What is the difference between deductions for AGI and deductions from AGI

for AGI can be claimed whether or not the taxpayer itemizes

from AGI result in a tax benefit only if they exceed the taxpayers standard deduction

Why are deductions for AGI important in determining the amount of itemized deductions?

Because many itemized deductoins are limited to amounts in excess of specified percentages of AGI.

Ex. medical expenses and personal casualty losses

The itemized deductions are increased when AGI is decreased

The purpose is to classify various deductions as deductions for AGI. It does NOT provided the statutory authority for taking the deduction.

1. Expenses attributable to a trade or business carried on by the TP (does not include the performance of services by the TP as an employee)

2.Expenses incurred by a TP in connection with the performance of services as an employee if the expenses are reimbursed and other conditions satisfied

3.Deductions from losses on the sale or exchange of property by the TP

4.Expenses from income producing property (rents & royalties)

5. Payment of Alimony

6. part of the self-employment tax paid by a self-employed TP

7. Medical insurance premiums paid by a self-employed taxpayer (for TP, spouse and dependants)

8. Certain contributions to pension, profit sharing, and annuity plans of self-emped individuals

9. Penalty for early w/drawl from time savings acct's or deposits

10. Moving Expenses

11. Interest Paid on Student Loan

12. Qualified tuition and related expenses under S 222

13. up to $250 for teacher supplies for elementary & secondary school teachers

"The deductions allowed other than the deductions allowable in arriving at AGI"

So if it isn't for AGI it's an itemized deduction

1. The production or collection of income

2. The management, conservation, or maintenance of property held for the production of income

3.Expenses paid in connection with the determination, collection, or refund of any tax

1. Expenses related to rent and royalty income (for AGI)

2.Expenses paid in connection with the determination, collection, or refund of taxes related to the income of sole proprietorships, rents & royalties, or farming operations (for AGI)

There are certain expenses that are primarily personal in nature that ARE allowed to be deducted.

1.These expenses are generally not related to the production of income. 

2.They are deductions from AGI (itemized deductions)

1. Contributions to qualified charitable organizations (can't exceed a certain % of AGI)

2. Medical Expenses (in excess of 7.5% of AGI)

3.Certain State and local taxes (ex. real estate taxes and state and local income or sales taxes)

4. Personal casualty losses (in excess of an aggregate floor of 10% of AGI and a $100 floor per casualty)

5.Certain personal interest (ex. mortgage interest on a personal residence)

What does Section 162(a) permit? Are those expenses a deduction for AGI or from AGI?

Section 162(a) permits a deduction for all ordinary and necessary expenses paid or incurred in carrying on a trade or buisness.

They are deducted for  AGI.

Ex. reasonable salaries paid for services, expenses for the use of business property, and part of self-employment taxes paid. 

It is usually necessary to ask one or more of the follwing questions to determind whether an item qualifies as a trade or buisness expense:

1. Was the use of the particular item related to a business activity? (ex. funds borrowed for use in a business, interest is deductible as a business expense.

2. Was the expenditure incurred with the intent to realize a profit or to produce income?

3. Were the TP's operation and management activities extensive enough to indicate the carrying on of a trade or business?

Section 162 excludes what items from being classified as a trade or business expense?

1. Charitable contributions or gifts

2. Illegal bribes & kickbacks and certain treble damage payments

3. Fines & Penaliteis

*A bribe paid to a domestic official is not deductible if it is illegal in the US

*Foreign bribes are deductible unless they are unlawful under the Foreign Corrupt Practices Act of 1977

The terms "ordinary and necessary" are found in both Section 162 & 212. What is the additional term that applies to both?

Compensation for services must be "reasonable" in amount

If a prudent business person would incur the same expense and the expense is expected to be appropriate & helpful in the taxpayer's business

1. The production or collection of income or to

2. the management, conservation, maintenance of property held for the production of income

A deduction for losses not compensated for by insurance. Itemized Deduction

-Individuals are allowed to deduct losses that are the result of a casualty: fire, storm, shipwreck, and theft

-subject to ceiling and floor

What is the difference between the phrase "paid" and "incurred"

-Paid refers to the cash basis TP who gets a deduction only in the year of payment.

-Incurred concerns the accrual basis TP who obtains the deduction in the year in which the liability for the expense becomes certain

To obtain a current deduction under the one-year rule a payment must be____.

required not voluntary

-The TP must also demonstrate that allowing the current deduction will not result in a material distortion of income.

How does an accrual basis TP determine which period an expense can be deducted? And when can the TP claim the deduction?

By applying the

1. All Events Test &

2. Economic Performance Test

All Events Test:

1. all of the events have occurred to create the TP's liability and

2. the amount of liability can be determined with reasonable accuracy.

Economic Performance Test is met when:

the service, property, or use of property giving rise to the liability is actually performed for, provided to, or used by the TP

 *exception to the econ perf. test allows certain recurring items to be deducted (with conditions)

1. Ordinary and necessary expenses incurred in connection with a trade or business

2. Ordinary and necessary expenses incurred in conjuction with rental or royalty property held for the production of income

-All other deductible legal expenses are deducted from AGI. Ex. Fees for tax advice

Schedule C - sole proprietor's trade or business

Schedule E - individual's rental or royalty income

What are the three exceptions to the disallowance of lobbing expenses?

