However generally have permitted business treatment

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however, generally have permitted business treatment where the taxpayer has devoted a major portion of time to the activities or the activities have been regular or continuous. ¶6225 Expense Must Be Ordinary and Necessary The second test for deductibility is whether the expense is ordinary and necessary. An expense is ordinary if it is normally incurred in the type of business in which the taxpayer is involved. A deductible expense must be not only ordinary, but also necessary . An expense is necessary if it is appropriate, helpful, or capable of making a contribution to the taxpayer’s pro fi t seeking activities. ¶6235 Expense must be Reasonable The third requirement for a deduction is that the expense be reasonable in amount. In practice, the reasonableness standard is most often applied in situations involving salary payments made by a closely held corporation to a shareholder who also is an employee. The courts have held, however, that reasonableness is implied in the phrase “ordinary and necessary.” Lincoln Electric Co. , 49-2 USTC ¶ 9388, 176 F.2d 815 (CA-6 1949), cert. denied, 338 US 949, 70 S.Ct. 488. Any expense will be denied if it is deemed unreasonable. ¶6245 Expense must be Paid or Incurred During the Taxable Year Code Secs. 162 and 212 both indicate that an expense is allowable as a deduction only if it is “paid or incurred during the taxable year”. The term paid refers to taxpayers using the cash method of accounting while the term incurred refers to taxpayers using the accrual method of accounting.
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79 Instructor’s Manual © 2009 CCH. All Rights Reserved. Chapter 6 Accrual Method Taxpayers An accrual method taxpayer deducts expenses when they are incurred. Code Sec. 461(h) provides that for this purpose, an expense is considered incurred when the all events test is satis fi ed and economic performance has occurred. Two requirements must be met under the all events test: (1) all events establishing the existence of a liability must have occurred (i.e., the liability is fi xed); and (2) the amount of the liability can be determined with reasonable accuracy. Cash Method Taxpayers A cash method taxpayer “pays” the expense when cash, check, property, or service is transferred. Neither a promise to pay nor a note evidencing such promise is considered payment. Consequently, when a cash method taxpayer buys on credit, no deduction is allowed until the debts are paid. However, if the taxpayer borrows cash and then pays the expense, the expense is deductible when paid. Restrictions on Use of the Cash Method Under the general rule, a cash method taxpayer deducts expenses when paid. Without restrictions, however, aggressive taxpayers could liberally interpret this provision to authorize not only deductions for routine items, but also deductions for capital expenditures and other expenses that bene fi t future periods (e.g., supplies, prepaid insurance, prepaid rent, and prepaid interest). Reg. § 1.446-1(a)(1) provides that any expenditure resulting “in the creation of an asset having a useful life which extends
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