Tax Implications of Income and Deductions

Interest from corporate bonds

Taxable and included in gross income.

Interest from U.S. government bonds

Taxable and included in gross income.

Interest from municipal bonds

Excluded from gross income.

Interest received on a federal tax refund

Taxable as ordinary income.

Gains on the sale of municipal bonds

Taxable and included in gross income.

True gifts

Excluded from gross income.

Income generated from gifts

Taxable.

Death benefit proceeds from life insurance

Excluded from gross income.

Excess life insurance payouts

Taxable as interest income.

Scholarships

Excluded from gross income if used for tuition, books, and required fees; amounts for room, board, and living expenses are taxable.

Research grants

Taxable as compensation if service is required; excluded if used for qualified education expenses without service requirements.

Payments for medical expenses and pain and suffering from personal injury settlements

Excluded from income.

Punitive damages

Always taxable.

Reimbursement for medical expenses

Included in income under the tax benefit rule if a tax deduction was previously taken.

Meals provided by an employer

Excluded from gross income if for the convenience of the employer and provided on the employer's premises.

Cafeteria plan benefits

Excluded from income if a tax-free benefit is selected; taxable if cash is chosen.

Qualified transportation fringe benefits

Excluded from income up to $315 per month (2024 limit).

No additional cost services

Excluded from gross income (e.g., free airline tickets for airline employees).

De minimis fringe benefits

Excluded from gross income (e.g., free coffee, occasional event tickets).

Employee discounts

Subject to limits and excluded from gross income.

Tax benefit rule for refunds

Refunds for previously deducted expenses are included in income to the extent a tax benefit was received.

Deductible business expense tests

An expense must be ordinary and necessary, reasonable in amount, and directly related to the business activity.

AGI (Above-the-line deductions)

Business expenses (Schedule C), rental expenses (Schedule E), self-employed health insurance.

From AGI (Itemized deductions)

Mortgage interest, medical expenses (7.5% AGI threshold), charitable contributions.

Not deductible

Personal living expenses, moving expenses (except military), personal casualty losses (unless federally declared disaster).

Illegal business expenses

Ordinary and necessary expenses of an illegal business are deductible, except for drug trafficking under §280E of the tax code.

Cost of goods sold (COGS)

The cost of goods sold is still deductible, even for illegal businesses.

Hobby income taxation

Hobby income is taxable, but hobby expenses are not deductible under current law (post-2018).

Reporting hobby income

Hobby income is reported on Schedule 1, Line 8 (Other Income), with no deductions allowed for hobby-related expenses.

Rental income from a vacation home (Rented < 15 days/year)

Rental income is not taxable.

Rental income from a vacation home (Primarily rental use)

Reported on Schedule E, expenses are deductible.

Rental income from a vacation home (Mixed-use)

Expenses are limited to rental income (no loss allowed).

Business bad debts

Business bad debts are deductible as ordinary losses.

Nonbusiness bad debts

Nonbusiness bad debts are deductible only as short-term capital losses.

Treatment of nonbusiness bad debt

Deducted as a short-term capital loss in the year it becomes totally worthless.

Recovery of previously written-off bad debt

The amount recovered is included in gross income, but only to the extent that a tax benefit was received from the original deduction.

Tax outcome of collecting less than 100% on a debt

If not in the lending business, the loss is a capital loss; if in the lending business, the loss is treated as an ordinary loss.

Section 1244 stock

Small business stock issued by a corporation with less than $1M in capital; losses on this stock are treated as ordinary losses up to $50,000 (single) or $100,000 (married filing jointly).

Casualty and theft losses (Business losses)

Deductible For AGI.

Casualty and theft losses (Personal losses)

Deductible only if federally declared disaster.

Formula for deductible casualty and theft losses

Loss - $100 - (10% of AGI) = Deductible Amount.

Qualifying R&D expenditures

Wages, lab supplies, prototype development.

Non-qualifying R&D expenditures

Market research, advertising, consumer surveys.

Deduction of R&D expenses

R&D expenses must be capitalized and amortized over 5 years.

Handling of net operating losses (NOLs)

Post-2018, NOLs can only offset 80% of taxable income and are carried forward indefinitely (no carrybacks).

Calculation of NOL

Start with taxable income, subtract NOL adjustments (e.g., nonbusiness deductions), and exclude standard/itemized deductions.

AGI Deductions Reporting

Reported on Schedule 1 (Form 1040), Part II; Business and rental deductions are on Schedule C or E.

From AGI Deductions Reporting

Reported on Schedule 1 (Form 1040), Part II; Business and rental deductions are on Schedule C or E.

From AGI Deductions (Itemized Deductions) Reporting

Reported on Schedule A (Form 1040).

What is an ordinary loss?

An ordinary loss is a loss that is fully deductible against any type of income in the year it is incurred.

Capital losses are limited to

$3,000 per year ($1,500 for MFS) and can only offset capital gains & a small portion of ordinary income.

What are some examples of ordinary losses?

Business Losses - Losses from a sole proprietorship (Schedule C) or rental property (Schedule E).

§1244 Stock Losses - Up to $50,000 ($100,000 MFJ) of small business stock losses.

Net Operating Loss (NOL) - If business expenses exceed business income, the loss can be carried forward indefinitely.

Theft or Casualty Losses (Business Property) - Fully deductible.