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Bc the capital gains & investment expenses receive special tax treatment, HG must report the items separately.
Ahmed's share of ordinary income $80,000
AGI $114000 (25,000+80,000+9000)
$4000 misc itemized deduction, which is reduced by 2% of AGI
Investment expenses $4000
2% X 114,000 (2280)
Investment expense deduction 1720
Ahmeds itemized deductions 13720 (12000+1720)
Tax inc 96580 (114000-13720-3700)
*Bc HG reports these items sep, Ahmed's tax inc increases by 2280 (96580-94300
1. Charitable contributions
2. Investment interest expense
3. Investment expenses
4. Misc Expenses (subject to 2% of AGI limit)
5. Nondeductible expenses
Profit motivated expenses or personal expenses
Bo's dominant motive in buying the bldg is to help Jr get his bus started. Bc there isn't a formal rental agreement & Bo won't sell the bldg w/o Jr's approval, the purchase of the bldg & the payment of costs related to the bldg are in the nature of a gift. Bo isn't trying to profit from rental pymts or potential appreciation in the value of the business. Any expenditures Bo makes regarding the bldg aren't classified as business expenses. Only property taxes are deductible as personal expenses.
1. Trade or business expenses
2. Expenses for the production of income
Trade or business expenses and production of income expenses are related to:
activities that are profit motivated
How is a trade/business expense identified from a production of income (investment) expense?
-A trade or business activity will be identified by the extent of the taxpayer's involvement and whether the intent is to earn a living from the activity
-Safe Deposit Box
-subscriptions to financial publications
Describe trade or business expenses.
-All ordinary and necessary investment expenses that are reasonable in amt are allowable as deductions
-the amt of the deduction may be limited due to the nature of the investment activity or through limitations put on deductions of individual investment expenses (misc itemized deductions)
-Certain personal expenditures (medical, taxes, home mortgage interest) are allowed as a deduction
-Some of the deductions are subject to limitations (medical, casualty and theft losses, misc itemized)
-only individuals who have significant personal deductions can take advantage of allowable deductions (individuals who use standard deduction do not benefit from specific expenditures)
1. Is it profit-motivated? Primary purpose must be to earn income or a profit
2. What is the continuity and regularity of the activity?
3. Is it a livelihood and not hobby? activities that are sporadic, constitute a hobby, or an amusement diversion are not trade or business expenses
activity a trade or business or a procution-of-income activity?
Bc Bo isn't actively invovled in the mgt of the property, the income earned is similar to the income earned by an investor in stocks or bonds. The lease doesn't constitute a trade/business. Bo's rental activity is considered a production-of-income activity
Bc Bo's rental activity is production-of-income activity, the $10000 is a capital loss.
$10,000 would be included in the capital gain-and-loss netting.
If Bo had no other capital gains and losses during the yr, he could deduct only $3000 of the loss w/remaining $7000 of loss carried forwar to next yr
1. Allowable personal itemized deductions
2. nondeductible personal expenses
Limit based on taxpayer's AGI
MUA: asset that's used both to earn income and for personal purposes
MUE: expenses that are incurred for both profit and personal reasons
As 2 separate assets.
Only $6000 (8000X75%) of the cost can be depreciated for tax purposes
$2000 is a personal use asset (no depreciation allowed)
Sale of 2 assets
$4000 sales price and $8000 purchase must be allocated b/t business and personal use
The $600 loss on the bus portion of the computer is dedutible as a business loss.
The $1000 loss on the personal use portion is a nondeductible personal use loss.
Pam has incured MUE
Expenses relate to business trip and a personal vacation
Bc primary motive for making the trip is to conduct business, Pam can deduct the full $800 airfare and $200/day she was in San Diego to conduct business
Pam cannot deduct any part of the $200/day for lodging and incidentals for the extra 2 days she stayed for personal expenses
Have a business purpose
The expense is "appropriate and helpful" to the taxpayer's business.
A reasonable and prudent businessman would incur the same expense in the same situation.
Doesn't mean the expense be essential to the continued existence of the income activity to be deductible
feed an ordinary expense?
The pymt for the grain qualifies as an ordinary expense. The advance purchase of the grain for feeding livestock is the normal way farmers conduct their business. By ensuring the grain is available, Russ can better plan the scope of its farm operations for coming mths
Operating the yacht is not the ordinary method of promoting the taxpayer's business.
The expenses of the yach were so personal in nature that they couldn't be necessary in the common sense of the world.
