Federal Taxation: Business Deductions, Depreciation, and Itemized Expenses

Comprehensive vocabulary flashcards covering individual and business tax deductions, cost recovery, MACRS, amortization, itemized deductions, employee/self-employed expenses, and tax limits for Exam 2 preparation.

Deductions for AGI

Deductions taken directly from gross income to determine Adjusted Gross Income (AGI), which can be claimed whether or not the taxpayer itemizes, including trade or business expenses, rental expenses, and student loan interest.

Deductions from AGI

Personal deductions, including itemized deductions and the Qualified Business Income (QBI) deduction, that must exceed the standard deduction to provide a tax benefit.

Section 162 Trade or Business Expenses

Ordinary, necessary, and reasonable expenses paid or incurred during the taxable year in carrying on a trade or business, deductible as deductions for AGI.

Ordinary, Necessary, and Reasonable Criteria

Statutory standards under Section 162 where 'ordinary' means normal, usual, or customary in the taxpayer's type of business; 'necessary' means appropriate and helpful as judged by a prudent businessperson; and 'reasonable' is a question of fact regarding amount.

Section 212 Expenses

Ordinary and necessary expenses incurred for the production or collection of income, or management/maintenance of income-producing property. Expenses related to rent and royalties are deductible for AGI, while investment interest is deductible from AGI.

Qualified Business Income (QBI) Deduction

A deduction from AGI under Section 199A allowing eligible noncorporate taxpayers to deduct up to $20\%$ of qualified business income from a sole proprietorship, partnership, or S corporation, subject to wage and property limitations.

12-Month Rule for Prepaid Expenses

An accounting doctrine permitting cash and accrual taxpayers to expense prepaid items immediately if the benefit does not extend beyond the earlier of $12\text{ months}$ after the first realization date or the end of the tax year following payment.

Millionaires' Provision

A corporate tax rule limiting the annual compensation deduction for publicly traded corporations to a maximum of $\$1,000,000$ per covered executive, including the CEO, CFO, and the three next highest-compensated officers.

Business Investigation Expenses

Costs incurred to determine the feasibility of entering a new business. Deductible immediately if in a similar line of business; if in a different business acquired, the first $\$5,000$ is expensed (phased out dollar-for-dollar over $\$50,000$) and the remainder is amortized over at least $180\text{ months}$.

Hobby Loss Presumptive Rule (§ 183)

A statutory presumption that an activity is engaged in for profit if it shows a profit in at least $3$ out of the preceding $5\text{ tax years}$ ($2$ of $7\text{ years}$ for horse breeding or racing), shifting the burden of proof to the IRS.

Vacation Home Rental Rules

Tax classification based on personal use: primarily personal (< $15\text{ rental days}$, rental income excluded), primarily rental (rented $\ge 15\text{ days}$ and personal days do not exceed the greater of $14\text{ days}$ or $10\%$ of rental days), or personal/rental (rented $\ge 15\text{ days}$ and personal days exceed threshold; deductions limited to rental income).

Section 267 Related-Party Loss Disallowance

A statutory provision disallowing realized losses from direct or indirect sales or exchanges of property between related parties, though the disallowed loss may offset subsequent gain recognized on a sale to an unrelated party.

Bad Debt Deduction Classification Process

The flowchart procedure verifying whether a valid debt exists, whether it is completely or partially worthless, whether it is held by a corporation or connected to a trade or business (ordinary business bad debt deduction), or personal (nonbusiness bad debt deducted as a short-term capital loss).

Specific Charge-Off Method

The mandatory tax method for deducting bad debts in the year a specific business debt becomes partially or wholly worthless, or when a nonbusiness bad debt becomes wholly worthless.

Nonbusiness Bad Debt

A debt unrelated to the taxpayer's trade or business that is deductible only upon becoming completely worthless and is treated as a short-term capital loss subject to the $\$3,000$ annual limitation.

Section 1244 Small Business Stock

Stock issued by a small business corporation whose capital contributions do not exceed $\$1,000,000$, allowing original purchasers to treat losses on sale or worthlessness as ordinary losses up to $\$50,000$ per year ($\$100,000$ on a joint return).

Casualty Loss

Loss of or damage to property resulting from an identifiable, sudden, unexpected, and unusual event such as a fire, storm, or shipwreck, or by theft.

Personal Casualty Loss Floors

Statutory reductions applied to nonbusiness personal casualty losses in federally declared disaster areas: each individual loss event is reduced by $\$500$ (or $\$100$ under regular rules), and total net casualty losses are further reduced by $10\%$ of AGI.

Excess Business Loss (EBL) Limitation

A limitation restricting noncorporate taxpayers from using net aggregate business losses to offset nonbusiness income beyond an annual threshold of $\$256,000$ for single filers and $\$512,000$ for married taxpayers filing jointly in $2026$, carrying the excess forward as an NOL.

Net Operating Loss (NOL)

An excess of allowable deductions over gross income resulting from trade or business operations and casualty/theft losses, deductible for AGI up to $80\%$ of taxable income and carried forward indefinitely.

Allowed vs. Allowable Cost Recovery

The rule establishing that an asset's tax basis must be reduced by the cost recovery actually claimed and allowed, but never by less than the amount that could have been taken under the applicable recovery method (allowable cost recovery).

