Tax Ch. 7

Flashcard maker : Lily Taylor
Business expenses and losses, are deducted for a from AGI?
A business bad debt is classified as a _______ and a nonbusiness bad debt is classified as a_______
1. Deduction for AGI, ordinary loss?
2. Short term capital loss
Bad debt
If a taxpayer sells goods or provides services on credit and the account receivable subsequently becomes worthless, a bad debt deduction is permitted only if the income arising from the creation of the account receivable was previously included in the income.


Specific Charge-Off Method
Taxpayers may use only the specific charge-off method in accounting for bad debts.

*Certain financial institutions are allowed to use the reserve method in computing the deductions.

When can a taxpayer using the specific charge-ff method claim a deduction for bad debt?
When the business debt becomes either partially OR wholly worthless .. If a business debt previously deducated as partially worthless becomes totally worthless in a future year, only the remainder not previously deducted can be deducted in the future year

or when a specific nonbusiness is WHOLLY worthless

*In the case of total worthlessness, a deduction is allowed for the entire amount in the year the debt becomes worthless. The amount of the deduction depends on the taxpayers basis of bad debt..
If the debt arose from the sale of services or products and the face amount was previously included in income, that amount is deductible. If the taxpayer PURCHASED the debt, the deduction is equal to the amount the taxpayer paid for the debt instrument
If a receivable has been written off (deducted) as uncollectible, the collection of the receivable in the later tax year may result in income being recognized. (No back side)
Nonbusiness bad debt
Debt unrelated to the taxpayer’s trade or business either hwne it was created or when it became worthless

The nature of the debt depends upon whether the lender was engaged in the business of lending money or whether there is a proximate relationship between the creation of the debt and the lender’s trade or business. The use to which the borrowed funds are put by the debtor is of no consequence.

Most common examples – Loans to relatives or friends
*Related party individuals bad debts are generally suspect and may be treated as gifts
-Valid and enforcable
-Fixed or determinable

Business bad debt
Individuals will generally have nonbusiness bad debts unless:
1. In the business of loaning money
2. Bad debt is associated with the individuals trade or business
Worthless Securities
Loss on worthless securities is deductible in the year they become COMPLETELY WORTHLESS

*Capital losses deemed to have occured on the last day of the year in which the securities are worthless. By treating the loss as having occured onthe last day of the taxable year, a loss that would otherwise have been classified as short term may be classified as long-term
*Capital losses may be of limited benefit due to the 2000 capital loss limitation

Section 1244 Stock – Small Business Stock
Sale or worthlessness of 1244 stock results in an ordinary loss rather than capital loss for individuals

LIMIT OF 1 million capital contributions

Ordinary loss treatment is limited to:
Single – 50000
MFJ: 100,000

Loss in excess is treated as capital loss .

Does not apply to gains

Losses of Individuals: Only the following losses are deductible by individuals
1. Losses incurred in a trade or business
2. Losses incurred in a transaction entered into for profit
3. Losses caused by fire, storm, shipwreck, or other casualty or by theft
Definition of Casualty and Theft
Losses or damages to the taxpayers property that arise from fire, storm, shipwreck, or other casualty/theft
Conditions for C&T
Loss is from event that is:

1. Identifiable
2. Damaging to taxpayer’s property
3. Sudden
4. Unexpected

Not included: Events such as disease and insect damage

Robbery, burglary, emezzlement, etc.

Does not include misplaced items

What casualty and theft is deductible
Casualties: The year in which the loss is sustained.

Exception: If declared a “disaster area” by the President, can elect to deduct loss in year prior to the occurrence to get immediate funds

Thefts: Year in which loss is discovered

Effect of claim for Reiumursement
If reasonable prospect of full recovery: No casualty loss is permitted, deduct in year of settlement any amount not reiumbursed

If only partial recovery is expected: deduct in year of loss any amount not covered
*Remainder is deducted in year claim is settled

read example 12 on page 7-9

Amount of C Deduction
Depends on whether:
1. Loss is from nonpersonal (business or production income) or personal property
2. Loss is partial or complete
Amount of Nonpersonal (Business) C Losses
Theft or complete casualty (FMV after =0), then loss is the adjusted basis in property less the insurance proceeds

Partial Casualty: Less the decline in value or the adjusted basis of the property, less the insurance proceeds

Limitations on C Losses
Losses on business, rental, and royalty properties: Deduction will be FOR AGI, not subject tothe 100 per event and the 10% of AGI limitation

Losses not connected with bussiness, rental, and royalty properties: Deduction will be FROM AGI.

**Examples – theft of a security: Theft losses of investment property are not subject to 2% of AGI floor on certain miscellaneous itemized deductions

Nonpersonal (Business)
Depending on the property, gain can be ordinary or captial

Amount of nonpersonal gains
-Insurance proceeds less the adjusted bases in property

Personal C Gains and Losses (Including Limitations)
Casualty and theft losses attributable to person use property are subject to the $100 per event and the 10% of AGI limitations

These losses are itemized deductions

Amount of personal C losses: Lesser of the decline in value or adjusted basis in property, less insurance proceeds

Insurance proceeds may results in a gain recognition on certain casualty thefts

If a taxpayer has both personal casualty and theft gains as well as losses, a special set of rules applies
A personal casualty gain is the recognized gain from a casualty or theft of personal use property. A personal casualty loss for this puprose is a casualty or theft loss of personal use property after the application of the 100 floor. You add the gains and losses together, and the tax treatment depends on the results of this netting
Research and Experimental Expenditures
Costs for the development of an experimental model, plant process, product, formula, invention, or similar property and improvement of such existing property
Three alternatives available for R expenditures
1. Expense in the year paid or incurred
2. Defer and amortize over period of 60 months or more
3. Capitalize (deductible when project is abandoned or worthless)
Tax Credits Available for R
Tax credit of 20% of incremental certain R expenditures is available
Net Operating Losses
NOLs from any one year can be offset against taxable income of other years

*The NOL provision is intended as a form of relief for business income and losses
*Only losses from trade or business operations, casualty or theft losses, or losses from foreign government confiscations can create a NOL

No nonbusiness (personal) losses or deductions may be used in computing NOL (exemption is personal casualty and theft losses)

NOL Carryover Period
Must carryback to 2 propr years, then carryforward to 20 future years, on a FIFO basis
*May make an irrevocable election to just carryforward

There are different carryback rules for exceptional cases

Computing the NOL Amount
Individual must start with taxable income and add back:
1. Personal and dependency exemptions
2. NOLs from other years
3. Excess nonbusiness capital losses
4. Excess nonbusiness deductions
5. Excess business capital losses
Effect of NOL in carryback year
Taxpayer must recompute taxable income and the income tax including the NOL as a FOR AGI deduction

All limitations and deductions based on AGI must be recomputed
**Exception: Charitable contribution deduction

All credits limited by or based on the tax liability must be recomputed

Calculating remaining NOL after carryovers
After using the NOL in the initial carryover year, the taxpayer must determine how much NOL remains to carry to other years

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