Education expense deductions can be beneficial to student taxpayers or their parents, however, knowing what qualifies as an appropriate expense is important. As the taxpayers in the next situation soon learned, even if you spend significant time educating yourself in various topics, if the expense is not deemed ordinary and necessary, it will be categorized as a non-deductible personal expense.

The Situation

Married taxpayers both worked at Seminole State College – the husband as an adjunct math and communications professor, the wife as the campus librarian. On their tax return, the couple deducted their home internet, television, books, DVDs, and CD expenses, claiming them to be unreimbursed employee expenses. With a doctorate degree in communication, the husband testified that the cost of maintaining a similar terminal degree falls on the individuals, who must spend their own time developing, gaining, and exploring information, to continue their knowledge and, in theory, self-educating.

IRC Section 162 allows a taxpayer to deduct the cost of internet service at home if it is a necessary and ordinary expense to the taxpayer’s job or business. Otherwise, the expense is considered personal, and therefore, non-deductible.

In his eyes, the taxpayer believed that access to the internet was crucial to developing his general knowledge. He argued that any incurred expenses should be considered deductible as unreimbursed employee expenses as they were used to increase his general knowledge. To him, this included the money spent on books, CDs and DVDs, as he claimed they were necessary to perform his job functions. Despite this, he did agree that he hadn’t been required to purchase the material by the university, nor was it expected of him to do so to continue at his job.

In this circumstance, general knowledge expenses are not deemed ordinary and necessary to the profession of a college professor, and instead fall under the notion of a personal expense. The court acknowledged the amount of time and resources expended by the taxpayers to fuel their quest for knowledge, however eventually ruled that these expenses cannot qualify as unreimbursed employee expenses for either a professor or college librarian.

Business travel can add up to a costly expense for many individuals, which is why deductions are offered at tax time to help alleviate the sting. In the case of mileage deductions, maintaining adequate records is extremely important to validate the expense, as the taxpayer in the following situation soon learned.

The Situation

The taxpayer drove 8,687 miles while distributing advertising materials in hope of attracting new clientele for his CPA business. When filing his tax return, the CPA claimed those miles as a business deduction, however the IRS denied the claim because his records were not simultaneous.

When in court, the taxpayer couldn’t provide a simultaneous record of his mileage for the appropriate year, and instead offered a calendar and copies of directions from the website MapQuest, printed two years after the fact. It became obvious that the records were produced after the audit had begun, and while some significant dates were circled on the calendar, there was no other information scribed – no miles driven, locations, appointments, or purpose of travel. The only information he supplied was the distance between his home and the towns in which he claimed to have performed business functions, as per MapQuest. The corresponding dates of travel had been written on top of each printout of directions, similar to the dates highlighted on the calendar.

The court determined the records (the calendar and the printouts) to have been organized two years after the fact, breaking the requirement set forth by Regulation section 1.274-5T(c)(2)(ii) that records must be maintained at the time of travel.

Additionally, because of the gap in time and the lack of information provided, the court decided that the directions and the calendar weren’t adequate and didn’t provide enough corroborative evidence to document the amount of business mileage, the purpose of travel, and the dates the business traveled occurred.

Employees who are required to wear a specific uniform to work may qualify for a deduction at tax time as an unreimbursed employee expense. However, as the next situation proves, the required clothing must not be suitable for wear outside of the workplace.

The Situation

Ralph Lauren Corporation sells, markets, and designs a wide range of men’s clothing – from polo shirts and t-shirts to dress shirts and sport coats – both casual and formal. A salesman for the Ralph Lauren Corporation was required by the company to represent the brand by wearing Ralph Lauren apparel while at work.

Due to this requirement, the taxpayer bought a range of Ralph Lauren attire including shirts, pants, suits and ties, and considered this purchase to fit under the category of unreimbursed employee expenses. He deducted the amount spent on work clothes on a Schedule A of Form 1040, however the IRS did not accept the deduction. Their reason: the clothing is considered a nondeductible personal expense as per IRC section 262. Taxpayers are not able to deduct costs related to basic living, personal expenses, and family.

In section 162 (a) of the IRC, taxpayers generally can deduct ordinary and necessary costs paid or incurred in relation to employment, trade, or business activities. As an employee, any costs that are ordinary or necessary to work, which you were not reimbursed for, may be deductible under IRC section 162.

