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Publication 535

Cat. No. 15065Z Contents

Introduction . . . . . . . . . . . . . . . . . . 1
of the What's New for 2015 . . . . . . . . . . . . . 2

Internal What's New for 2016 . . . . . . . . . . . . . 2
Service Reminders . . . . . . . . . . . . . . . . . . . 2

Chapter 1. Deducting Business

For use in preparing Expenses . . . . . . . . . . . . . . . . . 2

2015 Returns
Chapter 2. Employees' Pay . . . . . . . . 6

Chapter 3. Rent Expense ......... 8

Chapter 4. Interest . . . . . . . . . . . . 11

Chapter 5. Taxes . . . . . . . . . . . . . 16

Chapter 6. Insurance . . . . . . . . . . . 18

Chapter 7. Costs You Can Deduct

or Capitalize . . . . . . . . . . . . . . 22

Chapter 8. Amortization . . . . . . . . . 26

Chapter 9. Depletion . . . . . . . . . . . 33

Chapter 10. Business Bad Debts . . . . 38

Chapter 11. Other Expenses . . . . . . 41

Chapter 12. How To Get Tax Help . . . 47

Index . . . . . . . . . . . . . . . . . . . . . 52

This publication discusses common business
expenses and explains what is and is not de
ductible. The general rules for deducting busi
ness 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.
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Get forms and other information faster and easier at: we revise our tax products. (English) () (Espaol) (P) Ordering forms and publications. You () (TingVit) can order forms, instructions, and publications

Jan 07, 2016

online at You can also e-file include faster refunds, increased
visit to download forms, accuracy, and acknowledgment of IRS receipt
instructions, and publications. of your return. You can use one of the following
IRS e-file options. 1.
Tax questions. If you have a tax question, Use an authorized IRS e-file provider.
check the information available on or
Use a personal computer.
call 18008294933. We cannot answer tax
questions sent to the above address. Visit a Volunteer Income Tax Assistance Deducting
(VITA) or Tax Counseling for the Elderly
(TCE) site.
Future Developments For details on these fast filing methods, see

For the latest information about developments

your income tax package.
Form 1099-MISC. File Form 1099MISC, Mis
related to Publication 535, such as legislation cellaneous Income, for each person to whom
enacted after it was published, go to you have paid during the year in the course of your trade or business at least $600 in rents, Introduction
services (including parts and materials), prizes
and awards, other income payments, medical This chapter covers the general rules for de
and health care payments, and crop insurance ducting business expenses. Business expen
What's New for 2015 proceeds. See the Instructions for Form ses are the costs of carrying on a trade or busi
1099MISC for more information and additional ness, and they are usually deductible if the
The following items highlight some changes in business is operated to make a profit.
reporting requirements.
the tax law for 2015.
Premium tax credit. You may have to use the Photographs of missing children. The Inter
nal Revenue Service is a proud partner with the Topics
worksheets in Publication 974 instead of the This chapter discusses:
worksheet in chapter 6. For more information, National Center for Missing & Exploited
see chapter 6. Children. Photographs of missing children se
lected by the Center may appear in this publica What you can deduct
Film and television production costs. Legis
tion on pages that would otherwise be blank. How much you can deduct
lation signed into law on December 18, 2015,
You can help bring these children home by
has renewed the provision regarding the elec When you can deduct
looking at the photographs and calling
tion to expense film and television production Notforprofit activities
1800THELOST (18008435678) (24 hours
costs. For more information, see chapter 7.
a day, 7 days a week) if you recognize a child.
Standard mileage rate. Beginning in 2015,
the standard mileage rate for the cost of operat Preventing slavery and human trafficking. Useful Items
ing your car, van, pickup, or panel truck for Human trafficking is a form of modernday slav You may want to see:
each mile of business use is 57.5 cents per ery, and involves the use of force, fraud, or co
mile. For more information, see chapter 11. ercion to exploit human beings for some type of
labor or commercial sex purpose. The United
States is a source, transit, and destination 334 Tax Guide for Small Business
country for men, women, and children, both
What's New for 2016 U.S. citizens and foreign nationals, who are
subjected to the injustices of slavery and hu
463 Travel, Entertainment, Gift, and Car
The following items highlight a change in the tax man trafficking, including forced labor, debt
525 Taxable and Nontaxable Income
law for 2016. bondage, involuntary servitude, and sex traf
Form 1099MISC new filing date. New filing ficking. Trafficking in persons can occur in both 529 Miscellaneous Deductions
date.Public Law 114113, Division Q, section lawful and illicit industries or markets, including
201, requires Form 1099MISC to be filed on or in hotel services, hospitality, agriculture, manu 536 Net Operating Losses (NOLs) for
before January 31, 2017, when you are report facturing, janitorial services, construction, Individuals, Estates, and Trusts
ing nonemployee compensation payments in health and elder care, domestic service, broth
538 Accounting Periods and Methods
box 7. Otherwise, file by February 28, 2017, if els, massage parlors, and street prostitution,
you file on paper, or by March 31, 2017, if you among others. 542 Corporations
file electronically. The due dates for furnishing Many U.S. government and nongovern
payee statements remain the same. 547 Casualties, Disasters, and Thefts
mental entities are involved in combating hu
Standard mileage rate. Beginning in 2016, man trafficking. Online resources for recogniz 583 Starting a Business and Keeping
the standard mileage rate for the cost of operat ing and reporting trafficking activities, and Records
ing your car, van, pickup, or panel truck for assisting victims include the Department of
each mile of business use is 54 cents per mile. Homeland Security (DHS) Blue Campaign at 587 Business Use of Your Home, the Depart
925 Passive Activity and AtRisk Rules
ment of State Office to Monitor and Combat
Trafficking in Persons at 936 Home Mortgage Interest
Reminders tip/, and the National Human Trafficking Re Deduction
source Center (NHTRC) at http://
The following reminders and other items may You can also call 946 How To Depreciate Property
help you file your tax return. the DHS domestic 24hour tollfree number at
1866DHS2ICE (18663472423) or Form (and Instructions)
IRS e-file (Electronic Filing) 18028726199 (nontollfree international), or
Sch A (Form 1040) Itemized Deductions
the NHTRC toll free at 18883737888.
5213 Election To Postpone
Determination as To Whether the
Presumption Applies That an
Activity Is Engaged in for Profit

