Federal Taxation

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bad debts

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A deduction is permitted if a business account receivable subsequently becomes partially or completely worthless, providing the income arising from the debt previously was included in income. Available methods are the specific charge-off method and the reserve method. However, except for certain financial institutions, TRA of 1986 repealed the use of the reserve method for 1987 and thereafter. If the reserve method is used, partially or totally worthless accounts are charged to the reserve. A nonbusiness bad debt deduction is allowed as a short-term capital loss if the loan did not arise in connection with the creditor’s trade or business activities. Loans between related parties (family members) generally are classified as nonbusiness. § 166.

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business bad debt

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A tax deduction allowed for obligations obtained in connection with a trade or business that have become either partially or completely worthless. In contrast to nonbusiness bad debts, business bad debts are deductible as business expenses. § 166.

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casualty loss

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casualty is defined as “the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected or unusual nature” (e.g., floods, storms, fires, auto accidents). Individuals may deduct a casualty loss only if the loss is incurred in a trade or business or in a transaction entered into for profit or arises from fire, storm, shipwreck, or other casualty or from theft. Individuals usually deduct personal casualty losses as itemized deductions subject to a $100 ($500 in 2009) nondeductible amount and to an annual floor equal to 10 percent of adjusted gross income that applies after the $100 ($500 for 2009) per casualty floor has been applied. Special rules are provided for the netting of certain casualty gains and losses.

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disaster area loss

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A casualty sustained in an area designated as a disaster area by the President of the United States. In such an event, the disaster loss may be treated as having occurred in the taxable year immediately preceding the year in which the disaster actually occurred. Thus, immediate tax benefits are provided to victims of a disaster. § 165(i).

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domestic production gross receipts (DPGR)

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A key component in computing the domestic production activities deduction (DPAD). Includes receipts from the sale and other disposition of qualified production property produced in significant part within the United States. DPGR is defined in § 199(c)(4).

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modified adjusted gross income

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A key determinant in computing the domestic production activities deduction (DPAD). The deduction is limited to a percentage of the lesser of qualified production activities income (QPAI) or modified adjusted gross income. Aside from limited changes required by § 199(d)(2)(A), modified adjusted gross income is AGI as usually determined but without any domestic production activities deduction.

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net operating loss

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To mitigate the effect of the annual accounting period concept, § 172 allows taxpayers to use an excess loss of one year as a deduction for certain past or future years. In this regard, a carryback period of 2 years and a carryforward period of 20 years currently are allowed.

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nonbusiness bad deb

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A bad debt loss that is not incurred in connection with a creditor’s trade or business. The loss is classified as a short-term capital loss and is allowed only in the year the debt becomes entirely worthless. In addition to family loans, many investor losses are nonbusiness bad debts. § 166(d).

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personal casualty gain

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The recognized gain from any involuntary conversion of personal use property arising from fire, storm, shipwreck, or other casualty, or from theft.

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personal casualty loss

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The recognized loss from any involuntary conversion of personal use property arising from fire, storm, shipwreck, or other casualty, or from theft.

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qualified production activities income (QPAI)

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A key determinant in computing the domestic production activities deduction (DPAD). It consists of domestic production gross receipts (DPGR) reduced by cost of goods sold and other assignable expenses. Thus, QPAI represents the profit derived from domestic production activities. § 199.

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research and experimental expenditures

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The Code provides three alternatives for the tax treatment of research and experimentation expenditures. They may be expensed in the year paid or incurred, deferred subject to amortization, or capitalized. If the taxpayer does not elect to expense such costs or to defer them subject to amortization (over 60 months), the expenditures must be capitalized. § 174. Three types of research activities credits are available: the basic research credit, the incremental research activities credit, and the energy credit. The rate for each type is 20 percent. § 41.

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reserve method

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A method of accounting whereby an allowance is permitted for estimated uncollectible accounts. Actual write-offs are charged to the reserve, and recoveries of amounts previously written off are credited to the reserve. The Code permits only certain financial institutions to use the reserve method. § 166.

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specific charge-off method

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A method of accounting for bad debts in which a deduction is permitted only when an account becomes partially or completely worthless.

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theft loss

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A loss from larceny, embezzlement, or robbery. It does not include misplacement of items.

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W–2 wages

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The domestic production activities deduction (DPAD) cannot exceed50 percent of the W–2 wages paid for any particular year. Prop.Reg. § 199–2(f)(2) provides several methods for calculating the W–2 wages, but the payments must involve common law employees. To qualify, employees need to be involved in the production process. §199.

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worthless securities

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A loss (usually capital) is allowed for a security that becomes worthless during the year. The loss is deemed to have occurred on the last day of the year. Special rules apply to securities of affiliated companies and small business stock. § 165.