"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
When are rentals deductible?
If they are necessary.
substance over form applies
Starr’s Estate: If the practical effect of a rental agreement is to pass title, the rental agreement can be treated as a sale
When are education expenses deductible as a business expense?
(1) Deductible if
(a) Improve skills in the trade,
(b) Retention (renew certificates: Hill v. Commissioner),
(c) Maintaining / improving skills, or
(d) Meeting requirements of the employer
(2) In addition, must be DIRECTLY related to the professional duties(Coughlin)
Non-deductible if
(1) The minimum education requirement for the field, or
(2) Qualifying for a new trade of business
3 circumstamces allowing the deduction for business losses
Losses incurred
(1) in pursuit of trade or business,
(2) a transaction for profit, or
(3) from fire, storm, shipwreck or other casualty, or theft. Lesser of
- cost of repair, or
- AB in property
The loss must be realized through an identifiable event, such as a sale or exchange
The qualified business income deduction
applies to: partnerships, LLCs, and S-corps
the lesser of
(1) 20% of QBI, or
(2) 20% of taxable income (GI - SD)
Depreciation deductions reduces two things
Basis and GI
however, even if you do NOT take the depreciation deduction, you MUST reduce basis by the amount allowed
Three types of depreciation
(1) straight line
- equal through “useful life”
- salvage value reduce depreciable basis
(2) ACRS (majority) (1982+)
- double declining basis method with no salvage value, unless
- straight line produces greater deduction
(3) MACRS (1986+)
- same as ACRS, except
- If greater than 10 year property: 150% DB
What is the “mid year convention”?
Applies to all depreciation methods. Depreciation starts halfway through year one and ends halfway through the year following the last year in service.
Example for 7 year property
- recognized halfway through year one, until
- halfway through year 8
Can you deduct personal losses?
No, there is no deduction for personal losses.
What happens when an asset has both personal and business uses?
Sharp v. United States:
When an asset is only partly depreciable, divide the asset into two assets, one personal and one business, to calculate gain or loss
(DE District court, not a tax court case. Prof thinks could be argued against.)
taxpayer argument here was property should be depreciable by extent of business use
Does an asset need a “useful life” to be subject to depreciation?
No, it need only be subject to “wear and tear.”
Simon v. Commissioner
- suggests every asset is subject to wear and tear
- Professional violinists seek to depreciate antique bows
Dissent: bad policy, may even depreciate paintings now
What is the deduction for Section 168(k) additional depreciation?
Property acquired after SEP 27, 2017 and before 2023 gets 100% depreciation
- 80% 2023,
- 60% 2024,
- 40% 2025, and
- 20% 2026
Is the additional depreciation under S 168(k) automatic?
Yes. You need to elect out if you do not want the deduction.
When is Section 179 Bonus Depreciation allowed?
When you elect out of 168(k) and opt in to 179.
What is Section 179 Bonus Depreciation?
- Limit of $1 million per year, reduced by amount of S 179 property placed in service over $2.5 million
- Deduction may not exceed the amount of taxable income derived from the “active conduct” of trades or businesses
Recapture applies if such property is no longer used predominantly in the taxpayer’s trade or business
(T/F) You depreciate property under one of the three methods, then, you can choose either S 168(k) additional depreciation or S 179 bonus depreciation?
True. Normal depreciation method applies and then you can choose 168k or 179, but not both. They are mutually exclusive.
When do you amortize an intangible?
(1) acquired, not created, by the taxpayer
(2) listed as an intangible in S 197
How does Amortization of intangibles work?
Straight line method with a 15 year life and no salvage value
mid year convention still applies
Intangibles listed in S 197
(1) Goodwill;
(2) Going concern value;
(3) Certain specified types of intangible property that generally relate to workforce;
(4) Information base;
(5) Know-how;
(6) any license, permit, or other right granted;
(7) any covenant not to compete or similar arrangement; and
(8) any franchise, trademark, or trade name.
Does not include financial interests in a business, trust, or estate
Can you depreciate realty?
You can depreciate
(1) Residential rental property or
(2) nonresidential real property
How do you depreciate realty?
Depreciated under straight line method with no salvage value
- Residential rental has a 27.5 year life
- Nonresidential real has a 39 year life
Residential if
- 80% or more of the gross rental income from a building is from dwelling units
- “dwelling units” does not include hotels are others units where more than 50% of them are used on a “transient” basis
