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Unformatted text preview: Chapter 7: Certain Business Expenses and Losses Expenses and losses incurred in connection with a transaction entered into for profit and attributable to rents and royalties are deducted for AGI. All other expenses and losses incurred in connection with a transaction entered into for profit are deducted from AGI (itemized). BAD DEBTS If account receivable becomes worthless a bad debt deduction is allowed ONLY if income arising from the account was previously included in income. Business bad debt = deduction for AGI Non-business bad debt = short term capital loss Specific Charge-Off Method allows a deduction in the year a specific bad debt becomes partially (for business only) or totally worthless (business or non-business) All taxpayers must use this method for deducting bad debts! o Certain financial institutions are allowed to use the reserve method instead If business debt previously deducted as partially worthless becomes totally worthless in future year, only remainder not previously deducted can be deducted in that year If taxpayer purchased the debt (and it becomes totally worthless), deduction is equal to amount taxpayer paid for debt instrument. Bankruptcy may create worthlessness before settlement datetake deduction in year of worthlessness Recovery of accounts previously written offwrite-off entry is reversed Business vs. Non-Business Bad Debts Business Bad Debts arise from taxpayers trade or business o Deductible as an ordinary loss Non-Business Bad Debts unrelated to trade or business either when created or when it became worthless o Loans to relatives or friends are most common type of non-business bad debts o Treated as a short-term capital loss Maximum amount of net STCL deductible against ordinary income = $3,000 o Loans made to corporations are assumed to be related to trade or business and are not subject to non-business bad debt provisions WORTHLESS SECURITIES Losses arising from worthless securities (such as stocks and bonds) are generally treated as capital losses deemed to have occurred on the last day of the tax year o Subject to the $3,000 capital loss limitation. Small Business Stock exception to capital loss rule on worthless securitiesindividual taxpayers allowed ordinary loss treatment up to $50,000 ($100,000 for joint return) per year on qualified small business stock. This loss could arise from sale of the stock or from the stock becoming worthless Only individuals who acquired the stock from the corporation are eligible for this treatment Losses above this limit treated as capital losses Corporation must meet requirements for loss on small business stock to be treated as ordinarytotal amount of money/property of corporation does not exceed $1 million LOSSES OF INDIVIDUALS Individual may deduct following losses: 1. Losses incurred in trade or business 2. Loss was incurred in a transaction entered into for profit 3. Loss was caused by casualty or theft a. Casualty loss rules require event is: i. Identifiable ii.ii....
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- Spring '09