Chapter 7 Reading Notes Flashcards
Deductible losses on personal use property are deducted as
an itemized
deduction
If the gambling is a trade or business, his
gambling losses are deductions
for AGI
If the gambling activity is not a trade or
business, the losses are
itemized deductions
A business bad debt is classified as
a deduction for AGI
a nonbusiness bad debt is classified as
a short-term capital loss
If a taxpayer sells goods or provides services on credit and the account receivable
subsequently becomes worthless, a bad debt deduction is permitted only if income
arising from the creation of the account receivable was
previously included in
income.
No deduction is allowed, for example, for a bad debt arising from the sale
of a product or service when the taxpayer is on the
cash basis because no income is
reported until the cash has been collected.
Taxpayers (other than certain financial institutions) may use only the _____ ____ __ ____ in accounting for bad debts.
specific charge-off method
Certain financial institutions are
allowed to use the ______ _______ for computing deductions for bad debts.
reserve method
A taxpayer using the specific charge-off method may claim a deduction when a
specific business debt becomes what two things
either partially or wholly worthless
What about for a non-business debt
It must be wholly worthless
If a business debt previously deducted as partially worthless becomes totally
worthless in a future year, only what can be deducted?
the remainder not previously deducted can be
deducted in the future year.
If the taxpayer purchased the debt and it went bad, the deduction is equal to
the amount the taxpayer paid for the debt instrument
The loss is deductible only in the year of partial or total worthlessness for non-business
debts
False. The loss is deductible only in the year of partial or total worthlessness for business debt. It’s only recognized in the year of total worthlessness for non-business debts
In 2010, Ross loaned $1,000 to Kay, who agreed to repay the loan in two years. In
2012, Kay disappeared after the note became delinquent. If a reasonable investigation
by Ross indicates that he cannot find Kay or that a suit against Kay would not result in
collection, Ross can do what?
deduct the 1,000 in 2012
In Example 3, assume that Kay filed for personal bankruptcy in 2011 and that the debt
is a business debt. At that time, Ross learned that unsecured creditors (including Ross)
were ultimately expected to receive 20 cents on the dollar. In 2012, settlement is
made, and Ross receives only $150. How much should he deduct for 2011 and 2012
He should deduct 800 in 2011 and 50 in 2012
A nonbusiness bad debt is a debt unrelated to the taxpayer’s trade or business either
when it was _______ or when it became ______
created; worthless
the most common type of nonbusiness bad debt.
loans to relatives or friends
is deductible as an ordinary loss in the year incurred
business bad debt
is always treated as a short-term capital loss
nonbusiness bad debt
The maximum
amount of a net short-term capital loss that an individual can deduct against
ordinary income in any one year is
3000
What is better business debt or nonbusiness? Explain
business debt because is better because nonbusiness is limited to 3000
In 2011, Leif sold his business but retained a claim (note or account receivable) against E X A M P L E 6
Bob. The claim became worthless in 2012. Leif’s loss is treated as a?
business bad debt because the debt was created in the conduct of is former trade or business
Can corporations have nonbusiness bad debt?
The nonbusiness bad debt provisions are not applicable to corporations. It is
assumed that any loans made by a corporation are related to its trade or business.
Therefore, any bad debts of a corporation are business bad debts.
Lana loans $2,000 to her widowed mother for an operation. Lana’s mother owns no E X A M P L E 7
property and is not employed, and her only income consists of Social Security benefits.
No note is issued for the loan, no provision for interest is made, and no repayment
date is mentioned. In the current year, Lana’s mother dies, leaving no estate. Assuming
that the loan is not repaid, can Lana take a deduction?
Lana cannot take a deduction for a nonbusiness bad debt
because the facts indicate that no debtor-creditor relationship existed
Explain worthless securities?
securities that become completely worthless during the year. Such securities are shares of stock, bonds, notes, or other
evidence of indebtedness issued by a corporation or government
Explain small business stock (§ 1244 stock)
However, it is possible to receive an ordinary loss
deduction if the loss is sustained on small business stock (§ 1244 stock). This loss
could arise from a sale of the stock or from the stock becoming worthless
Who can receive ordinary loss deduction under the small business stock 1244 stock?
