Tax Exam 1 (Deductions)

What is a "qualified" moving expense?

''Qualified'' moving expenses include reasonable expenses of: -Moving household goods and personal effects to new location -Expenses of travel for taxpayer and family to new location. Lodging and actual auto costs (not depreciation) or mileage rate. -Meals are not deductible as moving expense Unreimbursed moving expenses are deductible for AGI

In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year for...

(1) for the production or collection of income; (2) for the management, conservation, or maintenance of property held for the production of income; or (3) in connection with the determination, collection, or refund of any tax.

What is the simplified method?

-A home office expense deduction of $5 per square foot is allowed. Since no more than 300 square feet can be counted, the maximum deduction is limited to $1,500 -No deduction is allowed for depreciation or other actual expenses of operating the home. Otherwise deductible amounts for interest and taxes may still be deducted in full.

What is required to deduct a legal expense incurred in defense of civil or criminal penalties?

-An application of "origin of the claim" test -To deduct legal expenses...Must be directly related to a trade or business, an income producing activity, or the determination, collection, or refund of a tax e.g., Corporate officer's legal fees in defending against price-fixing charges e.g., Landlord's legal fees associated with eviction of tenant

Unreimbursed business expenses for employees are generally ...

-Deductible FROM AGI, -Subject to 2% of AGI floor, -Only if take Itemized Deductions (rather than Standard Deduction) -Reported on Form 2106 (Employee Business Expenses) and Schedule A (Itemized Deductions)

What are the public policy limitations?

-Expenditures contrary to public policy -Legal Expenses Incurred In Defense Of Civil Or Criminal Penalties -Expenses Relating to an Illegal Business -Political Contributions and Lobbying Activities -Excessive Executive Compensation

What happens when moving expenses are reimbursed or paid by the employer?

-For qualified moving expenses, amount is excluded from gross income, but no deduction for related expenses -For nonqualified moving expenses, amount is included in gross income and no deduction is allowed

Deductible losses of individual taxpayers are limited to those...

-Incurred in a trade or business, -Incurred in a transaction entered into for profit -Casualty losses from fire, storm, shipwreck, and theft

Reimbursed under Accountable Plan:

-Plan must require adequate accounting to the employer for expense reimbursed, and -Any excess reimbursements must be returned to the employer -Adequate accounting is Submitting a record, with receipts, to the employer, or using a per diem allowance that is not more than the Federal per diem rate. -Employee reports no income and takes no deduction to the extent of the reimbursed expenses

Reimbursed under NONAccountable Plan:

-Plan that does not require adequate accounting or return of excess reimbursement or both -Reimbursed amounts received under this plan are included in gross income -Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% of AGI limitation

What is deductible as far as education expenses under IRC § 222?

-Qualified Higher Education tuition and related expenses include whatever is required for enrollment (usually, student activity fees, books; room and board not included; expenses can be for taxpayer, spouse or other dependent). -Deductible for AGI

A partial list of other expenses that are deductible includes:

-Special clothing (uniforms) -Union dues -Professional expenses --Membership dues to professional organizations --Subscriptions to trade publications --Licenses and fees -Job hunting in same profession -Educator expenses (deductible for AGI) --Limited to $250 per year for supplies, etc. of elementary and secondary school teachers

Person is classified as an employee if:

-Subject to will and control of another with respect to what shall be done and how it shall be done -Another furnishes tools or the place of work -Income based on time spent rather than task performed

What are the four exceptions for deducting commuting expenses?

1. Employee has a second job: Expenses of getting from one job to another are deductible. 2. Travel between workstations (of the same job): If the taxpayer is required to incur a transportation expense to travel between workstations, that expense is deductible. 3. Temporary workstation inside the area: The commuting costs from home to a temporary workstation and from the temporary workstation to home are deductible. 4. Temporary workstation outside the area: Also deductible is the reasonable travel cost between the general working area and a temporary workstation outside that area.

What are the two ways that deduction can be determined?

1. The regular (actual expense) method, or 2. The simplified (safe harbor) method

Under "in carrying on a trade or business," what are the three questions that should be asked?