You can file your tax returns electronically See chapter 12 for information about getting
using an IRS e-file option. The benefits of IRS publications and forms.

Page 2 Chapter 1 Deducting Business Expenses

in your business and are called capital expen recover the costs of these assets when you dis

What Can I Deduct? ses. Capital expenses are considered assets

in your business. In general, you capitalize
pose of them.

three types of costs. Business Assets

To be deductible, a business expense must be Business startup costs (See Tip below).
both ordinary and necessary. An ordinary ex
Business assets. There are many different kinds of business as
pense is one that is common and accepted in
Improvements. sets; for example, land, buildings, machinery,
your industry. A necessary expense is one that
furniture, trucks, patents, and franchise rights.
is helpful and appropriate for your trade or busi
You can elect to deduct or amortize You must fully capitalize the cost of these as
ness. An expense does not have to be indis
certain business start-up costs. See sets, including freight and installation charges.
pensable to be considered necessary. TIP
chapters 7 and 8.
Even though an expense may be ordinary Certain property you produce for use in your
and necessary, you may not be allowed to de trade or business must be capitalized under the
Cost recovery. Although you generally cannot
duct the expense in the year you paid or incur uniform capitalization rules. See Regulations
take a current deduction for a capital expense,
red it. In some cases you may not be allowed to section 1.263A2 for information on these rules.
you may be able to recover the amount you
deduct the expense at all. Therefore, it is impor
spend through depreciation, amortization, or
tant to distinguish usual business expenses
from expenses that include the following.
depletion. These recovery methods allow you to Improvements
deduct part of your cost each year. In this way,
The expenses used to figure cost of goods
you are able to recover your capital expense. Improvements are generally major expendi
See Amortization (chapter 8) and Depletion tures. Some examples are new electric wiring, a
Capital expenses.
(chapter 9) in this publication. A taxpayer can new roof, a new floor, new plumbing, bricking
Personal expenses. elect to deduct a portion of the costs of certain up windows to strengthen a wall, and lighting
depreciable property as a section 179 deduc improvements.
tion. A greater portion of these costs can be de
Cost of Goods Sold ducted if the property is qualified disaster assis Generally, you must capitalize the costs of
tance property. See Pub. 946 for details. making improvements to a business asset if the
If your business manufactures products or pur
chases them for resale, you generally must improvements result in a betterment to the unit
value inventory at the beginning and end of Going Into Business of property, restore the unit of property, or adapt
each tax year to determine your cost of goods the unit of property to a new or different use.
sold. Some of your business expenses may be The costs of getting started in business, before
included in figuring cost of goods sold. Cost of you actually begin business operations, are However, you can currently deduct repairs
goods sold is deducted from your gross re capital expenses. These costs may include ex that keep your property in a normal efficient op
ceipts to figure your gross profit for the year. If penses for advertising, travel, or wages for erating condition as a business expense. Treat
you include an expense in the cost of goods training employees. as repairs amounts paid to replace parts of a
sold, you cannot deduct it again as a business machine that only keep it in a normal operating
expense. If you go into business. When you go into condition.
business, treat all costs you had to get your
The following are types of expenses that go business started as capital expenses. Restoration plan. Capitalize the cost of recon
into figuring cost of goods sold. Usually you recover costs for a particular as ditioning, improving, or altering your property as
The cost of products or raw materials, in set through depreciation. Generally, you cannot part of a general restoration plan to make it suit
cluding freight. recover other costs until you sell the business able for your business. This applies even if
Storage. or otherwise go out of business. However, you some of the work would by itself be classified as
Direct labor (including contributions to pen can choose to amortize certain costs for setting repairs.
sion or annuity plans) for workers who pro up your business. See Starting a Business in
duce the products. chapter 8 for more information on business
Factory overhead. startup costs. Capital Versus Deductible
Under the uniform capitalization rules, you If your attempt to go into business is un-
must capitalize the direct costs and part of the successful. If you are an individual and your To help you distinguish between capital and de
indirect costs for certain production or resale attempt to go into business is not successful, ductible expenses, different examples are given
activities. Indirect costs include rent, interest, the expenses you had in trying to establish below.
taxes, storage, purchasing, processing, repack yourself in business fall into two categories.
aging, handling, and administrative costs.
1. The costs you had before making a deci Motor vehicles. You usually capitalize the
This rule does not apply to personal prop sion to acquire or begin a specific busi cost of a motor vehicle you use in your busi
erty you acquire for resale if your average an ness. These costs are personal and non ness. You can recover its cost through annual
nual gross receipts (or those of your predeces deductible. They include any costs deductions for depreciation.
sor) for the preceding 3 tax years are not more incurred during a general search for, or There are dollar limits on the depreciation
than $10 million. preliminary investigation of, a business or you can claim each year on passenger automo
investment possibility. biles used in your business. See Pub. 463.
For more information, see the following
sources. 2. The costs you had in your attempt to ac Generally, repairs you make to your busi
Cost of goods soldchapter 6 of Pub. quire or begin a specific business. These ness vehicle are currently deductible. However,
334. costs are capital expenses and you can amounts you pay to recondition and overhaul a
InventoriesPub. 538. deduct them as a capital loss. business vehicle are capital expenses and are
recovered through depreciation.
Uniform capitalization rulesPub. 538 and If you are a corporation and your attempt to
section 263A of the Internal Revenue Code go into a new trade or business is not success Roads and driveways. The cost of building a
and the related regulations. ful, you may be able to deduct all investigatory private road on your business property and the
costs as a loss. cost of replacing a gravel driveway with a con
Capital Expenses The costs of any assets acquired during crete one are capital expenses you may be able
your unsuccessful attempt to go into business to depreciate. The cost of maintaining a private
You must capitalize, rather than deduct, some are a part of your basis in the assets. You can road on your business property is a deductible
costs. These costs are a part of your investment not take a deduction for these costs. You will expense.

