 Income tax 2023-2024, itemized deductions, taxes you paid, tax software example, get ready and some coffees so we can lessen the sting from the iris smack with income tax preparation 2023-2024. 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. Like our CPA six pack shirts, a must have for any pool or beach time mixing money with muscle, always sure to attract attention. Even if you're not a CPA you need this shirt so you can like pull in that iconic CPA six pack stomach muscle vibe man. You know that CPA six pack everyone envisions in their mind when they think CPA. As a CPA I actually and unusually don't have tremendous abs. However, I was blessed with a whole lot of belly hair. Yeah, allowing me to sculpt the hair into a nice CPA six pack like shape, which is highly attractive. Yeah, maybe the shirt will help you generate some belly hair too. And if it does, make sure to let me know. Maybe I'll try wearing it on my head. And yes, I know six pack isn't spelled right, but three letters is more efficient than four. So I trimmed it down a bit, okay? It's an improvement. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. Here we are in our Form 1040 example problem using LASERT tax software. You don't need tax software to follow along, but if you have tax software, it's a great tool to run scenarios with. You can also get access to the forms, schedules, instructions at the IRS website, irs.gov, irs.gov, starting at our standard starting point tax payer, Adam Taxman. Just trying to avoid a dank tax man living in Beverly Hills 90210 single fire alert. No dependence starting out with 100,000 W2 income. We've got the 13850 standard deduction gives us the 86150 taxable income, which we can mirror on our tax worksheet income tax formula 100,000 13850, 86150. The tax calculated by the software 14266, which we can see on page two of the Form 1040. Let's go back to page one. Our point of focus is on the itemized deductions, which is on line 12, taking the greater of the standard or itemized deduction, the standard deduction being dependent largely on filing status. Single filers standard deduction 13850, double that for married filing joint 27,007, head of household in the middle 20,800. And then if they're over the age or blind, we can see those on 1040 SR page number four for single filers. We can have one of or two of those conditions increase in the standard deduction, married filing joint. We can have one to four of those conditions considering two people increasing the standard deduction accordingly. Okay, let's go back to the Form 1040. And we're looking at the schedule a that's going to be the schedule for the itemized deductions, which would only be populated if greater than the standard deduction. And our point of focus now are on the taxes you paid. So the taxes you paid, you will recall a quick recap of the general idea of a federal income tax system. Typically, if we have an income tax system, we want to tax people on the net income, not the gross income, which you can see on the schedule C. For example, where we have an income statement, we have income minus those expenses that we needed to generate the income business deductions. In other words, giving us the net income, which is in essence what we're taxed on. That's a natural thing that we would expect from an income tax system. However, most people are W2 employees and therefore don't have an income statement. But rather the assumption is the W2 income has already had the expenses incurred by the employer because there not shouldn't be something that's going to be paid by the employee. Therefore, that's where kind of like the W2 income comes into play for most filers. And then a lot of the stuff on the schedule A is a deviation from what you would think is just the normal thing that you would have on an income tax system. In other words, the government's trying to nudge us in some way, shape or form, or have been lobbied in some way, shape or form by particular industries. Such as the medical industry, for example, might benefit if we get a deduction for medical expenses and so on and so forth. People will spend more money on medicines, you would think. And then what the tax is, you have a similar... And by the way, I'm not trying to make an argument either way. I'm just saying that these deductions, if I was to make an argument, I would simplify the code basically. But the idea here is going to be we want to get an idea of what's going on so that we can basically understand and memorize what is happening and be able to explain it. So with regards to the taxes, this is also something that you would think would be kind of personal in nature unless you were paying the taxes as a business type of expense. Now the other thing that goes on with the taxes is we get confused in terms of who's the tax for, which taxes are deductible and which are not deductible. Clearly, when we're looking at the Form 1040, we're talking about the individual income tax return. So we're doing the federal income taxes, which is the primary tax collection body or way we pay for things for the federal government, which should be basically our defense, the military. That's what they're there for. So keep enough safe, right? That's what they're supposed to be doing over there. So that means that we're going to have our tax calculated on page 2, which is going to be the federal income tax. Can I deduct the 14,266 federal income tax on my 1040? Well, no, that wouldn't really make sense because then you would end up with a circle reference because I had to include the deductions in order to calculate the tax. So no, of course you can't deduct the federal income tax for the calculation of federal income taxes. But what about other taxes? You might say, hey, I have other taxes like the payroll taxes. In other words, if you're a W-2 employee, you could say, well, I have these taxes related to social security and Medicare. Those are basically payroll taxes that are being taken out of my paycheck. Can I deduct those? Well, those typically you can't generally deduct those as well. They are federal taxes, but they're not income taxes. That's why you might think that you might still be able to deduct them. But the general idea is no, you can't deduct the social security and Medicare generally for federal income tax purposes on the Schedule A. So then the next thing would be, well, what about the state and local taxes? Now, remember the state