In most situations, clothing expenses can’t be deducted, which includes maintenance and cleaning of uniforms, even if the clothing is worn while working. There are three different qualifications clothing costs must meet to be considered ordinary and necessary, and therefore deductible:

  1. The clothing is required for the taxpayer to maintain employment
  2. The clothing can’t be worn as personal wear
  3. The clothing isn’t suitable to be worn as personal wear or general streetwear

Even though the taxpayer is required to wear the specific clothing to work, it is still considered suitable for general streetwear. Because of this, the taxpayer was not able to deduct his expenses for the clothing he purchased.

Educational tax credits can help taxpayers save when they file their return if they incurred any education-related expenses during the year. However, as the student in the following situation discovered, educational tax credits are based on what you actually paid, not what was billed.

The Situation

In 2010, the full-time Hampton University student registered for classes occurring in the Spring ’11 semester. When she registered for classes, the school billed her $2,460 for tuition in relation to the courses she chose. Once the schedule was finalized and her classes were set, the university added an additional $1,230 to her balanced based on the final schedule on January 10, 2011.

This student primarily paid her educational expenses with student loans, which were not disbursed until ten days after the schedule was set. On January 20, 2011, the university directly received the funds from the loans, which prompted the school to generate a Form 1098-T, Tuition Statement for 2011.

This form, which is sent to both the student and the IRS, recorded no tuition payments received (Box 1), but stated $1,180 in billed qualified tuition and expenses (Box 2). The amount billed as represented in Box 2 referred to the $1,230 of tuition billed in January, along with a $50 mandatory fee. A $100 tuition credit was subtracted from the amount billed, leaving a total of $1,180 as stated on the Form 1098-T. (more…)

Unknowingly engaging in fraudulent transactions or learning you are the victim of a scam is never a good thing. When you’ve lost some of your hard-earned money due to theft, fraud, or a scam, you may be able to deduct the amount at tax time. However, state laws have three criteria that must be met to deduct losses resulting from these situations, as the taxpayer in the next situation unfortunately had to learn.

The Situation

At a local swap meet, the taxpayer met Eugene McCullough when interested in his gold clubs and accessories. After forming a quick friendship, McCullough mentioned an old Navy-mate, known as Lawyer Stanley, and claimed he had a troubled past. However, according to McCullough, Stanley was currently doing well in the diamond industry. Since the taxpayer wanted a small pair of diamond earrings, McCullough contacted Stanley, who could not make a sale because he only did wholesale.

Within a few weeks, McCullough told the taxpayer that Stanley had contacted him with an interesting offer, and that the taxpayer should consider. With an adequate initial investment, Stanley could offer her $1 million after he had acquired the diamonds and resold them. Because of her friendship and trust of McCullough, the taxpayer didn’t sign any contracts or documents, and was expecting a ROI within 10 to 30 days.

The taxpayer sent $320,000 via wire transfer to Africa World Trade, LLC, and within days McCullough told her that Stanley emailed him, excited about the millions she could make if she continued to provide capital. She could own a bank! She reacted to the immediacy of the emails, and wired $60,000 more. (more…)

Custodial Parent Rules

For purposes of deductions and exemptions, a custodial parent can claim a child as a dependent in many cases. The tax law has very specific rules about who can qualify as a custodial parent. The following describes a specific situation in which the rules of custodial parents needed to be examined closely to determine which taxpayer had the right to claim the child.

The Situation

Married in 2001, a taxpayer had a rocky relationship with his wife and was often splitting up and getting back together again. In 2013, the entire family – the husband, wife, and children – were living in the same public housing, however come 2014, the couple splits again and chooses to proceed with divorce.

When filing his 2013 tax return, the husband claimed an exemption for each of his children, along with the Earned Income Tax Credit, the child tax credit while using the Head of Household status. He didn’t include Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent with his 2013 return.

Because of his error in not including the form, the IRS didn’t permit the dependency exemption deduction, Earned Income Tax Credit or the child tax credit for 2013. He was also ineligible to file as Head of Household, so the IRS switched his status to Single. (more…)

When planning for the next tax year, taxpayers should keep accurate records and receipts of any expenses they plan to deduct. However, if no records exist, the Cohan Rule may benefit the taxpayer in such that it states expenses may be reasonably and credibly estimated. The taxpayer in the next situation benefited from the Cohan Rule in combination with appropriate testimony.

