Chapter 7 - Deductions and Losses: Certain Business Expenses and Losses

Question 1

When is a bad debt deduction permitted?

Answer 1

• If income arising from the creation of the worthless A/R was previously included in income.
• ONLY ACCRUAL BASIS

Question 2

Bad Debt difference b/w business debt and non-business debt

Answer 2

Business debt - can claim deduction when debt becomes either PARTIALLY or WHOLLY worthless. Recognize the portion of debt that is worthless.
Non-business debt - can claim when debt becomes WHOLLY worthless.

Question 3

Non-business bad debt

Answer 3

• debt unrelated to the taxpayer’s trade or business
• can only be written off when wholly worthless
• ALWAYS deducted as a SHORT TERM CAPITAL LOSS (limit 3,000 per year)

Question 4

Business bad debt

Answer 4

• For AGI deduction
• deductible as an ordinary loss in the year incurred
• Write off portion that is partially worthless

Question 5

Related Party

Answer 5

spouse, siblings, half-siblings, lineal descendants, and corps >50% owned

Question 6

Loans to related parties

Answer 6

Must be prepared as a loan and have the documentation to back up that distinguishes it as a loan and not a gift.

Question 7

Worthless Securities

Answer 7

• Loss is allowed when securities(stock) becomes completely worthless during the year
• treated as capital losses on the LAST DAY of the taxable year.
• potential for holding period to turn a STCL into a LTCL (ST Cap loss is better because of tax rates)

Question 8

Section 1244 stock (small business stock)

Answer 8

• if you invest directly into a small business and get a loss, then deduct as an ordinary loss up to $50,000/$100,000(MFJ) as an ordinary loss. Any excess is treated as a capital loss.
• domestic C-corp

Question 9

Casualty losses for individuals

Answer 9

• Must be:
  1) Identifiable
  2) damaging to property
  3) sudden, unexpected, and unusual in nature
• Form 4684

Question 10

Form 4684

Answer 10

casualty losses

feeds into Schedule A

Question 11

Items that are not casualty losses:

Answer 11

1) decrease in value of property, but no direct physical damage to property
2) termite damage

Question 12

Theft loss (when deducted and limitations)

Answer 12

• Deducted in the year of discovery

- limited to the amount not covered by insurance

Question 13

When to deduct casualty losses

Answer 13

• the year in which the loss occurs
• no loss is permitted if there is a “reasonable prospect of full recovery” from insurance.
• If insurance reimbursement is more than the loss then recognize a “casualty gain” and recognize it as income

Question 14

Disaster Area losses

Answer 14

• POTUS must designate

- Taxpayer may elect to to treat the loss as having occurred in the preceding taxable year.

Question 15

Amount of casualty loss to recognize (complete destruction of business property)

Answer 15

• if “completely destroyed”, then the loss = the adjusted basis of the property at the time of destruction (Historical cost of the the item)

Question 16

Amount of casualty loss to recognize (partial destruction of business property)

Answer 16

Lesser of:

1) Adjusted basis
2) (FMV before - FMV after)

Question 17

Amount of casualty loss to recognize (partial or complete destruction of personal property)

Answer 17

Lesser of:

1) Adjusted basis
2) (FMV before - FMV after)

Question 18

What can you substitute in place of FMV before a casualty loss if you don’t know the amount?

Answer 18

Replacement cost of the property

Question 19

Recognition of casualty losses (business and nonbusiness)

Answer 19

1) business losses = for AGI, ordinary losses

2) personal losses = from AGI, (SUM:Each casualty - 100) - 10% AGI

Question 20

Rules for Personal Casualty Gain/Loss

Answer 20

1) PCG gets netted against personal casualty losses
2) If the net is a gain, then treat all casualty gains/losses as capital gains/losses
3) If the net is a loss, then treat each gain as ordinary income and the losses will be treated as ordinary losses to cancel the gains.
4) Additional Casualty Losses - 10% AGI = from AGI deduction

Question 21

R&D expense rules

Answer 21

1) Expend in the year paid or incurred (common)
2) Defer and amortize over 60 months (good if no income generated from R&D yet)
3) capitalize (very uncommon)

Question 22

Domestic Production Activities Deduction (DPAD)

Answer 22

• Section 199
• Form 8903
  1) Take lesser of:
  a) Qualified Production Activities Income (QPAI)
  b) Taxable Income (modified AGI)
  2) multiply by 9%
  3) limit the deduction to 50% of W-2 wages

Question 23

Form 8903

Answer 23

Calculations for Domestic Production Activities Deduction (DPAD)

Question 24

Net Operating Loss Carryback Rules

Answer 24

1) 3 years - NOL from thefts or if a small business who’s NOL is result of a disaster
2) 5 years - farming losses

Question 25

How to report Carryback NOLs on previous years’ returns

Answer 25

Form 1040-X = amended tax return

Form 1045 = tentative request for refunds

Question 26

NOL Carryover Rules

Answer 26

A taxpayer can irrevocably decide to forego a NOL carryback. In this case the loss will be available for a NOL carryover for future years up to 20 years.