Itemized Deduction, AMT, and Other Tax Nightmares

The itemized deduction has several levels of complexity; increases in standard deductions can generate no tax change at all because the alternative minimum tax overrides all your deductions; and a variety of tax benefits disappear as your income increases.

This overview shows how some of these things affect your personal income tax return. (Note: Many limitations are based on your adjusted gross income, or AGI, which is the last line on page 1 of your Form 1040.)

Standard Deduction
For 2010, the standard deduction is $5,700 for singles, $11,400 for couples, and $8,400 for heads of household. Let’s compare 2009 and 2010:

  • 2009 Sales tax deduction on a new car is gone in 2010. (The deduction is still available for sales tax paid in 2010 on a 2009 vehicle purchase.)
  • Property tax: $500 deduction in 2009 ($1,000 per couple). No deduction in 2010.
  • Certain disaster losses in 2009 and 2010 can be deducted.

Itemized Deduction
With so many limitations on itemized deductions, and so many choices, it can drive you crazy! Here’s a rundown:

Medical expenses are reduced by 7.5 percent of AGI.

For the state tax deduction, chose between state income taxes and state sales taxes.

Property taxes don’t include the assessments on your property tax bill.

Home mortgage interest deductions are limited to two homes. In addition, you may only deduct interest on acquisition debt plus $100,000.

Interest may only be deducted on total mortgage debt of $1,100,000—regardless of the number of homes involved.

With mortgage insurance premiums, taxpayers are often prepaying ,000 or more—but can’t deduct it all up front.

Charitable contributions can be lost if you don’t have receipts before you file your tax return.

When reported here, casualty and theft losses are reduced by 10 percent of your AGI plus $100. Avoid this reduction by reporting these losses as additional standard deductions or as business casualty losses—if they qualify.

The main things you need to know about miscellaneous itemized deductions are:

  • Most of these expenses are reduced by 2 percent of AGI.
  • Certain expenses are not reduced—like gambling losses, Ponzi scheme losses, and a few others.
  • This area of Schedule A is the most abused and most audited.
  • This can generate a wealth of deductions for employees involved in outside sales or certain occupations with out-of-pocket expenses.

If you are married filing separately and your spouse itemizes, you must itemize—even when the standard deduction gives you a better deal. This also applies to nonresident aliens, dual-status aliens, and individuals who file returns for periods of less than twelve months due to a change in accounting periods.

Alternative Minimum Tax (AMT)
Fundamentally, AMT overrides your regular income tax calculation to prevent you from taking advantage of a variety of deductions and benefits. It’s complicated and rears its ugly head when you least expect it.

At-Risk and Passive Activity Rules
These rules are designed to prevent tax shelter abuse. They will limit your ability to deduct losses from your rental properties and partnership and LLC investments, and other investments where you are not actively running the business.

This list just scratches the surface. Come on back, and we’ll discuss these issues this year in more depth. If you have specific questions, post them. We’ll answer you.

Read More about Filing Your 2011 Taxes:

Eva Rosenberg, EA is the publisher of TaxMama.com, where your tax questions are answered. Eva is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com.