Chapter 1 Deducting Business Expenses Page 3

Tools. Unless the uniform capitalization rules If you have more than one business loca
apply, amounts spent for tools used in your
business are deductible expenses if the tools
tion, determine your principal place of business
based on the following factors. How Much Can I
have a life expectancy of less than 1 year or
their cost is minor.
The relative importance of the activities
performed at each location.
If the relative importance factor does not
Generally, you can deduct the full amount of a
Machinery parts. Unless the uniform capitali determine your principal place of business,
business expense if it meets the criteria of ordi
zation rules apply, the cost of replacing consider the time spent at each location.
nary and necessary and it is not a capital ex
shortlived parts of a machine to keep it in good
Optional safe harbor method. Individual pense.
working condition, but not add to its life, is a de
ductible expense. taxpayers can use the optional safe harbor
method to determine the amount of deductible Recovery of amount deducted (tax benefit
expenses attributable to certain business use of rule). If you recover part of an expense in the
Heating equipment. The cost of changing
a residence during the tax year. This method is same tax year in which you would have claimed
from one heating system to another is a capital
an alternative to the calculation, allocation, and a deduction, reduce your current year expense
substantiation of actual expenses. by the amount of the recovery. If you have a re
The deduction under the optional method is covery in a later year, include the recovered
Personal Versus Business limited to $1,500 per year based on $5 a square amount in income in that year. However, if part
Expenses foot for up to 300 square feet. Under this of the deduction for the expense did not reduce
method, you claim your allowable mortgage in your tax, you do not have to include that part of
terest, real estate taxes, and casualty losses on the recovered amount in income.
Generally, you cannot deduct personal, living,
the home as itemized deductions on Sched For more information on recoveries and the
or family expenses. However, if you have an ex
ule A (Form 1040). You are not required to allo tax benefit rule, see Pub. 525.
pense for something that is used partly for busi
cate these deductions between personal and
ness and partly for personal purposes, divide
business use, as is required under the regular Payments in kind. If you provide services to
the total cost between the business and per
method. If you use the optional method, you pay a business expense, the amount you can
sonal parts. You can deduct the business part.
cannot depreciate the portion of your home deduct is limited to your outofpocket costs.
used in a trade or business. You cannot deduct the cost of your own labor.
For example, if you borrow money and use
Business expenses unrelated to the home, Similarly, if you pay a business expense in
70% of it for business and the other 30% for a
such as advertising, supplies, and wages paid goods or other property, you can deduct only
family vacation, you generally can deduct 70%
to employees, are still fully deductible. All of the what the property costs you. If these costs are
of the interest as a business expense. The re
requirements discussed earlier under Business included in the cost of goods sold, do not de
maining 30% is personal interest and generally
use of your home still apply. duct them again as a business expense.
is not deductible. See chapter 4 for information
For more information on the deduction for
on deducting interest and the allocation rules.
business use of your home, including the op Limits on losses. If your deductions for an in
tional safe harbor method, see Pub. 587. vestment or business activity are more than the
Business use of your home. If you use part
of your home for business, you may be able to If you were entitled to deduct depreci- income it brings in, you have a loss. There may
deduct expenses for the business use of your ation on the part of your home used for be limits on how much of the loss you can de
home. These expenses may include mortgage
CAUTION business, you cannot exclude the part duct.
interest, insurance, utilities, repairs, and depre of the gain from the sale of your home that Not-for-profit limits. If you carry on your
ciation. equals any depreciation you deducted (or could business activity without the intention of making
To qualify to claim expenses for the busi have deducted) for periods after May 6, 1997. a profit, you cannot use a loss from it to offset
ness use of your home, you must meet both of other income. See Not-for-Profit Activities, later.
the following tests. Business use of your car. If you use your car
At-risk limits. Generally, a deductible loss
1. The business part of your home must be exclusively in your business, you can deduct
car expenses. If you use your car for both busi from a trade or business or other incomepro
used exclusively and regularly for your ducing activity is limited to the investment you
trade or business. ness and personal purposes, you must divide
your expenses based on actual mileage. Gen have at risk in the activity. You are at risk in
2. The business part of your home must be: erally, commuting expenses between your any activity for the following.
a. Your principal place of business; or home and your business location, within the 1. The money and adjusted basis of property
area of your tax home, are not deductible. you contribute to the activity.
b. A place where you meet or deal with You can deduct actual car expenses, which
patients, clients, or customers in the 2. Amounts you borrow for use in the activity
include depreciation (or lease payments), gas
normal course of your trade or busi if:
and oil, tires, repairs, tuneups, insurance, and
ness; or registration fees. Or, instead of figuring the a. You are personally liable for repay
c. A separate structure (not attached to business part of these actual expenses, you ment, or
your home) used in connection with may be able to use the standard mileage rate to
figure your deduction. Beginning in 2015, the b. You pledge property (other than prop
your trade or business. erty used in the activity) as security for
standard mileage rate is 57.5 cents per mile.
You generally do not have to meet the ex the loan.
If you are selfemployed, you can also de
clusive use test for the part of your home that duct the business part of interest on your car For more information, see Pub. 925.
you regularly use either for the storage of inven loan, state and local personal property tax on
tory or product samples, or as a daycare facility. the car, parking fees, and tolls, whether or not Passive activities. Generally, you are in a
Your home office qualifies as your principal you claim the standard mileage rate. passive activity if you have a trade or business
place of business if you meet the following re For more information on car expenses and activity in which you do not materially partici
quirements. the rules for using the standard mileage rate, pate, or a rental activity. In general, deductions
You use the office exclusively and regu see Pub. 463. for losses from passive activities only offset in
larly for administrative or management ac come from passive activities. You cannot use
tivities of your trade or business. any excess deductions to offset other income.
You have no other fixed location where In addition, passive activity credits can only off
you conduct substantial administrative or set the tax on net passive income. Any excess
management activities of your trade or loss or credits are carried over to later years.
business. Suspended passive losses are fully deductible

