Disallowance PossibilitiesCh6 Deductions + Losses on GeneralSee Concept summery 6-2 p.6-30Deductions For AGI §62T/B expensesExpenses for performance of service if reimbursed losses from sale/ exchange propertyDeductions for rental/ royalty propertiesDeduction for alimony paidSome contrib.. to pension, profit sharing + annuity plans for self employed individualsIRAPenalties for premature withdrawalSome moving expensesSome student loansIF a deduction is not classified as for AGI then it is from AGI as itemized deductionPersonal expenses: Charitable contri.Medical expense> 7.5% AGIState/ Local TaxesPersonal casualty lossPersonal interest (i.e. mortgage)Investment related exp.Trade or Business Expenses§162 © - deduction allowed for all ordinary + necessary expenses paid in carrying on a trade or businessexcludes: char contrib., gift, illegal bribes, kickbacks, fines, penalties3 requirements:(1) T/B  was use related to business activity? was exp incurred with intent to realize profit or produce income were ops + mgmt activities enough to indicate trade or business(2) Ordinary + necessary – courts have held:Necessary  a prodent business person would incur the same expense + the expense is appropriate + helpful in T/P ‘s businessOrdinary  normal, usual or customary in the type of business + is not capital asset - may be a one time expense(3) Reasonable – in amount + with respect to salaries + other comp.Eg. Unreasonable comp or excess comp. Not deducted for S/tt of closely held corp  dividend?Look at T/R for placement of deductions, losses, itemizedSee p.6-8 Fig. 6-1Timing of Expense Recognition(1) Cash Method- Expenses deductible when paid- Issuing note does not qualify- Credit cards purchases are treated as constructively paid- Payment must be for expenses to be consumed by end of next tax year for prepaid expenses otherwise capital- Capital expenses  depreciate/ amortize(2) Accrual Method§461(h) – must meet 1) all events test – all events have occurred to create the liab. + amt can be determined w/ reason accuracy2) economic performance test – when service, property or use of property giving rise to liab. Is actually performedexception recurring itemseg. Monthly management contractsReserves for estimates are generally not available b/ economic performance not metEg. Bad debts, warranty, inventoryDisallowance Possibilities(1) Deductions Contrary to Public PolicyDisallowed – Bribes + Kickbacks (if illegal under U.S. Foreign Concept Practices Act)- Fines + Penalties in violation of law eg. Speeding ticket- 2/3 treide damage made resulting from violation of antitrust lawExpenses for an illegal business are deductible ( eg. Racketcering ) unless it isop. expenses from drug dealing  not deductible drug dealers may nave CGS(2) Political Contrib. Not deductibleLobbying expenses generally not deductible exceptions:(1) Influencuy local legislation(2) Activities devoted to monitoring leg.(3) Deminimis – exp< $2,000; if exp> $2,000 the none deductible(3) Excessive Exec. Comp.a) reasonable requirementb) for public co. deduction limited to $1 million for CEO + Four most highly compensatedexcludes: commissions, performance based , payments to retirement + Funds + Benefits (excludable)(4) Investigation of Business exp. Incurred to determine the Feasiblity of entering a new business or expanding an existing businesseg. Travel, engineering, architect, marketingA. T/P in same or similar business- all expenses deductible on your paid or incurredB. T/P not in business being investigateda) If business is acquired then expenses are capitalized + amortized over 60 months as start up expenses §195b) If business is not acquired – not ded(5) Hobby Losses- Business or investment expenses are allowed if activity was entered into for profit eg. Horses, art, airplanes, certain farms may be hobbies- Expenses for hobbies are deductible to the extent of hobby income- Regs provide 9 factors to consider when determining activity is for profit see p.6-16  presence or absence of one factor is not determinative but besubjective §1,183-2(b)a) Activity conducted in business like mannerb) Expertisec) Time + effortd) Expected asset appreciatione) Previous success in similar activityf) History of income/loss from activityg) Relationship of profits earned to lossesh) Financial status of T/P (i.e. other inc. sources)i) Elements of personal pleasure or recreation§183 Presumptive rule – activity is profit acclcury if profit shown in at least 3 of 5 prior consecutive tax yearsIRS bears burden of proving personal activityDeduction amt of a hobby:- deductible as misc. deduction for extent losses > 2% AGI in order:a) mortgage invest seal estate taxes – Fully deductibleb) amts deductible as T/B expenses subject to 2% floorc) deprec.amount depetionIf T/P uses std. Ded. – then no hobby deductions(6) Rental of Vacation Homes see summary 6-1 on p.6-23- properties used for personal purposes + rented out a) Primarily Personal Use – rented fewer than 15 days/ yr  personal gross rental income excluded mtg invest + R/E taxws itemized no other expenses deductibleb) Primarily Rental Use – rented 15 days or more + not used for personal purposes more than the greater or (1) 14 days or (2) 10% of the total days rented- expenses must be allocated between personal + rental use- may result in a rental lossc) Personal/ Rental Use- If rented ≥ 15 days and used for personal > 14 days or 10% total days rented- Expenses are allocated between personal + rented- Expenses are allowed only to extent of rental income1) Deduct expenses that are deductible firstEg. Mtg int + R/E taxescourts  allocate based on 365 daysIRS  allocate based on base of total days used disagrees2) deduct otherwise onodeductible expenseseg. Mi\aint, util. Ins. allocated based on total days used3) deduct depreciation if any positive income remains ( but not below zero)(7) Transactions between related partiesA. losses - §267 disallows related party losses until subsequently sold to unrelated party - related parties include:1) brothers, sisters, spouse, ancestors, uneal descendants2) corp. owned > 50%3) 2 corps members of controlled groupconstructive ownership – stock owned by certain relatives deemed to be owned by T/P to apply related party loss rulesB. Gains – no disallowance(8) Substaintions own of Deductions required or IRS will disallow(9) Expenses paid for someone else’s benefit not