Lesson 7 - Deductions and LossesCertain Business Expenses and Losses

http://is.lsu.edu/iso/courses/ACCT3221B/ACCT3221B_lesson7.html

Table of Contents
Lesson Objectives Lesson Introduction Reading Assignment Self Check Lesson Assignment

Lesson Objectives
After you have completed this lesson, you should be able to do the following: Discuss specific expenses or losses which may occur to an individual taxpayer [Return to Top]

Lesson Introduction
Chapter 7 of the textbook introduces several specific items that a taxpayer may deduct, either as an expense or as a loss. The fact that determines if and when these items are deductible is whether the item is to be used in business or personal use. A brief outline follows for each expense and/or loss. When reading Chapter 7, you may want to expand this outline. I. Bad debts: The deduction for a bad debt affects taxpayers who lend money to others or who have included in gross income debts due from others for property sold or services rendered. A. Existence of debt: must be a real debtor-creditor relationship. B. Amount deductible: adjusted basis if and only if the basis is proven. C. Which bad debts are deductible: 1. If business incurred and bad debt is totally worthless, it is a deduction for AGI. 2. If business incurred and bad debt is partially worthless: a. The part that is worthless is a deduction for AGI in the year that it is determined to be worthless or in any latter year (the taxpayers choice). b. Debt must be specific and not a group of debts. 3. If nonbusiness related and the bad debt is totally worthless, the deduction is treated as a short-term capital loss (limited to $3,000 per year). D. How to deduct: 1. Specific charge-off method is required as a result of TRA of 1986. 2. Reserve method is no longer acceptable. II. Worthless securities: A. Taxpayer is entitled to a deduction for the year if they become totally worthless. B. The deduction is taken on the last day of the tax year, and it is a deduction for AGI. C. They are treated as long-term or short-term capital losses, depending on the time held (12 months, one day is long-term). III. Casualty and theft losses:
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Lesson 7 - Deductions and LossesCertain Business Expenses and Losses

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A. They are losses that are due to sudden, unexpected, and unusual events. B. Negligence, carelessness, and progressive deterioration are not casualty losses (e.g., rust or termites damage). C. They are limited to property losses that are your own. 1. Amount deductible: a. For a personal casualty, it is the lesser of sustained loss or adjusted basis reduced by: 1. Insurance. 2. Amount from employer or diaster relief agency. 3. Other compensation. 4. 10% of AGI. 5. $100 per event. b. For a business caualty, it is the same as a personal caualty except the two floors, $100 and 10% of AGI, do not apply. 2. When it is deductible: a. In the year sustained, or for a theft in the year of discovery. b. If the taxpayer has reasonable prospects of recovery, then it is not deductible. c. Special rules apply to disaster area losses. IV. Research and experimental costs (section 174) can be handled in one of three ways (the taxpayers choice): A. B. C. D. Expensed in the year paid or incurred. Deferred and amortized over a period of not less than 60 months. Capitalized. The law provides for a 20% research/experimental expenditures credit (see Chapter 13).

V. Domestic Production Activities Deduction (DPAD) A. For years after 2009 and thereafter, the DPAD is based upon the following formula: 9% times lesser of: Qualified production activities income (QPAI); Taxable (or modified adjusted gross) income or alternative minimum taxable income. Limited by 50% of appropriate W-2 wages. B. For years 2005 and 2006, the 9% factor was 3%, for 2007-2009, the 9% factor was 6%. VI. Net operating loss (section 172): A. Available to all taxpayers. B. It pertains to losses arising from a taxpayers operation of a trade or business. C. It can be carried back two years, and then forward, up to 20 years. There is an election to forgo the two year carryback. D. Computation of NOL: New loss figure is adjusted to reflect economic loss instead of tax loss. The following deductions or exclusions are added to the net loss (thus making a smaller loss): 1. Net operating loss from any other year. 2. Long-term capital gain deduction. 3. Personal exemptions. 4. Any excess of capital losses over capital gain; nonbusiness capital losses over capital gain; and nonbusiness capital gains. If nonbusiness capital losses exceed nonbusiness capital gains, the excess cannot be deducted even if there are enough business capital gains. 5. Any excess of nonbusiness deductions over nonbusiness income. 6. Contributions for self-employed person to a self-employed retirement plan. E. Computation of caryover amount: 1. Apply NOL to taxable income (TI) of year to which it is being carried back. If TI is zero or a positive amount after adding NOL, recompute tax. Otherwise, proceed to steps
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Lesson 7 - Deductions and LossesCertain Business Expenses and Losses

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two through five for necessary adjustments. Add back to loss personal exemption(s). Add back to loss LTCG deduction. Add back to loss net capital loss. Add back to loss an expense adjustment, if any, recomputed because of a percentage limitation for AGI changed by steps three or NOL from previous year. If any loss remains after adjustments, the loss amount can be carried over to the next applicable year. F. Taxable income in year of carryback or carryover: 1. AGI 2. (Operating loss) 3. Revised AGI (may be negative) 4. (Item deductions)medial limitation now based on revised AGI 5. (Personal Exemptions) 6. Revised taxable income G. Always use the earliest years loss first until used up. 2. 3. 4. 5. [Return to Top]

Reading Assignments
Hoffman et al., Chapter 7. Study Concept Summaries 7.1, 7.2, 7.3, and 7.4 plus all the examples throughout the chapter. [Return to Top]

Self Check
Answer the following questions to test and reinforce your knowledge of this lesson, as well as to prepare for exams. The exams are entirely in the form of multiple-choice questions, so practicing this type of question is essential. Do not submit these questions for grading. Answers are provided in the study guide.
Whittenburg, Chapter 7, multiple choice [Return to Top]

Lesson Assignment
Lesson 7 Assignment [Return to Top]

Preparation
It is now time to prepare for and take Examination I. If you are not going to take your exam at LSU-Baton Rouge, notify us of your proctor by sending the completed Exam Proctor Information Form located in Appendix A in the course guide to the Independent & Distance Learning office. Please read the College Examination Information instructions located in Appendix A for further details.
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Lesson 7 - Deductions and LossesCertain Business Expenses and Losses

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About the Examination I

Examination I will cover Lessons 17 and will consist of approximately 50 multiple-choice questions that are similar to those in the study guide. The exam will be worth a total of 100 points. You are responsible for all of the material covered in the reading assignments. The first exam is worth 25 percent of your final grade. You will be allowed to use three sheets (8 " x 11 " paper, written on both sides) of notes; you will be required to hand in those notes with the exam. You may also use a nonprogrammable calculator during the exam. It is

recommended that you take Exam I before proceeding beyond Lessons 8, 9, and 10.

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