Chapter 5 - Introduction to Business Expenses

Chapter 5 - Introduction to Business Expenses - Chapter 5...

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Chapter 5 – Introduction to Business Expenses I. Introduction a. Tax deductions are a matter of legislative grace and as a result, two restrictions immediately apply i. Only deductions allowed by the tax law may be subtracted to compute taxable income ii. A deduction is allowed for an item only if all the requirements for a deduction are satisfied b. Basis is the cost of an asset or the dollar amount of a specific expenditure i. The maximum amount of an expenditure that can be deducted as a recovery of capital II. Reporting Deductions a. Deductions for adjusted gross income and deductions from adjusted gross income identify where in the tax computation an individual taxpayer deducts an allowable expense i. Not necessary to use these phrases when discussing a business’s deductions b. Individual Reporting of Deductions: i. Deductions for AGI receive more favorable treatment than deductions from AGI ii. The allowable deduction from AGI is the greater of the taxpayer’s standard deduction amount or allowable itemized deductions 1. Itemized deductions consist of allowable personal expenditures and miscellaneous itemized deductions a. Most of these deductions are subject to limitations i. Miscellaneous itemized deductions must be reduced by 2 percent of AGI in calculating the amount of total expense that can be deducted c. Conduit Entity Reporting: i. Conduit entities (partnerships and S corporations) are not subject to tax
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1. The entity concept requires all deduction items to be traced to the tax unit responsible for taxation of the item ii. It is important that a conduit entity report separately any deduction that receives special tax treatment: 1. Charitable contributions 2. Investment interest expense 3. Investment expenses 4. Section 179 expenses 5. Nondeductible expenses III. Classifications of Deductions a. Profit-Motivated Expenditures: i. A taxpayer may legitimately plan transactions to avoid the payment of tax 1. Because business profits reflect tax costs and savings, the tax effect of a transaction is an important planning consideration a. If the sole purpose of the transaction is tax savings, however, it will not be allowed a deduction b. Trade or Business or Production-of-Income Expenses? i. Trade or Business Expenses: 1. If a taxpayer’s activities qualify as a trade or business, the related expenses are fully deductible a. Broadly defined as a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including: i. Reasonable allowances for salaries/other compensation ii. Traveling expenses iii. Rentals or other payments required to be made as condition to the continued use or possession of property 2. To be engaged in a trade or business, a taxpayer must meet the following requirements:
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a. Profit motivation i. Primary purpose of engaging in the activity is for profit b. Continuous and regular activity c. Livelihood, not a hobby 3. There is a problem when defining those who trade securities:
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This note was uploaded on 04/24/2011 for the course MGMT 504 taught by Professor Hatcher during the Spring '08 term at Purdue University-West Lafayette.

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Chapter 5 - Introduction to Business Expenses - Chapter 5...

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