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## Publication 535 

# Contents Cat. No. 15065Z **Introduction**

.................... . **1** Department of the **What’s New for 2010**

.............. . **2** Treasury 

# Business
**What’s New for 2011**

.............. . **2 Internal**  **Revenue Reminders** 

..................... . **2** 

# Expenses **Service 1.**  **Deducting Business Expenses** 

.................. . **2 2.**  **Employees’ Pay**

.............. . **6** 

# For use in preparing **3. Rent Expense** 

................ . **8 4.**  **Interest**

.................... . **11** 

# 2010Returns **5. Taxes** 

..................... . **15 6.**  **Insurance**

.................. . **17 7.**  **Costs You Can Deduct or Capitalize** 

.................. . **21 8.**  **Amortization**

................ . **26 9.**  **Depletion**

................... . **33 10.**  **Business Bad Debts**

........... . **38 11.**  **Other Expenses**

.............. . **40 12.**  **How To Get Tax Help**

.......... . **46 Index** 

......................... . **49** 

# Introduction This publication discusses common businessexpenses and explains what is and is not deductible. The general rules for deducting business expenses are discussed in the opening chapter. The chapters that follow cover specific expenses and list other publications and forms you may need. **Comments and suggestions.** We welcome your comments about this publication and your suggestions for future editions. You can write to us at the following address:

Internal Revenue Service Business Forms and Publications Branch SE:W:CAR:MP:T:B 1111 Constitution Ave. NW, IR-6526 Washington, DC 20224 We respond to many letters by telephone.Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. You can email us at *taxforms@irs.gov . (The asterisk must be included in the address.)Please put “Publications Comment” on the subject line. You can also send us comments from www.irs.gov/formspubs/ , select “Comment on Tax Forms and Publications ”under “Information about.” Although we cannot respond individually to each comment received, we do appreciate your 

# Get forms and other information feedback and will consider your comments as we revise our tax products. 

# faster and easier by: **Ordering forms and publications.** Visit 

# Internet IRS.gov www.irs.gov/formspubs to download forms and publications, call 1-800-829-3676, or write to the **Mar 24, 2011**

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address below and receive a response within 10 You can file your tax returns electronically using 

### Useful Items days after your request is received. an IRS e-fileoption. The benefits of IRS e-file You may want to see: include faster refunds, increased accuracy, and Internal Revenue Service **Publication** acknowledgment of IRS receipt of your return. 1201 N. Mitsubishi Motorway You can use one of the following IRS e-file Bloomington, IL 61705-6613 ❏ **334** Tax Guide for Small Business options. ❏ **463** Travel, Entertainment, Gift, and Car



### • Use an authorized IRSe-fileprovider. **Tax questions.** If you have a tax question, Expenses check the information available on IRS.gov or 

### • Use a personal computer. ❏ **525** Taxable and Nontaxable Income call 1-800-829-4933. We cannot answer tax 

### • Visit a Volunteer Income Tax Assistance questions sent to either of the above addresses. ❏ **529** Miscellaneous Deductions (VITA) or Tax Counseling for the Elderly ❏ **536** Net Operating Losses (NOLs) for (TCE) site. Individuals, Estates, and Trusts For details on these fast filing methods, see your ❏ **538** Accounting Periods and Methods 

# What’s New for 2010 income tax package. ❏ **542** Corporations The following items highlight some changes in **Form 1099 MISC.** File Form 1099-MISC, Mis❏ **547** Casualties, Disasters, and Thefts the tax law for 2010. cellaneous Income, for each person to whom you have paid during the year in the course of ❏ **587** Business Use of Your Home **Standard mileage rate.** For 2010, the stan- your trade or business at least $600 in rents, (Including Use by Daycare dard mileage rate for the cost of operating your services (including parts and materials), prizes Providers) car, van, pickup, or panel truck for each mile of and awards, other income payments, medical business use is 50 cents per mile. ❏ **925** Passive Activity and At-Risk Rules and health care payments, and crop insurance ❏ **936** Home Mortgage Interest **Self-employed health insurance deduction.** proceeds. See the Instructions for Form Deduction Effective March 30, 2010, if you were 1099-MISC for more information and additional self-employed and paid for health insurance, reporting requirements. ❏ **946** How To Depreciate Property you may be able to include in your deduction any **Photographs of missing children.** The Inter- premiums you paid to cover your child who was **Form (and Instructions)** nal Revenue Service is a proud partner with the under age 27 at the end of 2010, even if the child ❏ **Sch A (Form 1040)** Itemized Deductions National Center for Missing and Exploited Chil- was not your dependent. For 2010, the self-employed health insurance deduction is dren. Photographs of missing children selected ❏ **5213** Election To Postpone also allowed on Schedule SE. See chapter 6. by the Center may appear in this publication on Determination as To Whether the pages that would otherwise be blank. You can Presumption Applies That an **Business start-up costs.** For tax years be- help bring these children home by looking at the Activity Is Engaged in for Profit ginning in 2010, you can elect to deduct up to photographs and calling 1-800-THE-LOST $10,000 of business start-up costs paid or in- See chapter 12for information about getting (1-800-843-5678) if you recognize a child. curred after 2009. See chapter 7. publications and forms. **Environmental cleanup costs.** The election to deduct qualified environmental cleanup costs was extended to cover costs paid or incurred in 

# What Can I Deduct? 2010 and 2011. See chapter 7. **Marginal production of oil and gas.** For tax To be deductible, a business expense must be 

# 1. years beginning in 2010 and 2011, the 100% both ordinary and necessary. An ordinary extaxable income limit does not apply to percent- pense is one that is common and accepted in your industry. A necessary expense is one that age depletion on the marginal production of oil is helpful and appropriate for your trade or busi- and natural gas. See chapter 9. 

# Deducting ness. An expense does not have to be indispensable to be considered necessary.It is important to distinguish business ex

# Business penses from: 

# What’s New for 2011

**•** The expenses used to figure cost of goods The following items highlight some changes in 

# Expenses sold, the tax law for 2011. 

### • Capital expenses, and **Standard mileage rate.** For 2011, the stan- 

### • Personal expenses. dard mileage rate for the cost of operating your 

# Introduction car, van, pickup, or panel truck for each mile of This chapter covers the general rules for deduct- business use is 51 cents per mile 

## Cost of Goods Sold ing business expenses. Business expenses are the costs of carrying on a trade or business, and If your business manufactures products or they are usually deductible if the business is purchases them for resale, you generally must value inventory at the beginning and end of each operated to make a profit. 

# Reminders tax year to determine your cost of goods sold. Some of your business expenses may be in- 

### Topics The following reminders and other items may cluded in figuring cost of goods sold. Cost of help you file your tax return. This chapter discusses: goods sold is deducted from your gross receipts to figure your gross profit for the year. If you 

## IRS**e-file (Electronic Filing)**  **•** What you can deduct include an expense in the cost of goods sold,you cannot deduct it again as a business ex

### • How much you can deduct pense. 

### • When you can deduct The following are types of expenses that go 

### • Not-for-profit activities into figuring cost of goods sold. Page 2 Chapter 1 **Deducting Business Expenses**

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### • The cost of products or raw materials, in- **If you go into business.** When you go into it suitable for your business. This applies even if

cluding freight. business, treat all costs you had to get your some of the work would by itself be classified as business started as capital expenses. repairs. 

### • Storage. Usually you recover costs for a particular 

### • Direct labor (including contributions to asset through depreciation. Generally, you can- 

## Capital versus Deductible

pension or annuity plans) for workers who not recover other costs until you sell the busi- 

## Expenses produce the products. ness or otherwise go out of business. However, you can choose to amortize certain costs for To help you distinguish between capital and 

### • Factory overhead. setting up your business. See Starting a Busi- deductible expenses, different examples are ness in chapter 8 for more information on busi- given below. Under the uniform capitalization rules, you ness start-up costs. must capitalize the direct costs and part of the **Motor vehicles.** You usually capitalize the indirect costs for certain production or resale cost of a motor vehicle you use in your business. **If you do not go into business.** If you are an activities. Indirect costs include rent, interest, You can recover its cost through annual deduc- individual and your attempt to go into business is taxes, storage, purchasing, processing, repack- tions for depreciation. not successful, the expenses you had in trying to aging, handling, and administrative costs. There are dollar limits on the depreciation establish yourself in business fall into two cate- This rule does not apply to personal property you can claim each year on passenger automo- gories. you acquire for resale if your average annual biles used in your business. See Publication gross receipts (or those of your predecessor) for 1. The costs you had before making a deci- 463. the preceding 3 tax years are not more than $10 sion to acquire or begin a specific busi- Generally, repairs you make to your busi- million. ness. These costs are personal and ness vehicle are currently deductible. However, nondeductible. They include any costs in- amounts you pay to recondition and overhaul a For more information, see the following curred during a general search for, or pre- business vehicle are capital expenses and are sources. liminary investigation of, a business or recovered through depreciation.



### • Cost of goods sold

—chapter 6 of Publica- investment possibility.

tion 334. **Roads and driveways.** The cost of building a 2. The costs you had in your attempt to ac- private road on your business property and the 

### • Inventories

—Publication 538. quire or begin a specific business. These cost of replacing a gravel driveway with a con- costs are capital expenses and you can 

### • Uniform capitalization rules

—Publication crete one are capital expenses you may be able deduct them as a capital loss. 538 and section 263A of the Internal Rev- to depreciate. The cost of maintaining a private enue Code and the related regulations. road on your business property is a deductible If you are a corporation and your attempt to expense. go into a new trade or business is not success- ful, you may be able to deduct all investigatory 

## Capital Expenses **Tools.** Unless the uniform capitalization rules costs as a loss. apply, amounts spent for tools used in your The costs of any assets acquired during your You must capitalize, rather than deduct, some business are deductible expenses if the tools unsuccessful attempt to go into business are a costs. These costs are a part of your investment have a life expectancy of less than 1 year or their part of your basis in the assets. You cannot takein your business and are called “capital excost is minor. a deduction for these costs. You will recover thepenses.” Capital expenses are considered ascosts of these assets when you dispose of them. sets in your business. There are, in general, **Machinery parts.** Unless the uniform capitali- three types of costs you capitalize. zation rules apply, the cost of replacing



### • Business start-up costs (See Tip below). short-lived parts of a machine to keep it in good 

### Business Assets working condition, but not add to its life, is a 

### • Business assets. There are many different kinds of business as- deductible expense. 

### • Improvements. sets; for example, land, buildings, machinery, **Heating equipment.** The cost of changing furniture, trucks, patents, and franchise rights. from one heating system to another is a capital You must fully capitalize the cost of these as- You can elect to deduct or amortize expense. sets, including freight and installation charges. certain business start-up costs. See Certain property you produce for use in your chapters 7 and8

. trade or business must be capitalized under the 

## Personal versus Business uniform capitalization rules. See Regulations 

## Expenses section 1.263A-2 for information on these rules. **Cost recovery.** Although you generally canGenerally, you cannot deduct personal, living, or not take a current deduction for a capital ex- family expenses. However, if you have an ex- pense, you may be able to recover the amount 

### Improvements pense for something that is used partly for busiyou spend through depreciation, amortization, ness and partly for personal purposes, divide or depletion. These recovery methods allow you The costs of making improvements to a busi- the total cost between the business and per- to deduct part of your cost each year. In this ness asset are capital expenses if the improve- sonal parts. You can deduct the business part. way, you are able to recover your capital ex- ments add to the value of the asset, appreciably For example, if you borrow money and use pense. SeeAmortization (chapter 8) andDeple- lengthen the time you can use it, or adapt it to a 70% of it for business and the other 30% for a tion (chapter 9) in this publication. A taxpayer different use. Improvements are generally major family vacation, you generally can deduct 70% can elect to deduct a portion of the costs of expenditures. Some examples are: new electric of the interest as a business expense. The re- certain depreciable property as a section 179 wiring, a new roof, a new floor, new plumbing, maining 30% is personal interest and generally deduction. A greater portion of these costs can bricking up windows to strengthen a wall, and is not deductible. Seechapter 4for information be deducted if the property is qualified disaster lighting improvements. on deducting interest and the allocation rules. assistance property. See Publication 946 for de- However, you can currently deduct repairs tails. that keep your property in a normal efficient **Business use of your home.** If you use part operating condition as a business expense. of your home for business, you may be able to Treat as repairs amounts paid to replace parts of deduct expenses for the business use of your 

### Going Into Business a machine that only keep it in a normal operating home. These expenses may include mortgage condition. The costs of getting started in business, before interest, insurance, utilities, repairs, and depreyou actually begin business operations, are cap- ciation. ital expenses. These costs may include ex- **Restoration plan.** Capitalize the cost of re- To qualify to claim expenses for the business penses for advertising, travel, or wages for conditioning, improving, or altering your prop- use of your home, you must meet both of the training employees. erty as part of a general restoration plan to make following tests. Chapter 1 **Deducting Business Expenses** Page 3

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1. The business part of your home must be have a “net operating loss.” You can use a net operating loss to lower your taxes in other years. used exclusively and regularly for your 

# How Much Can I See Publication 536 for more information. trade or business. See Publication 542 for information about 

# Deduct? 2. The business part of your home must be: net operating losses of corporations. You can deduct the cost of a business expense a. Your principal place of business, or if it meets the criteria of ordinary and necessary b. A place where you meet or deal with and it is not a capital expense. patients, clients, or customers in the 

# When Can I **Recovery of amount deducted (tax benefit**normal course of your trade or busi**rule).** If you recover part of an expense in the 

# Deduct an Expense? ness, or same tax year in which you would have claimed a deduction, reduce your current year expense c. A separate structure (not attached to When you can deduct an expense depends on by the amount of the recovery. If you have a your home) used in connection with your accounting method. An accounting method recovery in a later year, include the recovered your trade or business. is a set of rules used to determine when and how amount in income in that year. However, if part income and expenses are reported. The two of the deduction for the expense did not reduce You generally do not have to meet the exclu- basic methods are the cash method and the your tax, you do not have to include that part of sive use test for the part of your home that you accrual method. Whichever method you choose the recovered amount in income. must clearly reflect income. regularly use either for the storage of inventory For more information on recoveries and the For more information on accounting meth- or product samples, or as a daycare facility. tax benefit rule, see Publication 525. ods, see Publication 538. Your home office qualifies as your principal **Payments in kind.** If you provide services to place of business if you meet the following re- **Cash method.** Under the cash method of ac- pay a business expense, the amount you can quirements. counting, you generally deduct business ex- deduct is limited to your out-of-pocket costs. penses in the tax year you pay them. You cannot deduct the cost of your own labor. 

### • You use the office exclusively and regu- Similarly, if you pay a business expense in

larly for administrative or management ac- **Accrual method.** Under an accrual method of goods or other property, you can deduct only tivities of your trade or business. accounting, you generally deduct business ex- what the property costs you. If these costs are penses when both of the following apply. 

### • You have no other fixed location where included in the cost of goods sold, do not deduct

you conduct substantial administrative or them as a business expense. 1. The all-events test has been met. The test management activities of your trade or is met when: **Limits on losses.** If your deductions for an business. investment or business activity are more than a. All events have occurred that fix the fact the income it brings in, you have a loss. There of liability, and If you have more than one business location, may be limits on how much of the loss you can determine your principal place of business b. The liability can be determined with readeduct. based on the following factors. sonable accuracy. **Not-for-profit limits.** If you carry on your 

### • The relative importance of the activities business activity without the intention of making 2. Economic performance has occurred.

performed at each location. a profit, you cannot use a loss from it to offset other income. SeeNot-for-Profit Activities later. 

### • If the relative importance factor does not **Economic performance.** You generally cannot deduct or capitalize a business expense determine your principal place of busi- **At-risk limits.** Generally, a deductible loss until economic performance occurs. If your ex- ness, consider the time spent at each lo- from a trade or business or other inpense is for property or services provided to you, come-producing activity is limited to the invest- cation. or for your use of property, economic performment you have “at risk” in the activity. You are at ance occurs as the property or services are risk in any activity for the following. For more information, see Publication 587. provided, or the property is used. If your ex1. The money and adjusted basis of property pense is for property or services you provide to **Business use of your car.** If you use your car you contribute to the activity. others, economic performance occurs as you exclusively in your business, you can deduct car provide the property or services. 2. Amounts you borrow for use in the activity expenses. If you use your car for both business if: **Example.** Your tax year is the calendar and personal purposes, you must divide your year. In December 2010, the Field Plumbing expenses based on actual mileage. Generally, a. You are personally liable for repayment, Company did some repair work at your place of or commuting expenses between your home and business and sent you a bill for $600. You paid it your business location, within the area of your b. You pledge property (other than prop- by check in January 2011. If you use the accrual tax home, are not deductible. erty used in the activity) as security for method of accounting, deduct the $600 on your the loan. You can deduct actual car expenses, which tax return for 2010 because all events have include depreciation (or lease payments), gas occurred to “fix” the fact of liability (in this case For more information, see Publication 925. and oil, tires, repairs, tune-ups, insurance, and the work was completed), the liability can bedetermined, and economic performance ocregistration fees. Or, instead of figuring the busi- **Passive activities.** Generally, you are in a curred in that year. ness part of these actual expenses, you may be passive activity if you have a trade or business If you use the cash method of accounting, activity in which you do not materially partici- able to use the standard mileage rate to figure deduct the expense on your 2011 return. pate, or a rental activity. In general, deductions your deduction. For 2010, the standard mileage for losses from passive activities only offset in- rate is 50 cents a mile for all business miles **Prepayment.** You generally cannot deduct come from passive activities. You cannot use driven before January 1, 2011. expenses in advance, even if you pay them in any excess deductions to offset other income. In advance. This rule applies to both the cash and If you are self-employed, you can also de- addition, passive activity credits can only offset accrual methods. It applies to prepaid interest, duct the business part of interest on your car the tax on net passive income. Any excess loss prepaid insurance premiums, and any other ex- loan, state and local personal property tax on the or credits are carried over to later years. Sus- pense paid far enough in advance to, in effect, car, parking fees, and tolls, whether or not you pended passive losses are fully deductible in the create an asset with a useful life extending sub- claim the standard mileage rate. year you completely dispose of the activity. For stantially beyond the end of the current tax year. more information, see Publication 925. For more information on car expenses and the rules for using the standard mileage rate, **Net operating loss.** If your deductions are **Example.** In 2010, you sign a 10-year lease see Publication 463. more than your income for the year, you may and immediately pay your rent for the first 3 Page 4 Chapter 1 **Deducting Business Expenses**

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years. Even though you paid the rent for 2010, **Presumption of profit.** An activity is pre- lines of Schedule A (Form 1040). For taxable sumed carried on for profit if it produced a profit 2011, and 2012, you can only deduct the rent for years beginning after Dec. 31, 2008, you can in at least 3 of the last 5 tax years, including the 2010 on your 2010 tax return. You can deduct deduct a casualty loss on property you own for current year. Activities that consist primarily of the rent for 2011 and 2012 on your tax returns personal use only to the extent it is more than breeding, training, showing, or racing horses are for those years. $500 and exceeds 10% of your adjusted gross presumed carried on for profit if they produced a income. The 10% AGI limitation does not apply profit in at least 2 of the last 7 tax years, includ- **Contested liability.** Under the cash method, to net disaster losses resulting from federally ing the current year. The activity must be sub- you can deduct a contested liability only in the declared disasters in 2008 and 2009 and individstantially the same for each year within this year you pay the liability. Under the accrual uals are allowed to claim the net disaster losses period. You have a profit when the gross income method, you can deduct contested liabilities even if they do not itemize their deductions. The from an activity exceeds the deductions. such as taxes (except foreign or U.S. posses- reduction amount returns to $100 for taxable If a taxpayer dies before the end of the sion income, war profits, and excess profits years beginning after Dec. 31, 2009. See Publi- 5-year (or 7-year) period, the “test” period ends taxes) either in the tax year you pay the liability cation 547 for more information on casualty on the date of the taxpayer’s death. (or transfer money or other property to satisfy losses. For the limits that apply to home mort- If your business or investment activity the obligation) or in the tax year you settle the gage interest, see Publication 936. passes this 3- (or 2-) years-of-profit test, the IRS contest. However, to take the deduction in the will presume it is carried on for profit. This year of payment or transfer, you must meet means the limits discussed here will not apply. **Category 2.** Deductions that do not result in certain conditions. See section 1.461-2 of the You can take all your business deductions from an adjustment to the basis of property are al- regulations. the activity, even for the years that you have a lowed next, but only to the extent your gross loss. You can rely on this presumption unless income from the activity is more than your de- **Related person.** Under an accrual method of the IRS later shows it to be invalid. ductions under the first category. Most business accounting, you generally deduct expenses deductions, such as those for advertising, insur- when you incur them, even if you have not yet **Using the presumption later.** If you are start- ance premiums, interest, utilities, and wages, paid them. However, if you and the person you ing an activity and do not have 3 (or 2) years belong in this category.showing a profit, you can elect to have the preowe are related and that person uses the cash sumption made after you have the 5 (or 7) years method of accounting, you must pay the ex- of experience allowed by the test. pense before you can deduct it. Your deduction **Category 3.** Business deductions that deYou can elect to do this by filing Form5213. is allowed when the amount is includible in in- crease the basis of property are allowed last, but Filing this form postpones any determination come by the related cash method payee. See only to the extent the gross income from the that your activity is not carried on for profit until 5 Related Personsin Publication 538. activity exceeds the deductions you take under (or 7) years have passed since you started the the first two categories. Deductions for deprecia- activity. tion, amortization, and the part of a casualty loss The benefit gained by making this election is an individual could not deduct in category (1) that the IRS will not immediately question 

# Not-for-Profit Activities belong in this category. Where more than one whether your activity is engaged in for profit. asset is involved, allocate depreciation and Accordingly, it will not restrict your deductions. If you do not carry on your business or invest- these other deductions proportionally. Rather, you will gain time to earn a profit in the ment activity to make a profit, you cannot use a required number of years. If you show 3 (or 2) Individuals must claim the amounts in loss from the activity to offset other income. years of profit at the end of this period, your categories (2) and (3) as miscellane- Activities you do as a hobby, or mainly for sport deductions are not limited under these rules. If ous deductions on Schedule A (Form or recreation, are often not entered into for profit. you do not have 3 (or 2) years of profit, the limit 1040). They are subject to the The limit on not-for-profit losses applies to can be applied retroactively to any year with a 2%-of-adjusted-gross-income limit. See Publi- individuals, partnerships, estates, trusts, and S loss in the 5-year (or 7-year) period. cation 529 for information on this limit. corporations. It does not apply to corporations Filing Form 5213 automatically extends the other than S corporations. period of limitations on any year in the 5-year (or **Example.** Ida is engaged in a not-for-profit In determining whether you are carrying on 7-year) period to 2 years after the due date of activity. The income and expenses of the activity an activity for profit, several factors are taken the return for the last year of the period. The are as follows. into account. No one factor alone is decisive. period is extended only for deductions of the Among the factors to consider are whether: activity and any related deductions that might be Gross income

................ . $3,200 affected. 

### • You carry on the activity in a businesslike Subtract:

manner, You must file Form 5213 within 3 years Real estate taxes

....... . $700 after the due date of your return (deter- Home mortgage interest

... . 900 

### • The time and effort you put into the activity mined without extensions) for the year Insurance

............ . 400

indicate you intend to make it profitable, in which you first carried on the activity, or, if Utilities

.............. . 700 

### • You depend on the income for your liveli- Maintenance

.......... . 200 earlier, within 60 days after receiving written hood, Depreciation on an automobile 600 notice from the Internal Revenue Service pro- Depreciation on a machine

. . 200 3,700 posing to disallow deductions attributable to the 

### • Your losses are due to circumstances beactivity.

yond your control (or are normal in the **Loss**

...................... . **$(500)** start-up phase of your type of business), 

## Limit on Deductions Ida must limit her deductions to $3,200, the 

### • You change your methods of operation in gross income she earned from the activity. The

an attempt to improve profitability, If your activity is not carried on for profit, take limit is reached in category (3), as follows. deductions in the following order and only to the 

### • You (or your advisors) have the knowl- extent stated in the three categories. If you are

edge needed to carry on the activity as a Limit on deduction

............ . $3,200 an individual, these deductions may be taken successful business, Category 1: Taxes and only if you itemize. These deductions may be 

### • You were successful in making a profit in interest

.............. . $1,600 taken on Schedule A (Form 1040). similar activities in the past, Category 2: Insurance, **Category 1.** Deductions you can take for per- utilities, and maintenance

. . . 1,300 2,900 

### • The activity makes a profit in some years, sonal as well as for business activities are al-

and **Available for Category 3**

....... . **$ 300** lowed in full. For individuals, all nonbusiness 

### • You can expect to make a future profit deductions, such as those for home mortgage The $800 of depreciation is allocated be-

from the appreciation of the assets used in interest, taxes, and casualty losses, belong in tween the automobile and machine as follows. the activity. this category. Deduct them on the appropriate Chapter 1 **Deducting Business Expenses** Page 5

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You can claim employment credits like enterprises pay for the same or similar serv- $600 depreciation for the x $300 = $225 such as the following if you hire individ- ices. $800 automobile uals who meet certain requirements. To determine if pay is reasonable, also con- sider the following items and any other pertinent 

### • Empowerment zone and renewal commu- $200 depreciation for the x $300 = $75 facts. nity employment credit (Form 8844). $800 machine 

### • The duties performed by the employee. 

### • Indian employment credit (Form 8845). The basis of each asset is reduced accord- 

### • The volume of business handled. 

### • Work opportunity credit (Form 5884). ingly. 

### • The character and amount of responsibil- Ida includes the $3,200 of gross income on 

### • Credit for employer differential wage pay- ity. line 22 (total income) of Form 1040. The $1,600 ments (Form 8932). for category (1) is deductible in full on the appro- 

### • The complexities of your business. priate lines for taxes and interest on Schedule A Reduce your deduction for employee wages 

### • The amount of time required. (Form 1040). Ida deducts the remaining $1,600 by the amount of any employment credits you ($1,300 for category (2) and $300 for category claim. For more information about these credits, 

### • The cost of living in the locality. (3)) as other miscellaneous deductions on see the form on which the credit is claimed. 

### • The ability and achievements of the indiSchedule A (Form 1040) subject to the vidual employee performing the service. 2%-of-adjusted-gross-income limit. 

### Topics **•** The pay compared with the gross and net This chapter discusses: **Partnerships and S corporations.** If a part- income of the business, as well as with nership or S corporation carries on a distributions to shareholders if the busi- 

### • Tests for deducting pay not-for-profit activity, these limits apply at the ness is a corporation. partnership or S corporation level. They are re- 

### • Kinds of pay 

### • Your policy regarding pay for all your em- flected in the individual shareholder’s or part- ployees. ner’s distributive shares. 

### Useful Items **•** The history of pay for each employee. You may want to see: **More than one activity.** If you have several undertakings, each may be a separate activity or **Publication** several undertakings may be combined. The 

## Test 2
**— For Services**  following are the most significant facts and cir- 

## Performed ❏ **15** (Circular E), Employer’s Tax Guide cumstances in making this determination. You must be able to prove the payment was ❏ **15-A** Employer’s Supplemental Tax 

### • The degree of organizational and eco- made for services actually performed. Guidenomic interrelationship of various undertakings. ❏ **15-B** Employer’s Tax Guide to Fringe **Employee-shareholder salaries.** If a corpo- Benefits 

### • The business purpose that is (or might be) ration pays an employee who is also a shareserved by carrying on the various under- holder a salary that is unreasonably high See chapter 12 for information about getting takings separately or together in a busi- considering the services actually performed, the publications and forms. ness or investment setting. excessive part of the salary may be treated as a constructive distribution to the em- 

### • The similarity of the undertakings. ployee-shareholder. For more information on corporate distributions to shareholders, see The IRS will generally accept your characteri- 

# Tests for Publication 542, Corporations.zation if it is supported by facts and circumstances. 

# Deducting PayIf you are carrying on two or more difTo be deductible, your employees’ pay must be ferent activities, keep the deductions 

# Kinds of Pay an ordinary and necessary expense and you and income from each one separate. must pay or incur it. These and other require- Figure separately whether each is a Some of the ways you may provide pay to your ments that apply to all business expenses are not-for-profit activity. Then figure the limit on employees in addition to regular wages or sala- explained in chapter 1. deductions and losses separately for each activ- ries are discussed next. For specialized and ity that is not for profit. In addition, the pay must meet both of the detailed information on employees’ pay and the following tests. employment tax treatment of employees’ pay, see Publications 15, 15-A, and 15-B. 

### • **Test 1.**It must be reasonable.



### • **Test 2.**It must be for services performed. 

## Awards The form or method of figuring the pay does not You can generally deduct amounts you pay to affect its deductibility. For example, bonuses 

# 2. your employees as awards, whether paid in and commissions based on sales or earnings, cash or property. If you give property to an and paid under an agreement made before the employee as an employee achievement award, services were performed, are both deductible. your deduction may be limited. 

# Employees’ Pay **Test 1**
**— Reasonableness**  **Achievement awards.** An achievement award is an item of tangible personal property You must be able to prove that the pay is rea- that meets all the following requirements. sonable. Base this determination on the circum- 

# Introduction stances that exist when you contract for the 

### • It is given to an employee for length of services, not those that exist when the reasona- You can generally deduct the pay you give your service or safety achievement. bleness is questioned. If the pay is excessive, employees for the services they perform. The 

### • It is awarded as part of a meaningful pres- the excess is disallowed for deduction. pay may be in cash, property, or services. It may entation. include wages, salaries, or other compensation **Factors to consider.** Determine the reasona- such as vacation allowances, bonuses, commis- 

### • It is awarded under conditions and circumbleness of pay by the facts and circumstances. sions, and fringe benefits. For information about stances that do not create a significant Generally, reasonable pay is the amount that deducting employment taxes see chapter 5. likelihood of disguised pay. Page 6 Chapter2 **Employees’ Pay**

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**Length-of-service award.** An award will **Gifts of nominal value.** If, to promote em- 

### • Meals you furnish to your employees as qualify as a length-of-service award only if either ployee goodwill, you distribute food or merchan- part of the expense of providing recreaof the following applies. dise of nominal value to your employees at tional or social activities, such as a comholidays, you can deduct the cost of these items pany picnic. 

### • The employee receives the award after his as a nonwage business expense. Your deduc-

or her first 5 years of employment. 

### • Meals you are required by federal law to tion for de minimis gifts of food or drink are not furnish to crew members of certain com- 

### • The employee did not receive another subject to the 50% deduction limit that generally mercial vessels (or would be required to

length-of-service award (other than one of applies to meals. For more information on this furnish if the vessels were operated at very small value) during the same year or deduction limit, seeMeals and lodging, later. sea). This does not include meals you fur- in any of the prior 4 years. nish on vessels primarily providing luxury 

## Education Expenses water transportation. **Safety achievement award.** An award for safety achievement will qualify as an achieve- 

### • Meals you furnish on an oil or gas platform If you pay or reimburse education expenses for ment awardunless one of the following applies. or drilling rig located offshore or in Alaska. an employee, you can deduct the payments if This includes meals you furnish at a sup- they are part of a qualified educational assis- 1. It is given to a manager, administrator, port camp that is near and integral to an tance program. Deduct them on the “Employee clerical employee, or other professional oil or gas drilling rig located in Alaska. benefit programs” or other appropriate line of employee. your tax return. For information on educational 2. During the tax year, more than 10% of assistance programs, see Educational Assis- **Employee benefit programs.** Employee ben- your employees, excluding those listed in tance in section 2 of Publication 15-B. efit programs include the following. (1), have already received a safety 

### • Accident and health plans. achievement award (other than one of very 

## Fringe Benefits small value). 

### • Adoption assistance.A fringe benefit is a form of pay for the perform

### • Cafeteria plans. **Deduction limit.** Your deduction for the ance of services. You can generally deduct the cost of employee achievement awards given to cost of fringe benefits. 

### • Dependent care assistance. any one employee during the tax year is limited You may be able to exclude all or part of the 

### • Educational assistance. to the following. value of some fringe benefits from your employ- ees’ pay. You also may not owe employment 

### • Life insurance coverage. 

### • $400 for awards that are not qualified plan taxes on the value of the fringe benefits. See

awards. 

### • Welfare benefit funds. Table 2-1, Special Rules for Various Types of 

### • $1,600 for all awards, whether or not qual- Fringe Benefits, in Publication 15-B for details. You can generally deduct amounts you spend

ified plan awards. Your deduction for the cost of fringe benefits on employee benefit programs on the applicable for activities generally considered entertain- line of your tax return. For example, if you pro- A qualified plan award is an achievement ment, amusement, or recreation, or for a facility vide dependent care by operating a dependent award given as part of an established written used in connection with such an activity (for care facility for your employees, deduct your plan or program that does not favor highly com- example, a company aircraft) for certain officers, costs in whatever categories they fall (utilities, pensated employees as to eligibility or benefits. directors, and more-than-10% shareholders is salaries, etc.). A highly compensated employee is an em- limited. ployee who meetseither of the following tests. **Life insurance coverage.** You cannot deCertain fringe benefits are discussed next. duct the cost of life insurance coverage for you, See Publication 15-B for more details on these 1. The employee was a 5% owner at any an employee, or any person with a financial and other fringe benefits. time during the year or the preceding year. interest in your business, if you are directly or 2. The employee received more than **Meals and lodging.** You can usually deduct indirectly the beneficiary of the policy. See Reg- $110,000 in pay for the preceding year. the cost of furnishing meals and lodging to your ulations section 1.264-1 for more information. employees. Deduct the cost in whatever cate- You can choose to ignore test (2) if the em- **Welfare benefit funds.** A welfare benefit gory the expense falls. For example, if you oper- ployee was not also in the top 20% of employees fund is a funded plan (or a funded arrangement ate a restaurant, deduct the cost of the meals ranked by pay for the preceding year. having the effect of a plan) that provides welfare you furnish to employees as part of the cost of An award is not a qualified plan award if the benefits to your employees, independent con- goods sold. If you operate a nursing home, average cost of all the employee achievement tractors, or their beneficiaries. Welfare benefits motel, or rental property, deduct the cost of awards given during the tax year (that would be are any benefits other than deferred compensa- furnishing lodging to an employee as expenses qualified plan awards except for this limit) is tion or transfers of restricted property. for utilities, linen service, salaries, depreciation, more than $400. To figure this average cost, Your deduction for contributions to a welfare etc. ignore awards of nominal value. benefit fund is limited to the fund’s qualified cost Deduct achievement awards as a nonwage **Deduction limit on meals.** You can gener- for the tax year. If your contributions to the fund business expense on your return or business ally deduct only 50% of the cost of furnishing are more than its qualified cost, carry the excess schedule. meals to your employees. However, you can over to the next tax year. deduct the full cost of the following meals. You may not owe employment taxes Generally, the fund’s “qualified cost” is the on the value of some achievement total of the following amounts, reduced by the 

### • Meals whose value you include in an em- awards you provide to an employee. after-tax income of the fund. ployee’s wages. See Publication 15-B. 

### • The cost you would have been able to 

### • Meals that qualify as a de minimis fringe deduct using the cash method of account-

benefit as discussed in section 2 of Publi- 

## Bonuses ing if you had paid for the benefits directly. cation 15-B. This generally includes meals you furnish to employees at your place of 

### • The contributions added to a reserve ac- You can generally deduct a bonus paid to an business if more than half of these em- count that are needed to fund claims in- employee if you intended the bonus as addi- ployees are provided the meals for your curred but not paid as of the end of the tional pay for services, not as a gift, and the convenience. year. These claims can be for supplemenservices were performed. However, the total bo- 

### • Meals you furnish to your employees at tal unemployment benefits, severance nuses, salaries, and other pay must be reasona- the work site when you operate a restau- pay, or disability, medical, or life insurance ble for the services performed. If the bonus is rant or catering service. paid in property, seeProperty , later. benefits.

