Ch. 1 - Business Income, Deductions, and Accounting Methods (Taxation)

What is business gross income?

All income from whatever source is derived including gross profit from inventory sales service income and certain rental income

What makes an expense deductible as a business expense?

It must be directly connected to the business ordinary and necessary reasonable in amount and paid or incurred during the tax year

What do ordinary necessary and reasonable mean?

Ordinary means common for similar businesses necessary means helpful or appropriate for the business and reasonable means the cost is reasonable compared with the expected benefit

What are common deductible business expenses?

COGS wages officer compensation repairs bad debts taxes interest depreciation advertising employee benefits professional services supplies travel transportation and qualifying meals

What business expenses are generally NOT deductible?

Fines and illegal bribes political contributions lobbying personal expenses entertainment capital expenditures expenses related to tax-exempt income certain life insurance premiums and certain transportation benefits

How are capital expenditures treated?

They are generally capitalized and recovered over time through depreciation depletion or amortization Land generally is not depreciated

How are expenses related to tax-exempt income treated?

They are generally not deductible including interest on money borrowed to purchase tax-free securities

How are life insurance premiums treated?

Key-person and personal life insurance premiums are generally nondeductible when the taxpayer owns the policy and is the beneficiary Group-term employee life insurance can generally be deducted as a fringe benefit

What are the basic requirements for deducting business meals?

The meal must be a legitimate business expense reasonable and not lavish the taxpayer or employee must be present and it must involve a business contact Food and beverage costs must be separately stated from entertainment

How much of a qualifying business meal is generally deductible?

50%

How are entertainment expenses treated?

Entertainment expenses are generally nondeductible although certain employee events office parties promotional activities and similar expenses can be fully deductible

What is the business gift deduction limit?

$25 per recipient per year with certain incidental costs excluded from the limit

What transportation expenses are deductible?

Business transportation from one place to another is generally deductible but normal commuting between home and a regular workplace is not

What are the two methods for deducting business vehicle expenses?

The actual expense method and the standard mileage method

What is included in the actual vehicle expense method?

The business portion of gas oil repairs insurance depreciation interest taxes and licenses plus business-only parking and tolls

What are the 2026 standard mileage rates in the chapter?

72.5 cents per mile from January through June 2026 and 76 cents per mile from July through December 2026

What is deductible business travel?

Transportation lodging meals and incidental expenses incurred while away from the taxpayer's tax home overnight or long enough to require sleep

What is a tax home and temporary work assignment?

A tax home is generally the vicinity of the taxpayer's regular workplace A temporary assignment of one year or less can generally qualify as being away from home if a permanent residence is maintained elsewhere

How are domestic and foreign business trips treated?

Domestic transportation is generally fully deductible when the trip is primarily business Foreign travel has additional requirements and if those requirements are not met transportation costs are generally divided between business and personal days

What are the substantiation requirements for business deductions?

Taxpayers must keep records that establish income deductions credits and other tax items Travel expenses have especially strict substantiation requirements

How are business casualty and theft losses generally calculated?

A completely destroyed or stolen asset generally uses adjusted basis minus insurance proceeds A partially damaged asset generally uses the lesser of the decline in FMV or adjusted basis reduced by insurance proceeds

What are the main types of tax years?

Calendar year fiscal year and 52/53-week year A short tax year can occur when a business begins ends or changes its tax year

What are the three main accounting methods?

Cash accrual and hybrid

When does a cash-method taxpayer generally recognize expenses?

When the expense is paid subject to exceptions such as inventory capital assets prepaid expenses and prepaid interest

What is the 12-month rule for prepaid expenses?

Certain prepaid expenses can be deducted immediately if the prepayment period is 12 months or less and does not extend beyond the end of the following tax year

What are the two tests for an accrual-method deduction?

The all-events test and the economic performance test

What do the all-events and economic performance tests mean?

All-events means the liability has occurred and can be determined with reasonable accuracy Economic performance means the activity creating the liability has actually occurred

When is inventory accounting required?

Generally when the sale of goods is a material income-producing factor A business may use a hybrid method when it uses accrual accounting for inventory but cash accounting for other items

What is UNICAP?

Uniform Capitalization rules requiring certain direct and indirect costs to be included in inventory costs instead of being immediately deducted

What inventory methods are discussed?

FIFO LIFO and specific identification LIFO generally requires book-tax conformity

What is a business bad debt vs a nonbusiness bad debt?

Business bad debt comes from a trade or business and can generally be deducted when worthless Nonbusiness bad debt is generally treated as a short-term capital loss

How are bad debts treated for cash vs accrual taxpayers?

Cash-method taxpayers generally cannot deduct unpaid accounts receivable because they never included the income Accrual taxpayers can generally deduct qualifying bad accounts receivable using the direct write-off method

What happens when a business changes its accounting method?

IRS permission is generally required Form 3115 is used and a Section 481 adjustment accounts for the cumulative difference from the change

What is the QBID under Section 199A?

A deduction generally equal to 20% of qualified business income for certain noncorporate taxpayers with qualifying pass-through business income subject to limitations

What are the major QBID rules and limitations?

QBI generally excludes investment income capital gains and certain compensation The deduction is limited by W-2 wages and property specified service business rules and the overall taxable-income limitation Negative QBI can reduce positive QBI and may carry forward