Basic Income Tax 2015-2016 William Kratzke
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- Moss v. Commissioner
Walliser v. Commissioner, 72 T.C. 433 (1979). TANNENWALD, Judge: .... FINDINGS OF FACT .... During the taxable years 1973 and 1974, James [Walliser] was vice president and branch manager of the First Federal Savings & Loan Association (First Federal) of Dallas, Tex., Richardson branch office. James began his career at First Federal as a trainee in mortgage lending and an appraiser. He later became a branch manager and a loan production officer. Subsequent to the taxable years at issue, James was made the head of the interim loan department of First Federal. Prior to his initial association with First Federal in 1964, James was primarily engaged in the business of home building in Dallas County, Tex. As branch manager of the Richardson office of First Federal, James supervised all aspects of the branch’s operations, but his primary responsibility was the marketing of permanent and interim loans. James was assigned loan production quotas, and he expected to receive annual raises in his salary if he met his yearly quotas, although First Federal was under no commitment to give James a raise in salary or a bonus if a quota was met. ... James met his quotas and received salary raises at the end of 1973 and 1974. During the taxable years at issue, petitioners traveled abroad in tour groups organized primarily for people involved in the building industry. In 1973, petitioners took two such trips. The first was to Rio de Janeiro and was sponsored by General Electric Co. (General Electric). It began on March 23, 1973, and ended on March 31, 1973. Their second trip, to London and Copenhagen, was sponsored by Fedders Co. (Fedders) and ran from October 3, 1973, to October 15, 1973. In 1974, petitioners went to Santo Domingo on a tour organized by Fedders which began on September 27, 1974, and ended on October 4, 1974. .... The majority of the people on a General Electric or Fedders builders’ tour were builders and developers from Texas and their spouses. The group also included lenders, title company personnel, and other users and distributors of the sponsor’s product. The dealers and builders who participated in the Fedders builders’ tours did so as part of the Fedders incentive program through which they were able to earn the cost of the tours in whole or in part by purchasing or selling a certain amount of central air conditioning equipment in a particular year. Fedders presented awards during the tours to some people it considered outstanding in its sales and promotional programs but conducted no business meetings. The builders’ tours were arranged as guided vacation trips, with sightseeing and other recreational activities. Petitioners, however, went on the tours because James found that they provided an unusual opportunity to associate with many potential and actual customers and believed that the tours would generate business, thereby helping him to meet his loan production quotas and obtain salary raises. He spent as much time as possible talking with builders whom he already knew and getting acquainted with builders he had not previously met to make them aware of First Federal’s services and of his own skills. His conversations frequently centered on conditions in the building industry and the availability of loans for builders, but he did not negotiate specific business transactions on the tours or conduct formal business meetings. Social relationships formed or renewed on the tours between petitioners and builders and their spouses resulted in a substantial amount of loan business for First Federal. .... Prior to 1973, First Federal had paid for James to participate in builders’ tours. During 1973 and 1974, First Federal stopped reimbursing employees for a variety of previously reimbursed expenses as part of a program of overall budget cutbacks. During the taxable years in issue, First Federal’s policy was to pay entertainment costs directly, or to provide reimbursement for expenses, when an officer of First Federal entertained current customers of the company at civic, social, or business meetings. The company did not customarily reimburse officers for the costs of goodwill meetings or trips for current customers along with prospective customers; however, the board of directors expected the officers, especially vice presidents in charge of marketing activities, to be active in cultivating new customers. First Federal did not reimburse petitioners for any travel expenses incurred in connection with the Fedders and General Electric tours taken by them in 1973 and 1974. James was, however, given leave with pay, in addition to his normal 2-week paid vacation, in order to participate in the tours. .... On their 1973 and 1974 tax returns, petitioners deducted, as employee business expenses, one-half of the price of each of the tours (the portion attributable to James’ travel) ... OPINION Initially, we must determine whether petitioners are entitled, under § 162, to deduct as employee business expenses costs incurred by James in connection with his travel on tours for builders organized by General Electric and Fedders. If we hold that the requirements of that section are satisfied, then we must face the further question as to the extent to which the limitations of § 274 apply. Section 162(a)(2) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including traveling expenses incurred while away from home in the pursuit of a trade or business. The question is essentially one of fact. [citations omitted] Petitioners must show that the expenses were incurred primarily for business rather than social reasons and that there was a proximate relation