"Above the Line" Deductions Flashcards
What are the two main “above the line” deductions?
(1) Business deductions under S 162, and
(2) Depreciation under S 167
Business deductions are a matter of . . .
Legislative Grace
Business deductions must be . . .
(1) ordinary, and
(2) necessary
Ordinary: Common and accepted
Necessary: Appropriate and helpful
Welch personally paid the debts of his business to solidify his reputation and tried to deduct the payments as business expenses. Ordinary and necessary?
In Welch v. Helvering, the court held that the expense was necessary, but not ordinary, since Welch was not personally liable for the business debts.
- Later cases have allowed this
- that indicates the analysis is VERY fact specific
S 263 on capitalization trumps S 162 on business expenses; when do you need to capitalize?
Capitalize amounts paid to
(1) acquire or produce tangible property;
(Includes depreciation of equipment used to build property)
(2) improve tangible property;
(a) Betterment,
(b) Restoration, or
(c) Adapt to a new use
(3) acquire or create intangible property; and
(4) facilitate an acquisition of a trade or business;
(Includes brokerage and other transaction costs like legal fees)
Is fixing asbestos a repair (business expense) or an improvement (must be capitalized)?
the regs hold you can deduct asbestos issues as a business expense rather than capitalizing
A meat packing plants water seepage issue results in oil seepage due to nearby refinery. Federal meat inspector says fix or shutdown. Does the fix count as a repair?
Yes. This is the Midland case.
Rule: An expenditure is a repair to property if it is made solely to keep the property in an ordinarily efficient operating condition.
This could also be seen as a betterment or restoration
In Midland, what facts convinced the court that the expense of fixing the oil seepage was a repair?
(1) Only made the expenditure to continue operations.
(2) Did not add value to or improve the basement in any way, nor did it adapt the property to a new use.
(3) Did not prolong the life of the property beyond what it was before the oil began seeping in.
(4) Although the oil-proofing did prevent further seepage of water, the basement was not improved because the water never interfered with Midland’s operations.
What constitutes a betterment?
When the expense
(1) ameliorates a preexisting condition or defect
(2) results in a material addition, or
(3) is reasonably expected to result in a material increase in
(a) capacity,
(b) productivity,
(c) efficiency,
(d) strength, or
(e) quality of the property
What is a “restoration”?
The amount paid
(1) returns the property to its ordinarily efficient operating condition after it deteriorated to a state of disrepair where it was no longer functional for its intended use, or
(2) is a replacement of a part or a combination of parts that comprise a major component or structural part of the property
Safe harbor for “routine maintenance”
Recurring activities that a taxpayer expects to perform to keep the property in its ordinarily efficient operating condition.
(1) must be done more than once over life of property
(2) factors
(a) industry practice,
(b) manufacturer recommendations, and
(c) taxpayer experience
Do you need to capitalize expenses related to business restructuring?
INDOPCO
Rule: Corporate expenses incurred for the purpose of changing the corporate structure in order to receive future benefits are not deductible as ordinary and necessary business expenses.
What is the deduction allowed for startup expenses?
Deduct up to 5g, reduced by the amount of expense over 50g
Couple travels the country researching the startup of a newspaper business and attempts to deduct their expenses as business expenses
Rule:
- Expenses incurred while investigating and looking for a new business are not deductible as ordinary and necessary business expenses.
- For business deductions, you must be “carrying on” a trade or business
Does being an employee constitute “carrying on a trade or business”?
Yes.
Can deduct licensing fees as a business expense
- If you exit the trade or business with no intent to re-enter, the licensing fees are no longer deductible
- If you subsequently start up again, wouldn’t be deductible at first (not in trade or business)
- If unemployed, whether or not you are in the trade or business gets thinner with time
Can you deduct expenses for seeking employment?
A taxpayer’s expenses in seeking employment elsewhere but in the same trade are deductible whether or not successful (subject to the length of unemployment)
Otherwise, deductible if
(1) payment for the service is not required until employment is secured, and
(2) is contingent upon employment
What are the two tests regarding the deduction of “reasonable salaries”?
The reasonable investor test: presumptively reasonable if the company’s investors obtain a higher return than they had reason to expect
Multi factor test:
(1) the nature of the services rendered;
(2) the lack of qualified employees;
(3) the qualifications and past earning power of the employee;
(4) the employee’s contributions to the company;
(5) the company’s net earnings;
(6) the standard compensation paid to employees in similar positions; and
(7) the particular characteristics of the company
The entire amount paid under a contingent compensation agreement is deductible, even if greater than what would ordinarily be paid, if it is paid pursuant to a free bargain. What is a free bargain?
- requires independent judgment
- a lack of leverage over either party
Harolds Club
- Dad comes and takes over his two sons’ gambling club. Dictates he gets 20% of profits as salary.
- Not a free bargain
What is the cap on the reasonable salary deduction?
$1 million
Business deductions for meals and lodging
Require the taxpayer to “travel away from home”
- Can’t deduct expenses for meals unless there is an overnight stay. (Carell)
- meals only 50% deduction
- The day after an overnight stay you can deduct breakfast and lunch
- Does not include deductions for “lavish or extravagant” expenses
Traveling salesman traveled 300 days per year and did not maintain a permanent residence; tried to deduct his expenses as travel expenses
This is disallowed by the court in Rosenspan.
Rule: In order to deduct business traveling expenses the taxpayer must maintain a place of residence.
- Can’t be “away from home” if you do not maintain a home
- Principal place of business can’t be home
tax home must nevertheless be in the vicinity of the principal place of business
Taxpayer has a pool business in MA, horse breeding in FL during the off season. Spends 6 months in each. Attempted to deduct expenses in FL.
This is deductible under travel expenses as “duplicated living expenses as a result of business necessity” (Andrews)
Steps:
(1) look to circumstances to determine the major and minor posts
(2) any duplicate living expenses at the minor post are deductible
Three circumstances where you can deduct transportation expenses incurred by traveling between residence and work location
(1) Going between residence and (i) a temporary work location (ii) outside metro area where taxpayer normally works
(2) if more than one regular work locations are away from the residence, can deduct travel expenses to temp location in same trade/business
(3) if residence is principal place of business, can deduct travel between residence and other location in same trade/business
What makes a work location “temporary”?
- “Temporary” if “realistically expected” to last for one year or less, unless circumstances indicate otherwise.
- If the expectation shifts to lasting longer, the location is considered temporary until the date that the expectation changed