1. Was there a trade or business? (Must have the intent to make a profit) 2. Did the expenditure relate to the trade or business? (Ask whether the "origin of the claim" directly relates to the taxpayer's trade or business) 3. Was the expenditure incurred during the EXISTENCE of the trade or business?

With a business bad debt, if an account receivable arising from credit sale of goods or services becomes worthless a bad debt deduction may be allowed, what is the bad debt deduction?

A bad debt deduction is permitted only if income arising from creation of the receivable was previously included in income (whether accrual or cash basis taxpayer). No deduction is allowed if taxpayer is on the cash basis since no income is reported until the cash has been collected

What is the business purpose doctrine?

A deduction is allowed only for an expenditure that is made for some business or economic purpose that exceeds any tax avoidance motive.

What qualifies an expense as necessary?

An expense is necessary if a prudent business person would incur the same expense and the expense is expected to be appropriate and helpful in the taxpayer's business. The IRS (and courts) seem to rarely disallow deductions as not meeting this requisite except when the payment is between related parties.

What qualifies an expense as ordinary?

An expense is ordinary if it is normal, usual, or customary in the type of business conducted by the taxpayer AND is not capital in nature. However, an expense need NOT be recurring to be deductible as ordinary.

In order to take a deduction, the expense of a taxpayer must be...

An expense of the taxpayer. Not even the expense of wholly-owned subsidiary will qualify.

What is tested for the test of deductibility for compensation for personal services?

The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services.

What does bankruptcy indicate?

Bankruptcy is generally an indication of at least partial worthlessness of a debt. Bankruptcy may create worthlessness before the settlement date. If this is the case, the deduction may be taken in the year of worthlessness.

Why are both employee and self-employed expenses deductible under IRC § 162?

Being both self-employed and an employee are a "trade or business."

Are business gifts deductible?

Business gifts of tangible personalty with a value of $25 or less per person per year are deductible. If the value is $4 or less (e.g., pen with company name), then not subject to $25 limit. Gifts to employers or superiors are not deductible

Things that trump deductibility include...

Capital Expense Lack of Substantiation Capital Recovery Concept Lack of Arm's Length Dealing Substance Over Form Business Purpose Doctrine Economic Substance Doctrine Loss in Transaction with Related Party

Office in the home deductibility.

Deductibility is restricted due to abuse possibilities. Office must be used exclusively and on a regular basis as: The principal place of business, or a place of business used by clients, patients, or customers. For employees, office must also be for the convenience of the employer (no office available at employer's place of business).

If amount represents previous loan made to debtor, can the amount be deductible?

Deduction equals principal of loan and accrued interest previously included in income.

Usually expenses of operating an illegal business or deductible except for what kind of fines/expenses?

Deduction for fines, bribes to public officials, illegal kickbacks, and other illegal payments are disallowed

If the taxpayer purchased the debt, can the amount be deductible?

Deduction is equal to amount paid for debt instrument.

How do you treat deductions for entertainment expenses?

Deductions are restricted due to abuse possibilities Deductible amount allowed: -50% of meals and entertainment costs including related taxes, tips, cover charges, and room rental fees -100% of transportation costs Amounts cannot be lavish or extravagant

What is the distance test?

Distance from old home to new job must be at least 50 miles farther than from old home to old job. New home location not relevant for decision/

What are types of deductions that are disallowed for certain specific types of expenditures that are considered contrary to public policy?

Examples: penalties, fines, illegal bribes or kickbacks

Under IRC §262 (Personal, living, and family expenses), what is the general rule?

Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.

What is an investigation expense?

Expenses incurred to determine the feasibility of entering a new business or expanding an existing business. Include costs such as travel, engineering, architectural surveys, marketing reports, various legal and accounting services.

What is a traveling expense?

Expenses while "away from tax home" at least OVERNIGHT on business. Includes transportation, lodging, meals, and miscellaneous expenses (only 50% of meals and entertainment may be deducted). "Tax Home" generally means business location, post, or station of the taxpayer. "Overnight" need not be a 24-hour period, but it must be a period substantially longer than an ordinary day's work and must require rest, sleep, or a relief-from-work period. A one-day business trip is not travel status, and meals and lodging for such a trip are not deductible.