between the cost of the builders’ tours and James’ business as an officer of First Federal. [citations omitted]. James’ primary responsibility as an officer of First Federal was marketing loans. He was assigned loan production quotas and considered yearly increases in his salary to be contingent upon meeting those quotas. The participants in the General Electric and Fedders tours were not a random group of Texas vacationers. On the contrary, they were largely builders and developers from Texas, the area in which First Federal operated. Thus, the tours were a useful means of maintaining relations with existing customers of First Federal and reaching prospective customers. Indeed, the record indicated that some of the participants considered the social relationships with James, including their association with him on the tours, as an influencing factor in their decisions to seek loans from First Federal. The fact that, during the years at issue, First Federal did not reimburse James for the costs of his travel does not render his expenses nondeductible. Where a corporate officer personally incurs expenditures which enable him to better perform his duties to the corporation and which have a direct bearing on the amount of his compensation or his chances for advancement, unreimbursed expenses may be deductible under § 162. [citations omitted].135 First Federal expected its officers in charge of marketing activities to participate in public or social functions without reimbursement and examined their performance in this regard when evaluating their compensation and overall value to the company. [citation omitted]. James met his loan quotas in 1973 and 1974 and received raises in his salary at the end of those years. In a later year, he became head of First Federal’s interim loan department. Moreover, the evidence tends to show that First Federal considered the trips valuable in generating goodwill. Although First Federal, which was in the midst of a program of budget cutbacks in 1973 and 1974, did not reimburse James for the tours as it had done in prior years, it continued to grant him additional leave with pay for the time he was on the tours. Finally, the testimony of petitioners, and particularly of Carol, which we found straightforward and credible, tended to show that the tours were strenuous, and not particularly enjoyable, experiences because of the amount of time expended in cultivating business and, therefore, that petitioners did not undertake the tours for primarily personal reasons. [They took family vacations to other destinations.] We conclude that, under the circumstances of this case, the requisite proximate relation has been shown to constitute James’ travel expenses as “ordinary and necessary” business expenses within the meaning of § 162(a)(2). We now turn our attention to the applicability of § 274, the issue on which respondent has concentrated most of his fire. That section disallows a deduction in certain instances for expenses which would otherwise be deductible under § 162. Respondent argues that the requirements of § 274 are applicable here and have not been satisfied in that petitioners have failed: (1) To show that James’ trips were “directly related” to the active conduct of his business (§ 274(a)) ... Section 274(a) provides in part: (a) ENTERTAINMENT, AMUSEMENT, OR RECREATION.— (1) IN GENERAL. – No deduction otherwise allowable under this chapter shall be allowed for any item— (A) ACTIVITY. – With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer’s trade or business, *** and such deduction shall in no event exceed the portion of such item directly related to, or, in the case of an item described in subparagraph (A) directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), the portion of such item associated with, the active conduct of the taxpayer’s trade or business. Petitioners urge that the “directly related” test of § 274(a) is not applicable because the expenditures at issue were incurred for travel, not entertainment. We disagree. Section 274(a) relates to activities of a type generally considered to constitute “entertainment, amusement, or recreation.” Reg. § 1.274-2(b) defines “entertainment, amusement, or recreation” as follows: (b) Definitions – (1) Entertainment defined – (i) In general. For purposes of this section, the term “entertainment” means any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family. *** (ii) Objective test. An objective test shall be used to determine whether an activity is of a type generally considered to constitute entertainment. Thus, if an activity is generally considered to be entertainment, it will constitute entertainment for purposes of this section and § 274(a) regardless of whether the expenditure can also be described otherwise, and even though the expenditure relates to the taxpayer alone. This objective test precludes arguments such as that “entertainment” means only entertainment of others or that an expenditure for entertainment should be characterized as an expenditure for advertising or public relations. (Emphasis added.) This regulation is squarely based on the language of the legislative history of § 274 and we find it to be valid as it relates to the issue herein.136 This regulation and the Congressional committee reports from which it is derived leave no doubt that the deductibility of an expenditure for travel, on what would objectively be considered a vacation trip, is subject to the limitations of subsection 274(a), even where the expenditure relates solely to the taxpayer himself. [citations omitted]. Furthermore, Reg. § 1.274-2(b)(1)(iii) provides that “any expenditure which might generally be considered *** either for travel or entertainment, shall be considered