Chapter2 **Employees’ Pay** Page 7

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For more information, see sections 419(c) and the payment under a nonaccountable plan, de- have or will receive equity in or title to the propduct it as wages and include it in the employee’s 419A of the Internal Revenue Code and the erty, the rent is not deductible. W-2. related regulations. **Unreasonable rent.** You cannot take a rental See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more informa- deduction for unreasonable rent. Ordinarily, the 

## Loans or Advances tion about deducting reimbursements and an issue of reasonableness arises only if you and You generally can deduct as wages an advance explanation of accountable and nonaccountable the lessor are related. Rent paid to a related you make to an employee for services per- plans. person (defined below) is reasonable if it is the formed if you do not expect the employee to same amount you would pay to a stranger for repay the advance. However, if the employee use of the same property. Rent is not unreason

## Sick and Vacation Pay performs no services, treat the amount you ad- able just because it is figured as a percentage of vanced as a loan. If the employee does not gross sales. **Sick pay.** You can deduct amounts you pay to repay the loan, treat it as income to the em- your employees for sickness and injury, includ- **Related persons.** For this purpose, the fol- ployee. ing lump-sum amounts, as wages. However, lowing are considered related persons. your deduction is limited to amounts not com- **Below-market interest rate loans.** On cer- 

### • An individual and his or her brothers and pensated by insurance or other means. tain loans you make to an employee or share- sisters, half brothers, half sisters, spouse, holder, you are treated as having received ancestors (parents, grandparents, etc.), **Vacation pay.** Vacation pay is an employee interest income and as having paid compensa- and lineal descendants (children, grandbenefit. It includes amounts paid for unused tion or dividends equal to that interest. See children, etc.). vacation leave. You can deduct vacation pay Below-Market Loans in chapter 4. only in the tax year in which the employee actu- 

### • An individual and a corporation if the indi- ally receives it. This rule applies regardless of vidual owns, directly or indirectly, more 

## Property whether you use the cash or accrual method of than 50% in value of the outstanding stock accounting. of the corporation.If you transfer property (including your company’s stock) to an employee as payment for 

### • Two corporations that are members of the services, you can generally deduct it as wages. same controlled group as defined in sec- The amount you can deduct is the property’s fair tion 267(f) of the Internal Revenue Code. market value on the date of the transfer less any 

### • A grantor and a fiduciary of any trust. amount the employee paid for the property. You can claim the deduction only for the tax 

### • Fiduciaries of two separate trusts if the 

# 3. year in which your employee includes the prop- same person is a grantor of both trusts. erty’s value in income. Your employee is 

### • A fiduciary and a beneficiary of the same deemed to have included the value in income if trust. you report it on Form W-2 in a timely manner. 

# Rent Expense

**•** A fiduciary and a beneficiary of two sepaYou treat the deductible amount as received rate trusts if the same person is a grantor in exchange for the property, and you must rec- of both trusts. ognize any gain or loss realized on the transfer, 

# Introduction unless it is the company’s stock transferred as 

### • A fiduciary of a trust and a corporation if payment for services. Your gain or loss is the This chapter discusses the tax treatment of rent the trust or a grantor of the trust owns, difference between the fair market value of the or lease payments you make for property you directly or indirectly, more than 50% in property and its adjusted basis on the date of use in your business but do not own. It also value of the outstanding stock of the cor- transfer. discusses how to treat other kinds of payments poration. you make that are related to your use of this These rules also apply to property trans- 

### • A person and a tax-exempt educational or property. These include payments you make for ferred to an independent contractor for services, charitable organization that is controlled taxes on the property, improvements to the generally reported on Form 1099-MISC. directly or indirectly by that person or by property, and getting a lease. There is a discus- members of the family of that person. sion about capitalizing (including in the cost of **Restricted property.** If the property you property) certain rent expenses at the end of the transfer for services is subject to restrictions that 

### • A corporation and a partnership if the chapter. affect its value, you generally cannot deduct it same persons own more than 50% in and do not report gain or loss until it is substan- value of the outstanding stock of the cor- 

### Topics tially vested in the recipient. However, if the poration and more than 50% of the capital recipient pays for the property, you must report This chapter discusses: or profits interest in the partnership. any gain at the time of the transfer up to the 

### • Two S corporations or an S corporation amount paid. 

### • The definition of rent and a regular corporation if the same per- “Substantially vested” means the property is 

### • Taxes on leased property sons own more than 50% in value of the not subject to a substantial risk of forfeiture. This outstanding stock of each corporation. 

### • The cost of getting a lease means that the recipient is not likely to have to give up his or her rights in the property in the 

### • An executor of an estate and a beneficiary 

### • Improvements by the lessee future. of the estate except in the case of a sale 

### • Capitalizing rent expenses or exchange in satisfaction of a pecuniary 

## Reimbursements bequest. See chapter 12for information about getting 

## for Business Expenses publications and forms. To determine whether an individual directly or indirectly owns any of the outstanding stock of a You can generally deduct the amount you pay or reimburse employees for business expenses in- corporation, seeRelated Persons in Publication curred for your business. However, your deduc- 542, Corporations. For rules that apply to transtion may be limited. actions between partners and partnerships, see 

# Rent Publication 541, Partnerships. If you make the payment under an accounta- ble plan, deduct it in the category of the expense Rent is any amount you pay for the use of **Rent on your home.** If you rent your home paid. For example, if you pay an employee for property you do not own. In general, you can and use part of it as your place of business, you travel expenses incurred on your behalf, deduct deduct rent as an expense only if the rent is for may be able to deduct the rent you pay for that this payment as a travel expense. If you make property you use in your trade or business. If you Page 8 Chapter3 **Rent Expense**

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part. You must meet the requirements for busi- **Leveraged leases.** Leveraged lease trans- more than $250,000 and any of the following apply. ness use of your home. For more information, actions may not be considered leases. Lever- seeBusiness use of your home in chapter 1. aged leases generally involve three parties: a 

### • Rents increase during the lease. lessor, a lessee, and a lender to the lessor. 

### • Rents decrease during the lease. Usually the lease term covers a large part of the **Rent paid in advance.** Generally, rent paid in useful life of the leased property, and the your trade or business is deductible in the year 

### • Rents are deferred (rent is payable after lessee’s payments to the lessor are enough to paid or accrued. If you pay rent in advance, you the end of the calendar year following the cover the lessor’s payments to the lender. can deduct only the amount that applies to your calendar year in which the use occurs and use of the rented property during the tax year. If you plan to take part in what appears to be the rent is allocated). You can deduct the rest of your payment only a leveraged lease, you may want to get an 

### • Rents are prepaid (rent is payable before over the period to which it applies. advance ruling. Revenue Procedure 2001-28 on the end of the calendar year preceding the page 1156 of Internal Revenue Bulletin 2001-19 calendar year in which the use occurs and **Example 1.** You are a calendar year tax- contains the guidelines the IRS will use to deter- the rent is allocated). payer and you leased a building for 5 years mine if a leveraged lease is a lease for federal beginning July 1. Your rent is $12,000 per year. income tax purposes. Revenue Procedure These rules do not apply if your lease specifies You paid the first year’s rent ($12,000) on June 2001-29 on page 1160 of the same Internal equal amounts of rent for each month in the 30. You can deduct only $6,000 (6 /12**×**$12,000) Revenue Bulletin provides the information re- lease term and all rent payments are due in the for the rent that applies to the first year. quired to be furnished in a request for an ad- calendar year to which the rent relates (or in the vance ruling on a leveraged lease transaction. preceding or following calendar year). **Example 2.** You are a calendar year tax- Internal Revenue Bulletin 2001-19 is available at Generally, if the special rules apply, you must payer. Last January you leased property for 3 www.irs.gov/pub/irs-irbs/irb01-19.pdf

. use an accrual method of accounting (and time years for $6,000 a year. You paid the full In general, Revenue Procedure 2001-28 value of money principles) for your rental ex- $18,000 (3**×**$6,000) during the first year of the provides that, for advance ruling purposes only, penses, regardless of your overall method of lease. Each year you can deduct only $6,000, the IRS will consider the lessor in a leveraged accounting. In addition, in certain cases in which the part of the lease that applies to that year. lease transaction to be the owner of the property the IRS has determined that a lease was deand the transaction to be a valid lease if all the signed to achieve tax avoidance, you must take **Canceling a lease.** You generally can deduct factors in the revenue procedure are met, in- rent and stated or imputed interest into account as rent an amount you pay to cancel a business cluding the following. under a constant rental accrual method in which lease. the rent is treated as accruing ratably over the 

### • The lessor must maintain a minimum un- entire lease term. For details, see section 467 of

conditional “at risk” equity investment in **Lease or purchase.** There may be instances the Internal Revenue Code. the property (at least 20% of the cost of in which you must determine whether your pay- the property) during the entire lease term. ments are for rent or for the purchase of the property. You must first determine whether your 

### • The lessee may not have a contractual right to buy the property from the lessor at agreement is a lease or a conditional sales con- 

# Taxes on less than fair market value when the right tract. Payments made under a conditional sales is exercised. contract are not deductible as rent expense. 

# Leased Property

**•** The lessee may not invest in the property, **Conditional sales contract.** Whether an If you lease business property, you can deduct except as provided by Revenue Procedure agreement is a conditional sales contract de- as additional rent any taxes you have to pay to 2001-28. pends on the intent of the parties. Determine or for the lessor. When you can deduct these intent based on the provisions of the agreement 

### • The lessee may not lend any money to the taxes as additional rent depends on your ac- and the facts and circumstances that exist when lessor to buy the property or guarantee the counting method. you make the agreement. No single test, or loan used by the lessor to buy the prop- special combination of tests, always applies. erty. **Cash method.** If you use the cash method of However, in general, an agreement may be con- accounting, you can deduct the taxes as addi- 

### • The lessor must show that it expects to sidered a conditional sales contract rather than tional rent only for the tax year in which you pay receive a profit apart from the tax deduc- a lease if any of the following is true. them. tions, allowances, credits, and other tax 

### • The agreement applies part of each pay- attributes. **Accrual method.** If you use an accrual

ment toward an equity interest you will re- method of accounting, you can deduct taxes as ceive. The IRS may charge you a user fee for issuing additional rent for the tax year in which you can a tax ruling. For more information, see Revenue 

### • You get title to the property after you make determine all the following.Procedure 2011-1 as modified by Announcea stated amount of required payments. 

### • That you have a liability for taxes on the ment 2011-7. See Revenue Procedure 2011-1, 

### • The amount you must pay to use the prop- leased property. 2011-1 I.R.B. 1, available at erty for a short time is a large part of the www.irs.gov/irb/2011-01_IRB/ar06.html. See 

### • How much the liability is. amount you would pay to get title to the Announcement 2011-7, 2011-5 I.R.B. 446, property. 

### • That economic performance occurred. available at www.irs.gov/irb/2011-05_IRB/ar10.html

. 

### • You pay much more than the current fair The liability and amount of taxes are deter-

rental value of the property. **Leveraged leases of limited-use property.** mined by state or local law and the lease agree- The IRS will not issue advance rulings on lever- 

### • You have an option to buy the property at ment. Economic performance occurs as you use aged leases of so-called limited-use property. a nominal price compared to the value of the property. Limited-use property is property not expected to the property when you may exercise the be either useful to or usable by a lessor at the option. Determine this value when you **Example 1.** Oak Corporation is a calendar end of the lease term except for continued leas- make the agreement. year taxpayer that uses an accrual method of ing or transfer to a lessee. See Revenue Proce- accounting. Oak leases land for use in its busi- 

### • You have an option to buy the property at dure 2001-28 for examples of limited-use ness. Under state law, owners of real property

a nominal price compared to the total property and property that is not limited-use become liable (incur a lien on the property) for amount you have to pay under the agree- property. real estate taxes for the year on January 1 of ment. that year. However, they do not have to pay 

### • The agreement designates part of the pay- **Leases over $250,000.** Special rules are pro- these taxes until July 1 of the next year (18

ments as interest, or that part is easy to vided for certain leases of tangible property. The months later) when tax bills are issued. Under recognize as interest. rules apply if the lease calls for total payments of the terms of the lease, Oak becomes liable for Chapter3 **Rent Expense** Page 9

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the real estate taxes in the later year when the **Cost of a modification agreement.** You may amortize it over the remaining term of the lease. tax bills are issued. If the lease ends before the have to pay an additional “rent” amount over part You can depreciate the part that is for your tax bill for a year is issued, Oak is not liable for of the lease period to change certain provisions investment in the improvements over the recovthe taxes for that year. in your lease. You must capitalize these pay- ery period of the property as discussed earlier, ments and amortize them over the remaining without regard to the lease term. Oak cannot deduct the real estate taxes as period of the lease. You cannot deduct the payrent until the tax bill is issued. This is when Oak’s ments as additional rent, even if they are deliability under the lease becomes fixed. scribed as rent in the agreement.

**Example 2.** The facts are the same as in 

# Capitalizing Example 1except that, according to the terms of **Example.** You are a calendar year taxpayer the lease, Oak becomes liable for the real estate and sign a 20-year lease to rent part of a building 

# Rent Expenses taxes when the owner of the property becomes starting on January 1. However, before you ocliable for them. As a result, Oak will deduct the cupy it, you decide that you really need less Under the uniform capitalization rules, you must real estate taxes as rent on its tax return for the space. The lessor agrees to reduce your rent capitalize the direct costs and part of the indirect earlier year. This is the year in which Oak’s from $7,000 to $6,000 per year and to release costs for certain production or resale activities. liability under the lease becomes fixed. the excess space from the original lease. In Include these costs in the basis of property you exchange, you agree to pay an additional rent produce or acquire for resale, rather than claim- amount of $3,000, payable in 60 monthly install- ing them as a current deduction. You recover the ments of $50 each. costs through depreciation, amortization, or cost 

# Cost of Getting a Lease You must capitalize the $3,000 and amortize of goods sold when you use, sell, or otherwise it over the 20-year term of the lease. Your amor- dispose of the property. You may either enter into a new lease with the tization deduction each year will be $150 Indirect costs include amounts incurred for lessor of the property or get an existing lease ($3,000**÷**20). You cannot deduct the $600 (12**×** renting or leasing equipment, facilities, or land. from another lessee. Very often when you get an $50) that you will pay during each of the first 5 existing lease from another lessee, you must years as rent. pay the previous lessee money to get the lease, **Uniform capitalization rules.** You may be besides having to pay the rent on the lease. subject to the uniform capitalization rules if you **Commissions, bonuses, and fees.** Commis- If you get an existing lease on property or do any of the following, unless the property is sions, bonuses, fees, and other amounts you equipment for your business, you generally produced for your use other than in a business pay to get a lease on property you use in your must amortize any amount you pay to get that or an activity carried on for profit. business are capital costs. You must amortize lease over the remaining term of the lease. For these costs over the term of the lease. example, if you pay $10,000 to get a lease and 1. Produce real property or tangible personal there are 10 years remaining on the lease with property. For this purpose, tangible per- **Loss on merchandise and fixtures.** If you no option to renew, you can deduct $1,000 each sonal property includes a film, sound re- sell at a loss merchandise and fixtures that you year. cording, video tape, book, or similar bought solely to get a lease, the loss is a cost of property. The cost of getting an existing lease of tangi- getting the lease. You must capitalize the loss ble property is not subject to the amortization and amortize it over the remaining term of the 2. Acquire property for resale. rules for section 197 intangibles discussed in lease. However, these rules do not apply to the followchapter 8

. ing property. **Option to renew.** The term of the lease for 1. Personal property you acquire for resale if amortization includes all renewal options plus 

# Improvements your average annual gross receipts are any other period for which you and the lessor $10 million or less for the 3 prior tax years. reasonably expect the lease to be renewed. 

# by Lessee However, this applies only if less than 75% of 2. Property you produce if you meet either of the cost of getting the lease is for the term the following conditions. If you add buildings or make other permanent remaining on the purchase date (not including improvements to leased property, depreciate any period for which you may choose to renew, a. Your indirect costs of producing the the cost of the improvements using the modified extend, or continue the lease). Allocate the property are $200,000 or less. accelerated cost recovery system (MACRS). lease cost to the original term and any option b. You use the cash method of accounting Depreciate the property over its appropriate re- term based on the facts and circumstances. In and do not account for inventories. covery period. You cannot amortize the cost some cases, it may be appropriate to make the over the remaining term of the lease. allocation using a present value computation. If you do not keep the improvements when For more information, see Regulations section **Example 1.** You rent construction equip- you end the lease, figure your gain or loss based 1.178-1(b)(5). ment to build a storage facility. If you are subject on your adjusted basis in the improvements at to the uniform capitalization rules, you must cap- **Example 1.** You paid $10,000 to get a lease that time. italize as part of the cost of the building the rent with 20 years remaining on it and two options to For more information, see the discussion of you paid for the equipment. You recover your renew for 5 years each. Of this cost, you paid MACRS in Publication 946, How To Depreciate cost by claiming a deduction for depreciation on $7,000 for the original lease and $3,000 for the Property. renewal options. Because $7,000 is less than the building. 75% of the total $10,000 cost of the lease (or **Assignment of a lease.** If a long-term lessee **Example 2.** You rent space in a facility to $7,500), you must amortize the $10,000 over 30 who makes permanent improvements to land years. That is the remaining life of your present conduct your business of manufacturing tools. If later assigns all lease rights to you for money lease plus the periods for renewal. you are subject to the uniform capitalization and you pay the rent required by the lease, the rules, you must include the rent you paid to amount you pay for the assignment is a capital **Example 2.** The facts are the same as in occupy the facility in the cost of the tools you investment. If the rental value of the leased land Example 1, except that you paid $8,000 for the produce. increased since the lease began, part of your original lease and $2,000 for the renewal op- capital investment is for that increase in the tions. You can amortize the entire $10,000 over rental value. The rest is for your investment in **More information.** For more information on the 20-year remaining life of the original lease. the permanent improvements. these rules, seeUniform Capitalization Rules in The $8,000 cost of getting the original lease was The part that is for the increased rental value Publication 538 and the regulations under Inter- not less than 75% of the total cost of the lease of the land is a cost of getting a lease, and you nal Revenue Code section 263A. (or $7,500). Page 10 Chapter3 **Rent Expense**

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Allocate your interest expense to the follow- for a passive activity expenditure. On September 4, Connie uses an additional $40,000 from ing categories. the account for personal purposes.



### • Nonpassive trade or business activity in- 

# 4. Under the interest allocation rules, the entire terest $100,000 loan is treated as property held for 

### • Passive trade or business activity interest investment for the period from January 4 through April 1. From April 2 through September 

### • Investment interest 

# Interest 3, Connie must treat $20,000 of the loan as used 

### • Portfolio interest in the passive activity and $80,000 of the loan as property held for investment. From September 4 

### • Personal interest through December 31, she must treat $40,000 

# Introduction In general, you allocate interest on a loan the of the loan as used for personal purposes, same way you allocate the loan proceeds. You $20,000 as used in the passive activity, and This chapter discusses the tax treatment of busi- allocate loan proceeds by tracing disburse- $40,000 as property held for investment. ness interest expense. **Business interest ex** ments to specific uses. **pense**is an amount charged for the use of **Order of funds spent.** Generally, you treat money you borrowed for business activities. loan proceeds deposited in an account as used The easiest way to trace disburse- (spent) before either of the following amounts. ments to specific uses is to keep the 

### Topics proceeds of a particular loan separate 

### • Any unborrowed amounts held in the This chapter discusses: from any other funds. same account.


### • Any amounts deposited after these loan 

### • Allocation of interest **Secured loan.** The allocation of loan pro- proceeds. 

### • Interest you can deduct ceeds and the related interest is not generally affected by the use of property that secures the 

### • Interest you cannot deduct **Example.** On January 9, Edith opened a loan. checking account, depositing $500 of the pro

### • Capitalization of interest ceeds of Loan A and $1,000 of unborrowed **Example.** You secure a loan with property 

### • When to deduct interest funds. The following table shows the transac- used in your business. You use the loan pro- tions in her account during the tax year. 

### • Below-market loans ceeds to buy an automobile for personal use. You must allocate interest expense on the loan **Date Transaction**  to personal use (purchase of the automobile) 

### Useful Items even though the loan is secured by business January 9 $500 proceeds of Loan A You may want to see: property. and $1,000 unborrowed funds deposited If the property that secures the loan is **Publication** January 14 $500 proceeds of Loan B your home, you generally do not allo- ❏ **537** Installment Sales deposited cate the loan proceeds or the related interest. The interest is usually deductible as February 19 $800 used for personal ❏ **550** Investment Income and Expenses qualified home mortgage interest, regardless of purposes ❏ **936** Home Mortgage Interest Deduction how the loan proceeds are used. For more inforFebruary 27 $700 used for passive mation, see Publication 936. activity **Form (and Instructions)** June 19 $1,000 proceeds of Loan C **Allocation period.** The period for which a ❏ **Sch A (Form 1040)** Itemized Deductions deposited loan is allocated to a particular use begins on the ❏ **Sch E (Form 1040)** Supplemental date the proceeds are used and ends on the November 20 $800 used for an Income and Loss earlier of the following dates. investment ❏ **Sch K-1 (Form 1065)** Partner’s Share of 

### • The date the loan is repaid. December 18 $600 used for personal Income, Deductions, Credits, etc. purposes 

### • The date the loan is reallocated to another ❏ **Sch K-1 (Form 1120S)** Shareholder’s use. Edith treats the $800 used for personal pur- Share of Income, Deductions, poses as made from the $500 proceeds of Loan Credits, etc. A and $300 of the proceeds of Loan B. She **Proceeds not disbursed to borrower.** Even treats the $700 used for a passive activity as if the lender disburses the loan proceeds to a ❏ **1098** Mortgage Interest Statement made from the remaining $200 proceeds of third party, the allocation of the loan is still based ❏ **3115** Application for Change in Loan B and $500 of unborrowed funds. She on your use of the funds. This applies whether Accounting Method treats the $800 used for an investment as made you pay for property, services, or anything else entirely from the proceeds of Loan C. She treats by incurring a loan, or you take property subject ❏ **4952** Investment Interest Expense the $600 used for personal purposes as made to a debt. Deduction from the remaining $200 proceeds of Loan C ❏ **8582** Passive Activity Loss Limitations and $400 of unborrowed funds. **Proceeds deposited in borrower’s account.** For the periods during which loan proceeds Treat loan proceeds deposited in an account as See chapter 12 for information about getting are held in the account, Edith treats them as property held for investment. It does not matter publications and forms. property held for investment. whether the account pays interest. Any interest you pay on the loan is investment interest ex- **Payments from checking accounts.** Gen- pense. If you withdraw the proceeds of the loan, erally, you treat a payment from a checking or you must reallocate the loan based on the use of similar account as made at the time the check is the funds. 

# Allocation of Interest written if you mail or deliver it to the payee within a reasonable period after you write it. You can **Example.** Connie, a calendar-year tax- The rules for deducting interest vary, depending treat checks written on the same day as written payer, borrows $100,000 on January 4 and im- on whether the loan proceeds are used for busi- in any order. mediately uses the proceeds to open a checking ness, personal, or investment activities. If you account. No other amounts are deposited in the use the proceeds of a loan for more than one **Amounts paid within 30 days.** If you reaccount during the year and no part of the loan type of expense, you must make an allocation to ceive loan proceeds in cash or if the loan proprincipal is repaid during the year. On April 2, determine the interest for each use of the loan’s ceeds are deposited in an account, you can treat Connie uses $20,000 from the checking account proceeds. any payment (up to the amount of the proceeds) Chapter4 **Interest** Page 11

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made from any account you own, or from cash, account ($867) continues to be investment inter- you use the proceeds of the loan for a trade or est expense until you either repay it or reallocate business expense. It does not matter what type as made from those proceeds. This applies to it to another use. of property secures the loan. You can deduct any payment made within 30 days before or interest on a debt only if you meet all the follow- after the proceeds are received in cash or de- **Loan repayment.** When you repay any part of ing requirements. posited in your account. a loan allocated to more than one use, treat it as If the loan proceeds are deposited in an 

### • You are legally liable for that debt. being repaid in the following order. account, you can apply this rule even if the rules 

### • Both you and the lender intend that the 1. Personal use. stated earlier underOrder of funds spentwould debt be repaid. otherwise require you to treat the proceeds as 2. Investments and passive activities (other 

### • You and the lender have a true used for other purposes. If you apply this rule to than those included in (3)). debtor-creditor relationship. any payments, disregard those payments (and 3. Passive activities in connection with a the proceeds from which they are made) when rental real estate activity in which you ac- applying the rules stated under Order of funds **Partial liability.** If you are liable for part of a tively participate. spent. business debt, you can deduct only your share If you received the loan proceeds in cash, 4. Former passive activities. of the total interest paid or accrued. you can treat the payment as made on the date 5. Trade or business use and expenses for **Example.** You and your brother borrow you received the cash instead of the date you certain low-income housing projects. money. You are liable for 50% of the note. You actually made the payment. use your half of the loan in your business, and **Line of credit (continuous borrowings).** you make one-half of the loan payments. You **Example.** Frank gets a loan of $1,000 on The following rules apply if you have a line of can deduct your half of the total interest pay- August 4 and receives the proceeds in cash. credit or similar arrangement. ments as a business deduction. Frank deposits $1,500 in an account on August 18 and on August 28 writes a check on the 1. Treat all borrowed funds on which interest **Mortgage.** Generally, mortgage interest paid account for a passive activity expense. Also, accrues at the same fixed or variable rate or accrued on real estate you own legally or Frank deposits his paycheck, deposits other as a single loan. equitably is deductible. However, rather than loan proceeds, and pays his bills during the deducting the interest currently, you may have 2. Treat borrowed funds or parts of borrowed same period. Regardless of these other transac- to add it to the cost basis of the property as funds on which interest accrues at different tions, Frank can treat $1,000 of the deposit he explained later underCapitalization of Interest. fixed or variable rates as different loans. made on August 18 as being paid on August 4 Treat these loans as repaid in the order **Statement.** If you paid $600 or more of from the loan proceeds. In addition, Frank can shown on the loan agreement. mortgage interest (including certain points) dur- treat the passive activity expense he paid on ing the year on any one mortgage, you generally August 28 as made from the $1,000 loan pro- **Loan refinancing.** Allocate the replacement will receive a Form 1098 or a similar statement. ceeds treated as deposited in the account. loan to the same uses to which the repaid loan You will receive the statement if you pay interest was allocated. Make the allocation only to the **Optional method for determining date of** to a person (including a financial institution or a extent you use the proceeds of the new loan to **reallocation.** You can use the following cooperative housing corporation) in the course repay any part of the original loan. of that person’s trade or business. A governmethod to determine the date loan proceeds are mental unit is a person for purposes of furnishing reallocated to another use. You can treat all **Debt-financed distribution.** A debt-financed the statement. payments from loan proceeds in the account distribution occurs when a partnership or S cor- If you receive a refund of interest you over- during any month as taking place on the later of poration borrows funds and allocates those paid in an earlier year, this amount will be re- the following dates. funds to distributions made to partners or share- ported in box 3 of Form 1098. You cannot holders. The manner in which you report the 

### • The first day of that month. deduct this amount. For information on how to interest expense associated with the distributed report this refund, see Refunds of interestlater 

### • The date the loan proceeds are deposited debt proceeds depends on your use of those in this chapter.

in the account. proceeds. **Expenses paid to obtain a mortgage.** However, you can use this optional method only **How to report.** If the proceeds were used in Certain expenses you pay to obtain a mortgage if you treat all payments from the account during a nonpassive trade or business activity, report cannot be deducted as interest. These ex- the same calendar month in the same way. the interest on Schedule E (Form 1040), line 28; penses, which include mortgage commissions, enter “interest expense” and the name of the **Interest on a segregated account.** If you abstract fees, and recording fees, are capital partnership or S corporation in column (a) and have an account that contains only loan pro- expenses. If the property mortgaged is business the amount in column (h). If the proceeds were ceeds and interest earned on the account, you or income-producing property, you can amortize used in a passive activity, follow the Instructions can treat any payment from that account as the costs over the life of the mortgage. for Form 8582, Passive Activity Loss Limita- being made first from the interest. When the **Prepayment penalty.** If you pay off your tions, to determine the amount of interest ex- interest earned is used up, any remaining pay- mortgage early and pay the lender a penalty for pense that can be reported on Schedule E ments are from loan proceeds. doing this, you can deduct the penalty as inter(Form 1040), line 28; enter “interest expense” est. and the name of the partnership in column (a) **Example.** You borrowed $20,000 and used and the amount in column (f). If the proceeds **Interest on employment tax deficiency.** In- the proceeds of this loan to open a new savings were used in an investment activity, enter the terest charged on employment taxes assessed account. When the account had earned interest interest on Form 4952. If the proceeds are used on your business is deductible. of $867, you withdrew $20,000 for personal pur- for personal purposes, the interest is generally poses. You can treat the withdrawal as coming not deductible. **Original issue discount (OID).** OID is a form first from the interest earned on the account, of interest. A loan (mortgage or other debt) gen- $867, and then from the loan proceeds, $19,133 erally has OID when its proceeds are less than ($20,000

**−**$867). All the interest charged on the its principal amount. The OID is the difference loan from the time it was deposited in the ac- between the stated redemption price at maturity 

# Interest You count until the time of the withdrawal is invest- and the issue price of the loan. ment interest expense. The interest charged on A loan’s stated redemption price at maturity 

# Can Deduct the part of the proceeds used for personal pur- is the sum of all amounts (principal and interest) poses ($19,133) from the time you withdrew it You can generally deduct as a business ex- payable on it other than qualified stated interest. until you either repay it or reallocate it to another pense all interest you pay or accrue during the Qualified stated interest is stated interest that is use is personal interest expense. The interest tax year on debts related to your trade or busi- unconditionally payable in cash or property charged on the loan proceeds you left in the ness. Interest relates to your trade or business if (other than another loan of the issuer) at least Page 12 Chapter4 **Interest**

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annually over the term of the loan at a single **Example.** The facts are the same as in the You cannot currently deduct interest that previous example, except that you deduct the must be capitalized, and you generally cannot fixed rate. OID on a constant yield basis over the term of deduct personal interest. You generally deduct OID over the term of the loan. The yield to maturity on your loan is the loan. Figure the amount to deduct each year **Interest paid with funds borrowed from origi-** 10.2467%, compounded annually. For 2010, using the constant-yield method, unless the OID **nal lender.** If you use the cash method of you can deduct $93 [($98,500 **×**.102467)

**−** on the loan is de minimis. accounting, you cannot deduct interest you pay $10,000]. For 2011, you can deduct $103 **De minimis OID.** The OID is de minimis if it with funds borrowed from the original lender [($98,593**×**.102467)

**−**$10,000]. is less than one-fourth of 1% (.0025) of the through a second loan, an advance, or any other **Loan or mortgage ends.** If your loan or stated redemption price of the loan at maturity arrangement similar to a loan. You can deduct mortgage ends, you may be able to deduct any multiplied by the number of full years from the the interest expense once you start making pay- remaining OID in the tax year in which the loan date of original issue to maturity (the term of the ments on the new loan. or mortgage ends. A loan or mortgage may end loan). When you make a payment on the new loan, due to a refinancing, prepayment, foreclosure, If the OID is de minimis, you can choose one you first apply the payment to interest and then or similar event. of the following ways to figure the amount you to the principal. All amounts you apply to the If you refinance with the original lender, can deduct each year. interest on the first loan are deductible, along you generally cannot deduct the re- with any interest you pay on the second loan, 

### • On a constant-yield basis over the term of maining OID in the year in which the subject to any limits that apply.

the loan. refinancing occurs, but you may be able to de- duct it over the term of the new mortgage or 

### • On a straight-line basis over the term of **Capitalized interest.** You cannot currently loan. SeeInterest paid with funds borrowed from the loan. deduct interest you are required to capitalize original lender under Interest You Cannot De- under the uniform capitalization rules. SeeCapi- 

### • In proportion to stated interest payments. duct,later. talization of Interest,later. In addition, if you buy 

### • In its entirety at maturity of the loan. property and pay interest owed by the seller (for **Points.** The term “points” is used to describe example, by assuming the debt and any interest You make this choice by deducting the OID in a certain of the charges paid, or treated as paid, accrued on the property), you cannot deduct the manner consistent with the method chosen on by a borrower to obtain a loan or a mortgage. interest. Add this interest to the basis of the your timely filed tax return for the tax year in These charges are also called loan origination property. which the loan is issued. fees, maximum loan charges, discount points, or **Commitment fees or standby charges.** premium charges. If any of these charges **Example.** On January 1, 2010, you took out Fees you incur to have business funds available (points) are solely for the use of money, they are a $100,000 discounted loan and received on a standby basis, but not for the actual use of interest. $98,500 in proceeds. The loan will mature on the funds, are not deductible as interest pay- Because points are prepaid interest, you January 1, 2020 (a 10-year term), and the ments. You may be able to deduct them as generally cannot deduct the full amount in the $100,000 principal is payable on that date. Inter- business expenses. year paid. However, you can choose to fully est of $10,000 is payable on January 1 of each deduct points in the year paid if you meet certain If the funds are for inventory or certain prop- year, beginning January 1, 2011. The $1,500 tests. For exceptions to the general rule, see erty used in your business, the fees are indirect OID on the loan is de minimis because it is less Publication 936. costs and you generally must capitalize them than $2,500 ($100,000 **×**.0025 **×**10). You The points reduce the issue price of the loan under the uniform capitalization rules. SeeCapi- choose to deduct the OID on a straight-line basis and result in original issue discount, deductible talization of Interest,later. over the term of the loan. Beginning in 2010, you as explained in the preceding discussion. can deduct $150 each year for 10 years. **Interest on income tax.** Interest charged on **Partial payments on a nontax debt.** If you **Constant-yield method.** If the OID is not de income tax assessed on your individual income make partial payments on a debt (other than a minimis, you must use the constant-yield tax return is not a business deduction even debt owed the IRS), the payments are applied, method to figure how much you can deduct each though the tax due is related to income from in general, first to interest and any remainder to year. You figure your deduction for the first year your trade or business. Treat this interest as a principal. You can deduct only the interest. This using the following steps. business deduction only in figuring a net operat- rule does not apply when it can be inferred that ing loss deduction.the borrower and lender understood that a differ1. Determine the issue price of the loan. Gen- **Penalties.** Penalties on underpaid deficien- ent allocation of the payments would be made. erally, this equals the proceeds of the loan. cies and underpaid estimated tax are not inter-If you paid points on the loan (as disest. You cannot deduct them. Generally, you **Installment purchase.** If you make an install- cussed later), the issue price generally is cannot deduct any fines or penalties. ment purchase of business property, the con- the difference between the proceeds and tract between you and the seller generally the points. **Interest on loans with respect to life insur** provides for the payment of interest. If no inter- 2. Multiply the result in (1) by the yield to **ance policies.** You generally cannot deduct est or a low rate of interest is charged under the maturity. interest on a debt incurred with respect to any contract, a portion of the stated principal amount life insurance, annuity, or endowment contract payable under the contract may be recharacter- 3. Subtract any qualified stated interest pay- that covers any individual unless that individual ized as interest (unstated interest). The amount ments from the result in (2). This is the is a key person. recharacterized as interest reduces your basis OID you can deduct in the first year. in the property and increases your interest ex- If the policy or contract covers a key person, To figure your deduction in any subsequent pense. For more information on installment you can deduct the interest on up to $50,000 of year, follow the above steps, except determine sales and unstated interest, see Publication debt for that person. However, the deduction for the adjusted issue price in step (1). To get the 537. any month cannot be more than the interest adjusted issue price, add to the issue price any figured using Moody’s Composite Yield on Sea- OID previously deducted. Then follow steps (2) soned Corporate Bonds (formerly known as and (3) above. Moody’s Corporate Bond Yield AverThe yield to maturity is generally shown in age-Monthly Average Corporates) (Moody’s 

# Interest You the literature you receive from your lender. If you rate) for that month. do not have this information, consult your lender 

# Cannot Deduct **Who is a key person?** A key person is an or tax advisor. In general, the yield to maturity is officer or 20% owner. However, the number of the discount rate that, when used in computing Certain interest payments cannot be deducted. individuals you can treat as key persons is lim- the present value of all principal and interest In addition, certain other expenses that may ited to the greater of the following. payments, produces an amount equal to the seem to be interest are not, and you cannot principal amount of the loan. deduct them as interest. 

