Deductions

Question 1

What are the 3 equations to get to tax owed for corporations?

Answer 1

Gross income - Allowed deductions = Taxable Income
Taxable Income * Tax rate = Tax liability
Tax liability - Tax credits = Tax owed

Question 2

What are the 4 equations to get to tax owed for individuals?

Answer 2

Gross Income + Schedule C income = Adj Gross Income
Adj Gross Income - Itemized deductions or standard deduction = Taxable Income
Taxable Income * Tax Rates in Sec 1 = Tax liability
Tax liability - Credits = Tax owed

Question 3

What are schedule C and Schedule A?

Answer 3

Schedule C is filled out for each trade or business and has the gross income and allowable deductions to get net income for that trade or business

Schedule A is filled out for itemized deductions not related to trade or business “below the line” deductions

Question 4

What are Miscellaneous itemized deductions?

Answer 4

any deduction not listed in 67b is a MID

Question 5

What is the effect of eliminating the deduction for MIDs iin 67g?

Answer 5

This makes parsing investment activity in a trade or business extremely important until 2026 (when the normal haircut applies)

Deductions in trade or business are 162 and on schedule c so can be taken investment expense deductions under 212 are MIDs so are useless

Question 6

What is the normal haircut that applies to MIDs?

Answer 6

MIDs are usually only allowable to the extent they exceed 2% of adjusted gross income

Question 7

How have businesses who used to be investment expenses adjusted their business models?

Answer 7

They are trying to move their fees into ways that they can be capitalized. e.g. an interior designer will mark up the price of their product so that people can capitalize the cost. Of course these changes only matter if the client cannot deduct as part of a trade or business

Question 8

What does Higgins hold?

Answer 8

there is a difference between investment activity and trade or business and it’s a fact specific inquiry

Question 9

What’s theoretically wrong with Higgins?

Answer 9

There is no reason to draw a distinction between investment activity and trade or business. Expenses associated with all profit seeking activity should be deductible in an income tax

Question 10

What was the Congressional response to Higgins? Was it effective?

Answer 10

Congress wrote 212 to make expenses incurred in investment activity deductible. (the better way would have been to redefine trade or business to include all profit seeking activity)

It was effective until 67g which eliminated all MIDs because 212 is a MID. So now we have a situation where not all profit seeking expenses are deductible

Question 11

What is the problem with 67g disallowing deductions of investment expense deductions under 212?

Answer 11

We no longer have an income tax, we have a gross receipts tax because not all profit seeking expenses are deductible

Question 12

You win a $1M case and your lawyer takes $400K. How are the legal fees treated if t/b? If investment activity short of t/b? If personal injury?

Answer 12

If t/b then legal fees are deductible under 162

If investment activity, legal fees are not deductible because 67g eliminated deduction of miss and 212 is a mid

If personal injury, 104a2 says it’s all tax exempt

Question 13

Fill in the blank with investment activity or trade or business

Profit seeking activity of a corporation is always ____

Trading stock for your own account is always _____

Answer 13

Trade or business

Investment activity (no matter how much time you spend doing it or if you hire employees

Question 14

What are the touchstones for parsing investment activity from trade or business?

Answer 14

Groetzinger (prof gambler case) says:

• Amt of time and level of activity is considered
• Offering goods and services is not required to be a t/b
• fact specific inquiry (prof. gambler who spends all his time at the track is a t/b)

Question 15

What is the litigation strategy when trying to get an expense deducted and it might be considered personal

Answer 15

Prove it’s notpersonal (not deductible under 183) and is a trade or business (162). Nobody will argue that something is investment activity because 212 is turned off by 67g

Question 16

What is the standard to deduct an expense as part of a trade or business?

Answer 16

Activity must be primarily profit seeking. Activity is primarily profit seeking if the taxpayer subjectively intends to make a profit.

Question 17

How do courts determine if a taxpayer subjectively intends to make a profit?

Answer 17

They look to objective factors to determine the taxpayer’s subjective state of mind

Question 18

What is the presumption that can help taxpayers prove that their expenditures have profit seeking intent

Answer 18

183(d). If you make $ in 3 of 5 years, then IRS will presume you have profit seeking intent

Question 19

I have proven under 183 that I had profit seeking intent, can I deduct for sure now?

Answer 19

No, you still have to prove that you’re in a trade or business and no just investment activity under the Higgins/Groetzinger line of cases

Question 20

What is the purpose of the origin of the claim doctrine?

Answer 20

It is useful for parsing personal from profit seeking in the context of legal fees.

Can also look to the origin of the claim to determine of the expenditure is short-term benefit (expense) or long term benefit (capitalize) (recall the hypo about the parent reimbursing the sub’s directors for cost of a derivative suit. They could have easily capitalized into basis in the stock but they wanted to deduct so they characterized the origin of the claim as an employment expense)

Question 21

What is the origin of the claim doctrine?

Answer 21

To determine if legal fees and payments on claims are profit seeking or personal, look to if the origin of the claim was profit seeking or personal

Gilmore could not deduct the legal fees for his divorce because it arose out of the personal activity of the marriage

Question 22

When can you capitalize legal fees?