an expenditure for entertainment rather than for *** travel.” This regulation too has a solid foundation in the statute, which provides, in [§ 274(o)], authority for the promulgation of regulations necessary to carry out the purpose of § 274 [footnote omitted] and in the committee reports, which provide that rules be prescribed for determining whether § 274(a) should govern where another section is also applicable. H. Rept. 1447, supra; S. Rept. 1881, supra. Although the participants in the tours that petitioners took were drawn, for the most part, from the building industry, their activities – sightseeing, shopping, dining – were the same as those of other tourists. Fedders presented some awards to persons considered outstanding in its sales or promotional programs on the tours but did not conduct any business meetings. Nor is there any evidence that any business meetings were conducted on the 1973 General Electric tour; on the itinerary for the 1974 tour, for which petitioners canceled their reservation, only 1 hour out of 10 days of guided tours, dinners, and cocktail parties, was set aside for a business meeting. Under the objective test set forth in the regulations, it is irrelevant that petitioners did not regard the trips as vacations or did not find them relaxing. Clearly, the tours were of a type generally considered vacation trips and, thus, under the objective test, constituted entertainment for the purposes of § 274(a). Therefore, the requirements of that section must be satisfied. For a deduction to be allowed for any item under § 274(a)(1)(A), the taxpayer must establish that the item was directly related to the active conduct of the taxpayer’s trade or business or, in the case of an item directly preceding or following a substantial and bona fide business discussion, that such item was associated with the active conduct of the taxpayer’s trade or business. The “directly related” test requires that a taxpayer show a greater degree of proximate relationship between an expenditure and the taxpayer’s trade or business than that required by § 162. [citations omitted]. Reg. § 1.274-2(c)(3) provides that, for an expenditure to be directly related to the active conduct of the taxpayer’s trade or business, it must be shown that the taxpayer had more than a general expectation of deriving some income or business benefit from the expenditure, other than the goodwill of the person or persons entertained. While the language of this regulation is awkward and not completely apt in a situation where the entertainment expenditure relates to the taxpayer alone, it is clear, nevertheless, that more than a general expectation of deriving some income at some indefinite future time is necessary for an expenditure to be deductible under § 274(a). [citations omitted]. The record shows that petitioners participated in the builders’ tours because they provided an opportunity for James to meet new people who might be interested in the services he, and First Federal, had to offer and to maintain good personal relations with people already using those services. While James discussed business continually during the tours, his wife testified that this was typical of his behavior during all social activities. He engaged in general discussions about business conditions and the services he could provide to a builder but did not engage in business meetings or negotiations on the tours. James could not directly connect particular business transactions with specific discussions which occurred during the trips. [footnote omitted]. In short, petitioners’ purpose in taking the trips was to create or maintain goodwill for James and First Federal, his employer, in order to generate some future business. Although the evidence tends to indicate that the trips did, in fact, enhance goodwill and contribute to James’ success in loan production and otherwise constituted ordinary and necessary business expenses deductible under § 162, we hold, nevertheless, that Congress intended, by means of the more stringent standard of the “directly related” test in § 274(a), to disallow deductions for this type of activity, which involves merely the promotion of goodwill in a social setting. [citation omitted]. We also hold that the petitioners’ trips do not qualify as entertainment “associated with” the active conduct of a trade or business. To be deductible, entertainment “associated with” the active conduct of a trade or business must directly precede or follow a substantial business discussion. In St. Petersburg Bank & Trust Co. v. United States, [362 F. Supp. 674 (M.D. Fla. 1973), aff’d in an unpublished order, 503 F.2d 1402 (5th Cir. 1974)], a decision affirmed by the Fifth Circuit, the District Court concluded that the phrase “directly preceding or following” in § 274(a)(1)(A) should be read restrictively in cases in which entertainment expenditures are related to the taxpayer’s trade or business only in that they promote goodwill. [footnote omitted]. In view of the legislative history, which reveals that the “associated with” test is an exception to the general rule intended to limit deductions for entertainment which has as its sole business purpose the promotion of goodwill [footnote omitted], we agree with the District Court’s conclusion. Accordingly, we do not consider the costs of the vacation trips to be deductible under § 274(a)(1)(A) as entertainment directly preceded or followed by a substantial and bona fide business discussion merely because James had general discussions of a business nature intended to promote goodwill during the course of the trips. [citation omitted]. We conclude that § 274(a) bars a deduction for the costs of James’ trips. ... Decision will be entered for