### • Five individuals. Chapter4 **Interest** Page 13

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### • The lesser of 5% of the total officers and the property is used in your trade or business, until the tax year the final determination of liabilemployees of the company or 20 individu- recover capitalized interest through an adjust- ity is made. If you do not contest the deficiency, als. ment to basis, depreciation, amortization, or then the interest accrues in the year the tax was other method. asserted and agreed to by you. **Exceptions for pre-June 1997 contracts.** However, if you contest but pay the pro- **Partnerships and S corporations.** The inter- You can generally deduct the interest if the con- posed tax deficiency and interest, and you do est capitalization rules are applied first at the tract was issued before June 9, 1997, and the not designate the payment as a cash bond, then partnership or S corporation level. The rules are covered individual is someone other than an the interest is deductible in the year paid. then applied at the partners’ or shareholders’ employee, officer, or someone financially inter- level to the extent the partnership or S corpora- **Related person.** If you use an accrual ested in your business. If the contract was pur- tion has insufficient debt to support the produc- chased before June 21, 1986, you can generally method, you cannot deduct interest owed to a tion or construction costs. deduct the interest no matter who is covered by related person who uses the cash method until If you are a partner or a shareholder, you the contract. payment is made and the interest is includible in may have to capitalize interest you incur during the gross income of that person. The relation- **Interest allocated to unborrowed policy** the tax year for the production costs of the part- ship is determined as of the end of the tax year **cash value.** Corporations and partnerships nership or S corporation. You may also have to for which the interest would otherwise be de- generally cannot deduct any interest expense capitalize interest incurred by the partnership or ductible. See section 267 of the Internal Reve- allocable to unborrowed cash values of life in- S corporation for your own production costs. To nue Code for more information. surance, annuity, or endowment contracts. This properly capitalize interest under these rules, rule applies to contracts issued after June 8, you must be given the required information in an 1997, that cover someone other than an officer, attachment to the Schedule K-1 you receive director, employee, or 20% owner. For more from the partnership or S corporation. information, see section 264(f) of the Internal 

# Below-Market Loans Revenue Code. **Additional information.** The procedures for If you receive a below-market gift or demand applying the uniform capitalization rules are be- yond the scope of this publication. For more loan and use the proceeds in your trade or information, see sections 1.263A-8 through business, you may be able to deduct the forgone 

# Capitalization 1.263A-15 of the regulations and Notice 88-99. interest. See Treatment of gift and demand Notice 88-99 is in Cumulative Bulletin 1988-2. loanslater in this discussion. 

# of Interest A below-market loan is a loan on which no interest is charged or on which interest is Under the uniform capitalization rules, you gen- charged at a rate below the applicable federal erally must capitalize interest on debt equal to 

# When To rate. A gift or demand loan that is a be- your expenditures to produce real property or low-market loan generally is considered an certain tangible personal property. The property 

# Deduct Interest arm’s-length transaction in which you, the bormust be produced by you for use in your trade or rower, are considered as having received both business or for sale to customers. You cannot If the uniform capitalization rules, discussed the following. capitalize interest related to property that you under Capitalization of Interest,earlier, do not acquire in any other manner. apply to you, deduct interest as follows. 

### • A loan in exchange for a note that requires Interest you paid or incurred during the pro- the payment of interest at the applicable **Cash method.** Under the cash method, you duction period must be capitalized if the property federal rate.can generally deduct only the interest you actuproduced is designated property. Designated 

### • An additional payment in an amount equal ally paid during the tax year. You cannot deduct property is any of the following. to the forgone interest. a promissory note you gave as payment be- 

### • Real property. cause it is a promise to pay and not an actual The additional payment is treated as a gift, divi- payment. 

### • Tangible personal property with a class life dend, contribution to capital, payment of com-

of 20 years or more. pensation, or other payment, depending on the **Prepaid interest.** You generally cannot de- duct any interest paid before the year it is due. substance of the transaction. 

### • Tangible personal property with an esti- Interest paid in advance can be deducted only in

mated production period of more than 2 **Forgone interest.** the tax year in which it is due. years. For any period, forgone interestis: **Discounted loan.** If interest or a discount is 

### • Tangible personal property with an esti- subtracted from your loan proceeds, it is not a

mated production period of more than 1 1. The interest that would be payable for that payment of interest and you cannot deduct it year if the estimated cost of production is period if interest accrued on the loan at the when you get the loan. For more information, more than $1 million. applicable federal rate and was payable seeOriginal issue discount (OID) underInterest annually on December 31, You Can Deduct,earlier. minus **Property you produce.** You produce property **Refunds of interest.** If you pay interest and if you construct, build, install, manufacture, de- 2. Any interest actually payable on the loan then receive a refund in the same tax year of any velop, improve, create, raise, or grow it. Treat for the period.part of the interest, reduce your interest deducproperty produced for you under a contract as tion by the refund. If you receive the refund in a produced by you up to the amount you pay or Applicable federal rates are published later tax year, include the refund in your income incur for the property. by the IRS each month in the Internal to the extent the deduction for the interest re- Revenue Bulletin. Internal Revenue **Carrying charges.** Carrying charges include duced your tax. Bulletins are available on the IRS web site at taxes you pay to carry or develop real estate or www.irs.gov/irb. You can also contact an IRS to carry, transport, or install personal property. **Accrual method.** Under an accrual method, office to get these rates. You can choose to capitalize carrying charges you can deduct only interest that has accrued not subject to the uniform capitalization rules if during the tax year. they are otherwise deductible. For more infor- **Loans subject to the rules.** The rules for be- **Prepaid interest.** See Prepaid interest, mation, see chapter 7. low-market loans apply to the following. above. **Capitalized interest.** Treat capitalized inter- 1. Gift loans (below-market loans where the **Discounted loan.** See Discounted loan, est as a cost of the property produced. You forgone interest is in the nature of a gift). above. recover your interest when you sell or use the 2. Compensation-related loans (beproperty. If the property is inventory, recover **Tax deficiency.** If you contest a federal in- low-market loans between an employer capitalized interest through cost of goods sold. If come tax deficiency, interest does not accrue Page 14 Chapter4 **Interest**

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**Exceptions for loans without significant tax** and an employee or between an indepen- the health of the individual or individual’s **effect.** The following loans are specifically ex- dent contractor and a person for whom the spouse in an: empted from the rules for below-market loans contractor provides services). a. independent living unit (which has addi- because their interest arrangements do not 3. Corporation-shareholder loans. tional available facilities outside the unit have a significant effect on the federal tax liabil- for the provision of meals and other per- 4. Tax avoidance loans (below-market loans ity of the borrower or the lender. sonal care), and where the avoidance of federal tax is one 1. Loans made available by lenders to the of the main purposes of the interest ar- b. assisted living or nursing facility avail- general public on the same terms and con- rangement). able in the continuing care facility. ditions that are consistent with the lender’s 5. Loans to qualified continuing care facilities customary business practices. 3. The individual or individual’s spouse will beunder a continuing care contract (made afprovided with assisted living or nursing 2. Loans subsidized by a federal, state, or ter October 11, 1985). care available in the continuing care facil- municipal government that are made avail- Except as noted in (5) above, these rules ity, as required for the health of the individ- able under a program of general applica- apply to demand loans (loans payable in full at ual or the individual’s spouse. tion to the public. any time upon the lender’s demand) outstanding For more information, see section 7872(h) of 3. Certain employee-relocation loans. after June 6, 1984, and to term loans (loans that the Internal Revenue Code. are not demand loans) made after that date. 4. Certain loans to or from a foreign person, unless the interest income would be effec- **Sale or exchange of property.** Different rules **Treatment of gift and demand loans.** If you tively connected with the conduct of a U.S. generally apply to a loan connected with the sale receive a below-market gift loan or demand trade or business and not exempt from or exchange of property. If the loan does not loan, you are treated as receiving an additional U.S. tax under an income tax treaty. provide adequate stated interest, part of the payment (as a gift, dividend, etc.) equal to the principal payment may be considered interest. 5. Any other loan if the taxpayer can show forgone interest on the loan. You are then However, there are exceptions that may require that the interest arrangement has no signif- treated as transferring this amount back to the you to apply the below-market interest rate rules icant effect on the federal tax liability of thelender as interest. These transfers are considto these loans. SeeUnstated Interest and Origi-lender or the borrower. Whether an interered to occur annually, generally on December nal Issue Discount (OID) in Publication 537. est arrangement has a significant effect on 31. If you use the loan proceeds in your trade or the federal tax liability of the lender or the business, you can deduct the forgone interest **More information.** For more information on borrower will be determined by all the facts each year as a business interest expense. The below-market loans, see section 7872 of theand circumstances. Consider all the followlender must report it as interest income. Internal Revenue Code and section 1.7872-5 of ing factors. **Limit on forgone interest for gift loans of** the regulations. **$100,000 or less.** For gift loans between indi- a. Whether items of income and deduction viduals, forgone interest treated as transferred generated by the loan offset each other. back to the lender is limited to the borrower’s net b. The amount of the items.investment income for the year. This limit applies if the outstanding loans between the lender c. The cost of complying with the be- and borrower total $100,000 or less. If the bor- low-market loan provisions if they were rower’s net investment income is $1,000 or less, to apply. 

# 5. it is treated as zero. This limit does not apply to a d. Any reasons, other than taxes, for loan if the avoidance of any federal tax is one of structuring the transaction as a be- the main purposes of the interest arrangement. low-market loan. 

# Taxes **Treatment of term loans.** If you receive abelow-market term loan other than a gift or de**Exception for loans to qualified continuing** mand loan, you are treated as receiving an addi- 

# Introduction **care facilities.** The below-market interest tional cash payment (as a dividend, etc.) on the rules do not apply to a loan owed by a qualified date the loan is made. This payment is equal to You can deduct various federal, state, local, and continuing care facility under a continuing care the loan amount minus the present value, at the foreign taxes directly attributable to your trade or contract if the lender or lender’s spouse is age applicable federal rate, of all payments due business as business expenses. 62 or older by the end of the calendar year. under the loan. The same amount is treated as You cannot deduct federal income original issue discount on the loan. SeeOriginal A qualified continuing care facility is one or taxes, estate and gift taxes, or state issue discount (OID) under Interest You Can more facilities (excluding nursing homes) meetinheritance, legacy, and succession Deduct , earlier. ing the requirements listed below. taxes. 1. Designed to provide services under contin**Exceptions for loans of $10,000 or less.** The uing care contracts (defined below). 

### Topics rules for below-market loans do not apply to any This chapter discusses: day on which the total outstanding loans be- 2. Includes an independent living unit, and tween the borrower and lender is $10,000 or either an assisted living or nursing facility, 

### • When to deduct taxes less. This exception applies only to the follow- or both. ing. 

### • Real estate taxes 3. Substantially all of the independent living 1. Gift loans between individuals if the loan is 

### • Income taxes unit residents are covered by continuing not directly used to buy or carry in- care contracts. 

### • Employment taxes come-producing assets. A continuing care contract is a written con- 

### • Other taxes 2. Compensation-related loans or corpora- tract between an individual and a qualified contion-shareholder loans if the avoidance of tinuing care facility that includes all of the any federal tax is not a principal purpose of following conditions. 

### Useful Items the interest arrangement. You may want to see: 1. The individual or individual’s spouse must This exception does not apply to a term loan be entitled to use the facility for the rest of **Publication** described in (2) above that was previously sub- their life or lives. ject to the below-market loan rules. Those rules ❏ **15** (Circular E), Employer’s Tax Guide 2. The individual or individual’s spouse will be will continue to apply even if the outstanding provided with housing, as appropriate for balance is reduced to $10,000 or less. ❏ **334** Tax Guide for Small Business Chapter5 **Taxes** Page 15

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❏ **510** Excise Taxes deduction reduced your federal income tax in date of sale. You can usually find this informathe earlier year. For more information, see Re- tion on the settlement statement you received at ❏ **538** Accounting Periods and Methods covery of amount deducted (tax benefit rule) in closing. ❏ **551** Basis of Assets chapter 1. If you (the seller) use an accrual method and have not elected to ratably accrue real estate You must include in income any inter- **Form (and Instructions)** taxes, you are considered to have accrued your est you receive on tax refunds. part of the tax on the date you sell the property. ❏ **Sch A (Form 1040)** Itemized Deductions ❏ **Sch SE (Form 1040)** Self-Employment **Example.** Al Green, a calendar year accrual Tax method taxpayer, owns real estate in Elm County. He has not elected to ratably accrue ❏ **3115** Application for Change in property taxes. November 30 of each year is the Accounting Method 

# Real Estate Taxes assessment and lien date for the current real property tax year, which is the calendar year. He See chapter 12for information about getting Deductible real estate taxes are any state, local, sold the property on June 30, 2010. Under his publications and forms. or foreign taxes on real estate levied for the accounting method he would not be able to general public welfare. The taxing authority claim a deduction for the taxes because the sale must base the taxes on the assessed value of occurred before November 30. He is treated as the real estate and charge them uniformly having accrued his part of the tax, 180 / 365(Janu- 

# When To against all property under its jurisdiction. De- ary 1

–June 29), on June 30, and he can deduct ductible real estate taxes generally do not in- it for 2010. 

# Deduct Taxes clude taxes charged for local benefits and improvements that increase the value of the Generally, you can only deduct taxes in the year **Electing to ratably accrue.** If you use an ac- property. See Taxes for local benefits, later. you pay them. This applies whether you use the crual method, you can elect to accrue real estate If you use an accrual method, you generally cash method or an accrual method of account- tax related to a definite period ratably over that cannot accrue real estate taxes until you pay ing. period. them to the government authority. However, you Under an accrual method, you can deduct a can elect to ratably accrue the taxes during the tax before you pay it if you meet the exception **Example.** John Smith is a calendar year year. SeeElecting to ratably accrue, later. for recurring items discussed under Economic taxpayer who uses an accrual method. His real Performance in Publication 538. You can also estate taxes for the real property tax year, July 1, **Taxes for local benefits.** Generally, you can- elect to ratably accrue real estate taxes as dis- 2010, to June 30, 2011, are $1,200. July 1 is the not deduct taxes charged for local benefits and cussed later underReal Estate Taxes

. assessment and lien date. improvements that tend to increase the value of your property. These include assessments for If John elects to ratably accrue the taxes, **Limit on accrual of taxes.** A taxing jurisdic- streets, sidewalks, water mains, sewer lines, $600 will accrue in 2010 ($1,200 **×** 6 /12, July tion can require the use of a date for accruing and public parking facilities. You should in- 1

–December 31) and the balance will accrue in taxes that is earlier than the date it originally crease the basis of your property by the amount 2011. required. However, if you use an accrual of the assessment. method, and can deduct the tax before you pay **Separate elections.** You can elect to rata- You can deduct taxes for these local benefits it, use the original accrual date for the year of bly accrue the taxes for each separate trade or only if the taxes are for maintenance, repairs, or change and all future years to determine when business and for nonbusiness activities if you interest charges related to those benefits. If part you can deduct the tax. account for them separately. Once you elect to of the tax is for maintenance, repairs, or interest, ratably accrue real estate taxes, you must use you must be able to show how much of the tax is **Example.** Your state imposes a tax on per- that method unless you get permission from the for these expenses to claim a deduction for that sonal property used in a trade or business con- IRS to change. SeeForm 3115, later. part of the tax. ducted in the state. This tax is assessed and becomes a lien as of July 1 (accrual date). In **Making the election.** If you elect to ratably **Example.** To improve downtown commer- 2010, the state changed the assessment and accrue the taxes for the first year in which you cial business, Waterfront City converted a down- lien dates from July 1, 2011, to December 31, incur real estate taxes, attach a statement to town business area street into an enclosed 2010, for property tax year 2011. Use the origi- your income tax return for that year. The state- pedestrian mall. The city assessed the full cost nal accrual date (July 1, 2011) to determine ment should show all the following items. of construction, financed with 10-year bonds, when you can deduct the tax. You must also use 

### • The trades or businesses to which the against the affected properties. The city is pay- the July 1 accrual date for all future years to election applies and the accounting ing the principal and interest with the annual determine when you can deduct the tax. method or methods used. payments made by the property owners. **Uniform capitalization rules.** Uniform capi- The assessments for construction costs are 

### • The period to which the taxes relate. talization rules apply to certain taxpayers who not deductible as taxes or as business exproduce real property or tangible personal prop- 

### • The computation of the real estate tax de- penses, but are depreciable capital expenses. erty for use in a trade or business or for sale to duction for that first year. The part of the payments used to pay the inter- customers. They also apply to certain taxpayers est charges on the bonds is deductible as taxes. who acquire property for resale. Under these Generally, you must file your return by the due rules, you either include certain costs in inven- **Charges for services.** Water bills, sewerage, date (including extensions). However, if you tory or capitalize certain expenses related to the and other service charges assessed against timely filed your return for the year without elect- property, such as taxes. For more information, your business property are not real estate taxes, ing to ratably accrue, you can still make the seechapter 1

. but are deductible as business expenses. election by filing an amended return within 6 months after the due date of the return (exclud- **Carrying charges.** Carrying charges include **Purchase or sale of real estate.** If real estate ing extensions). Attach the statement to the taxes you pay to carry or develop real estate or is sold, the real estate taxes must be allocated amended return and write “Filed pursuant to to carry, transport, or install personal property. between the buyer and the seller. section 301.9100-2” on the statement. File the You can elect to capitalize carrying charges not The buyer and seller must allocate the real amended return at the same address where you subject to the uniform capitalization rules if they estate taxes according to the number of days in filed the original return. are otherwise deductible. For more information, the real property tax year (the period to which seechapter 7

. **Form 3115.** If you elect to ratably accrue the tax imposed relates) that each owned the real estate taxes for a year after the first year in **Refunds of taxes.** If you receive a refund for property. Treat the seller as paying the taxes up which you incur real estate taxes, or if you want any taxes you deducted in an earlier year, in- to but not including the date of sale. Treat the to revoke your election to ratably accrue real clude the refund in income to the extent the buyer as paying the taxes beginning with the Page 16 Chapter5 **Taxes**

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estate taxes, file Form 3115. For more informa- the tax as part of that service or cost. If the tion, including applicable time frames for filing, property is merchandise bought for resale, the 

# Employment Taxes see the Instructions for Form 3115. sales tax is part of the cost of the merchandise. If the property is depreciable, add the sales tax to If you have employees, you must withhold vari- **Note.** If you are filing an application for a the basis for depreciation. For more information ous taxes from your employees’ pay. Most em- change in accounting method filed after January on basis, see Publication 551. ployers must withhold their employees’ share of 9, 2011, for a year of change ending after April social security and Medicare taxes along with Do not deduct state and local sales 29, 2010, see Revenue Procedure 2011-14, state and federal income taxes. You may also taxes imposed on the buyer that you 2011-4 I.R.B. 330, available at need to pay certain employment taxes from your must collect and pay over to the state www.irs.gov/irb/2011-04IRB/ar08.html

. own funds. These include your share of social or local government. Also, do not include these security and Medicare taxes as an employer, taxes in gross receipts or sales. along with unemployment taxes. Your deduction for wages paid is not re- 

# Income Taxes **Self-employment tax.** You can deduct duced by the social security, medicare, and in- one-half of your self-employment tax as a busi- come taxes you withhold from your employees. This section discusses federal, state, local, and ness expense in figuring your adjusted gross You can deduct the employment taxes you must foreign income taxes. income. This deduction only affects your income pay from your own funds as taxes. tax. It does not affect your net earnings from **Federal income taxes.** You cannot deduct **Example.** You pay your employee $18,000 self-employment or your self-employment tax. federal income taxes. a year. However, after you withhold various To deduct the tax, enter on Form 1040, line taxes, your employee receives $14,500. You 27, the amount shown on the Deduction for **State and local income taxes.** A corporation also pay an additional $1,500 in employment one-half of self-employment tax line of Schedule or partnership can deduct state and local in- taxes. You should deduct the full $18,000 as SE (Form 1040). come taxes imposed on the corporation or part- wages. You can deduct the $1,500 you pay from nership as business expenses. An individual For more information on self-employment your own funds as taxes. can deduct state and local income taxes only as tax, see Publication 334. For more information on employment taxes, an itemized deduction on Schedule A (Form see Publication 15 (Circular E). 1040). However, an individual can deduct a state **Unemployment fund taxes.** As an employer, tax on gross income (as distinguished from net you may have to make payments to a state income) directly attributable to a trade or busi- unemployment compensation fund or to a state ness as a business expense. disability benefit fund. Deduct these payments as taxes. **Accrual of contested income taxes.** If you 

# 6. use an accrual method, and you contest a state or local income tax liability, you must accrue and deduct any contested amount in the tax year in which the liability is finally determined. 

# Other Taxes 

# Insurance If additional state or local income taxes for a prior year are assessed in a later year, you can The following are other taxes you can deduct if deduct the taxes in the year in which they were you incur them in the ordinary course of youroriginally imposed (the prior year) if the tax liabiltrade or business. 

# What’s New ity is not contested. You cannot deduct them in the year in which the liability is finally deter- **Excise taxes.** You can deduct as a business **Self-employed health insurance deduction.** mined. expense all excise taxes that are ordinary and Effective March 30, 2010, if you were necessary expenses of carrying on your trade or The filing of an income tax return is not self-employed and paid for health insurance, business. However, seeFuel taxes, later. considered a contest and, in the ab- you may be able to include in your deduction any sence of an overt act of protest, you premiums you paid to cover your child who was **Franchise taxes.** You can deduct corporate can deduct the tax in the prior year. Also, you under age 27 at the end of 2010, even if the child franchise taxes as a business expense. can deduct any additional taxes in the prior year was not your dependent. For 2010, the if you do not show some affirmative evidence of self-employed health insurance deduction is **Fuel taxes.** Generally, taxes on gasoline, die- denial of the liability. also allowed on Schedule SE. See sel fuel, and other motor fuels that you use in However, if you consistently deduct addi- Self-Employed Health Insurance Deduction. your business are included as part of the cost of tional assessments in the year they are paid or the fuel. Do not deduct these taxes as a sepafinally determined (including those for which rate item. there was no contest), you must continue to do You may be entitled to a credit or refund for so. You cannot take a deduction in the earlier federal excise tax you paid on fuels used for 

# Introduction year unless you receive permission to change certain purposes. For more information, see You generally can deduct the ordinary and necyour method of accounting. For more informa- Publication 510. essary cost of insurance as a business expense tion on accounting methods, see When Can I if it is for your trade, business, or profession. Deduct an Expense in chapter 1. **Occupational taxes.** You can deduct as a However, you may have to capitalize certain business expense an occupational tax charged **Foreign income taxes.** Generally, you can insurance costs under the uniform capitalization at a flat rate by a locality for the privilege of take either a deduction or a credit for income rules. For more information, see Capitalized working or conducting a business in the locality. taxes imposed on you by a foreign country or a Premiums, later. U.S. possession. However, an individual cannot **Personal property tax.** You can deduct any take a deduction or credit for foreign income tax imposed by a state or local government on 

### Topics taxes paid on income that is exempt from U.S. personal property used in your trade or busi- This chapter discusses: tax under the foreign earned income exclusion ness. or the foreign housing exclusion. For information 

### • Deductible premiums on these exclusions, see Publication 54, Tax **Sales tax.** Treat any sales tax you pay on a Guide for U.S. Citizens and Resident Aliens service or on the purchase or use of property as 

### • Nondeductible premiums Abroad. For information on the foreign tax credit, part of the cost of the service or property. If the 

### • Capitalized premiums see Publication 514, Foreign Tax Credit for Indi- service or the cost or use of the property is a 

### • When to deduct premiums viduals. deductible business expense, you can deduct Chapter6 **Insurance** Page 17

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8. Overhead insurance that pays for business them and report the premium amounts on 

### Useful Items Schedule K-1 (Form 1065) as guaranteed overhead expenses you have during long You may want to see: payments to be included in your gross inperiods of disability caused by your injury come. However, if the policy is in your or sickness. **Publication** name and you pay the premiums yourself, 9. Car and other vehicle insurance that cov- the partnership must reimburse you and ❏ **15-B** Employer’s Tax Guide to Fringe ers vehicles used in your business for lia- report the premium amounts on Schedule Benefits bility, damages, and other losses. If you K-1 (Form 1065) as guaranteed payments operate a vehicle partly for personal use, ❏ **525** Taxable and Nontaxable Income to be included in your gross income. Oth- deduct only the part of the insurance pre- erwise, the insurance plan will not be con- ❏ **538** Accounting Periods and Methods mium that applies to the business use of sidered to be established under your the vehicle. If you use the standard mile- ❏ **547** Casualties, Disasters, and Thefts business. age rate to figure your car expenses, you 

### • For more-than-2% shareholders, a policy **Form (and Instructions)** cannot deduct any car insurance premi- can be either in the name of the S corpo- ums. ❏ **1040** U.S. Individual Income Tax Return ration or in the name of the shareholder. 10. Life insurance covering your officers and You can either pay the premiums yourself employees if you are not directly or indi- See chapter 12for information about getting or your S corporation can pay them and rectly a beneficiary under the contract. publications and forms. report the premium amounts on Form W-2 as wages to be included in your gross 11. Business interruption insurance that pays income. However, if the policy is in your for lost profits if your business is shut down name and you pay the premiums yourself, due to a fire or other cause. the S corporation must reimburse you and 

# Deductible Premiums report the premium amounts on Form W-2 

## Self-Employed Health as wages to be included in your gross You generally can deduct premiums you pay for income. Otherwise, the insurance plan will 

## Insurance Deduction the following kinds of insurance related to your not be considered to be established under trade or business. your business. You may be able to deduct premiums paid for medical and dental insurance and qualified 1. Insurance that covers fire, storm, theft, ac- Medicare premiums you voluntarily pay to oblong-term care insurance for yourself, your cident, or similar losses. tain insurance that is similar to qualifying private spouse, and your dependents. Effective March 2. Credit insurance that covers losses from health insurance can be used to figure the de- 30, 2010, the insurance can also cover your business bad debts. duction. If you previously filed a return without child who was under age 27 at the end of 2010, using Medicare premiums to figure the deduc3. Group hospitalization and medical insur- even if the child was not your dependent. A child tion, you can file an amended return to refigure ance for employees, including long-term includes your son, daughter, stepchild, adopted the deduction. For more information, see Form care insurance. child, or foster child. A foster child is any child 1040X, Amended U.S. Individual Income Tax placed with you by an authorized placement a. If a partnership pays accident and Return. agency or by judgment, decree, or other order of health insurance premiums for its part- Amounts paid for health insurance coverage any court of competent jurisdiction. ners, it generally can deduct them as from retirement plan distributions that were non- One of the following statements must be guaranteed payments to partners. taxable because you are a retired public safety true. officer cannot be used to figure the deduction. b. If an S corporation pays accident and 

### • You were self-employed and had a net Take the deduction on Form 1040, line 29. health insurance premiums for its profit for the year reported on Schedule C more-than-2% shareholder-employees, (Form 1040), Profit or Loss From Busi- **Qualified long-term care insurance.** You it generally can deduct them, but must ness; Schedule C-EZ (Form 1040), Net can include premiums paid on a qualified also include them in the shareholder’s Profit From Business; or Schedule F long-term care insurance contract when figuring wages subject to federal income tax (Form 1040), Profit or Loss From Farming. your deduction. But, for each person covered, withholding. See Publication 15-B. you can include only the smaller of the following 

### • You were a partner with net earnings from amounts. 4. Liability insurance. self-employment for the year reported on Schedule K-1 (Form 1065), Partner’s 5. Malpractice insurance that covers your 1. The amount paid for that person. Share of Income, Deductions, Credits, personal liability for professional negli- 2. The amount shown below. Use the per- etc., box 14, code A. gence resulting in injury or damage to pa- son’s age at the end of the tax year. tients or clients. 

### • You used one of the optional methods to figure your net earnings from a. Age 40 or younger

–$330 6. Workers’ compensation insurance set by self-employment on Schedule SE. state law that covers any claims for bodily b. Age 41 to 50

–$620 injuries or job-related diseases suffered by 

### • You were a shareholder owning more than c. Age 51 to 60

–$1,230 employees in your business, regardless of 2% of the outstanding stock of an S corpofault. ration with wages for the year from the d. Age 61 to 70

–$3,290 corporation reported on Form W-2, Wage a. If a partnership pays workers’ compen- e. Age 71 or older

–$4,110 and Tax Statement.sation premiums for its partners, it generally can deduct them as guaranteed The insurance plan must be established, or **Qualified long-term care insurance con-** payments to partners. considered to be established as discussed in the **tract.** A qualified long-term care insurance following bullets, under your business. b. If an S corporation pays workers’ com- contract is an insurance contract that only propensation premiums for its vides coverage of qualified long-term care serv- 

### • For self-employed individuals filing a more-than-2% shareholder-employees, ices. The contract must meet all the following Schedule C, C-EZ, or F, a policy can be it generally can deduct them, but must requirements. either in the name of the business or in the also include them in the shareholder’s name of the individual. 

### • It must be guaranteed renewable. wages. 

### • For partners, a policy can be either in the 

### • It must provide that refunds, other than name of the partnership or in the name of 7. Contributions to a state unemployment in- refunds on the death of the insured or the partner. You can either pay the premi- surance fund are deductible as taxes if complete surrender or cancellation of the they are considered taxes under state law. ums yourself or your partnership can pay contract, and dividends under the contract Page 18 Chapter6 **Insurance**

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may be used only to reduce future premi- **Effect on self-employment tax.** For tax years you cannot get business insurance coverums or increase future benefits. beginning in 2010, you can subtract the age for certain business risks. However, self-employed health insurance deduction when your actual losses may be deductible. See 

### • It must not provide for a cash surrender figuring net earnings for your self-employment Publication 547.

value or other money that can be paid, tax from the business under which the insurance assigned, pledged, or borrowed. 2. Loss of earnings. You cannot deduct pre- plan is established, or considered to be estab- miums for a policy that pays for lost earn- 

### • It generally must not pay or reimburse ex- lished as discussed earlier. For more informa- ings due to sickness or disability. However,

penses incurred for services or items that tion, see Schedule SE (Form 1040). see the discussion on overhead insurance, would be reimbursed under Medicare, ex- item (8), underDeductible Premiums,ear- cept where Medicare is a secondary payer **How to figure the deduction.** Generally, you lier. or the contract makes per diem or other can use the worksheet in the Form 1040 instrucperiodic payments without regard to ex- 3. Certain life insurance and annuities. tions to figure your deduction. However, if any of penses. the following apply, you must use Worksheet a. For contracts issued before June 9, 6-A in this chapter. **Qualified long-term care services.** Quali- 1997, you cannot deduct the premiums 

### • You had more than one source of income fied long-term care services are: on a life insurance policy covering you, subject to self-employment tax. an employee, or any person with a fi- 

### • Necessary diagnostic, preventive, thera- nancial interest in your business if you 

### • You file Form 2555, Foreign Earned In- peutic, curing, treating, mitigating, and re- are directly or indirectly a beneficiary of come, or Form 2555-EZ, Foreign Earned habilitative services, and the policy. You are included among Income Exclusion. 

### • Maintenance or personal care services. possible beneficiaries of the policy if the 

### • You are using amounts paid for qualified policy owner is obligated to repay a The services must be required by a chronically ill long-term care insurance to figure the de- loan from you using the proceeds of the individual and prescribed by a licensed health duction. policy. A person has a financial interest care practitioner. in your business if the person is an If you are claiming the health coverage tax **Chronically ill individual.** A chronically ill owner or part owner of the business or credit, complete Form 8885, Health Coverage individual is a person who has been certified as has lent money to the business. Tax Credit, before you figure this deduction. one of the following. b. For contracts issued after June 8, 1997, **Health coverage tax credit.** You may be 

### • An individual who has been unable, due to you generally cannot deduct the premi- able to take this credit only if you were an eligible loss of functional capacity for at least 90 ums on any life insurance policy, en- trade adjustment assistance (TAA) recipient, al- days, to perform at least two activities of dowment contract, or annuity contract if ternative TAA (ATAA) recipient, reemployment daily living without substantial assistance you are directly or indirectly a benefi- trade adjustment assistance (RTAA) recipient, from another individual. Activities of daily ciary. The disallowance applies without or Pension Benefit Guaranty Corporation pen- living are eating, toileting, transferring regard to whom the policy covers. sion recipient. Use Form 8885 to figure the (general mobility), bathing, dressing, and amount, if any, of this credit. continence. c. Partners. If, as a partner in a partner- When figuring the amount to enter on line 1 ship, you take out an insurance policy 

### • An individual who requires substantial su- of Worksheet 6-A, do not include the following. on your own life and name your part-

pervision to be protected from threats to ners as beneficiaries to induce them to 

### • Any amounts you included on Form 8885, health and safety due to severe cognitive retain their investments in the partner- line 4. impairment. ship, you are considered a beneficiary. 

### • Any qualified health insurance premiums The certification must have been made by a You cannot deduct the insurance premiyou paid to “U.S. Treasury-HCTC.” licensed health care practitioner within the previ- ums. ous 12 months. 

### • Any health coverage tax credit advance 4. Insurance to secure a loan. If you take out payments shown in box 1 of Form 1099-H, **Benefits received.** For information on exa policy on your life or on the life of an- Health Coverage Tax Credit (HCTC) Ad- cluding benefits you receive from a long-term other person with a financial interest in vance Payments. care contract from gross income, see Publica- your business to get or protect a business tion 525. loan, you cannot deduct the premiums as **More than one health plan and business.** a business expense. Nor can you deduct If you have more than one health plan during the **Other coverage.** You cannot take the deduc- the premiums as interest on business year and each plan is established under a differ-tion for any month you were eligible to particiloans or as an expense of financing loans. ent business, you must use separate work- pate in any employer (including your spouse’s) In the event of death, the proceeds of the sheets (Worksheet 6-A) to figure each plan’s net subsidized health plan at any time during that policy are generally not taxed as income earnings limit. Include the premium you paid month, even if you did not actually participate. In even if they are used to liquidate the debt. under each plan on line 1 or line 2 of that sepa- addition, effective March 30, 2010, if you were rate worksheet and your net profit (or wages) eligible for any month or part of a month to from that business on line 4 (or line 11). For a participate in any subsidized health plan main- tained by the employer of either your dependent plan that provides long-term care insurance, the or your child who was under age 27 at the end of total of the amounts entered for each person on 

# Capitalized Premiums 2010, do not use amounts paid for coverage for line 2 of all worksheets cannot be more than the that month to figure the deduction. These rules appropriate limit shown on line 2 for that person. Under the uniform capitalization rules, you must are applied separately to plans that provide capitalize the direct costs and part of the indirect long-term care insurance and plans that do not costs for certain production or resale activities. provide long-term care insurance. However, any Include these costs in the basis of property you medical insurance payments not deductible on 

# Nondeductible produce or acquire for resale, rather than claim- Form 1040, line 29, can be included as medical ing them as a current deduction. You recover the expenses on Schedule A (Form 1040), Itemized 

# Premiums costs through depreciation, amortization, or cost Deductions, if you itemize deductions. of goods sold when you use, sell, or otherwise You cannot deduct premiums on the following dispose of the property. **Effect on itemized deductions.** Subtract the kinds of insurance. Indirect costs include premiums for insurhealth insurance deduction from your medical 1. Self-insurance reserve funds.You cannot ance on your plant or facility, machinery, equipinsurance when figuring medical expenses on deduct amounts credited to a reserve set ment, materials, property produced, or property Schedule A (Form 1040) if you itemize deduc- up for self-insurance. This applies even if tions. acquired for resale. Chapter6 **Insurance** Page 19

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### Worksheet 6-A.**Self-Employed Health Insurance Deduction Worksheet** Keep for Your Records **Note.**Use a separate worksheet for each trade or business under which an insurance plan is established.
**1.** Enter the total amount paid in 2010 for health insurance coverage established under your business for

2010 for you, your spouse, and your dependents. Effective March 30, 2010, your insurance can also cover your child who was under age 27 at the end of 2010, even if the child was not your dependent. But**do not**include the following.



