Deductions and Losses

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Chapter 6

• Deductions and Losses

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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

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Learning Objectives

• Explain the tax consequences of wash sales
• Explain the tax consequences of transaction
  between related parties
• Discuss the criteria for determining whether an
  activity is a hobby or trade or business
• Determine the tax consequences of vacation
  homes.

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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

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For Versus From AGI Classification

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

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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)

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General Restrictions on the Deductibility of
Expenses

• A capital expenditure
• Expenses related to exempt income
• Illegal or in violation of public policy
• Specifically disallowed by tax law

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Special Disallowance Rules

• Wash sales occurs when substantially identical
  stock or securities are acquired by the taxpayer
  within a 61 day period of time that extends from
  30 days before the date of sale to 30 days after
  the date of sale

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Special Disallowance Rules

• Related parties transaction

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Special Disallowance Rules

• Hobby losses
• The IRS uses several factors to determine whether
  an activity is profit-motivated
• Does the taxpayer conduct the activity in a
  businesslike manner
• The time and effort expended
• Whether the assets are expected to appreciate.
• Hobby Income must be reported on Form 1040 and
  Expenses are deducted on Schedule A.

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Special Disallowance Rules

• Property used for personal and rental use
  (Vacation Home)
• See allocation formula on page 6-32 in textbook
• Home office

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Tax Planning Considerations

• Control timing of hobby losses
• Unreasonable Compensation If the IRS feels that
  a salary payment to an officer is excessive, it
  will often recharacterize the excess portion as a
  dividend
• Timing of deductions

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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

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Compliance And Procedural Considerations

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

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Compliance And Procedural Considerations

• Hobby Losses
• Form 8829 to claim home office deduction on
  Schedule C
• Form 2106 to claim home office deduction by
  employees
• Taxpayer may be willing to extend statute of
  limitations period to prove profit motive by
  filing Form 5231