Advanced Individual Income Tax

Accounting 811: Spring, 1998

Week 5: Costs of Doing Business

Outline (c) 1997-98 Robert H. Daniels

Control Panel

 

1. Costs of doing business: Overview:

We move from "what is Y" and "Whose Y" to "What offsets allowed?"

Sec. 162 is basic "costs of business" section:

212 parallels for costs of non-biz income (landlord, investor)

 most  sched "C" categories are IRS examples of Sec 162

Note use in setting up small biz chart of accounts

Extensive Explanation in Regs and Case law

Stemming mostly from 1 sentence of 162

2. Elements of Sec. 162

Specific Rules

Other subsections of 162

3. Ordinary and Necessary

Leading Case Welch v. Helvering

Facts: T is secretary of corp, which goes bankrupt
  To reestablish relations, T pays co's debts.

Issue: Deductible? Holding: No

Reasoning:

Was "necessary": "appropriate and helpful"
Ordinary not mean daily: can be only once per business
W/in ordinary norms of conduct
What Tp did was "extra-ordinary"

"THe standard set up by the statute is not a rule of law. It is rather a way of life. Life in all its fullness must supply the answer to the riddle"

Critique: if not an expense, what is it?

Capital? (goodwill?) when recover the asset? (assets are future costs).

Note: courts may say " no deduction -- capitalize"

That's a question of the timing of the deduction.

Lawyers think that saying something is "charged to capital" is meaningful.
No -- that just says: debit an asset account.
Doesn't say what to do with the account then.
An "asset" is not a thing -- it is an accounting abstraction

4. Expenses

Current as opposed to capitalized

Two Cases: Midland Empire and Mt. Morris Drive In

Facts: ME lines basement of 25 yr old packing plant
  vs. new problem of oil leakage

Issue: repair/expense or capital? Held Repair

Reasoning:
  is ordinary and necessary
  in order to continue existing operations
  xx regs.: not add to value or extend life

Problem: Mt. Morris similar, tho there it was flow out

threat of a nuisance suit
and flow prevention held to be capital

Big issue now: environmental remediation and negative IRS rulings

5. Paid or incurred

6. Carrying on

7. Trade or business

8. Sec. 162 Specific Rules

162(a)(1) Specific rule for reasonable compensation

Generally comes up in context of closely held, or family

Smith case

Facts: S managed casino he'd built up, tho owned by sons 
  S got % of profits since 1/41. Written contract
  Business grew, and $$ got large
  Competitors said it was "reasonable"

Issue: does co deduct? Held: no

Reasoning: Regs. 1.162-7:

a contingent %%, even if it grows large, is  OK if free bargain
Not a free bargain due to father's domination of sons
Even tho they were adult

"Parachute payments": Sec. 280G

162(a)(2) Specific rule for travel away from home

Rosenspan case

Facts: R was jewelry salesman 300 days /yr traveling
  in NY at co offices 5-6 times / yr
  Used brother's residential address, voted
  but actually stayed at hotel

Issue: is R's employer's location R's "tax home"

Held: not the correct issue:
  R has no home in the ordinary sense of the word

Reasoning: note the R is trying to turn IRS rule against IRS

162(a)(3) Specific rule for business rentals

Starr's Estate case

Regs. 1.162-5: Specific Rule for Continuing Education

Distinguish better in same job vs. qualify for new job

Miscellaneous Deductions under Sec. 162

1.162-4 incidental supplies
1.162-6 professional expenses, books and furniture
For employer expense reimbursement, cross reference 1.62-2
"accountable plan"

9. Other Subsections of Sec. 162

162(c) bribes and illegal payments

no deduction for corrupting govt official
what if company pays off customs in Shanghai?
no deduction for commercial bribe, if illegal under enforced law

162(e) lobbying

1993 change: now no deduction for "influencing legislation" or "direct communication with "covered" executive branch official"

exception for local legislation and for $2K in-house

162(f) fines and penalties paid to government

162(l) self-employed health insurance

40% of amount is adjustment to Y (rest is med deduction)
100% in 2002

162(m) executive pay over $1mm

applies to CEO and other 4 highest paid of public companies
exception for performance based compensation

 

 

Build date 2/21/98