## • Amounts for any month you were eligible to participate in a health plan subsidized by your or your

spouse’s employer or, effective March 30, 2010, the employer of either your dependent or your child who was under the age of 27 at the end of 2010. 

## • Any amounts paid from retirement plan distributions that were nontaxable because you are a

retired public safety officer. 

## • Any amounts you included on Form 8885, line 4. 

## • Any qualified health insurance premiums you paid to “U.S. Treasury-HCTC.” 

## • Any health coverage tax credit advance payments shown in box 1 of Form 1099-H. 

## • Any payments for qualified long-term care insurance (see line 2)

...................... . **1. 2.**  For coverage under a qualified long-term care insurance contract, enter for each person covered the **smaller**of the following amounts. a) Total payments made for that person during the year. b) The amount shown below. Use the person’s age at the end of the tax year. $330

—if that person is age 40 or younger $620

—if age 41 to 50 $1,230

—if age 51 to 60 $3,290

—if age 61 to 70 $4,110

—if age 71 or older **Do not** include payments for any month you were eligible to participate in a long-term care insurance plan subsidized by your or your spouse’s employer or, effective March 30, 2010, the employer of either your dependent or your child who was under the age of 27 at the end of 2010. If more than one person is covered, figure separately the amount to enter for each person. Then enter the total of those amounts

............................................ . **2. 3.**  Add lines 1 and 2

.......................................................... . **3. 4.**  Enter your net profit* and any other earned income** from the trade or business under which the insurance plan is established. Do not include Conservation Reserve Program payments exempt from self-employment tax. If the business is an S corporation, skip to line 11

.................... . **4. 5.**  Enter the total of all net profits* from: Schedule C (Form 1040), line 31; Schedule C-EZ (Form 1040), line 3; Schedule F (Form 1040), line 36; or Schedule K-1 (Form 1065), box 14, code A; plus any other income allocable to the profitable businesses. Do not include Conservation Reserve Program payments exempt from self-employment tax. See the Instructions for Schedule SE (Form 1040).**Do not** include any net losses shown on these schedules.

................................ . **5. 6.**  Divide line 4 by line 5

....................................................... . **6. 7a.**  Complete Schedule SE (Form 1040) as a worksheet. When completing Section A, line 3, or Section B, line 3, of the worksheet Schedule SE, treat the amount from Form 1040, line 29, as zero. Enter on this line the amount shown on that worksheet Schedule SE, Section A, line 6, or Section B, line 13

.... . **7a. 7b.**  Multiply line 7a by the percentage on line 6

........................................ . **7b.**

**8.** Subtract line 7b from line 4

................................................... . **8. 9.**  Enter the amount, if any, from Form 1040, line 28, attributable to the same trade or business in which

the insurance plan is established

............................................... . **9. 10.**  Subtract line 9 from line 8

.................................................... . **10. 11.**  Enter your Medicare wages (Form W-2, box 5) from an S corporation in which you are a more-than-2% shareholder and in which the insurance plan is established

.................. . **11. 12.**  Enter any amount from Form 2555, line 45, attributable to the amount entered on line 4 or 11 above, or any amount from Form 2555-EZ, line 18, attributable to the amount entered on line 11 above. When completing Form 2555, line 44, use the deduction figured on line 7a above (in place of the amount from Form 1040, line 27) that is allocable to the excluded income

......................... . **12. 13.**  Subtract line 12 from line 10 or 11, whichever applies

................................. . **13. 14.**  Enter the**smaller**of line 3 or line 13 here and on Form 1040, line 29.**Do not**include this amount when figuring any medical expense deduction on Schedule A (Form 1040).

.................. . **14.**
* If you used either optional method to figure your net earnings from self-employment from any business, do not enter your net profit from the business.

Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Section B, line 4b. * ***Earned income**includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it does not include capital gain

income.

Page 20 Chapter6 **Insurance**

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**Uniform capitalization rules.** You may be can deduct in 2011 and 2012 the premium allo- 

### • Form 4626, Alternative Minimum Tax

— subject to the uniform capitalization rules if you cable to those years. Corporations. do any of the following, unless the property is **Dividends received.** If you receive dividends produced for your use other than in a business 

### Topics from business insurance and you deducted the or an activity carried on for profit. This chapter discusses: premiums in prior years, at least part of the 1. Produce real property or tangible personal dividends generally are income. For more infor- 

### • Carrying charges property. For this purpose, tangible per- mation, see Recovery of amount deducted (tax sonal property includes a film, sound re- 

### • Research and experimental costs benefit rule) in chapter 1 underHow Much Can I cording, video tape, book, or similar Deduct? 

### • Intangible drilling costs property. 

### • Exploration costs 2. Acquire property for resale. 

### • Development costsHowever, these rules do not apply to the following property. 

### • Circulation costs



### • Environmental cleanup costs 1. Personal property you acquire for resale if 

# 7.

your average annual gross receipts are 

### • Qualified disaster expenses $10 million or less for the 3 prior tax years. 

### • Business start-up and organizational costs 2. Property you produce if you meet either of 

# Costs You **•** Reforestation costs the following conditions.


### • Retired asset removal costs a. Your indirect costs of producing the 

# Can Deduct property are $200,000 or less. 

### • Barrier removal costs b. You use the cash method of accounting 

### • Film and television production costs 

# or Capitalize and do not account for inventories. 

### Useful Items **More information.** For more information on You may want to see: 

# What’s New these rules, seeUniform Capitalization Rules in Publication 538 and the regulations under Inter- **Publication Business start-up costs.**  For tax years benal Revenue Code section 263A. ginning in 2010, you can elect to deduct up to ❏ **544** Sales and Other Dispositions of $10,000 of business start-up costs paid or in- Assets curred after 2009. See Business Start-Up and Organizational Costs for more information. **Form (and Instructions)** 

# When To Deduct **Environmental cleanup costs.** The election ❏ **3468** Investment Credit 

# Premiums to deduct qualified environmental cleanup costs ❏ **8826** Disabled Access Credit was extended to cover costs paid or incurred in You can usually deduct insurance premiums in 2010 and 2011. See Environmental Cleanup See chapter 12 for information about getting the tax year to which they apply. Costs for more information. publications and forms. **Cash method.** If you use the cash method ofaccounting, you generally deduct insurance premiums in the tax year you actually paid them, 

# Introduction even if you incurred them in an earlier year. 

# Carrying Charges However, seePrepayment , later. This chapter discusses costs you can elect to deduct or capitalize. Carrying charges include the taxes and interest **Accrual method.** If you use an accrual You generally deduct a cost as a current you pay to carry or develop real property or to method of accounting, you cannot deduct insur- business expense by subtracting it from your carry, transport, or install personal property. ance premiums before the tax year in which you income in either the year you incur it or the year Certain carrying charges must be capitalized incur a liability for them. In addition, you cannot you pay it. under the uniform capitalization rules. (For infor- deduct insurance premiums before the tax year If you capitalize a cost, you may be able to mation on capitalization of interest, seechapter in which you actually pay them (unless the ex- recover it over a period of years through periodic 4.) You can elect to capitalize carrying charges ception for recurring items applies). For more deductions for amortization, depletion, or depre- not subject to the uniform capitalization rules,information about the accrual method of acciation. When you capitalize a cost, you add it to but only if they are otherwise deductible. counting, see chapter 1.For information about the basis of property to which it relates. You can elect to capitalize carrying charges the exception for recurring items, see Publica- A partnership, corporation, estate, or trust separately for each project you have and for tion 538. makes the election to deduct or capitalize the each type of carrying charge. For unimproved costs discussed in this chapter except for explo- **Prepayment.** You cannot deduct expenses in and unproductive real property, your election is ration costs for mineral deposits. Each individual advance, even if you pay them in advance. This good for only 1 year. You must decide whether partner, shareholder, or beneficiary elects rule applies to any expense paid far enough in to capitalize carrying charges each year the whether to deduct or capitalize exploration advance to, in effect, create an asset with a property remains unimproved and unproductive. costs. useful life extending substantially beyond the For other real property, your election to capitalend of the current tax year. ize carrying charges remains in effect until con- You may be subject to the alternative Expenses such as insurance are generally struction or development is completed. For minimum tax (AMT) if you deduct re- allocable to a period of time. You can deduct personal property, your election is effective until search and experimental, intangible insurance expenses for the year to which they the date you install or first use it, whichever is drilling, exploration, development, circulation, or are allocable. later. business organizational costs. For more information on the alternative mini- **Example.** In 2010, you signed a 3-year in- **How to make the election.** To make the elec- mum tax, see the instructions for one of the surance contract. Even though you paid the pre- tion to capitalize a carrying charge, write a state- following forms. miums for 2010, 2011, and 2012 when you ment saying which charges you elect to signed the contract, you can only deduct the 

### • Form 6251, Alternative Minimum Tax

— capitalize. Attach it to your original tax return for premium for 2010 on your 2010 tax return. You Individuals. the year the election is to be effective. However, Chapter7 **Costs You Can Deduct or Capitalize** Page 21

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**IF you . . . THEN . . .**  if you timely filed your return for the year without making the election, you can still make the elec- Elect to deduct research and Deduct all research and experimental costs in the tion by filing an amended return within 6 months experimental costs as a current first year you pay or incur the costs and all later of the due date of the return (excluding exten- business expense years. sions). Attach the statement to the amended return and write “Filed pursuant to section Do not deduct research and If you meet the requirements, amortize them over at experimental costs as a current least 60 months, starting with the month you first 301.9100-2” on the statement. File the amended business expense receive an economic benefit from the research. See return at the same address you filed the original Research and Experimental Costs in chapter 8. return.



### • Quality control testing. 

### • Amounts properly allocable to the cost of depreciable property, or 

# Research and **•** Research in connection with literary, historical, or similar projects. 

### • Amounts paid only out of production or 

# Experimental Costs proceeds from production if these 

### • The acquisition of another’s patent, model, amounts are depletable income to the re-

production, or process. The costs of research and experimentation are cipient. generally capital expenses. However, you can elect to deduct these costs as a current business **When and how to elect.** You make the elec**How to make the election.** You elect to de- expense. Your election to deduct these costs is tion to deduct research and experimental costs duct IDCs as a current business expense by binding for the year it is made and for all later by deducting them on your tax return for the year taking the deduction on your income tax return years unless you get IRS approval to make a in which you first pay or incur research and for the first tax year you have eligible costs. No change. experimental costs. If you do not make the elecformal statement is required. If you file Schedule If you meet certain requirements, you may tion to deduct research and experimental costs C (Form 1040), enter these costs under “Other elect to defer and amortize research and experi- in the first year in which you pay or incur the expenses.” mental costs. For information on electing to de- costs, you can deduct the costs in a later year For oil and gas wells, your election is binding fer and amortize these costs, seeResearch and only with approval from the IRS. for the year it is made and for all later years. For Experimental Costsin chapter 8. geothermal wells, your election can be revoked **Research credit.** If you pay or incur qualified **Research and experimental costs defined.** by the filing of an amended return on which you research expenses, you may be able to take the Research and experimental costs are reasona- do not take the deduction. You can file the research credit. For more information about the ble costs you incur in your trade or business for amended return for the year up to the normal research credit, see the instructions for Form activities intended to provide information that time of expiration for filing a claim for credit or 6765, Credit for Increasing Research Activities. would eliminate uncertainty about the develop- refund, generally, within 3 years after the date ment or improvement of a product. Uncertainty you filed the original return or within 2 years after exists if the information available to you does not the date you paid the tax, whichever is later. establish how to develop or improve a product or 

# Intangible **Energy credit for costs of geothermal wells.** the appropriate design of a product. Whether If you capitalize the drilling and development costs qualify as research and experimental 

# Drilling Costs costs of geothermal wells that you place in servcosts depends on the nature of the activity to ice during the tax year, you may be able to claim which the costs relate rather than on the nature The costs of developing oil, gas, or geothermal a business energy credit. See the instructions of the product or improvement being developed wells are ordinarily capital expenditures. You for Form 3468 for more information. or the level of technological advancement. can usually recover them through depreciation The costs of obtaining a patent, including or depletion. However, you can elect to deduct **Nonproductive well.** If you capitalize your attorneys’ fees paid or incurred in making and intangible drilling costs (IDCs) as a current busiIDCs, you have another option if the well is perfecting a patent application, are research and ness expense. These are certain drilling and nonproductive. You can deduct the IDCs of the experimental costs. However, costs paid or in- development costs for wells in the United States nonproductive well as an ordinary loss. You curred to obtain another’s patent are not re- in which you hold an operating or working intermust indicate and clearly state your election on search and experimental costs. est. You can deduct only costs for drilling or your tax return for the year the well is completed. preparing a well for the production of oil, gas, or **Product.** The term “product” includes any of Once made, the election for oil and gas wells is geothermal steam or hot water. the following items. binding for all later years. You can revoke your You can elect to deduct only the costs of election for a geothermal well by filing an 

### • Formula. items with no salvage value. These include amended return that does not claim the loss. wages, fuel, repairs, hauling, and supplies re- 

### • Invention. lated to drilling wells and preparing them for **Costs incurred outside the United States.** 

### • Patent. production. Your cost for any drilling or develop- You cannot deduct as a current business ex- ment work done by contractors under any form 

### • Pilot model. pense all the IDCs paid or incurred for an oil, of contract is also an IDC. However, see gas, or geothermal well located outside the 

### • Process. Amounts paid to contractor that must be capital- United States. However, you can elect to include ized ,later. 

### • Technique. the costs in the adjusted basis of the well to You can also elect to deduct the cost of figure depletion or depreciation. If you do not 

### • Property similar to the items listed above. drilling exploratory bore holes to determine the make this election, you can deduct the costs location and delineation of offshore hydrocarbon It also includes products used by you in your over the 10-year period beginning with the tax deposits if the shaft is capable of conducting trade or business or held for sale, lease, or year in which you paid or incurred them. These hydrocarbons to the surface on completion. It license. rules do not apply to a nonproductive well. does not matter whether there is any intent to **Costs not included.** Research and experi- produce hydrocarbons. mental costs do not include expenses for any of If you do not elect to deduct your IDCs as a the following activities. current business expense, you can elect to de

# Exploration Costs duct them over the 60-month period beginning 

### • Advertising or promotions. with the month they were paid or incurred. The costs of determining the existence, location, 

### • Consumer surveys. extent, or quality of any mineral deposit are **Amounts paid to contractor that must be** 

### • Efficiency surveys. ordinarily capital expenditures if the costs lead **capitalized.** Amounts paid to a contractor to the development of a mine. You recover these 

### • Management studies. must be capitalized if they are either: Page 22 Chapter7 **Costs You Can Deduct or Capitalize**

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costs through depletion as the mineral is re- Method 2

—Do not claim any depletion de- timely filed your return for the year without making the election, you can still make the election moved from the ground. However, you can elect duction for the tax year the mine reaches by filing an amended return within 6 months of to deduct domestic exploration costs paid or the producing stage and any later tax years the due date of the return (excluding extenuntil the depletion you would have deducted incurred before the beginning of the develop- sions). Clearly indicate the election on your equals the exploration costs you deducted. ment stage of the mine (except those for oil, gas, amended return and write “Filed pursuant to and geothermal wells). section 301.9100-2.” File the amended return at You also must recapture deducted explora- the same address you filed the original return. tion costs if you receive a bonus or royalty from **How to make the election.** You elect to de- mine property before it reaches the producing duct exploration costs by taking the deduction **Foreign development costs.** The rules dis- stage. Do not claim any depletion deduction for on your income tax return, or on an amended cussed earlier for foreign exploration costs apply the tax year you receive the bonus or royalty and income tax return, for the first tax year for which to foreign development costs. any later tax years, until the depletion you would you wish to deduct the costs paid or incurred have deducted equals the exploration costs you during the tax year. Your return must adequately **Reduced corporate deductions for develop-** deducted. describe and identify each property or mine, and **ment costs.** The rules discussed earlier for Generally, if you dispose of the mine before clearly state how much is being deducted for reduced corporate deductions for exploration you have fully recaptured the exploration costs each one. The election applies to the tax year costs also apply to corporate deductions for de- you deducted, recapture the balance by treating you make this election and all later tax years. velopment costs. all or part of your gain as ordinary income. **Partnerships and S corporations.** Each Under these circumstances, you generally partner, not the partnership, elects whether to treat as ordinary income all of your gain if it is capitalize or to deduct that partner’s share of less than your adjusted exploration costs with exploration costs. Each shareholder, not the S 

# Circulation Costs respect to the mine. If your gain is more than corporation, elects whether to capitalize or to your adjusted exploration costs, treat as ordi- deduct that shareholder’s share of exploration A publisher can deduct as a current business nary income only a part of your gain, up to the costs. expense the costs of establishing, maintaining, amount of your adjusted exploration costs. or increasing the circulation of a newspaper, **Reduced corporate deductions for explora-** magazine, or other periodical. For example, a **Foreign exploration costs.** If you pay or incur **tion costs.** A corporation (other than an S publisher can deduct the cost of hiring extra exploration costs for a mine or other natural corporation) can deduct only 70% of its domes- employees for a limited time to get new sub- deposit located outside the United States, you tic exploration costs. It must capitalize the re- scriptions through telephone calls. Circulation cannot deduct all the costs in the current year. maining 30% of costs and amortize them over costs are deductible even if they normally would You can elect to include the costs (other than for the 60-month period starting with the month the be capitalized. an oil, gas, or geothermal well) in the adjusted exploration costs are paid or incurred. A corpo- This rule does not apply to the following basis of the mineral property to figure cost de- ration may also elect to capitalize and amortize costs that must be capitalized. pletion. (Cost depletion is discussed in chapter mining exploration costs over a 10-year period. 9.) If you do not make this election, you must 

### • The purchase of land or depreciable prop-For more information on this method of amortideduct the costs over the 10-year period begin- erty. zation, see Internal Revenue Code section ning with the tax year in which you pay or incur 59(e). 

### • The acquisition of circulation through the them. These rules also apply to foreign develop- The 30% the corporation capitalizes cannot purchase of any part of the business of ment costs. be added to its basis in the property to figure another publisher of a newspaper, magacost depletion. However, the amount amortized zine, or other periodical, including the is treated as additional depreciation and is sub- purchase of another publisher’s list of subject to recapture as ordinary income on a dispo- scribers. 

# Development Costs sition of the property. See Section 1250 Property underDepreciation Recapturein chap- **Other treatment of circulation costs.** If you You can deduct costs paid or incurred during the ter 3 of Publication 544. do not want to deduct circulation costs as a tax year for developing a mine or any other These rules also apply to the deduction of current business expense, you can elect one of natural deposit (other than an oil or gas well) development costs by corporations. SeeDevel- the following ways to recover these costs. located in the United States. These costs must opment Costs, later. be paid or incurred after the discovery of ores or 

### • Capitalize all circulation costs that are minerals in commercially marketable quantities. properly chargeable to a capital account **Recapture of exploration expenses.** When Development costs include those incurred for (seechapter 1). your mine reaches the producing stage, you you by a contractor. Also, development costs must recapture any exploration costs you 

### • Amortize circulation costs over the 3-year include depreciation on improvements used in elected to deduct. Use either of the following period beginning with the tax year they the development of ores or minerals. They do methods. were paid or incurred.not include costs for the acquisition or improvement of depreciable property. Method 1

—Include the deducted costs in Instead of deducting development costs in **How to make the election.** You elect to capigross income for the tax year the mine the year paid or incurred, you can elect to treat talize circulation costs by attaching a statement reaches the producing stage. Your election them as deferred expenses and deduct them to your return for the first tax year the election must be clearly indicated on the return. In- ratably as the units of produced ores or minerals applies. Your election is binding for the year it is crease your adjusted basis in the mine by benefited by the expenses are sold. This elec- made and for all later years, unless you get IRS the amount included in income. Generally, tion applies each tax year to expenses paid or approval to revoke it. you must elect this recapture method by the incurred in that year. Once made, the election is due date (including extensions) of your re- binding for the year and cannot be revoked for turn. However, if you timely filed your return any reason. for the year without making the election, you can still make the election by filing an 

# Environmental Cleanup amended return within 6 months of the due **How to make the election.** The election to date of the return (excluding extensions). deduct development costs ratably as the ores or 

# Costs Make the election on your amended return minerals are sold must be made for each mine and write “Filed pursuant to section or other natural deposit by a clear indication on Environmental cleanup costs are generally capi301.9100-2” on the form where you are in- your return or by a statement filed with the IRS tal expenditures. However, you can elect to decluding the income. File the amended re- office where you file your return. Generally, you duct these costs as a current business expense turn at the same address you filed the must make the election by the due date of the if certain requirements (discussed later) are met. original return. return (including extensions). However, if you This special tax treatment is generally available Chapter7 **Costs You Can Deduct or Capitalize** Page 23

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for environmental cleanup costs you pay or incur than one environmental cleanup cost, you can section 1245 when you sell or otherwise dispose before January 1, 2012. elect to deduct one or more of such expendi- of the property that would have received an tures for that year. You can elect to deduct one addition to basis had you not made the election. **Environmental cleanup costs.** Environmen- expenditure and elect to capitalize another ex- For more information on recapturing the deduc- tal cleanup costs are generally costs you pay or penditure (whether or not they are of the same tion, seeDepreciation and amortization under incur to abate or control hazardous substances type or paid or incurred with respect to the same Gain Treated as Ordinary Income in Publication at a qualified contaminated site. qualified contaminated site). An election to de- 544. duct an expenditure for one year has no effect **Hazardous substance.** Hazardous sub- **More information.** For more information on other years. You must make a separate elec- stances are defined in section 101(14) of the about expensing of qualified disaster expenses, tion for each year in which you intend to deduct Comprehensive Environmental Response, see Internal Revenue Code section 198A. environmental cleanup costs. Compensation, and Liability Act of 1980 and certain substances are designated as hazard- **Recapture.** This deduction may have to be ous in section 102 of the Act. Also, petroleum recaptured as ordinary income under section products are treated as hazardous substances. 1245 when you sell or otherwise dispose of the 

# Business Start-Up and However, substances are not hazardous if a property that would have received an addition to removal or remedial action is prohibited under basis if you had not elected to deduct the expen- 

# Organizational Costs sections 104 and 104(a)(3) of the Act. diture. For more information on recapturing the deduction, seeDepreciation Recapture in Publi- **Qualified contaminated site.** A qualified Business start-up and organizational costs are cation 544. contaminated site is any area that meets both of generally capital expenditures. However, you the following requirements. can elect to deduct up to $5,000 of business **More information.** For more information start-up and $5,000 of organizational costs paid about the environmental cleanup cost deduc- 1. You hold it for use in a trade or business, or incurred after October 22, 2004. The $5,000 tion, see Internal Revenue Code section 198. for the production of income, or as inven- deduction is reduced by the amount your total tory. start-up or organizational costs exceed $50,000. Any remaining costs must be amortized. For 2. There has been a release, threat of re- information about amortizing start-up and orga- lease, or disposal of any hazardous sub- 

# Qualified Disaster nizational costs, seechapter 8

. stance at or on the site. Start-up costs include any amounts paid or 

# Expenses You must get a statement from the designated incurred in connection with creating an active state environmental agency that the site meets trade or business or investigating the creation or You can elect to deduct rather than capitalize requirement (2). acquisition of an active trade or business. Orga- any qualified disaster expenses that you paid or A site is not eligible if it is on, or proposed for, nizational costs include the costs of creating a incurred after 2007. the national priorities list under section corporation. For more information on start-up 105(a)(8)(B) of the Comprehensive Environ- and organizational costs, seechapter 8

. **Qualified disaster expense.** A qualified dis- mental Response, Compensation, and Liability aster expense is an expenditure that: **Special rule for 2010 start-up costs.** For Act of 1980. To find out if a site is on the national tax years beginning in 2010, you can elect to priorities list, contact the U.S. Environmental 1. Is paid or incurred in connection with a deduct up to $10,000 of business start-up costs Protection Agency. trade or business or with business-related paid or incurred after 2009. The $10,000 deduc- property, **Expenditures for depreciable property.** tion is reduced (but not below zero) by the You cannot deduct the cost of acquiring depre- 2. Is otherwise capitalized, and amount such start-up costs exceed $60,000. ciable property used in connection with the Any remaining costs must be amortized. 3. Is for one of the following purposes. abatement or control of hazardous substances at a qualified contaminated site. However, the **How to make the election.** You elect to de- a. The abatement or control of hazardous part of the depreciation for such property that is duct the start-up or organizational costs by substances that were released because otherwise allocated to the qualified contami- claiming the deduction on the income tax return of a federally declared disaster occur- nated site shall be treated as an environmental (filed by the due date including extensions) for ring before January 1, 2010, cleanup cost. the tax year in which the active trade or business b. The removal of debris from, or the dem- begins. However, if you timely filed your return **When and how to elect.** You elect to deduct olition of structures on, real property for the year without making the election, you can environmental cleanup costs by taking the de- that is business-related property dam- still make the election by filing an amended duction on the income tax return (filed by the due aged or destroyed as a result of a fed- return within 6 months of the due date of the date including extensions) for the tax year in erally declared disaster occurring return (excluding extensions). Clearly indicate which the costs are paid or incurred. The costs before such date, or the election on your amended return and write are deducted differently depending on the type “Filed pursuant to section 301.9100-2.” File the c. The repair of business-related property of business entity involved. amended return at the same address you fileddamaged as a result of a federally dethe original return. The election applies when **Individuals.** Deduct the environmental clared disaster occurring before such computing taxable income for the current tax cleanup costs on the “Other Expenses” line of date. year and all subsequent years. Schedule C, E, or F (Form 1040). If the schedule requires you to separately identify each expense **Federally declared disaster.** A federally de- included in “Other Expenses” write “Section 198 clared disaster is a disaster that occurred in an Election” on the line next to the environmental area declared by the President to be eligible for 

# Reforestation Costs cleanup costs. federal assistance under the Robert T. Stafford

**All other entities.** All other taxpayers (in- Relief and Emergency Assistance Act. Reforestation costs are generally capital expen- cluding S corporations, partnerships, and trusts) ditures. However, you can elect to deduct up to **Business-related property.** Busi- deduct the environmental cleanup costs on the $10,000 ($5,000 if married filing separately; $0 ness-related property is property you held (a) for “Other Deductions” line of the appropriate fed- for a trust) of qualifying reforestation costs paid use in a trade or business or for the production eral income tax return. On a schedule attached or incurred after October 22, 2004, for each of income or (b) that is stock in trade or other to the return that separately identifies each ex- qualified timber property. The remaining costs property included in inventory or held mainly for pense included in “Other Deductions” write can be amortized over an 84-month period. For sale to customers. “Section 198 Election” on the line next to the information about amortizing reforestation amount for environmental cleanup costs. **Recapture.** If you made the election to deduct costs, seechapter 8

.

**More than one environmental cleanup** qualified disaster expenses, the deduction may Qualifying reforestation costs are the direct **cost.** If, for any tax year, you pay or incur more have to be recaptured as ordinary income under costs of planting or seeding for forestation or Page 24 Chapter7 **Costs You Can Deduct or Capitalize**

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reforestation. Qualified timber property is prop- his share of the partnership’s expenses because of how John applied the limit, ABC can add erty that contains trees in significant commercial 

# Retired Asset Removal $6,000 to the basis of its property. quantities. See chapter 8 for more information 

# Costs on qualifying reforestation costs and qualified **Qualification standards.** You can deduct timber property. If you retire and remove a depreciable asset in your costs as a current expense only if the bar- If you elect to deduct qualified reforestation connection with the installation or production of rier removal meets the guidelines and require- costs, create and maintain separate timber ac- a replacement asset, you can deduct the costs ments issued by the Architectural and counts for each qualified timber property and of removing the retired asset. However, if you Transportation Barriers Compliance Board include all reforestation costs and the dates replace a component (part) of a depreciable under the Americans with Disabilities Act (ADA) each was applied. Do not include this qualified asset, capitalize the removal costs if the re- of 1990. You can view the Americans with Disatimber property in any account (for example, placement is an improvement and deduct the bilities Act at www.ada.gov/pubs/ada.htm

. costs if the replacement is a repair. depletion block) for which depletion is allowed. The following is a list of some architectural barrier removal costs that can be deducted. **How to make the election.** You elect to de- 

### • Ground and floor surfaces. duct qualifying reforestation costs by claiming 

# Barrier Removal Costs **•** Walks. the deduction on your timely filed income tax return (including extensions) for the tax year the 

### • Parking lots. The cost of an improvement to a business asset expenses were paid or incurred. If Form T (Tim- is normally a capital expense. However, you can 

### • Ramps. ber), Forest Activities Schedule, is required, elect to deduct the costs of making a facility or 

### • Entrances. complete Part IV of Form T. If Form T is not public transportation vehicle more accessible to required, attach a statement containing the fol- and usable by those who are disabled or elderly. 

### • Doors and doorways. You must own or lease the facility or vehicle for lowing information for each qualified timber 

### • Stairs. use in connection with your trade or business. property for which an election is being made. A facility is all or any part of buildings, struc- 

### • Floors.



### • The unique stand identification numbers. tures, equipment, roads, walks, parking lots, or 

### • Toilet rooms.similar real or personal property. A public trans

### • The total number of acres reforested dur- portation vehicle is a vehicle, such as a bus or

ing the tax year. 

### • Water fountains. railroad car, that provides transportation service 

### • The nature of the reforestation treatments. 

### • Telephones. to the public (including service for your custom- ers, even if you are not in the business of provid- 

### • The total amounts of qualified reforesta- 

### • Elevators. ing transportation services). tion expenditures eligible to be amortized 

### • Controls. You cannot deduct any costs that you paid or or deducted. incurred to completely renovate or build a facility 

### • Signage. or public transportation vehicle or to replace However, if you timely filed your return for the 

### • Alarms. depreciable property in the normal course of year without making the election, you can still business. 

### • Protruding objects. make the election by filing an amended return within 6 months of the due date of the return 

### • Symbols of accessibility. **Deduction limit.** The most you can deduct as (excluding extensions). Clearly indicate the a cost of removing barriers to the disabled and You can find the ADA guidelines and require- election on your amended return and write “Filed the elderly for any tax year is $15,000. However, ments for architectural barrier removal at www. pursuant to section 301.9100-2.” File the you can add any costs over this limit to the basis usdoj.gov/crt/ada/reg3a.html

. amended return at the same address you filed of the property and depreciate these excess The following is a list of some deductible the original return. The election applies when costs. transportation barrier removal costs. computing taxable income for the current tax **Partners and partnerships.** The $15,000 year and all subsequent years. 

### • Rail facilities. limit applies to a partnership and also to each If you elected to deduct qualified timber costs 

### • Buses. partner in the partnership. A partner can allocate on a federal income tax return filed before June the $15,000 limit in any manner among the part- 

### • Rapid and light rail vehicles. 15, 2006, but did not include the above informa- ner’s individually incurred costs and the part- tion, complete Part IV of Form T or the required You can find the guidelines and requirements for ner’s distributive share of partnership costs. If statement and attach it to the first federal income transportation barrier removal at www.fta.dot. the partner cannot deduct the entire share of tax return you file after June 14, 2006. If you gov
. partnership costs, the partnership can add any have not elected to deduct qualified timber costs costs not deducted to the basis of the improved Also, you can access the ADA website at property. in a prior year you may be able to do so by filing www.ada.gov for additional information. A partnership must be able to show that any Form 3115, Application for Change in Account- **Other barrier removals.** To be deductible, amount added to basis was not deducted by the ing Method. For more information, see Notice expenses of removing any barrier not covered partner and that it was over a partner’s $15,000 2006-47 on page 892 of Internal Revenue Bulle- limit (as determined by the partner). If the part- by the above standards must meet all three of tin 2006-20. Internal Revenue Bulletin 2006-20 nership cannot show this, it is presumed that the the following tests. is available atwww.irs.gov/pub/irs-irbs/irb06-20. partner was able to deduct the distributive share pdf. 1. The removed barrier must be a substantial of the partnership’s costs in full. barrier to access or use of a facility or For additional information on reforestation public transportation vehicle by persons costs, seechapter 8

. **Example.** John Duke’s distributive share of who have a disability or are elderly. ABC partnership’s deductible expenses for the removal of architectural barriers was $14,000. 2. The removed barrier must have been a **Recapture.** This deduction may have to be John had $12,000 of similar expenses in his sole barrier for at least one major group of per- recaptured as ordinary income under section proprietorship. He elected to deduct $7,000 of sons who have a disability or are elderly 1245 when you sell or otherwise dispose of the them. John allocated the remaining $8,000 of (such as people who are blind, deaf, or property that would have received an addition to the $15,000 limit to his share of ABC’s ex- wheelchair users). basis if you had not elected to deduct the expen- penses. John can add the excess $5,000 of his diture. For more information on recapturing the 3. The barrier must be removed without creown expenses to the basis of the property used deduction, seeDepreciation Recapture in Publi- ating any new barrier that significantly imin his business. Also, if ABC can show that John cation 544. pairs access to or use of the facility or could not deduct $6,000 ($14,000

–$8,000) of Chapter7 **Costs You Can Deduct or Capitalize** Page 25

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vehicle by a major group of persons who see chapter 3 of Publication 550, Investment have a disability or are elderly. Income and Expenses. 

# Starting a Business **Topics** When you start a business, treat all eligible costs **How to make the election.** If you elect to you incur before you begin operating the busi- This chapter discusses: deduct your costs for removing barriers to the ness as capital expenditures which are part of disabled or the elderly, claim the deduction on your basis in the business. Generally, you re- 

### • Deducting amortization your income tax return (partnership return for cover costs for particular assets through depre- partnerships) for the tax year the expenses were 

### • Amortizing costs of starting a business ciation deductions. However, you generally paid or incurred. Identify the deduction as a 

### • Amortizing costs of getting a lease cannot recover other costs until you sell the separate item. The election applies to all the business or otherwise go out of business. See qualifying costs you have during the year, up to 

### • Amortizing costs of section 197 intangibles Capital Expenses in chapter 1 for a discussion the $15,000 limit. If you make this election, you 

### • Amortizing reforestation costs on how to treat these costs if you do not go into must maintain adequate records to support your deduction. business. 