the respondent. Notes and Questions: 1. Is it appropriate that § 274 denies this taxpayer a deduction when § 162 permits it? 2. Suppose that taxpayer Walliser could prove that he actually closed a lending deal (except for documentary formalities) with a person he met and conversed with extensively about his bank’s lending services. The borrower came by the bank three days after the end of the tour and signed the necessary documents. Would (should) the result be different? •Suppose that at the end of the signing formalities, Walliser gave the borrower two tickets which cost $25 each to that night’s baseball game. The borrower happily accepted. Walliser did not attend the game with the borrower. Should Walliser be permitted to deduct the cost of the baseball tickets? •Would it make any difference if the tickets cost $60 each? Moss v. Commissioner, 758 F.2d 211 (7th Cir. 1985) POSNER, Circuit Judge The taxpayers, a lawyer named Moss and his wife, appeal from a decision of the Tax Court disallowing federal income tax deductions of a little more than $1,000 in each of two years, representing Moss’s share of his law firm’s lunch expense at the Café Angelo in Chicago. The Tax Court’s decision in this case has attracted some attention in tax circles because of its implications for the general problem of the deductibility of business meals. See, e.g., McNally, Vulnerability of Entertainment and Meal Deductions Under the Sutter Rule, 62 Taxes 184 (1984). Moss was a partner in a small trial firm specializing in defense work, mostly for one insurance company. Each of the firm’s lawyers carried a tremendous litigation caseload, averaging more than 300 cases, and spent most of every working day in courts in Chicago and its suburbs. The members of the firm met for lunch daily at the Café Angelo near their office. At lunch the lawyers would discuss their cases with the head of the firm, whose approval was required for most settlements, and they would decide which lawyer would meet which court call that afternoon or the next morning. Lunchtime was chosen for the daily meeting because the courts were in recess then. The alternatives were to meet at 7:00 a.m. or 6:00 p.m., and these were less convenient times. There is no suggestion that the lawyers dawdled over lunch, or that the Café Angelo is luxurious. The framework of statutes and regulations for deciding this case is simple, but not clear. Section 262 of the Internal Revenue Code disallows, ”except as otherwise expressly provided in this chapter,” the deduction of ”personal, family, or living expenses.” Section 119 excludes from income the value of meals provided by an employer to his employees for his convenience, but only if they are provided on the employer’s premises; and § 162(a) allows the deduction of ‘”all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including – ... (2) traveling expenses (including amounts expended for meals ...) while away from home....’” Since Moss was not an employee but a partner in a partnership not taxed as an entity, since the meals were not served on the employer’s premises, and since he was not away from home (that is, on an overnight trip away from his place of work, see United States v. Correll, 389 U.S. 299 (1967)), neither § 119 nor § 162(a)(2) applies to this case. The Internal Revenue Service concedes, however, that meals are deductible under § 162(a) when they are ordinary and necessary business expenses (provided the expense is substantiated with adequate records, see § 274(d)) even if they are not within the express permission of any other provision and even though the expense of commuting to and from work, a traveling expense but not one incurred away from home, is not deductible. Reg. § 1.262-1(b)(5); Fausner v. Commissioner, 413 U.S. 838 (1973) (per curiam). The problem is that many expenses are simultaneously business expenses in the sense that they conduce to the production of business income and personal expenses in the sense that they raise personal welfare. This is plain enough with regard to lunch; most people would eat lunch even if they didn’t work. Commuting may seem a pure business expense, but is not; it reflects the choice of where to live, as well as where to work. Read literally, § 262 would make irrelevant whether a business expense is also a personal expense; so long as it is ordinary and necessary in the taxpayer’s business, thus bringing § 162(a) into play, an expense is (the statute seems to say) deductible from his income tax. But the statute has not been read literally. There is a natural reluctance, most clearly manifested in the regulation disallowing deduction of the expense of commuting, to lighten the tax burden of people who have the good fortune to interweave work with consumption. To allow a deduction for commuting would confer a windfall on people who live in the suburbs and commute to work in the cities; to allow a deduction for all business-related meals would confer a windfall on people who can arrange their work schedules so they do some of their work at lunch. Although an argument can thus be made for disallowing any deduction for business meals, on the theory that people have to eat whether they work or not, the result would be excessive taxation of people who spend more money on business meals because they are business meals than they would spend on their meals if they were not working. Suppose a theatrical agent takes his clients out to lunch at the expensive restaurants that the clients demand. Of course he can deduct the expense of their meals, from which he derives no pleasure or sustenance, but can he also deduct the expense of his own? He can, because he cannot eat more cheaply; he cannot munch surreptitiously on a peanut