 Hello and welcome to this session in which we will discuss deductions for individual taxpayers. Think of deductions as expenses for individual taxpayers. Now in contrast to financial accounting, we like deductions and taxes. We like to have more deductions for tax purposes, more expenses. Why? Because expenses or deductions lower our taxable income, lower the individual taxes or if it's a corporation, it lowers the corporation taxes. If it lowers your taxable income, obviously it's going to lower your taxes or your tax bill. Now we need to understand that for individuals we have two categories of deductions and we're going to have to differentiate between those two categories. We have deductions for adjusted gross income. Don't worry, we're going to define what adjusted gross income shortly. Sometime known as above the line deductions. So deductions that are above a certain line. And that line is AGI and you're going to see why we call it above the line. On the tax return, they are taking before the line. That's why it's called above the line. And we have deduction from adjusted gross income. From adjusted gross income, it means below the line. Those deductions are below the line. Now which line are we referring to? Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true, false questions, as well as exercises. Go ahead, start your free trial today. Well, let's take a look at a tax form to look at the line itself. So this is a form of 1040. I'm going to focus on this area here. So I'm going to focus on this area. Specifically, I'm going to be looking at line 11. And line 11 here, it says this is adjusted gross income. Simply put, what we do first is we report our income. Then after we report our income, we deduct certain adjustments, certain deductions. So what we deduct above this line, above, it happens to be for this particular year, line 11, anything above line 11, anything that's deducted above line 11 is called deduction for AGI, to arrive to AGI. Any deduction we take, let me change colors here. Any deduction we take below the line, below this line, it's going to be from AGI. And this is what we need to talk about today. What are the deductions for AGI? What are the deductions from AGI? So let's take a look at the form itself and notice here, at the beginning we have mostly income, income stuff. Well, included in an income, we have a line that says here, other income from schedule one line 10. So we have to go to schedule one, okay, other income. So if we go to schedule one line 10, so this is schedule one, and this is coming from line 10, so the total is here. So here's what I want you to notice. For on schedule one, there is this thing here that says business income or loss, business income or loss. Let me highlight it in yellow. When we have business income or loss, when we have business income or loss, how do you compute your business income? You compute your business income by taking your revenues minus your revenues minus your deduction from the business. So any business deduction, any business deduction is taking for AGI. So notice why? Because the income is reported above the line. So the deductions was already taking above the line. Also we have, for example, farm income. Any deduction for farm income. We have rental real estate income. Any deduction is taking, we have partnership as corporation. All these deductions are taking for AGI. Why? Because the number that you get here, whatever that numbers happens to be, let's assume it's, you know, 45,000. Well, that number 45,000 is listed here, which is listed under line 8, 45,000. This 45,000, what's embedded in it, all the deductions for business, for real estate, for S corporation. So therefore all these deductions are for AGI. Then we have line 10. It says adjustment to income from schedule one, line 26. Let's go to schedule one, line 26. So this is schedule one, the first page. This is schedule one, page two, and this is line 26. Now, what is line 26? When line 26 is various adjustments, various adjustments, educator expenses, health savings account, I'm just pointing some out, penalty on early withdrawals of saving, IRA deductions, other adjustments, jury duty, non-taxable amount of the value of Olympics medal, so on and so forth. So all, and we're gonna look at all these deductions separately in a separate chapter. So all these deductions are for AGI because whatever the deductions happened to be here, let's assume 12,000. Well, we're gonna go to line 10 and put here, and this is a deduction, this is negative 12,000. So notice business expenses, rental expenses are deducted before AGI as well as this list. Again, I'm not gonna go over the list because we're gonna go over this list later in another this list here from adjustment to income in another chapter, but those are for AGI, so you can look at them rather than list them on a PowerPoint, you could just look at the form itself. Now, let's talk about AGI. We keep talking AGI before AGI and after AGI. AGI is an important subtotal, why? Because AGI serves as the basis for computing percentage limitation on certain itemized deductions. What does that mean? It means there are certain deductions we take based on AGI, therefore AGI is important because AGI, whatever number we get on AGI, it's gonna determine our itemized deduction. So what are itemized deductions? Well, we're gonna have many of them, but medical expenses, charitable contribution and certain casualty losses, they are based on your AGI. For example, and we're gonna talk about itemized deduction later on much, much, much more in the tales, but this is just to illustrate the importance of AGI. For example, your medical expenses. Let's assume your AGI happens to be 100,000. So on this line, on line 11 here, happens to be 100,000. This is your adjusted gross income. Well, now you have medical expenses. Are your medical expenses deductible? Well, it all depends. What does it depend on? Well, your medical expenses to be deductible, they have to exceed 7.5 of your AGI. 7.5 of your