### • Amortizing costs of geological and geo- For your election to be valid, you generally For costs paid or incurred after September 8, physical costs must file your return by its due date, including 2008, you can deduct a limited amount of 

### • Amortizing costs of pollution control facili- extensions. However, if you timely filed your start-up and organizational costs. The costs that ties return for the year without making the election, are not deducted currently can be amortized you can still make the election by filing an ratably over a 180-month period. The amortiza- 

### • Amortizing costs of research and experi- amended return within 6 months of the due date tion period starts with the month you begin oper- mentation of the return (excluding extensions). Clearly indi- ating your active trade or business. You are not cate the election on your amended return and 

### • Amortizing costs of certain tax preferences required to attach a statement to make this elec- write “Filed pursuant to section 301.9100-2.” File tion. Once made, the election is irrevocable. See the amended return at the same address you Temporary Regulations sections 1.195-1T, 

### Useful Items filed the original return. Your election is irrevoca- 1.248-1T, and 1.709-1T. You may want to see: ble after the due date, including extensions, of For costs paid after October 22, 2004, and your return. before September 9, 2008, you can elect to **Publication** deduct a limited amount of business start-up **Disabled access credit.** If you make your ❏ **544** Sales and Other Dispositions of and organizational costs in the year your active business accessible to persons with disabilities trade or business begins. Any costs not de- Assets and your business is an eligible small business, ducted can be amortized ratably over a you may be able to claim the disabled access ❏ **550** Investment Income and Expenses 180-month period, beginning with the month you credit. If you choose to claim the credit, you must ❏ **946** How To Depreciate Property begin business. If the election is made, you must reduce the amount you deduct or capitalize by attach any statement required by Regulations the amount of the credit. **Form (and Instructions)** sections 1.195-1(b), 1.248-1(c), and 1.709-1(c).For more information about the disabled acHowever, you can apply the provisions of Tem- cess credit, see Form 8826. ❏ **4562** Depreciation and Amortization porary Regulations sections 1.195-1T, ❏ **4626** Alternative Minimum Tax

— 1.248-1T, and 1.709-1T to all business start-up and organizational costs paid or incurred after Corporations October 22, 2004, provided the period of limita- 

# Film and Television ❏ **6251** Alternative Minimum Tax

— tions on assessment has not expired for the year Individuals of the election. Otherwise the provisions under 

# Production Costs Regulations section 1.195-1(b), 1.248-1(c), and See chapter 12for information about getting 1.709-1(c) will apply. Film and television production costs are gener- publications and forms. ally capital expenses. However, you can elect to For costs paid or incurred before October 23, deduct costs paid or incurred for certain produc- 2004, you can elect to amortize business tions that begin after October 22, 2004. For start-up and organization costs over an amortimore information, see section 181 of the Internal zation period of 60 months or more. SeeHow To 

# How To Deduct Revenue Code and Temporary Regulations Make the Election, later. sections 1.181-1T through 1.181-6T. The cost must qualify as one of the following. 

# Amortization
**•** A business start-up cost. To deduct amortization that begins during the 

### • An organizational cost for a corporation. current tax year, complete Part VI of Form 4562 

### • An organizational cost for a partnership. and attach it to your income tax return. To report amortization from previous years, 

# 8. in addition to amortization that begins in the **Note.** For a tax year beginning in 2010, the current year, list on Form 4562 each item sepa- maximum deduction for business start-up costs rately. For example, in 2009, you began to amor- has increased. For more information, see Busi- ness Start-Up and Organizational Costsin chaptize a lease. In 2010, you began to amortize a 

# Amortization ter 7. Also see section 195(b)(3). second lease. Report amortization from the new lease on line 42 of your 2010 Form 4562. Report 

## Business Start-Up Costs amortization from the 2009 lease on line 43 of 

# Introduction your 2010 Form 4562. Start-up costs are amounts paid or incurred for: Amortization is a method of recovering (deduct- If you do not have any new amortizable ex- **(a)**creating an active trade or business; or **(b)** ing) certain capital costs over a fixed period of penses for the current year, you are not required investigating the creation or acquisition of an time. It is similar to the straight line method of to complete Form 4562 (unless you are claiming active trade or business. Start-up costs include depreciation. depreciation). Report the current year’s deduc- amounts paid or incurred in connection with an The various amortizable costs covered in tion for amortization that began in a prior year existing activity engaged in for profit; and for the this chapter are included in the list below. How- directly on the “Other deduction” or “Other ex- production of income in anticipation of the activever, this chapter does not discuss amortization pense line” of your return. ity becoming an active trade or business. of bond premium. For information on that topic, Page 26 Chapter8 **Amortization**

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**Qualifying costs.** A start-up cost is amortiz- **Qualifying costs.** To qualify as an organiza- 

### • Filing fees. able if it meets both of the following tests. tional cost, it must be: **Nonqualifying costs.** The following costs



### • It is a cost you could deduct if you paid or 

### • For the creation of the corporation, cannot be amortized.

incurred it to operate an existing active 

### • Chargeable to a capital account (see trade or business (in the same field as the 

### • The cost of acquiring assets for the part- chapter 1), one you entered into). nership or transferring assets to the part- 

### • Amortized over the life of the corporation if nership. 

### • It is a cost you pay or incur before the day the corporation had a fixed life, and

your active trade or business begins. 

### • The cost of admitting or removing part- 

### • Incurred before the end of the first tax year ners, other than at the time the partnership Start-up costs include amounts paid for the in which the corporation is in business. is first organized. following: 

### • The cost of making a contract concerning A corporation using the cash method of ac- 

### • An analysis or survey of potential markets, the operation of the partnership trade or counting can amortize organizational costs in- products, labor supply, transportation facil- business including a contract between a curred within the first tax year, even if it does not ities, etc. partner and the partnership. pay them in that year. 

### • Advertisements for the opening of the Examples of organizational costs include: 

### • The costs for issuing and marketing inter-

business. ests in the partnership such as brokerage, 

### • The cost of temporary directors. registration, and legal fees and printing 

### • Salaries and wages for employees who 

### • The cost of organizational meetings. costs. These “syndication fees” are capital

are being trained and their instructors. expenses that cannot be depreciated or 

### • State incorporation fees. 

### • Travel and other necessary costs for se- amortized.

curing prospective distributors, suppliers, 

### • The cost of legal services. or customers. **Liquidation of partnership.** If a partnership is 

### • Salaries and fees for executives and con- **Nonqualifying costs.** The following items are liquidated before the end of the amortization

sultants, or for similar professional serv- capital expenses that cannot be amortized: period, the unamortized amount of qualifying ices. organizational costs can be deducted in the 

### • Costs for issuing and selling stock or se- partnership’s final tax year. However, these

curities, such as commissions, profes- costs can be deducted only to the extent they **Nonqualifying costs.** Start-up costs do not sional fees, and printing costs. qualify as a loss from a business. include deductible interest, taxes, or research 

### • Costs associated with the transfer of as- and experimental costs. See Research and Exsets to the corporation. perimental Costs, later. 

## How To Amortize **Purchasing an active trade or business.** Deduct start-up and organizational costs in 

## Costs of Organizing Amortizable start-up costs for purchasing an ac- equal amounts over the applicable amortization 

## a Partnership tive trade or business include only investigative period (discussed earlier). You can choose an costs incurred in the course of a general search amortization period for start-up costs that is dif- The costs to organize a partnership are the for or preliminary investigation of the business. ferent from the period you choose for organiza- direct costs of creating the partnership. These are costs that help you decide whether to tional costs, as long as both are not less than the purchase a business. Costs you incur in an applicable amortization period. Once you **Qualifying costs.** A partnership can amortize attempt to purchase a specific business are cap- choose an amortization period, you cannot an organizational cost only if it meets all the ital expenses that you cannot amortize. change it. following tests. To figure your deduction, divide your total **Example.** On June 1st, you hired an ac- start-up or organizational costs by the months in 

### • It is for the creation of the partnership and counting firm and a law firm to assist you in the the amortization period. The result is the amount not for starting or operating the partner- potential purchase of XYZ, Inc. They researched you can deduct for each month. ship trade or business.XYZ’s industry and analyzed the financial pro

### • It is chargeable to a capital account (see jections of XYZ, Inc. In September, the law firm **Cash method partnership.** A partnership us- chapter 1). prepared and submitted a letter of intent to XYZ, ing the cash method of accounting can deduct Inc. The letter stated that a binding commitment 

### • It could be amortized over the life of the an organizational cost only if it has been paid by would result only after a purchase agreement partnership if the partnership had a fixed the end of the tax year. However, any cost the was signed. The law firm and accounting firm life. partnership could have deducted as an organi- continued to provide services including a review zational cost in an earlier tax year (if it had been 

### • It is incurred by the due date of the part- of XYZ’s books and records and the preparation paid that year) can be deducted in the tax year of nership return (excluding extensions) for of a purchase agreement. On October 22nd, you payment. the first tax year in which the partnership signed a purchase agreement with XYZ, Inc. is in business. However, if the partnership All amounts paid or incurred to investigate uses the cash method of accounting and the business before October 22nd are amortiz- 

### How To Make the Election pays the cost after the end of its first tax able investigative costs. Amounts paid on or year, seeCash method partnership under after that date relate to the attempt to purchase To elect to amortize start-up or organizational How To Amortize, later. the business and therefore must be capitalized. costs, you must complete and attach Form 4562 to your return for the first tax year you are in 

### • It is for a type of item normally expected to **Disposition of business.** If you completely business. You may also be required to attach an benefit the partnership throughout its en- dispose of your business before the end of the accompanying statement (described later) to tire life. amortization period, you can deduct any remain- your return. ing deferred start-up costs. However, you can For start-up or organizational costs paid or Organizational costs include the following deduct these deferred start-up costs only to the incurred after September 8, 2008, an accompa- fees. extent they qualify as a loss from a business. nying statement is not required. Generally, for 

### • Legal fees for services incident to the or- start-up or organizational costs paid or incurred

ganization of the partnership, such as ne- 

## Costs of Organizing before September 9, 2008, unless you choose gotiation and preparation of the to apply Temporary Regulations sections 

## a Corporation partnership agreement. 1.195-1T and 1.248-1T, you must also attach an Amounts paid to organize a corporation are the 

### • Accounting fees for services incident to accompanying statement to elect to amortize direct costs of creating the corporation. the organization of the partnership. the costs. Chapter8 **Amortization** Page 27

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If you have both start-up and organizational 

### • The month your corporation or partnership You cannot deduct amortization for the month began active business (or acquired the you dispose of the intangible. costs, attach a separate statement (if required) business). to your return for each type of cost. SeeStarting If you pay or incur an amount that increases a Business, earlier, for more information. 

### • The number of months in your amortiza- the basis of an amortizable section 197 intangi- Generally, you must file the return by the due tion period (which is generally 180 ble after the 15-year period begins, amortize it date (including any extensions). However, if you months). over the remainder of the 15-year period begintimely filed your return for the year without mak- ning with the month the basis increase occurs. ing the election, you can still make the election **Partnerships.** The statement prepared for You are not allowed any other depreciation by filing an amended return within 6 months of a cash basis partnership must also indicate the or amortization deduction for an amortizable the due date of the return (excluding exten- amount paid before the end of the year for each section 197 intangible. sions). For more information, see the instruc- cost. **Tax-exempt use property subject to a lease.** tions for Part VI of Form 4562. You do not need to separately list any part- The amortization period for any section 197 in- nership organizational cost that is less than $10. Once you make the election to amortize tangible leased under a lease agreement en- Instead, you can list the total amount of these start-up or organizational costs, you cannot re- tered into after March 12, 2004, to a tax-exempt costs with the dates the first and last costs were voke it. organization, governmental unit, or foreign per- incurred. If your business is organized as a corpora- son or entity (other than a partnership), shall not After a partnership makes the election to tion or partnership, only the corporation or part- be less than 125 percent of the lease term. amortize organizational costs, it can later file an nership can elect to amortize its start-up or amended return to include additional organiza- **Cost attributable to other property.** The organizational costs. A shareholder or partner tional costs not included in the partnership’s rules for section 197 intangibles do not apply to cannot make this election. You, as a share- original return and statement. any amount that is included in determining the holder or partner, cannot amortize any costs you cost of property that is not a section 197 intangi- incur in setting up your corporation or partner- ble. For example, if the cost of computer ship. Only the corporation or partnership can software is not separately stated from the cost of amortize these costs. hardware or other tangible property and you 

# Getting a Lease However, you, as an individual, can elect to consistently treat it as part of the cost of the amortize costs you incur to investigate an inter- hardware or other tangible property, these rules If you get a lease for business property, you est in an existing partnership. These costs qual- do not apply. Similarly, none of the cost of ac- recover the cost by amortizing it over the term of ify as business start-up costs if you acquire the quiring real property held for the production of the lease. The term of the lease for amortization partnership interest. rental income is considered the cost of goodwill, purposes generally includes all renewal options going concern value, or any other section 197 (and any other period for which you and the **Start-up costs election statement.** If you intangible. lessor reasonably expect the lease to be re- elect to amortize your start-up costs, attach a newed). However, renewal periods are not inseparate statement (if required) that contains cluded if 75% or more of the cost of acquiring the 

## Section 197 Intangibles the following information. lease is for the term of the lease remaining on 

## Defined the acquisition date (not including any period for 

### • A description of the business to which the which you may choose to renew, extend, or The following assets are section 197 intangibles

start-up costs relate. continue the lease). and must be amortized over 180 months: 

### • A description of each start-up cost in- For more information on the costs of getting

curred. a lease, seeCost of Getting a Lease in 1. Goodwill; chapter 3. 

### • The month your active business began (or 2. Going concern value;

was acquired). **How to amortize.** Enter your deduction in Part 3. Workforce in place; VI of Form 4562 if you are deducting amortiza- 

### • The number of months in your amortiza- 4. Business books and records, operating tion that begins during the current year, or on the tion period (which is generally 180 systems, or any other information base, appropriate line of your tax return if you are not months). including lists or other information concernotherwise required to file Form 4562. ing current or prospective customers; **Filing the statement early.** You can elect to amortize your start-up costs by filing the state- 5. A patent, copyright, formula, process, dement with a return for any tax year before the sign, pattern, know-how, format, or similar 

# Section 197 Intangibles year your active business begins. If you file the item; statement early, the election becomes effective 6. A customer-based intangible; Generally, you may amortize the capitalized in the month of the tax year your active business costs of “section 197 intangibles” (defined later) 7. A supplier-based intangible; begins. ratably over a 15-year period. You must amor8. Any item similar to items (3) through (7);

**Revised statement.** You can file a revised tize these costs if you hold the section 197 statement to include any start-up costs not in- intangibles in connection with your trade or busi- 9. A license, permit, or other right granted by cluded in your original statement. However, you ness or in an activity engaged in for the produc- a governmental unit or agency (including cannot include on the revised statement any tion of income. issuances and renewals); cost you previously treated on your return as a You may not be able to amortize sec- 10. A covenant not to compete entered into in cost other than a start-up cost. You can file the tion 197 intangibles acquired in a trans- connection with the acquisition of an inter- revised statement with a return filed after the action that did not result in a significant est in a trade or business; return on which you elected to amortize your change in ownership or use. SeeAnti-Churning start-up costs. 11. Any franchise, trademark, or trade name; Rules, later. and Your amortization deduction each year is the **Organizational costs election statement.** If applicable part of the intangible’s adjusted basis 12. A contract for the use of, or a term interest you elect to amortize your corporation’s or part- (for purposes of determining gain), figured by in, any item in this list. nership’s organizational costs, attach a sepa- amortizing it ratably over 15 years (180 months). rate statement (if required) that contains the You cannot amortize any of the in- The 15-year period begins with the later of: following information. tangibles listed in items (1) through (8) 

### • The month the intangible is acquired, or 

### • A description of each cost. that you created rather than acquired 

### • The month the trade or business or activity unless you created them in acquiring assets that 

### • The amount of each cost. engaged in for the production of income make up a trade or business or a substantial part 

### • The date each cost was incurred. begins. of a trade or business. Page 28 Chapter8 **Amortization**

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**Goodwill.** This is the value of a trade or busi- services used or sold by the business because 4. Most computer software. (SeeComputer ness based on expected continued customer of business relationships with suppliers. software, later.) patronage due to its name, reputation, or any For example, you must amortize the part of 5. Any of the following assets not acquired in other factor. the purchase price of a business that is for the connection with the acquisition of a trade existence of the following intangibles. or business or a substantial part of a trade **Going concern value.** This is the additional or business. value of a trade or business that attaches to 

### • A favorable relationship with distributors property because the property is an integral part (such as favorable shelf or display space a. An interest in a film, sound recording, of an ongoing business activity. It includes value at a retail outlet). video tape, book, or similar property. based on the ability of a business to continue to 

### • A favorable credit rating. function and generate income even though b. A right to receive tangible property or there is a change in ownership (but does not 

### • A favorable supply contract. services under a contract or from a govinclude any other section 197 intangible). It also ernmental agency. includes value based on the immediate use or **Government-granted license, permit, etc.** c. An interest in a patent or copyright. availability of an acquired trade or business, This is any right granted by a governmental unit such as the use of earnings during any period in d. Certain rights that have a fixed duration or an agency or instrumentality of a governmen- which the business would not otherwise be or amount. (SeeRights of fixed duration tal unit. For example, you must amortize the available or operational. or amount , later.) capitalized costs of acquiring (including issuing or renewing) a liquor license, a taxicab medal- **Workforce in place, etc.** This includes the 6. An interest under either of the following.lion or license, or a television or radio broadcastcomposition of a workforce (for example, its ex- ing license. perience, education, or training). It also includes a. An existing lease or sublease of tangi- the terms and conditions of employment, ble property. **Covenant not to compete.** Section 197 inwhether contractual or otherwise, and any other b. A debt that was in existence when the tangibles include a covenant not to compete (or value placed on employees or any of their attrib- interest was acquired. similar arrangement) entered into in connection utes. with the acquisition of an interest in a trade or For example, you must amortize the part of 7. A right to service residential mortgages un- business, or a substantial portion of a trade or the purchase price of a business that is for the less the right is acquired in connection with business. An interest in a trade or business existence of a highly skilled workforce. Also, you the acquisition of a trade or business or a includes an interest in a partnership or a corpo- must amortize the cost of acquiring an existing substantial part of a trade or business. ration engaged in a trade or business. employment contract or relationship with em- ployees or consultants. An arrangement that requires the former 8. Certain transaction costs incurred by par- owner to perform services (or to provide prop- ties to a corporate organization or reorgan- **Business books and records, etc.** This in- erty or the use of property) is not similar to a ization in which any part of a gain or loss is cludes the intangible value of technical manuals, covenant not to compete to the extent the not recognized. training manuals or programs, data files, and amount paid under the arrangement represents accounting or inventory control systems. It also Intangible property that is not amortizable reasonable compensation for those services or includes the cost of customer lists, subscription under the rules for section 197 intangibles can for that property or its use. lists, insurance expirations, patient or client files, be depreciated if it meets certain requirements. and lists of newspaper, magazine, radio, and You generally must use the straight line method **Franchise, trademark, or trade name.** A television advertisers. over its useful life. For certain intangibles, the franchise, trademark, or trade name is a section depreciation period is specified in the law and **Patents, copyrights, etc.** This includes pack- 197 intangible. You must amortize its purchase regulations. For example, the depreciation pe- age design, computer software, and any interest or renewal costs, other than certain contingent riod for computer software that is not a section in a film, sound recording, videotape, book, or payments that you can deduct currently. For 197 intangible is generally 36 months. other similar property, except as discussed later information on currently deductible contingent For more information on depreciating intanunder Assets That Are Not Section 197 In- payments, seechapter 11

. gible property, see Intangible Property under tangibles

. **Professional sports franchise.** A What Method Can You Use To Depreciate Your franchise engaged in professional sports and **Customer-based intangible.** This is the com- Property? in chapter 1 of Publication 946. any intangible assets acquired in connection position of market, market share, and any other with acquiring the franchise (including player value resulting from the future provision of **Computer software.** Section 197 intangibles contracts) is a section 197 intangible amortiz- goods or services because of relationships with do not include the following types of computer able over a 15-year period. customers in the ordinary course of business. software. For example, you must amortize the part of the **Contract for the use of, or a term interest in, a** purchase price of a business that is for the 1. Software that meets all the following re- **section 197 intangible.** Section 197 in- existence of the following intangibles. quirements. tangibles include any right under a license, con- 

### • A customer base. a. It is, or has been, readily available for tract, or other arrangement providing for the use 

### • A circulation base. of any section 197 intangible. It also includes purchase by the general public. any term interest in any section 197 intangible, 

### • An undeveloped market or market growth. b. It is subject to a nonexclusive license. whether the interest is outright or in trust. 

### • Insurance in force. c. It has not been substantially modified. This requirement is considered met if 

## Assets That Are Not **•** A mortgage servicing contract. the cost of all modifications is not more 

## Section 197 Intangibles **•** An investment management contract. than the greater of 25% of the price of the publicly available unmodified The following assets are not section 197 in- 

### • Any other relationship with customers in- software or $2,000. tangibles. volving the future provision of goods or services. 2. Software that is not acquired in connection 1. Any interest in a corporation, partnership, with the acquisition of a trade or business

trust, or estate. Accounts receivable or other similar rights to or a substantial part of a trade or business. income for goods or services provided to cus- 2. Any interest under an existing futures contomers before the acquisition of a trade or busi- tract, foreign currency contract, notional **Computer software defined.** Computer ness are not section 197 intangibles. principal contract, interest rate swap, or software includes all programs designed to similar financial contract. cause a computer to perform a desired function. **Supplier-based intangible.** This is the value It also includes any database or similar item that resulting from the future acquisition of goods or 3. Any interest in land. Chapter8 **Amortization** Page 29

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is in the public domain and is incidental to the 1. You or a related person (defined later) held indirectly controls the organization (or or used the intangible at any time from July whose family members control it). operation of qualifying software. 25, 1991, through August 10, 1993. 

### • A corporation and a partnership if the **Rights of fixed duration or amount.** Section 2. You acquired the intangible from a person same persons own more than 20% of the 197 intangibles do not include any right under a who held it at any time during the period in value of the outstanding stock of the cor- contract or from a governmental agency if the (1) and, as part of the transaction, the user poration and more than 20% of the capital right is acquired in the ordinary course of a trade did not change. or profits interest in the partnership. or business (or in an activity engaged in for the 3. You granted the right to use the intangible 

### • Two S corporations, and an S corporation production of income) but not as part of a to a person (or a person related to that and a regular corporation, if the same per- purchase of a trade or business and either: person) who held or used it at any time sons own more than 20% of the value of



### • Has a fixed life of less than 15 years, or during the period in (1). This applies only if the outstanding stock of each corporation. the transaction in which you granted the 

### • Is of a fixed amount that, except for the 

### • Two partnerships if the same persons right and the transaction in which you ac- rules for section 197 intangibles, would be own, directly or indirectly, more than 20% quired the intangible are part of a series of recovered under a method similar to the of the capital or profits interests in both related transactions. SeeRelated person, unit-of-production method of cost recov- partnerships. later, for more information. ery. 

### • A partnership and a person who owns, However, this does not apply to the following directly or indirectly, more than 20% of the **Exceptions.** The anti-churning rules do not intangibles. capital or profits interests in the partnerapply in the following situations. ship. 

### • Goodwill. 

### • You acquired the intangible from a dece

### • Two persons who are engaged in trades dent and its basis was stepped up to its 

### • Going concern value. or businesses under common control (as fair market value. 

### • A covenant not to compete. described in section 41(f)(1) of the Internal 

### • The intangible was amortizable as a sec- Revenue Code). 

### • A franchise, trademark, or trade name. tion 197 intangible by the seller or transferor you acquired it from. This exception 

### • A customer-related information base, cus- **When to determine relationship.** Persons does not apply if the transaction in which tomer-based intangible, or similar item. are treated as related if the relationship existed you acquired the intangible and the trans- at the following time.action in which the seller or transferor acquired it are part of a series of related 

### • In the case of a single transaction, imme

## Safe Harbor for Creative transactions. diately before or immediately after the 

## Property Costs transaction in which the intangible was ac- 

### • The gain-recognition exception, discussed quired. If you are engaged in the trade or business of later, applies. film production, you may be able to amortize the 

### • In the case of a series of related transaccreative property costs for properties not set for tions (or a series of transactions that com- **Related person.** For purposes of the production within 3 years of the first capitalized prise a qualified stock purchase under anti-churning rules, the following are related per- transaction. You may amortize these costs rata- section 338(d)(3) of the Internal Revenue sons. bly over a 15-year period beginning on the first Code), immediately before the earliest 

### • An individual and his or her brothers, sis- day of the second half of the tax year in which transaction or immediately after the last ters, half-brothers, half-sisters, spouse, transaction. you properly write off the costs for financial ac- ancestors (parents, grandparents, etc.), counting purposes. If, during the 15-year period, and lineal descendants (children, grand- **Ownership of stock.** In determining you dispose of the creative property rights, you children, etc.). whether an individual directly or indirectly owns must continue to amortize the costs over the any of the outstanding stock of a corporation, the remainder of the 15-year period. 

### • A corporation and an individual who owns, following rules apply. directly or indirectly, more than 20% of the Creative property costs include costs paid or value of the corporation’s outstanding incurred to acquire and develop screenplays, **Rule 1.** Stock directly or indirectly owned by stock. scripts, story outlines, motion picture production or for a corporation, partnership, estate, or trust rights to books and plays, and other similar is considered owned proportionately by or for its 

### • Two corporations that are members of the properties for purposes of potential future film shareholders, partners, or beneficiaries. same controlled group as defined in sec- development, production, and exploitation. tion 1563(a) of the Internal Revenue **Rule 2.** An individual is considered to own Amortize these costs using the rules of Rev- Code, except that “more than 20%” is sub- the stock directly or indirectly owned by or for his enue Procedure 2004-36. For more information, stituted for “at least 80%” in that definition or her family. Family includes only brothers and see Revenue Procedure 2004-36, 2004-24 and the determination is made without re- sisters, half-brothers and half-sisters, spouse, I.R.B. 1063, available at gard to subsections (a)(4) and (e)(3)(C) of ancestors, and lineal descendants. www.irs.gov/irb/2004-24_IRB/ar16.html

. section 1563. (For an exception, see sec- **Rule 3.** An individual owning (other than by tion 1.197-2(h)(6)(iv) of the regulations.) A change in the treatment of creative applying Rule 2) any stock in a corporation is property costs is a change in method of 

### • A trust fiduciary and a corporation if more considered to own the stock directly or indirectly accounting. than 20% of the value of the corporation’s owned by or for his or her partner.outstanding stock is owned, directly or in**Rule 4.** For purposes of applying Rule 1, 2, directly, by or for the trust or grantor of the 

## Anti-Churning Rules or 3, treat stock constructively owned by a per- trust. son under Rule 1 as actually owned by that 

### • The grantor and fiduciary, and the fiduci- Anti-churning rules prevent you from amortizing person. Do not treat stock constructively owned ary and beneficiary, of any trust. most section 197 intangibles if the transaction in by an individual under Rule 2 or 3 as owned by which you acquired them did not result in a the individual for reapplying Rule 2 or 3 to make 

### • The fiduciaries of two different trusts, and significant change in ownership or use. These another person the constructive owner of the the fiduciaries and beneficiaries of two dif- rules apply to goodwill and going concern value, stock. ferent trusts, if the same person is the and to any other section 197 intangible that is grantor of both trusts. not otherwise depreciable or amortizable. **Gain-recognition exception.** This exception 

### • The executor and beneficiary of an estate. Under the anti-churning rules, you cannot to the anti-churning rules applies if the person use 15-year amortization for the intangible if any you acquired the intangible from (the transferor) 

### • A tax-exempt educational or charitable or- of the following conditions apply. meets both of the following requirements. ganization and a person who directly or Page 30 Chapter8 **Amortization**

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### • That person would not be related to you 

### Changing Your 

## Disposition of

(as described underRelated person, ear- 

### Accounting Method 

## Section 197 Intangibles lier) if the 20% test for ownership of stock Generally, you must get IRS approval to change and partnership interests were replaced by A section 197 intangible is treated as deprecia- your method of accounting. File Form 3115, a 50% test. ble property used in your trade or business. If Application for Change in Accounting Method, to you held the intangible for more than 1 year, any 

### • That person chose to recognize gain on request a change to a permissible method of gain on its disposition, up to the amount of allow-

the disposition of the intangible and pay accounting for amortization. able amortization, is ordinary income (section income tax on the gain at the highest tax The following are examples of a change in 1245 gain). If multiple section 197 intangibles rate. See chapter 2 in Publication 544 for method of accounting for amortization. are disposed of in a single transaction or a information on making this choice. series of related transactions, treat all of the 

### • A change in the amortization method, pe- section 197 intangibles as if they were a single

riod of recovery, or convention of an amor- If this exception applies, the anti-churning asset for purposes of determining the amount of tizable asset. rules apply only to the amount of your adjusted gain that is ordinary income. Any remaining basis in the intangible that is more than the gain 

### • A change in the accounting for amortiz- gain, or any loss, is a section 1231 gain or loss. If recognized by the transferor. able assets from a single asset account to you held the intangible 1 year or less, any gain a multiple asset account (pooling), or vice or loss on its disposition is an ordinary gain or **Notification.** If the person you acquired the versa. loss. For more information on ordinary or capital intangible from chooses to recognize gain under gain or loss on business property, see chapter 3 

### • A change in the accounting for amortiz- the rules for this exception, that person must in Publication 544.able assets from one type of multiple asnotify you in writing by the due date of the return set account to a different type of multiple on which the choice is made. **Nondeductible loss.** You cannot deduct any asset account. loss on the disposition or worthlessness of a section 197 intangible that you acquired in the **Anti-abuse rule.** You cannot amortize any Changes in amortization that are not a change same transaction (or series of related transac- section 197 intangible acquired in a transaction in method of accounting include the following: tions) as other section 197 intangibles you still for which the principal purpose was either of the have. Instead, increase the adjusted basis of 

### • A change in computing amortization in the following. each remaining amortizable section 197 intangi- tax year in which your use of the asset 

### • To avoid the requirement that the intangi- ble by a proportionate part of the nondeductible changes. loss. Figure the increase by multiplying the non- ble be acquired after August 10, 1993. 

### • An adjustment in the useful life of an am- deductible loss on the disposition of the intangi- 

### • To avoid any of the anti-churning rules. ortizable asset. ble by the following fraction. 

### • Generally, the making of a late amortiza- 

### • The numerator is the adjusted basis of **More information.** For more information tion election or the revocation of a timely each remaining intangible on the date of about the anti-churning rules, including addi- valid amortization election. the disposition. tional rules for partnerships, see Regulations 

### • Any change in the placed-in-service date 

### • The denominator is the total adjusted ba- section 1.197-2(h). of an amortizable asset. ses of all remaining amortizable section 197 intangibles on the date of the disposi- 

## Incorrect Amount of See Regulations section 1.446-1(e)(2)(ii)(a) tion. for more information and examples. 

## Amortization Deducted **Covenant not to compete.** A covenant not to If you later discover that you deducted an incor- **Automatic approval.** In some instances, you compete, or similar arrangement, is not consid- rect amount for amortization for a section 197 may be able to get automatic approval from the ered disposed of or worthless before you dis- intangible in any year, you may be able to make IRS to change your method of accounting for pose of your entire interest in the trade or a correction for that year by filing an amended amortization. For a list of automatic accounting business for which you entered into the cove- return. SeeAmended Return, next. If you are not method changes, see the Instructions for Form nant. allowed to make the correction on an amended 3115. Also see the Instructions for Form 3115 return, you can change your accounting method for more information on getting approval, auto- **Nonrecognition transfers.** If you acquire a matic approval procedures, and a list of excep- to claim the correct amortization. SeeChanging section 197 intangible in a nonrecognition transtions to the automatic approval process. Your Accounting Method , later. fer, you are treated as the transferor with respect For more information, see Revenue Proce- to the part of your adjusted basis in the intangidure 2006-12, as modified by Revenue Proce- ble that is not more than the transferor’s ad

### Amended Return dure 2006-37, and Revenue Procedure justed basis. You amortize this part of the 2008-52, as amplified, clarified, and modified by adjusted basis over the intangible’s remaining If you deducted an incorrect amount for amorti- Revenue Procedure 2009-39. See Revenue amortization period in the hands of the trans- zation, you can file an amended return to correct Procedure 2006-12, 2006-3 I.R.B. 310, avail- feror. Nonrecognition transfers include transfers the following. able at to a corporation, partnership contributions and www.irs.gov/irb/2006-03_IRB/ar14.html

. distributions, like-kind exchanges, and involun

### • A mathematical error made in any year. See Revenue Procedure 2006-37, 2006-38 tary conversions. 

### • A posting error made in any year. I.R.B. 499, available at In a like-kind exchange or involuntary con- www.irs.gov/irb/2006-38_IRB/ar10.html

. version of a section 197 intangible, you must 

### • An amortization deduction for a section See Revenue Procedure 2008-52, 2008-36 continue to amortize the part of your adjusted

197 intangible for which you have not I.R.B. 587, available at basis in the acquired intangible that is not more adopted a method of accounting. www.irs.gov/irb/2008-36_IRB/ar09.html

. than your adjusted basis in the exchanged or See Revenue Procedure 2009-39, 2009-38 converted intangible over the remaining amorti- **When to file.** If an amended return is allowed, I.R.B. 371, available at zation period of the exchanged or converted you must file it by the later of the following dates. www.irs.gov/irb/2009-38_IRB/ar08.html

. intangible. Amortize over a new 15-year period the part of your adjusted basis in the acquired 

### • 3 years from the date you filed your origi- **Note.** If you are filing an application for a intangible that is more than your adjusted basis

nal return for the year in which you did not change in accounting method filed on or after in the exchanged or converted intangible. deduct the correct amount. (A return filed January 10, 2011, for a year of change ending early is considered filed on the due date.) on or after April 30, 2010, see Revenue Proce- **Example.** You own a section 197 intangible 

### • 2 years from the time you paid your tax for dure 2011-14, 2011-4 I.R.B. 330, available at you have amortized for 4 full years. It has a www.irs.gov/irb/2011-04_IRB/ar08.html

. that year. remaining unamortized basis of $30,000. You Chapter8 **Amortization** Page 31

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exchange the asset plus $10,000 for a like-kind **Amortization period.** The 84-month amortisection 197 intangible. The nonrecognition pro- zation period starts on the first day of the first 

# Geological and visions of like-kind exchanges apply. You amor- month of the second half of the tax year you tize $30,000 of the $40,000 adjusted basis of the incur the costs (July 1 for a calendar year tax- 

# Geophysical Costs acquired intangible over the 11 years remaining payer), regardless of the month you actually in the original 15-year amortization period for the incur the costs. You can claim amortization de- You can amortize the cost of geological and transferred asset. You amortize the other ductions for no more than 6 months of the first geophysical expenses paid or incurred in con- $10,000 of adjusted basis over a new 15-year and last (eighth) tax years of the period. nection with oil and gas exploration or develop- period. ment within the United States. These costs can be amortized ratably over a 24-month period **Life tenant and remainderman.** If one per- beginning on the mid-point of the tax year in son holds the property for life with the remainder which the expenses were paid or incurred. For going to another person, the life tenant is entitled 

# Reforestation Costs major integrated oil companies (as defined in to the full amortization for qualifying reforesta- section 167(h)(5)), these costs must be amor- tion costs incurred by the life tenant. Any re- You can elect to deduct a limited amount of tized ratably over a 5-year period for costs paid mainder interest in the property is ignored for reforestation costs paid or incurred during the or incurred after May 17, 2006 (a 7-year period amortization purposes. tax year. See Reforestation Costs in chapter 7. for costs paid or incurred after December 19, You can elect to amortize the qualifying costs 2007). **Recapture.** If you dispose of qualified timber that are not deducted currently over an If you retire or abandon the property during property within 10 years after the tax year you 84-month period. There is no limit on the amount the amortization period, no amortization deduc- incur qualifying reforestation expenses, report of your amortization deduction for reforestation tion is allowed in the year of retirement or aban- any gain as ordinary income up to the amortiza- costs paid or incurred during the tax year. donment. tion you took. See chapter 3 of Publication 544 The election to amortize reforestation costs for more information.incurred by a partnership, S corporation, or estate must be made by the partnership, corpora**How to make the election.** To elect to amor- tion, or estate. A partner, shareholder, or 

# Pollution Control tize qualifying reforestation costs, complete Part beneficiary cannot make that election. VI of Form 4562 and attach a statement that A partner’s or shareholder’s share of amor- 

# Facilities contains the following information. tizable costs is figured under the general rules for allocating items of income, loss, deduction, 

### • A description of the costs and the dates You can elect to amortize the cost of a certified etc., of a partnership or S corporation. The am- you incurred them. pollution control facility over 60 months. How- ortizable costs of an estate are divided between ever, seeAtmospheric pollution control facilities 

### • A description of the type of timber being the estate and the income beneficiary based on for an exception. The cost of a pollution control grown and the purpose for which it is the income of the estate allocable to each. facility that is not eligible for amortization can be grown. depreciated under the regular rules for deprecia- **Qualifying costs.** Reforestation costs are the Attach a separate statement for each property tion. Also, you can claim a special depreciation direct costs of planting or seeding for forestation for which you amortize reforestation costs. allowance on a certified pollution control facility or reforestation. Qualifying costs include only that is qualified property even if you elect to those costs you must capitalize and include in Generally, you must make the election on a amortize its cost. You must reduce its cost (am- the adjusted basis of the property. They include timely filed return (including extensions) for the ortizable basis) by the amount of any special costs for the following items. tax year in which you incurred the costs. How- allowance you claim. See chapter 3 of Publica- ever, if you timely filed your return for the year 

### • Site preparation. tion 946. without making the election, you can still make A certified pollution control facility is a new 

### • Seeds or seedlings. the election by filing an amended return within 6 identifiable treatment facility used in connection months of the due date of the return (excluding 

### • Labor. with a plant or other property in operation before extensions). Attach Form 4562 and the state- 1976, to reduce or control water or atmospheric 

### • Tools. ment to the amended return and write “Filed pollution or contamination. The facility must do pursuant to section 301.9100-2” on Form 4562. 

