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Exam 6: Deductions and Losses: in General

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Question 51

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Briefly discuss the two tests that an accrual basis taxpayer must apply before an expense can be deducted.

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The two tests that an accrual basis taxp...

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Question 52

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The cash method can always be used by a corporation even if inventory and cost of goods sold are a significant income-producing factor in the business.

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Question 53

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Aaron, a shareholder-employee of Pigeon, Inc., receives a $300,000 salary. The IRS classifies $100,000 of this amount as unreasonable compensation. The effect of this reclassification is to decrease Aaron's gross income by $100,000 and increase Pigeon's gross income by $100,000.

Tommy, an automobile mechanic employed by an auto dealership, is considering opening a fast-food franchise. If Tommy decides not to acquire the fast-food franchise, any investigation expenses are:

Deductions are allowed unless a specific provision in the tax law provides otherwise.

Albie operates an illegal drug-running business and has the following items of income and expense. What is Albie's adjusted gross income from this operation? $\begin{array}{lr}\text { Income }&\$800,000\\\text { Expenses: }\\\text { Rent } & 24,000 \\\text { Utilities } & 9,000 \\\text { Bribes to police } & 55,000 \\\text { Medical expense } & 5,000 \\\text { Legal fees } & 25,000 \\\text { Depreciation } & 30,000 \\\text { Illegal kickbacks } & 30,000 \\\text { Cost of goods sold } & 300,000\end{array}$

The portion of a shareholder-employee's salary that is classified as unreasonable has no effect on the amount of the shareholder-employee's gross income but results in an increase in the taxable income of the corporation.

Jacques, who is not a U.S. citizen, makes a contribution to the campaign of a candidate for governor. Cassie, a U.S. citizen, also makes a contribution to the same campaign fund. If contributions by noncitizens are illegal under state law, the contribution by Cassie is deductible while that by Jacques is not.

Only under limited circumstances can a loss on the sale of a personal use asset be deducted.

Sandra owns an insurance agency. The following selected data are taken from the agency balance sheet and income statement prepared using the accrual method. $\begin{array} { l r } \text { Revenue } & \$ 250,000 \\\text { Salaries and commissions } & 100,000 \\\text { Rent } & 10,000 \\\text { Insurance } & 5,000 \\\text { Utilities } & 6,000 \\\text { Accounts receivable, } 1 / 1 / 2019 & 40,000 \\\text { Accounts receivable, } 12 / 31 / 2019 & 38,000 \\\text { Accounts payable, } 1 / 1 / 2019 & 12,000 \\\text { Accounts payable, } 12 / 31 / 2019 & 11,000\end{array}$ Calculate Sandra's net profit using the cash method for 2019.

On January 2, 2019, Fran acquires a business from Chuck. Among the assets purchased are the following intangibles: patent with a 7-year remaining life, a covenant not to compete for 10 years, and goodwill. Of the purchase price, $140,000 was paid for the patent and $60,000 for the covenant. The amount of the excess of the purchase price over the identifiable assets was $100,000. What is the amount of the amortization deduction for 2019?

In a related-party transaction where realized loss is disallowed, when can the disallowed loss be used by the buyer on the subsequent sale of the property? In the case of a related-party disallowed loss transaction, can the related- party seller's disallowed loss be used by a taxpayer other than the related-party buyer?

During 2018, the first year of operations, Silver, Inc., pays salaries of $175,000. At the end of the year, employees have earned salaries of $20,000, which are not paid by Silver until early in 2019. What is the amount of the deduction for salary expense?

What losses are deductible by an individual taxpayer?

Robyn rents her beach house for 60 days and uses it for personal use for 30 days during the year. The rental income is $6,000 and the expenses are as follows: $\begin{array} { l r } \text { Mortgage interest } & \$ 9,000 \\\text { Real estate taxes } & 3,000 \\\text { Utilities } & 2,000 \\\text { Maintenance } & 1,000 \\\text { Insurance } & 500 \\\text { Depreciation (rental part) } & 4,000\end{array}$ Using the IRS approach, total expenses that Robyn can deduct on her tax return associated with the beach house are:

Mattie and Elmer are separated and are in the process of obtaining a divorce. They incur legal fees in 2019 for their respective attorneys with the expenses being itemized as follows: $\begin{array}{lrr}\text { For } &{\text { Mattie }} & \text { Elmer } \\\text { General costs of the divorce } & \$ 3,500 & \$ 3,000 \\\text { Determination of dependency exemptions } & 1,500 & -0- \\\text { Property settlement tax consequences } & 400 & 1,500\\&\$5,400&\$4,500\\\end{array}$ Although there is no requirement that he do so, Elmer pays Mattie's lawyer as a gesture of the positive feelings he still has for her. Determine the deductions for Mattie and for Elmer.

Melba incurred the following expenses for her dependent daughter during the current year: $\begin{array} { l r } \text { Payment of principal on daughter's automobile loan } & \$ 3,600 \\\text { Payment of interest on daughter's automobile loan } & 2,900 \\\text { Payment of daughter's property taxes } & 1,800 \\\text { Payment of principal on daughter's personal residence loan } & 2,800 \\\text { Payment of interest on daughter's personal residence loan } & 7,000\end{array}$ How much may Melba deduct in computing her itemized deductions?

Terry and Jim are both involved in operating illegal businesses. Terry operates a gambling business and Jim operates a drug-running business. Both businesses have gross revenues of $500,000. The businesses incur the following expenses. $\begin{array}{lrr}&\text { Terry }&\text { Jim }\\\text { Employee salaries } & \$ 200,000 & \$ 200,000 \\\text { Bribes to police } & 25,000 & 25,000 \\\text { Rent and utilities } & 50,000 & 50,000 \\\text { Cost of goods sold } & -0- & 125,000\end{array}$ Which of the following statements is correct?

Fines and penalties paid for violations of the law (e.g., illegal dumping of hazardous waste) are deductible only if they relate to a trade or business.

Petal, Inc. is an accrual basis taxpayer. Petal uses the aging approach to calculate the reserve for bad debts. During 2019, the following associated with bad debts occur . $\begin{array}{lr}\text { Credit sales } & \$ 400,000 \\\text { Collections on credit sales } & 250,000 \\\text { Amount added to the reserve } & 10,000 \\\text { Beginning balance in the reserve } & -0- \\\text { Identifiable bad debts during 2019 } & 12,000\end{array}$ The amount of the deduction for bad debt expense for Petal for 2019 is: