This document discusses various types of deductions allowed for individuals, including trade or business deductions, deductions for producing income, and deductions for losses. It provides examples of expenses that fall under each category and whether they are deductible "above the line" or "below the line" on a tax return. The document also examines business investigation and start-up expenses in more detail, outlining how they are treated depending on whether the business is similar or new.

1. Chapter 6
Deductions:
General Concepts
and
Trade or Business
Deductions
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2. Chapter 6 Exhibits
1. Classification of Deductions
2. Classification: “For” vs. “From” AGI
3. Trade or Business Expenses
4. Production of Income Deductions
5. Deductions for Losses
6. Other Allowable Deductions “For” AGI
7. Business Investigation and Start-Up Expenses
8. Deductibility of Business Investigation and Start-Up Expenses
9. Job Seeking Expenses
Chapter 6, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 43

3. Chapter 6 Exhibits
10. Business Gifts
11. Travel & Transportation Expenses
12. Moving Expenses
13. Student Loan Interest—Qualified Education Expenses
14. Student Loan Interest
15. Qualified Education Expenses Deduction
16. Health Insurance, HSAs, MSAs
17. Employee Business-Related Expenses
18. Employee v. Self-Employed
19. Limitations on the Deductibility of Expenses and Losses
Chapter 6, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 43

4. Chapter 6 Exhibits
20. Other Limitations on the Deductibility of Expenses and Losses
21. Business Deductions Related to Capital Expenditures
22. Depreciation of Tangible Property
23. MACRS Depreciation of Tangible Property
24. Limitations on Depreciation of Automobiles
25. Depreciation Code Sec. 179 Election
26. Bonus Depreciation Reintroduced by the Tax Relief, Unemployment Insurance
Reauthorization and Job Creation Act of 2010
27. Amortization
28. Research and Experimental (R & E)
29. Depletion
Chapter 6, Exhibit Contents C CCH Federal Taxation Basic Principles 4 of 43

5. Classification of Deductions
There are 4 categories of tax deductions allowed to individual taxpayers.
1. Trade or business deductions are generally deductible FOR AGI.
2. Deductions incurred for the production of income are generally
deductible FROM AGI as miscellaneous itemized deductions subject
to the 2% floor.
3. Deductions for losses incurred on the sale of business or investment
assets are generally deductible FOR AGI (though they may be subject
to capital loss limitation).
4. Personal expenses are generally NOT deductible unless expressly
permitted. Allowable personal deductions, such as medical expenses,
are deductible as itemized deductions, subject to various limitations.
Chapter 6, Exhibit 1 CCH Federal Taxation Basic Principles 5 of 43

6. Classification: “For” vs. “From” AGI
 Deductions “for” AGI are subtracted from income in calculating
adjusted gross income
 These deductions often reduce earned income subject to self-
employment taxes as well
 In addition, state income taxes are often based on federal AGI
 Many tax benefits are available only for taxpayers whose AGIs
do not exceed specified levels (e.g., ability to contribute to Roth
IRA, ability to deduct student loan interest, etc.)
 Deductions “from” AGI are subtracted from AGI itself in computing
taxable income
 This category of deductions is generally allowed as an alternative
to the standard deduction
 Deductions “from” AGI are often subject to limitations
calculated as a percentage of AGI
Chapter 6, Exhibit 2 CCH Federal Taxation Basic Principles 6 of 43

7. Trade or Business Expenses
Business expenses are generally deductible without limitation when the
following criteria are met:
1. Related to carrying on trade or business activity – taxpayer must
demonstrate commitment to and substantial involvement in the activity and
must have a legitimate profit motive.
2. Ordinary and necessary – commonly incurred by other businesses (not
necessarily your own) and appropriate for a particular business.
3. Reasonable in amount. This is of main concern to closely held corporations,
particularly regarding officers’ salaries. One way to substantiate
reasonableness is by presenting documentation of similar expenses by
comparable businesses.
Chapter 6, Exhibit 3a CCH Federal Taxation Basic Principles 7 of 43

