Federal Income Tax Business Notes

Tax deductions are related to the legislative grace and the ability-to-pay concept. 2 Restrictions:

1. Only deductions allowed by the tax law may be subtracted to compute taxable income. Congress allows deductions for the costs of earning income and certain expenditures.

2. A deduction is allowed for an item only if all requirements are satisfied.

Business Expense: the expense must have a business purpose that is unrelated to its tax effect.

Gross Income: Only the excess of an individual’s capital investement. The deduction for an item may not exceed the cost.

Basis: The cost of an asset or an expense. Represents the max amt of an expenditure that can be deducted as a recovery of capital.

Trade or business expenses are deducted FOR adjusted gross income (always)

Production-of-income expenses are deducted FROM adjusted gross income-Does not apply to Corportations (deduction is reduced by 2% agi. If agi is 40,000 (6%=$800) and exp is $6000, amt of deduction is $5200)

Conduit Entity: Investment expenses of individuals & miscellaneous itemized deductions must be reduced by 2% of agi. Most common deductions that must be reported separately

-Charitable contributions - Investment interest expense

-Investment expense -Section 179 expense -Nondeductible expenses

TRADE OR BUSINESS EXPENSES

• Sec 162, “ all the ordinary and necessary expenses…including salaries & compensation, traveling expenses (including meals & lodging), and rentals or other payments required).

• To be engaged in trade/business must have profit motivation, continuous and regular activity & livelihood not a hobby.

Active Investor: A person who continually , regularly, and extensively manages their won portfolio with a view toward long-term appreciation in the portfolio’s value and not short-term profit. Earned income is interest, dividends, & gains from long-term holdings. Inv. Expenses are only miscellaneous itemized deductions. An active investor is NEVER deemed to be engaged...