Chap008 - Chapter 08 - Business Income and Deductions...

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Unformatted text preview: Chapter 08 - Business Income and Deductions Chapter 8 Business Income and Deductions Discussion Questions 1. [LO 1] What is an ordinary and necessary business expenditure? Ordinary and necessary imply that an expense must be customary and helpful, respectively. Because these terms are subjective, the tests are ambiguous. However, ordinary is interpreted by the courts as including expenses which may be unusual for a specific taxpayer (but not for that type of business) and necessary is not interpreted as only essential expenses. These limits can be contrasted with the reasonable limit on amounts and the bona fide requirement for profit motivation. 2. [LO 1] Is cost of goods sold deductible as a business expense for a business selling inventory? Explain. No. Under the return of capital principal, cost of goods sold represents a reduction in gross income rather than a business expense. For example, if a taxpayer sells inventory for $100,000 and reports a cost of goods sold of $40,000, the businesss gross income is $60,000 ($100,000 40,000) not $100,000. 3. [LO 1] Tom is an attorney who often represents individuals injured while working (worker liability claims). This year Dewey spent $50 on a book entitled Plumbing For Dummies and paid $500 to take a course on plumbing residences and rental housing. Can you imagine circumstances in which these expenditures would be deductible as ordinary and necessary for an attorney. Explain. Ordinary and necessary imply that an expense must be customary and helpful, respectively. Because these terms are subjective, the tests are ambiguous. However, ordinary is interpreted by the courts as including expenses which may be unusual for a specific taxpayer (but not for that type of business) and necessary is not interpreted as only essential expenses. Tom may represent a plumber and incurred these expenditure so he can better understand and explain how his client was injured on the job. In this case, the expenses would be both ordinary and necessary to Toms practice as an attorney, and therefore deductible. 4. [LO 1] Jake is a professional dog trainer who purchases and trains dogs for use by law enforcement agencies. Last year Jake purchased 500 bags of dog food from a large pet food company at an average cost of $30 per bag. This year, however, Jake purchased 500 bags of dog food from a local pet food company at an average cost of $45 per bag. Under what circumstances would the IRS likely challenge the cost Jakes dog food as unreasonable? Reasonableness is an issue of fact and circumstance, and extravagance is difficult to determine definitely. However, a common test for reasonableness is whether the 8-1 Chapter 08 - Business Income and Deductions expenditure is comparable to an arm's length amount a price charged by objective (unrelated) individuals who do not receive any incidental personal benefits....
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Chap008 - Chapter 08 - Business Income and Deductions...

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