Converted Personal-Use Property Basis

The cost recovery basis and loss basis for personal use property converted to business or income-producing use, equal to the lower of the adjusted basis or fair market value at the date of conversion.

Mid-Quarter Convention

A MACRS convention applied to all personal property placed in service during the year when more than $40\%$ of the total depreciable basis of personal property is placed in service in the last three months of the taxable year.

Qualified Improvement Property (QIP)

Any improvement made to the interior portion of nonresidential real property after it is placed in service, classified as $15\text{-year}$ property using the straight-line method and half-year convention.

Section 179 Expensing

An elective deduction allowing immediate write-off of qualifying tangible personal property up to $\$2,560,000$ in $2026$, phased down dollar-for-dollar when property placed in service exceeds $\$4,090,000$ and limited to taxable business income.

Bonus Depreciation

An additional first-year cost recovery deduction equal to $100\%$ of adjusted basis for qualified property placed in service after January 19, 2025, computed after Section 179 expensing.

Listed Property Predominant Use Test

A test requiring that listed property (such as passenger automobiles) be used more than $50\%$ for trade or business purposes to qualify for MACRS accelerated depreciation and Section 179; failing this test mandates straight-line depreciation under ADS.

Section 197 Intangibles

Acquired intangible assets such as goodwill, going-concern value, patents, and covenants not to compete that must be amortized ratably over a statutory period of $15\text{ years}$ ($180\text{ months}$) beginning in the month of acquisition.

Cost Depletion

A natural resource depletion method determined by dividing the asset's adjusted basis by total estimated recoverable units and multiplying by the number of units sold during the taxable year.

Percentage Depletion

A statutory depletion deduction calculated by multiplying gross income from a natural resource property by a specified statutory rate, limited to $50\%$ of the property's taxable income before depletion.

Medical Expense Deduction Floor

The statutory limitation allowing an itemized deduction for unreimbursed medical expenses only to the extent that qualifying expenditures exceed $7.5\%$ of the taxpayer's AGI.

Tax Benefit Rule

The requirement that a reimbursement or refund of an expense deducted in a prior taxable year (such as medical expenses or state income taxes) must be included in gross income in the year received to the extent the prior deduction reduced taxable income.

State and Local Tax (SALT) Cap

A limitation on the itemized deduction for state and local real estate, personal property, and income (or sales) taxes, set at $\$40,400$ for $2026$ with a phasedown threshold of $\$505,000$ of MAGI.

Acquisition Indebtedness

Debt incurred in acquiring, constructing, or substantially improving a qualified principal or second residence, secured by the residence, with deductible interest limited to loan balances up to $\$750,000$ ($\$1,000,000$ if incurred on or before December 15, 2017).

Charitable Contribution Percentage Ceilings

Limitations based on AGI restricting the annual charitable itemized deduction: $60\%$ of AGI for cash donations to public charities, $50\%$ for ordinary property to public charities, $30\%$ for capital gain property, and a 5-year carryforward for excess contributions.

Independent Contractor vs. Employee

A classification distinction where an employer-employee relationship exists if the employer exercises substantial control over how work is done, provides tools, and offers benefits; self-employed independent contractors report income and deductions for AGI on Schedule C.

Statutory Employee

Workers who are treated as independent contractors for income tax purposes (permitting trade or business expense deductions for AGI on Schedule C) but treated as employees for FICA/Social Security tax purposes.

Automatic Mileage Method

A standard rate method for computing deductible business automobile expenses ($72.5\text{ cents per mile}$ in $2026$) plus parking fees and tolls, used as an alternative to calculating actual operating and depreciation expenses.

Away-from-Home Requirement

The condition for deducting travel expenses (lodging, meals, transportation) requiring the taxpayer to be away from their tax home overnight or for a period substantially longer than an ordinary workday needing rest, sleep, or relief, for a temporary duration of under one year.

Home Office Deduction Methods

Deductions for exclusive and regular business use of a home calculated under either the Regular Method (allocating direct and indirect actual home expenses) or the Simplified Method ($\$5\text{ per sq ft}$ up to $300\text{ sq ft}$, capped at $\$1,500$ without depreciation).

50% Business Meal Limitation

A statutory disallowance rule limiting the deduction for food and beverage expenses incurred with clients or while traveling for trade or business to $50\%$ of the cost.

Educator Expense Deduction

An above-the-line deduction for AGI allowing eligible elementary and secondary school educators working at least $900\text{ hours}$ per school year to deduct up to $\$350$ in $2026$ ($\$300$ in $2025$) of unreimbursed classroom supplies and professional development costs.

Deduction for Tip Income

An above-the-line deduction for AGI of up to $\$25,000$ for qualified tips earned in traditional tip occupations, phasing out at a rate of $\$100$ per $\$1,000$ of MAGI above $\$150,000$ ($\$300,000$ for married taxpayers filing jointly).

Deduction for Overtime Pay

An above-the-line deduction for AGI allowing up to $\$12,500$ ($\$25,000$ for joint filers) of qualified FLSA overtime compensation, phased out by $\$100$ for each $\$1,000$ of MAGI above $\$150,000$ ($\$300,000$ MFJ).

Accountable Plan

An employer expense reimbursement arrangement requiring employees to substantiate all expenses with adequate records and return any excess reimbursement; payments under this plan are excluded from employee gross income.