Page 4 Chapter 1 Deducting Business Expenses

in the year you completely dispose of the activ create an asset with a useful life extending sub You can expect to make a future profit from
ity. For more information, see Pub. 925. stantially beyond the end of the current tax the appreciation of the assets used in the
year. activity.
Net operating loss. If your deductions are
more than your income for the year, you may Example. In 2015, you sign a 10year lease Presumption of profit. An activity is pre
have a net operating loss. You can use a net and immediately pay your rent for the first 3 sumed carried on for profit if it produced a profit
operating loss to lower your taxes in other years. Even though you paid the rent for 2015, in at least 3 of the last 5 tax years, including the
years. See Pub. 536 for more information. 2016, and 2017, you can only deduct the rent current year. Activities that consist primarily of
See Pub. 542 for information about net oper for 2015 on your 2015 tax return. You can de breeding, training, showing, or racing horses
ating losses of corporations. duct the rent for 2016 and 2017 on your tax re are presumed carried on for profit if they pro
turns for those years. duced a profit in at least 2 of the last 7 tax
years, including the current year. The activity
When Can I Contested liability. Under the cash method, must be substantially the same for each year
Deduct an Expense? you can deduct a contested liability only in the
year you pay the liability. Under the accrual
within this period. You have a profit when the
gross income from an activity exceeds the de
method, you can deduct contested liabilities ductions.
When you can deduct an expense depends on such as taxes (except foreign or U.S. posses If a taxpayer dies before the end of the
your accounting method. An accounting
sion income, war profits, and excess profits 5year (or 7year) period, the test period ends
method is a set of rules used to determine when
taxes) either in the tax year you pay the liability on the date of the taxpayer's death.
and how income and expenses are reported.
(or transfer money or other property to satisfy If your business or investment activity
The two basic methods are the cash method
the obligation) or in the tax year you settle the passes this 3 (or 2) yearsofprofit test, the
and the accrual method. Whichever method
contest. However, to take the deduction in the IRS will presume it is carried on for profit. This
you choose must clearly reflect income.
year of payment or transfer, you must meet cer means the limits discussed here will not apply.
For more information on accounting meth tain conditions. See Regulations section You can take all your business deductions from
ods, see Pub. 538. 1.4612. the activity, even for the years that you have a
loss. You can rely on this presumption unless
Cash method. Under the cash method of ac Related person. Under an accrual method of the IRS later shows it to be invalid.
counting, you generally deduct business expen accounting, you generally deduct expenses
ses in the tax year you pay them. when you incur them, even if you have not yet Using the presumption later. If you are start
paid them. However, if you and the person you ing an activity and do not have 3 (or 2) years
Accrual method. Under an accrual method of owe are related and that person uses the cash showing a profit, you can elect to have the pre
accounting, you generally deduct business ex method of accounting, you must pay the ex sumption made after you have the 5 (or 7) years
penses when both of the following apply. pense before you can deduct it. Your deduction of experience allowed by the test.
is allowed when the amount is includible in in You can elect to do this by filing Form 5213.
1. The allevents test has been met. The test come by the related cash method payee. See Filing this form postpones any determination
is met when: Related Persons in Pub. 538. that your activity is not carried on for profit until
a. All events have occurred that fix the 5 (or 7) years have passed since you started
