Chapter 9 Notes Guide.docx - NOTE SHEET FOR CHAPTER 9...

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NOTE SHEET FOR CHAPTER 9 – BUSINESS INCOME, DEDUCTIONS, AND ACCOUNTING METHODS: I. BUSINESS GROSS INCOME AND DEDUCTIONS Rules Business gross income (general case) IRC Sec. 61(a) Generally, recognizable income includes gross profit from inventory sales (sales – COGS 1 ) and income from services or renting property to customers. Like gross income for individuals, certain types that are realizable are not recognizable because of a specific exclusion or deferral provision (e.g. municipal bond interest) Cost of goods sold (COGS) are inventory costs, which follow “uniform cost capitalization” (UNICAP) rules IRC Sec. 263A(a). Tax inventory costs are generally higher than for financial accounting because UNICAP incorporates additional costs within the inventory classification (purchasing, general and administrative costs, and IT costs for the portion of their time influencing inventory). Business deduction (general case) IRC Sec. 162 Generally expenditures that are ordinary (normal or appropriate for the business under the circumstances) and necessary (helpful or conducive to the business activity) to the extent that they are reasonable in amount (at the market/arm’s length cost) constitute for AGI deductions . Examples: Advertising Car and truck expenses (costs to operate them once you already own them Cost recovery through depreciation of tangible assets or amortization of intangible assets 2 Employee compensation and benefits Insurance costs (but not when the proceeds from potential insurance proceeds are tax-exempt) Interest expense (but not when used to generate income that is tax- exempt) Deduction on net interest expense is limited to 30% of EBITDA Net interest expense = any excess of general interest expense that exceeds interest income Legal fees Office expenses Rent Repairs Supplies Utilities Wages Research and experimentation expenses 1 See discussion later in the notes 2 We’ll talk more about cost recovery through depreciation and amortization in Chapter 10. 1
Business deduction (unique types of deductions or deductions with limitations on general rules) For AGI deductions : No deduction for fines and penalties or illegal bribes/kickbacks (IRC Sec. 162(c)) No deductions for most political contributions and lobbying costs (IRC Sec. 162(e)) o Exception (i.e. when deductible) costs for direct connection for appearance in front of or communication to either: 1) a body with respect to legislation or proposed legislation of direct interest to the taxpayer or 2) an organization the taxpayer is a member of with respect to any such legislation or proposed legislation which is of direct interest to the taxpayer and to such organization No deduction for personal use only expenditures (IRC Sec. 262(a)) No deduction for entertainment expense

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