Tax Preparation Fees (Line 21)

You can usually deduct tax preparation fees in the year you pay them. Thus, on your 2002 return, you can deduct fees paid in 2002 for preparing your 2001 return. These fees include the cost of tax preparation software programs and tax publications. They also include any fee you paid for electronic filing of your return.

Deduct expenses of preparing tax schedules relating to profit or loss from business (Schedule C or C-EZ), rentals or royalties (Schedule E), or farm income and expenses (Schedule F) on the appropriate schedule. Deduct the expenses of preparing the remainder of the return on line 21, Schedule A (Form 1040).

Other Expenses (Line 22)

You can deduct certain other expenses as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit. These are expenses you pay:

1. To produce or collect income that must be included in your gross income,
2. To manage, conserve, or maintain property held for producing such income, or
3. To determine, contest, pay, or claim a refund of any tax.

You can deduct expenses you pay for the purposes in (1) and (2) above only if they are reasonably and closely related to these purposes. Some of these other expenses are explained in the following discussions.

If the expenses you pay produce income that is only partially taxable, see Tax-Exempt Income Expenses, later, under Nondeductible Expenses.

Appraisal Fees

You can deduct appraisal fees if you pay them to figure a casualty loss or the fair market value of donated property.

Certain Casualty and Theft Losses

You can deduct a casualty or theft loss as a miscellaneous itemized deduction subject to the 2% limit if you used the damaged or stolen property in performing services as an employee. First report the loss in Section B of Form 4684, Casualties and Thefts. You may also have to include the loss on Form 4797, Sales of Business Property, if you are otherwise required to file that form. Your deduction is the amount of the loss included on lines 32 and 38b of Form 4684 and line 18b(1) of Form 4797. For other casualty and theft losses, see chapter 27.

Clerical Help and Office Rent

You can deduct office expenses, such as rent and clerical help, that you have in connection with your investments and collecting the taxable income on them.

Depreciation on Home Computer

You can deduct depreciation on your home computer if you use it to produce income (for example, to manage your investments that produce taxable income). You generally must depreciate the computer using the straight line method over the Alternative Depreciation System (ADS) recovery period. But if you work as an employee and also use the computer in that work, see Publication 946.

Excess Deductions of an Estate

If an estate's total deductions in its last tax year are more than its gross income for that year, the beneficiaries succeeding to the estate's property can deduct the excess. Do not include deductions for the estate's personal exemption and charitable contributions when figuring the estate's total deductions. The beneficiaries can claim the deduction only for the tax year in which, or with which, the estate terminates, whether the year of termination is a normal year or a short tax year. For more information, see Termination of Estate in Publication 559, Survivors, Executors, and Administrators.

Fees to Collect Interest and Dividends

You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect your taxable bond interest or dividends on shares of stock. But you cannot deduct a fee you pay to a broker to buy investment property, such as stocks or bonds. You must add the fee to the cost of the property.

You cannot deduct the fee you pay to a broker to sell securities. You can use the fee only to figure gain or loss from the sale. See the instructions for columns (d) and (e) of Schedule D (Form 1040) for information on how to report the fee.

Hobby Expenses

You can generally deduct hobby expenses, but only up to the amount of hobby income. A hobby is not a business because it is not carried on to make a profit. See Activity not for profit in chapter 13 under Other Income.

Indirect Deductions of Pass-Through Entities

Pass-through entities include partnerships, S corporations, and mutual funds that are not publicly offered. Deductions of pass-through entities are passed through to the partners or shareholders. The partners or shareholders can deduct their share of passed-through deductions for investment expenses as miscellaneous itemized deductions subject to the 2% limit.

Example.   You are a member of an investment club that is formed solely to invest in securities. The club is treated as a partnership. The partnership's income is solely from taxable dividends, interest, and gains from sales of securities. In this case, you can deduct your share of the partnership's operating expenses as miscellaneous itemized deductions subject to the 2% limit. However, if the investment club partnership has investments that also produce nontaxable income, you cannot deduct your share of the partnership's expenses that produce the nontaxable income.

Publicly offered mutual funds.   Publicly offered mutual funds do not pass deductions for investment expenses through to shareholders. A mutual fund is publicly offered if it is:

1. Continuously offered pursuant to a public offering,
2. Regularly traded on an established securities market, or
3. Held by or for at least 500 persons at all times during the tax year.

A publicly offered mutual fund will send you a Form 1099-DIV, Dividends and Distributions, or a substitute form, showing the net amount of dividend income (gross dividends minus investment expenses). This net figure is the amount you report on your return as income. You cannot deduct investment expenses.

Information returns.   You should receive information returns from pass-through entities.

Partnerships and S corporations.   These entities issue Schedule K-1, which lists the items and amounts you must report and identifies the tax return schedules and lines to use.

Nonpublicly offered mutual funds.   These funds will send you a Form 1099-DIV, or a substitute form, showing your share of gross income and investment expenses. You can claim the expenses only as a miscellaneous itemized deduction subject to the 2% limit.

Investment Fees and Expenses

You can deduct investment fees, custodial fees, trust administration fees, and other expenses you paid for managing your investments that produce taxable income.

Legal Expenses

You can usually deduct legal expenses that you incur in attempting to produce or collect taxable income or that you pay in connection with the determination, collection, or refund of any tax.

You can also deduct legal expenses that are:

1. Related to either doing or keeping your job, such as those you paid to defend yourself against criminal charges arising out of your trade or business,
2. For tax advice related to a divorce if the bill specifies how much is for tax advice and it is determined in a reasonable way, or
3. To collect taxable alimony.