butter and jelly sandwich brought from home while his client is wolfing down tournedos Rossini followed by souffle au grand marnier. No doubt our theatrical agent, unless concerned for his longevity, derives personal utility from his fancy meal, but probably less than the price of the meal. He would not pay for it if it were not for the business benefit; he would get more value from using the same money to buy something else; hence the meal confers on him less utility than the cash equivalent would. The law could require him to pay tax on the fair value of the meal to him; this would be (were it not for costs of administration) the economically correct solution. But the government does not attempt this difficult measurement; it once did, but gave up the attempt as not worth the cost, see United States v. Correll, supra, 389 U.S. at 301 n. 6. The taxpayer is permitted to deduct the whole price, provided the expense is ‘”different from or in excess of that which would have been made for the taxpayer’s personal purposes.’” Sutter v. Commissioner, 21 T.C. 170, 173 (1953). Because the law allows this generous deduction, which tempts people to have more (and costlier) business meals than are necessary, the Internal Revenue Service has every right to insist that the meal be shown to be a real business necessity. This condition is most easily satisfied when a client or customer or supplier or other outsider to the business is a guest. Even if Sydney Smith was wrong that ‘”soup and fish explain half the emotions of life,’” it is undeniable that eating together fosters camaraderie and makes business dealings friendlier and easier. It thus reduces the costs of transacting business, for these costs include the frictions and the failures of communication that are produced by suspicion and mutual misunderstanding, by differences in tastes and manners, and by lack of rapport. A meeting with a client or customer in an office is therefore not a perfect substitute for a lunch with him in a restaurant. But it is different when all the participants in the meal are coworkers, as essentially was the case here (clients occasionally were invited to the firm’s daily luncheon, but Moss has made no attempt to identify the occasions). They know each other well already; they don’t need the social lubrication that a meal with an outsider provides – at least don’t need it daily. If a large firm had a monthly lunch to allow partners to get to know associates, the expense of the meal might well be necessary, and would be allowed by the Internal Revenue Service. See Wells v. Commissioner, 36 T.C.M. 1698, 1699 (1977), aff’d without opinion, 626 F.2d 868 (9th Cir. 1980). But Moss’s firm never had more than eight lawyers (partners and associates), and did not need a daily lunch to cement relationships among them. It is all a matter of degree and circumstance (the expense of a testimonial dinner, for example, would be deductible on a morale-building rationale); and particularly of frequency. Daily – for a full year – is too often, perhaps even for entertainment of clients, as implied by Hankenson v. Commissioner, 47 T.C.M. 1567, 1569 (1984), where the Tax Court held nondeductible the cost of lunches consumed three or four days a week, 52 weeks a year, by a doctor who entertained other doctors who he hoped would refer patients to him, and other medical personnel. We may assume it was necessary for Moss’s firm to meet daily to coordinate the work of the firm, and also, as the Tax Court found, that lunch was the most convenient time. But it does not follow that the expense of the lunch was a necessary business expense. The members of the firm had to eat somewhere, and the Café Angelo was both convenient and not too expensive. They do not claim to have incurred a greater daily lunch expense than they would have incurred if there had been no lunch meetings. Although it saved time to combine lunch with work, the meal itself was not an organic part of the meeting, as in the examples we gave earlier where the business objective, to be fully achieved, required sharing a meal. The case might be different if the location of the courts required the firm’s members to eat each day either in a disagreeable restaurant, so that they derived less value from the meal than it cost them to buy it, cf. Sibla v. Commissioner, 611 F.2d 1260, 1262 (9th Cir. 1980); or in a restaurant too expensive for their personal tastes, so that, again, they would have gotten less value than the cash equivalent. But so far as appears, they picked the restaurant they liked most. Although it must be pretty monotonous to eat lunch the same place every working day of the year, not all the lawyers attended all the lunch meetings and there was nothing to stop the firm from meeting occasionally at another restaurant proximate to their office in downtown Chicago; there are hundreds. An argument can be made that the price of lunch at the Café Angelo included rental of the space that the lawyers used for what was a meeting as well as a meal. There was evidence that the firm’s conference room was otherwise occupied throughout the working day, so as a matter of logic Moss might be able to claim a part of the price of lunch as an ordinary and necessary expense for work space. But this is cutting things awfully fine; in any event Moss made no effort to apportion his lunch expense in this way. AFFIRMED. Notes and Questions: 1. Walliser was a § 274 case. Moss was not. Why not? 2. What requirement of deductibility under § 162 did taxpayer fail to meet? 3. If this firm had only monthly lunches, the court seems to say that the cost of those lunches might have been deductible. Why should such meals be treated differently than the daily lunches at Café Angelo? 