8. Trade or Business Expenses
4. Expense must be paid or incurred during the taxable year:
 Expenses not deductible until paid for cash method taxpayers
 Accrual method taxpayers generally must demonstrate that expense
has been economically incurred
 Cash method taxpayers face limitations on deductibility of prepaid
expenses
 Property taxes must be allocated between seller and buyer in year
property is sold
 Deduction for business bad debts allowed on partial worthlessness of
debt
 No deduction for non-business bad debts until debt is wholly
worthless
Chapter 6, Exhibit 3b CCH Federal Taxation Basic Principles 8 of 43

9. Production of Income Deductions
 Production of income expenses are generally deductible FROM
AGI as miscellaneous itemized deductions, to the extent they
exceed 2% of AGI.
 Production of income expenses are related to the production of
non business income, such as investment expenses and tax
planning and compliance expenses.
 They must meet the same criteria for deductibility as trade or
business expenses, except they do not have to relate to a trade or
business.
Chapter 6, Exhibit 4a CCH Federal Taxation Basic Principles 9 of 43

10. Production of Income Deductions
The following is a list of typical production of income expenses which are
deductible FROM AGI.
 Safe deposit box rentals
 Subscriptions to investment related journals and newspapers
 Legal and accounting fees related to investments
 Cost of having a tax return prepared by a CPA
 Tax planning expenses
 Tax advice for divorce proceedings
There is an exception for expenses associated with the production
of rent and royalty income, which are deductible FOR AGI.
Chapter 6, Exhibit 4b CCH Federal Taxation Basic Principles 10 of 43

11. Deductions for Losses
For individual taxpayers, losses are restricted to the following (subject
to limitations):
1. Business losses (including casualty and theft).
2. Investment losses.
3. Personal casualty and theft losses.
Business and investment losses are deductible FOR AGI, while
personal casualty and theft losses are deductible FROM AGI.
Business losses generally reduce ordinary income, while investment
losses are classified as capital losses subject to more stringent
limitations.
To be deductible, losses must be realized during the year and not
compensated by insurance.
Chapter 6, Exhibit 5 CCH Federal Taxation Basic Principles 11 of 43

12. Other Allowable Deductions “For” AGI
 Business investigation & start-up costs
 Business gifts
 Transportation expenses
 Travel expenses
 Moving expenses
 Student loan interest and qualified tuition expenses
 Health insurance premiums for self-employed taxpayers
 Contributions to Health Savings Accounts
 Manufacturing deduction
Chapter 6, Exhibit 6 CCH Federal Taxation Basic Principles 12 of 43

13. Business Investigation and Start-Up Expenses
Type of Investigation Expenses Start-Up Expenses
Expense
Definition Expenditures that help determine Pre-operational costs
whether to create or buy a
business
Timing Occur before a decision to make Occur after a "go for it" decision is
or buy is reached reached, but before the doors open
for business
Examples Travel, marketing surveys, legal, Employee training and stationery
accounting, and engineering
Chapter 6, Exhibit 7 CCH Federal Taxation Basic Principles 13 of 43

14. Deductibility of Business Investigation and
Start-Up Expenses
Type Pursue business? Decline?
Business Similar business ⇒ Deductible in the Similar business ⇒ Deductible in the
Investigation year paid or incurred. year paid or incurred.
Expenses
New business ⇒ $5,000 can be New business ⇒ Not deductible or
expensed, the remainder is capitalized capitalized, but lost
and amortized over 180 months
Business Start- Similar business ⇒Deductible in the N/A – if taxpayer declines to pursue the
up Expenses year paid or incurred. opportunity, there will be no start-up
costs, only investigation expenses.
New business ⇒ $5,000 can be
expensed, the remainder is capitalized
and amortized over 180 months
Chapter 6, Exhibit 8 CCH Federal Taxation Basic Principles 14 of 43

15. Business Gifts
 Deduction limited to $25 per client/customer
 Inexpensive (< $4) tokens not treated as gifts if taxpayer’s
name or business name is permanently imprinted on item.
 Promotional materials to be used on business premises not
treated as gifts
 Employment service/achievement awards not treated as
gifts if value < $400
Chapter 6, Exhibit 10 CCH Federal Taxation Basic Principles 15 of 43

16. Travel & Transportation Expenses
 Self-employed taxpayers – deductible “for” AGI
 Employees – deductible as miscellaneous itemized deductions
if qualified:
 Not reimbursed by employer
 “Temporarily” away from home (> 1 night; < 1 year)
 Travel between work sites during work day
 No deduction for commuting expenses, regardless of distance
Chapter 6, Exhibit 11a CCH Federal Taxation Basic Principles 16 of 43