### • Depreciation on equipment used in plant- so by removing, changing, disposing, storing, or File the amended return at the same address ing and seeding. preventing the creation or emission of pollu- you filed the original return. tants, contaminants, wastes, or heat. The facility Qualifying costs do not include costs for which must be certified by state and federal certifying the government reimburses you under a **Revoking the election.** You must get IRS ap- authorities. cost-sharing program, unless you include the proval to revoke your election to amortize quali- The facility must not significantly increase reimbursement in your income. fying reforestation costs. Your application to the output or capacity, extend the useful life, or revoke the election must include your name, reduce the total operating costs of the plant or **Qualified timber property.** Qualified timber address, the years for which your election was in other property. Also, it must not significantly property is property that contains trees in signifi- effect, and your reason for revoking it. Please change the nature of the manufacturing or pro- cant commercial quantities. It can be a woodlot provide your daytime telephone number (op- duction process or facility. or other site that you own or lease. The property tional), in case we need to contact you. You, or The federal certifying authority will not certify qualifies only if it meets all of the following re- your duly authorized representative, must sign your property to the extent it appears you will quirements. the application and file it at least 90 days before recover (over the property’s useful life) all or part the due date (without extensions) for filing your 

### • It is located in the United States. of its cost from the profit based on its operation income tax return for the first tax year for which (such as through sales of recovered wastes). 

### • It is held for the growing and cutting of your election is to end. The federal certifying authority will describe the

timber you will either use in, or sell for use nature of the potential cost recovery. You must in, the commercial production of timber then reduce the amortizable basis of the facility products. by this potential recovery. Send the application to: 

### • It consists of at least one acre planted with Internal Revenue Service **New identifiable treatment facility.** A new

tree seedlings in the manner normally Associate Chief Counsel identifiable treatment facility is tangible depre- used in forestation or reforestation. Passthroughs and Special Industries ciable property that is identifiable as a treatment CC:PSI:6 facility. It does not include a building and its Qualified timber property does not include 1111 Constitution Ave., NW, IR-5300 structural components unless the building is ex- property on which you have planted shelter belts Washington, DC 20224 clusively a treatment facility. or ornamental trees, such as Christmas trees. Page 32 Chapter8 **Amortization**

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**Atmospheric pollution control facilities.** (excluding extensions). Attach Form 4562 to the Certain atmospheric pollution control facilities amended return and write “Filed pursuant to can be amortized over 84 months. To qualify, section 301.9100-2” on Form 4562. File the 

# 9. the following must apply. amended return at the same address you filed the original return. 

### • The facility must be acquired and placed

in service after April 11, 2005. If acquired, Your election is binding for the year it is the original use must begin with you after 

# Depletion made and for all later years unless you obtain April 11, 2005. approval from the IRS to change to a different method. 

### • The facility must be used in connection

with an electric generation plant or other 

# What’s Newproperty placed in operation after December 31, 1975, that is primarily coal fired. **Marginal production of oil and gas.** The 

# Optional Write-off temporary suspension of the 100% taxable in

### • If you construct, reconstruct, or erect the come limitation on percentage depletion on the

facility, only the basis attributable to the 

# of Certain Tax marginal production of oil and natural gas also construction, reconstruction, or erection applies to tax years beginning in 2010 and 2011. completed after April 11, 2005, qualifies. 

# Preferences **Basis reduction for corporations.** A corpo- You can elect to amortize certain tax preference ration must reduce the amortizable basis of a items over an optional period beginning in the 

# Introduction pollution control facility by 20% before figuring tax year in which you incurred the costs. If you the amortization deduction. Depletion is the using up of natural resources by make this election, there is no AMT adjustment. mining, quarrying, drilling, or felling. The deple- The applicable costs and the optional recovery **More information.** For more information on tion deduction allows an owner or operator to periods are as follows: the amortization of pollution control facilities, account for the reduction of a product’s see Code sections 169 and 291(c) and the re- 

### • Circulation costs

—3 years, reserves. lated regulations. There are two ways of figuring depletion: 

### • Intangible drilling and development costs cost depletion and percentage depletion. For

—60 months, mineral property, you generally must use the 

### • Mining exploration and development costs method that gives you the larger deduction. For 

# Research and

—10 years, and standing timber, you must use cost depletion.


### • Research and experimental costs

—10 

# Experimental Costs **Topics** years. This chapter discusses: You can elect to amortize your research and experimental costs, deduct them as current **How to make the election.** To elect to amor- 

### • Who can claim depletion business expenses, or write them off over a tize qualifying costs over the optional recovery 10-year period (see Optional write-off method 

### • Mineral property period, complete Part VI of Form 4562 and at- below). tach a statement containing the following infor- 

### • Timber If you elect to amortize these costs, deduct mation to your return for the tax year in which the them in equal amounts over 60 months or more. election begins: The amortization period begins the month you first receive an economic benefit from the costs. 

### • Your name, address, and taxpayer identifi-For a definition of “research and experimencation number; and 

# Who Can tal costs” and information on deducting them as 

### • The type of cost and the specific amount current business expenses, seechapter 7

. 

# Claim Depletion? of the cost for which you are making the **Optional write-off method.** Rather than election. amortize these costs or deduct them as a cur- If you have an economic interest in mineral prop- rent expense, you have the option of deducting erty or standing timber, you can take a deduction Generally, the election must be made on a (writing off) research and experimental costs for depletion. More than one person can have an timely filed return (including extensions) for the ratably over a 10-year period beginning with the economic interest in the same mineral deposit or tax year in which you incurred the costs. How- tax year in which you incurred the costs. For timber. ever, if you timely filed your return for the year more information, seeOptional Write-off of Cer- You have an economic interest if both the without making the election, you can still make tain Tax Preferences, later, and section 59(e) of following apply. the election by filing an amended return within 6 the Internal Revenue Code. months of the due date of the return (excluding 

### • You have acquired by investment any in- **Costs you can amortize.** You can amortize extensions). Attach Form 4562 to the amended terest in mineral deposits or standing tim- costs chargeable to a capital account (seechap- return and write “Filed pursuant to section ber. ter 1) if you meet both of the following require- 301.9100-2” on Form 4562. File the amended 

### • You have a legal right to income from the ments. return at the same address you filed the original extraction of the mineral or cutting of the return. 

### • You paid or incurred the costs in your timber to which you must look for a return

trade or business. of your capital investment. **Revoking the election.** You must obtain con- 

### • You are not deducting the costs currently. A contractual relationship that allows you an sent from the IRS to revoke your election. Your economic or monetary advantage from products request to revoke the election must be submit- of the mineral deposit or standing timber is not, **How to make the election.** To elect to amor- ted to the IRS in the form of a letter ruling before in itself, an economic interest. A production pay- tize research and experimental costs, complete the end of the tax year in which the optional ment carved out of, or retained on the sale of, Part VI of Form 4562 and attach it to your in- recovery period ends. The request must contain mineral property is not an economic interest. come tax return. Generally, you must file the all of the information necessary to demonstrate return by the due date (including extensions). Individuals, corporations, estates, and the rare and unusual circumstances that would However, if you timely filed your return for the trusts who claim depletion deductions justify granting revocation. If the request for rev- year without making the election, you can still may be liable for alternative minimum ocation is approved, any unamortized costs are make the election by filing an amended return tax. deductible in the year the revocation is effective. within 6 months of the due date of the return Chapter9 **Depletion** Page 33

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You must estimate or determine recoverable by your gross income from the property during units (tons, pounds, ounces, barrels, thousands the tax year. 

# Mineral Property of cubic feet, or other measure) of mineral prod- The rates to be used and other conditions ucts using the current industry method and the and qualifications for oil and gas wells are dis- Mineral property includes oil and gas wells, most accurate and reliable information you can cussed later under Independent Producers and mines, and other natural deposits (including ge- obtain. Royalty Owners and under Natural Gas Wells. othermal deposits). For this purpose, the term Rates and other rules for percentage depletion “property” means each separate interest you **Number of units sold.** You determine the of other specific minerals are found later in own in each mineral deposit in each separate number of units sold during the tax year based Mines and Geothermal Deposits. tract or parcel of land. You can treat two or more on your method of accounting. Use the following separate interests as one property or as sepa- **Gross income.** When figuring your percenttable to make this determination. rate properties. See section 614 of the Internal age depletion, subtract from your gross income Revenue Code and the related regulations for from the property the following amounts. **IF you THEN the units sold**  **use ... during the year are ...**  rules on how to treat separate mineral interests. 

### • Any rents or royalties you paid or incurred There are two ways of figuring depletion on for the property. The cash The units sold for which mineral property. method of you receive payment 

### • The part of any bonus you paid for a lease accounting during the tax year 

### • Cost depletion. on the property allocable to the product (regardless of the year of sold (or that otherwise gives rise to gross 

### • Percentage depletion. sale). income) for the tax year. Generally, you must use the method that gives An accrual The units sold based on A bonus payment includes amounts you paid as you the larger deduction. However, unless you method of your inventories and a lessee to satisfy a production payment re- are an independent producer or royalty owner, accounting method of accounting for tained by the lessor. you generally cannot use percentage depletion inventory. for oil and gas wells. See Oil and Gas Wells, Use the following fraction to figure the part of later. The number of units sold during the tax year the bonus you must subtract.does not include any for which depletion deductions were allowed or allowable in earlier years. No. of units sold in the tax year 

## Cost Depletion Bonus Recoverable units from the **×** Payments **Figuring the cost depletion deduction.** property To figure cost depletion you must first determine Once you have figured your property’s basis for the following. For oil and gas wells and geothermal depos- depletion, the total recoverable units, and the its, gross income from the property is defined 

### • The property’s basis for depletion. number of units sold during the tax year, you can later underOil and Gas Wells. For property other figure your cost depletion deduction by taking 

### • The total recoverable units of mineral in than a geothermal deposit or an oil and gas well, the following steps. the property’s natural deposit. gross income from the property is defined later underMines and Geothermal Deposits

. 

### • The number of units of mineral sold during **Step Action**  **Result**

the tax year. **Taxable income limit.** The percentage deple- 1 Divide your property’s Rate per tion deduction generally cannot be more than basis for depletion by unit. **Basis for depletion.** To figure the property’s 50% (100% for oil and gas property) of your total recoverable units. taxable income from the property figured without basis for depletion, subtract all the following 2 Multiply the rate per Cost the depletion deduction and the domestic pro- from the property’s adjusted basis. unit by units sold depletion duction activities deduction. during the tax year. deduction. 1. Amounts recoverable through: Taxable income from the property means gross income from the property minus all allowa- a. Depreciation deductions, ble deductions (excluding any deduction for de- **Note.** You must keep accounts for the de- pletion or qualified domestic production b. Deferred expenses (including deferred pletion of each property and adjust these ac- activities) attributable to mining processes, in- exploration and development costs), counts each year for units sold and depletion cluding mining transportation. These deductible and claimed. items include, but are not limited to, the follow- c. Deductions other than depletion. ing. **Elective safe harbor for owners of oil and gas property.**  Owners of oil and gas property may 

### • Operating expenses. 2. The residual value of land and improve- use an elective safe harbor in determining the ments at the end of operations. 

### • Certain selling expenses. property’s recoverable reserves for purposes of 3. The cost or value of land acquired for pur- computing cost depletion. If this election is 

### • Administrative and financial overhead. poses other than mineral production. made, special rules apply. See Revenue Proce- 

### • Depreciation. dure 2004-19 on page 563 of Internal Revenue **Adjusted basis.** The adjusted basis of your Bulletin 2004-10, available at www.irs.gov/pub/ 

### • Intangible drilling and development costs. property is your original cost or other basis, plus irs-irbs/irb04-10.pdf

. 

### • Exploration and development expendi- certain additions and improvements, and minus To make the election, attach a statement to tures. certain deductions such as depletion allowed or your timely filed (including extensions) original allowable and casualty losses. Your adjusted return for the first tax year for which the safe The following rules apply when figuring your basis can never be less than zero. See Publica- harbor is elected. The statement must indicate taxable income from the property for purposes tion 551, Basis of Assets, for more information that you are electing the safe harbor provided by of the taxable income limit. on adjusted basis. Revenue Procedure 2004-19. The election, if made, is effective for the tax year in which it is 

### • Do not deduct any net operating loss de**Total recoverable units.** The total recover- made and all subsequent years. It cannot be duction from the gross income from the able units is the sum of the following. revoked for the tax year in which it is elected, but property. may be revoked in a later year. Once revoked, it 

### • The number of units of mineral remaining 

### • Corporations do not deduct charitable con- cannot be re-elected for the next 5 years. at the end of the year (including units re- tributions from the gross income from the covered but not sold). property. 

## Percentage Depletion **•** The number of units of mineral sold during 

### • If, during the year, you dispose of an item

the tax year (determined under your To figure percentage depletion, you multiply a of section 1245 property that was used in method of accounting, as explained next). certain percentage, specified for each mineral, connection with mineral property, reduce Page 34 Chapter9 **Depletion**

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any allowable deduction for mining ex- 

### • The interest in the profits or capital of a 

### • The retailer does not buy oil or natural gas penses by the part of any gain you must from your customers or persons related to partnership. report as ordinary income that is allocable your customers. 

### • The beneficial interests in an estate or to the mineral property. See section 

### • There are no arrangements for the retailer trust. 1.613-5(b)(1) of the regulations for infor- to acquire oil or natural gas you produced mation on how to figure the ordinary gain for resale or made available for purchase Any interest owned by or for a corporation, allocable to the property. by the retailer. partnership, trust, or estate is considered to be owned directly both by itself and proportionately 

### • Neither you nor the retailer knows of or by its shareholders, partners, or beneficiaries. 

## Oil and Gas Wells controls the final disposition of the oil or natural gas you sold or the original source You cannot claim percentage depletion for an oil of the petroleum products the retailer ac- **Retailers who cannot claim percentage de-** or gas well unless at least one of the following quired for resale. **pletion.** You cannot claim percentage deple- applies. tion if both the following apply.



### • You are either an independent producer or **Transferees who cannot claim percentage** 1. You sell oil or natural gas or their a royalty owner. **depletion.** You cannot claim percentage de- by-products directly or through a related pletion if you received your interest in a proven 

### • The well produces natural gas that is ei- person in any of the following situations. oil or gas property by transfer after 1974 and

ther sold under a fixed contract or pro- before October 12, 1990. For a definition of the duced from geopressured brine. a. Through a retail outlet operated by you term “transfer,” see section 1.613A-7(n) of the or a related person. regulations. For a definition of the term “interest If you are an independent producer or royalty b. To any person who is required under an in proven oil or gas property,” see section owner, seeIndependent Producers and Royalty 1.613A-7(p) of the regulations. agreement with you or a related person Owners, next. to use a trademark, trade name, or For information on the depletion deduction **Figuring percentage depletion.** Generally, service mark or name owned by you or for wells that produce natural gas that is either as an independent producer or royalty owner, a related person in marketing or distrib- sold under a fixed contract or produced from you figure your percentage depletion by comput- uting oil, natural gas, or their geopressured brine, see Natural Gas Wells, ing your average daily production of domestic oil by-products. later. or gas and comparing it to your depletable oil or c. To any person given authority under an gas quantity. If your average daily production agreement with you or a related person does not exceed your depletable oil or gas quan- 

### Independent Producers and to occupy any retail outlet owned, tity, you figure your percentage depletion by 

### Royalty Owners leased, or controlled by you or a related multiplying the gross income from the oil or gas person. property (defined later) by 15%. If your average If you are an independent producer or royalty daily production of domestic oil or gas exceeds owner, you figure percentage depletion using a 2. The combined gross receipts from sales your depletable oil or gas quantity, you mustrate of 15% of the gross income from the prop(not counting resales) of oil, natural gas, or make an allocation as explained later underAverty based on your average daily production of their by-products by all retail outlets taken erage daily production exceeds depletable domestic crude oil or domestic natural gas up to into account in (1) are more than $5 million quantities. your depletable oil or natural gas quantity. How- for the tax year. In addition, there is a limit on the percentage ever, certain refiners, as explained next, and depletion deduction. See Taxable income limit , certain retailers and transferees of proven oil For the purpose of determining if this rule later. and gas properties, as explained later, cannot applies, do not count the following. claim percentage depletion. For information on 

### • Bulk sales (sales in very large quantities) **Average daily production.** Figure your averfiguring the deduction, see Figuring percentage of oil or natural gas to commercial or in- age daily production by dividing your total dodepletion, later. mestic production of oil or gas for the tax year by dustrial users. the number of days in your tax year. **Refiners who cannot claim percentage de-** 

### • Bulk sales of aviation fuels to the Depart- **pletion.** You cannot claim percentage deple- **Partial interest.** If you have a partial inter- ment of Defense. tion if you or a related person refine crude oil and est in the production from a property, figure your you and the related person refined more than 

### • Sales of oil or natural gas or their share of the production by multiplying total pro- 75,000 barrels on any day during the tax year by-products outside the United States if duction from the property by your percentage of based on average (rather than actual) daily re- none of your domestic production or that interest in the revenues from the property. finery runs for the tax year. The average daily of a related person is exported during the You have a partial interest in the production refinery run is computed by dividing total refinery tax year or the prior tax year. from a property if you have a net profits interest runs for the tax year by the total number of days in the property. To figure the share of production in the tax year. **Related person.** To determine if you and for your net profits interest, you must first deteranother person are related persons, see Re- **Related person.** You and another person mine your percentage participation (as mealated person under Refiners who cannot claim are related persons if either of you holds a signif- sured by the net profits) in the gross revenue percentage depletion, earlier. icant ownership interest in the other person or if from the property. To figure this percentage, you a third person holds a significant ownership in- divide the income you receive for your net profits **Sales through a related person.** You are terest in both of you. interest by the gross revenue from the property.considered to be selling through a related perThen multiply the total production from the prop- For example, a corporation, partnership, es- son if any sale by the related person produces erty by your percentage participation to figure tate, or trust and anyone who holds a significant gross income from which you may benefit beyour share of the production. ownership interest in it are related persons. A cause of your direct or indirect ownership inter- partnership and a trust are related persons if one est in the person. **Example.** John Oak owns oil property in person holds a significant ownership interest in You are**not**considered to be selling through which Paul Elm owns a 20% net profits interest. each of them. a related person who is a retailer if all the follow- During the year, the property produced 10,000 For purposes of the related person rules, ing apply. barrels of oil, which John sold for $200,000. significant ownership interest means direct or John had expenses of $90,000 attributable to 

### • You do not have a significant ownership indirect ownership of 5% or more in any one of the property. The property generated a net profit interest in the retailer. the following. of $110,000 ($200,000

**−**$90,000). Paul re- 

### • You sell your production to persons who 

### • The value of the outstanding stock of a ceived income of $22,000 ($110,000**×**.20) for are not related to either you or the retailer. corporation. his net profits interest. Chapter9 **Depletion** Page 35

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**Partner’s or shareholder’s adjusted basis.** Paul determined his percentage participation percentage depletion purposes without regard The partnership or S corporation must allocate to be 11% by dividing $22,000 (the income he to the RMFP. to each partner or shareholder his or her share received) by $200,000 (the gross revenue from Gross income from the property does not of the adjusted basis of each oil or gas property the property). Paul determined his share of the include lease bonuses, advance royalties, or held by the partnership or S corporation. The oil production to be 1,100 barrels (10,000 bar- other amounts payable without regard to propartnership or S corporation makes the alloca- rels**×**11%). duction from the property. tion as of the date it acquires the oil or gas property. **Depletable oil or natural gas quantity.** Gen- **Average daily production exceeds deplet** Each partner’s share of the adjusted basis of erally, your depletable oil quantity is 1,000 bar- **able quantities.** If your average daily produc- the oil or gas property generally is figured ac- rels. Your depletable natural gas quantity is tion for the year is more than your depletable oil cording to that partner’s interest in partnership 6,000 cubic feet multiplied by the number of or natural gas quantity, figure your allowance for capital. However, in some cases, it is figured barrels of your depletable oil quantity that you depletion for each domestic oil or natural gas according to the partner’s interest in partnership choose to apply. If you claim depletion on both property as follows. income.oil and natural gas, you must reduce your deThe partnership or S corporation adjusts the 1. Figure your average daily production of oil pletable oil quantity (1,000 barrels) by the num- partner’s or shareholder’s share of the adjusted or natural gas for the year. ber of barrels you use to figure your depletable basis of the oil and gas property for any capital natural gas quantity. 2. Figure your depletable oil or natural gas expenditures made for the property and for any quantity for the year. change in partnership or S corporation interests. **Example.** You have both oil and natural gas 3. Figure depletion for all oil or natural gas production. To figure your depletable natural Each partner or shareholder must sep- produced from the property using a per- gas quantity, you choose to apply 360 barrels of arately keep records of his or her share centage depletion rate of 15%. your 1000-barrel depletable oil quantity. Your of the adjusted basis in each oil and depletable natural gas quantity is 2.16 million gas property of the partnership or S corporation. 4. Multiply the result figured in (3) by a frac- cubic feet of gas (360**×**6000). You must reduce The partner or shareholder must reduce his or tion, the numerator of which is the result your depletable oil quantity to 640 barrels (1000 her adjusted basis by the depletion allowed or figured in (2) and the denominator of which

**−**360). allowable on the property each year. The part- is the result figured in (1). This is your If you have production from marginal wells, ner or shareholder must use that reduced addepletion allowance for that property for see section 613A(c)(6) of the Internal Revenue justed basis to figure cost depletion or his or her the year. Code to figure your depletable oil or natural gas gain or loss if the partnership or S corporation quantity. disposes of the property. **Taxable income limit.** If you are an indepen- **Business entities and family members.** dent producer or royalty owner of oil and gas, **Reporting the deduction.** Information that You must allocate the depletable oil or gas your deduction for percentage depletion is lim- you, as a partner or shareholder, use to figure quantity among the following related persons in ited to the smaller of the following. your depletion deduction on oil and gas properproportion to each entity’s or family member’s ties is reported by the partnership or S corpora

### • 100% of your taxable income from the production of domestic oil or gas for the year. tion on Schedule K-1 (Form 1065) or on property figured without the deduction for 

### • Corporations, trusts, and estates if 50% or Schedule K-1 (Form 1120S). Deduct oil and gas depletion and the deduction for domestic more of the beneficial interest is owned by depletion for your partnership or S corporation production activities under section 199 of the same or related persons (considering interest on Schedule E (Form 1040). The deple- the Internal Revenue Code. For a defini- only persons that own at least 5% of the tion deducted on Schedule E is included in figur- tion of taxable income from the property, beneficial interest). ing income or loss from rental real estate or see Taxable income limit , earlier, under royalty properties. The instructions for Schedule 

### • You and your spouse and minor children. Mineral Property. E explain where to report this income or loss and A related person is anyone mentioned in the 

### • 65% of your taxable income from all whether you need to file either of the following related persons discussion under Nondeduct- sources, figured without the depletion al- forms. ible loss in chapter 2 of Publication 544, except lowance, the deduction for domestic pro

### • Form 6198, At-Risk Limitations. that for purposes of this allocation, item (1) in duction activities, any net operating loss that discussion includes only an individual, his or carryback, and any capital loss carryback. 

### • Form 8582, Passive Activity Loss Limita- her spouse, and minor children. tions. You can carry over to the following year any **Controlled group of corporations.** Mem- amount you cannot deduct because of the bers of the same controlled group of corpora- 65%-of-taxable-income limit. Add it to your de- **Electing large partnerships must figure de-** tions are treated as one taxpayer when figuring pletion allowance (before applying any limits) for **pletion allowance.** An electing large partner- the depletable oil or natural gas quantity. They the following year. ship, rather than each partner, generally must share the depletable quantity. Under this rule, a figure the depletion allowance. The partnership controlled group of corporations is defined in figures the depletion allowance without taking **Note.** For tax years beginning after 2009 section 1563(a) of the Internal Revenue Code, into account the 65-percent-of-taxable-income and before 2012, the 100% taxable income limit except that the stock ownership requirement in limit and the depletable oil or natural gas quan- does not apply to percentage depletion on mar- that definition is “more than 50%” rather than “at tity. Also, the adjusted basis of a partner’s inter- ginal production of oil and natural gas. For infor- least 80%.” est in the partnership is not affected by the mation on marginal production, see section depletion allowance. 613A(c)(6) of the Internal Revenue Code. **Gross income from the property.** For pur- An electing large partnership is one that poses of percentage depletion, gross income meets both the following requirements. from the property (in the case of oil and gas 

### Partnerships and S Corporations **•** The partnership had 100 or more partners wells) is the amount you receive from the sale of in the preceding year. the oil or gas in the immediate vicinity of the well. Generally, each partner or shareholder, and not If you do not sell the oil or gas on the property, the partnership or S corporation, figures the de- 

### • The partnership chooses to be an electing but manufacture or convert it into a refined prod- pletion allowance separately. (However, see large partnership. uct before sale or transport it before sale, the Electing large partnerships must figure deplegross income from the property is the represen- tion allowance,later.) Each partner or share- **Disqualified persons.** An electing large tative market or field price (RMFP) of the oil or holder must decide whether to use cost or partnership does not figure the depletion allowgas, before conversion or transportation. percentage depletion. If a partner or shareholder ance of its partners that are disqualified peruses percentage depletion, he or she must ap- If you sold gas after you removed it from the sons. Disqualified persons must figure it ply the 65%-of-taxable-income limit using his or premises for a price that is lower than the RMFP, themselves, as explained earlier. her taxable income from all sources. determine gross income from the property for All the following are disqualified persons. Page 36 Chapter9 **Depletion**

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### • Refiners who cannot claim percentage de- requirements, the additional authorized trans- Clay and shale used or sold for pletion (discussed underIndependent Pro- portation is considered mining and included in use in making sewer pipe or bricks ducers and Royalty Owners,earlier). the computation of gross income from mining. or used or sold for use as sintered or burned lightweight aggregates 71/ 2% 

### • Retailers who cannot claim percentage If you wish to include transportation of

depletion (discussed underIndependent more than 50 miles in the computation Clay used or sold for use in Producers and Royalty Owners,earlier). of gross income from mining, file an making drainage and roofing tile, application in duplicate with the IRS. Include on flower pots, and kindred products, 

### • Any partner whose average daily produc- the application the facts concerning the physical and gravel, sand, and stone (other tion of domestic crude oil and natural gas than stone used or sold for use by and other requirements which prevented the is more than 500 barrels during the tax a mine owner or operator as construction and operation of the plant within 50 year in which the partnership tax year dimension or ornamental stone) 5% miles of the point of extraction. Send this appli- ends. Average daily production is dis- cation to: You can find a complete list of minerals and cussed earlier. Internal Revenue Service their percentage depletion rates in section Associate Chief Counsel 613(b) of the Internal Revenue Code. Passthroughs and Special Industries 

### Natural Gas Wells **Corporate deduction for iron ore and coal.** CC:PSI:FO You can use percentage depletion for a well that The percentage depletion deduction of a corpo- 1111 Constitution Ave., N.W., IR-5300 produces natural gas either sold under a fixed ration for iron ore and coal (including lignite) is Washington, DC 20224 contract or produced from geopressured brine. reduced by 20% of: **Disposal of coal or iron ore.** You cannot take 

### • The percentage depletion deduction for **Natural gas sold under a fixed contract.** a depletion deduction for coal (including lignite) the tax year (figured without regard to this Natural gas sold under a fixed contract qualifies or iron ore mined in the United States if both the reduction), minus for a percentage depletion rate of 22%. This is following apply. 

### • The adjusted basis of the property at the domestic natural gas sold by the producer under 

### • You disposed of it after holding it for more close of the tax year (figured without the a contract that does not provide for a price in- than 1 year. depletion deduction for the tax year). crease to reflect any increase in the seller’s tax liability because of the repeal of percentage de- 

### • You disposed of it under a contract under pletion for gas. The contract must have been in which you retain an economic interest in **Gross income from the property.** For prop- effect from February 1, 1975, until the date of the coal or iron ore. erty other than a geothermal deposit or an oil or sale of the gas. Price increases after February 1, gas well, gross income from the property means Treat any gain on the disposition as a capital 1975, are presumed to take the increase in tax the gross income from mining. Mining includes gain. liability into account unless demonstrated other- all the following. wise by clear and convincing evidence. **Disposal to related person.** This rule does 

### • Extracting ores or minerals from the not apply if you dispose of the coal or iron ore to

ground. **Natural gas from geopressured brine.** Qual- one of the following persons. ified natural gas from geopressured brine is eli- 

### • Applying certain treatment processes. 

### • A related person (as listed in chapter 2 of gible for a percentage depletion rate of 10%. Publication 544). 

### • Transporting ores or minerals (generally, This is natural gas that is both the following. not more than 50 miles) from the point of 

### • A person owned or controlled by the same



### • Produced from a well you began to drill extraction to the plants or mills in which interests that own or control you.

after September 1978 and before 1984. the treatment processes are applied.


