23.12.08

Individual Deductions for US Taxpayers Living Overseas
By John Harvey CPA, MBT
ExpatCPA.com

 
Deduction timing is an important element of year-end tax planning. Deduction planning is complex due to factors such as adjusted gross income (AGI) levels and filing status. If you are a cash-method taxpayer, remember to keep the following in mind:

Foreign Earned Income Exclusion

The Foreign earned income exclusion has increased to $87,600 for the 2008 tax year. It will increase to $91,400 for the 2009 tax year.

Foreign Housing Exclusion/ Deduction

The base (floor) above which housing expenses are deductible is $14,016 in 2008. The 2008 cap (ceiling) on the maximum exclusion allowed is $26,280. Separate caps are also issued for high-cost cities such as Moscow, but at this time those have not been announced. For updated information, check ExpatCPA.com.

Standard Deduction Planning:

Deduction planning is also affected by the standard deduction. For 2008 returns, the standard deduction is:

• $10,900 for married taxpayers filing jointly
• $5,450 for single taxpayers
• $8,000 for heads of households, and
• $5,450 for married taxpayers filing separately

If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying such deductible expenses in 2008 as mortgage interest due in January 2009.

Itemize deductions

Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.

State Taxes: If you anticipate a state income tax liability for 2008 and plan to make an estimated payment, consider making the payment before the end of 2008. Note that in 2008, you can elect to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes. New for 2008, taxpayers who do not itemize their deductions can deduct up to $1,000 if filing jointly or up to $500 for single taxpayers for property taxes. This benefit is in the form of an additional standard deduction.

Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2008 even though you will not pay the bill until 2009. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.

To avoid capital gains, you may want to consider giving appreciated property to charity.

Regarding charitable contribution please remember the following rules:

• No deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better.
• The IRS may deny a deduction for any item with minimal monetary value.
• The restrictions above do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return.
• Charitable contributions of money, regardless of the amount, will be denied a deduction, unless the donor maintains a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, and the date and amount of the contribution.

The ability to distribute to charity up to $100,000 from a traditional or Roth IRA maintained for an individual who has reached age 701/2 continues into 2008. Ordinarily, such distributions would be taxable to the individual, who would not be able to offset the income fully because of the percentage limitations on charitable contribution deductions.

The following is a list of expenses you can pay before Dec. 31, 2008 to increase your 2008 itemized deductions:

• Make an extra mortgage payment. The extra interest you pay will be added to this year's mortgage interest by your lender, boosting your itemized deductions. You may want to confirm with your lender that your payment will be credited as paid in the current year.
• Pay your property taxes. Real estate taxes are tax deductible. If your property tax bill is due in early 2009, you might want to pay it now and take the deduction.
• Donate to charity. It pays to be charitable, especially at the end of the year. Donating cash is always a good idea. You can also donate household goods, clothing, and other items. Under the Pension Protection Act, you will need a written receipt for all charitable donations, and donated items must be in good or better condition. You can also deduct the cost of driving for charity at 14 cents per mile. You cannot take a charity deduction, however, for the value of your time or services when volunteering.
• Pay doctor bills, insurance premiums, buy eyeglasses, or stock up on prescription medications. You can take a deduction for medical expenses exceeding 7.5% of your adjusted gross income.

Education and Child Tax Benefits

Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on the 2008 tax return. The credit is phased at the modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. A portion of the credit may be refundable.

Credit for Adoption Expenses: The adoption credit limitation is $11,650 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $11,650 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $174,730 and $214,730. This credit will reduce your tax up to zero, however, it will not result in a refund.

HOPE Credit and Lifetime Learning Credit: The maximum HOPE credit for 2008 is $1,800 (100% on the first $1,200, plus 50%of the next $1,200) for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for only the first two years of the student's post-secondary education.

The Lifetime Learning credit maximum in 2008 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent.

For 2008, both the HOPE credit and the Lifetime Learning credit are phased out at modified AGI levels between $96,000 and $116,000 for joint filers, and between $48,000 and $58,000 for single taxpayers. The foreign earned income exclusion needs to be added to the AGI for the limitations of this test.

Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2008 is phased out at a modified AGI level between $115,000 and$145,000 for joint filers, and between $55,000 and $70,000 for individual taxpayers. The foreign earned income exclusion needs to be added to the AGI for the limitations of this test.

Kiddie Tax: Beginning in 2008, the kiddie tax applies to:

• children under 18;
• 18-year old children who have unearned income in excess of the threshold amount, do not file a joint return and who have earned income, if any, that does not exceed one-half of the amount of the child's support; and
• children between the ages of 19 and 23 and if, in addition to the above rules, they are full-time students. For 2008, the kiddie tax threshold amount is $1,800.

Business Deductions

Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5% of AGI floor.

Equipment Purchases: If you are in business and purchase equipment, you may make a “Section 179 Election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2008, thanks to Congressional legislation, you may elect to expense up to $250,000 of equipment costs (with a phase-out for purchases in excess of $800,000) if the asset was placed in service during 2008. In 2009, these dollar amounts are reduced to $133,000 and $530,000, so 2008 is the year to put property into your business to take advantage of the increased dollar amounts.

In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2008. Please note that under the “half-year convention,” you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.)

Bonus Depreciation: Taxpayers meeting certain criteria can claim a 50% bonus depreciation allowance for property placed in service after 2007 and before 2009, thanks again to Congressional legislation. The original use of the property must begin with the taxpayer after December 31, 2007, and before January 1, 2009. Also, the property must be acquired between such dates. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials placed in service after August 31, 2008.

Organize Your Financial Records

Good record-keeping can really pay off at tax time. Not only will it make your tax preparation easier and faster, but you might uncover enough tax deductions to be able to itemize. More importantly, the IRS will require receipts and other records in the event of an audit. Entrepreneurs should be using accounting software such as Peachtree, QuickBooks, or Microsoft Office Accounting to ensure that all their income and expenses are recorded properly. Individual taxpayers may want to use Microsoft Money or Intuit's Quicken to keep track of their personal spending. As an added bonus, these programs provide reports that summarize your tax deductions for faster tax preparation.

Please contact us if you have any questions, if you would like a personal year end consultation, or if you would like us to prepare 2008 estimate. We hope you find this information helpful and informative. We look forward to working with you in the preparation of your 2008 tax return.

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