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Ch6 - 2015
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7/21/2019 Ch6 - 2015
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2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible ebsite, in hole or in part.
Comprehensive Volume
1
Chapter !
"eductions and Losses#$n %eneral
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&he 'ig (icture )slide 1 o* 2+
"r. Cli** (ayne deter-ines that his deductible epenses associated ith his
dental practice are as *ollos#/alaries including $CA )unpaid at yearend o* 5,000+ 120,000
'uilding rent 23,000
"epreciation o* dental e4uip-ent and o**ice
*urnishings and e4uip-ent 52,000$nsurance )-alpractice and o* dental e4uip-ent
and o**ice *urnishings and e4uip-ent+ 22,000
"ental supplies 1!,000
**ice supplies 6,000
$nvestigation epenses !,000
Contribution to 7./. /enate ca-paign *und o* &o- /-ith 1,000
Contribution to 7./. /enate ca-paign *und o* 8irginia 9hite 1,000
Legal epenses associated ith patient lasuit ):ury decision *or
de*endant+ 3,000
ine i-posed by city *or i-proper disposal o* -edical aste 6,000
"ra by "r. (ayne *or living epenses )5,000 -onthly+ !0,000
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&he 'ig (icture )slide 2 o* 2+
;as "r. (ayne correctly calculated the business
epenses *or his dental practicepenses *or the use o* business property
=nehal* o* sel*e-ploy-ent taes paid
/uch epenses are deductedforA%$
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&rade or 'usiness "eductions)slide 2 o* 2+
$n order *or epenses to be deductible, they
-ust be#
=rdinary# nor-al, usual, or custo-ary *or others in
si-ilar business, and not capital in nature
=Hecessary# prudent businessperson ould incur
sa-e epense
=Reasonable# 4uestion o* *act=$ncurred in conduct o* business
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/ection 212 >penses )slide 1 o* 2+
/ection 212 allos deductions *or ordinary
and necessary epenses paid or incurred *or
the *olloing#
=&he production or collection o* inco-e
=&he -anage-ent, conservation, or -aintenance o*
property held *or the production o* inco-e
=>penses paid in connection ith thedeter-ination, collection, or re*und o* any ta
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/ection 212 >penses )slide 2 o* 2+
G 212 epenses that are deductionsforA%$ include#
= >penses related to rent and royalty inco-e
= >penses paid in connection ith the deter-ination,
collection, or re*und o* taes related to the inco-e o* soleproprietorships, rents and royalties, or *ar-ing operations
All other G 212 epenses are ite-i?ed deductions
)deductionsfromA%$+
= or ea-ple, invest-entrelated epenses )e.g., sa*edeposit bo rentals+ are deductible as ite-i?ed deductions
attributable to the production o* invest-ent inco-e
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'usiness And
Honbusiness Losses "eductible losses o* individual tapayers are
li-ited to those#
=$ncurred in a trade or business,
=$ncurred in a transaction entered into *or pro*it
$ndividuals -ay also deduct casualty losses
*ro- *ire, stor-, shiprecI, and the*t
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Methods o* Accounting
&he -ethod o* accounting a**ects hen
deductions are taIen
=Cash# epenses are deductible only hen paid
=Accrual# epenses are deductible hen incurred
Apply the all events testand the economic performance
test
= >ception to the econo-ic per*or-ance test *or recurring
items
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"isalloance (ossibilities
&he ta la disallos the deduction o* certain types
o* epenses *or a variety o* reasons
= e.g., May restrict tapayer atte-pts to deduct certain ite-s
that, in reality, are personal ependitures Certain disalloance provisions are a codi*ication or
etension o* prior court decisions
= e.g., A*ter courts denied deductions *or pay-ents in
violation o* public policy, ta la as changed to providespeci*ic authority *or the disalloance
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>penditures Contrary
&o (ublic (olicy
"eductions are disalloed *or certain speci*ic
types o* ependitures that are considered
contrary to public policy
=>a-ples# penalties, *ines, illegal bribes or
IicIbacIs, tothirds o* treble da-age pay-ents
*or violation o* antitrust la
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&he 'ig (icture >a-ple 16
Hondeductible ines
Return to the *acts o* &he 'ig (icture on p. !1.
"r. (ayne had not instituted proper procedures *or
disposing o* -edical aste *ro- his laboratory.
="uring the current ta year, he as *ined 6,000 bythe city.
="r. (ayne believes the *ine should be deducted as
an ordinary business epense. ;oever, because the *ine as due to a
violation o*public policy, the 6,000 is notdeductible.