AGI is 7,500. So if you have 6,000 of medical expenses, you cannot take them. If you happen to have 8,000 of medical expenses, you will take the access, you will take 500, which is because you have 8,000 and the floor is 7,500. Therefore you have to take the addition above that limit. So notice here, if your AGI happens to be, just for the sake of illustration, 10,000, just kind of to illustrate the point, the floor is 750. Therefore the 6,000, you will take the deduction will be 6,000 minus 750. I don't think anyone can afford 6,000 of medical expenses if they only have 10,000 of AGI, but the point is the access amount will be deductible. So that's why AGI is an important figure. It's an important figure. Again, this is AGI. We have deduction above the line, we have deduction below the line. Now let's talk, after we get to this 100,000 AGI, now what can we take? We're gonna be taking deduction from AGI. What are the deductions that we take from AGI? We have two deductions, two groups of deduction. We can either take the standard deduction and what is the standard deduction? The standard deduction is a number given by the government. They say, based on your filing status, you can have a deduction of such and such. But for this particular year that we are working with, if you are single or married filing separately, it's 12,950, it's printed on the form, married 25,900, ahead of a household 19,400. So notice this number is giving to you. Do you have to use this number? Well, you can, or notice here, or you can use your itemized deduction. Notice we talked about itemized deduction a minute ago. Let's talk a little bit more about itemized deduction. So itemized deduction goes on your schedule A. Ducctions from AGI, as I mentioned, you will take the greater of these two, the standard deductions or the itemized deductions. Now also, you can take personal and dependency exemption, but those personal and dependency exemptions, deductions from AGI are suspended from year 2018 to year 2025. So you don't have to worry about them because the law would reset starting 2026 and you will have those deductions, personal and dependency. Now for the standard deduction, every year is different. For example, for year tax 2022, these are the amount. For year tax 2023, these are the amount. Now these amounts for 2023 could change. Those are tentative, but usually they don't because the IRS already published them. And obviously for the year 2024, every year they increase them, those will change a little. So if you're looking at this recording 24, 25, 26, those numbers will change, but the concept is the same. The concept is the same. The numbers will change from year to year. Now you said we can either use a standard deduction, which are listed here, just given to you by the government based on your filing status or itemized deductions. What are the itemized deductions? Well, we're gonna have a whole chapter about itemized deductions with several recording, but we need to take a look at them here. There's a schedule called Schedule A. On Schedule A, what you do, you add up all your medical and dental expenses, taxes you paid, interests you paid. There are certain rules, gifts to charities, casualty and theft losses, and other itemized deductions. What you do for each group, whatever you qualify for, you add them up. And after you add them up, let's assume you happen to be single and all of them add up to be 7,000, all of them. They would say, okay, I'm single. What should I do? Should I take the 7,000, which is my itemized deduction, or should I use my standard deduction, which is higher? Well, without thinking, I'm gonna use my standard deduction because the government is telling me I can deduct 12,950. If I use my itemized deduction, I can only take 7,000. I would say, no, that's not the case. I will take the standard deduction. Let's assume I add them all up and they add up to be 17,000 instead. I'll go back here. I would say, okay, now I'm comparing 17,000 that I can take an itemized deduction or 12,950. No, thank you. I will take my itemized deduction, 17,000. Let's take a look at an example to illustrate this concept in a moment, but let's take a look at something called additional to the standard deduction because the standard deduction is the sum of two components. The basic one, which I just covered, which is given to you, that's based on your filing status. I showed you the different filing status with a different amount. Again, this number will change every year. Then we have an additional standard deduction. Specifically, we have two additional standard deduction that allowed for taxpayers who are age 65 or over and blind. What does that mean? It means if you're over 65 years old or blind, if you're both, you'll get two additional standard deduction. Now, the amount of those additional standard deduction again, depend on your filing status and they change from year to year. Now, just to give you an example for the year 2022, if you are over 65 and older or blind, for the age you will get, if you're single, you'll get 1750, which is an increase of $50 from the prior year because 2021 was only 70, 1700. This tells me that in 2023, it's gonna be different in 2024, it's gonna be different, so on and so forth. Married taxpayer or qualifying widow or widower, 1400, it's again an increase of $50 from the prior year. Notice if you're single, you're getting more deduction here. Again, for each instant, if you're over 65, you'll get, you know, if you're single, you'll get 1750 and if you're blind, you'll get 1750 together, you will combine both deductions. Let's take a look at an example here. After renting an apartment for a while, David and Sarah, a married couple filing joint return, were able to purchase a home early 2022. The home mortgage interest for the year amounted to 10,200. They paid property taxes of 5,600. They also made charitable contribution of 7,000 and they paid income taxes of 4,100. Now, you don't have to know this, but all these are itemized