You can deduct expenses of resolving tax issues relating to profit or loss from business (Schedule C or C-EZ), rentals or royalties (Schedule E), or farm income and expenses (Schedule F) on the appropriate schedule. You deduct expenses of resolving nonbusiness tax issues on Schedule A (Form 1040).

Loss on Deposits

For information on whether, and if so, how, you may deduct a loss on your deposit in a qualified financial institution, see Deposit in Insolvent or Bankrupt Financial Institution in chapter 15.

Repayments of Income

If you had to repay an amount that you included in income in an earlier year, you may be able to deduct the amount you repaid. If the amount you had to repay was ordinary income of $3,000 or less, the deduction is subject to the 2% limit. If it was more than $3,000, see Repayments Under Claim of Right under Deductions Not Subject to the 2% Limit, later.

Repayments of Social Security Benefits

For information on how to deduct your repayments of certain social security benefits, see Repayments More Than Gross Benefits in chapter 12.

Safe Deposit Box Rent

You can deduct safe deposit box rent if you use the box to store taxable income-producing stocks, bonds, or investment-related papers and documents. You cannot deduct the rent if you use the box only for jewelry, other personal items, or tax-exempt securities.

Service Charges on Dividend Reinvestment Plans

You can deduct service charges you pay as a subscriber in a dividend reinvestment plan. These service charges include payments for:

1. Holding shares acquired through a plan,
2. Collecting and reinvesting cash dividends, and
3. Keeping individual records and providing detailed statements of accounts.

Trustee's Administrative Fees for IRA

Trustee's administrative fees that are billed separately and paid by you in connection with your individual retirement arrangement (IRA) are deductible (if they are ordinary and necessary) as a miscellaneous itemized deduction subject to the 2% limit. For more information about IRAs, see chapter 18.

Deductions Not Subject to the 2% Limit

You can deduct the items listed below as miscellaneous itemized deductions. They are not subject to the 2% limit. Report these items on line 27, Schedule A (Form 1040).

List of Deductions

Each of the following items are discussed in detail after the list.

• Amortizable premium on taxable bonds.
• Casualty and theft losses from income-producing property.
• Federal estate tax on income in respect of a decedent.
• Gambling losses up to the amount of gambling winnings.
• Impairment-related work expenses of persons with disabilities.
• Repayments of more than $3,000 under a claim of right.
• Unrecovered investment in an annuity.
• Expenses of officials paid on a fee basis.

Amortizable Premium on Taxable Bonds

In general, if the amount you pay for a bond is greater than its stated principal amount, the excess is bond premium. You can elect to amortize the premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item.

Part of the premium on some bonds may be a miscellaneous deduction not subject to the 2% limit. For more information, see Amortizable Premium on Taxable Bonds in Publication 529 and Bond Premium Amortization in chapter 3 of Publication 550, Investment Income and Expenses.

Certain Casualty and Theft Losses

You can deduct a casualty or theft loss as a miscellaneous itemized deduction not subject to the 2% limit if the damaged or stolen property was income-producing property (property held for investment, such as stocks, notes, bonds, gold, silver, vacant lots, and works of art). First report the loss in Section B of Form 4684. You may also have to include the loss on Form 4797 if you are otherwise required to file that form. Your deduction is the amount of the loss included on lines 32 and 38b of Form 4684 and line 18b(1) of Form 4797. For more information on casualty and theft losses, see chapter 27.

Federal Estate Tax on Income in Respect of a Decedent

You can deduct the federal estate tax attributable to income in respect of a decedent that you as a beneficiary include in your gross income. Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. See Publication 559 for more information.

Gambling Losses Up to the Amount of Gambling Winnings

You must report the full amount of your gambling winnings for the year on line 21, Form 1040. You deduct your gambling losses for the year on line 27, Schedule A (Form 1040). You cannot deduct gambling losses that are more than your winnings.

You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses up to the amount of winnings as an itemized deduction. Therefore, your records should show your winnings separately from your losses.

Diary of winnings and losses. You must keep an accurate diary or similar record of your losses and winnings.

Your diary should contain at least the following information.

1. The date and type of your specific wager or wagering activity.
2. The name and address or location of the gambling establishment.
3. The names of other persons present with you at the gambling establishment.
4. The amount(s) you won or lost.

See Publication 529 for more information.

Impairment-Related Work Expenses

If you have a physical or mental disability that limits your being employed, or substantially limits one or more of your major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, you can deduct your impairment-related work expenses.

Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at your place of work and other expenses in connection with your place of work that are necessary for you to be able to work.

Where to report.   If you are an employee, you enter impairment-related work expenses on Form 2106 or Form 2106-EZ. Enter on line 27, Schedule A (Form 1040) that part of the amount on line 10 of Form 2106, or line 6 of Form 2106-EZ, that is related to your impairment. Enter the amount that is unrelated to your impairment on line 20, Schedule A (Form 1040).

Repayments Under Claim of Right

If you had to repay more than $3,000 that you included in your income in an earlier year because at the time you thought you had an unrestricted right to it, you may be able to deduct the amount you repaid or take a credit against your tax. See Repayments in chapter 13 for more information.

Unrecovered Investment in Annuity

A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final income tax return. See chapter 11 for more information about the tax treatment of pensions and annuities.

Officials Paid on a Fee Basis

If you are a fee-basis official, you can claim your expenses in performing services in that job as an adjustment to income rather than as a miscellaneous itemized deduction. To qualify as a fee-basis official, you must be employed by a state or local government and be paid in whole or in part on a fee basis.

Where to report.   If you qualify as a fee-basis official, you should first complete Form 2106 or Form 2106-EZ. Then include your expenses in performing services in that job (line 10 of Form 2106 or line 6 of Form 2106-EZ) on line 34 of Form 1040. Then write FBO and the amount of those expenses on the dotted line next to line 34 of Form 1040.

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