Chapter 7 Deductions & LossesA.) Bad Debts (see summary p. 7-7)Business  ordinary lossNon-business  straight capital loss- Deduction permitted only if income from A/R was previously included inincome- Deduction permitted from non-repayment of loan  Specific charge off method only method (some financial institutions allowed reserve method)allowed when debt becomes partially or wholly worthless (e.g. bankruptcy)Personal bad debts (e.g. loan to friend)  Note all bad debts of corporations are considered business bad debts Look at related party loans closely to determine if loan is bona fide otherwise it was a gift. (see p. 7-6)Indication: note. Interest collated, collection efforts, intent Losses on deposits in insolvent financial institutes may be either personal casualty loss ($100 floor + 10% AGI Floor) otherwise it is non-business bad debt.B.) Worthless Securities Capital loss allowed for securities that become completely worthless during the year Sale deemed on the last day of the tax yearSale or exchange of 1244 stock – small business stock may receive ordinary loss up to $50,000 or $100,000 for MFJ & remainder is capital – gains are capital Small business  initial investment < $1MC.) Losses caused by: 1) Fire 2) Storm 3) Shipwreck 4) Other casualty – event must bea) Identifiableb) Damaging to propertyc) Sudden, unexpected & unusual in natureSudden – not gradual- does not include corrosion & termites (LT)Weather damages must be unusual and severe for the region. Eg. Drought in desert5) Theft losses – includes larceny, embezzlement & robbery- Does not include lost itemsYear of Deduction- Generally in year loss incurred if no reasonable prospect to recovery from insurance claim- Theft losses reported in year of discovery- Any future recover of previously deducted losses included in gross income (no lox ox)- For disaster areas  may claim loss in year prior to actual lossAmount of LossBusiness: complete destruction – adj. basisPartial destruction – less of 1. adj. basis, 2. FMV before – FMV after.Personal: for complete or partial destruction a) Lesser of 1. adj basis, 2, FMV before – FMV afterb) Less $100 per eventc) Subject to 10% AGI Reported as itemized deduction  Any insurance recovery reduces amount of loss and could actually be again. Taxpayers must file insurance claim if applicable in order to get casualty loss FMV done by appraisalIf net gain – First offset person casualty gains + personal casualty losses and report as G/L from sale of capital assetIf net loss – all gains and losses are treated as ordinary – but gains reported as ordinary and losses reported as itemized deductions and as ordinary loss to extent of gains.Expenditures Choices:1. Expense in year paid or incurred for current year and all subsequent years.2. Deferral and amortization – must make election - R & E expenses amortized ratably over 60 months- Used deferral if not enough income to cover R & E expenses e.g. Staff up drug co.3. Capitalize – deduction not allowed until research project is abandoned or deemed worthless4. R & D credit – available for 20% of certain research & exp. expenditures.Expenses include those incurred in developing new products or improving already existing products, processes, formats, inventions, etc. Exclude – ordinary testing, inspection, quality control, management studies, consumer surveys, and adv. Proms. Etc. NOL’S- Relief for business losses, casualty or theft losses or confiscation of a business by a foreign country.- Carry back 2 years first to offset ply income (3 yrs for casualty losses) file form 1045 quick refund claim or 1040x- Carry forward up to 20 years- Irrevocable election available to carry forward and forego all carry backsNOL computation:Add backs: 1) personal dependency exemptions 2) ply NOL’s 3) Capital losses and non business deductions limiteda) Non-bus. Cap loss > non-bus. Cap gains b) Non bus dedu > non bus income and net non bus cap gainc) bus cap loss > bus cap