fact of liability, and the activity.
b. The liability can be determined with
Not-for-Profit Activities The benefit gained by making this election is
that the IRS will not immediately question
reasonable accuracy.
If you do not carry on your business or invest whether your activity is engaged in for profit.
2. Economic performance has occurred. ment activity to make a profit, you cannot use a Accordingly, it will not restrict your deductions.
loss from the activity to offset other income. Ac Rather, you will gain time to earn a profit in the
Economic performance. You generally required number of years. If you show 3 (or 2)
tivities you do as a hobby, or mainly for sport or
cannot deduct or capitalize a business expense years of profit at the end of this period, your de
recreation, are often not entered into for profit.
until economic performance occurs. If your ex ductions are not limited under these rules. If you
pense is for property or services provided to The limit on notforprofit losses applies to do not have 3 (or 2) years of profit, the limit can
you, or for your use of property, economic per individuals, partnerships, estates, trusts, and S be applied retroactively to any year with a loss
formance occurs as the property or services are corporations. It does not apply to corporations in the 5year (or 7year) period.
provided, or the property is used. If your ex other than S corporations. Filing Form 5213 automatically extends the
pense is for property or services you provide to period of limitations on any year in the 5year
others, economic performance occurs as you In determining whether you are carrying on (or 7year) period to 2 years after the due date
provide the property or services. an activity for profit, several factors are taken of the return for the last year of the period. The
into account. No one factor alone is decisive. period is extended only for deductions of the
Example. Your tax year is the calendar Among the factors to consider are whether: activity and any related deductions that might
year. In December 2015, the Field Plumbing You carry on the activity in a businesslike be affected.
Company did some repair work at your place of
business and sent you a bill for $600. You paid You must file Form 5213 within 3
The time and effort you put into the activity
it by check in January 2016. If you use the ac years after the due date of your return
indicate you intend to make it profitable, TIP
crual method of accounting, deduct the $600 on (determined without extensions) for
You depend on the income for your liveli
your tax return for 2015 because all events the year in which you first carried on the activity,
have occurred to fix the fact of liability (in this or, if earlier, within 60 days after receiving writ-
Your losses are due to circumstances be
case, the work was completed), the liability can ten notice from the IRS proposing to disallow
yond your control (or are normal in the
be determined, and economic performance oc deductions attributable to the activity.
startup phase of your type of business),
curred in that year.
You change your methods of operation in
If you use the cash method of accounting,
deduct the expense on your 2016 return.
an attempt to improve profitability,
You (or your advisors) have the knowledge
Gross Income
needed to carry on the activity as a suc
Prepayment. You generally cannot deduct ex Gross income from a notforprofit activity in
cessful business,
penses in advance, even if you pay them in ad cludes the total of all gains from the sale, ex
You were successful in making a profit in
vance. This rule applies to both the cash and change, or other disposition of property, and all
similar activities in the past,
accrual methods. It applies to prepaid interest, other gross receipts derived from the activity.
The activity makes a profit in some years,
prepaid insurance premiums, and any other ex Gross income from the activity also includes
pense paid far enough in advance to, in effect, capital gains and rents received for the use of

