 Income tax 2023-2024, itemized deductions, interest you paid. Get ready and some coffee because we're looking to get the tax man off our back with income tax preparation 2023-2024. Most of this information can be found in the instructions for Schedule A Tax Year 2023 which you can find on the IRS website at IRS.gov, IRS.gov. Looking at the income tax formula, we're focused on what I would call the below the line deductions. More specifically, the itemized deductions. Remembering the first half of the income tax formula is basically a funny income statement. Most income statements having income minus expenses resulting in net income. Here having income minus various deductions resulting in taxable income. Remembering that for taxes deductions are good therefore we look for more of them. The difference between the types of deductions include the above the line deductions or adjustments to income do not have to clear a threshold such as the standard deduction before we get a benefit from them whereas the itemized deductions do typically have to increase higher than the threshold of the standard deduction before we get a benefit from them. Looking at the first page of the Form 1040 focused on line number 12 the greater of the standard deduction or itemized deduction noting that the standard deduction is tied heavily to the filing status and determining the value of that standard deduction which we would need to clear to take the itemized deduction. First a word from our sponsor. Yeah actually we're sponsoring ourselves on this one because apparently the merchandisers they don't want to be seen with us but that's okay whatever because our merchandise is better than their stupid stuff anyways. 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If you would like a commercial free experience consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com If we were itemizing then we would be attaching the schedule A typically the schedule A being the itemized deductions worksheet the major categories on the left-hand side although this is not the entire schedule here this is the standard deductions that we would need to be clearing noting that the standard deduction again is tied heavily to filing status single filers 13,850 married filing joint 27,700 in the middle head of household 12,800 if they are over a certain age and or blind we can then have single filing statuses if one or two of those items apply here's the standard deduction increases married filing joint you can have one through four of those items considering we have two people and the corresponding standard deductions which we would have to clear in order to get a benefit from the itemized deductions typically alright now we're talking about interest paid remembering once again that when we talk about the federal income taxes or any income tax you would think it'd be most normal for an income tax to have deductions that you needed to expend in order to generate the revenue which we can most clearly see on a schedule see where we have an income statement income minus expenses which are business deductions were taxed on the net income normally if you're a W2 employee you don't have any expenses because the idea is that the employer is paying for the expenses therefore you just have the W2 income the schedule A on the other hand is full of a bunch of items that don't correspond to the standard deductions you would think natural to an income tax system if it was just designed to collect money to protect us with the military and whatnot and not to nudge us and manipulate us in all other kinds of way because all the stuff on the itemized deductions on the schedule A or many of them are personal types of deductions which we get to deduct for one reason or another which could add to some complications in terms of what's going to be the qualifying factor that allows us to take the deduction and when the deductions on the schedule A that were personal in nature but now deductible also kind of collide with the natural types of deductions such as business deductions how are we going to deal with basically splitting the capacity to deduct between those two particular areas in a way that we don't basically double dip is the general idea if you hear interest paid the first thing that should come to your mind is mortgage interest and the mortgage interest because that's usually the big line item that pushes people over from the standard deduction to the itemized deduction so if you're trying to determine if someone is itemizing you can look at their prior year tax return that helps but you can also say hey do you own a home you can almost assume given home prices that they have a loan on it and if they have a loan on it they're paying mortgage interest and the mortgage interest is a big one that possibly could be significantly adding to the itemized deductions if you compile that or combine it with the property taxes which will certainly be there as well although varies greatly depending on location where you're at then those are the things that often kick people over from the interest okay so the rules for deducting interest vary depending on whether the loan proceeds are used for business personal or investment activities so if you looked at this just from like if you're like just saying hey I have an income tax what's the kind of loan that you would expect would be deductible you would expect the loan for business to be deductible if you took out a business loan for example and you bought stuff that you're going to use to generate revenue which as a sole proprietorship then you don't get to deduct the principal payments on the loan like the mortgage payments that people make the actual payments but the renting of the money the renting of the purchasing power which is called interest possibly could be