4. Another limitation on §§ 162 and 212 is § 280A, which limits taxpayer’s deductions for business use of a home. Section 280A limits deductions for business use of a dwelling unit that taxpayer (individual or S corporation) uses as a residence. Section 280A(a) provides taxpayer is entitled to no deduction for such use “[e]xcept as otherwise provided in” § 280A itself. Section 280A(c) provides those exceptions. •Section 280A(c)(1) permits deductions when taxpayer regularly uses a portion of the dwelling “exclusively” •as a principal place of business, including a place that taxpayer uses for administrative or management activities of taxpayer’s trade or business, and there is no other fixed location where taxpayer conducts substantial management or administrative activities, •as a place of business that patients, clients, or customers use to meet with taxpayer “in the normal course of his trade or business,” OR •in connection with taxpayer’s trade or business “in the case of a separate structure which is not attached to the dwelling unit.” •Section 280A(c)(2) permits deductions when taxpayer regularly uses space in the dwelling unit to store inventory or product samples that taxpayer sells at retail or wholesale, provided the dwelling unit is the only fixed location of taxpayer’s trade or business. •Section 280A(c)(3) permits deductions when they are attributable to rental of the dwelling unit. •Section 280A(c)(4) permits deductions attributable to use of a portion of the dwelling unit for licensed child or dependent care services. Section 280A(c)(5) limits the amount of any deductions attributable to business use of the home to the gross income that taxpayer derives from such use. § 280A(c)(5)(A). Section 280A(c)(5) and Prop. Reg. § 1-280A(i) provide a sequence in which taxpayer may claim deductions attributable to the business activity. 1. the gross income that taxpayer derives from use of a dwelling unit in a trade or business does not include “expenditures required for the activity but not allocable to use of the unit itself, such as expenditures for supplies and compensation paid to other persons.” Prop. Reg. § 1.280A-2(i)(2)(iii). 2. deductions attributable to such trade or business and allocable to the portion of the dwelling unit that taxpayer uses that the Code would allow taxpayer even if he/she/it did not conduct a trade or business in the dwelling unit, e.g., real property taxes, § 164(a)(1), mortgage interest, § 163(h)(2)(D). 3. deductions attributable to such trade or business use that do not reduce basis, e.g., utilities, homeowners’ insurance. 4. basis-reducing deductions, i.e., depreciation. If taxpayer’s deductions exceed his/her/its gross income derived from the business use of the dwelling unit that he/she/it uses as a home, taxpayer may carry those deductions forward to succeeding years. •Notice that unless taxpayer operates a trade or business in the home that is genuine, in the sense that it is profitable, it is unlikely that taxpayer will ever be able to exploit all of the deductions that business use of a home would generate. A taxpayer who does not carry on a profitable trade or business in the home will likely carry forward unused deductions forever. •Notice also that the sequence of deductions that § 280A(c)(5) and Prop. Reg. § 1.280A-2(i) mandate requires taxpayer to “use up” the deductions to which he/she/it would be entitled – even if taxpayer did not use his/her/its dwelling unit for business activities, i.e., direct expenses of the business itself followed by deductions to which taxpayer is entitled in any event. •The deductions that might motivate taxpayer to claim business use of a home are the ones to which he/she/it would not otherwise be entitled to claim, e.g., a portion of homeowners’ insurance, utilities, other expenses of home ownership, and (perhaps most importantly) depreciation. Those deductions may be effectively out of reach.
5. Do the CALI Lesson, Basic Federal Income Taxation: Deductions: Trade or Business Deductions. Hopefully, you will find some of it to be in the nature of review. 3. Education Expenses 
Do CALI Lesson, Basic Federal Income Taxation: Deductions: Education Expenses •Read Reg. § 1.162-5. •Read §§ 274(m)(2), 274(n). A taxpayer may incur expenses for various educational activities, e.g., training, that he/she/it may deduct as ordinary and necessary business expenses. Recall that in Welch v. Helvering, the Court indicated that investment in one’s basic education is a nondeductible investment in human capital. Not surprisingly, then, the regulations draw lines around education undertaken to meet the minimum requirements of a particular trade or business or to qualify for a new trade or business. Reg. § 1.162-5 implements these distinctions. Reg. § 1.162-5(a) states the general rule that expenditures made for education are deductible, even when those expenditures may lead to a degree, if the education – “(1) Maintains or improves skills required by the individual in his employment or other trade or business, or (2) Meets the express requirements of the individual’s employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship status, or rate of compensation.” Id. However, even expenditures that meet one of these two conditions are nevertheless not deductible if – •the expenditures are “made by an individual for education which is required of him in order to meet the minimum educational requirements for qualification in his employment or other trade or business. ... The fact that an individual is already performing service in an employment status does not establish that he has met the minimum educational requirements for qualification in that employment. Once an individual has met the