Restrictions on deductions

Question 1

If you invest in a tax shelter . . .

Answer 1

Must file an 8966 that identifies and discloses investment in the tax shelter

If you don’t file, 75% of additional tax penalty

Question 2

(T/F) can you deduct entertainment expenses related to business activities?

Answer 2

No. S 274 limits business deductions by disallowing

(1) entertainment activities

(2) club dues (country clubs or other entertainment venues)

(3) expenses associated with an entertainment facility

(4) Expenses of spouse or dependent accompanying taxpayer on a business trip

Question 3

When can you deduct travel, lodging, and meals?

Answer 3

Travel if majority of the trip is spent on business
- (time important factor)
- Unclear if a “week” is a 5 or 7 day week

Lodging and meals deductible for business purposes (meals 50% haircut)

Question 4

If a charge for entertainment, such as a box at a sports event, includes meals, are the meals deductible?

Answer 4

Only if the charges are listed separately on the receipt (or charged separately on their own receipt)

Question 5

What two deductions are not limited by “activities engaged in for profit?”

Answer 5

Taxes (upt to the 10g limit) and mortgage interest.

Question 6

Rebuttable presumption that the activity is engaged in for profit if

Answer 6

Profitable for 3 out of the last 5 years, or

2 out of the last 7 years for equine businesses

Question 7

If there is no presumption, can the taxpayer still show they are engaged in the activity for profit?

Answer 7

Yes. Using the factors in Reg 1.183-2(b) and in Engdahl.

(1) Manner engaged in the activity
- recordkeeping
- similarity to for-profit business
- any changes to increase profitability

(2) expertise in the activity

(3) time and effort spent

(4) any expectation assets will appreciate

(5) the individual’s success in engaging in other activities;

(6) profit or loss history;

(7) any occasional profit earned;

(8) the individual’s financial status; and

(9) whether the individual engages in the activity at all for leisure

Question 8

If an activity is determined to be NOT for profit, can deductions still be taken?

Answer 8

Yes, but they are now limited by the amount that GI exceeds the deductions taken on taxes and mortgage interest.

Ie. can’t take a loss for the year

Question 9

What is a good “last ditch” argument when a lack of profitability causes the taxpayer to fail the presumption of engaged in for profit?

Answer 9

Bad luck

Question 10

How does S 465, Deductions limited to amount at risk, work?

Answer 10

For trade/business (162) or production of income (212)

• Can only deduct up to the amount “at risk”
• Losses reduce the amount the taxpayer is “at risk” in subsequent years to the extent of the loss deduction previously allowed, however,
• disallowed losses can be carried forward

Question 11

What makes up an amount “at risk”?

Answer 11

(1) Cash

(2) Adjusted basis of property

(3) any amounts borrowed that taxpayer is personally liable for, and

(4) FMV of any pledged property, other than that used in the activity as security

Question 12

What is explicitly not at risk?

Answer 12

(1) Nonrecourse loans, and
(2) Amounts borrowed from
- a person having an interest in the activity, or
- from anyone “related” to such persons

exception for nonrecourse loans in real estate

Question 13

What is the exception for nonrecourse loans in real estate financing?

Answer 13

Nonrecourse real estate financing is at risk if the financing is from

(1) the government,
(2) is guaranteed by the government, or
(3) is from a qualified person who is in the business of lending money (not related to)
- taxpayer
- seller
- person receiving a fee for taxpayer’s investment

Question 14

When is the “qualified person” requirement, regarding at risk nature of nonrecourse real estate financing, waived?

Answer 14

if the terms of the nonrecourse financing are

(1) commercially reasonable and

(2) on substantially the same terms as loans involving unrelated persons

Question 15

Can you deduct losses from passive activities as they are recognized?

Answer 15

No, but passive losses can:
(1) reduce passive income
(2) carry forward, and
(3) become deductible upon sale of entire interest

Any such deduction applies in this order:
(1) income from passive activity,
(2) other passive income, then
(3) other income

Question 16

What is explicitly not passive income, that might otherwise seem passive?

Answer 16

Portfolio Interest

Question 17

Activities in which the taxpayer materially participates are not passive.

Answer 17

Material participation is:
(1) Regular
(2) Continuous, and
(3) Substantial

but the reg lists explicit ways

Question 18

The explicit methods to show material participation

Answer 18

(1) More than 500 hours per year,

(2) The taxpayer makes up substantially all of the participation,

(3) More than 100 hours, and not less than anyone else, or

(4) The aggregate hours of “significant activities,” those 100 hours or more, exceeds 500 hours

Question 19

What is a reg on material participation that the professor thinks is outside the scope of the code?

Answer 19

The taxpayer must work a minimum of 100 hours per year for material participation to be found

may be situation where under 100 hours, but nevertheless is regular, continuous, and substantial

Question 20

What counts as “per se NON-material participation?”

Answer 20

Status as a limited partner

Question 21

Do the actions of agents count as material participation?

Answer 21

No

Question 22

How can taxpayer use grouping to effectively reduce taxable income?

Answer 22

You can group a passive activity with an active activity to use passive losses to reduce income

material participation can change, but grouping can’t

This means plan using expectations:
- long term loser group with active
- short term loser
(a) lessen participation in a winner, to make passive and have passive income to reduce, or
(b) start another more profitable passive activity

Question 23

Activities can only be grouped if they are “an appropriate economic unit”?

Answer 23

Factors include:
(1) Similarities and differences in the types of trades/businesses,

(2) Extent of common control,

(3) Extent of common ownership,

(4) Geographical location, and

(5) Interdependencies

Question 24

Drug trafficker reports income from drug trafficking, seeks to deduct related expenses

Answer 24

No deductions for expenses related to drug trafficking (S 280E)

Question 25

For tax purposes, what is COGS?

Answer 25

Gross income is sales less cost of goods sold

** COGS is an offset against income, and is NOT available as a deduction**

Question 26

If a business engages in drug trafficking, can they still take deductions for normal business activities?

Answer 26

Yes.
(1) separate their ordinary business activities from drug trafficking activities for the sake of determining taxable income, and

(2) Deductions may be taken against the ordinary, and non drug related, business activities

Question 27

When are legal expenses deductible?

Answer 27

If the source is the taxpayer’s business activities