Chapter 5: Business Deductions Flashcards
(34 cards)
Section 162?
Common Business deductions
What is generally deductible?
Ordinary and necessary business expenses
Current deductions for capital expenditures?
The regulations require capitalization of any expenditure that creates an asset having a useful life that extends substantially beyond the end of the tax year.
Can only take a current deduction for capital expenditures through AMORTIZATION, DEPLETION, OR DEPRECIATION over the tax life of the asset.
All events Test
A deduction cannot be claimed until;
- All of the events have occurred to create the taxpayer’s liability
- The amount of the liability can be determined with reasonable accuracy
Economic performance test
Following the all events test, the deduction is only permitted if economic performance has occurred.
Economic performance is met when the service, property, or use of the property giving rise to the liability is actually performed for, provided to, or used by the taxpayer.
Expenditures that are not deductible because they are contrary to public policy?
- Bribes and Kickbacks illegal under fed/state law (Including those associated with medicare and medicaid)
- Two thirds of the treble damage payments made to claimants resulting from violation of antitrust law.
- Fines and penalties paid to a government for violation of law.
Justification for denying deductions?
Violation of public policy is not a necessary expense and is not deductible. A deduction would, in effect, represent an indirect governmental subsidy for taxpayer wrongdoing.
Legal expenses incurred in defense of civil or criminal penalties?
To deduct legal expenses, taxpayer must be able to show that the origin and character of the claim are directly related to a trade or business.
Personal legal expenses are not deductible.
Legal fees are only deductible if the crime is associated with the taxpayer’s trade or business.
Expenses related to an illegal Business?
Deductible
Law taxes net income from a business operation, not gross revenue.
Disallowed deduction for fines, brides to public officials, illegal kickbacks, and other illegal payments without regard to whether these payments are part of a legal or illegal business.
Exception: expenses incurred in trafficking drugs; drug dealers are not allowed a deduction for ordinary and necessary business expenses incurred in their business.
Political contributions?
Generally, no business deduction is permitted for direct or indirect payments for political purposes.
Allowing deductions might encourage abuses and enable business to have undue influence on the political process.
lobbying Expenditures?
Deny deductions for expenditures incurred in connection with attempting to influence;
- State or federal legislation
- The actions of certain high ranking public officials
Exceptions;
- Influencing local legislation
- Activities devoted solely to monitoring legislation
- De Minimis exceptions: allow deductions of up to 2,000 of annual in house expenditures incurred by the taxpayer if the expenditures are not otherwise disallowed under the provisions discussed above
In house lobbying expenditures: dont include expenses paid to professional lobbyist or any portion of dues used by associations for lobbying. If > $2,000, none of the in house expenditures can be deducted.
Excessive Executive Compensation?
Millionaires’ provision: applies to compensation paid by publicly held corporations. Does not limit the amount of compensation that can be paid to an employee, it limits the amount the employer can deduct for the taxable compensation of a covered executive to 1 Million annually.
This disallowance does not apply to commissions based on individual performance and performance based compensation tied to overall company performance
Dissallowance of deductions for capital expenditures?
The code specifically disallows a deduction for “any amount paid out for a new building or for permanent improvements or betterments made to increase the value of any property or estate”
Incidental repairs and maintenance of property are not capital expenditures and can be deducted as ordinary and necessary business expenses.
Capitalization versus expenses?
When an expenditure is capitalized rather than expensed, the deduction is deferred or lost forever. Immediate tax benefit is lost, but the cost may be deductible in increments over a longer period of time as the asset provides utility to the taxpayer.
Example: tangible asset that has ascertainable life, it is capitalized and may be deducted as depreciation over the life of the asset.
Land is not subject to depreciation; doesn’t have ascertainable life.
Investigation of a business
Investigation expenses are incurred to determine the feasibility of starting a new business or expanding an existing business.
How they are treated for tax depends on:
- The current business, if any, of the taxpayer
- The nature of the business being investigated
- whether the acquisition actually takes place.
If the taxpayer is in a business that is the same or similar to that being investigated. all investigation expenses are deductible in the year paid or incurred. (Tax result is the same whether the business is acquired or not)
When the taxpayer is not in the business that is the same or similar to the one being investigated, tax result depends on whether the new business is acquired. Not acquired=all expenses generally not deductible.