has its own obligations. They're not in charge of the military. They're in charge of the police and the fire department and whatnot. And they should be paying for those basically separate from federal tax dollars. So then the question is, well, how is the state going to get the money? Well, they could have a mirroring system of the federal income tax system, basically having a state income tax system if they wanted to. But they're not required to. They might tax in other ways. They might have like a sales tax and property tax and that kind of stuff and not want to pay for their stuff using the same system as the federal government. It might just not work for their community or whatever might not be the best way that they want to do it. So they should be sovereign to do their own kind of system. That means that the state taxes are going to be different from state to state and locale to locale, which kind of puts more complications when we're trying to deduct things on the federal side. So I think what really started with these taxes is they started to say, well, it's going to allow state tax deductions for state income tax. So if you had a state income tax that mirrored the federal government, the system would be much the same, meaning the state income tax is going to be quite complex. Like in California, for example, you shoot to overpay so you don't get hit with a penalty and then you're going to basically get like a refund. And then the Fed is saying that you can possibly deduct the state taxes here that you're paying to the state. So that's going to be the general idea that we might be able to deduct and it's kind of convenient if you're using tax software, because the tax software can calculate both the federal and state and help you to kind of manage the state taxes, which is nice. But some states said, some states took advantage of that by saying, okay, we're going to maximize this benefit. We're going to do it the way the federal government wants and we're basically going to subsidize our state through the deduction of the tax benefits and so on. And then the other state said, no, we're going to stick with other taxes such as the sales tax, which is the other common taxing thing that you could use. And these other states then kind of got cheated for a while, you would think, because the sales tax wasn't deductible, whereas the state tax was. So then they said, okay, the government finally said we'll allow you to deduct both the state taxes and the sales tax, but the sales tax is going to be a little bit more complicated because we don't calculate the sales tax when we file the return. You'll note that all of this would be easier if they said we're not going to allow you to deduct any taxes, right, would be the general idea. And they actually did limit the number of taxes you can deduct a few years ago. So now there's a cap on the taxes of 10,000. So that's actually fairly low if you're talking about high cost of living areas. You can hit that fairly easily in like California and New York. So that was a big kind of thing, a debate over that. So that's going to be the general idea. So those are the major taxes that we're considering. The state taxes that are the sales tax and the income tax. Then we also have real estate taxes, which is the other big one, which typically is going to be tied to people owning like a house. And so the real estate taxes is the other big one. So let's imagine that, for example, if I go back on over here and I say that we paid state taxes on our W-2 and we saw state taxes of $5,000 that we paid out of the W-2, well just by doing the data input on the W-2, it will help us to populate and pull into the deductibility of those state taxes on the Schedule A. And this would also be populated on the state tax return if I'm doing both in the same software as a withholding in a similar way as we see on page 2 of our federal tax return. These would be the payments that we made here to calculate the refund on the state side of things. On the federal side of things, we're saying it could be a deduction. Now if all you had was state taxes, it's not likely that it's going to push you over the threshold because even with a single filer, the threshold is the $13,850. And even if I was a high income individual and I paid state taxes say of $15,000, it's not going to push me over in and of itself given the fact that we now have a cap of the $10,000. So that $15,000 got capped at the $10,000, therefore the state taxes in and of themselves is not going to push me over to be standardizing. What normally pushes people over, it's the home, right? The ownership of the home is usually what pushes people over because that comes with a mortgage typically and the interest on the mortgage typically is the thing that's taxable or deductible. So if I jump to that, if I have a mortgage interest at the same time, then I could say well what if that was at like $10,000 for the mortgage interest, just the interest portion on the loan. And so now I've got the $10,000 plus the $10,000, that gets me to $20,000. Now notice the other thing that comes along with the home though is usually the real estate taxes. If I'm already capped out at the $15,000, the real estate taxes aren't going to give me another benefit. In other words, if I go back in here and I go into my Schedule A and I look at my real estate taxes, I'm in taxes and I want to look at the real estate taxes, principal residence, let's say that was like $6,000 or something. Notice if I pull that over, it's still not giving me a benefit. That gives me $21,000 of taxes but I can only deduct the $10,000 because they put that cap on it. Now the reason I mention this is because a lot of times you will hear when you're thinking about like purchasing a home that you should purchase a home almost specifically and exclusively so that you can get deductions. Be careful of that because there's a couple things that you need to be aware of and one of those things is going to be how close are you to being able to itemize. If I go back to the Form 1040, then if I'm nowhere near itemizing, I'm nowhere near that $13,000, let's say I only have $3,000 of itemized deductions and then I get to deduct another $10,000 or so. If I just barely clear that threshold, then still I'm not getting the full tax benefit because I would have got $13,850 anyways. Let me just show you that for an example. If I was at, let's go back to the wages and