### • Determined in accordance with section **Geothermal deposits.** Geothermal deposits **Excise tax.** Gross income from mining in- 503 of the Natural Gas Policy Act of 1978 located in the United States or its possessions cludes the separately stated excise tax received to be produced from geopressured brine. qualify for a percentage depletion rate of 15%. A by a mine operator from the sale of coal to geothermal deposit is a geothermal reservoir of compensate the operator for the excise tax the natural heat stored in rocks or in a watery liquid 

## Mines and mine operator must pay to finance black lung or vapor. For percentage depletion purposes, a benefits. 

## Geothermal Deposits geothermal deposit is not considered a gas well. **Extraction.** Extracting ores or minerals Figure gross income from the property for a Certain mines, wells, and other natural deposits, from the ground includes extraction by mine geothermal steam well in the same way as for oil including geothermal deposits, qualify for per- owners or operators of ores or minerals from the and gas wells. SeeGross income from the prop- centage depletion. waste or residue of prior mining. This does not erty earlier, under Oil and Gas Wells.Percentapply to extraction from waste or residue of prior age depletion on a geothermal deposit cannot **Mines and other natural deposits.** For a nat- mining by the purchaser of the waste or residue be more than 50% of your taxable income from ural deposit, the percentage of your gross in- or the purchaser of the rights to extract ores or the property. come from the property that you can deduct as minerals from the waste or residue. depletion depends on the type of deposit. **Treatment processes.** The processes in- 

## Lessor’s Gross Income The following is a list of the percentage de- cluded as mining depend on the ore or mineral pletion rates for the more common minerals. A lessor’s gross income from the property that mined. To qualify as mining, the treatment qualifies for percentage depletion usually is the processes must be applied by the mine owner or **DEPOSITS RATE**  total of the royalties received from the lease. operator. For a listing of treatment processes However, for oil, gas, or geothermal property, Sulphur, uranium, and, if from considered as mining, see section 613(c)(4) of deposits in the United States, gross income does not include lease bonuses, the Internal Revenue Code and the related regu- asbestos, lead ore, zinc ore, nickel advanced royalties, or other amounts payable lations. ore, and mica

............ . 22% without regard to production from the property. **Transportation of more than 50 miles.** If Gold, silver, copper, iron ore, and the IRS finds that the ore or mineral must be **Bonuses and advanced royalties.** Bonuses certain oil shale, if from deposits in transported more than 50 miles to plants or mills and advanced royalties are payments a lessee the United States

.......... . 15% to be treated because of physical and other makes before production to a lessor for the grant Borax, granite, limestone, marble, of rights in a lease or for minerals, gas, or oil to mollusk shells, potash, slate, be extracted from leased property. If you are the soapstone, and carbon dioxide lessor, your income from bonuses and ad- produced from a well

....... . 14% vanced royalties received is subject to an allowCoal, lignite, and sodium chloride 10% ance for depletion. Chapter9 **Depletion** Page 37

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**Figuring cost depletion.** To figure cost de- The term “timber property” means your eco- IRS’s consent. The prior election (and revocanomic interest in standing timber in each tract or pletion on a bonus, multiply your adjusted basis tion) is disregarded for purposes of making a block representing a separate timber account. in the property by a fraction, the numerator of subsequent election. See Form T (Timber), Forwhich is the bonus and the denominator of which est Activities Schedule, for more information. **Depletion unit.** You figure your depletion is the total bonus and royalties expected to be unit each year by taking the following steps. received. To figure cost depletion on advanced **Form T.** Complete and attach Form T (Timber) royalties, use the computation explained earlier 1. Determine your cost or adjusted basis of to your income tax return if you claim a deduc- under Cost Depletion, treating the number of the timber on hand at the beginning of the tion for timber depletion, choose to treat the units for which the advanced royalty is received year. Adjusted basis is defined underCost cutting of timber as a sale or exchange, or make as the number of units sold. Depletion in the discussion onMineral an outright sale of timber. Property. **Figuring percentage depletion.** In the case of mines, wells, and other natural deposits 2. Add to the amount determined in (1) the other than gas, oil, or geothermal property, you cost of any timber units acquired during the year and any additions to capital. may use the percentage rates discussed earlier underMines and Geothermal Deposits.Any bo- 3. Figure the number of timber units to take nus or advanced royalty payments are generally into account by adding the number of tim- part of the gross income from the property to ber units acquired during the year to the 

# 10. which the rates are applied in making the calcu- number of timber units on hand in the ac- lation. However, in the case of independent pro- count at the beginning of the year and then ducers and royalty owners of oil and gas adding (or subtracting) any correction toproperty, bonuses and advance royalty paythe estimate of the number of timber units 

# Business ments are not a part of gross income. remaining in the account.

**Terminating the lease.** If you receive a bo- 4. Divide the result of (2) by the result of (3). nus on a lease that expires, terminates, or is 

# Bad Debts This is your depletion unit. abandoned before you derive any income from the extraction of mineral, include in income for **Example.** You bought a timber tract forthe year of expiration, termination, or abandon$160,000 and the land was worth as much as 

# Introduction ment, the depletion deduction you took. Also the timber. Your basis for the timber is $80,000. increase your adjusted basis in the property to If someone owes you money that you are not Based on an estimated one million board feet restore the depletion deduction you previously going to be able to collect, you have a bad debt. (1,000 MBF) of standing timber, you figure your subtracted. There are two kinds of bad debts

—business depletion unit to be $80 per MBF ($80,000 **÷** For advanced royalties, include in income for and nonbusiness. This chapter discusses only 1,000). If you cut 500 MBF of timber, your deple- the year of lease termination, the depletion business bad debts. tion allowance would be $40,000 (500 MBF **×** claimed on minerals for which the advanced $80). Generally, a business bad debt is one thatroyalties were paid if the minerals were not procomes from operating your trade or business. duced before termination. Increase your ad- **When to claim depletion.** Claim your deple- You can deduct business bad debts on your justed basis in the property by the amount you tion allowance as a deduction in the year of sale include in income. business income tax return. or other disposition of the products cut from the timber, unless you choose to treat the cutting of All other bad debts are nonbusiness bad timber as a sale or exchange (explained below). **Delay rentals.** These are payments for defer- debts and are deductible only as short-term cap- Include allowable depletion for timber products ring development of the property. Since delay ital losses on Schedule D (Form 1040). For more not sold during the tax year the timber is cut as a rentals are ordinary rent, they are ordinary in- information on nonbusiness bad debts, see Pub- cost item in the closing inventory of timber prod- come that is not subject to depletion. These lication 550. ucts for the year. The inventory is your basis for rentals can be avoided by either abandoning the determining gain or loss in the tax year you sell lease, beginning development operations, or 

### Topics the timber products. obtaining production. This chapter discusses: **Example.** Assume the same facts as in the previous example except that you sold only half 

### • Definition of business bad debt of the timber products in the cutting year. You 

# Timber **•** When a debt becomes worthless would deduct $20,000 of the $40,000 depletion that year. You would add the remaining $20,000 

### • How to claim a business bad debt You can figure timber depletion only by the cost depletion to your closing inventory of timber method. Percentage depletion does not apply to 

### • Recovery of a bad debt products. timber. Base your depletion on your cost or other **Electing to treat the cutting of timber as a** basis in the timber. Your cost does not include 

### Useful Items **sale or exchange.** You can elect, under certhe cost of land or any amounts recoverable tain circumstances, to treat the cutting of timber You may want to see: through depreciation. held for more than 1 year as a sale or exchange. Depletion takes place when you cut standing You must make the election on your income tax **Publication** timber. You can figure your depletion deduction return for the tax year to which it applies. If you when the quantity of cut timber is first accurately ❏ **525** Taxable and Nontaxable Income make this election, subtract the adjusted basis measured in the process of exploitation. for depletion from the fair market value of the ❏ **536** Net Operating Losses (NOLs) for timber on the first day of the tax year in which Individuals, Estates, and Trusts **Figuring cost depletion.** To figure your cost you cut it to figure the gain or loss on the cutting. depletion allowance, you multiply the number of ❏ **544** Sales and Other Dispositions of You generally report the gain as long-term capi- timber units cut by your depletion unit. Assets tal gain. The fair market value then becomes **Timber units.** When you acquire timber your basis for figuring your ordinary gain or loss ❏ **550** Investment Income and Expenses property, you must make an estimate of the on the sale or other disposition of the products ❏ **556** Examination of Returns, Appeal quantity of marketable timber that exists on the cut from the timber. For more information, see Rights, and Claims for Refund property. You measure the timber using board Timber in chapter 2 of Publication 544, Sales feet, log scale, cords, or other units. If you later and Other Dispositions of Assets. See chapter 12 for information about getting determine that you have more or less units of You may revoke an election to treat the cut- timber, you must adjust the original estimate. ting of timber as a sale or exchange without publications and forms. Page 38 Chapter 10 **Business Bad Debts**

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as debts sold by a business. The executor of the **Example.** Jane Zayne owns the Zayne decedent’s estate treats any loss from the debts Dress Company. She guaranteed payment of a 

# Definition of Business as a business bad debt if the debts were closely $20,000 note for Elegant Fashions, a dress outrelated to the decedent’s trade or business let that is not a “related person.” Elegant Fash

# Bad Debt when they became worthless. Otherwise, a loss ions is one of Zayne’s largest clients. Elegant from these debts becomes a nonbusiness bad Fashions later defaulted on the loan. As a result, A business bad debt is a loss from the worth- debt for the decedent’s estate. Ms. Zayne paid the remaining balance of the lessness of a debt that was either: loan in full to the bank. **Liquidation.** If you liquidate your business 

### • Created or acquired in your trade or busi- She can claim a business bad debt deducand some of your accounts receivable become ness, or tion only for the amount she paid, since her worthless, they become business bad debts. guarantee was made in the course of her trade 

### • Closely related to your trade or business or business for a good faith business purpose.

when it became partly or totally worthless. 

## Types of Business Bad She was motivated by the desire to retain one of her better clients and keep a sales outlet. 

## Debts A debt is closely related to your trade or busi- ness if your primary motive for incurring the debt **Deductible in the year paid.** If you make a The following are situations that may result in a is business related. Bad debts of a corporation payment on a loan you guaranteed, you can business bad debt. (other than an S corporation) are always busi- deduct it in the year paid, unless you have rights ness bad debts. **Loans to clients and suppliers.** If you loan against the borrower. money to a client, supplier, employee, or distrib- **Credit sales.** Business bad debts are mainly **Rights against a borrower.** When you utor for a business reason and subsequently, the result of credit sales to customers. Goods make payment on a loan you guaranteed, you after making attempts to collect, the loan receiv- that have been sold, but not yet paid for, and may have the right to take the place of the able becomes worthless, you have a business services that have been performed, but not yet lender. The debt is then owed to you. If you have bad debt. paid for, are recorded in your books as either this right, or some other right to demand payaccounts receivable or notes receivable. After a ment from the borrower, you cannot claim a bad **Debts of political parties.** If a political party reasonable period of time, if you have tried to debt deduction until these rights become partly (or other organization that accepts contributions collect the amount due, but are unable to do so, or totally worthless. or spends money to influence elections) owes the uncollectible part becomes a business bad you money and the debt becomes worthless, **Joint debtor.** If two or more debtors jointly debt. you can claim a bad debt deduction only if you owe you money, your inability to collect from one Accounts or notes receivable valued at fair use an accrual method of accounting and meet does not enable you to deduct a proportionate market value (FMV) when received are deducti- all the following tests. amount as a bad debt. ble only at that value, even though the FMV may 1. The debt arose from the sale of goods or be less than the face value. If you purchased an **Sale of mortgaged property.** If mortgaged or services in the ordinary course of your account receivable for less than its face value, pledged property is sold for less than the debt, trade or business. and the receivable subsequently becomes the unpaid, uncollectible balance of the debt is a worthless, the most you are allowed to deduct is 2. More than 30% of your receivables ac- bad debt. the amount you paid to acquire it. crued in the year of the sale were from sales to political parties. You can claim a bad debt deduction only if the amount owed to you was 3. You made substantial and continuing efpreviously included in gross income. forts to collect on the debt. 

# When a Debt Becomes This applies to amounts owed to you from all sources of taxable income, including sales, 

# Worthless **Loan or capital contribution.** You cannot services, rents, and interest. claim a bad debt deduction for a loan you made You do not have to wait until a debt is due to to a corporation if, based on the facts and cir- **Accrual method.** If you use the accrual determine whether it is worthless. A debt be- cumstances, the loan is actually a contribution to method of accounting, generally, you report in- comes worthless when there is no longer any capital. come as you earn it. You can only claim a bad chance the amount owed will be paid. debt deduction for an uncollectible receivable if **Debts of an insolvent partner.** If your busi- It is not necessary to go to court if you can you have previously included the uncollectible ness partnership breaks up and one of your show that a judgment from the court would be amount in income. former partners becomes insolvent, you may uncollectible. You must only show that you have If you qualify, you can use the nonac- have to pay more than your pro rata share. If you taken reasonable steps to collect the debt. crual-experience method of accounting dis- pay any part of the insolvent partner’s share of Bankruptcy of your debtor is generally good evi- cussed later. Under this method, you do not the debts, you can claim a bad debt deduction dence of the worthlessness of at least a part of have to accrue income that, based on your ex- for the amount you paid that is attributable to the an unsecured and unpreferred debt. perience, you do not expect to collect. insolvent partner’s share. **Property received for debt.** If you receive

**Cash method.** If you use the cash method **Business loan guarantee.** If you guarantee a property in partial settlement of a debt, reduce of accounting, generally, you report income debt that subsequently becomes worthless, the the debt by the FMV of the property received. when you receive payment. You cannot claim a debt can qualify as a business bad debt if all the You can deduct the remaining debt as a bad bad debt deduction for amounts owed to you following requirements are met. debt if and when it becomes worthless. because you never included those amounts in If you later sell the property, any gain on the 

### • You made the guarantee in the course of income. For example, a cash basis architect sale is due to the appreciation of the property. It your trade or business. cannot claim a bad debt deduction if a client fails is not a recovery of a bad debt. For information to pay the bill because the architect’s fee was 

### • You have a legal duty to pay the debt. on the sale of an asset, see Publication 544. never included in income. 

### • You made the guarantee before the debt **Debts from a former business.** If you sell became worthless. You meet this requireyour business but retain its receivables, these ment if you reasonably expected you debts are business debts because they arose would not have to pay the debt without full 

# How To Claim a out of your trade or business. If any of these reimbursement from the issuer. receivables subsequently become worthless, 

# Business Bad Debt **•** You receive reasonable consideration for the loss is still a business bad debt. making the guarantee. You meet this re- There are two methods to claim a business bad

**Debt acquired from a decedent.** The char- quirement if you made the guarantee in debt. acter of a loss from debts of a business acquired accord with normal business practice or from a decedent is determined in the same way for a good faith business purpose. 

### • The specific charge-off method. Chapter 10 **Business Bad Debts** Page 39

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### • The nonaccrual-experience method. You may have longer to file the claim if you were **Change in accounting method.** See Form 3115, Application for Change in Accounting unable to manage your financial affairs due to a Generally, you must use the specific charge-off Method, and the Instructions for Form 3115 for physical or mental impairment. Such an impair- method. However, you may use the nonac- information on obtaining consent to change to a ment requires proof of existence. crual-experience method if you meet the re- nonaccrual-experience method (other than one quirements discussed later under For details and more information about filing a of the safe harbor methods) or to change from Nonaccrual-Experience Method

. claim, see Publication 556. Use one of the fol- one method to another.lowing forms to file a claim. For more information, see the instructions for the applicable form. 

## Specific Charge-Off Method If you use the specific charge-off method, you 

### Table 10-1.**Forms Used To File a** 

# Recovery of a Bad can deduct specific business bad debts that 

### Claim become either partly or totally worthless during 

# Debt the tax year. **IF you filed as THEN file...**  **a...** If you claim a deduction for a bad debt on your **Partly worthless debts.** You can deduct spe- income tax return and later recover (collect) all Sole proprietor orForm 1040X cific bad debts that become partly uncollectible farmer or part of it, you may have to include all or part of during the tax year. Your tax deduction is limited the recovery in gross income. The amount you to the amount you charge off on your books Corporation Form 1120X include is limited to the amount you actually during the year. You do not have to charge off deducted. However, you can exclude the S corporation Form 1120S and deduct your partly worthless debts annually. amount deducted that did not reduce your tax. (check box H(4)) You can delay the charge off until a later year. Report the recovery as “Other income” on the However, you cannot deduct any part of a debt Partnership Form 1065 appropriate business form or schedule. after the year it becomes totally worthless. (check box G(5)) SeeRecoveries in Publication 525 for more **Significantly modified debt.** An exception information. to the charge-off rule exists for debt which has **Net operating loss (NOL) carryover.** If a been significantly modified and on which the 

## Nonaccrual-Experience bad debt deduction increases an NOL carryover holder recognized gain. For more information, 

## Method that has not expired before the beginning of the see Regulations section 1.166-3(a)(3). tax year in which the recovery takes place, you If you use an accrual method of accounting and **Deduction disallowed.** Generally, you can treat the deduction as having reduced your tax. qualify under the rules explained in this section, claim a partial bad debt deduction only in the A bad debt deduction that contributes to a NOL you can use the nonaccrual-experience method year you make the charge-off on your books. If, helps lower taxes in the year to which you carry for bad debts. Under this method, you do not under audit, the IRS does not allow your deduc- the NOL. See Publication 536 for more informaaccrue service related income you expect to be tion and the debt becomes partly worthless in a tion about NOLs. uncollectible. later tax year, you can deduct the amount you charged off in that year plus the disallowed Generally, you can use the nonacamount charged off in the earlier year. The crual-experience method for accounts receivacharge-off in the earlier year, unless reversed on ble for services you performed only if: your books, fulfills the charge-off requirement for 

### • The services are provided in the fields of the later year. accounting, actuarial science, architecture, 

# 11. consulting, engineering, health, law, or the **Totally worthless debts.** If a debt becomes performing arts, or totally worthless in the current tax year, you can deduct the entire amount, less any amount de- 

### • You meet the $5 million gross receipts test 

# Other Expenses ducted in an earlier tax year when the debt was for all prior years. only partly worthless. You do not have to make an actual **Service related income.** You can use the charge-off on your books to claim a bad debt nonaccrual-experience method only for 

# What’s New deduction for a totally worthless debt. However, amounts earned by performing services. You you may want to do so. If you do not and the IRS cannot use this method for amounts owed to you **Standard mileage rate.** The standard mile- later rules the debt is only partly worthless, you from activities such as lending money, selling age rate for the cost of operating your car, van, will not be allowed a deduction for the debt in goods, or acquiring receivables or other rights to pickup, or panel truck in 2010 is 50 cents a mile that tax year. A deduction of a partly worthless receive payment. for all business miles. For more information, see bad debt is limited to the amount actually Car and truck expenses, under Miscellaneous charged off. **Gross receipts test.** You meet the gross re- Expenses

. ceipts test if your average annual gross receipts **Filing a claim for refund.** If you did not deduct for any prior 3-tax-year period does not exceed a bad debt on your original return for the year it $5,000,000. became worthless, you can file a claim for a 

# Introduction credit or refund. If the bad debt was totally worth- **Interest or penalty charged.** Generally, you less, you must file the claim by the later of the This chapter covers business expenses that cannot use the nonaccrual-experience method following dates. may not have been explained to you, as a busi- for amounts due on which you charge interest or ness owner, in previous chapters of this publica- 

### • 7 years from the date your original return a late payment penalty. However, do not treat a tion.

was due (not including extensions). discount offered for early payment as the charg- ing of interest or a penalty if both the following 

### • 2 years from the date you paid the tax. 

### Topics apply. This chapter discusses: If the claim is for a partly worthless bad debt, 

### • You otherwise accrue the full amount due you must file the claim by the later of the follow- as gross income at the time you provide 

### • Travel, meals, and entertainment ing dates. the services. 

### • Bribes and kickbacks



### • 3 years from the date you filed your origi- 

### • You treat the discount allowed for early

nal return. 

### • Charitable contributions payment as an adjustment to gross in- come in the year of payment. 

### • 2 years from the date you paid the tax. 

### • Education expenses Page 40 Chapter 11 **Other Expenses**

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### • Lobbying expenses 

### Table 11-1.**Reporting Reimbursements**

**•** Penalties and fines **IF the type of reimbursement (or other expense allowance) arrangement is under**  **THEN the employer reports on Form W-2** 

### • Repayments (claim of right)



### • Other miscellaneous expenses **An accountable plan with:** Actual expense reimbursement: No amount. Adequate accounting made and excess 

### Useful Items returned You may want to see: Actual expense reimbursement: The excess amount as wages in box 1.

**Publication** Adequate accounting and return of excess both required but excess not returned ❏ **15-B** Employer’s Tax Guide to Fringe Benefits Per diem or mileage allowance up to the No amount. federal rate: ❏ **463** Travel, Entertainment, Gift, and Car Adequate accounting made and excess Expenses returned ❏ **526** Charitable Contributions Per diem or mileage allowance up to the The excess amount as wages in box 1. The ❏ **529** Miscellaneous Deductions federal rate: amount up to the federal rate is reported only Adequate accounting and return of excess in box 12

—it is not reported in box 1. ❏ **544** Sales and Other Dispositions of both required but excess not returned Assets Per diem or mileage allowance exceeds the The excess amount as wages in box 1. The ❏ **970** Tax Benefits for Education federal rate: amount up to the federal rate is reported only Adequate accounting made up to the federal in box 12

—it is not reported in box 1. ❏ **1542** Per Diem Rates rate only and excess not returned See chapter 12 for information about getting **A nonaccountable plan with:** publications and forms. Either adequate accounting or return of The entire amount as wages in box 1. excess, or both, not required by plan **No reimbursement plan** The entire amount as wages in box 1. 

# Reimbursement of **Travel, Meals, and** reimburse these expenses under an accounta- 

### • You make the advance within a reasonable period of time. ble plan, then you can deduct the amount allow- 

# Entertainment able to the extent of the tax law as travel, meal, If any expenses reimbursed under this ar- and entertainment expenses on your tax return. The following discussion explains how to handle rangement are not substantiated, or an excess any reimbursements or allowances you may If you reimburse these expenses under a reimbursement is not returned within a reasona- provide for travel, meals, and entertainment ex- nonaccountable plan, then you must report the ble period of time by an employee, you are not penses when incurred by your employees. If you reimbursements as wages on Form W-2, Wage allowed to deduct these expenses as reim- are self-employed and report your income and and Tax Statement,and deduct them as wages bursed under an accountable plan. Instead, expenses on Schedule C or C-EZ (Form 1040), on the appropriate line of your tax return. If you treat the reimbursed expenses as paid under a see Publication 463. make a single payment to your employees and it nonaccountable plan, discussed later. To be deductible for tax purposes, expenses includes both wages and an expense reim- incurred for travel, meals, and entertainment **Adequate accounting.** Your employees must bursement, you must specify the amount attribu- must be ordinary and necessary expenses in- adequately account to you for their travel, table to reimbursement and report it accordingly. curred while carrying on your trade or business. meals, and entertainment expenses. They must See Table 11-1, Reporting Reimbursements. Generally, you also must show that entertain- give you documentary evidence of their travel, ment expenses (including meals) are directly mileage, and other employee business exrelated to, or associated with, the conduct of penses. This evidence should include items 

### Accountable Plans your trade or business. For more information on such as receipts, along with either a statement travel, meals, and entertainment, including de- of expenses, an account book, a day-planner, or An accountable plan requires your employees to ductibility, see Publication 463. similar record in which the employee entered meet all of the following requirements. They each expense at or near the time the expense must: was incurred. 

## Reimbursements 1. Have paid or incurred deductible expenses **Excess reimbursement or allowance.** An A “reimbursement or allowance arrangement” while performing services as your employ- excess reimbursement or allowance is any provides for payment of advances, reimburse- ees, amount you pay to an employee that is more ments, and charges for travel, meals, and enter- than the business-related expenses for which 2. Adequately account to you for these ex- tainment expenses incurred by your employees the employee adequately accounted. The em- during the ordinary course of business. Upon penses within a reasonable period of time, ployee must return any excess reimbursement satisfying your established substantiation re- and or other expense allowance to you within a rea- quirements, you can deduct the allowable 3. Return any excess reimbursement or al- sonable period of time. amount on your tax return. Because of differ- lowance within a reasonable period of ences between accounting methods and tax **Reasonable period of time.** A reasonable time. law, these amounts may not be the same. For period of time depends on the facts and circum- example, you can deduct 100% of the cost of An arrangement under which you advance stances. Generally, actions that take place meals on your business books and records. money to employees is treated as meeting (3) within the times specified in the following list will However, for tax purposes, only 50% of these be treated as taking place within a reasonable above only if the following requirements are also costs are allowed by law as a tax deduction. period of time. met. A reimbursement or allowance arrangement 

### • The advance is reasonably calculated not (including per diem allowances, discussed later) 1. You give an advance within 30 days of the to exceed the amount of anticipated ex- depends on whether you have: (1) an accounta- time the employee has incurred the expenses. ble plan or (2) a nonaccountable plan. If you pense. Chapter 11 **Other Expenses** Page 41

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2. Your employees adequately account for combination of payments covering fixed and va- allowance compares to the federal rate. See their expenses within 60 days after the ex- riable costs, such as a cents-per-mile rate to Table 11-1

. penses were paid or incurred. cover your employees’ variable operating costs **Allowance less than or equal to the federal** (such as gas, oil, etc.) plus a flat amount to cover **rate.** If your allowance for the employee is less 3. Your employees return any excess reim- your employees’ fixed costs (such as deprecia- than or equal to the appropriate federal rate, that bursement within 120 days after the ex- tion, insurance, etc.). For information on using a allowance is not included as part of the em- penses were paid or incurred. FAVR allowance, see Revenue Procedure ployee’s pay in box 1 of the employee’s Form 4. You give a periodic statement (at least 2010-39 in Internal Revenue Bulletin 2010-42. W-2. Deduct the allowance as travel expenses quarterly) to your employees that asks You can read Revenue Procedure 2010-39 at (including meals that may be subject to the 50% them to either return or adequately ac- www.irs.gov/pub/irs-irbs/irb10-42.pdf

. limit, discussed later). SeeHow to deduct under count for outstanding advances**and** they Accountable Plans,earlier. **Per diem allowance.** If your employee actu- comply within 120 days of the date of the ally substantiates to you the other elements (dis- statement. **Allowance more than the federal rate.** If cussed earlier) of the expenses reimbursed your employee’s allowance is more than the using the per diem allowance, how you report appropriate federal rate, you must report the **How to deduct.** You can claim a deduction for and deduct the allowance depends on whether allowance as two separate items. travel, meals, and entertainment expenses if the allowance is for lodging and meal expenses Include the allowance amount up to the fed- you reimburse your employees for these ex- or for meal expenses only and whether the al- eral rate in box 12 (code L) of the employee’s penses under an accountable plan. Generally, lowance is more than the federal rate. Form W-2. Deduct it as travel expenses (as the amount you can deduct for meals and enter- **Regular federal per diem rate.** The regular explained above). This part of the allowance is tainment, is subject to a 50% limit, discussed federal per diem rate is the highest amount the treated as reimbursed under an accountable later. If you are a sole proprietor, or are filing as a federal government will pay to its employees plan. single member limited liability company, deduct while away from home on travel. It has two the travel reimbursement on line 24a and the Include the amount that is more than the components: deductible part of the meals and entertainment federal rate in box 1 (and in boxes 3 and 5 if they reimbursement on line 24b, Schedule C (Form apply) of the employee’s Form W-2. Deduct it as 1. Lodging expense, and 1040) or line 2, Schedule C-EZ (Form 1040). wages subject to income tax withholding, social 2. Meal and incidental expense (M & IE). security, Medicare, and federal unemployment If you are filing an income tax return for a taxes. This part of the allowance is treated as corporation, the reimbursement should be in- The rates are different for different locations. reimbursed under a nonaccountable plan as ex- cluded with the amount claimed on the Other Publication 1542 lists the rates in the continental plained later underNonaccountable Plans. deductions line of Form 1120, U.S. Corporation United States. Income Tax Return. If you are filing any other **Standard meal allowance.** The federal rate business income tax return, such as a partner- for meal and incidental expenses (M & IE) is the 

### Meals and Entertainment ship or S corporation return, deduct the reim- standard meal allowance. You can pay only an bursement on the appropriate line of the return Under an accountable plan, you can generally M & IE allowance to employees who travel away as provided in the instructions for that return. deduct only 50% of any otherwise deductible from home if: business-related meal and entertainment ex-



### • You pay the employee for actual expenses penses you reimburse your employees. The de- 

### Per Diem and Car Allowances for lodging based on receipts submitted to duction limit applies even if you reimburse them you, for 100% of the expenses. You can reimburse your employees under an accountable plan based on travel days, miles, or 

### • You provide for the lodging, **Application of the 50% limit.** The 50% de- some other fixed allowance. In these cases, 

### • You pay for the actual expense of the duction limit applies to reimbursements you your employee is considered to have accounted lodging directly to the provider, make to your employees for expenses they incur to you for the amount of the expense that does for meals while traveling away from home on 

### • You do not have reasonable belief that not exceed the rates established by the federal lodging expenses were incurred by the business and for entertaining business customgovernment. Your employee must actually sub- employee, or stantiate to you the other elements of the ex- ers at your place of business, a restaurant, or pense, such as time, place, and business another location. It applies to expenses incurred 

### • The allowance is computed on a basis purpose. at a business convention or reception, business similar to that used in computing the em- meeting, or business luncheon at a club. The ployee’s wages (that is, number of hours **Federal rate.** The federal rate can be figured deduction limit may also apply to meals you worked or miles traveled). using any one of the following methods. furnish on your premises to your employees. **Internet access.** Per diem rates are avail- **Related expenses.** Taxes and tips relating 1. For per diem amounts: able on the Internet. You can access per diem to a meal or entertainment activity you reima. The regular federal per diem rate. rates at www.gsa.gov. burse to your employee under an accountable plan are included in the amount subject to the b. The standard meal allowance. **High-low method.** This is a simplified 50% limit. Reimbursements you make for ex- method of computing the federal per diem rate c. The high-low rate. penses, such as cover charges for admission to for lodging and meal expenses for traveling a nightclub, rent paid for a room to hold a dinner within the continental United States. It elimi- 2. For car expenses: or cocktail party, or the amount you pay for nates the need to keep a current list of the per parking at a sports arena, are all subject to the diem rate in effect for each city in the continental a. The standard mileage rate. 50% limit. However, the cost of transportation to United States. and from an otherwise allowable business meal b. A fixed and variable rate (FAVR). Under the high-low method, the per diem or a business-related entertainment activity is amount for travel during 2010 is $233 ($65 for M not subject to the 50% limit. & IE) for certain high-cost locations. All other **Car allowance.** Your employee is considered areas have a per diem amount of $160 ($52 for to have accounted to you for car expenses that **Amount subject to 50% limit.** If you provide M & IE). The high-cost locations eligible for the do not exceed the standard mileage rate. For your employees with a per diem allowance only $233 per diem amount under the high-low 2010, the standard mileage rate for each busi- for meal and incidental expenses, the amount method are listed in Publication 1542. ness mile is 50 cents per mile for all business treated as an expense for food and beverages is miles. the lesser of the following. **Reporting per diem and car allowances.** You can choose to reimburse your employ- The following discussion explains how to report 

### • The per diem allowance. ees using a fixed and variable rate (FAVR) al- per diem and car allowances. The manner in 

### • The federal rate for M & IE. lowance. This is an allowance that includes a which you report them depends on how the Page 42 Chapter 11 **Other Expenses**

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If you provide your employees with a per diem deduct the reimbursement as compensation or reasonably expect to gain in the future. For exallowance that covers lodging, meals, and inci- wages only to the extent it meets the deductibil- ample, the cost of advertising that encourages dental expenses, you must treat an amount ity tests for employees’ pay in chapter 2. Deduct people to contribute to the Red Cross, to buy equal to the federal M & IE rate for the area of the allowable amount as compensation or U.S. Savings Bonds, or to participate in similar travel as an expense for food and beverages. If wages on the appropriate line of your income tax causes is usually deductible. the per diem allowance you provide is less than return, as provided in its instructions. the federal per diem rate for the area of travel, **Anticipated liabilities.** Anticipated liabilities Generally, amounts paid for meals, enter- you can treat 40% of the per diem allowance as or reserves for anticipated liabilities are not de- tainment, and amusement provided to individu- the amount for food and beverages. ductible. For example, assume you sold 1-year als who are not your employees are not subject TV service contracts this year totaling $50,000. to the 50% limit. Such activities must be directly **Meal expenses when subject to “hours of** From experience, you know you will have ex- related to the active conduct of your trade or **service” limits.** You can deduct 80% of the penses of about $15,000 in the coming year for business. Examples include: reimbursed meals your employees consume these contracts. You cannot deduct any of the while away from their tax home on business 

### • Amounts paid for meals, goods, services, $15,000 this year by charging expenses to a during, or incident to, any period subject to the or the use of a facility. You are allowed a reserve or liability account. You can deduct your Department of Transportation’s “hours of serv- deduction only to the extent it is included expenses only when you actually pay or accrue ice” limits. in the gross income of the recipient as them, depending on your accounting method. See Publication 463 for a detailed discussion compensation for services or as a prize or of individuals subject to the Department of award. **Bribes and kickbacks.** Engaging in the pay- Transportation’s “hours of service” limits. ment of bribes or kickbacks is a serious criminal 

### • Expenses that exceed $600 and are re- matter. Such activity could result in criminal

quired to be reported on an information **De minimis (minimal) fringe benefit.** The prosecution. Any payments that appear to have return, for example, Form 1099-MISC. 50% limit does not apply to an expense for food been made, either directly or indirectly, to an See theGeneral Instructions for Certain or beverage that is excluded from the gross official or employee of any government or an Information Returns,for more information income of an employee because it is a de agency or instrumentality of any government are about reporting requirements. minimis fringe benefit. See Publication 15-B for not deductible for tax purposes and are in viola- additional information on de minimis fringe ben- 

### • The cost of providing meals, entertain- tion of the law. efits. ment, goods and services, or use of facili- Payments paid directly or indirectly to a per- ties you sell to the public. For example, if **Company cafeteria or executive dining** son in violation of any federal or state law (but you operate a nightclub, your expense for **room.** The cost of food and beverages you only if that state law is generally enforced, de- the entertainment you furnish to your cus- provide primarily to your employees on your fined below) that provides for a criminal penalty tomers, such as a floor show, is a busi- business premises is deductible. This includes or for the loss of a license or privilege to engage ness expense that is fully deductible. the cost of maintaining the facilities for providing in a trade or business are also not allowed as a the food and beverages. These expenses are deduction for tax purposes. 

### • The cost of providing meals, entertain- subject to the 50% limit unless they qualify as a ment, or recreational facilities to the gen- **Meaning of “generally enforced.”** A state de minimis fringe benefit, discussed in Publica- eral public as a means of advertising or law is considered generally enforced unless it is tion 15-B, or unless they are compensation to promoting goodwill in the community is never enforced or enforced only for infamous your employees and you treat them as provided fully deductible. persons or persons whose violations are exunder a nonaccountable plan. traordinarily flagrant. For example, a state law is **Employee activities.** The expense of provid- generally enforced unless proper reporting of a ing recreational, social, or similar activities (in- violation of the law results in enforcement only cluding the use of a facility) for your employees under unusual circumstances. 

# Miscellaneous is deductible. The benefit must be primarily for **Kickbacks.** A kickback is a payment for re- your employees who are not highly compen- 

# Expenses ferring a client, patient, or customer. The com- sated. mon kickback situation occurs when money or For this purpose, a highly compensated em- In addition to travel, meal, and entertainment property is given to someone as payment for ployee is an employee who meets either of the expenses, other miscellaneous expenses that influencing a third party to purchase from, use following requirements. are deductible, subject to limitations, include: the services of, or otherwise deal with the person who pays the kickback. In many cases, the 1. Owned a 10% or more interest in the busi- 

### • Amounts paid for the reasonable cost of person whose business is being sought or en- ness during the year or the preceding year. advertising that are directly related to your joyed by the person who pays the kickback is not An employee is treated as owning any in- business activities. Generally, amounts aware of the payment. terest owned by his or her brother, sister, paid to influence legislation (i.e., lobbying) spouse, ancestors, and lineal descend- For example, the Yard Corporation is in the are not deductible for tax purposes. See ants. business of repairing ships. It engages in the Lobbying expenses, later. practice of returning 10% of the repair bills as 2. Received more than $110,000 in pay for 

### • Amounts paid that are directly related to kickbacks to the captains and chief officers of the preceding year. You can choose to in- the conduct of business meetings of your the vessels it repairs. Although this practice is clude only employees who were also in the employees, partners, stockholders, considered an ordinary and necessary expense top 20% of employees when ranked by agents, or directors. Some minor social of getting business, it is clearly a violation of a pay for the preceding year. activities may be allowed, however, these state law that is generally enforced. These ex- expenses are subject to the 50% limit. For example, the expenses for food, bever- penditures are not deductible for tax purposes, ages, and entertainment for a company-wide whether or not the owners of the shipyard are 

### • Amounts paid that are directly related to picnic are not subject to the 50% limit. subsequently prosecuted. and necessary for attending business meetings or conventions of certain **Form 1099-MISC.** It does not matter tax-exempt organizations. These organi- whether any kickbacks paid during the tax year 

### Nonaccountable Plans zations include business leagues, cham- are deductible on your income tax return in re- bers of commerce, real estates boards, A nonaccountable plan is an arrangement that gards to information reporting. See Form and trade and professional associations. does not meet the requirements for an account- 1099-MISC for more information. able plan. All amounts paid, or treated as paid, under a nonaccountable plan are reported as **Advertising expenses.** You can usually de- **Car and truck expenses.** The costs of operatwages on Form W-2. The payments are subject duct as a business expense the cost of institu- ing a car, truck, or other vehicle in your business to income tax withholding, social security, Medi- tional or goodwill advertising to keep your name are deductible. For more information on how to care, and federal unemployment taxes. You can before the public if it relates to business you figure your deduction, see Publication 463. Chapter 11 **Other Expenses** Page 43

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**Charitable contributions.** Cash payments to of contract or fiduciary duty, or antitrust viola- you to be able to work (impairment-related exan organization, charitable or otherwise, may be tions. You must include this compensation in penses) as a business expense, rather than as a deductible as business expenses if the pay- your income. However, you may be able to take medical expense. ments are not charitable contributions or gifts. If a special deduction. The deduction applies only You are disabled if you have either of the the payments are charitable contributions or to amounts recovered for actual injury, not any following. gifts, you cannot deduct them as business ex- additional amount. The deduction is the smaller 

### • A physical or mental disability (for exam- penses. However, corporations (other than S of the following. ple, blindness or deafness) that function- corporations) can deduct charitable contribu- 

### • The amount you received or accrued for ally limits your being employed. tions on their income tax returns, subject to damages in the tax year reduced by the 

### • A physical or mental impairment that sub- limitations. See the Instructions for Form 1120 amount you paid or incurred in the year to stantially limits one or more of your major for more information. Sole proprietors, partners recover that amount. life activities. in a partnership, or shareholders in an S corpo- 

### • Your losses from the injury you have not ration may be able to deduct charitable contribu- The expense qualifies as a business expense deducted. tions made by their business on Schedule A if all the following apply. (Form 1040). **Demolition expenses or losses.** Amounts 

### • Your work clearly requires the expense for

**Example.** You paid $15 to a local church for paid or incurred to demolish a structure are not you to satisfactorily perform that work. a half-page ad in a program for a concert it is deductible. These amounts are added to the sponsoring. The purpose of the ad was to en- 

### • The goods or services purchased are basis of the land where the demolished structure courage readers to buy your products. Your pay- clearly not needed or used, other than in- was located. Any loss for the remaining un- ment is not a charitable contribution. However, cidentally, in your personal activities. depreciated basis of a demolished structure you can deduct it as an advertising expense. would not be recognized until the property is 

### • Their treatment is not specifically provided disposed. for under other tax law provisions. **Example.** You made a $100,000 donation to a committee organized by the local Chamber **Education expenses.** Ordinary and neces- of Commerce to bring a convention to your city, **Example.** You are blind. You must use a sary expenses paid for the cost of the education intended to increase business activity, including reader to do your work, both at and away from and training of your employees are deductible. yours. Your payment is not a charitable contribu- your place of work. The reader’s services are SeeEducation Expenses in chapter 2. tion. However, you can deduct it as a business only for your work. You can deduct your ex- You can also deduct the cost of your own expense. penses for the reader as a business expense. education (including certain related travel) re- See Publication 526 for a discussion of lated to your trade or business. You must be **Internet-related expenses.** Generally, you donated inventory, including capital gain prop- able to show the education maintains or im- can deduct internet-related expenses including erty. proves skills required in your trade or business, domain registrations fees and webmaster con- or that it is required by law or regulations, for sulting costs. If you are starting a business you **Club dues and membership fees.** Generally, keeping your license to practice, status, or job. may have to amortize these expenses as amounts paid or incurred for membership in any For example, an attorney can deduct the cost of start-up costs. For more information about am- club organized for business, pleasure, recrea- attending Continuing Legal Education (CLE) ortizing start-up and organizational costs, see tion, or any other social purpose are not deducti- classes that are required by the state bar associ- chapter 8. ble. Clubs organized for business, pleasure, ation to maintain his or her license to practice recreation, or other social purpose include, but law. **Interview expense allowances.** Reimburse- are not limited to country clubs, golf and athletic Education expenses you incur to meet the ments you make to job candidates for transpor- clubs, hotel clubs, sporting clubs, airline clubs, minimum requirements of your present trade or tation or other expenses related to interviews for and clubs operated to provide meals under cir- business, or those that qualify you for a new possible employment are not wages. You can cumstances generally considered to be condu- trade or business, are not deductible. This is true deduct the reimbursements as a business ex- cive to business discussions. even if the education maintains or improves pense. However, expenses for food, beverages, skills presently required in your business. For **Exception.** The following organizations are and entertainment are subject to the 50% limit more information on education expenses, see not treated as clubs organized for business, discussed earlier under Meals and Entertain- Publication 970. pleasure, recreation, or other social purpose un- ment. less one of the main purposes is to conduct **Franchise, trademark, trade name.** If you entertainment activities for members or their **Legal and professional fees.** Fees charged buy a franchise, trademark, or trade name, you guests or to provide members or their guests by accountants and attorneys that are ordinary can deduct the amount you pay or incur as a with access to entertainment facilities. and necessary expenses directly related to op- business expense only if your payments are part erating your business are deductible as busi- 

### • Boards of trade. of a series of payments that are: ness expenses. However, usually legal fees you 

### • Business leagues. pay to acquire business assets are not deducti- 1. Contingent on productivity, use, or disposi- ble. These costs are added to the basis of the 

### • Chambers of commerce. tion of the item, property. 

### • Civic or public service organizations. 2. Payable at least annually for the entire Fees that include payments for work of a term of the transfer agreement, and personal nature (such as drafting a will, or dam- 

### • Professional organizations such as bar as- ages arising from a personal injury), are not

sociations and medical associations. 3. Substantially equal in amount (or payable allowed as a business deduction on Schedule C under a fixed formula). 

