Discussion Questions

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I:6-1

Chapter I:6

Deductions and Losses

Discussion Questions

I:6-1 Deductions for AGI (before AGI) reduce the taxpayer’s taxable income by the full amount of the deduction even if the standard deduction is used. Deductions from AGI are not beneficial unless their sum exceeds the standard deduction, in which case these deductions will be included as itemized deductions. Also, some deductions from AGI are decreased by a percentage of AGI (e.g., 7.5% x AGI for medical expenses). pp. I:6-3 and I:6-4.

I:6-2 Expenses incurred in producing rental income are deductions for AGI. p. I:6-3.

I:6-3 A deduction for a loss incurred on the sale of a capital asset held for investment is a

deduction for AGI. p. I:6-3.

I:6-4 Joe’s AGI is computed as follows:

Gross Income from Business $200,000 Business Deductions ( 60,000) $ 140,000 Alimony paid ( 30,000) Self-employed health insurance premiums (

6,000) AGI $ 104,000

The $4,000 mortgage interest on his personal home and the $2,000 for medicine and doctors that Joe paid during the year are deductions from AGI. pp. I:6-3 and I:6-4.

I:6-5 a. If the expenses are deductions for AGI, Mario’s taxable income is as follows.Income $55,000 Deductions for AGI

• 9,000) AGI $46,000 Standard deduction (15,000)

Taxable income $31,000

• If the expenses are deductions from AGI, Mario’s taxable income is as follows.

Income $55,000 Deductions for AGI

• 0) AGI $55,000 Standard deduction (15,000)

Taxable income $40,000

p. I:6-4.

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I:6-2

I:6-6 a. Factors used to determine whether an activity is profit-motivated include:

• Whether the activity is conducted in a business-like manner,
• The expertise of the taxpayer or his advisor,
• The time and effort expended by the taxpayer in carrying on the activity,
• Whether the assets used are expected to appreciate in value,
• The taxpayer’s success in carrying on other similar activities,
• The history of income or losses with respect to the activity,
• The amount of occasional profits,
• The financial status of the taxpayer, and
• Any elements of personal pleasure or recreation, which the activity might

involve.

• Whether an activity is profit-motivated depends upon the intent of the taxpayer.

These factors provide an objective way of determining a taxpayer’s intent. Expenses incurred in a profit-motivated activity are deductible, whereas expenses incurred in a personal activity generally are not deductible (with certain exceptions). Thus, external indications of a taxpayer’s motive or intent are extremely important in determining the deductibility of an expenditure. pp.I:6-29 and I:6-30.

I:6-7 No, it is not automatically deemed a hobby. The other factors mentioned in the Regulations can be relied upon to assess whether the activity is a business. The burden to prove it is not a hobby is generally on the taxpayer. However, meeting the 3 out of 5 year test (presumptive test) shifts the burden of proof to the IRS. pp I:6-29 and I:6-30.

I:6-8 It is important to determine whether the activity is a business or an investment because different tax consequences may result depending on the type of activity. For example, deductions incurred in a business are generally for AGI whereas investment expenses may be deductible for AGI (rental property) but are otherwise not deductible. Losses incurred on business property are ordinary, whereas losses on investment property generally are capital losses and are subject to limitation. pp. I:6-5 and I:6-6.

I:6-9 An ordinary expense is an expense that bears a reasonable and close (or direct) relationship to the income-producing activity or property. It must be customary or usual to the particular activity. Also, ordinary expenses are currently deductible as opposed to expenditures that must be capitalized.

Necessary is defined as appropriate or helpful. However, an expense does not need to be indispensable in order to be necessary. The test here is whether a reasonable business person would have incurred the same expenditure.

A reasonable expense is one that is reasonable in amount. It must not be excessive or unusual when compared to similar expenses made by similar businesses. pp. I:6-7 through I:6-9.

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I:6-3

I:6-10 Capital expenditures:

Under the tangible property regulations, capital expenditures are amounts paid for:

• New buildings
• Permanent improvement or betterments that increase the value of any property, or

• Restoring property to its normal usage.

A currently deductible expenditure generally keeps a business asset in a normal operating condition and does not improve the asset.

p. I:6-10.

I:6-11 The disallowance for expenses related to tax-exempt income prevents the taxpayer from enjoying a double tax benefit. If expenses related to tax-exempt income were deductible, the taxpayer would benefit by not paying tax on the income and at the same time would be able to

deduct the expenses related to that income. p. I:6-12.

I:6-12 A bribe or kickback that is illegal under state law may be deducted by the taxpayer if the state law is not generally enforced. pp. I:6-12 and I:6-13.

I:6-13 a. None of the $400 is deductible. Prior to 2018, such an expense was deductible from AGI as a miscellaneous itemized deduction. Under the Tax Cuts and Jobs Act, Sec. 67(g) repeals miscellaneous itemized deductions subject to the 2% floor from 2018-2025.

• Because $250 of the fee is attributable to Michelle’s business, this amount is

deductible under Sec. 162(a) as a for AGI deduction. The remaining $150 is not deductible (see above for part a). pp. I:6-6 and I:6-7.

I:6-14 a. Although Otter Corporation’s lobbying expenses relate to its business, they are not deductible. The de minimis exception in Sec.162(e)(4)(B) is not helpful because the expenses incurred by Otter exceed $2,000 for the year.

• No. The Tax Cuts and Jobs Act (2017) repealed the exception allowing

deductions for the cost of lobbying local legislation.

• Yes. These are in-house expenditures that do not exceed $2,000 for the year.

Thus, under the de minimis exception (Sec. 162(e)(4)(B)), they are deductible. pp. I:6-14 and

I:6-15.

I:6-15 a. Tommy’s Inc. has incurred these $6,800 in expenses in the regular course of its existing restaurant business. Tommy’s Inc. can deduct the expenses in the year incurred (last year).

• Because Tommy’s Inc. is not in the restaurant business when these expenses are

incurred, they are not deductible as business expenses. However, they do qualify as start-up costs, deductible beginning in the month Tommy’s begins its restaurant business. If Tommy’s makes a Sec. 195 election, it can take a current deduction for $5,000 of the expenses, and amortize the remaining $1,800 over a 180-month period. This year, Tommy’s may deduct $5,110 [$5,000 + ($6,800 - $5,000)/180 months x 11 months].

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