Tax 802 Ch. 10 Lecture Notes

Tax 802 Ch. 10 Lecture Notes - 1Chapter 10 CERTAIN BUSINESS...

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1Chapter 10 CERTAIN BUSINESS DEDUCTIONS AND LOSSES LECTURE OUTLINE I. Introduction. A. This chapter examines specific provisions governing certain deductions and losses common to businesses. B. Topics considered: 1. Business and nonbusiness bad debts 2. Casualty and theft losses 3. Net operating losses 4. Inventory accounting II. Losses in general. A. General rules. 1. As discussed in Chapter 7, a taxpayer is allowed, under § 165(a), a deduction for any loss sustained during the taxable year when he or she is not compensated for it by insurance. 2. Section 165 imposes limitations on the losses of individuals, allowing deductions for only three types of losses: a. Losses incurred in a trade or business; b. Losses incurred in any transaction entered into for profit (not connected with a trade or business); and c. Casualty losses. 3. Additional restrictions or special rules have been created to govern certain types of losses: a. Bad debts (§ 166); b. Worthless securities [§ 165(g)]; c. Section 1244 stock; and d. Wagering losses [§ 165(d)]. III. Bad debts. A. Introduction. 1. Bad debts are not governed by § 165, the general provision governing losses; rather, special rules govern their treatment in § 166. 2. General rule. Section 166(a) allows a deduction for “any debt which becomes worthless within the taxable year.” 3. Basic considerations. a. Is there a debt ? b. Is there a bad debt? c. What is the character of the bad debt, business or nonbusiness? B. General requirements. 1. Bona fide debt. a. Qualifies if it arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed and determinable sum. b. Definition precludes deduction for uncollectible loans that are in effect: 1. Gifts (bad debts among family members); 2. Contributions to capital (advances by shareholders); 3. Obligations that are unenforceable because they are disputed or cannot be enforced (e.g., usury laws prohibit collection of interest beyond the legal maximum); and 2. Basis. a. No deduction is allowed unless the taxpayer has a basis in the debt. b. A cash basis taxpayer’s claims for unpaid amounts such as wages or payments for services cannot be deducted since his or her basis in such claims is zero. In effect, the deduction is obtained by never having to include the amount in income. c. A cash basis taxpayer who makes expenditures on behalf of a customer is deemed to have made a loan and can deduct this amount. For example, if an attorney incurs $1,000 in court costs on behalf of his client and bills this amount, as well as $5,000 for services, and the client fails to pay, the attorney can deduct the portion paid for court costs. 3. Worthlessness. a.
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Tax 802 Ch. 10 Lecture Notes - 1Chapter 10 CERTAIN BUSINESS...

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