Ch_6_Questions - Income Tax I Name _Christian Yimgnia _...

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Income Tax I Name ___Christian Yimgnia _______________________ Chapter 6 Questions Explain and/or discuss the following based on reading the chapter and viewing the power points. Be thorough with your answers. You may take all the space you need. EXPLAIN IN YOUR OWN WORDS 1. Expenses must be incurred in a trade or business activity-explain. An expense is deductible depending on the type of activity in which it was incurred. The tax law states that an expense can be deducted if it is paid or incurred in an activity that constitutes a trade or business. This is to avoid the deduction of personal expenses. For example if the owner of a construction company purchases a truck that will serve in the company, he will able to deduct that expense in the tax return. 2. Expense must be ordinary and necessary-explain. Give some examples Another requirement for deductibility is whether the expense is ordinary and necessary. An expense is ordinary when it is incurred in the type of business in which the taxpayer is involved. It should also be necessary if it is appropriate, helpful, or capable of making a contribution to the taxpayer’s profit seeking activities. For example if a an accounting firm is sued by a client because he believed that they gave him wrong financial information that lead his business to fail, and that accounting firm spends money to hire legal officers to defend them for the case, the legal fees would be considered ordinary and necessary. 3. Expense must be reasonable-explain. An expense should also be in reasonable amount to be considered a deduction. This is similar to the ordinary and necessary adjectives. The expense must be of an amount that makes sense for the business. This standard is mostly applied in situations involving salary payments made by a closely held corporation to a shareholder who also is an employee. In these situations the compensation paid exceeds that ordinarily paid for similar services. 4. Expense must be paid or incurred during the taxable year-explain. The tax law states that expense is allowable as a deduction only if it is paid or incurred during the taxable year. The taxpayer will deduct the expense according to the tax accounting method he used to record that expense. If he used an accrual method, then he would deduct the expenses when he incurred them. And the same applies to a cash method taxpayer that will deduct the expense in the year he paid for that expense with cash.
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5. Explain some restrictions of use of the cash method, such as prepaid rent, prepaid insurance, prepaid interest, and other prepayments. There are some restrictions the taxpayer faces when using a cash method. When it
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Ch_6_Questions - Income Tax I Name _Christian Yimgnia _...

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