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Legal >penses $ncurred $n "e*ense
* Civil r Cri-inal (enalties
&o deduct legal epenses
=Must be directly related to a trade or business, an
inco-e producing activity, or the deter-ination,
collection, or re*und o* a ta e.g., Corporate o**icerJs legal *ees in de*ending against
price*iing charges
e.g., LandlordJs legal *ees associated ith eviction o*
tenant
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>penses Relating &o
An $llegal 'usiness
7sual epenses o* operating an illegal business
are deductible
=;oever, deduction *or *ines, bribes to public
o**icials, illegal IicIbacIs, and other illegal
pay-ents are disalloed
&ra**icIing in controlled substances# only cost
o* goods sold can reduce gross inco-e
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23
(olitical Contributions And
Lobbying Activities
%enerally, no business deduction is alloed
*or pay-ents -ade *or political purposes or
*or lobbying
=>ceptions are alloed *or lobbying#
&o in*luence local legislation,
&o -onitor legislation, and
"e -ini-is inhouse epenses )li-ited to 2,000+= $* greater than 2,000, none can be deducted
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&he 'ig (icture >a-ple 1@
(olitical Contributions
Return to the *acts o* &he 'ig (icture on p. !1.
"r. (ayne -ade political contributions to the /tate /enate
ca-paigns o* &o- /-ith and 8irginia 9hite.
="r. (ayne -ade these contributions to encourage thesesenators to support a ne bill that is bene*icial to the stateJs
dental pro*ession.
= &here*ore, he assu-ed that these ould be deductible
business epenses.
;oever, political contributions are not deductible,
so he ill receive no ta bene*it *ro- the-.
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>cessive >ecutive Co-pensation)slide 1 o* 2+
or publicly held corporations#
="eduction *or co-pensation o* C> and *our
other highest co-pensated o**icers is li-ited to 1
-illion each
="oes not include#
Certain per*or-ancebased co-pensation
(ay-ents to 4uali*ied retire-ent plans (ay-ents ecludible *ro- gross inco-e
i i i
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>cessive >ecutive Co-pensation
)slide 2 o* 2+ An additional li-itation applies only to
covered eecutives o* co-panies receiving&roubled Asset Relie* (rogra- )&AR(+
assistance=&he deduction *or co-pensation paid to a covered
eecutive is li-ited to 500,000
=Covered e-ployees include the C>, the C,and the three other -ost highly co-pensatedo**icers
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$nvestigation * A 'usiness)slide 1 o* 6+
$nvestigation epenses incurred to deter-ine the*easibility o* entering a ne business or epanding aneisting business= $nclude costs such as travel, engineering, architectural
surveys, -arIeting reports, various legal and accountingservices
&a treat-ent o* these epenses depends on#= &he current business, i* any, o* the tapayer
= &he nature o* the business being investigated
= &he etent to hich the investigation has proceeded
= 9hether or not the ac4uisition actually taIes place
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$nvestigation * A 'usiness)slide 2 o* 6+
$* the tapayer is in a business the same as or
similar tothat being investigated
=$nvestigation epenses are deductible in the year
paid or incurred
&he ta result is the sa-e hether or not the tapayer
ac4uires the business being investigated
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$nvestigation * A 'usiness)slide 6 o* 6+
9hen the tapayer is not in a business the sa-e as orsi-ilar to that being investigated= &a result depends on hether ne business is ac4uired
$* not ac4uired= All investigation epenses generally are nondeductible
$* ac4uired= $nvestigation epenses -ust be capitali?ed
= May elect to deduct the *irst 5,000 o* epenses currently
= Any ecess epenses can be a-orti?ed over a period o* not less than
1D0 -onths )15 years+= $n arriving at the 5,000 i--ediate deduction alloed, a dollar*or
dollar reduction -ust be -ade *or those epenses in ecess o*50,000
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&he 'ig (icture >a-ple 1E
$nvestigation * A 'usiness )slide 1 o* 2+
Return to the *acts o* &he 'ig (icture on p. !1.
"r. (ayne believes that his ad-inistrative and
business sIills can be used to turn around dental
practices hose revenues have been declining.= ;e investigates &eeth Restoration, LLC, a local dental
practice that is *or sale.
=>penses paid to consultants and accountants as
part o* this investigation totaled !,000.
=;e deter-ined that &eeth Restoration ould not be
a good invest-ent, so he did not buy it.
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&he 'ig (icture >a-ple 1E
$nvestigation * A 'usiness )slide 2 o* 2+
Return to the *acts o* &he 'ig (icture on p. !1.
