CHAPTER 7
                          Bad Debts
• Rules:
  – All
     • Retail
           – Only deductible if included in income
     • Direct writeoff
     • Basis calculation
     • Subsequent collections (tax benefit rule)
  – Business
     • May deduct when partially worthless
     • Ordinary loss
  – Nonbusiness
     • May only deduct when fully worthless
     • Short-term capital loss (subject to the $3,000/$1,500
                      Bad Debts
• Related party loans
  – Gift vs. loan
  – To determine consider
     •   Was a note properly executed
     •   Was there a reasonable rate of interest charged
     •   Was collateral provided
     •   Were collection efforts made
     •   What was the intent of the parties
          Worthless Securities
• Securities
  – Must be COMPLETELY worthless
  – Capital loss (Subject to the $1,500/$3,000
  – Assumed to have occurred on the last day of the
    taxable year (For determination of short/long
           Worthless Securities
• Small business stock
  – Section 1244 stock (Upon issuance, the
    corporation does not exceed $1 million in stock)
  – Only available to purchasers directly from the
  – Ordinary loss (up to $50,000 or $100,000 for
    married filing joint taxpayers)
  – Only applies to losses, gains are treated as capital
             Individual Losses
• Trade/Business
  – Business/Rental losses
  – Includes casualty losses
• For profit transactions
  – Selling business/certain investment assets at a loss
  – Includes casualty losses
              Individual Losses
• Casualty/theft on personal assets
• Includes
  – Fire
  – Storm
  – Shipwreck
  – Other
     • Identifiable event
     • Damaging to the property (must be to the taxpayer’s
     • Sudden, unexpected, and unusual in nature
          Casualty/Theft Losses
• Events that are not casualties
  – Erosion (it occurs over time)
  – Insect damage
  – Decline in value if there was no loss of property
• Theft
  – Does not include misplaced items
            Casualty/Theft Losses
• Deductibility
  – Casualty
     • In the year of the loss
     • If there is a reasonable prospect of full recovery from
       insurance, no deduction is allowed.
     • If there is a partial recovery, a partial deduction is allowed.
     • If reimbursed after deduction, the tax benefit rule is applied
  – Theft
     • Deductible in the year of discovery, not in the year of the
       actual theft
• Amount of Loss
  – Business property/Income producing property
     • Completely destroyed
        – Loss = the adjusted basis of the property
     • Partially destroyed
        – Loss = the lesser of
            » The adjusted basis of the property
            » The difference between FMV of the property immediately
              before and immediately after the event.
• Personal property
  – Partial or Complete destruction
     • Loss = the lesser of
        – The adjusted basis of the property
        – The difference between FMV of the property immediately
          before and immediately after the event.
  – Personal property losses are subject to the $100
    per loss reduction and 10% of AGI floor.
  – Losses on insured personal property are not
    deductible unless a timely insurance claim is filed.
• Fair market value after casualty may be measured
  by the cost of the repairs as long as certain
  criteria are met:
  – The repairs are necessary to restore the property to
    its condition immediately before the casualty.
  – The amount spent for such repairs is not excessive
  – The repairs do not extend beyond the damage
  – The value of the property, as a result of the repairs,
    after the repairs does not exceed the value of the
    property immediately before the casualty.
Research & Experimental Expenditures
• Includes:
  – All such costs incident to the development of an
    experimental or pilot model, a plant process, a
    product, a formula, an invention, or similar
    property, and the improvement of already existing
    property of the type mentioned. The term does
    not include expenditures such as those for the
    ordinary testing or inspection of materials or
    products for quality control or those for efficiency
    surveys, management studies, consumer surveys,
    advertising, or promotions.
    Research & Experimentation
• Three methods:
  – Expense in the year paid/incurred
     • Must continue with this method unless permission granted
       from the IRS.
  – Defer & amortize
     • Amortized over not less than 60 months
     • May begin taking the deduction the month that benefits are
       realized from the expenditures
     • Requires permission from the IRS to change method
  – Capitalize
     • Not deductible until the project is abandoned or deemed
       worthless as research projects do not have a definite life
     Domestic Production Activities
• 9% of the smaller of
  – Qualified production activities income (with
    respect to business activities only)
  – AGI calculated without the Domestic Production
  – Cannot exceed 50% of W-2 wages paid by the
    business for the year (with respect to business
  – http://www.irs.gov/pub/irs-pdf/i8903.pdf
          Net Operating Losses
• Only applicable to trade or business activity
• Carryback 2 years Carryforward 20 years

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