Only
individuals7 who acquired the stock from the corporation are eligible
The ordinary loss treatment is limited to how much?
50,000 (100,000 for married indivuduals filing jointly)
Losses on § 1244 stock in
excess of the statutory limits receive capital loss treatment?
True
Ordinary is business bad debt? Capital loss is nonbusiness?
True
The corporation must meet certain requirements for the loss on such stock to
be treated as an ordinary—rather than a capital—loss. The major requirement is
that the total amount of money and other property received by the corporation for
stock as a contribution to capital (or paid-in surplus) does not exceed $1 million.
The $1 million test is made at the time the stock is issued
ection 1244 stock cannot
be common or preferred stock.
False. It can be both
Bad Debt Deduction table 7.2 on page 7-7
.
An individual may deduct the following losses under § 165(c):
- Losses incurred in a trade or business.
- Losses incurred in a transaction entered into for profit.
- Losses caused by fire, storm, shipwreck, or other casualty or by theft.
An individual taxpayer may deduct losses to property used in the taxpayer’s
trade or business or losses to property used in a transaction entered into for profit.
Examples include
a loss on property used in a proprietorship, a loss on property
held for rent, or a loss on stolen bearer bonds.
Note that an individual’s losses on
property used in a trade or business or on transactions entered into for profit are
not limited to losses caused by fire, storm, shipwreck, or other casualty or by theft?
True
An individual taxpayer suffering losses from damage to nonbusiness property
can deduct only those losses attributable to
fire, storm, shipwreck, or other casualty
or theft. Although the meaning of the terms fire, storm, shipwreck, and theft is relatively
free from dispute, the term other casualty needs further clarification. It means
casualties analogous to fire, storm, or shipwreck. The term also includes accidental
loss of property provided the loss qualifies under the same rules as any other casualty.
The term also includes accidental
loss of property provided the loss qualifies under the same rules as any other casualty.
These rules are that the loss must result from an event that is what 3 things.
- identifiable
- damaging to property
- sudden, unexpected and unusual
an event that is swift and precipitous and not gradual or progressive.
sudden event
an event that is ordinarily unanticipated and occurs
without the intent of the individual who suffers the loss.
unexpected event
is an
event that is extraordinary and nonrecurring and does not commonly occur during
the activity in which the taxpayer was engaged when the destruction occurred
unusual event. Examples include hurricanes, tornadoes, floods, storms, shipwrecks, fires, auto accidents,
mine cave-ins, sonic booms, and vandalism.
Damage must be to the taxpayer’s property to qualify as a
casualty loss
A taxpayer can take a deduction for a casualty loss from an automobile accident
only if
the damage was not caused by the taxpayer’s willful act or willful negligence.
Ted parks his car on a hill and fails to set the brake properly and to curb the wheels.
As a result of Ted’s negligence, the car rolls down the hill and is damaged. Do the repairs qualify for casualty loss treatment.
The repairs
to Ted’s car should qualify for casualty loss treatment because Ted’s act of negligence
appears to be simple rather than willful
Not all acts of God are treated as casualty losses for income tax purposes. Because a
casualty must be what three things?
Sudden
unexpected,
unusual
Examples of nonsudden events that generally do not qualify as casualties include
disease and insect damage
Other examples of events that are not casualties are losses resulting from
a
decline in value rather than an actual loss of the property. No loss was allowed
where the taxpayer’s home declined in value as a result of a landslide that
destroyed neighboring homes but did no actual damage to the taxpayer’s home
Similarly, a taxpayer was allowed a loss for the actual flood damage to his property
but not for the decline in market value due to the property being flood-prone?
true
are computed like other casualty losses (discussed in the following
section), but the timing for recognition of the loss differs
theft losses
When is a theft loss deducted
in
the year of discovery, not the year of the theft (unless, of course, the discovery
occurs in the same year as the theft
Keith’s new sailboat, which he uses for personal purposes, was stolen from the storage E X A M P L E 1 1
marina in December 2011. He discovered the loss on June 3, 2012, and filed a claim
with his insurance company that was settled on January 30, 2013. Assuming that there
is a reasonable expectation of full recovery, no deduction is allowed in 2012. A partial
deduction may be available in 2013 if
the actual insurance proceeds are less than the
lower of the fair market value or the adjusted basis of the asset. (Loss measurement
rules are discussed later in this chapter.)
are casualties sustained in an area designated as a disaster area
by the President of the United States
disaster area losses
different measurement rule applies for partial destruction of business property
and income-producing property and for partial or complete destruction of personal
use property. In these situations, the loss is the lesser of the following:
• The adjusted basis of the property.