Taxpayer not in business that is the same or similar to the one being investigated, and actually acquires the new business, the expenditures must be capitalized as STARTUP EXPENDITURES. Startup expenditures are not deductible under section 162 because they are incurred before a business begins rather than in operation of a trade or business. First $5,000 of the expenses is immediately deducted. any excess of expense is amortized over a period of 180 months (15 years)
Can elect not to deduct or amortize any portion of the start up costs and the asset will remain on the business sheet until the business is sold.
Transactions between related parties?
The code places restrictions on the recognition of gains and losses from related parties.
Constructive ownership provisions applied to determine whether the taxpayers are related. Under these provisions, stock owned by certain relatives or related entities is deemed to be owned by the tax payer for purposes of applying the loss and expense deduction disallowance provisions.
Related Parties
Related parties:
- Brothers and sisters (whole, half, or adopted), spouse, ancestors (parents and g-parents), lineal descendants (children and g-children) of the taxpayer
- A corporation owned more than 50% (directly and indirectly) by the taxpayer
- Two corporations that are members of a controlled group
- A series of other complex relationships between trusts, corporations, and individual taxpayers.
Losses and related parties?
Disallowance of any losses from sales or exchanges of property directly or indirectly between related parties. A right of offset is creates equal to the disallowed loss. When property is eventually sold to an unrelated party, any gain recognized is is reduced by the right of offset.
(offset can’t create or increase a loss)
(any right of offset that is not used is permanently lost)
Unpaid Expenses and interest?
The law prevents taxpayers from engaging in tax avoidance schemes where one related taxpayer uses the accrual method of accounting and the other uses the cash basis.
Lack of adequate substantiation?
Taxpayer has the burden of proof for sustaining expenses deducted not he returns and must retain adequate records. Upon audit, the IRS can disallow any undocumented or unsubstantiated deductions.
Expenses and interest related to tax exempt income?
The law does not permit a tax payer to profit at the expense of the government by excluding interest income and deducting any related interest expense.
The code specifically disallows a deduction for the expenses of producing tax exempt income. Interest on ay indebtedness incurred or continued to purchase or carry tax-exempt obligations is also disallowed.
Charitable contributions?
Corporations and individuals are allowed to deduct contributions made to qualified domestic charitable organizations, these organizations include;
- a state or possession of the united states or any subdivisions thereof.
- A corporation, trust, or community chest, fund, or foundation that is situated in the United states and is organized and operates exclusively for religious, charitable, scientific, literary, or educational purposes of for the prevention of cruelty to children or animals.
Generally a deduction will be allowed only for the year in which the payment is made, but an accrual basis corporation may claim the deduction in the year preceding payment of two requirements are met;
- contribution must be authorized by the board of directors by the end of that year.
- It must be paid on or before the 15th day of the third month of the following year.
Property contributions?
The amount that can be deducted for a non cash charitable contribution depends on the type of property contributed (must identify as capital gain property to ordinary income property)
CAPIATL GAIN PROPERTY: property that if sold would result in a long term capital gain or section 1231 gain for the taxpayer
-Generally must be a capital asset and must be held for
a long term holding period (more than one year)
- Deduction is generally measured using the Fair
market value
ORDINARY INCOME PROPERTY: property that if sold would result in ordinary income for the taxpayer
- Inventory or capital assets held short term (less than a
year)
In what two situations it is a non cash charitable donation measured by the basis of the property, not FMV?
- If a corporation contributes tangible personal property and the charitable organization puts the property to an unrelated use. (unrelated use: use that is not related to the purpose or function that qualifies the organization for exempt status)
- As a general rule, the deduction for a contribution of ordinary income property is limited to the basis of the property. On certain contributions of inventory by corporations the amount of the deductions is equal to the lesser of
- the same of the property’s basis plus 50% of the
appreciation of the property
-Twice the property’s basis.
- the same of the property’s basis plus 50% of the
The following contributions of inventory qualify for this increased contribution amount;
- A contribution of property to a charitable organization for use that is related to the organization’s exempt function and such use is solely for the care of the ill, needy, or infants.
- A contribution of tangible personal research property constructed by the corporation to a qualified educational or scientific organization that uses the property for research or experimentation or for research training (the property must be contributed within two years from the date of its construction by the donor, and its original use must begin with the done)