Chapter 1 Deducting Business Expenses Page 5

property which is held in connection with the ac Gross income . . . . . . . . . . . . . . . . . . . . . . $3,200 If you are carrying on two or more dif-
tivity. TIP ferent activities, keep the deductions
Subtract: and income from each one separate.
You can determine gross income from any Real estate taxes . . . . . . . . . . . . . $700
Figure separately whether each is a
notforprofit activity by subtracting the cost of Home mortgage interest . . . . . . . . 900
not-for-profit activity. Then figure the limit on de-
goods sold from your gross receipts. However, Insurance . . . . . . . . . . . . . . . . . . 400
Utilities . . . . . . . . . . . . . . . . . . . . 700 ductions and losses separately for each activity
if you determine gross income by subtracting that is not for profit.
Maintenance . . . . . . . . . . . . . . . . 200
cost of goods sold from gross receipts, you Depreciation on an automobile . . . 600
must do so consistently, and in a manner that Depreciation on a machine . . . . . . 200 3,700
follows generally accepted methods of account
ing. Loss . . . . . . . . . . . . . . . . . . . . . $(500)

Limit on Deductions Adriana must limit her deductions to $3,200,

If your activity is not carried on for profit, take

the gross income she earned from the activity.
The limit is reached in category (3), as follows. 2.
deductions in the following order and only to the
extent stated in the three categories. If you are Limit on deduction $3,200
Employees' Pay
. . . . . . . . . . . . . . . . . . . .
an individual, these deductions may be taken
Category 1: Taxes and interest . . . $1,600
only if you itemize. These deductions may be Category 2: Insurance, utilities, and
taken on Schedule A (Form 1040). maintenance . . . . . . . . . . . . . . . . 1,300 2,900

