses paid during
the year (no matter when the services were provided) reduced by 7.5 percent of the
taxpayer's AGI
Taxes - Individuals may deduct itemized deductions payments for the followingtaxes:
• State, local, and foreign income taxes
• State and local real estate taxes on property held for personal orinvestment
purposes
• State and local personal property taxes that are assessed on thevalue of the
specific property
Sales tax deduction
• State and local sales taxes can be deducted in lieu of state andlocal income taxes.
