DEDUCTIONS

1
Chapter 6

• DEDUCTIONS
• AND LOSSES

2
FOR VERSUS FROM AGI CLASSIFICATION

• FOR AGI
• REDUCES AGI WHICH AFFECTS THE ALLOWABLE DEDUCTION
  FROM
• MOST COMMON DEDUCTIONS FOR AGI
• TRADE OR BUSINESS EXPENSES
• IRAs
• ALIMONY
• LOSSES ON INVESTMENT
• INTEREST PAID BY CERTAIN INDIVIDUALS ON QUALIFIED
  EDUCATIONAL LOANS
• 1/2 OF SELF-EMPLOYMENT TAX AND 60 OF HEALTH
  INSURANCE COSTS PAID BY SELF-EMPLOYED INDIVIDUALS

3
FOR VERSUS FROM AGI CLASSIFICATION

• FROM AGI
• ITEMIZED DEDUCTION ONLY WILL HAVE TAX BENEFIT IF
  THE TOTAL DEDUCTIONS EXCEED THE APPLICABLE
  STANDARD DEDUCTION

4
CRITERIA FOR DEDUCTING BUSINESS AND INVESTMENT

• BUSINESS OR INVESTMENT
• ORDINARY EXPENSES
• NECESSARY EXPENSES
• REASONABLE EXPENSES

5
CRITERIA FOR DEDUCTING BUSINESS AND INVESTMENT

• CAPITALIZATION VERSUS EXPENSE DEDUCTION
• EXPENSES RELATED TO EXEMPT INCOME
• EXPENDITURES THAT ARE CONTRARY TO PUBLIC POLICY
• OTHER EXPENDITURES THAT ARE SPECIFICALLY
  DISALLOWED

6
PROPER SUBSTANTIATION REQUIREMENT

• THE TAXPAYER HAS THE BURDEN OF PROOF
• MORE RESTRICTIVE SUBSTANTIATION REQUIREMENTS FOR
  TRAVEL, ENTERTAINMENT, BUSINESS GIFTS

7
WHEN AN EXPENSE IS DEDUCTIBLE

• CASH METHOD
• DEDUCT EXPENSES WHEN PAID
• PREPAID EXPENSES WHICH EXTEND BEYOND THE END OF
  TAX YEAR MUST BE AMORTIZED
• POINTS PAID IN PRINCIPAL RESIDENCE
• CLEARLY DISCLOSED
• SECURED BY RESIDENCE
• TO PURCHASE OR IMPROVE (NOT REFINANCE)

8
WHEN AN EXPENSE IS DEDUCTIBLE

• ACCRUAL METHOD
• ALLOWED TO DEDUCT EXPENSES IN THE PERIOD IN WHICH
  THE EXPENSES ACCRUE UNDER THE ALL-EVENTS TEST AND
  ECONOMIC PERFORMANCE TEST
• ALL-EVENTS TEST IS MET
• WHEN AMOUNT OF LIABILITY IS ESTABLISHED
• AMOUNT OF LIABILITY IS DETERMINED WITH
  REASONABLE ACCURACY
• ECONOMIC PERFORMANCE TEST IS MET
• WHEN ECONOMIC PERFORMANCE IS DEEMED TO OCCUR (SEE
  TABLE I6-1)

9
SPECIAL DISALLOWANCE RULES

• WASH SALES
• RELATED PARTIES TRANSACTION
• HOBBY LOSSES
• PROPERTY USED FOR PERSONAL AND RENTAL USE
• HOME OFFICE
• ENTERTAINMENT FACILITY

10
WASH SALES

• Losses on sales of stock if acquire substantially
  identical stock w/in 30 days before and 30 days
  after the sale are disallowed
• The amount of disallowed loss is added to basis
  of new shares
• Example TP sells 100 sh on 3/1 at (5,000)
• TP buys 100 sh identical stock on 3/15 for
  10,000
• The (5,000) is disallowed
• Basis in new shares is 15,000 (10,000 cost
  5,000 disallowed loss)

11
Section 183 - Hobby Losses

• Losses on activities not entered in for a profit
  are disallowed (referred to as hobby losses)
• Hobby expenses are only deductible to extent of
  hobby income in following order
• Expenses otherwise deductible
• Other related expenses (not cost recovery)
• Depreciation/cost recovery
• Profit motive is presumed if profits in 3 of 5
  yrs
• 2 of 7 if horse breeding, training,showing, or
  racing

12
Hobby Losses

• Example of hobby expenses
• Taxpayer sells dogs raised as a hobby for 15,500
• Order Amount
• Amount Taken Taken
• Income 15,500
• Interest 6,000 1
  6,000
• Taxes 3,000 1
  3,000
• Vet Bills 2,000 2
  2,000
• Feed 4,000 2
  4,000
• Depreciation 1,000 3
  500
• 15,500

13
Rental of Vacation Homes

• Primarily personal
• Rented less than 15 days
• No rental income no rental expenses
• Personal/Rental
• Rented more than 14 days and used as a residence
  for the longer of
• 1) 14days or 2) 10 of rental use
• Treatment similar to hobby rules
• Primarily Rental
• Rented more than 14 days and used as a residence
  for less than the longer of
• 1) 14days or 2) 10 of rental use
• Expenses not limited to gross income

14
Office in the Home(slide 1 of 2)

• Deductibility is very 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

15
COMPLIANCE AND PROCEDURAL CONSIDERATIONS

• SCHEDULE C FOR INDIVIDUAL TRADE OR BUSINESS
• SCHEDULE E FOR RENTS AND ROYALTIES
• OTHER INVESTMENT EXPENSES ARE REPORTED ON
  SCHEDULE A

16
COMPLIANCE AND PROCEDURAL CONSIDERATIONS

• PROPER SUBSTANTIATION
• IRS SCRUTINY
• STATUTORY REQUIREMENTS
• TRAVEL AND ENTERTAINMENT ARE OF PARTICULAR
  INTEREST TO THE IRS