The Situation:

A sole-proprietor of a restaurant was able to devote a small portion of the day to the business, as he had other full-time employment. His employees included a part-time chef, a dishwasher, and a minimum of one waitress, all who were paid in cash. At the time, his current girlfriend was responsible for maintaining the books, along with a little manual work around the restaurant. When they broke up, she took the business records with her.

On his tax return, the restauranteur reported $21,280 on a Schedule C, with no cost goods sold. He claimed a deduction of $9, 258 in supplies, and $5,620 in contract labor, though he reported no wages. Both deductions were denied by the IRS, citing lack of substantial proof.

In court, the taxpayer could not provide substantiation for the amounts deducted, due to his ex-girlfriend having the appropriate paperwork. His supplies deduction consisted of food and other items that would have been calculated in his cost of goods sold. He admitted that the deduction he claimed regarding contract labor was the amounts he paid to his dishwasher, cook, and waitress. (more…)

Once known as the Hope College credit, the American Opportunity tax credit can save taxpayers up to $2,500 on their 2016 return.

Remember: A tax credit is a dollar-for-dollar reduction of your taxable income. In theory, the AOTC translates to $2,500 from the government each year for each qualifying college student in your household.

While the previous credit – the Hope College Credit – was only available during the first two years of college, the AOTC is an option for taxpayers during all four years of post-secondary education. To receive the maximum credit amount, you’ll have to spend at least $4,000 in qualifying expenses. Currently, book fees, tuition, and other enrollment costs are considered qualified expenses.

High and Low Income Effects

Low-income taxpayers are happy to learn that up to 40% of the credit (around $1,000) is refundable should the credit be worth more than your tax liability. This is different form the former credit, which could reduce your tax bill to zero, but offered no refund.

Higher-income earners benefit from the expansion of families who meet the qualifications for the credit. Previously, the Hope Credit phased out at AGI over $50,000 for single taxpayers, and was eliminated completely at $60,000. For joint filers, the phase-out ranged between $100,000 and $120,000 AGI.

The new rules expanded the phase-out limits to $80,000 and $160,000 AGI for single and joint filers respectively. The credit is now eliminated at $90,000 and $180,000.

If you claimed the Hope Credit for your student’s first two years of college, you can still use the AOTC if the student is currently a junior or senior in 2016.

Qualifications

To qualify for the credit, students must be enrolled at least half-time while pursuing an undergraduate degree or other recognized credential. The credit can be used for expenses paid by you, your spouse, or your dependent child. Even if the student pays the expense, if they are listed as a dependent on your tax return, you will get the credit.

Lifetime Learning Credit

Available to those enrolled in graduate school or any other post-secondary class, the Lifetime Learning Credit is worth up to $2,000. The credit is 20% of the first $10,000 of expenses. The income limits are lower than the AOTC, however.

For 2016:

Single taxpayers experience phase-out between $55,000 and $65,000 AGI

Joint filers experience phase-out between $110,000 and $130,000 AGI

If your spouse and children are U.S. citizens, it is easy to claim them on your tax returns. You just provide their name and Social Security numbers. It can be a bit more difficult to claim a non-U.S. citizen spouse or children on your return. But, you’re still able to claim them and take advantage of the tax benefits.

Each person that you claim on your tax return will impact your taxable income. This amount is referred to as an exemption and for 2016 you get $4,050 per person. An example of this: if you claim yourself, your spouse and two children, your taxable income would be reduced by $16,200. This would lessen your tax bill, and depending on your total income, might abolish it.

Resident and nonresident aliens

Your spouse’s residency status will determine how you can claim them as an exemption. Your spouse can either be a resident alien or a non-resident alien. Here are two ways to tell if your spouse qualifies as a non-resident alien.

  1. Your spouse has a green card which gives them government clearance to live and work in the United States on a permanent basis. This is referred to as the green card test by the IRS.
  2. Your spouse spent at least 31 days in the year in the United States and at least 183 days for the previous three years. This is referred to as the substantial presence test by the IRS.

If your spouse doesn’t meet these criteria then they are considered a non-resident alien.

