Tax professionals often speak about deductions that are “above” or “below” the line. In this case, the “line” is the point for determining adjusted gross income (AGI). The types of expenses generally associated with tax deductions—such as charitable donations and mortgage interest—are deducted below the line after being transferred from Schedule A. But “above-the-line deductions” are more valuable than Schedule A deductions because they reduce AGI for other tax purposes. Also, these deductions may be claimed by non-itemizers.
Which expenses are deductible above the line? Here are a few common examples:
Tuition deduction: If a taxpayer falls below certain income limits, he or she may deduct up to $4,000 of the tuition and fees paid for postsecondary school education in 2011. The $4,000 write-off is available for single filers with a modified AGI (MAGI) up to $65,000; $130,000 for joint filers. Single filers can claim a $2,000 deduction if they have a MAGI up to $80,000; $160,000 for joint filers. Caveat: This deduction cannot be claimed in conjunction with a higher education tax credit.
IRA contributions: The rules limiting IRA deductions based on the amount of income apply only to active participants in employer-sponsored retirement plans. In that case, deductions for 2011 returns are phased out for single filers with a MAGI between $56,000 and $66,000; $90,000 and $110,000 for joint filers if both spouses are active participants. If only one spouse is an active participant, the deduction for joint filers is phased out between $169,000 and $179,000 of MAGI.
Student loan interest: A taxpayer who is legally obligated to pay off a student loan for higher education can deduct up to $2,500 of interest on his or her tax return. This deduction is phased out for a single filer with a MAGI between $60,000 and $75,000; $120,000 and $150,000 for joint filers. Note: A child taking this deduction cannot be claimed as someone else’s dependent.
Moving expenses: Job-related moving expenses are deductible if a two-part test is passed: (1) The commute from the old home to the new workplace must be 50 miles farther than the commute from the old home to the old workplace. (2) The taxpayer is generally required to stay at the new job for at least 39 weeks of the next 12 months. If an individual qualifies, he or she can deduct the cost of transporting household goods and personal effects plus travel and lodging costs (but not meals) en route to the new home.
Self-employment tax breaks: If a taxpayer is self-employed, he or she may be able to claim several tax deductions above the line. This includes 50% of the self-employment tax the taxpayer is required to pay and 100% of health insurance costs and qualified retirement plan contributions. For example, a self-employed individual may deduct annual contributions to one of the “simplified” retirement plans allowed by law within generous limits.
Caution: This list is certainly not all-inclusive. Obtain professional assistance to maximize deductions on 2011 returns.
The IRS has issued new guidance on the tax treatment of employer-provided cell phones used by employees. The guidance is in accordance with the removal of strict reporting requirements under the Small Business Jobs Act of 2010.
The IRS explains that the value of a cell phone provided to an employee where use might be both business and personal is excluded from the employee’s taxable income if there are substantial business reasons for providing the cell phone. Some examples are
- The employer needs to contact the employee for work-related emergencies.
- The employer requires that the employee be available to speak with clients outside the office.
- The employee must speak with clients in other time zones outside the usual work day.
Also, in a new memo to its field force, the IRS has provided instructions concerning deductions of cell phones provided to employees and reimbursements to employees for business use of their personal cell phones. For instance, IRS agents have been cautioned to look for reimbursements for personal cell phone use by employees that exceed the actual cost of the cell phone. Both the new guidance and memo relating to cell phone use are effective retroactively for tax years beginning after 2009.
Finally, note that a cell phone provided as a benefit to an employee without any business connection is not considered a tax-free fringe benefit.
A few years ago, the tax rules requiring substantiation for charitable donations were tightened. Now, a new ruling shows that the IRS really means business.
Background: To deduct charitable contributions of $250 or more, a taxpayer must obtain a written acknowledgment from a qualified charitable organization. The acknowledgement should include the amount of the donation, a description of any noncash property contributed and the value of any goods or services provided. The acknowledgements must be obtained by the earlier of either the date the tax return is filed or the due date of the return (plus any extensions).