let's remove the state taxes here and just include the real estate taxes. Now I'm at $17,205, the Schedule A is being populated and now I have the sales tax is being calculated and I didn't include the state tax and I got $6,000 of the real estate. It's all being included now because I haven't hit the cap of $10,000 and then I've got the $10,000 here for the interest. That puts me to $17,205. So if I go back on over, that's greater than the standard deduction of the $13,850 but the tax benefit is still at $13,518. So let's compare that. I'm at $13,518. That's a difference from what we had before of $748. And basically what happened is I had a deduction of $10,000 of a deduction. That was the change between the real estate taxes and the interest. So if I was to take this divided by this, it's only like 5% that we got like a benefit from and you would think that you would have a change that would be something like the tax rate of the highest tax rate like 22%. Why is that the case? Because before I added these things, I really only had the itemized deductions of like $1,205. I was nowhere near this threshold of the $13,850. So if I got deductions of what were my deductions that I got, $17,205, $13,850 of them, I already had before because they were part of the standard deduction. So I really only got the difference between the two as the added benefit. So if someone says, hey, look, you're going to get a deduction of $17,205 as an itemized deduction, true, but somewhat deceiving. Because even though I get a deduction of $17,205, I would have got a deduction anyways of the $13,850. It's only the difference between the two that's given me the added benefit. So the way that you have to budget for this is to actually do the calculation in software so you can really see the actual impact when you make the purchase. So just something to keep aware of. So let's go back on over. So once we're over the threshold, then we can add the state taxes. So if you're in like California or something, you'll have your state taxes and you'll typically see them if you have a W-2 in the withholdings on the W-2s. If they're retired individuals, you'll see them possibly in withholdings on the 1099R. And let's say it was only like $3,000. Then if I go back on over, now we've got the $3,000 plus the $6,000 adds up to $9,000 plus the $10,000 mortgage interest to the $19,000. If I mirror that in my income tax formula, we can say, okay, I had income here. I've got then the, let's go to the itemized deductions and the taxes you paid. And let's actually try to make one that's going to be here standard all the time. So I'm going to copy these and put these down here. State tax. And I'm also, you might pull this in from like the withholdings. You might have a withholding sheet, but let's actually just plug it in there. What did I say the state tax was $3,000? We paid $3,000 for the state taxes. Real estate taxes we said was $6,000. And then we also had the interest, which we said was $10,000. And so that adds up to a total of $19,000, which is pulling to my tax formula. There's our $19,000 taxable income, $81,000. So we go back on over here, boom, and taxable income, $81,000. Page two, calculate in the tax, $13,133. So we're going to say, all right, $13,133. There is that one. Okay, now a couple of things to note that become a little bit confusing is that the tax that we're paying here is on a cash-based system generally. So you might say, well, what would happen if you've got a refund of your taxes for tax year 2023 from 2022? What are you going to do with that? Because what happened then is I overpaid 2022 taxes, I recorded it as a deduction, and then I got a refund in 2023. Do I need to go back and amend tax year 2022 to adjust the amount that I included in there? No, that would be kind of tedious to do because that's going to happen all the time in an income tax system because it's designed to result in a refund. Well, should I just reduce it from the taxes this year? What I should do is go in here and reduce the tax deduction this year. No, the reason they don't do that most likely is because you might not be itemizing in the following year, right? If you weren't itemizing this year, you wouldn't be able to reduce the tax. What we do instead is possibly include it in income as we saw in a prior presentation. So if in the prior year someone got a benefit from the deduction last year for taxes in the current year, when they get the refund, they might have to include it on Schedule 1 refund here and jump to it. And we're going to say include it in income. And then we saw that in a prior presentation. Now this can be a little bit tricky because the software is going to try to see if you got a benefit from it last time as we saw when we looked at the income side of things. And so if someone is itemizing, I highly recommend if they're a new client or something like that, or that you put the information into the prior software for the prior year and then roll it forward so that any of those roll forwards will populate automatically and it will properly be able to calculate whether or not the refund should be recorded in income. And then you can kind of basically double check it on your end. So that's one thing to note. Also, if we're on a cash-based type of system, if you're having withholdings made, the withholdings of course will be made in the current year, 2023. But if you're making estimated tax payments, then you might make the last estimated tax payment for tax year 2023 but which was made in 2024. Which year do you include that in? You would include it in 2024 in that case. So for example, if I go back on over here, let's say they were a Schedule C business and they're making their estimated tax payments. Now we're going to make the state estimated tax payments. Let's imagine we paid another $1,000 and let's say we paid it in 2023, 060623. Well then if I go back on over here, it's going to then include that here. So now we're at 4,000 up top, it was at 3,000. But if I said that I made this estimated tax payment for tax year 2023 by 1 January 6, 2024, then although I applied it to 2023, it's not included in this number and will be included possibly as a deduction next year if you're itemizing next year. So the cutoff gets a little bit confusing sometimes because it's applied. You get the deduction possibly when you pay the tax, not in accordance to what year the tax has been applied to. So if