ch 9 tax

Chapter 9: Business Income, Deductions, and Accounting Methods

1. Learning Objectives:
   
   

   • Identify common business deductions.

   • Determine the limits on deducting business expenses.

   • Describe accounting periods available to businesses.

   • Apply cash and accrual methods to determine business income and expense deductions.

2. Gross Receipts Test:
   
   

   • Businesses with gross receipts exceeding $30 million over a 3-year period must use the accrual method.

   • For businesses without 3 years of data, the available period is used.

3. Business Deductions:
   
   

   • Deductions must be ordinary (common and accepted in the industry) and necessary (appropriate and helpful for the business).

   • Expenses must be reasonable, not extravagant.

4. Example of Reasonableness in Deductions:
   
   

   • Rick paid his brother Tom an additional $5 per hour over other part-time employees for educational support, which is deemed unreasonable. Only $2,000 of the $2,500 paid is deductible.

5. Statutory Limits on Business Expense Deductions:
   
   

   • No deductions for fines, bribes, lobbying, or political contributions.

   • No deductions for expenses related to tax-exempt income, such as interest on municipal bonds or certain insurance premiums.

6. Capital Expenditures and the 12-Month Rule:
   
   

   • Capitalize expenses that provide benefits beyond the current year.

   • Prepaid expenses with benefits not exceeding 12 months and not extending beyond the end of the next tax year can be deducted.

7. Example of the 12-Month Rule:
   
   

   • Ben can deduct $10,000 for utilities, $3,000 for insurance, and $7,200 for interest, based on how the 12-month rule applies to each expense type.

8. Business Expenses with Personal Benefits:
   
   

   • No deductions for purely personal expenses.

   • Business travel deductions vary based on the primary motive of the trip (business vs. personal).

9. Business Interest Limitation:
   
   

   • Limitation does not apply if average annual gross receipts are $30 million or less.

   • Interest deduction is limited to business interest income plus 30% of adjusted taxable income.

10. Examples of Business Asset Sales and Interest Limitations:
    
    

    • Losses from business property sales are deductible unless sold to related parties.

    • Detailed example calculating business interest deduction limits based on income and expenses.

11. Accounting Methods:
    
    

    • Cash Method: Recognize income when received and expenses when paid.

    • Accrual Method: Recognize income when earned and expenses when incurred.

12. Choosing and Changing Accounting Methods:
    
    

    • Method changes usually require IRS permission.

    • Automatic changes are allowed in some circumstances, but correcting the use of an impermissible method requires approval.