17. Travel & Transportation Expenses
 Deductible Expenses include:
 Lodging & meals (subject to 50% limit).
 Airfare, automobile expenses, etc.
 For automobile expenses, taxpayer may choose standard
mileage allowance rather than actual costs. For 2012, the
mileage rate is 55.5 cents per mile.
 Tax “home” is geographic location where taxpayer works.
Chapter 6, Exhibit 11b CCH Federal Taxation Basic Principles 17 of 43

18. Moving Expenses
Moving expenses are deductible FOR AGI.
Qualified moving expenses.
1. Transporting household goods and personal effects
2. Traveling from old residence to new residence
3. Lodging during the move
Nonqualified moving expenses.
1. Pre-move house hunting
2. Temporary living quarters at new location
3. Meals during a qualified move
4. Real estate commissions on sale of old residence
Chapter 6, Exhibit 12a CCH Federal Taxation Basic Principles 18 of 43

19. Moving Expenses
Time Requirement for the Moving Expense Deduction
Self-Employed Employee
Work full time at new job > 39 Work full time at new job > 39
weeks during first 12 months, AND weeks during first 12 months
Work full time at new job > 78
weeks during first 24 months
Chapter 6, Exhibit 12b CCH Federal Taxation Basic Principles 19 of 43

20. Moving Expenses
Distance Requirement for the Moving Expense Deduction
If the move is due to a relocation:
 Distance from the old residence to the new job must be
50 miles further than the
 Distance from the old residence to the old job.
Chapter 6, Exhibit 12c CCH Federal Taxation Basic Principles 20 of 43

21. Student Loan Interest
Qualified Education Expenses
Tax Treatment. Deductible “for” AGI. Thus, a student can
claim the student loan interest deduction even if the standard
deduction is used.
Deductible Limitation: $2,500 for student loan interest
up to $4,000 qualified tuition & fees
Qualified Student Loans. To be eligible for the deduction, the
education loan must be used solely to pay for any of the
following expenses: tuition, student activity fees, room and
board, books and supplies, and other related expenses.
Chapter 6, Exhibit 13 CCH Federal Taxation Basic Principles 21 of 43

22. Student Loan Interest
Phaseout of Student Loan Interest Deduction
Filing Status Threshold for Modified AGI
Floor Ceiling Phaseout Range
Single, head of household, $60,000 $75,000 $15,000
surviving spouse
Married filing jointly $120,000 $150,000 $30,000
Married filing separately N/A N/A N/A
Chapter 6, Exhibit 14 CCH Federal Taxation Basic Principles 22 of 43

23. Qualified Education Expenses Deduction
 Amount of deduction depends on taxpayer’s filing status and income:
 Single taxpayers:
 AGI < $65,000 $4,000
 AGI > $65,000, < $80,000 $2,000
 AGI > $130,000 zero
 Married taxpayers:
 AGI < $130,000 $4,000
 AGI > $130,000, < $160,000 $2,000
 AGI > $160,000 zero
 Married filing separate return – no deduction allowed
Chapter 6, Exhibit 15 CCH Federal Taxation Basic Principles 23 of 43

24. Health Insurance and HSAs
 Self-employed taxpayers allowed to deduct health insurance
premiums “for” AGI
 Self-employed taxpayers and small employers (< 50
employees) with “high deductible” insurance may deduct
contributions to health savings accounts of up to $6,250 for
2012 ($3,100 if taxpayer has “self-only” high deductible
medical insurance).
 Neither earnings nor qualified distributions of HSAs are
taxable.
Chapter 6, Exhibit 16 CCH Federal Taxation Basic Principles 24 of 43

25. Employee Business-Related Expenses
If an individual is an employee, unreimbursed employment expenses are
deductible as miscellaneous itemized deductions, to the extent they
exceed 2% of the taxpayer’s AGI.
The following are examples of typical employment related expenses
deductible as miscellaneous itemized deductions:
 Professionalsociety dues
 Subscriptions to professional journals
 Travel expenses
 Home office expenses
Note: Commuting expenses incurred going to and from work are not
deductible. However, the expenses of going from one job to
another job on the same workday are deductible.
Chapter 6, Exhibit 17 CCH Federal Taxation Basic Principles 25 of 43