deductible so if it was a business expense that seems kind of natural you needed that money in order to generate the revenue therefore the expense on it would be deductible naturally for an income tax system personal interest usually you would think not right and this would be things like if you used your credit card for example to go in a shopping spree for personal clothes that you don't even wear or something like that or just to arrest whatever it is I'm not trying to pick on people who wear whatever whatever you buy personally if it's a personal expense you would think it wouldn't normally be deductible if you financed the personal expense with a loan if you took out a loan to go on a vacation to Hawaii or something and it's totally personal you would think the interest on the loan would not be deductible because it would be personal that's the general rule the big exception to that is of course the mortgage interest in which case you're buying a home and the home is typically personal possibly deductible possibly because in part you've got big lobbyists in the home building and selling in real estate area that want to subsidize the market I would think it might be one reason if there but anyway that's somewhat skeptical of a or investment activities now investments kind of in the middle because if you think about investment activities you basically think of a situation where you might take out a loan in order to buy say stocks and bonds because you think the stocks and bonds are going to go up in value for example so if you think like Apple stock is going to go up in value I need to buy Apple stock because it's going to double in value tomorrow but I don't have any money well what I can do is leverage it I could take out a loan and then purchase the stocks and then we'll see what happens if it goes up in value I still have to pay off the loan payments because the increase in value is greater than the amount of the interest that I have to pay then I'm a winner in that game and that works great as long as you're winning but if the stock goes down in value you can also get in the hole real quickly so there's a real question in terms of should we have it deductible or not in terms of basically investment speculative purposes because the question there is do we want to be incentivizing people to taking on risks that seem more closer akin to like gambling rather than legitimate long term business risk which would be more like the situation where you buy equipment and you're planning on building a business which is a long term thing rather than a short term investment gain that you might be trying to take out a loan because you heard some inside news on a stock trade or something like that so you can see publication 535 for more information about deducting business interest expenses alright so see publication 550 for more information about deducting investment interest expenses you can't deduct personal interest so the credit card not typically included you can't typically deduct if you got a car loan or something like that you can't typically deduct a car loan what about student loans? again it's personal you don't deduct it here but maybe you could deduct it somewhere it might be an above the line type of deduction that's another kind of exception to the general rule why most likely because the schools have a big lobbying industry for the universities which jacked up the cost of education was that actually beneficial in the long run to people? I don't know because I think the cost of education would be a whole lot cheaper than that and it would be easier to know what's happening but that's how it is so however you can deduct the qualified home mortgage interest so that's the big one that it used to be before by the way a long time ago they had more interest that was deductible like even like credit card interest and whatnot and once something is deductible you'll note that it's very hard to remove it like I feel bad for people that have large student loans that feel like they're tied to like a political parties for example who are promising to relieve the loan because they basically that's what they bet on right that's what they their action was based on the tax code the tax code incentivize their action and now it's almost like you've accepted money from the state and now the states got you locked in like happens to some people when we're on like welfare or something like that it's hard to get off sometimes because because then you'll you'll lose it right it's hard then they pull the rug out from under you so that's the problem with the tax code once a deduction is in place it's hard to take it out because people have already made long term plans on it and that's why the tax code seems to move along kind of like a zombie and you can't basically simplify it and so that's also why we need to be very careful when we make more and further complications to the tax code which people put long term plans on such as investments in education investments in homes and and all that kind of stuff because you can't you can't just change it if it doesn't work out it's not something you can tinker with but I get so then we have the however you can deduct qualified home mortgage interest on your schedule a an interest on certain student loans that's on schedule one we talked about it before and schedule one remember that schedule one is not an itemized deduction so you might get a benefit of being able to deduct things on schedule one such as the student loan interest even if you're not itemizing so form 1040 line 21 you can see more information on that in publication 936 and publication 970 so if you use proceeds of a loan for more than one purpose for example personal and business you must allocate the interest on the loan to each use now again because we are now