Business expenses must be what to be deductible?
Ordinary and necessary
Normal for business and does not have to be typical or repetitive
Ordinary expense
Helpful for business but does not have to be essential
Necessary expense
How is extravagance determined?
Compare to market value or an arms length amount
Statutory limits on business expense deductions against public policy
no deduction for fines, bribes, lobby expenditures, or political contribution
Statutory limits on business expense deductions relating tax exempt income
Interest on loan where proceeds invested in municipal bonds
Capital expenditure
Deduct if benefit is less than 12 months (if greater, capitalize)
Specifically authorized business deductions
Start up expenditures, bad debts, and losses on disposing assets
Two tests met in order to deduct an expense under accrual?
All events and economic performance tests
Prepayments for goods under accrual method
Recorded under full inclusion or deferral methods
Full inclusion method
Immediately recognized the prepayment as income
Deferral method
Recognizes when it would be recognized for tax purposes were it not a prepayment or when it recognizes the income for financial reporting purposes
Inventory costs include
Purchase price of raw materials, shipping, and indirect costs allocated to inventory (under UNICAP rules)
UNICAP rules
Must capitalize more costs than they normally would under financial accounting rules (capitalize a portion of compensation)
Who must use UNICAP?
Manufacturers and large retailers ($10mil or less over 3 year period doesn't have to)
Economic performance test
May not recognize a deduction for an expense until the underlying activity has occurred
Business forgets to take depreciation expense deductions?
Cannot claim it until the return is amended
When can the cost of an asset be recouped?
Once the asset is used
Adjusted tax basis
Amount of assets cost that has yet to be recovered through cost recovery deductions
Initial basis for assets
Cost plus purchase, preparation, and starting expenses
MACRS
Modified Accelerated Cost Recovery System
Personal property
Tangible property other than real property with a short life
Real property
Buildings and land
Depreciation convention for personal property
Either half year or mid quarter
Half year convention
allows one full half year depreciation in the year the asset is used
Calculate half year convention
Calculate depreciation for the year and multiply by 50%
Assets bought and sold the same year
Cannot take depreciation
When must the mid quarter convention be used?
40% of tangible personal property for the year is first used during the 4th quarter
Listed property
Property used for both business and personal purposes
Method of depreciation for intangibles
Straight line
Section 197 intangibles
Purchased intangibles must be amortized over 15 years regardless of actual life.
Patents and copyrights
Directly purchased must be amortized over the remaining life and self created over legal life
adjusted basis
Cost - cost recovery allowed
Ultimate gain or loss
Proceeds - Adjusted basis
Realized loss
A computed loss
Recognized loss
A deducted loss
How does the IRS test for extravagance?
Compare the expense to the market price or the arm's length amount
Firms recover the cost of capitalized tangible assets through
depreciation
Firms recover the cost of capitalized intangible assets through
amortization
How much can you deduct for a business meals?
50%
Can you deduct entertainment as a business expense?
Yes if the amounts are reasonable and relevant
Direct cost of transporting the taxpayer between business sites
Traveling expense deduction
What's included in traveling expense?
meals, lodging, and incidental expenses
Reduces the tax burden on domestic manufacturers as an incentive to invest
Domestic Production Activities Deduction (DPAD)
DPAD=
9% of the lesser of QPAI or MAGI
Qualified Production Activities Income=
Domestic production gross receipts - related expenses
50% of wages allocated to qualified activities
DPAD limit
Recurring item
immaterial items that occur on a regular basis
Adjusted Basis
asset's cost not yet recovered through deductions (Initial cost - accumulated depreciation)
Components of MACRS
Original cost, depreciation method, recover period, and the depreciation convention
Depreciation Convention
Amount of depreciation deductible in the year of acquisition and disposition
Personal Property Depreciation
All tangible property