minimum educational requirements for qualification in his employment or other trade or business (as in effect when he enters the employment or trade or business), he shall be treated as continuing to meet those requirements even though they are changed.” Reg. § 1.162-5(b)(2)(i). OR •the expenditures are “made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business.” Reg. § 1.162-5(b)(3)(i). Consider: Pere Alegal works for a downtown Memphis law firm. He works under the supervision of attorneys, but in many respects he does the same type of work that attorneys do. The firm’s partners advise Alegal that if he does not obtain a law license, he will not be retained. Alegal therefore enrolled in one of the nation’s best-value law schools. Pere will continue to work for the firm. Alegal incurs costs for tuition, books, etc. At the end of the educational program, Alegal passed the bar examination and obtained a license to practice law. Alegal continues to work for the firm and in fact his job functions did not change at all. •If Alegal sought to deduct the expenses of his legal education, could he argue that his job functions did not change at all once he obtained his law license? •Is it relevant that a law license did not cause Alegal to take up a new trade or business? 4. Section 172
•Read § 172(c). It defines a “net operating loss” (NOL) to be the excess of deductions allowed over gross income. •Read § 172(d). Its effect is to limit the deductions that would “take taxpayer’s taxable income negative” to essentially trade or business expenses. For individual taxpayers, capital losses are deductible only to the extent of capital gains, § 172(d)(2)(A); no deduction is allowed for personal exemptions, § 172(d)(3); nonbusiness deductions are allowed only to the extent of taxpayer’s non-trade or business income, § 172(d)(4); the § 199 domestic production deduction is not allowed, § 172(d)(7). •Section 172(a) permits NOL carryovers and carrybacks to reduce taxpayer’s taxable income. •An NOL carryback is first allowed against the taxable income of each of the two taxable years preceding the taxable year of the net loss. § 172(b)(1)(A)(i). •An NOL carryover is allowed against the taxable income of each of the 20 years following the taxable year of the net loss. § 172(b)(1)(A)(ii).137 •A taxpayer must use carrybacks and carryovers beginning with the earliest taxable year and then apply them to each succeeding year. § 172(b)(2). The taxable income against which an NOL may be used is computed without regard to capital losses or personal exemptions. § 172(b)(2)(A). A taxpayer may waive the entire carryback period. § 172(b)(3). •The carryback period is extended to three years in the case of NOLs caused by casualties, federally declared disasters, and certain farming losses. § 172(b)(1)(F). •The effect of any extension of the carryback period is to get money into the pockets of the affected taxpayer(s) quickly. A casualty or natural disaster likely causes significant losses to the affected taxpayer in the year of the disaster. A carryforward deduction will only benefit such taxpayers in the future. Such taxpayers may have been (quite) profitable in the immediately preceding years and paid a significant amount in federal income tax. An extension of the carryback period permits affected taxpayers to recoup more of such income taxes paid sooner. •One measure to deal with the economic crisis is § 172(b)(1)(H). This provision permits a taxpayer to extend the carryback period to 3, 4, or 5 years for an operating loss occurring in 2008 or 2009. § 172(b)(1)(H)(i and ii). Taxpayer may make this election only with respect to one taxable year. § 172(b)(1)(H)(iii)(I). •A 5-year carryback is limited to 50% of the taxpayer’s taxable income as of the carryback year, computed without regard to the NOL for the loss year or any other succeeding loss year whose NOL would be carried back. § 172(b)(2)(H)(iv)(I). •Presumably, a taxpayer would choose a carryback period that would maximize his/her refund. Consider: In 2011, taxpayer had net losses of $500,000. Redetermine taxpayer’s taxable income under the rules of § 172 if taxpayer’s taxable income would otherwise have been the following amounts for the years in question. •2009: $50,000 •2010: $75,000 •2011: ? •2012: $110,000 •2013: $165,000 •2014: $200,000 •2015: $100,000 •2016: $60,000 D. Special Rules to Encourage Manufacturing and Exploitation of Natural Resources 1. Section 199: Income Attributable to Domestic Production Activities In order to encourage taxpayers to engage in manufacturing trades or businesses in the United States, Congress enacted § 199. Section 199(a) allows a deduction of 9% of a taxpayer’s “qualified production activities income” or the taxpayer’s taxable income determined without regard to § 199 – whichever is less. A taxpayer’s “qualified production activities income” is taxpayer’s net (§ 199(c)(1)) income derived from “ any lease, rental, license, sale, exchange, or other disposition of” (§ 199(c)(4)(A)(i)) •tangible personal property, computer software, or sound recording, § 199(c)(5), •a film if at least 50% of the compensation relating to its production is for services performed in the United States, §§ 199(c)(A)(i)(II), 199(c)(6), or •“electricity, natural gas, or potable water produced by the taxpayer in the United States. § 199(c)(4)(A)(i)(III). Such income also includes income derived from – •“construction of real property performed in the United States by the taxpayer in the ordinary course of” his/her/its trade or business, § 199(c)(4)(A)(ii), or •engineering or architectural services performed in the United States by the taxpayer in the ordinary course of his/her/its trade or business, § 199(c)(4)(iii).
