DEDUCTIONS FROM GROSS INCOME Flashcards
What are deductions? How are deductions different from exclusions?
Deductions are the amounts which the law allows to be deducted from gross income in order to arrive at net income.
Exclusions are something earned by the taxpayer but do not form part of gross income, while deductions are those incurred by the taxpayer in order to earn that gross income.
What are the kinds of deductions for income tax purposes?
- Itemized Deductions
- Optional Standard Deductions
- Personal Exemptions (Repealed)
- Special Deductions in special cases
Explain the rule on entertainment, amusement, and recreation expenses.
The amount deductible for these expenses allowed is the one LOWER BETWEEN:
- Actual expenses
- Limit allowed
The limit is as follows:
- Business is engaged in SALE OF GOODS/PROPERTIES - NET SALES x 0.5%
- Business is engaged in SALE OF SERVICES - NET REVENUE x 1%
If the taxpayer is involved in sales of both services and goods, the total EAR expense is pro-rated between the total of net sales from goods and net revenue from services to get the actual EAR. The limit is then computed by using the 0.005 and 0.01 for the net revenue and net sales. The actual and limit are then compared.
T or F
Provision for doubtful accounts are deductible.
False. Provision for doubtful accounts are UNREALIZED LOSSES, therefore it is not deductible. What is deductible is accounts actually written off.
T or F
To be deductible, business expenses must be actually paid during the taxable year.
False. Business expenses can be deductible if incurred and/or paid.
T or F
For leasehold improvements, the lessee has no option to fully expense outright the cost of the leasehold improvement.
True. Such option is available only to the lessor and it is for full recognition of the leasehold improvement as INCOME, NOT EXPENSE.
The lessee has to recognize depreciation expense on the improvement based on the useful life or lease term whichever is shorter.
T or F
If the lessee pays the real property tax on the property he leased as per the lease arrangement, such payment of real property tax shall be deductible by him as an expense.
True.
What are the requisites for the deductibility of interest expenses?
- There must be and INDEBTEDNESS
- The indebtedness must be that of the TAXPAYER
- The indebtedness is CONNECTED TO THE TAXPAYER’S TRADE OR BUSINESS
- There must be a LEGAL LIABILITY to pay interest
- It MUST BE PAID OR INCURRED DURING THE TAXABLE YEAR.
- The interest must be STIPULATED IN WRITING
- The interest must be LEGALLY DUE.
- The interest payment arrangement must not be between related taxpayers
- The interest must not be incurred to finance petroleum operations
- The interest was not treated as capital expenditure if such interest was incurred in acquiring property used in trade/business/exercise of profession.
Under the law, what are the interest expenses that are non-deductible?
- Interest paid to persons classified as RELATED TAXPAYERS
- If the indebtedness is incurred to finance PETROLEUM EXPLORATION
- Interest on preferred stock
T or F
Interest paid when there is no stipulation for the payment thereof is NOT a deductible expense.
True.
T or F
Interest on TAX DELINQUENCY or DEFICIENCY is deductible, even if it is not connected to the taxpayer’s business.
False. The related tax must be BUSINESS-RELATED for the interest on tax to be deductible. Business taxes are considered operating expenses, therefore the interest on tax deficiency/delinquency is also deductible at full amount.
Explain the “Tax Arbitrage Rule”.
The tax arbitrage rule applies when there is an interest on loans or borrowings. The deductible interest is computed as follows:
Interest Expense (from loan or borrowings) xxx Interest Income subject to FWT x 33% (xxx) Deductible interest XXX
The interest income must come from the amount of money borrowed. (MATCHING PRINCIPLE)
See page 342 #42, 44
T or F
Cost of Sales or CoGS are part of itemized deductions.
False.
Abdul borrowed 2,000,000 from ABC Bank, payable in 2 years in lump sum. However, he received 1,900,000. The bank deducted in advance the interest of 100,000. When can Abdul claim the 100,000 interest as expense? Abdul uses cash basis.
Since Abdul is using cash basis, the prepaid interest shall be deductible in the year that the interest was paid, therefore in 2018.
Abdul borrowed 2,000,000 from ABC Bank, payable in 2 years in lump sum. However, he received 1,900,000. The bank deducted in advance the interest of 100,000. When can Abdul claim the 100,000 interest as expense? Abdul uses cash basis.
Since Abdul is using cash basis, the prepaid interest shall be deductible in the year that the interest was paid, therefore in 2018.
What is the rule on taxes claimed as deductions?
GR: The taxes paid or incurred must be within the taxable year in connection with the taxpayer’s trade or profession/trade/business to be deductible. (Business Taxes)
EX:
- Income tax
- Income tax paid abroad if claimed as tax credit
- Estate and Donor’s tax
- Special Assessments
- Stock Transactions Taxes
Abdul has been charged because of late payment of percentage taxes as follows:
Surcharge - 20,000
Interest - 50,000
Penalties - 17,000
What amount can be claimed as deductions?
Percentage taxes in general (except STTs) are deductible expenses, therefore the related interest is also deductible. Only the 50,000 interest is deductible in addition to the percentage tax.
SURCHARGE AND PENALTIES ARE NON-DEDUCTIBLE REGARDLESS OF THE CLASSIFICATION OF THE TAX PAID.
Abdul has been charged because of late payment of donor’s taxes as follows:
Surcharge - 20,000
Interest - 50,000
Penalties - 17,000
What amount can be claimed as deductions?
None can be claimed as deductions for income tax purposes, since donor’s tax is not related to business/trade/profession.
Abdul is engaged in the sale of goods and services. He has the following data:
Net sales - 3,000,000
Net revenue - 2,000,000
Actual entertainment and amusement expense incurred is 30,000.
What is Abdul’s deductible EAR expense?
Actual EAR is computed first by pro-rating between net sales and revenue:
Goods: 3M/5M x 30,000 = 18,000
Services: 2M/5M x 30,000 = 12,000
The limit is computed as follows:
Goods: 3,000,000 x 0.005 = 15,000
Services 2,000,000 x 0.01 = 20,000
The lower amount between actual and limit for goods and services is added together to get the EAR allowed as deduction:
15,000 + 12,000 = 27,000 ALLOWED DEDUCTIBLE EAR
Explain the rules on NOLCO.
Net operating loss carryover (NOLCO) is a deduction allowed for prior losses (excess of allowable deductions over gross income) CARRIED OVER THE NEXT 3 FOLLOWING YEARS against available net income.
