Itemizing deductions is a taxing situation

A nonprofit radio station I was listening to last week indicated that one could support the station by donating one’s automobile and that the donation was tax deductible. The short answer to the question of whether an automobile donation to a charitable organization will reduce the taxpayer’s tax liability is, “It depends.”

The Tax Cuts and Jobs Act, which was passed in December 2017, contained a number of provisions that affected both the standard and itemized deduction calculations. The standard deduction is a function of the taxpayer’s filing status. If a taxpayer files their return as a single person, their basic standard deduction amount is $12,200. If a taxpayer qualifies as a head of household, the basic standard deduction rises to $18,350. Finally, if the taxpayer qualifies to file as married filing jointly, the basic standard deduction rises to $24,400. In addition, taxpayers may receive additional standard deduction amounts if they are 65 years of age or older and/or blind. The additional standard deduction amount for taxpayers who are using the single or head of household filing status is $1,650.  The additional standard deduction amount for taxpayers using the married filing jointly status is $1,300. Both the basic and additional standard deduction amounts are indexed annually and therefore will change each year. The basic standard deduction amounts were essentially doubled over the amounts available under the tax law in effect in 2017.

The taxpayer should use the larger of the allowed standard deduction (i.e. the sum of the basic standard deduction plus any additional standard deduction amounts) or their itemized deductions. The taxpayer should be aware that there are also significant limitations applicable to itemized deductions in the current tax law. There are six categories of itemized deductions. Each of these categories have limitations unique to that category that will be discussed in the following paragraphs.

Medical expenses paid by the taxpayer for themselves, their spouse, and their dependents are generally deductible. However, expenditures for the general improvement of health (for example, a gym membership), over the counter medicines, and unnecessary cosmetic surgery are excluded. Further, once the taxpayer has determined their total medical expenses, the total is reduced by 10% of the taxpayer’s Adjusted Gross Income (AGI). The result is that most taxpayers will have a significant medical expense deduction only if their medical expenditures are large in a tax year and/or their AGI is small relative to the medical expenditures. For example, if a taxpayer has an AGI of $100,000, medical expenditures would have to exceed $10,000 before there would be any allowable deduction.

Some taxes are also allowed as an itemized deduction. Generally, the taxpayer will deduct the greater of the amount of state and/or local income taxes withheld (including estimated tax payments) or the sales tax paid during the tax year. In addition, property taxes are also generally deductible. The current tax law limits this tax deduction to a maximum of $10,000 each year ($5,000 if the taxpayer is married filing separately).

Under previous tax law, qualified residence mortgage interest and the interest on home equity loans was included in the total of itemized deductions. Under the current tax law two significant changes have occurred. Now interest on home equity loans (i.e. second mortgage loans) will not be deductible. Also, deductible interest on qualified residence indebtedness incurred after December 17, 2017 will be limited to loan amounts of no more than $750,000 ($375,000 for taxpayers who are married filing separately).

Charitable contributions are allowed as an itemized deduction. In the case of the automobile mentioned earlier the amount of the deduction would be the fair market value of the auto at the time of the contribution. Generally, there is an overarching limit on total charitable contributions equal to 50% of the taxpayer’s AGI, with amounts in excess of the limit carried over and deductible in subsequent years. However, in the case of cash contributions, the current tax law raises the limit to 60% of the taxpayer’s AGI.

Miscellaneous deductions are a fifth category of possible itemized deductions. Space limitations preclude a proper discussion of these items. However, the taxpayer should be aware that once the total miscellaneous itemized deductions have been determined, the total is then reduced by 2% of the taxpayer’s AGI.

Casualty and theft losses are the sixth category of possible itemized deductions. Personal casualties and thefts are subject to two sets of limitations. The first is a $100 per event reduction. Once this first limit has been used to reduce the amount of the loss, the remaining losses are totaled and then that amount is further reduced by 10% of the taxpayer’s AGI. In addition to these limits the current tax law also requires the loss to have been incurred in a Federally Declared Disaster Area. If the loss does not occur in a Federally Declared Disaster Area, no deduction is allowed. This leads to following inequitable result. Assume your personal residence was destroyed by fire and your loss was $75,000 after any insurance reimbursement. It the destruction was caused by a wildfire and a federal Disaster Area was declared, you have a deductible $75,000 loss (subject to the limits previously noted). Alternatively, let us assume that your home simply burned down. In this case your deduction is zero.

From the preceding paragraphs, it is obvious that Congress’ intention was to significantly reduce the number of taxpayers claiming itemized deductions (instead of the standard deduction) on their tax returns. It would appear that Congress has accomplished this goal, however the simplicity gained may have reduced the equity of our tax system. Taxpayers response to this must be to increase their tax planning. Itemized deductions for medical and charitable contributions should be bunched into a specific tax year so as to maximize their effect on reducing the tax liability. The wise taxpayer should contact their tax professional well in advance of the due date of the tax return so that a plan appropriate for them may be developed.        


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