Note that special rules apply to charitable contributions of property. For instance, the property must be used to further the charity’s tax-exempt function. Additional tax return information is required for noncash contributions exceeding $500. Also, for property valued above $5,000, a taxpayer must obtain a qualified appraisal of the property’s value. Note: The cost of the appraisal is treated as a miscellaneous expense. The taxpayer may deduct annual miscellaneous expenses in excess of 2% of adjusted gross income.
Recent change: Under a 2006 tax law affecting all monetary contributions (including gifts by check and credit card), no deduction is allowed without receiving a written communication from the charity. The written communication must show the amount of the contribution, the date the contribution was made and the name of the charitable organization. However, for contributions less than $250 a cancelled check or a bank statement may suffice for this purpose.
Finally, for contributions of more than $75 where a benefit is received in exchange for a contribution—for example, dinner or prizes at a charity fundraiser—the charity must provide a “good faith estimate” of the goods or services received and the amount of payment exceeding the value of the benefit. The deductible amount is limited to the difference between the payment and the value.
The IRS continues to hold taxpayers accountable to the strict letter of the law.
With so much at stake, it makes sense to carefully substantiate charitable contributions made during the year and file all receipts.
The Department of Labor has recently released the final rules on fee disclosures (also known as the 408(b)(2) rules), which are designed to increase transparency of fees inside retirement plans. After several delays, the effective date is July 1, 2012.
The DOL press release (http://www.dol.gov/opa/media/press/ebsa/EBSA20111653.htm) says “The measures will expand transparency in the 401(k) plan marketplace and broaden the availability of retirement plan options so that Americans can maximize their ability to save responsibly and securely.”
The final regulations are 109 pages long, but the DOL has also provided a Fact Sheet (http://www.dol.gov/ebsa/newsroom/fs408b2finalreg.html ) and a summary of the changes from the interim rules (http://www.dol.gov/ebsa/408b2changes.html )
The 401(k) plan has long supplanted the traditional pension plan as the most popular type of tax-qualified retirement plan. Thus, there is a good chance that an employee will be eligible to participate in a 401(k) where he or she works. If the employee is married and working, both spouses may be able to participate in their respective plans.
However, many eligible employees are guilty of “mistakes” involving 401(k) plans. What is particularly frustrating is that these errors are relatively easy to avoid. Here are five common mistakes to watch out for:
Mistake #1: The participant sits on the sidelines. Many participants bailed out of their 401(k) plans in the wake of the stock market decline of 2008–2009 or cut back or eliminated deferrals. But history has shown that, despite the inherent risks, investing through a 401(k) will generally provide long-term rewards. For 2011, the deferral limit is $16,500, plus an extra $5,500 contribution is allowed for someone age 50 or older. Furthermore, an employer may “match” a participant’s contribution up to a stated percentage of salary. This matching contribution costs the employee zero.
Mistake #2: The participant does not invest carefully. As with investments outside a 401(k) plan, a participant should avoid an overly heavy concentration in one particular offering. Other errors include over-diversification such as investing in every possible mutual fund or other available option. Try to find the proper balance. A logical approach is to allocate assets based on current age, expected retirement age, the annual contribution amount and tolerance for risk. Caveat: There are no absolute guarantees with any investment.
Mistake #3: The participant “raids” the 401(k) early in life. A 401(k) plan is meant to be a savings vehicle for retirement. However, participants often take distributions well before retiring, especially if they are changing jobs. This reduces the funds that would be available in retirement. As a general rule, a distribution made prior to age 59½ is subject to a 10% penalty tax on the taxable portion, in addition to the regular income tax that is owed. Note: If a participant switches jobs and rolls over funds from a 401(k) to an IRA or another qualified plan in a timely fashion, the rollover is exempt from current income tax. A direct trustee-to-trustee transfer is recommended.
Mistake #4: The participant borrows money from the plan: As with raiding, a participant should be discouraged from taking a loan from the 401(k). Even though the participant is effectively being paid back, it will be more difficult to meet retirement goals. The participant will not have access to the funds that could have been earned if the principal had remained intact. Borrowing may be necessary in an emergency, but it should generally be viewed as a last resort.
Mistake #5: The participant does not seek assistance. Recent law changes encourage 401(k) participants to obtain advice within certain parameters. There is no need to go it alone. With professional guidance, 401(k) participants can sidestep the common pitfalls outlined above.