deducting personal things on the schedule a this type of thing will happen more often in that we might be able to qualify for the same cost the same expense in different areas for example if we used part of our home not simply for personal use but for the business we have a home office in it if we have a home office in it then the mortgage that we paid for the home which we're using in part for our business you would think would be deductible because that would be similar to me basically getting a separate building that was my business and I own it and I'm paying interest on the loan that I got for my office building or something like that you would think that would be deductible because it would be business related however if it's with regards to your home that means only part of your home is going to be deductible on the schedule a which is typically more beneficial than deducting on the schedule a because you don't have any limitation you don't have that cap of clearing the standard deduction to be able to deduct deduct on the schedule c so what are you going to do because you you get only one interest 1098 form you're going to have to use some kind of percentage allocation allocating between schedule c and schedule a what you can't do is report the whole the amount on schedule c and then double dip recording the same amount on schedule a in other words if you have $10,000 of mortgage interest on the home and you're able you're going to have you can only deduct 10,000 where is it going to be some ratio of it will have to go to schedule a like 2000 of it or whatever and the rest go to I'm sorry to the schedule c 2000 and then a thousand on schedule a or something like that and you might use some allocation method such as the square footage of the home versus the office square footage which we'll talk about when we get to a schedule c type of business so you allocate interest on a loan in the same way as the loan is allocated you do this by tracing disbursements of the debt proceeds to specific uses for more information on allocating interest you can see publication 535 so you allocate interest on the loan the same way as the loan is allocated in other words you were determining that the home mortgage loan is something that is deductible whereas whereas a loan for other purposes is not so then the question is well what if I took a $10,000 loan out how do I know what it was used for right because I mean I could have just got a loan and put collateral on it and on vacation I got $10,000 loan I went on vacation how do I know where it should be allocated for or I might have put the home as collateral on the loan so now the home is collateral for the loan but I used the money to buy a car or something like that rather than basically increase the value of the home or something like that so that can get kind of confusing because on the bank side of things the bank isn't really concerned about whether it's deductible or not the bank is concerned with whether you're going to be able to pay back the loan so what they're looking for is collateral on the loan in the that you default on the loan but what we need for taxes is to know what the proper allocation of the loan was for so we can determine that the rent on the purchasing power of the money if it's deductible or not and if deductible where on schedule C on schedule A possibly not deductible at all and so that's the question in general if you paid interest in 2023 that applies to any period after 2023 you can deduct only amounts that apply to for 2023 okay so this is another complication that remember that the income tax code for individual taxes is typically a cashed based system you get the deduction in other words when you pay it which is simple it's easy to audit it's easy to track however also easy to manipulate which is why when we talk about like businesses they're required to use an accrual system and they're held to that accrual system with an audit right that's what we do for corporations we can't basically have an audit of every individual's taxes therefore we want to keep it simple cashed based system and then the iris might randomly audit people which they can then follow the money fairly easily however people will come up with plans then to distort when they're going to try to get the deduction meaning I would rather have the deduction sooner rather than later in general and some years I might have more income than other years which because of the progressive practice system will result in higher tax rates so if in this year I have a higher tax rate then I think I'm going to have next year because I earned more money I might be looking for more deductions this year one of the bright ideas I might come up with is that hey look why don't I just say to my mortgage company I'm going to pay you all of the interest on the loan up front and then I'm going to pay the principal later is that okay well it would be okay if with the bank if they were if they were allowed to do that maybe because that might mean they get an upfront payment sooner but the iris is going to say no you can't do that you can't you can't just you can't just that would be like prepaying the rent like if you're going to prepay the rent on your office building for the next 10 years and I paid it today and I got to deduct the whole thing today because I paid it today well you can't really do that because you're you didn't use the office building so now the iris is going to have to kind of limit that from happening and say well you can't you can't do this whole prepayment thing to try to distort and take the deduction earlier than you otherwise would alright you schedule a to deduct qualified home mortgage interest and investment interest so we'll talk a little bit more specifically on some of those categories in a future presentation