### • Real estate boards. or C-EZ. If the invoice includes both business When determining the term of the transfer and personal charges, compute the business 

### • Trade associations. agreement, include all renewal options and any portion as follows: multiply the total amount of other period for which you and the transferrer the bill by a fraction, the numerator of which is **Credit card convenience fees.** Credit card reasonably expect the agreement to be re- the amount attributable to business matters, the companies charge a fee to businesses who ac- newed. denominator of which is the total amount paid. cept their cards. This fee when paid or incurred A franchise includes an agreement that gives The result is the portion of the invoice attributaby the business can be deducted as a business one of the parties to the agreement the right to ble to business expenses. The portion attributaexpense. distribute, sell, or provide goods, services, or ble to personal matters is the difference facilities within a specified area. between the total amount and the business por**Damages recovered.** Special rules apply to tion (computed above). compensation you receive for damages sus- **Impairment-related expenses.** If you are dis- Legal fees relating to personal tax advice tained as a result of patent infringement, breach abled, you can deduct expenses necessary for may be deductible on Line 22, Schedule A Page 44 Chapter 11 **Other Expenses**

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(Form 1040), if you itemize deductions. How- 3. Any officer or employee of the White each day that completion is delayed beyond the House Office of the Executive Office of the ever, the deduction is subject to the 2% limita- completion date stipulated in the contract. President and the two most senior level tion on miscellaneous itemized deductions. See These additional costs are deductible business officers of each of the other agencies in Publication 529, Miscellaneous Deductions. expenses. the Executive Office. On the other hand, penalties or fines paid to **Tax preparation fees.** The cost of hiring a any government agency or instrumentality be- 4. Any individual who: tax professional, such as a C.P.A., to prepare cause of a violation of any law are not deducti-that part of your tax return relating to your busia. Is serving in a position in Level I of the ble. These fines or penalties include the ness as a sole proprietor is deductible on Sched- Executive Schedule under section 5312 following amounts. ule C or Schedule C-EZ. Any remaining cost of title 5, United States Code, may be deductible on Schedule A (Form 1040) if 

### • Paid because of a conviction for a crime or you itemize deductions. b. Has been designated by the President after a plea of guilty or no contest in a You can also claim a business deduction for as having Cabinet-level status, or criminal proceeding. amounts paid or incurred in resolving asserted c. Is an immediate deputy of an individual 

### • Paid as a penalty imposed by federal, tax deficiencies for your business operated as a listed in item (a) or (b). state, or local law in a civil action, includsole proprietor. ing certain additions to tax and additional **Licenses and regulatory fees.** Licenses and amounts and assessable penalties im**Exceptions to denial of deduction.** The regulatory fees for your trade or business paid posed by the Internal Revenue Code. general denial of the deduction does not apply to annually to state or local governments generally the following. 

### • Paid in settlement of actual or possible are deductible. Some licenses and fees may 

### • Expenses of appearing before, or commu- liability for a fine or penalty, whether civil have to be amortized. See chapter 8 for more nicating with, any local council or similar or criminal. information. governing body concerning its legislation 

### • Forfeited as collateral posted for a pro- (local legislation) if the legislation is of di- **Lobbying expenses.** Generally, lobbying ex- ceeding that could result in a fine or pen- rect interest to you or to you and an organ- penses are not deductible. Lobbying expenses alty. ization of which you are a member. An include amounts paid or incurred for any of the Indian tribal government is treated as a following activities. Examples of nondeductible penalties and local council or similar governing body. fines include the following. 

### • Influencing legislation. 

### • Any in-house expenses for influencing leg- 

### • Fines for violating city housing codes. 

### • Participating in or intervening in any politi- islation and communicating directly with a

cal campaign for, or against, any candi- covered executive branch official if those 

### • Fines paid by truckers for violating state date for public office. expenses for the tax year do not exceed maximum highway weight laws. $2,000 (excluding overhead expenses). 

### • Attempting to influence the general public, 

### • Fines for violating air quality laws.

or segments of the public, about elections, 

### • Expenses incurred by taxpayers engaged 

### • Civil penalties for violating federal laws re- legislative matters, or referendums. in the trade or business of lobbying (pro- garding mining safety standards and dis- fessional lobbyists) on behalf of another 

### • Communicating directly with covered ex- charges into navigable waters. person (but does apply to payments by the ecutive branch officials (defined later) in other person to the lobbyist for lobbying any attempt to influence the official actions A fine or penalty does not include any of the activities). or positions of those officials. following.


### • Researching, preparing, planning, or coor- 

### • Legal fees and related expenses to defend **Moving machinery.** Generally, the cost of dinating any of the preceding activities. yourself in a prosecution or civil action for moving machinery from one city to another is a a violation of the law imposing the fine or deductible expense. So is the cost of moving Your expenses for influencing legislation and civil penalty. machinery from one plant to another, or from communicating directly with a covered execu- one part of your plant to another. You can de- 

### • Court costs or stenographic and printing tive branch official include a portion of your labor duct the cost of installing the machinery in the charges. costs and general and administrative costs of new location. However, you must capitalize the your business. For information on making this 

### • Compensatory damages paid to a govern- costs of installing or moving newly purchased allocation, see section 1.162-28 of the regula- ment. machinery. tions. You cannot claim a charitable or business **Outplacement services.** The costs of out**Political contributions.** Contributions or gifts expense deduction for amounts paid to an or- placement services you provide to your employ- paid to political parties or candidates are not ganization if both of the following apply. ees to help them find new employment, such as deductible. In addition, expenses paid or in- career counseling, r ́ esum ́ e assistance, skills as- 

### • The organization conducts lobbying activi- curred to take part in any political campaign of a sessment, etc. are deductible. ties on matters of direct financial interest candidate for public office are not deductible. The costs of outplacement services may to your business. cover more than one deduction category. For **Indirect political contributions.** You can- 

### • A principal purpose of your contribution is example, deduct as a utilities expense the cost not deduct indirect political contributions and

to avoid the rules discussed earlier that of telephone calls made under this service and costs of taking part in political activities as busi- prohibit a business deduction for lobbying deduct as rental expense the cost of renting ness expenses. Examples of nondeductible ex- expenses. machinery and equipment for this service. penses include the following.For information on whether the value of out

### • Advertising in a convention program of a If a tax-exempt organization, other than a sec- placement services is includable in your employ- tion 501(c)(3) organization, provides you with a political party, or in any other publication if ees’ income, see Publication 15-B. notice on the part of dues that is allocable to any of the proceeds from the publication **Penalties and fines.** Penalties paid for late nondeductible lobbying and political expenses, are for, or intended for, the use of a politi- performance or nonperformance of a contract you cannot deduct that part of the dues. cal party or candidate. are generally deductible. For instance, you own **Covered executive branch official.** For 

### • Admission to a dinner or program (includand operate a construction company. You have purposes of this discussion, a covered executive ing, but not limited to, galas, dances, film been contracted to construct a building by a branch official is any of the following. presentations, parties, and sporting certain date. Due to construction delays, the events) if any of the proceeds from the building is not completed and ready for occu- 1. The President. function are for, or intended for, the use of pancy on the date stipulated in the contract. You 2. The Vice President. a political party or candidate. are now required to pay an additional amount for Chapter 11 **Other Expenses** Page 45

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### • Admission to an inaugural ball, gala, **Method 1.** Figure your tax for 2010 claiming for the tax year in which it is a proper deduction a deduction for the repaid amount. under your accounting method. For example, if parade, concert, or similar event if identi- you use the accrual method, you are entitled to fied with a political party or candidate. **Method 2.** Figure your tax for 2010 claiming the deduction or credit in the tax year in which a credit for the prepaid amount. Follow these the obligation for the repayment accrues. steps. **Repairs.** The cost of repairing or improving property used in your trade or business is either **Subscriptions.** Subscriptions to professional, 1. Figure your tax for 2010 without deducting a deductible or capital expense. Routine mainte- technical, and trade journals that deal with your the repaid amount. nance that keeps your property in a normal effi- business field are deductible. cient operating condition, but that does not 2. Refigure your tax from the earlier year materially increase the value or substantially **Supplies and materials.** Unless you have dewithout including in income the amount prolong the useful life of the property is deducti- ducted the cost in any earlier year, you generally you repaid in 2010. can deduct the cost of materials and supplies ble in the year that it is incurred. Otherwise, the 3. Subtract the tax in (2) from the tax shown actually consumed and used during the tax year. cost must be depreciated over the useful life of on your return for the earlier year. This is If you keep incidental materials and supplies the property. See Form 4562 and its instructions the amount of your credit. on hand, you can deduct the cost of the incidenfor how to compute and claim the depreciation 4. Subtract the answer in (3) from the tax for tal materials and supplies you bought during the deduction. 2010 figured without the deduction (step tax year if all the following requirements are met. The cost of repairs includes the costs of 1). labor, supplies, and certain other items. The 

### • You do not keep a record of when they are value of your own labor is not deductible. Exam- If Method 1 results in less tax, deduct the used. ples of repairs include: amount repaid as discussed earlier under Type 

### • You do not take an inventory of the of deduction. 

### • Reconditioning floors (but not replace- amount on hand at the beginning and end If Method 2 results in less tax, claim the ment), of the tax year. credit on line 72 of Form 1040, and write “I.R.C. 

### • Repainting the interior and exterior walls 

### • This method does not distort your income. 1341” next to line 72. of a building, You can also deduct the cost of books, profes- **Example.** For 2009, you filed a return and 

### • Cleaning and repairing roofs and gutters, sional instruments, equipment, etc., if you nor- reported your income on the cash method. In and mally use them within a year. However, if the 2010, you repaid $5,000 included in your 2009 

### • Fixing plumbing leaks (but not replace- usefulness of these items extends substantially gross income under a claim of right. Your filing beyond the year they are placed in service, you ment of fixtures). status in 2010 and 2009 is single. Your income generally must recover their costs through deand tax for both years are as follows: preciation. For more information regarding de- **Repayments.** If you had to repay an amount preciation see Publication 946, How To **2009 2009**  you included in your income in an earlier year, **With Income Without Income**  Depreciate Property. you may be able to deduct the amount repaid for Taxable the year in which you repaid it. Or, if the amount **Utilities.** Business expenses for heat, lights, Income $15,000 $10,000 you repaid is more than $3,000, you may be able power, telephone service, and water and sewer- Tax $ 1,836 $ 1,086 to take a credit against your tax for the year in age are deductible. However, any part attributa- which you repaid it. ble to personal use is not deductible. **2010 2010**  **Type of deduction.** The type of deduction **Without Deduction With Deduction**  **Telephone.** The cost of basic local teleyou are allowed in the year of repayment de- Taxable phone service (including any taxes) for the first Income $49,950 $44,950 pends on the type of income you included in the telephone line you have in your home, even earlier year. For instance, if you repay an though you have an office in your home is not Tax $8,675 $7,425 amount you previously reported as a capital deductible. However, charges for business gain, deduct the repayment as a capital loss on long-distance phone calls on that line, as well as Your tax under Method 1 is $7,425. Your tax Schedule D (Form 1040). If you reported it as the cost of a second line into your home used under Method 2 is $7,925, figured as follows: self-employment income, deduct it as a busi- exclusively for business, are deductible business deduction on Schedule C or Schedule Tax previously determined for 2009 $ 1,836 ness expenses. Less: Tax as refigured

......... . **−**1,086 C-EZ (Form 1040) or Schedule F (Form 1040). Decrease in 2009 tax $ 750 If you reported the amount as wages, unem- Regular tax liability for 2010

...... . $8,675 ployment compensation, or other nonbusiness Less: Decrease in 2009 tax

...... . **−**750 ordinary income, enter it on Schedule A (Form **Refigured tax for 2010 $ 7,925**  1040) as a miscellaneous itemized deduction that is subject to the 2% limitation. However, if Because you pay less tax under Method 1, you 

# 12. the repayment is over $3,000 and Method 1 should take a deduction for the repayment in (discussed later) applies, deduct it on Schedule 2010.A (Form 1040) as a miscellaneous itemized de**Repayment does not apply.** This discus- duction that is not subject to the 2% limitation. 

# How To Get Tax sion does not apply to the following. **Repayment**
**— $3,000 or less.**  If the 

### • Deductions for bad debts. amount you repaid was $3,000 or less, deduct it 

# Help from your income in the year you repaid it. 

### • Deductions from sales to customers, such as returns and allowances, and similar **Repayment**
**— over $3,000.**  If the amount You can get help with unresolved tax issues, items. you repaid was more than $3,000, you can de- order free publications and forms, ask tax ques- duct the repayment, as described earlier. How- 

### • Deductions for legal and other expenses tions, and get information from the IRS in sev- ever, you can instead choose to take a tax credit of contesting the repayment. eral ways. By selecting the method that is best for the year of repayment if you included the for you, you will have quick and easy access to income under a “claim of right.” This means that **Year of deduction (or credit).** If you use tax help. at the time you included the income, it appeared the cash method of accounting, you can take the that you had an unrestricted right to it. If you deduction (or credit, if applicable) for the tax **Contacting your Taxpayer Advocate.** The qualify for this choice, figure your tax under both year in which you actually make the repayment. Taxpayer Advocate Service (TAS) is an indemethods and use the method that results in less If you use any other accounting method, you can pendent organization within the IRS. We help tax. deduct the repayment or claim a credit for it only taxpayers who are experiencing economic Page 46 Chapter 12 **How To Get Tax Help**

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harm, such as not being able to provide necessi- you can listen to on the telephone. The majority **Phone.**Many services are available by ties like housing, transportation, or food; taxpay- phone. of the information and services listed in this ers who are seeking help in resolving tax publication are available to you free of charge. If problems with the IRS; and those who believe there is a fee associated with a resource or 

### • Ordering forms, instructions, and publica- that an IRS system or procedure is not working service, it is listed in the publication. tions.Call 1-800-TAX-FORM as it should. Here are seven things every tax- Accessible versions of IRS published prod- (1-800-829-3676) to order current-year payer should know about TAS: ucts are available on request in a variety of forms, instructions, and publications, and alternative formats for people with disabilities. 

### • The Taxpayer Advocate Service is your prior-year forms and instructions. You

voice at the IRS. should receive your order within 10 days. **Free help with your return.** Free help in pre- 

### • Our service is free, confidential, and tai- 

### • Asking tax questions.Call the IRS with paring your return is available nationwide from lored to meet your needs. your tax questions at 1-800-829-4933. IRS-trained volunteers. The Volunteer Income 

### • You may be eligible for our help if you Tax Assistance (VITA) program is designed to 

### • Solving problems.You can get

have tried to resolve your tax problem help low-income taxpayers and the Tax Coun- face-to-face help solving tax problems through normal IRS channels and have seling for the Elderly (TCE) program is designed every business day in IRS Taxpayer Asgotten nowhere, or you believe an IRS to assist taxpayers age 60 and older with their sistance Centers. An employee can exprocedure just isn’t working as it should. tax returns. Many VITA sites offer free electronic plain IRS letters, request adjustments to filing and all volunteers will let you know about your account, or help you set up a pay- 

### • We help taxpayers whose problems are ment plan. Call your local Taxpayer Assis- credits and deductions you may be entitled to causing financial difficulty or significant tance Center for an appointment. To find claim. To find the nearest VITA or TCE site, call cost, including the cost of professional the number, go to 1-800-829-1040. representation. This includes businesses www.irs.gov/localcontacts or look in the As part of the TCE program, AARP offers the as well as individuals. phone book underUnited States Govern- Tax-Aide counseling program. To find the near- 

### • Our employees know the IRS and how to ment, Internal Revenue Service

. est AARP Tax-Aide site, call 1-888-227-7669 or navigate it. If you qualify for our help, we’ll visit AARP’s website at 

### • TTY/TDD equipment.If you have access assign your case to an advocate who will www.aarp.org/money/taxaide

. to TTY/TDD equipment, call listen to your problem, help you under- For more information on these programs, go 1-800-829-4059 to ask tax questions or to stand what needs to be done to resolve it, to IRS.gov and enter keyword “VITA” in the order forms and publications. and stay with you every step of the way upper right-hand corner. until your problem is resolved. 

### • TeleTax topics.Call 1-800-829-4477 to lis**Internet.**You can access the IRS web- ten to pre-recorded messages covering 

### • We have at least one local taxpayer advo- site at IRS.gov 24 hours a day, 7 days various tax topics.

cate in every state, the District of Colum- a week to: bia, and Puerto Rico. You can call your 

### • Refund information.To check the status of local advocate, whose number is in your 

### • E-file your return. Find out about commer- your 2010 refund, call 1-800-829-1954 or phone book, in Pub. 1546, Taxpayer Ad- cial tax preparation ande-file services 1-800-829-4477 (automated refund infor- vocate Service

—Your Voice at the IRS, available free to eligible taxpayers. mation 24 hours a day, 7 days a week). and on our website at www.irs.gov/advo- Wait at least 72 hours after the IRS ac- 

### • Check the status of your 2010 refund. Go cate. You can also call our toll-free line at knowledges receipt of your e-filed return, to IRS.gov and click on Where’s My Re- 1-877-777-4778 or TTY/TDD or 3 to 4 weeks after mailing a paper re- fund . Wait at least 72 hours after the IRS 1-800-829-4059. turn. If you filed Form 8379 with your re- acknowledges receipt of your e-filed re- turn, wait 14 weeks (11 weeks if you filed 

### • You can learn about your rights and re- turn, or 3 to 4 weeks after mailing a paper electronically). Have your 2010 tax return

sponsibilities as a taxpayer by visiting our return. If you filed Form 8379 with your available so you can provide your social online tax toolkit at www.taxtoolkit.irs.gov

. return, wait 14 weeks (11 weeks if you security number, your filing status, and the You can get updates on hot tax topics by filed electronically). Have your 2010 tax exact whole dollar amount of your refund. visiting our YouTube channel at www.you- return available so you can provide your If you check the status of your refund and tube.com/tasnta and our Facebook page social security number, your filing status, are not given the date it will be issued, at www.facebook.com/YourVoiceAtIRS, or and the exact whole dollar amount of your please wait until the next week before by following our tweets at www.twitter. refund. checking back. com/YourVoiceAtIRS

. 

### • Download forms, including talking tax 

### • Other refund information.To check the **Low Income Taxpayer Clinics (LITCs).** forms, instructions, and publications. status of a prior

–year refund or amended The Low Income Taxpayer Clinic program return refund, call 1-800-829-1040. 

### • Order IRS products online. serves individuals who have a problem with the 

### • Research your tax questions online. IRS and whose income is below a certain level. **Evaluating the quality of our telephone** LITCs are independent from the IRS. Most **services.** To ensure IRS representatives give 

### • Search publications online by topic or LITCs can provide representation before the accurate, courteous, and professional answers, keyword. IRS or in court on audits, tax collection disputes, we use several methods to evaluate the quality and other issues for free or a small fee. If an 

### • Use the online Internal Revenue Code, of our telephone services. One method is for a individual’s native language is not English, some regulations, or other official guidance. second IRS representative to listen in on or clinics can provide multilingual information record random telephone calls. Another is to ask 

### • View Internal Revenue Bulletins (IRBs) about taxpayer rights and responsibilities. For some callers to complete a short survey at the published in the last few years. more information, see Publication 4134, Low end of the call. Income Taxpayer Clinic List. This publication is 

### • Figure your withholding allowances using available at IRS.gov, by calling the withholding calculator online at **Walk-in.** Many products and services 1-800-TAX-FORM (1-800-829-3676), or at your www.irs.gov/individuals

. are available on a walk-in basis. local IRS office. 

### • Determine if Form 6251 must be filed by using our Alternative Minimum Tax (AMT) **Free tax services.** Publication 910, IRS 

### • Products.You can walk in to many post Assistant. Guide to Free Tax Services, is your guide to IRS offices, libraries, and IRS offices to pick up services and resources. Learn about free tax certain forms, instructions, and publica- 

### • Sign up to receive local and national tax information from the IRS, including publications, tions. Some IRS offices, libraries, grocery news by email. services, and education and assistance pro- stores, copy centers, city and county gov

### • Get information on starting and operating grams. The publication also has an index of over ernment offices, credit unions, and office a small business. 100 TeleTax topics (recorded tax information) supply stores have a collection of products Chapter 12 **How To Get Tax Help** Page 47

# Page 48 of 50 of Publication 535 15:23 - 25-MAR-2011
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available to print from a CD or photocopy a special need, such as a disability, an 

### • Tax Map: an electronic research tool and from reproducible proofs. Also, some IRS finding aid. appointment can be requested. All other offices and libraries have the Internal Rev- issues will be handled without an appoint- 

### • Tax law frequently asked questions. enue Code, regulations, Internal Revenue ment. To find the number of your local 

### • Tax Topics from the IRS telephone re- Bulletins, and Cumulative Bulletins avail- office, go to www.irs.gov/localcontacts or sponse system. able for research purposes. look in the phone book underUnited 

### • Internal Revenue Code

—Title 26 of the 

### • Services.You can walk in to your local States Government, Internal Revenue U.S. Code.

Taxpayer Assistance Center every busi- Service

. ness day for personal, face-to-face tax 

### • Fill-in, print, and save features for most tax help. An employee can explain IRS letters, **Mail.** You can send your order for forms. request adjustments to your tax account, forms, instructions, and publications to 

### • Internal Revenue Bulletins. or help you set up a payment plan. If you the address below. You should receive need to resolve a tax problem, have ques- a response within 10 days after your request is 

### • Toll-free and email technical support. tions about how the tax law applies to your received. 

### • Two releases during the year. individual tax return, or you are more com-

–The first release will ship the beginning fortable talking with someone in person, Internal Revenue Service of January 2011. visit your local Taxpayer Assistance

–The final release will ship the beginning Center where you can spread out your 1201 N. Mitsubishi Motorway of March 2011. records and talk with an IRS representa- Bloomington, IL 61705-6613tive face-to-face. No appointment is nec**DVD for tax products.**You can order Purchase the DVD from National Technical essary—just walk in. If you prefer, you Publication 1796, IRS Tax Products Information Service (NTIS) at can call your local Center and leave a DVD, and obtain: www.irs.gov/cdorders for $30 (no handling fee) message requesting an appointment to re- or call 1-877-233-6767 toll-free to buy the DVD solve a tax account issue. A representa- 

### • Current-year forms, instructions, and pub- for $30 (plus a $6 handling fee). tive will call you back within 2 business lications.days to schedule an in-person appoint

### • Prior-year forms, instructions, and publicament at your convenience. If you have an tions. ongoing, complex tax account problem or

Page 48 Chapter 12 **How To Get Tax Help**

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### To help us develop a more useful index, please let us know if you have ideas for index entries. **Index** See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

**Circulation costs, newspapers Experimentation costs** 

..... 22, Below-market

.............. 14 

### A **and periodicals**

........... 23 33 Business expense for

....... 11 **Advertising**

.................. 43 Capitalized

............. 13, 14 **Cleanup costs, Exploration costs** 

........... 22 **Amortization:** Carrying charge

............ 21 **environmental**

............. 23 Anti-abuse rule

............. 31 Deductible

................. 12 **Club dues**

................... 44 Anti-churning rules

......... 30 

### F Forgone

................... 14 **Comments on publication**

.... 1 Atmospheric pollution control **Fees:** Life insurance policies

...... 13

facilities

................. 32 **Commitment fees**

........... 13 Commitment

............... 13 Not deductible

............. 13 Corporate organization **Computer software**

.......... 29 Legal and professional

...... 44 Refunds of

................. 14

costs

.................... 27 **Constant-yield method,** Regulatory

................. 45 When to deduct

............ 14 Dispositions of section 197 **OID**

....................... 13 Tax return preparation

...... 45 **Internet-related**

intangibles

............... 31 **Contested liability**

............ 5 **Fines**

........................ 45 **expenses**
................. 44 Experimental costs

......... 33 **Contributions: Forgone interest** 

............ 14 **Interview expenses**

.......... 44 Geological and geophysical Charitable

................. 44 **Form:**

costs

.................... 32 Political

.................... 45 3115

.................. 16,31 How to deduct

............. 26 

### K **Copyrights**

.................. 29 4562

...................... 26 Incorrect amount **Key person**

.................. 13 **Cost depletion**

.............. 34 5213

....................... 5 deducted

................ 31 **Kickbacks**

................... 43 **Cost of getting lease**

.... 10,28 8826

...................... 26 Partnership organization 8885

...................... 19 **Cost of goods sold**

........... 2 costs

.................... 27 T

.......................... 38 **Cost recovery**

................ 3 

### L Pollution control facilities

.... 32 **Franchise**

............... 29,44 **Covenant not to Leases:**  Reforestation costs

......... 32 **Franchise taxes**

............. 17 **compete**

.................. 29 Canceling

................... 9 Reforestation expenses

..... 24 **Free tax services**

............ 46 Cost of getting

......... 10,28 **Credit card convenience** Related person

............. 30 Improvements by lessee

.... 10 **fees**

....................... 44 **Fringe benefits**

............... 7 Research costs

............ 33 Leveraged

.................. 9 Section 197 intangibles **Fuel taxes**

................... 17 Mineral

.................... 37

defined

.................. 28 

### D Oil and gas

................ 37 Starting a business 

### G Sales distinguished

.......... 9 **De minimis OID**

............. 13 costs

.................... 26 Taxes on

................... 9 **Gas wells**

................... 37 **Debt-financed** Start-up costs

.............. 26 **Legal and professional distributions** 

.............. 12 **Geological and geophysical Anticipated liabilities** 

........ 43 **fees**

....................... 44 **costs: Definitions:**  **Assessments, local**

......... 16 Development, oil and **Licenses**

................ 29,45 Business bad debt

.......... 39 **Assistance**(See Tax help) gas
...................... 32 **Life insurance coverage**

...... 7 Necessary expense

......... 2 **At-risk limits**

................. 4 Exploration, oil and gas

..... 32 Ordinary expense

........... 2 **Limit on deductions**

.......... 5 **Attorney fees**

................ 44 **Geothermal wells**

........ 22,37 Section 197 intangibles

..... 28 **Line of credit**

................ 12 **Awards**

..................... 6,7 **Gifts, nominal value**

.......... 7 **Demolition expenses**

........ 44 **Loans: Going into business** 

.......3,26 Below-market interest **Depletion: Goodwill** 

.................... 29 rate

..................... 14

Mineral property

............ 34 

### B Discounted

................ 14 Oil and gas wells

........... 35 **Bad debts: Loans or Advances** 

........... 8 Percentage table

........... 37 Defined

.................... 39 

### H **Lobbying expenses**

......... 45 Timber

..................... 38 How to treat

................ 39 **Health insurance, deduction for** Who can claim

............. 33 Recovery

.................. 40 **Long-term care self-employed** 

............. 18 **insurance**

................. 18 Types of

................... 39 **Depreciation**(See Cost **Heating equipment**

........... 3 When worthless

............ 39 recovery) **Losses**

..................... 4,5 **Help**(See Tax help) At-risk limits

................. 4 **Bonuses: Development costs,**  Net operating

............... 4 **miners**

.................... 23 Employee

................... 7 Passive activities

............ 4 Royalties

.................. 37 **Disabled, improvements** 

### I **for**

........................ 25 **Bribes**

....................... 43 **Impairment-related Drilling and development**  **Brownfields**(See Environmental **expenses**
................. 44 

### M **costs**

...................... 22 cleanup costs) **Improvements**

................ 3 **Machinery parts**

.............. 3 **Dues, membership**

.......... 44 **Business:** By lessee

.................. 10 **Meals**

....................... 41

Assets

...................... 3 For disabled and elderly

.... 25 **Meals and entertainment**

.... 42 Books and records

......... 29 **Income taxes**

................ 17 **Meals and lodging**

............ 7 

### E Meal expenses

............. 42 **Incorrect amount of Methods of accounting** 

....... 4 **Economic interest**

........... 33 Use of car

...............4,43 **amortization deducted**

.... 31 **Mining: Economic performance** 

...... 4 Use of home

................ 3 **Insurance:** Depletion

.................. 37 **Education expenses**

.......7,44 Capitalized premiums

....... 19 Development costs

......... 23 **Elderly, improvements** Deductible premiums

....... 18 Exploration costs

........... 22 

### C **for**

........................ 25 Nondeductible **More information**(See Tax help) **Campaign contribution**

...... 45 **Employee benefit** premiums

................ 19 **Mortgage**

.................... 12 **Capital expenses**

............. 3 **programs**
.................. 7 Self-employed **Moving expenses, Capitalization of interest** 

.... 14 **Employment taxes**

.......... 17 individuals

............... 18 **machinery**

................ 45 **Car allowance**

............... 42 **Entertainment**

............... 41 **Intangible drilling costs**

..... 22 **Car and truck expenses**

..... 43 **Environmental cleanup Intangibles, amortization** 

.... 28 **Carrying charges**

............ 21 **(remediation) costs**

....... 23 

### N **Interest: Charitable contributions** 

..... 44 **Excise taxes**

................ 17 Allocation of

................ 11 **Natural gas**

.................. 37 **Publication 535**  **(2010)** Page 49

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**Nonqualifying Percentage depletion** 

........ 34 **Removal**

.................... 25 Fuel

....................... 17

**intangibles**

................ 29 Income

.................... 17 **Personal property tax**

....... 17 **Rent expense,** Leased property

............. 9 **Not-for-profit activities**

....... 5 **capitalizing**

................ 10 **Political contributions**

....... 45 Personal property

.......... 17 **Repairs**

..................... 46 **Pollution control** Real estate

................ 16

**facilities**

................... 32 **Repayments (claim of** 

### O Sales

...................... 17 **right)**

...................... 46 **Prepaid expense**

............. 4 **Office in home**

............... 3 Unemployment fund

........ 17 Extends useful life

.......... 21 **Research costs**

......... 22,33 **Oil and gas wells: Taxpayer Advocate** 

.......... 46 Interest

.................... 14 Depletion

.................. 35 **Telephone**

................... 46 Rent

........................ 9 Drilling costs

............... 22 

### S **Timber**

.................. 32,38 **Prepayment penalty**

......... 12 Partnerships

............... 36 **Sales taxes**

.................. 17 **Tools**

......................... 3 **Presumption of profit**

......... 5 S corporations

............. 36 **Section 179 expense deduction Trademark, trade name** 

..... 29, **Publications**(See Tax help) **Optional write-off method:** (See Cost recovery) 44 Circulation costs

........... 33 **Self-employed health insurance Travel** 

....................... 41 Experimental costs

......... 33 

### R **deduction**

................. 18 **TTY/TDD information**

........ 46 Intangible drilling and **Real estate taxes**

............ 16 **Self-employment tax**

........ 17

development costs

....... 33 **Recapture: Self-insurance, reserve**  Mining exploration and 

### U Exploration expenses

....... 23 **for**

........................ 19 development costs

....... 33 **Unemployment fund** Timber property

............ 32 **Sick pay**

...................... 8 Research costs

............ 33 **taxes**

...................... 17 **Recovery of amount Standard meal allowance** 

.... 42 **Organization costs: Unpaid expenses, related**  **deducted**

................... 4 **Standard mileage rate**

....... 42 Corporate

.................. 27 **person**
.................... 14 **Refiners who cannot claim Standby charges** 

............ 13 Partnership

................ 27 **Utilities**

...................... 46 **percentage depletion**

...... 35 **Start-up costs**

........... 24,26 **Organizational costs**

........ 24 **Reforestation costs**

..... 24,32 **Subscriptions**

............... 46 **Original issue discount**

...... 12 **Regulatory fees**

............. 45 

### V **Suggestions for Outplacement services** 

...... 45 **Reimbursements**

............ 41 **Vacation pay**

................. 8 **publication**

................. 1 Business expenses

.......... 8 **Supplies and materials**

...... 46 

### P Mileage

.................... 42 

### W **Passive activities**

............. 4 Nonaccountable plan

....... 43 **Wages:** 

### T Per diem

................... 42 **Payments in kind**

............. 4 Property

.................... 8 **Tax help**

..................... 46 **Related persons: Penalties** 

.................... 12 Tests for deducting pay

...... 6 **Tax preparation fees**

........ 45 Anti-churning rules

......... 30 Deductible

................. 45 **Welfare benefit funds**

......... 7 **Taxes**

........................ 9 Coal or iron ore

............ 37 Nondeductible

............. 45 Carrying charge

............ 21 Payments to

.............5, 14 Prepayment

................ 12 

### ■ Employment

............... 17 Refiners

................... 35 **Per diem and car** Excise

..................... 17 Rent expense

............... 8 **allowances**

................ 42 Franchise

.................. 17 Unreasonable rent

........... 8

Page 50 **Publication 535**  **(2010)**