2. Discuss the Concepts of Ordinary, Necessary, and Reasonable in Relation to Trade Or

Ch6.
1. Discuss the definition of trade or business. Why does it matter whether a taxpayer is classified as an employee or as self-employed?

A trade or business is any activity that is engaged in for profit. The profit motive is necessary, and the activity should be engaged in with continuity and regularity. The income from a sole proprietor is netted with related ordinary and necessary business expenses to determine the effect on AGI.

2. Discuss the concepts of ordinary, necessary, and reasonable in relation to trade or business expenses.

Ordinary: it must be customary or usual in the taxpayer’s particular business.

Necessary: refers to an expense that is appropriate and helpful rather than one that is essential to the taxpayer’s business.

Reasonable: reasonable in amount and reasonable in relation to its purpose. In most situations, making payments to related parties that are larger than normally required where the payee is an unrelated third party violated the reasonableness standard.

IRS provides the simple possible expenses to deductible, since many are self –explanatory, but the listed expense are not exhaustive. This is preventing a lot of unrelated expenses to deductible and the conditions are limits.

9. Discuss the concept of electing §179 expense. Does the election allow a larger expense deduction in the year of asset acquisition?

The §179 deduction is designed to benefit small businesses by permitting them to expense the cost of the assets in the year of purchase rather than over time. The expense is allowed in full only if the total of personal property purchases is less than $2,000,000 in 2010 in aggregate cost. The expense election is phased out dollar-for-dollar for purchases in excess of $2,000,000. Thus the expense election is completely eliminated when asset purchases reach $2,500,000.

15. Why were the hobby loss rules established? What factors determine whether an activity is a trade or business or a hobby? Is any one factor controlling?

Congress established the hobby loss rules with 9 factors, if an activity is characterized as a hobby rather than a trade or business.
1. Manner in which the taxpayer carries on activity.
2. Expertise of the taxpayer or his or her advisors.
3. Time and effort extended by the taxpayer in carrying on the activity.
4. Expectations that assets used in the activity can appreciate in value.
5. Success of taxpayer in carrying on other similar or dissimilar activities.
6. Taxpayer’s history of income or losses with respect to the activity.
7. Amount of occasional profit, if any, that are earned.
8. Taxpayer’s financial status.
9. Elements of personal pleasure or recreation.
The regulations note that taxpayers are to take all of the facts and circumstances into account and that no one factor is controlling in the hobby determination. If the IRS asserts that an activity is a hobby, the burden to prove that the activity is a trade or business rests with the taxpayer. If the taxpayer has shown a profit for three out of five consecutive tax years( two out of seven for horse racing), the burden of proof shifts to the IRS.

Ch7.

1. How are the terms basis, adjusted basis, and fair market value defined as they apply to the calculation of gains and losses?

a. Basis is defined as the cost of the property bought in cash, debt obligations, or other property of services. Property can also be acquired other than through a purchase as by gift, inheritance, divorces, or other exchange.

b. Adjusted basis is the cost including any increases made to the property such as additions made to property or commission fees incurred on stock transactions and decreases such as depreciation on property of stock dividends or splits.

c. Fair market value is the price at which the property would change hands between a buyer and a seller, neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts. Sales of similar property, around the same date are typically used in figuring fair market value.

2. What is meant by the terms realized gain (loss) and recognized gain (loss) as they apply to the sale of assets by a taxpayer?

A sale or trade of property is everything the taxpayer receivers in the transaction. This includes cash received plus the FMV of any property or services received plus the amount of any debt assumed by the purchaser. The difference between the amount realized and the adjusted basis determines if there is a gain or loss on the sale. A sale or trade of property is the amount that will be recorded on the tax return as a gain or loss. Gains and losses can be realized and recognized, or they can be realized and not recognized, such as in nontaxable exchange, or a loss on the disposition of property that is held for personal use, or a gain that is excluded as with the sale of a residence.

8. What are the different classifications of capital assets? Define each classification and explain the difference in the preferential tax treatment (the rate at which the gains are taxed).

1. ordinary income property: is the any asset that is” not a capital asset.” the tow most common ordinary assets are inventory and accounts or notes receivable.

2. §1221 Capital property (capital Assets): any asset used for personal purposes or investment. A common example of a capital asset is an investment in stocks or bonds.

3. §1231trade or business property: depreciable or non-depreciable property (such as land) used in a trade or business and held for more than one year. The most typical examples of §1231 assets are machinery and equipment used in a business, business buildings, and business land.

This is posted by May 5, 2003.

Collectibles 28% rate

IRC §1202 Gain 28% rate

Un-recaptured §1250 Gain 25% rate

Other Capital Gains when in the 25% or higher tax bracket 15% rate

Other Capital Gains when the tax bracket is less than 25% 0% rate *

* beginning in 2008

12. How is a net capital loss treated? Include in your answer a discussion of how a net capital loss is treated in relation to other income.

The condition of in net capital loss treated:

Net short-term gain and net long-term loss: A long term loss is offset against a short-term gain. If a net short-term gain results, the short-term gain is taxed using regular tax rates. If a long-term loss results, the loss, up to $3,000. Reduces other income, and any excess carries forward indefinitely.

Net short-term loss and net long-term gain: in this case, separate the long-term gains into 28%, 25% or 0% groups. Any net short-term loss is first offset against the 28% group, then the 25% group, and if any loss remains, the 15% or 0% group.

Net short-term loss and net long-term loss: in this case, only $3,000 of the loss is deductible against other income in any one year. First, the short-term losses are deducted against other income, and if any of the $3,000 maximum remains, deduct the long-term loss up to the maximum $3,000 annual loss limit.

Excess losses are carried forward to the next year and retain their original character. A short-term loss carries over as a short-term loss, and a long-term loss carries over as a long-term loss.