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Chapter 8 - Income Taxation Chapter 8 Income Certain...

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Unformatted text preview: Income Taxation: Chapter 8 Income Certain Business Deductions and Losses 1 Losses in General x Sec. 165 allows deductions for three types of losses for individuals if the loss is not compensated by insurance y Losses incurred in a T/B y Losses incurred in any transaction entered into for profit y Casualty/Theft losses x Additional rules govern certain types of losses: y Bad debts ­ Sec. 166 y Worthless securities ­ Sec. 165(g) y Sec. 1244 stock 2 Bad Debts Business vs. Nonbusiness x Effect of the Distinction y Business bad debts are deductible as an ordinary deduction y Nonbusiness bad debts are deductible only as a STCL x Business Bad Debts y Must be closely related to a business y Loans made by a corporation are always treated as business debts y Examples 3 Bad Debts Business vs. Nonbusiness x Nonbusiness Bad Debts y A nonbusiness bad debt is a bad debt unrelated to the TP’s business either x when the debt was created, or x when the debt became worthless y Loans made to protect investments are classified as nonbusiness debts. x Problem areas: x x x Loans made by employee shareholders to corporations Guaranteeing a loan: business purpose or something else? Loans regularly made by TP for profit, when the TP is not in the Loans business of lending full-time business 4 Bad Debts Requirements for Deduction Three requirements: 1. A Bona Fide Debtor­Creditor Relationship Must Exist y A bona fide debt ­­ Reg.1.166 ­1(e) y Problem areas: x “Loans” between related parties: gifts or loans? x Loan from a shareholder to a controlled corporation x Loan from a corporation to a shareholder 5 Bad Debts Requirements for Deduction 2. TP Must Have Basis in the Debt y Cash basis TP’s x No bad debt deduction for accounts receivable x Bad debt deduction is available for loans y Accrual basis TP’s x Bad debt deduction available for accounts receivable x Bad debt deduction is available for loans 3. The Debt Must Be Worthless y TP must show the debt is worthless x Indicators of worthlessness y No legal action necessary 6 Bad Debts Deduction Methods x Permitted Methods (for businesses) y Reserve method generally not available except for small banks y Specific write­off (direct write­off) required x Qualifying Service Businesses y Allowed to reduce accruals for amounts not expected to be collected y Qualifying businesses 7 Worthless Securities x Capital Loss as of last day of tax year x When is a security worthless? 8 Casualties x General Rule: Casualty and Theft Losses Are Deductible y FOR AGI: business/profit property y FROM AGI: personal use property x Definition of a Casualty: y Unreimbursed losses of TP’s property caused by: x Fire x Shipwreck x Storm x Theft x Any other casualty caused by an external force and sudden, unexpected or unusual event 9 Casualties x Examples of what is or is not included: x Theft x Progressive (slow) deterioration x Misplacing/losing property x Loss of land x Farmer’s crops x Loss of trees, shrubs Stretching the concept of unexpected or unusual x When Deductible y Theft y Presidentially declared disasters y Others 10 Casualties x Computing the Deduction y Computation: Compute the loss, then subtract insurance reimbursement x Business/Profit Property y Partial destruction x Deduct the smaller of adjusted basis or decline in FMV (sustained loss) less insurance proceeds y Complete destruction x Deduct the adjusted basis less insurance proceeds y Deduct FOR AGI 11 Casualties x Personal Use Property y Partial destruction x Deduct the smaller of adjusted basis or decline in FMV (sustained loss) x $100 floor limitation for losses per casualty x sum all casualties for year, deduct only to extent they exceed 10% AGI y Complete destruction x Same as partial destruction for personal use property y Deduct FROM AGI x The $100 Floor Limitation for Personal Use Items Destroyed by Casualty y Apply one time per casualty x Several items may be destroyed in casualty 12 Casualties x Insured Casualty Losses for Which No Claim Is Filed y No deduction x Casualty Gains and Losses y What causes a casualty gain? y Casualty gains and losses for personal use assets must be netted x Net after applying $100 floor limitation y If netting results in a loss, apply 10% of AGI limitation y If netting results in a gain, treat as a 15% category capital gain (15% as of May 6, 2003: JGTRRA of 2003) 13 Casualties Comprehensive Example 1 Individual Z has two casualties in 199A Asset Date of Casualty Reduction in FMV Adj. Basis Insurance Reimbursement W 1/20/A 10,000 3,000 10,000 X 1/20/A 4,000 5,000 2,000 Y 8/30/A 2,000 3,000 0 G/L after Insurance Single casualty net G/L After $100 floor Single After W 7,000 7,000 5,000 5,000 5,000 X (2,000) Y (2,000) (2,000) (1,900) Casualties Comprehensive Casualties Example 2 Same facts as above, except loss on asset X is 12,000, and Same Z’s AGI = 50,000. No insurance reimbursement on X. Z’s G/L after Insurance Single casualty net G/L After $100 floor Single After W 7,000 (5,000) (4,900) (5,000) X (12,000) (12,000) Y (2,000) (2,000) (1,900) (2,000) (6,800) 10% AGI Deduction: 5,000 5,000 (1,800) (1,800) ...
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