2. Section 611: The Depletion Deduction Section 611(a) provides for a deduction in computing taxable income for depletion. This deduction is available for “mines, oil and gas wells, other natural deposits, and timber[.]”138 The depletion allowance deduction is similar to the depreciation deduction, infra, in that both deductions are a form of cost recovery of capital investments. Unlike the depreciation deduction, which is an allowance for the gradual consumption of an asset that the taxpayer uses to produce a product (or to provide a service), the depletion allowance deduction is an allowance for the cost recovery of wasting assets that are the product.139 The depletion allowance is part of the cost of the thing that the taxpayer sells. Congress enacted the depletion allowance deduction as a means for fossil fuel companies and mine operators to deduct an amount equal to the reduction in value of their mineral reserves as they extracted and sold the mineral. § 611(a). The deduction allows a taxpayer to recover its capital investment so that the investment will not diminish as the minerals are extracted and sold.140 Despite this purpose, there is no requirement that the taxpayer invest any money in the mineral rights,141 and taxpayer does not have to have legal title to take advantage of the deduction.142 First codified in 1913, the depletion allowance deduction was originally limited to mines – and only 5% of the gross value of a mine’s reserves could be deducted in a year.143 Over time, the depletion allowance deduction has expanded to include resources other than mining – such as oil, gas, and timber – and to allow for deductions greater than 5%. Anyone with an “economic interest” may share144 in the depletion allowance deduction.145 “An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place or standing timber and secures, by any form of legal relationship, income derived from the extraction of the mineral or severance of the timber, to which he must look for a return of his capital.”146 A broad range of economic interests exists whose owners may claim the depletion allowance deduction. There are now two ways to calculate a depletion allowance deduction, and taxpayer chooses the one that yields the greater deduction. However, taxpayer may not choose percentage depletion in the case of an interest in timber.147 Cost Depletion: Under cost depletion, taxpayer allocates annually an equal amount of basis148 to each recoverable unit.149 Taxpayer may claim the deduction when it sells the unit150 or cuts the timber.151 Depletion allowance deductions – allowed or allowable – reduce taxpayer’s basis in the property until the basis is $0.152 At that time, taxpayer may shift to percentage depletion, except when taxpayer claims depletion allowance deductions for timber. Recapture of depletion allowance deductions upon sale or exchange of the property is subject to income taxation at ordinary income rates.153 Percentage Depletion: Percentage depletion is a deduction based on a specified percentage of taxpayer’s gross income from the activity154 up to 50% of the taxable income from the activity.155 The limit is 100% of taxable income from oil and gas properties.156 However, Sections 613(d) and 613A disallow any depletion allowance deduction for oil and gas wells, except for some small independent producers and royalty owners of domestic oil and gas.157 Their percentage depletion allowance deduction is 15%158 of gross income, limited to 65% of taxable income.159 A percentage depletion allowance deduction is available even though taxpayer has no basis remaining in the asset. The percentage depletion method serves to encourage the further development and exploitation of certain natural resources. This is important in a time when we believe that preservation of natural resources should be national policy.160 In recent years, depletion allowance deductions have increased significantly: in 2003, total corporate depletion allowance deductions were nearly $10.2 billion, while in 2009, total corporate depletion allowance deductions rose to more than $21.5 billion.161 Directory: sites -> default -> files files -> Answer True False 2 points Question 2 files -> Northern England’s set-jetting locations files -> Nstructions for Acquiring Excess Equipment online, through the 1033 Program files -> Occupational health and safety files -> The Black Panther Party’s Ten Point Program files -> International programs roel profile files -> Fermi Questions a guide for Teachers, Students, and Event Supervisors Lloyd Abrams, Ph. D. DuPont Company, cr&D/ccas experimental Station Wilmington, de 19880 files -> Personal Information Name: Maha Al-Ammari Nationality: Saudi Relationship Status Download 2.25 Mb. Share with your friends:
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