26. Employee v. Self-Employed
Independent contractors sell services to the public, and are
considered self-employed. All trade or business expenses are
deductible FOR AGI.
The following criteria should be considered when determining if an
individual is an employee or self-employed:
1. Does the individual work for many clients, or just one?
2. Does the individual make services available to the public?
3. Does the individual determine work hours and schedules?
4. Does the individual received payments from one firm, or many
firms?
Chapter 6, Exhibit 18 CCH Federal Taxation Basic Principles 26 of 43

27. Limitations on the Deductibility of Expenses and
Losses
 Hobby expenses and losses – expenses deducted to extent of
income only
 Personal expenses and losses – generally not deductible,
unless specifically authorized by Code
 No deduction for expenses that frustrate public policy:
 Fines or penalties paid to government
 Illegal kickbacks, bribes, and other illegal payments
 Illegal trafficking in controlled substances (although
expenses incurred in other illegal businesses are generally
deductible)
Chapter 6, Exhibit 19a CCH Federal Taxation Basic Principles 27 of 43

28. Limitations on the Deductibility of Expenses and
Losses
 Lobbying – expenses deductible only if incurred to influence
legislation at local level in which taxpayer has direct interest
(e.g., local business lobbying city officials on local zoning
laws)
 Political contributions – no deduction
 Meals & entertainment – fifty percent deductible for expenses
“directly related to” or “associated with” taxpayer’s business,
if such expenses are substantiated.
Chapter 6, Exhibit 19b CCH Federal Taxation Basic Principles 28 of 43

29. Limitations on the Deductibility of Expenses and
Losses
Meals and Entertainment
Tax Treatment
Self-Employed Individuals Nonreimbursed Employees
50% deductible 50% deductible, and limited to
the 2% AGI floor
“For” AGI “From” AGI as a miscellaneous
itemized deduction
Chapter 6, Exhibit 19c CCH Federal Taxation Basic Principles 29 of 43

30. Other Limitations on the Deductibility of
Expenses and Losses
 Expenses and interest related to tax-exempt income are not
deductible (because income is not taxable)
 Transactions between related parties:
 Losses not deductible, but may be used to offset gain
subsequently realized by buyer on “re-sale” of property
 Payment by accrual method taxpayer to related cash method
taxpayer may not be deducted by payer until tax year in
which recipient reports payment in income.
 No deduction allowed for payment of expenses of another
(e.g., payment by shareholder of corporate business expense).
Chapter 6, Exhibit 20 CCH Federal Taxation Basic Principles 30 of 43

31. Business Deductions Related to Capital
Expenditures
Capital expenditures are expenditures that will benefit
more than one tax year. Generally, capital expenditures do
not qualify as deductions in the year the expenditure is
made, but must be allocated to the tax years expected to
benefit from the expenditure.
Tangible capital expenditures placed in service for business
or investment purposes after 1986 should be depreciated
using MACRS depreciation.
Tangible property placed after 1980 and before 1987
should be depreciated using ACRS depreciation.
Chapter 6, Exhibit 21 CCH Federal Taxation Basic Principles 31 of 43

32. Depreciation of Tangible Property
Personal property refers to the physical nature of the
property. It means that the property is mobile.
 This is different than “Personal-use” property
which refers to the function of property. This is
property held for the taxpayer’s own enjoyment.
Real property also refers to the physical nature of the
property. It means the property is immobile.
Chapter 6, Exhibit 22 CCH Federal Taxation Basic Principles 32 of 43

33. MACRS Depreciation of Tangible Property
Class of property
Personal property is divided into 6 classes:
3-year, 5-year, 7-year, 10-year, 15-year and 20-year property.
Real property is divided into 3 classes:
27.5-year residential rental property
39-year non-residential real property (ex. office buildings)
50-year property railroad gradings and tunnel bores
Chapter 6, Exhibit 23a CCH Federal Taxation Basic Principles 33 of 43

34. MACRS Depreciation of Tangible Property
Depreciation method
200% declining balance applies to 3-year, 5-year, 7-year and 10-year
classes of property.
150% declining balance applies to 15-year and 20-year classes of
property.
Straight-line is used for 27.5-year and 39-year classes of property. Do
not consider salvage value.
Chapter 6, Exhibit 23b CCH Federal Taxation Basic Principles 34 of 43