&he !,000 spent to investigate this business is
deductible as a business epense because "r. (ayne is
already in the dental business.= $nvestigating ne business opportunities in oneJs current
trade or business is an ordinary and necessary business
epense.
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;obby Losses )slide 1 o* D+
;obby de*ined
=Activity not entered into *or pro*it
(ersonal pleasure associated ith activity
>a-ples# raising horses, *ishing boat charter
$* an activity is not engaged in *or pro*it, the
hobby loss rules apply
=;obby epenses are deductible only to the etento* hobby inco-e
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;obby Losses )slide 2 o* D+
(ro*it activity
=$* activity is entered into *or pro*it, tapayer can
deduct epenses *or A%$ even in ecess o* inco-e
*ro- the activity AtrisI and passive loss rules -ay apply
*ten it is di**icult to deter-ine i* an activity
is pro*it -otivated or a hobby Regulations provide nine *actors to consider in -aIing
this deter-ination
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;obby Losses )slide 6 o* D+
(resu-ptive rule o* G 1D6
=$* activity shos pro*it 6 out o* 5 years )2 out o* @
years *or horses+, the activity is presu-ed to be a
trade or business rather than a personal hobby= Rebuttable presu-ption, shi*ts burden o* proo* to $R/
=therise, tapayer has burden to prove pro*it
-otive
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;obby Losses )slide 3 o* D+
Year Income (loss) Hobby?
200D 500 Kes
200E )1,500+ Kes2010 @00 Kes
2011 )1,000+ Kes
2012 E00 Ho, pro*it 6 o* 5 years
2016 )500+ Kes, pro*it only 2 o* 5 years
2013 1,200 Ho, pro*it 6 o* 5 years
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;obby Losses )slide 5 o* D+
$* an activity is dee-ed to be a hobby
=Can only deduct epenses to etent o* inco-e
*ro- activity )i.e., cannot deduct hobby losses+
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;obby Losses )slide ! o* D+
$* an activity is a hobby#
=>penses are deductiblefromA%$
&reated as -iscellaneous ite-i?ed deductions sub:ect to
the 2 o* A%$ li-itation >ception# epenses that are deductible ithout regard
to pro*it -otive are deductible in *ull, such as
= ;o-e -ortgage interest
= (roperty taes
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;obby Losses )slide @ o* D+
rder in hich hobby epenses are deductible#
=irst# &hose otherise deductible# e.g., ho-e
-ortgage interest and property taes
=&hen# >penses that do not a**ect ad:usted basis#
e.g., -aintenance, utilities
=&hen# >penses that a**ect ad:usted basis# e.g.,
depreciation )or cost recovery+
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;obby Losses )slide D o* D+
>a-ple o* hobby epenses# &apayer sells
horses raised as a hobby *or15,500
Amount Order Amount$nco-e 15,500
$nterest !,000 1 !,000
&aes 6,000 1 6,000
8et 'ills 2,000 2 2,000
eed 3,000 2 3,000
"epreciation 1,000 6 Ltd. to 500
&otal 15,500
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Rental 8acation ;o-es)slide 1 o* E+
May have both personal and rental use o* avacation ho-e
"eduction o* rental epenses -ay be li-ited
to rental inco-e i* pri-arily used *or personalpurposes
"eter-ination o* vacation ho-e treat-ent is
dependent on personal use vs. rental use
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Rental 8acation ;o-es)slide 2 o* E+
Rental days
=Less than 15 days# Ho gross inco-e recogni?ed
*ro- rentals and no deductible rental epenses
Mortgage interest and property taes treated as i* onpersonal residence )generally deductible in *ull+
=More than 13 days# &reat-ent depends on a-ount
o* personal use
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Rental 8acation ;o-es)slide 6 o* E+
(ri-arily rental use
=$* rented *or 15 days or -ore and personal use
days H& -ore than the greater o* 13 days or 10
percent o* *air rental days=Can deduct all epenses allocated to rental use
even i* loss results
Rental loss sub:ect to atrisI and passive loss rules
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Rental 8acation ;o-es)slide 3 o* E+
(ersonalrental use
=$* rented *or 15 days or -ore and personal use
days eceed the greater o* 13 days or 10 o* *air
rental days=&reated si-ilar to hobby
Rental epenses deducted in three step process
Ho rental loss alloed
Carry*orard o* disalloed rental epenses
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Rental 8acation ;o-es)slide 5 o* E+
>a-ple o* personal use
Rental days# 200 )10 20+
(ersonal use Hot /igni*icant /igni*icant
@ days N 1D days N
25 days N