Yes, the $500 for the ad is deductible
The expense satisfies both the ordinary and necessary tests
It's customary for clothing retailers to advertise their merchandise
The ad helps the bus promote the store to the public & attract the attn of the customers and it gives them an incentive to shop @ the store
Connie has a gain of $2000 on the sale. The $600 commission is a reduction of the amt realized on the sale; it's not a current period expense
Selling price (100 X $130) 13000
Amt realized from sale 12400
Basis of shares sold (10400)
Gain on sale 2,000
repair-and maintenance expenses
Repair-and-maint expenses are allowed as a deduction in the current accounting period
Include: rewiring or putting a new roof on a bldg
Capitalized bc they either extend useful life or add to the value of the property
Whether Jason decides to expand his business and open a 2nd cafe or not, he can deduct the costs of investigating a location for a 2nd cafe as a current deduction.
Bc the expenses are related to opening a business that is related to Jason's existing bus, they are allowed as a current dedduction, no matter what he decides
The retail speedboat would be a new bus bc it's unrelated to his cafe bus. If Jason decides not to enter the retail boat bus, he can't deduct any investigation expenses. They're considered nondeductible personal expenses.
If Jason acquires the retail store, he can deduct $5000 of the start-up costs. The remaining $35000 ($40000-5000) in start-up costs is amortized over 180 mths, beg in the mth the retail speedboat store begins operations
$2850 (2000+ 850) of start-up costs
Bc his start-up costs exceed $50,000, Jason can only receive a 1-time deduction of $2000 ($5000-3000(53000-50000))
The remaining 51000 (53000-2000 1-time deduction) of start-up costs is amortized over 180 mths, beg in Oct
The amortized amt of Jason's start-up costs is $850 (51000/180)X 3 mths
In subsequent yrs, Jason will deduct $3400/yr (3400 (51000/180) X 12 mths
True, cannot be another's expense
Exception: medical expenses of a dependent
2. Misc Itemized Deductions (2% of AGI limitation)
3. ND Personal Expenses
Rent Period Personal Use Period Tax Result
IRS: Taxpayer must allocate vacation home expenses bt personal and rental by using the ration of personal days to total days of use (sum of personal days & rental days)
Courts: Proper allocation interest and property taxes is based on total # of days in the yr rather than # of days used
Courts: More favorable allocates less to the rental & more to the personal use, resulting in a larger overall deduction (inc item ded for mortg int & property taxes
A taxpayer who operates a bus from home can claim a deduction for expenses related to its business use.
Examples: mortgage interest, real property taxes, ins, utilities, repairs, & depreciation
Allowed for the use of an office in the home that is exclusively used continuously and regularly as:
a. principal place of business
b. place for meeting & dealing w/customers, clients, etc.
Expenses: allocated b/t home ofc & areas used as residence; based on # of rooms or sq ft
Deductions: Based on income earned fr the home ofc activity after subtracting the other unrelated direct costs of the bus (COGS, auto expenses, supplies)
- Any home ofc costs not deductible under the limitation may be carried forward & deducted in furture yrs, subject to the income limitation
*Yes, but you must have a separate telephone line/number.
*Business related long distance is always deductible
Annual Accounting Period Concept
*The taxpayer must adopt an accounting method (overall method to computer income and deductions belonging to the tax yr) that reflects income
1. Cash method of income
2. Accrual method for expense
*Control the timing of a deduction
-Cash basis taxpayer can claim a deduction in yr an expense is pd
-Payment occurs when payment is made
-Prepaid expenses have a 1-yr rule (may deduct prepaid expenses in the yr pd if the prepayment doesn't create an asset that extends beyond the EOY pymt. Must show that pymt is required by creditor & pymt doesn't distort income)
-Prepaid taxes are deductible in yr pd, even if prepymt results in a refund in a ltr yr; under tax benefit rul, tax refund is reported as income
-Prepaid ins is not generally deductible under 1-yr rule. Must be accounted for w/accrual method
-Deduct expenses in the yr in which 2 tests are met: all-events test and economic performance test
All-events test: met when all the events have occurred that determine that a liability exists and the amt of the liability can be determine w/reasonable accuracy
Economics Performance test: occurs when services or property are provided to the taxpayer or when the taxpayer uses property
*Only when the 2 tests have been met can an expense be accrued and deducted for tax purposes
1. All events test is met without regard to economic performance.
2. Economic performance occurs within the shorter of 8 1/2 mths after the EOY or a reasonable time after the EOY2.
3. Item is recurring in nature & taxpayer consistently treats similar items as incurred in the yr the all-events test is met
4. Expense is not material or accrual of expense results in better matching of income
Only if the expense is not mater.
A material prepaid expense cannot qualify for the recurring item exception bc deducting the total amt of the expense in the current period doesn't result in a better match of the expense with income
1. Cash method must be used by an accrual basis taxpayer for recognition of expenses pd to a cash basis related party.
2. Related party: family members & bus entities where taxpayer owns more than 50%
3. Arms-length transaction & business purpose concepts require that related party transactions be scrutinized closely to discourage unwarranted tax avoidance
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