Introduction to Taxation

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ACCT 330 – TEST 2
CHAPTER 6 – DEDUCTIONS AND LOSSES
Criteria for deducting business and investment expenses – must be… * Related to a profit-motivated activity of the taxpayer
* Ordinary, necessary, and reasonable in amount
* Properly documented
* An expense of the taxpayer
Expenditure is not deductable if it is…
* A capital expenditure
* Expense related to tax-exempt income
* Illegal or in violation of public policy, or
* Specifically disallowed by tax law
Business or investment activity? – requirements have two parts * Activity must be engaged in for profit
* Trade or business vs. investment classification – distinction important only to individuals * Expenses incurred in a trade or business are deductions for AGI * Investment expenses, other than those incurred to produce rents and royalties are deductions from AGI Legal and accounting fees – may deduct if incurred in conduct of trade or business or for the production of income * Deductions for AGI if incurred in trade or business and any fees incurred in the determination or collection of taxes * All other legal and acct fees incurred by taxpayer are from AGI * Cannot deduct legal fees incurred in the acquisition of property (these are capitalized) Ordinary expense – reasonable in amount, bears reasonable and proximate relationship to the income-producing activity or property * Does not mean the property must be producing income currently Necessary expense – appropriate and helpful in the taxpayer’s business Reasonable – compensation does not exceed the value of work put in Expenses and losses incurred directly by the taxpayer – taxpayers may not take a deduction for a loss or expense of another person * In order for a business to deduct personal employee expenses one of two things must happen… * The employee must report additional compensation, or * The employee must reimburse the company for the compensation received * Exception: medical expenses paid on behalf of a dependent Capitalization vs. Expense deduction

General capitalization requirements – taxpayer may not take current deduction for capital expenditures Capital expenditures – expenses that add to the value of, substantially prolong the useful life of, or change the use of the property Depreciable/amortizable assets – buildings, machinery, equipment, furniture, purchased goodwill Non depreciable/amortizable assets – land, stock, partnership interests Maintenance/repair expenditures – deductable only if they do not increase the value or prolong the useful life of the asset Expenses related to tax exempt income - may not deduct any expense allocated or related to tax-exempt income * Purpose – to prevent taxpayer from receiving a double tax benefit * Also disallows interest expense on debt the taxpayer incurs in order to purchase or hold tax-exempt securities * Depends on intent of the loan, intent determined w/tax-exempt securities if the securities themselves are used as collateral to secure the loan Expenditures contrary to public policy – not deductable If payment itself is illegal or if it is a penalty or fine from an illegal act * Bribes and kickbacks – applies to pmts made to federal officials, state, local, and foreign governments, and officials of an agency of government. * Fines and penalties – deductions not allowed

* Expenses related to illegal activity – deductable if they are ordinary, necessary, and reasonable and the taxpayer reports the income from the illegal activity * However, disallows any illegal business of trafficking or drug dealing Political Contributions and lobbying expenses – may not deduct if made in connection w/the following… * Influencing legislation

* Participating or intervening in a political campaign
* Attempting to influence the general public w/respect to election matters * Communicating directly w/the president, vice president, or other federal...
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