What is the tax treatment for excessive executive compensation?

For publicly held corporations: Deduction for compensation of CEO and four other highest compensated officers is limited to $1 million each Does not include: Certain performance-based compensation (HUGE Loop-hole), payments to qualified retirement plans, payments excludable from gross income (e.g., for health insurance premiums).

How is a nonbusiness bad debt defined?

For purposes of paragraph (1) , the term "nonbusiness debt" means a debt other than— (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.

How do you determine the amount of a bad debt deduction?

For purposes of subsection (a) , the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.

How do you determine that amount to be deducted for losses?

For purposes of subsection (a), the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.

What is the general rule for nonbusiness bad debts?

General rule: In the case of a taxpayer other than a corporation— (A) subsection (a) shall not apply to any nonbusiness debt; and (B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year.

What is the general rule for expenses and interest relating to tax-exempt income?

General rule: No deduction shall be allowed for... (1) Expenses Any amount otherwise allowable as a deduction which is allocable to one or more classes of income . . wholly exempt from the taxes imposed by this subtitle . . . . (2) Interest Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from the taxes imposed by this subtitle.

Under IRC § 263(a) (Capital expenditures), what is the general rule?

General rule: No deduction shall be allowed for— (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. This paragraph shall not apply to— (2) research and experimental expenditures deductible under section 174,

What is the general rule for deduction of losses?

General rule: There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

What are the restrictions on convention travel expenses?

Generally, accompaniment by the spouse or dependent must serve a bona fide business purpose, and the expenses must be otherwise deductible.

What is the tax treatment for political contributions and lobbying activities?

Generally, no business deduction is allowed for payments made for political purposes or for lobbying. Exceptions are allowed for lobbying: To influence local legislation, to monitor legislation, and De minimis in-house expenses (limited to $2,000). If greater than $2,000, none can be deducted.

What is lack of substantiation?

Generally, taxpayers must retain records to prove that they meet each and every requirement of the statute under which a deduction is being taken. However, for most expenses, if a taxpayer can prove every requirement for a deduction except establishing the precise amount of the deduction, the taxpayer can obtain a deduction. However, the courts (or IRS) will approximate the amount downward.

Related party bad debts are generally suspect and may be treated as what?

Gifts Regulations state that a bona fide debt arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed or determinable sum of money. Thus, individual circumstances must be examined to determine whether advances between related parties are gifts or loans.

What constitutes "principal place of business?"

Home office qualifies as a principal place of business if: Taxpayer conducts administrative and management activities in the home office, and there is no other fixed location where taxpayer could conduct these activities.

What is temporary assignment?

If taxpayer is on Temporary Assignment, then they are "away from tax home" and can thus deduct Travel Expenses If taxpayer-employee is reassigned to a new post for an indefinite period of time, the new post becomes his or her tax home. Temporary indicates that the assignment's termination is expected within a reasonably short period of time. The Code specifies that a taxpayer "shall not be treated as temporarily away from home during any period of employment if such period exceeds 1 year."

In regards to capitalization, what happens if the expenditure is for a tangible asset?

If the expenditure is for a tangible asset that has an ascertainable life, it is capitalized and may be deducted as depreciation (or cost recovery) over its depreciable life. Land is not subject to depreciation (or cost recovery) because it does not have an ascertainable life.

In regards to capitalization, what happens if the expenditure is for an intangible asset?

If the expenditure is for an intangible asset (e. g., copyright, patent, covenant not to compete, and goodwill), the capitalized expenditure can be amortized regardless of whether the intangible asset has an ascertainable life. Intangible assets, referred to as § 197 intangibles, are amortized over a 15- year statutory period using the straight- line method.

Under IRC § 261, what is the general rule for disallowance of deductions?

In computing taxable income no deduction shall, in any case, be allowed in respect of the items specified in this part.

What is the general rule for evidence of worthlessness?

In determining whether a debt is worthless in whole or in part, the district director will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor.

What is a moving expense?