deductions. Again, we're gonna have a whole chapter about itemized deduction. What should David and Sarah do? Should they take their standard deduction or should they take their itemized deduction? So what you do is you say, okay, what is my standard deduction? If I go to year 2022, again, for the sake of illustration, you could be in a different year. Married couple, they have a deduction of 25,900. So now we know the standard deduction is 25,900. Now what they do is they would say, okay, this is my standard deduction. Let's add up all our itemized deduction, 10,200 plus 5,600 plus 7,000. Plus 4,100. Well, I have itemized deduction of 26,900. You will tell the government, thank you for your offer, but I'm gonna itemize. Therefore you will take the itemized deduction of 26,900 rather than taking the standard deduction. Let's take a look at an example that illustrates the additional deduction. Sarah, who's unmarried, which is single, used to opt for itemizing her deduction. However, upon turning 65, her itemized deduction were 13,500. So her itemized deduction, 13,200, her standard deduction is single, 12,950. So you would say she's gonna take her itemized deduction. However, remember, because she turned 65, in addition to the 12,950, she qualify for the additional 1,750. Now her standard deduction is 14,250. She's gonna say, well, I am not going to use all my itemized deduction. I will skip that. I don't have to prepare schedule A. I don't have to prepare schedule A this year. I'm simply gonna take the government deduction, 14,250. Why? Because it's higher than my itemized deductions. You need to know that the standard deductions are not allowed for certain taxpayers under what circumstances. If you are married by filing separately and one of the spouse itemizes, the other one will have to itemize. Matter of fact, this year, a friend of mine, that's what happened with them. He's one of my best friends. His spouse itemizes, he had to itemize. Actually, they're going through some marriage issues, but that's a different story. So under those circumstances, if your spouse itemizes, you have to itemize because they filed separately. Also non-resident aliens, if you happen to be in the US and you are not a resident alien, you cannot take those standard deduction because those are given for citizen by the US government. Let's talk about standard deduction for dependent. So if you're a dependent, simply put, you are claim on someone else's return. I'm showing a child, but if you're claim on someone else's return, okay? If you can be claimed as a dependent by another taxpayer, you don't have to be a child to be a dependent. I'm just having this picture kind of to kind of grab your attention. Your standard deduction for 2022, again, these numbers will change, but the point is the standard deductions for dependent are different. It's the greater of 1,150, or if you are working your earned income plus $400, but you cannot exceed 12,950, which is your standard deduction. Simply put, if you are not working and you file a return, you have some income, well, you'll get a standard, let's assume you have some interest income of $400. Well, guess what? You will report this income and then you would say I have a standard deduction of 1,150, it's gonna wipe out my income. If you have earned income, your standard deduction becomes $400 plus your earned income. But when you add those up, they cannot be, they can be more than 12,950, but the maximum you take is 12,950, and this number is not fixed 12,950, this number will changes from year to year. For year 2022 happens to be the standard deduction for single. So in a different year, it cannot exceed, for example, 2023, I believe the numbers are out, 13,000 something. I don't know the number, I just showed it to you on the prior slide for single. Also bear in mind that additional deductions are available for blindness, for example. Let's take a look at few examples. A blind child who earns $200 is claimed by their parents as a dependent. So what is this blind child's standard deduction? Well, their standard deduction is the standard one, which is 11,50, plus the additional standard deduction in total of how much? 2,650, so if they find a return, that's their standard deduction. Assuming they have no income, that will be their standard deduction. If they have income, what we do is we'll take 400 plus their earned income and we only use it if it's greater than 2,650, but it cannot be more than the standard deduction. Let's assume a child earns 1,500 and is claimed by their parents as a dependent. Now, if they earn 1,500, well, they don't want to use the 1150. If they earn 1,500, what's their standard deduction? Well, it's the greater of, what? The greater of 1,150 or 400 plus earned income. Which one is greater? Well, 400 plus earned income, 400 plus 1,500 is 1,900. Therefore, their standard deduction is 1,900. Let's take a look at a third example. A child who earns 1,300 and is claimed by a dependent. What's their standard deduction? Well, we have to compare two figures. 1,150 or 400 plus their earned income. Well, obviously their earned income is greater than 1,150, so we'll take this one out. So if we take 400 plus their earned income, they're gonna get 1,400. Can they take 1,400 and the answer, absolutely not. Why? Because the standard deduction for single is 1,950 and this will be their standard deduction because they cannot take the amount of 1,400. That will be nice, but they can't because it's above the standard deduction that happens to be for this particular year which is happens to be 2022, which could be a different number, 2023, 2024, so on and so forth, so you just have to know the concept. What should you do now? Go to Farhat Lectures. Look at additional lectures, MCQs through false notes that's gonna help you understand your course, whether you are preparing for your CPA, enrolled agent, exams or any other professional certification, invest in yourself, invest in your career, good luck, study hard and of course, stay safe.