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Rental 8acation ;o-es)slide ! o* E+
>a-ple o* personal use
Rental days# 100 )10 10+
(ersonal 7se Hot /igni*icant /igni*icant
@ days N
13 days N
1D days N
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Rental 8acation ;o-es)slide @ o* E+
Allocation o* epenses beteen personal and
rental
=Mortgage interest and real estate taes
$R/ re4uires allocation based on total days used
Courts have alloed allocation based on days in year
=ther epenses are allocated based on total days
used
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Rental 8acation ;o-es)slide D o* E+
&a treat-ent o* inco-e and epenses o* a
pri-arily rental vacation ho-e
=Rental inco-e included in gross inco-e
=Rental epenses deductibleforA%$
=Rental inco-e and epenses reported on /ch. >
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Rental 8acation ;o-es)slide E o* E+
&reat-ent o* allocated personal portion o*
vacation ho-e epenses
=(ri-arily rental use# taes deductiblefromA%$,
-ortgage interest nondeductible )personal interest+
=(ersonalrental use# -ortgage interest and taes
deductiblefromA%$
=(ersonal portion o* other epenses )e.g., insurance,-aintenance+ nondeductible
di d *
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>penditures $ncurred *or &apayerJs
'ene*it or bligation
Ho deduction is alloed *or pay-ent o*
another tapayerJs epenses
=Must be incurred *or tapayerJs bene*it or arise
*ro- tapayerJs obligation
=>ception# (ay-ent o* -edical epenses *or a
dependent
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(ersonal >penditures
7nless otherise provided in the Code,
personal epenses are not deductible
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Capital >penditures
A-ounts are capitali?ed
Asset -ay be sub:ect to depreciation )or cost
recovery+, a-orti?ation, or depletion
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&ransactions 'eteen Related (arties)slide 1 o* 2+
/ection 2!@ disallos losses *ro- direct or
indirect sales or echanges o* property
beteen related parties
=a-ily and entity relationships apply
=Constructive onership rules apply
=Loss disalloed -ay reduce gain on subse4uent
disposition to unrelated third party
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&ransactions 'eteen Related (arties)slide 2 o* 2+
/ection 2!@ also re4uires the -atching
principle be applied *or unpaid epenses and
interest hen di**erent accounting -ethods
used=>a-ple# An accrual basis, closely held
corporation, cannot deduct accrued, but unpaid,
salary to cash basis related partye-ployeeshareholder until it is actually paid
> d $ t t R l ti t
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>penses and $nterest Relating to
&a>e-pt $nco-e
>penses relating to production o* taee-pt
inco-e are nondeductible
=>a-ple# interest epense on loan here *unds
used to ac4uire -unicipal bonds
(i
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&he 'ig (icture >a-ple 32
&a (lanning /hi*ting "eductions
Re*erring to the *acts o* &he 'ig (icture on p. !1,
Assu-e that "r. (ayneJs -arginal ta rate in 2013 is
25 but that he esti-ates his rate in 2015 to be 30.
$n this case, he should consider de*erring thecharitable contribution to 7HA College until 2015.
= ;is ta bene*it in 2015 ill be 2,000.
)30 N 5,000+
= ;is ta bene*it in 2013 ould only be 1,250.
)25 5,000+
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Re*ocus n &he 'ig (icture )slide 1 o* 2+
* the epenses incurred by "r. (ayne, several co--ents need
to be -ade.
= 'eingpersonal in nature, none o* the 5,000 -onthly dra
is deductible and the a-ount involved is not sub:ect to the
reasonableness test )see >a-ple !+. "r. (ayne is a sole proprietor and not in an e-ploy-ent
relationship.
= &he *ine paid *or violating aste control rules co-es under
the public policy li-itations )see >a-ple 16+ and isspeci*ically -ade nondeductible by Code G 1!2)*+.
= Along the sa-e line are the political contributions
)>a-ple 1@+ -ade nondeductible by G 1!2)e+.
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Re*ocus n &he 'ig (icture )slide 2 o* 2+
;oever, "r. (ayneJs investigation o* the
practice o* another dental *ir- )>a-ple 1E+
appears reasonable and the epense incurred
deductible.
Although not speci*ically discussed in the tet,
"r. (ayneJs legal *ees incurred in connection
ith a lasuit *iled by a patient appear relatedto his practice )>a-ple 15+.
=As such, they are ordinary and necessary to his
trade or business.
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