Category 1. Deductions you can take for per Available for Category 3 . . . . . . . . . . $ 300
sonal as well as for business activities are al
lowed in full. For individuals, all nonbusiness The $800 of depreciation is allocated be You can generally deduct the amount you pay
deductions, such as those for home mortgage tween the automobile and machine as follows. your employees for the services they perform.
interest, taxes, and casualty losses, belong in The pay may be in cash, property, or services. It
$600 depreciation for the may include wages, salaries, bonuses, commis
this category. Deduct them on the appropriate $800
x $300 = $225
lines of Schedule A (Form 1040). sions, or other noncash compensation such as
You can deduct a casualty loss on property vacation allowances and fringe benefits. For in
you own for personal use only to the extent
x $300 = $75
depreciation for the formation about deducting employment taxes,
$800 machine see chapter 5.
each casualty loss is more than $100, and the
total of all casualty losses exceeds 10% of your The basis of each asset is reduced accord You can claim employment credits,
adjusted gross income (AGI). See Pub. 547 for ingly. TIP such as the following, if you hire indi-
more information on casualty losses. Adriana includes the $3,200 of gross in viduals who meet certain require-
For the limits that apply to home mortgage come on line 21 (other income) of Form 1040. ments.
interest, see Pub. 936. The $1,600 for category (1) is deductible in full Empowerment zone employment credit
on the appropriate lines for taxes and interest (Form 8844).
Category 2. Deductions that do not result in an on Schedule A (Form 1040). Adriana deducts Indian employment credit (Form 8845).
adjustment to the basis of property are allowed the remaining $1,600 ($1,300 for category (2) Work opportunity credit (Form 5884).
next, but only to the extent your gross income and $300 for category (3)) as other miscellane
from the activity is more than your deductions ous deductions on Schedule A (Form 1040) Credit for employer differential wage pay-
under the first category. Most business deduc subject to the 2%ofadjustedgrossincome ments (Form 8932).
tions, such as those for advertising, insurance limit.
premiums, interest, utilities, and wages, belong Reduce your deduction for employee wages by
in this category. Partnerships and S corporations. If a part the amount of employment credits you claim.
nership or S corporation carries on a For more information about these credits, see
Category 3. Business deductions that de notforprofit activity, these limits apply at the the form on which the credit is claimed.
crease the basis of property are allowed last, partnership or S corporation level. They are re
but only to the extent the gross income from the flected in the individual shareholder's or part Topics
activity exceeds the deductions you take under ner's distributive shares. This chapter discusses:
the first two categories. Deductions for depreci
ation, amortization, and the part of a casualty More than one activity. If you have several Tests for deducting pay
loss an individual could not deduct in category undertakings, each may be a separate activity
(1) belong in this category. Where more than or several undertakings may be combined. The Kinds of pay
one asset is involved, allocate depreciation and following are the most significant facts and cir
these other deductions proportionally. cumstances in making this determination. Useful Items
The degree of organizational and eco You may want to see:
Individuals must claim the amounts in
nomic interrelationship of various under
TIP categories (2) and (3) as miscellane- takings.
ous deductions on Schedule A (Form Publication
The business purpose that is (or might be)
1040). They are subject to the 2%-of-adjus-
served by carrying on the various under 15 Employer's Tax Guide
ted-gross-income limit. See Pub. 529 for infor-
takings separately or together in a busi
mation on this limit. 15-A Employer's Supplemental Tax Guide
ness or investment setting.
The similarity of the undertakings. 15-B Employer's Tax Guide to Fringe
Example. Adriana is engaged in a Benefits
notforprofit activity. The income and expenses The IRS will generally accept your charac
of the activity are as follows. terization if it is supported by facts and circum See chapter 12 for information about getting
stances. publications and forms.

Tests for Deducting Pay

To be deductible, your employees' pay must be
an ordinary and necessary business expense