1. influencing local legislation

2. activites devoted soley to monitoring legislation

3. a de minimis exception is provided for annual in-house expenditures if they do not exceed $2000. If they exceed $2,000 none of the in-house expenditures can be deducted

What are the three limitations on excessive executive compensation?

1. Compensation of a SH-empee of closely held corporations is subject to the reasonableness requirement

2."millionaires' provision" applies to publicly held coporations (a corp that has atleast 1 class of stock registered under the Securites and Exchange Act of 1934)

3. Covered executives of companies receiving Troubled Asset Relief Program (TARP) -the deduction in this case is limited to $500k

Covered Employees: CEO and the four other most highly compensated officers [with TARP it's CEO, CFO and 3 next]

Excluded empee compensation:

1. commissions based on individual performance

2. vertain performance-based compensation based on company performance according to a formula approved by a board of directors compensation committee and SH vote

3. Payments to tax-qualified compensation plans

4. payments that are excludible from the emplee's GI (certain fringe benefits)

How are investigation expenses treated when the TP is in a business that is the same as or similar to that being investigated?

All investigaton expenses are deductible in the year paid or incurred

What happens to investigation expenses when the TP is not in the same or a similar time of business?

If the new business is accuired, the expenses must be capitalized as start up expenses. The first $5k (reduced by the amount over $50k) can be immediately deducted. Any excess expenses must be amortized ove 180 months (15 years)

When do hobby loss rules apply and how are the expenses treated?

Hobby loss rules apply only if the activity is not engaged in for profit.

Hobby expenses are deductible only to the extent of hobby income

What order must hobby expenses (a deduct. from AGI) be deducted in?

1. Normally allowed sched. A expenses

- Interest

- Taxes

2. Otherwise allowable business expenses

- Supplies

- Maintenance

- Utilities

- Repairs

3. Depreciation on fixed assets

What are the characteristics of a Primarily Personal Use vaction home?

If the residence is rented for ≤14 days, it is treated like a personal residence.

- Rent income is excluded from GI and no expenses are deductible [except for the ones you would deduct anyway: mortgage interest expense and real estate taxes (on sched A)]

What are the characteristics of a Primarily Rental Use vaction home?

The residence is rented for ≥15 days and 

Not used for personal perposes for more than the greater of: 

(1) 14 days or

(2) 10 percent of the total days rented

-The expenses must be allocated between personal and rental days if there are any personal use days during the year.

-The deduct. of expenses allocated to rental days CAN exceed rent income and result in a rental loss.

What are the characteristics of a Personal/Rental Use vaction home?

The residence is rented for ≥14 and is used for personal purposes for  more than the greater of 

(1) 14 days or

(2) 10% of the total days rented

-The expenses must be allocated between personal days & rental days.

-Expenses are allowed only to the extent of rent income

How are the expenses for a personal/rental use property deducted?

1. Expenses that would be deducted anyway

(ex. Mortgage interest &real estate taxes)

-If positive net income results:

2. Otherwise nondeductible expenses that do not affect adjusted basis

(ex. maintenance, utilities, insurance)

-if any positive net income is left:

3. Depreciation 

(whatever isn't used is carried forward and used in future years subject to the same limitations.

What are the 2 approaches for allocating expenses between personal and rental use and what are their differences? Which approach will reduce TI more?

Court's Approach

-Real Estate Taxes and Mortgage Interest are allocated on the basis of 365 days

-Other expenses are allocated on the basis of total days used

IRS Approach

-All expenses are allocated on the basis of total days used

*the courts approach will reduce TI more than IRS

*This is all schedule E stuff

"except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses." 

For example, Legal fees associated with a property settlement that results in one party retaining ownership of a family buisness is not deductible. 

-The legal fee paid to resolve the title to income-producing property is also not deductible.

-The deduction of legal fees incurred in connection with a divorce proceeding is limited to expenses related to tax advice

-Also deductible: costs of creating a trust to make periodic alimony payments and the determination of tax consequences for a property settlement

Get attny to itemize!

If an expense is for a tangible asset has no ascertainable life (land), it is not subject to depreciation. If the expense is for an intangible asset (copyright, patent), is it treated the same?

No, intangible assets can be amortized whether they have an ascertainable life or not. 

-Intangible assets are amortized over a 15-year statutory period using the straight-line method.

What happens when property is sold to a relative and then subsequently sold to a non-relative?

When it is sold to the non-related party, any gain recognized is reduced by the loss previously disallowed.

- If it is a loss, you can't use the suspended loss because there is no gain.

-The suspended loss only applies to one year, if you don't use it the rest is gone.

In regards to transactions between related parties, who is considered a related party?

1. Brother & Sisters, Spouse, Ancestors (parents & grandparents), and lineal descendants (kids and grandkids)

2.A corporation owned more than 50% (directly or indirectly) by the TP

3. Two corporations that are members of a controlled group

4. A series of other complex relationships between trusts, corporations, and individual TP