FedTax Chapter 6

Deductions and Losses

Deductions for AGI vs. from AGI

For AGI is better. Why?
Can be claimed whether or not taxpayer itemizes (from AGI take standardized or itemized)
For AGI determines amount of itemized deductions b/c many itemized are limited to % of AGI
Itemized deductions are subject to 3% cutback when AGI too high
Section 62 specifies what qualifies as for AGI deductions
for expenses of employer or self-employed

Expenses relating to a trade or business carried on by taxpayer (doesnt apply for employees!)
Losses on sale or exchange of property
Expenses related to rent for production of rents/royalties
Alimony
of SE tax paid by self-employed (to match what is done for corporations)
Medical insurance premiums paid by self-employed
Retirement plans contributions by self-employed 401K, traditional IRA
Moving expenses (only for business purposes)
Student loan interest (up to $2,500) but phaseout if income too high
Qualified tuition max $4,000 but phaseout if income too high

Section 162 Specifies what is deductible for & from AGI

always for AGI if employer or self-employed
from AGI if employee (with some exceptions)
1. Ordinary and necessary
a. Ordinary: Is expense normal, usual or customary for your type of business?
b. Necessary: would a prudent businessperson incur such expenses and is it appropriate/helpful for your
business?
c. EX.) You have a privet jet to use for promoting your business, is it deductible? can you just take a
commercial plane? Is it ordinary and necessary?
2. Reasonable - owner salaries
a. C corps tend to overstate salary to avoid double tax issue (to give out less distributions)
b. S corps tend to understate salary to avoid SE tax and just pay higher PT
3. Paid or incurred during taxable year
a. Paid cash basis
b. Incurred accrual basis
4. In the Pursuit of a Trade of Business
a. 1. Need a significant degree of taxpayer participation (time spent)
b. 2. Profit motive
i. need to show profit in at least 3 out of 5 prior years
ii. ex. Is Ed motivated by profit to play golf to win a tournament? No.. its a hobby
c. such expenses can exceed incomecan offset other income!
d. ** Hobby expenses ** are deductible from AGI /itemized to the extent that it does not exceed income
cant record loss
e. But you have to have won some income in order to deduct any hobby expense

Cash Basis vs. Accrual Basis

Generally want to be a cash basis taxpayer cuz you can control it better
For ex, you can ask client to pay for sth later because you want lower NI.. can prepay or defer expenses
Cash Basis requirements:
Cant use cash basis if:
o Taxpayer has inventory
o If its a C-corp with revenue in excess of $5m
can prepay ahead (but no more than a year ahead) for deductions
Accrual Basis requirements:
1. All Events Test
a. All events have to have occurred. The work has to be done, liability fixed.
2. Economic performance test
a. When expense is performed
b. No estimates allowed
i. Ex. BDE only gets expensed/deducted when written off
ii. Sales returns, warranties, inventory write-off..
Section 212 Specifies what qualifies as deductions for individuals/employees (usually from AGI)
Ordinary & necessary expenses paid/incurred by an individual for following can deduct:
1. production or collection of income $$
2. management or maintenance of property held for production of income
a. ex. Rental expenses for AGI*
3. Expenses paid in connection with the determination, collection or refund of any tax

Expenses not deductible either for/from AGI:

Fines/punishment payments to gov for violation of law

o Ex. Speeding tickets on way to business trip
Drug trafficking expenses (only COGS deductible)
o (usually even illegal business expenses are deductible)
Personal expenses
Capital expenses
o If you buy a machine cant deduct all need to depreciate
Political contributions
Hobby losses* Only to extent of income, and from AGI

Rental of Vacation Homes

1. 100% Personal Use
a. expenses not deductible
b. except mortgage interest/property tax deductible
2. 100% Rental
a. Rental income taxable
b. Rental expense deductible
3. Only Rent < 15 Days
a. Rental income excludable!
b. Expenses not deductible
4. Mixed Use:
a. Primary rental?
i. Rented more than 15 days & not personal for greater of: less than 14 days or 10% of rented days
ii. Rental income taxable
iii. Rental expense deductible (can exceed income)
b. Primarily personal?
i. rent for 15/more days and use some for personal
ii. Expense deductible
iii. But cannot show losses/exceed income
c. Ex.1) Rent for 200 days, you can use up to 20 days personally to still keep it primarily rental
d. Ex. 2) Rent for 100 days, you can use 14 personal days to still keep it primary rental