Professional Documents
Culture Documents
Deductions
Various deductions and allowances are
permitted by the IRC based on tax logic or tax favoritism These deductions and allowances are subtracted from gross income to arrive at taxable income, the tax base under the IRC Deductions may be broadly clustered into two categories:
and not gross receipts from a business venture IRC 162 codifies that policy by providing that that it is appropriate to offset gross income by expenditures incurred in earning that income Business income (loss) is entered on Line 12, Form 1040 through Schedule C, for an individual
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Adjustment to Adjusted Gross Income (AGI) Not subject to standard deduction No need to itemize deductions to use
necessary expenses paid or incurred during a taxable year in carrying on a trade or business. IRC 162(a). Burden of proof on deductions shouldered by the taxpayer.
Expenses
Carry on Trade or business
Expenditure is ordinary if it is one that is common within the industry even if once-ina-lifetime expenditure for the actual taxpayer. Courts employ a horizontal test.
Expenditure is necessary if appropriate and helpful to the business. Court employs a reasonableness test. If expense can be reimbursed, then it is not necessary.
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Necessary:
turns on a careful consideration of the facts of each case. Because of changes in attitudes and business norms, what may not have been ordinary and necessary in the past may no longer be controlling
EXPENSES
Rule 1: A 162 deduction is allowed only for
an item of expense and not a capital expenditure. Rule 2: Capital expenditures (Cap X) may not be deducted at the time the amount is paid or incurred
Rather, the Cap X may give rise to deductions for depreciation in later years.
Deduction v. Cap X
Recognize, in the business context, the difference
between deduction and Cap X is one of timing and the time value of money. However, in personal context, the difference between deduction and Cap X may be more substantively important
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CARRY ON
Rule: Expenses are deductible only if
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trade or business?
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business?
stage and is dropped before a trade or business is developed or acquired, then the transactional expenditures may give rise to a loss deduction. IRC 165(c)(2).
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Start-Up Expenses
What about start-up expenditures?
or starting a new trade or business may be deducted as start-up expenditures if the taxpayer elects. See IRC 195.
Under 195, these expenditures are deducted ratably over at least 60 months (time period selected by taxpayer) and begins in the month in which the active business begins.
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employment as an employee? Individual may be in the trade of business of providing services as employee.
Expenses incurred in obtaining another job in the same line of work are deductible Expenses incurred in obtaining another job in a new line of work are not deductible Expenses incurred in obtaining ones first job not deductible
TRADE OR BUSINESS
Does the taxpayers profit-seeking
Taxpayer must have a profit motive for engaging in the activity that gives rise to the expense Personal expenses are generally not deductible
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Business
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Contingent Compensation
If employment agreement provides for
compensation based on future events, such as percentage of profits, then amount actually paid is reasonable if fruits of arms length bargain and reasonable when the agreement was made.
If agreement is not product of arms length bargaining, then it must be reasonable at time it was paid
services actually rendered. Payment to taxpayer as partial payment for property transferred or as disguised dividend do not qualify as salary
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including lodging and a portion of the cost of meals, incurred while a taxpayer is away from home in the pursuit of a trade or business. IRC 162(a)(2). Three requirements:
Expense must be reasonable and necessary traveling expense (cannot be extravagant or lavish) Expense must be incurred while away from home Expense must be incurred in the pursuit of business Further limit with meals: 50% limit on deductibility
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Travel Expenses
Tips, telephone calls, internet access, baggage charges, postage, laundry, handicapped traveler aid
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tax purposes
(and not her abode) is a taxpayers tax home Principal place of business:
Amount of income earned at each location Nature and extent of business activity that takes place in each location Amount of time spent at each location
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Temporary Assignment
TAD must be expected to be less than one
year and must in fact be less than one year. If temporary assignment is greater than one year (regardless of intent), then no portion of expenses may be deducted.
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Overnight Rule
Rule: Deduction permitted for expenses
incurred in lodging and 50% of meals only if taxpayer is away from home overnight. Overnight means:
Taxpayer is away from home long enough to require her to stop for substantial sleep or rest no matter what distance she travels or mode of transportation she employs. Otherwise, nondeductible personal expense under 262.
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deductible only to the extent they are properly allocable to the business. Special rules for foreign travel. No deduction for spouse or dependents.
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Meals
Away from home: 50% if not extravagant or
lavish Not away from home: 50% but only if present and related directly to trade or business, that is, an entertainment expense (more restrictive test) IRC 274 (50% limitation)
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other payments for use of property in a taxpayers trade or business. IRC 162(a)(3). Transfer/Lease-Back:
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Education
Entertainment Uniforms
Dues
Periodicals Utilities Taxes (IRC 164) Health insurance for self-employed individuals Charitable donations (IRC 170)
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Payment of Interest
Deduction for interests payments on business
loans (IRC 163). Generally no deduction for payments of interest on personal loans with several important exceptions:
Home mortgage interest deductions Certain qualified student loans for qualifying taxpayers
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maintains or improves skills required by a taxpayer in his employment or other trade or business or if education meets express requirements imposed by law or a taxpayers employment, status, or rate of compensation. Treas. Reg. 1.162-5(a). No deduction if education is necessary to qualify for trade or business or meet minimum educational requirements.
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Uniforms
Meals and entertaining: Must show demonstrable business benefit. Generally 50% limit. Section 274 limitation.
Work clothing specifically required as condition of employment and not adaptable to general use. Think police, nurses, sports uniforms, Mr. Goodwrench, fire fighters, etc. Do not think military uniforms of full-time active duty personnel If uniform cost is deductible, then maintenance is deductible.
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self-employed individuals
Self-employed taxpayer may deduct the costs of medical insurance coverage for himself, spouse, and dependents
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Substantiation
Rule: If a taxpayer does not have
substantiation of a deduction, then a court may allow an estimate of the expense unless the IRC specifically requires substantiation.
Estimation is known as the Cohan rule. IRC 274(d) requires substantiation for the following expenses:
Traveling expenses (including lodging and meals away from home), business gifts, entertainment expenses, and business meals.
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circumstances for ordinary and necessary expenses incurred or paid in furtherance of profit-seeking activity, specifically:
The production or collection of income Dealing with property that is being held for the production of income Dealing with tax matters
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Ordinary and necessary Expense Must not be inherently personal in nature Must be individual (or by extension, estate or trust by personal representative or trustee)
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a taxable year for the production or collection of income are deductible by individual taxpayer. Expenses need not match income in the same year.
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a taxable year for the management, conservation, or maintenance of property held for the production of income are deductible. This is the case even where the property is not currently producing income or even where the property may be sold for a loss.
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Preparing return, contesting tax liability, or determining tax consequences of proposed action
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is, that a taxpayer must itemize deductions to receive any tax benefit. Section 162 is an above the line deduction no need to itemize to receive a tax benefit. Section 212 does not require that taxpayer is actually carrying on trade or business to qualify. Section 162 requires carrying on trade or business.
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Conclusion
Questions?
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