Chapter 10 - CHAPTER 10-CERTAIN BUSINESS DEDUCTIONS AND...

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CHAPTER 10—CERTAIN BUSINESS DEDUCTIONS AND LOSSES TRUE/FALSE 1. Dr. S has done extremely well financially. Several years ago, his good friend T started a small amuse- ment park with such attractions as a water slide and a miniature golf course. T persuaded S to lend his new business $5,000, which he would repay to S in three years with 15 percent interest annually. The note came due this year and T was unable to repay because his business had failed. In light of the busi- ness nature of this debt, Dr. S may treat the bad debt as an ordinary loss. ANS: F S's loan was in the nature of an investment. It did not arise during the ordinary course of his business. Therefore, the debt is considered a nonbusiness bad debt and is deductible as a short-term capital loss. PTS: 1 REF: Example 1 and pp. 10-2 and 10-3 2. Q Corporation uses the cash method of accounting. The corporation manufactures microwave ovens. Two years ago it loaned $50,000 to a supplier who was having difficulties due to an unexpected rise in material prices. This year the debt became worthless. Q may not claim a deduction because it is a cash basis taxpayer and has no basis in the debt. ANS: F Uncollectible loans made by a cash or accrual basis taxpayer may be deducted. A cash basis taxpayer cannot deduct uncollectible receivables arising in the ordinary course of business because the taxpayer has no basis in the receivable since the corresponding income has not been reported. PTS: 1 REF: Example 3 and p. 10-4 3. B made a $20,000 loan to his good friend C to help his struggling business venture. This year, C filed for bankruptcy. B anticipates receiving $4,000 after the bankruptcy proceedings are complete, prob- ably next year. B may claim a deduction this year. ANS: F The debt would be considered a nonbusiness bad debt for which there is no deduction for partial worthlessness. B would only be able to claim the loss once the claim is finally settled. PTS: 1 REF: Example 1 and pp. 10-1 and 10-2 4. N Airlines declared bankruptcy this year. As a result, it was unable to pay many of its employees their salaries which they had earned. For example, S, one of its pilots, worked all of October and did not re- ceive his $5,000 salary for that month. S is not entitled to a bad debt deduction. ANS: T S has no basis in the debt because he has not included the amount in income. PTS: 1 REF: p. 10-4 5. An individual's nonbusiness bad debt is treated as if it arose from the sale of a capital asset. ANS: T A nonbusiness bad debt is deductible as a short-term capital loss.
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PTS: 1 REF: Example 1, pp. 10-1 and 10-2, and § 166(d)(1)(B) 6. Cash basis taxpayers are not allowed a bad debt deduction for worthless accounts receivable arising from routine credit sales. ANS: T
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Chapter 10 - CHAPTER 10-CERTAIN BUSINESS DEDUCTIONS AND...

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