Your Spouse’s Tax Status

Generally, all resident aliens are taxed just like U.S citizens. You would just list your resident alien spouse on your tax return and provide their Social Security Number. If your spouse does not qualify for a social security number they will have to get an Individual Taxpayer Identification Number (ITIN) from the IRS.

You have two options if your spouse is a non-resident alien.

  1. You can treat your spouse as a resident alien on your taxes. If you decide to do this you can file a joint tax return with your spouse. You will get an exemption for your spouse but any income earned, anywhere in the world will be taxed by the United States.
  2. You can also treat your spouse as a non-resident alien on your taxes. Doing this will not allow you to file a joint tax return and you must file married filing separately. There is still a possibility you can claim your spouse as a dependent on your return if they have no income in the United States and they cannot be claimed as a dependent by someone else.

Dependent Children that are Non-Citizens

If your non-citizen children meet the IRS definition of a qualifying child, you can claim them on your tax return as a dependent. This rule is the same that applies to children who are citizens. Your child qualifies if all the below apply:

  • The dependent is your son, daughter, stepchild, foster child, brother, sister, half-sibling, step-sibling, an adopted child or a descendant of one of these people such as a grandchild. Both biological and adopted children are treated the same.
  • On the final day of the year your child is either under the age of 19, a student enrolled full-time under the age of 24 or they are permanently and totally disabled.
  • The dependent lived with you for more than half of the year.
  • You provided over half the financial support of the dependent throughout the year.
  • Your child did not file a joint return with their spouse, if they are married, except only the claim a refund of taxes withheld or estimated taxes paid.
  • The child is a U.S. resident alien, U.S. National or a resident of Canada or Mexico.

If your non-citizen child dependent does not have a Social Security number (SSN), you’ll need to obtain an Individual Taxpayer Identification Number (ITIN) from the IRS for him or her.

 

 

Higher Ed Deductions

After 2016, the Tuition and Fees Deduction will expire. Currently, you are eligible to deduct up to $4,000 from your taxable income for tuition expenses that you paid for either yourself, your spouse, or your dependents.

Expenses paid in 2016 can be deducted if they were paid for one of the following purposes:

  • Education during the tax year
  • Education beginning during the tax year
  • Education that starts within the first three months of the next year

Qualifying Expenses

Expenses that include enrollment fees and tuition qualify for the deduction, if they are used to attend an accredited post-secondary institution of higher education. Expenses that do not count toward the deduction include:

  • Room and board
  • Transportation
  • Student health insurance and other personal expenses
  • Books and supplies, unless required to buy them from the school
  • Courses related to sports, games, or hobbies, unless mandatory as part of the degree program

Should you receive any assistance with these expenses, in the form of scholarships, grants, or other nontaxable income in regards to educational use, you’ll need to subtract them before taking the deduction. As an example, an employer sponsored tuition reimbursement plan covers $1,000 of a course that costs $1,500 total. For the deduction, only $500 qualifies.

Qualifying Persons

The deduction can be taken for expenses you paid for either yourself, your spouse, or your dependent. The only two exceptions to this rule are:

  1. if you are claimed as a dependent on another taxpayer’s return, you can’t take the deduction for higher education expenses
  2. if you are married but file a separate return, you can’t claim the deduction

Deduction Amount

Depending on your modified adjusted gross income (MAGI) the deduction amounts are $0, $2,000 or $4,000.

The income limits for different filing status are as follows:

Single

  • $65,000 or less nets a $4,000 deduction
  • $65,001 to $80,000 nets a $2,000 deduction
  • $80,0001 and greater – the deduction is eliminated

Joint

  • $130,000 or less is a $4,000 deduction
  • $130,001 to $160,000 is a $2,000 deduction
  • $160,001 and greater – the deduction is eliminated

You can’t deduct the same expense twice.

That means if you use another provision of the tax rules to deduct an expense, you aren’t able to use it for the Tuition and Fees deduction either. Additionally, you are unable to deduct expenses you paid using money that is tax-free. Expenses are ineligible to deducted if paid by:

  • Tax-free savings bond interest
  • Tax-free earnings from Section 529 plans and qualified state tuition programs
  • Tax-free earnings from Coverdell Education Savings Accounts

This deduction cannot be combined with educational credits such as the American Opportunity or Lifetime Learning credits when applied to the same student in the same year.