Chapter 8 Flashcards
T/F Deductions for activities that violate public policy are permitted for income tax purposes
False, penalties, fines, illegal bribes, and kickbacks are not permitted for income tax purposes.
T/F Some illegal activities will generate tax deductions.
True, Government wants us to include income even if the business is illegal. If you have an illegal gambling ring, you can take all the necessary and reasonable deductions for expenses.
T/F If the illegal activity generating income involves trafficking in controlled substances, the only deduction the taxpayer is permitted to take is the cost of goods sold.
True.
T/F As a general rule, businesses and individuals can deduct political contributions or lobbying expenses
False, businesses and individuals cannot deduct political contributions or lobbying expenses.
T/F Publicly held corporations are subject to a deduction limitation on executive compensation
True, compensation deduction limited to 1,000,000 dollars for the four highest paid executives.
T/F The 1 million compensation limitation does apply to performance-based compensation, commissions, payments to qualified retirement plans, or payments.
False the compensation limit does not apply.
Hobby Losses
All ordinary, necessary, and reasonable business expenses are deductible against income. To be classified as a business activity the taxpayer must have a profit motive. When there is no profit motive the activity is classified as a hobby, all of the hobby income must be included in gross income, but expenses associated with the activity may only be deducted to the extent of the income from the activity. In other words, hobbies cannot generate losses.
T/F Hobby expeses are subject to 2% AGI
True
Hobby expenses deduction order
- Expenses that are otherwise deductible, such as mortgage interest, property taxes and casualty losses.2 Non-depreciation expenses not deducted under 1. 3. Cost recovery (depreciation, depletion, amortization)
Rental property greater than than 15 days.
Income is included but can deduct rental expenses. If loss then only 25,000 if actively managed phaseout 100-150k
Rental property mixed use.
Income is included. Deducted only to the extent of income. Allocate between personal an rental 1st interest and taxes. 2. operating expense and 3. depreciation.
Rental real estate activities
If the activity is classified as a nontaxable activity, the income is not reported but expenses may not be claimed. To the extent that the taxpayer makes mortgage interest or property tax payments on the property, however, those amounts can be claimed as personal expenses as itemized deductions.
Real estate activities continued
If the activity is classified as a primarily rental use activity, the taxpayer must report all of the income generated from the activity, but is permitted to deduct all ordinary, necessary, and reasonable expenses associated with the operation of the activity even if the activity produces a loss. If the activity is classified as a mixed use activity, the tax rules that apply are similar to the hobby loss rules.
How are bad business debts treated for tax purposes.
Deducted if the taxpayer uses the accrual method of accounting. Accrual method payers may deduct bad debts to offset income reported but not received.
T/F Most businesses are required to use the specific charge-off method which allows the business to deduct the bad debt as an ordinary loss in the year in which the debt becomes partially or wholly worthless
True
T/F If the bad debt is classified as a non business debt, the specific charge off method must be used
True
T/F no deductions are permitted for partial worthlessness when the debt is a non business debt.
True
Worthless securities
A taxpayer is entitled to take a loss on a security that becomes worthless during the taxable year. IRS Section 165 creates an artificial sale date on the last day of the taxable year in which the security becomes worthless. For most taxpayers, since they are cash basis, the artificial sale date will be December 31st.
Section 1244 Stock
To encourage investment in small business enterprise, Congress enacted Section 1244 of the Code, which allows the first 50,000 of losses for taxpayers who are married filing jointly per year. On section 1244 to be the stock classified as ordinary income instead of as a capital loss. . Any additional loss incurred on the stock would still qualify as a capital loss. Section 1244 only applies to losses not gains so any gains on the sale of stock will still be taxed at the favorable capital gains tax rate.
Losses incurred by individuals
As a general rule, the only losses that an individual can deduct are those incurred in a trade or business, incurred in a transaction entered into for profit, or specifically allowed by the Code (casualty loss).
Research & Experimental Expenditures
There are three methods that can be used to deduct research and experimental costs. First, the expenses can be deducted in the year paid or incurred. Often, this is the most favorable choice, since it gives the company an immediate tax deduction for research costs. Second, the expense can be amortized over a five year period. Third, the expenses can be capitalized and can be deducted when the project is abandoned or becomes worthless.
Net Operating Losses
When trade of business activities generate higher expenses than income in a given year, a net operating loss results. NOL for one taxable year can be taken as a deduction for AGI against income from the prior and future tax year. Under the current law, the NOL can be carried back two years, and carried forward 20 years.
Depreciation
Represents the portion of an asset placed in service in a trade or business that is used up in the conduct of business for that year.
What are the three penalties for retirement plan contributions/withdrawals
Excess contributions, early distributions, late distributions.
10 percent penalty exceptions for early withdrawal.
Distributions is made after the participant is age 591/2. Distribution is made on account of death of the participant. Distribution is made on account of disability of the participant. Distribution is part of a series of substantially equal periodic payments made at elast annually for the life or life expectancy of the participant or the joint lives or joint life expectancies of the participant and his designated beneficiary. Distribution is made after separation from service after the participant attains age 55. Distributions are dividends paid within 90 days of the plan year from an ESOP. Distributions is made to pay certain unpaid income taxes because of a tax levy on the plan. Distributions to the extent you have deductible medical expenses whether or not you itemize your deductions for this year. Distributions pursuant to a qualified domestic relations order.
Other Loss Disallowances
Section 1031 Exchanges relational party transactions. Wash sales-gifts below fair market value or sale of personal use asset at a loss.