35. MACRS Depreciation of Tangible Property
Convention
A half-year convention applies to personal property. Under this
convention, property placed in service (or disposed of) during the tax
year is considered placed in service (or disposed of) at the midpoint of
the tax year.
A mid-month convention applies to real property. Under this
convention, property is considered placed in service (or disposed of) in
the middle of the month for the first month of service and the last month
of service.
Chapter 6, Exhibit 23c CCH Federal Taxation Basic Principles 35 of 43

36. MACRS Depreciation of Tangible Property
Convention
A mid-quarter convention applies when more than 40% of the cost
of all personal property is placed in service during the last quarter of
the taxable year. Under the mid-quarter convention, personal property
is treated as placed in service (or disposed of) in the middle of the
quarter.
In determining whether 40% of the aggregate basis of MACRS
property is placed in service during the last 3 months of the tax year,
property placed in service and disposed of within the same tax year is
disregarded.
Chapter 6, Exhibit 23d CCH Federal Taxation Basic Principles 36 of 43

37. Limitations on Depreciation of Automobiles
Depreciation (including Code Sec. 179 deduction) for cars purchased in
2012 limited to:
Passenger Cars Trucks and Vans
First year $3,060 $3,260
Second year $4,900 $5,200
Third year $2,950 $3,150
Subsequent years $1,775 $1,875
Chapter 6, Exhibit 24 CCH Federal Taxation Basic Principles 37 of 43

38. Depreciation Code Sec. 179 Election
For 2012, an election may be made to expense up to $139,000
of tangible personal property used in a trade or business,
rather than capitalize and depreciate it.
Phaseout. The expense allowance is phased out on a dollar-
for-dollar basis for purchases exceeding $560,000.
Chapter 6, Exhibit 25 CCH Federal Taxation Basic Principles 38 of 43

39. Bonus Depreciation Reintroduced by the Tax Relief,
Unemployment Insurance Reauthorization and Job
Creation Act of 2010
 Bonus Depreciation
 2011 – 100%
 2012 – 50%
 First year Code Sec. 280F limitation increased by $8,000
 Sec. 179 deduction for autos between 6,000 and 14,000
pounds -- $25,000
 Relevant only for 2012 (100% bonus allowed for 2011)
 No limit on depreciation or 179 for vehicles weighing more
than 14,000 pounds
Chapter 6, Exhibit 26 CCH Federal Taxation Basic Principles 39 of 43

40. Amortization
Amortizable property is intangible property that is used for
business and is of limited life. For example, goodwill, going-
concern value, licenses, covenants not to compete, franchises,
trademarks, patents, and copyrights.
Method. Straight-line method over 15 years. (Code Section
197).
Chapter 6, Exhibit 27 CCH Federal Taxation Basic Principles 40 of 43

41. Research and Experimental (R & E)
Qualifying expenditures. Experimental and laboratory costs
for pilot models, plant processes, products, formulas,
inventions, or similar properties. These costs include R&E
salaries.
Non qualifying expenditures. Ordinary testing or inspection
of materials or products for quality control, management
studies, consumer surveys, advertising, or promotions.
Tax treatment. R&E expenditures may be expensed
immediately, or if elected, amortized over a minimum of 5
years.
Chapter 6, Exhibit 28 CCH Federal Taxation Basic Principles 41 of 43

42. Depletion
There are 2 methods available to compute the depletion
deduction. The taxpayer should compute the proper deduction
under both methods and claim the deduction that is higher.
Cost depletion method
Cost of natural resources excluding land x (Number of units
Recoverable units recovered AND sold)
% depletion method
Statutory % x Gross income from natural resource*
*Gross income equals revenues without regard to cost of sales
Chapter 6, Exhibit 29a CCH Federal Taxation Basic Principles 42 of 43

43. Depletion
Limitation of % Depletion
 Oil and gas properties: 100% of taxable income from
natural resources BEFORE depletion.
 Other natural resources (copper and gold): 50% of taxable
income from natural resources BEFORE depletion.
Chapter 6, Exhibit 29b CCH Federal Taxation Basic Principles 43 of 43