Deductions and Losses

1
Chapter 6

• Deductions and Losses

2
Learning Objectives

• Distinguish between deductions for and from AGI
• Discuss the criteria for deducting business and
  investment expenses
• List the substantiation requirements for
  deducting travel and entertainment expenses
• Explain the timing of deductions under both the
  cash and accrual methods

3
For Versus From AGI Classification

• For AGI
• Reduces AGI which affects the allowable deduction
  for itemized deductions
• 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 100 of health
  insurance costs paid by self-employed individuals

4
For Versus From AGI Classification

• From AGI
• Itemized deduction only will have tax benefit if
  the total deductions exceed the applicable
  standard deduction

5
Criteria For Deducting Business And Investment
Expenses

• Related to a profit-motivated activity
• Ordinary expenses
• Necessary expenses
• Reasonable expenses
• Properly documented
• An expense of the taxpayers (not someone elses
  expense)

6
General Restrictions on the Deductibility of
Expenses

• Capitalization versus expense deduction
• Expenses related to exempt income
• Expenditures that are contrary to public policy
• Other expenditures specifically disallowed

7
Proper Substantiation Requirement

• The taxpayer has the burden of proof
• The Cohan rule
• More restrictive substantiation requirements for
  travel, entertainment, business gifts

8
When An Expense Is Deductible

• Cash method
• Deduct expenses when paid
• Prepaid expenses which extend beyond the end of
  tax year must be capitalized and amortized
• Points paid in principal residence
• Clearly disclosed
• Secured by residence

9
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 existence 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)

10
Compliance And Procedural Considerations

• Schedule C for individual trade or business
• Schedule F for individual ranch or farming
  business
• Schedule E for rents and royalties
• Other investment expenses are reported on
  Schedule A (miscellaneous itemized)

11
Compliance And Procedural Considerations

• Proper substantiation
• IRS scrutiny
• Statutory requirements
• Travel and entertainment are of particular
  interest to the IRS