In general, for purposes of this section, the term "moving expenses" means only the reasonable expenses: (A) of moving household goods and personal effects from the former residence to the new residence, and (B) of traveling (including lodging) from the former residence to the new place of residence. Such term shall not include any expenses for meals. (C) Conditions for allowance: No deduction shall be allowed under this section unless the taxpayer's new principal place of work...(a) is at least 50 miles farther from his former residence than was his former principal place of work, or (b) if he had no former principal place of work, is at least 50 miles from his former residence.

What is the capital recovery concept?

In general, the amount of a deduction can never exceed its cost. The amount invested in an item, its cost, is the maximum amount that can be deducted in determining taxable income.

In general, what is IRC § 162?

In general: There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including— (1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

Individuals will generally have non-business Bad Debts unless...

In the business of loaning money, or bad debt is associated with the individual's trade or business.

What are the limitations on losses of individuals?

In the case of an individual, the deduction under subsection (a) shall be limited to: (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

What is a transportation expense?

Includes only the cost of transporting the employee from one place to another in the course of employment when the employee is NOT away from home in travel status.

If the taxpayer is in a business the same as or similar to that being investigated, when are investigation expenses deductible?

Investigation expenses are deductible in the year paid or incurred (because relate to business the taxpayer is already in). The tax result is the same whether or not the taxpayer acquires the business being investigated

What is the legal action required to prove worthlessness?

Legal action is not required. Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgement, a showing of these facts will be sufficient evidence of the worthlessness of the debt for purposes of the deduction under section 166.

In order to deduct under IRC § 222, does the taxpayer need to already be in the related trade or business?

No

Substantiation

No deduction allowed for an expense if the taxpayer does not have adequate records for the expense. Therefore, taxpayers need to have good records for employee or self-employed expenses. In some cases, use of per diem allowance will be deemed substantiation. Records should include: -The amount of the expense -The time and place of travel or entertainment (or date of gift) -The business purpose of the expense -The business relationship of the taxpayer to the person entertained (or receiving the gift)

Convention Travel Expenses

No deduction for convention travel unless directly related to taxpayer's trade or business. Example: Doctor attending out-of-town seminar on estate planning would not have deductible travel expenses

Are club dues deductible?

No, generally not deductible. Exception: Clubs formed for public service and community volunteerism (e.g., Kiwanis, Rotary). Business entertainment expenses incurred at club are still deductible (50%).

Do worthless securities apply to bad debt?

No, worthless securities do not apply to a debt which is evidenced by a security as defined in section 165(g)(2)(C) .

Is commuting from home to work and back is generally deductible?

No. It is generally nondeductible.

What is the tax treatment of non-business bad debts?

Non-business Bad Debts should be deducted as short-term capital loss in year amount of worthlessness is known with certainty. No deduction is allowed for partial worthlessness of a non-business bad debt

What is the legislative grace concept?

Nothing is deductible unless a Code provision allows the deduction. Applied to deductions, the legislative grace concept means that deductions are allowed only as a result of a specific act of Congress and that any relief granted in the form of a deduction must be strictly interpreted. A taxpayer must point to a specific Code provision allowing a deduction and prove that a given item meets each and every requirement of the provision (and no other provision such as IRC § 263 Capital Expenditures precludes the deduction).

What happens when you have combined business/pleasure travel?

Only actual expenses for business are deductible. Meals, lodging, and other expenses must be allocated between business and personal days. Deductibility of transportation costs depends on whether the trip is domestic or foreign. For domestic travel, If primary purpose of trip is business (more days spent on business than pleasure), transportation is deductible in full. If primary purpose is pleasure, no deduction for transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible.

What happens if a business bad debt previously deducted as partially worthless becomes totally worthless in a future year?

Only the remainder not previously deducted can be deducted in the future year.

What is the regular method?

Relevant expenses are categorized as direct or indirect -Direct expenses benefit only the business part of the home (e.g., the office is repainted). Deducted in full -Indirect expenses are for maintaining and operating the home. Allocate between business and personal

What is required for a bad debt to be deducted?