• The difference between the fair market value of the property before the event
and the fair market value immediately after the event.
Rocky, who had AGI of $30,000, was involved in a motorcycle accident in 2012. His
motorcycle, which was used only for personal use and had a fair market value of
$12,000 and an adjusted basis of $9,000, was completely destroyed. He received $5,000
from his insurance company. What is rocky’s casualty loss deduction?
Rocky’s casualty loss deduction is $900 [$9,000 basis −
$5,000 insurance recovery − $100 floor − $3,000 (.10 × $30,000 AGI)]. The $900 casualty
loss is an itemized deduction (from AGI). n
When a nonbusiness casualty loss is spread between two taxable years because of
the reasonable prospect of recovery doctrine, the loss in the second year is reduced
by the $100 floor
False. It is not reduced in the second year. owever, the loss in
the second year is still subject to the 10 percent floor based upon the taxpayer’s second-
year AGI
What types of losses are subject to the 100 dollar floor and 10% of AGI.
Only personal use assets
Casualty and theft losses incurred by an employee
in connection with a trade or business are deductible for AGI if
the loss is reimbursed by the employer.
If the loss is not reimbursed, the loss is deductible
from AGI as a miscellaneous itemized deduction subject to the 2 percent of AGI floor
all such costs incident to the development of an experimental or
pilot model, a plant process, a product, a formula, an invention, or
similar property, and the improvement of already existing property
of the type mentioned. The term does not include expenditures such
as those for the ordinary testing or inspection of materials or products
for quality control or those for efficiency surveys, management
studies, consumer surveys, advertising, or promotions.
research and experimental expenditures
The law permits the following three alternatives for the handling of research and
experimental expenditures:
- Expensed in the year paid or incurred.
- Deferred and amortized.
- Capitalized.
If the costs are capitalized, a deduction is not available until
the research project
is abandoned or is deemed worthless
domestic
production activities deduction (DPAD) is?
9% times the lesser of Qualified production activities income (QPAI) or Taxable (or modified adjusted gross) income
or alternative minimum taxable income
Qualified production activities income (QPAI) is the excess of
domestic production
gross receipts (DPGR) over the sum of:
• The cost of goods sold allocated to such receipts.
• Other deductions, expenses, or losses directly allocated to such receipts.
• The ratable portion of deductions, expenses, and losses not directly allocable
to such receipts or another class of income
Five specific categories of DPGR qualify for the DPAD:
• The lease, license, sale, exchange, or other disposition of qualified production
property (QPP) that was manufactured, produced, grown, or extracted
(MPGE) in the United States.
• Qualified films largely created in the United States.
• The production of electricity, natural gas, or potable water.
• Construction (but not self-construction) performed in the United States.
• Engineering and architectural services for domestic construction.
Do Example 28
.
An NOL generally must be applied initially to the
wo taxable years preceding the
year of the loss (unless an election is made not to carry the loss back at all). It is carried
first to the second prior year and then to the immediately preceding tax year
(or until used up).
If the loss is not fully used in the carryback period, it must be
carried forward to the first year after the loss year and then forward to the second,
third, etc., year after the loss year.
The carryover period is 20 years. A loss sustained
in 2012 is used in this order:
2010, 2011, 2013 through 2032
A three-year carryback period is available for any portion of an individual’s NOL
resulting from a
casualty or theft loss
small business is a business whose average annual gross receipts
for a three-year period are
$5 million or less
A 5-year carryback period and a 20-year carryover period are allowed for a
farming loss
When the taxpayer has NOLs in two or more years, the rule is always to use what loss first?
the earliest
year’s loss first until it is completely absorbed. The later years’ losses can then be
used until they also are absorbed or lost
A taxpayer can irrevocably elect not to carry back an NOL to any of the prior years. In that
case, the loss is available as a carryover for 20 years?
True. This could be beneficial if the tax bracket is higher in carryforward years
