PH6ky412

PH6ky412 - CHAPTER 6 INTRODUCTION TO DEDUCTIONS AND LOSSES...

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CHAPTER 6 INTRODUCTION TO DEDUCTIONS AND LOSSES
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CODE SECTIONS TO KNOW: §162 - Trade or business expenses §212 - Expenses for the production of income §165 - Deductible losses §183 - Presumptive rule for hobby losses PRIMARY CONCEPTS FOR DEDUCTIBILITY: The costs of living are generally not deductible The costs of earning a living are deductible CRITERIA FOR DEDUCTIBILITY OF EXPENSES EXPENSE CLASSIFICATION: A. §162 - 1. Trade or business expenses - Dfor AGI 2. Employee expenses If reimbursed - Dfor AGI If not reimbursed - Dfrom AGI B. §212 - Expenses for the production of income Interest Rents
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Dividends Dfrom AGI Royalties DforAGI Other Capital Activities Losses C. Personal - Itemized deductions specifically allowed by statute - Dfrom AGI WHY CHARACTERIZE DFOR VERSUS DFROM AGI? 1. AGI serves as a reference point for limitations on itemized deductions. Dfor expenses affect AGI. Medical - deductible in excess of 7.5% of AGI Charitable Contributions - deductible up to 50% of AGI Casualties - deductible in excess of 10% of AGI Miscellaneous I.D. - deductible in excess of 2% of AGI 2. If ID < SD all Dfrom's are lost. 3. Dfor's are always deductible. 4. For self-employment tax--Dfor expenses lower Net Income. A lower Net Income results in a lower self-employment tax. THERE ARE THREE GENERAL CRITERIA FOR DEDUCTIBILITY-- 1. ORDINARY - The expense must be customary or usual in the context of
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a particular industry or business community (need not be recurring). 2. NECESSARY - The expense must be that which a reasonable or prudent businessperson would incur under similar circumstances. 3. REASONABLE -The expense must be reasonable relative to the business (usually applies to salaries). These criteria are used to help establish that a relationship exists between the expense and the profit activity. A case for illustrating the difficulty of determining whether the proper relationship exists is Harold L. Jenkins who is better known as Conway Twitty, the famous country and western singer. Twitty decided to try his luck in the fast food business and established Twitty Burger, Inc. He had lured several of his famous friends including Merle Haggard and Sonny James to invest in the business which went broke within two years after it opened. Twitty decided it was in his best interest to reimburse his friends for their losses. Consequently, he reimbursed the investors $97,000 even though he was not legally obligated to do so. The IRS denied the deduction for the payments indicating that Twitty did it out of a sense of moral obligation. Twitty, however, asserted that the payments were made to protect his reputation. According to Twitty, the similarity of his name and the corporation established the necessary relationship between the payments and his business. The Tax Court judge summarized his opinion as follows: Twitty Burger went belly up. But Conway remained true. He repaid his investors one in all.
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This note was uploaded on 10/03/2011 for the course ACCT 412 taught by Professor Crabtree during the Spring '11 term at UNL.

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PH6ky412 - CHAPTER 6 INTRODUCTION TO DEDUCTIONS AND LOSSES...

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