Answer 22

If you litigate to defend the property line of your house, you can capitalize that cost to your basis in the house
(notice how this does not require 212 so no MID problem)

Question 23

Remember the Higgins/212/67g issue doesn’t stop you from capitalizing personal expenditures if they have long term benefit!

Answer 23

true

Question 24

What was the purpose of Section 199A

Answer 24

when the 2017 act was giving the corporate tax cuts, some of the non corporate businesses rule left out. 199A cut them in

Question 25

What kinds of businesses are “qualified trades or businesses” under 199A?

Answer 25

never corps. If (Taxable income threshold amount + 50K and not a professional service)

And even then only a certain amount of income is eligible

Question 26

What is weird about the code’s approach to interest deductions?

Answer 26

The deductibility of interest is a function of what the proceeds are used for but that doesn’t make much sense because cash is fungible. See the arbitrary tracing rules for a demonstration of how arbitrary it is

Question 27

Is personal interest deductible?

Answer 27

No unless it’s interest on acquisition indebtedness on a qualified residence

Question 28

Is trade or business interest deductible?

Answer 28

Yes, but subject to the 163j limitation

Interest deduction limited to the sum of (business interest income + 30% of taxpayer’s adjusted taxable income). Does not apply to small businesses. Any excess can be carried over

Question 29

Is investment interest deductible?

Answer 29

Yes under 163(d) (and 163 is part of the list that is not a MID under 67b)

But only deductible to the extent of the taxpayer’s net “investment income” for the year. any interest paid in excess of the cap can be carried forward to the next year

Question 30

I paid a lot of investment interest and I can’t deduct it because of the 163(d) cap. what should I do?

Answer 30

You have a choice:

1) call some of your capital gain or qualified dividend investment income and use the investment interest as a deduction to offset the cap gain (but you lose the benefit of the lower cap gain rates)
2) don’t call the cap gain investment income and get the benefit of the lower capital gain rates and carry forward the investment interest for a future deduction

Question 31

What is the hierarchy of charitable organizations

Answer 31

Non-profit corp formed under state law broader than
501(a) tax exempt org broader than
501(c)3 charities.

Within 501(c)3 charities there are 2 types: private foundations and public charities

Question 32

what are the limitations on a 501(c)3 org’s ability to engage in political activities?

Answer 32

501(c)3 orgs cannot focus “in substantial part” on influencing legislation and cannot (at all) participate in campaigns or support candidates

Question 33

What type of nonprofit can do political activities and what are the downsides of this kind of org?

Answer 33

501(c)4 can do political activities but donations to them are not deductible under 170

Question 34

What is a contribution under 170?

How do courts judge that?

Answer 34

Cannot be a quid pro quo (singer sewing machine donation not deductible)
Determination is based on objective criteria not subjective criteria as in gifts

Question 35

I bought a $1000 dinner ticket to support the Salvation Army. Can I deduct any of that?

Answer 35

You can deduct the excess of the price paid over the FMV of the goods/services

Question 36

What are the theoretical pros and cons of charitable deductions?

Answer 36

Pros: charities provide services that would otherwise have to be provided by the government

Cons: subsidy of the deduction goes to benefit charities that only rich people donate to
IRS is put in the position of distinguishing acceptable from unacceptable charities
Inefficient allocation from individuals speculating about how others will allocate their $

Question 37

Evaluate the theory behind the state and local tax deduction

Answer 37

State and local taxes should be taxable to the extent they are part of consumption

Property tax on your house should not be deductible because you’re choosing to live in an expensive house

The amount that the government just takes (like it’s never even yours) should probably be deductible

Question 38

What is the rule for 162 travel expenses?

Answer 38

To deduct travel fare, meals, and lodging, the travel must meet 3 requirements per 1.162-a2:

1) reasonable and necessary (not lavish or extravagant under the circumstances)
2) Must be incurred while away from home
3) Must be incurred in pursuit of business

Question 39

What is the holding of Flowers?

Answer 39

Flowers defines the “pursuit of business prong of the reg to mean that commuting is never deductible because it is motivated by a personal desire to live away from the office

Question 40

Is entertainment deductible if it is to woo a client?

Answer 40

No 274 negates 162

Question 41

What are the requirements of Notice 2018-76 relating to when you can deduct business meals under 162

Answer 41

Notice 2018-76 provides that business meals are deductible IF
Meets 162 ordinary and necessary requirements for a trade or business
Not lavish or extravagant under the circumstance
Food and beverages are provided to a current or potential business customer
If provided alongside entertainment must be separately purchased/itemized

Question 42

How does 280A treat deductions of primary residence for profit seeking activity?

Answer 42

280A generally disallows deductions under 162 for use of primary residence and then carves out narrow exceptions

Question 43

What does 280A allow you to deduct under 162?

Answer 43

Allows deductions for portion of residence that is PPB (ie you have no other office) OR used to see clients or if there is a separate structure.

If in trade or business of being an employee, use of residence must be for the convenience of the employer