you're in a state that doesn't have taxes for the state taxes on an income tax system, then you're going to have the sales tax. Now if I don't put anything in, it's going to automatically calculate the sales tax because the assumption is that you're being taxed on a sales tax if you didn't include an income tax. And so then the software, this is what's great about software, the software can help to calculate what that tax should be. So it says here state and local income taxes or general sales taxes. You may include either taxes or general sales taxes on line 5A, but not both. So you have to choose, am I going to do sales tax or income tax? Most states primarily use a sales tax or income tax as their primary revenue generation. Some states have both because some states love to tax. So if you elect to include general sales taxes instead of income taxes, check the box. And then you have your worksheet here which is going through the calculation. And this will help us out to apply the worksheet to calculate the sales tax. But as we saw in the prior presentation, you can have a whole lot of confusing scenarios with the sales tax. And if you purchased a large item such as like a boat or a car or something, then it's likely that your sales tax calculation for actual tax might be greater than the calculation here, which is you would think kind of like the average based in part by location. So in that case, you might want to do your actual sales tax rather than basically using the tables. So you could jump in and say the actual expense method of the sales tax. And then you can go through here and basically enter the actual sales tax. Now I'm not going to go into that in detail because that will be dependent in part on the state that you are in. And as a tax preparer, the question is going to be do I want to focus on my locality, which possibly is more likely to have a sales tax calculation or an income tax calculation? Do I want to take on more complex returns that might have multiple state kind of situations or possibly even like for an income? So, but that's the general gist of that one. And then we saw the property taxes, which we can call like the real estate taxes are the other one, the big one that might be included in here. And then we have other taxes. And the main one that goes down here most of the time is going to be for like the automobile, for example, because everyone has the registration on the automobile. Now the general idea here, you paid a yearly fee for registration of your car. Part of the fee was based on the car's value and part was based on weight. You can deduct only the part of the fee that was based on the car's value is the general idea because that's going to be what they considered to be in essence the state tax. So the general idea there would be that put $100 in here or so. You're going to say, okay, is someone itemizing if they are itemizing, then we're going to have to have some kind of tax calculated up here, which will either be the state tax or the sales tax. And then if they own a home, which they probably do because the mortgage interest on the home is probably the thing that made them itemize, then they're probably going to have real estate taxes, which we want to make sure that we pick up because the real estate taxes might not be reported on any form. It might be, it might be unlike the 1098 if they're paying it through the mortgage company, but if they're paying it on their own, then the state or locale is not going to give you like a 1098 or something for it. You just have to ask and make sure that you get it because you know that they must have something there because they paid mortgage interest, which means they have a home, which means they're going to be paying property taxes. And then they also are almost surely going to have a car, so we might as well pick up the registration fees, which once again, you're not going to get a documentation like a 1099 or 1098 for, but it's something that you can ask for and basically fairly easily pick up, even though it's usually fairly small in dollar amount and possibly somewhat in material or insignificant, at least in relation to the mortgage interest and the property tax, for example. Now the other thing we got to watch out for is that sometimes you'll be able to deduct these taxes somewhere else, which is actually more legitimate from an income tax perspective, and then you have to split it between here and there. So for example, if I had a Schedule C business, and I purchased things for the Schedule C, let's say I purchased supplies for the Schedule C or even equipment that I have to depreciate or something, I can't take the sales tax if I'm calculating sales tax on even the equipment, because I'm going to be deducting that in the form of depreciation, that'll be part of the cost. Therefore it'll be a business expense. So I also could have like property taxes on the home, for example, and I might be using my home as an office. So if I'm using my home as an office, then I might be able to deduct part of the taxes as like a home office expense, which we might talk more about when we get to the Schedule C business, but if I'm deducting things with a home office expense, part of the expense is the taxes for the real estate for the home office, right? And so I would get to deduct that possibly on the Schedule C. If that happens, I can't also deduct it on the Schedule A, at least not the entire thing, because then I would be double-dipping. So I'm going to have to do some kind of fraction thing you would think, such as, what's the square footage of the office? Let me take the percentage of the square footage of the office compared to the total square footage ratio, allocate that to the Schedule C, and then the rest possibly still being deductible on the Schedule A. So we end up with that kind of issue as well, which often comes up in part because the IRS keeps on deviating from a natural income tax system, deductions only being allowed if they were necessary to help generate revenue and go into personal things like where you decide to live, taxes, property taxes, are you going to buy a home, and lobbyists that are trying to get the mortgage interest to deduction, I would think, are the real estate industry and so on, nudging us with charitable deductions. These things end up complicating the code greatly more than you would really think. But I digress. That's the general idea with the taxes.