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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 date—take deduction in year of worthlessness • Recovery of accounts previously written off—write-off entry is reversed Business vs. Non-Business Bad Debts • Business Bad Debts— arise from taxpayer’s 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 securities—individual 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 ordinary—total 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
- Business, Expenses, Taxation in the United States, Deduction