Specific charge-off method must be used. That is, a deduction may only be taken when a SPECIFIC debt is identified as uncollectible (i.e., worthless). No deduction for "allowance for bad debts" required as expense and contra-asset under GAAP.

What is the tax treatment when the taxpayer is not in a business the same as or similar to that being investigated?

Tax result depends on whether a new business is acquired... If not acquired, all investigation expenses generally are nondeductible. If acquired, investigation expenses must be capitalized, may elect to deduct the first $5,000 of expenses currently, and any excess expenses can be amortized over a period of not less than 180 months (15 years).

What is the time test?

Taxpayer must be full-time employee for 39 weeks in the 12-month period following the move. Test waived if die, disabled, discharged, or transferred. If time test not met during taxable year, two alternatives: 1. Take the deduction in year moved. If test is not met in following year, either include the amount deducted in gross income in the following year, or file amended return for year of move. 2. Wait until time test is met and then file amended return for year of move.

What qualifies an expense as reasonable in amount?

The Reasonable in Amount requisite is not explicitly stated in IRC § 162(a), but courts have held it to be an implicit requirement of IRC § 162(a). Another way to look at the requirement is that amounts that are not Reasonable in Amount are not Ordinary and/or Necessary.

In terms of mileage, what amount is deductible?

The actual expenses: Must keep adequate records of all expenses and depreciation. OR The automatic mileage method: The rate for 2016 was 54 cents per mile for business miles Plus parking, tolls, etc. Adequate documentation of mileage required.

If a receivable has been written off, can the amount be deductible?

The collection of the receivable in a later tax year may result in income being recognized. Income will result if the deduction yielded a tax benefit in the year it was taken

For business bad debts, when do you deduct debt that is wholly or partially worthless?

The same year in which the debt is partially or wholly worthless. Legal proceedings need NOT be initiated against the debtor when the surrounding facts indicate that such action will not result in collection.

Uner IRC § 195, what is a start-up expenditure?

The term "start-up expenditure" means any amount - A) Paid or incurred in connection with i. investigating the creation or acquisition of an active trade or business, or ii. creating an active trade or business, or iii. any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business, and B) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A)), would be allowable as a deduction for the taxable year in which paid or incurred.

What is the rule for wholly worthless bad debts?

There shall be allowed as a deduction any debt which becomes worthless within the taxable year.

Describe the deduction allowed for net operating losses.

There shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year. For purposes of this subtitle, the term "net operating loss deduction" means the deduction allowed by this subsection.

Moving expense deduction are allowed for...

There shall be allowed as a deduction moving expenses paid or incurred during the taxable year in connection with the commencement of work by the taxpayer as an employee or as a self-employed individual at a new principal place of work.

Employment (employee or self-employed) related expenses fall into one of the following categories:

Transportation Travel Moving Education Entertainment Home Office Other *All deducible under IRC § 162, unless otherwise indicated

IRC § 162 Deductible Education expenses include:

Tuition Books Supplies Transportation Travel (including lodging and 50% meals)

What are the factors that should be considered when determining if something is a loan or a gift with related parties?

Was a note properly executed? Was there a reasonable rate of interest? Was collateral provided? What collection efforts were made? What was the intent of the parties?

What are the consequences of capitalization?

When an expenditure is capitalized rather than expensed, the deduction is at best deferred and at worst lost forever. Although an immediate tax benefit for a large cash expenditure is lost, the cost may be deductible in increments over a longer period of time as the asset is depreciated, amortized, or depleted.

What is the rule for partially worthless bad debts?

When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

If debt arose from sale of services or products and the face amount was previously included in income, can the amount be deductible?

Yes, that amount is deductible.

For treatment of employment-related expenses, expenses not reimbursed are...

deductible from AGI as miscellaneous itemized deductions subject to the 2% of AGI limitation

For education expenses, they are not deductible if...

expenses are incurred: -To meet minimum educational standards for existing job, or -To qualify taxpayer for new trade or business (even if also related to existing trade or business) e.g., Accountant who is already CPA takes law school courses, even if never intend to take Bar exam

To deduct educational expenses under IRC § 162 expense must...

pertain to trade or business taxpayer is already in (must be "carrying on trade or business")