Page 6 Chapter 2 Employees' Pay

and you must pay or incur it. These and other You can choose to ignore test (2) if the em
requirements that apply to all business expen
ses are explained in chapter 1. Kinds of Pay ployee wasn't also in the top 20% of employees
ranked by pay for the preceding year.
An award isn't a qualified plan award if the
In addition, the pay must meet both of the Some of the ways you may provide pay to your average cost of all the employee achievement
following tests. employees in addition to regular wages or salar awards given during the tax year (that would be
Test 1. It must be reasonable. ies are discussed next. For specialized and de qualified plan awards except for this limit) is
Test 2. It must be for services performed. tailed information on employees' pay and the more than $400. To figure this average cost, ig
employment tax treatment of employees' pay, nore awards of nominal value.
The form or method of figuring the pay doesn't see Pubs. 15, 15A, and 15B.
affect its deductibility. For example, bonuses Deduct achievement awards as a nonwage
and commissions based on sales or earnings, business expense on your return or business
and paid under an agreement made before the Awards schedule.
services were performed, are both deductible.
You can generally deduct amounts you pay to You may not owe employment taxes
your employees as awards, whether paid in on the value of some achievement
Test 1Reasonableness
cash or property. If you give property to an em awards you provide to an employee.
ployee as an employee achievement award, See Pub. 15-B.
You must be able to prove that the pay is rea your deduction may be limited.
sonable. Whether the pay is reasonable de
pends on the circumstances that existed when Achievement awards. An achievement award Bonuses
you contracted for the services, not those that is an item of tangible personal property that
exist when reasonableness is questioned. If the meets all the following requirements. You can generally deduct a bonus paid to an
pay is excessive, the excess pay is disallowed It is given to an employee for length of employee if you intended the bonus as addi
as a deduction. service or safety achievement. tional pay for services, not as a gift, and the
It is awarded as part of a meaningful pre services were performed. However, the total
Factors to consider. Determine the reasona sentation. bonuses, salaries, and other pay must be rea
bleness of pay by the facts and circumstances. It is awarded under conditions and circum sonable for the services performed. If the bonus
Generally, reasonable pay is the amount that a stances that don't create a significant likeli is paid in property, see Property, later.
similar business would pay for the same or simi hood of disguised pay.
lar services. Gifts of nominal value. If, to promote em
To determine if pay is reasonable, also con Length-of-service award. An award will ployee goodwill, you distribute food or mer
sider the following items and any other pertinent qualify as a lengthofservice award only if ei chandise of nominal value to your employees at
facts. ther of the following applies. holidays, you can deduct the cost of these
The duties performed by the employee. The employee receives the award after his items as a nonwage business expense. Your
or her first 5 years of employment. deduction for de minimis gifts of food or drink
The volume of business handled. The employee didn't receive another aren't subject to the 50% deduction limit that
The character and amount of responsibil lengthofservice award (other than one of generally applies to meals. For more informa
ity. very small value) during the same year or tion on this deduction limit, see Meals and lodg-
The complexities of your business. in any of the prior 4 years. ing, later.
The amount of time required.
Safety achievement award. An award for
The cost of living in the locality. safety achievement will qualify as an achieve Education Expenses
The ability and achievements of the indi ment award unless one of the following applies.
vidual employee performing the service. 1. It is given to a manager, administrator, If you pay or reimburse education expenses for
The pay compared with the gross and net clerical employee, or other professional an employee, you can deduct the payments if
income of the business, as well as with dis employee. they are part of a qualified educational assis
tributions to shareholders if the business is tance program. Deduct them on the Employee
a corporation. 2. During the tax year, more than 10% of benefit programs or other appropriate line of
Your policy regarding pay for all your em your employees, excluding those listed in your tax return. For information on educational
ployees. (1), have already received a safety ach assistance programs, see Educational Assis-
The history of pay for each employee. ievement award (other than one of very tance in section 2 of Pub. 15B.
small value).

Test 2For Services Deduction limit. Your deduction for the Fringe Benefits
cost of employee achievement awards given to
Performed any one employee during the tax year is limited A fringe benefit is a form of pay for the perform
to the following. ance of services. You can generally deduct the
You must be able to prove the payment was cost of fringe benefits.
$400 for awards that aren't qualified plan
made for services actually performed.
$1,600 for all awards, whether or not quali You may be able to exclude all or part of the
Employee-shareholder salaries. If a corpo value of some fringe benefits from your employ
fied plan awards.
ration pays an employee who is also a share ees' pay. You also may not owe employment
holder a salary that is unreasonably high con A qualified plan award is an achievement taxes on the value of the fringe benefits. See
sidering the services actually performed, the award given as part of an established written Table 21 in Pub. 15B for details.
excessive part of the salary may be treated as a plan or program that doesn't favor highly com
constructive dividend to the employeeshare pensated employees as to eligibility or benefits. Your deduction for the cost of fringe benefits
holder. The excessive part of the salary A highly compensated employee is an em for activities generally considered entertain
wouldn't be allowed as a salary deduction by ployee who meets either of the following tests. ment, amusement, or recreation, or for a facility
the corporation. For more information on corpo used in connection with such an activity (for ex
1. The employee was a 5% owner at any ample, a company aircraft) for certain officers,
rate distributions to shareholders, see Pub. 542. time during the year or the preceding year. directors, and morethan10% shareholders is
2. The employee received more than limited.
$115,000 in pay for 2014.
Certain fringe benefits are discussed next.
See Pub. 15B for more details on these and
other fringe benefits.

Chapter 2 Employees' Pay Page 7

Meals and lodging. You can usually deduct contractors, or their beneficiaries. Welfare ben fect its value, you generally can't deduct it and
the cost of furnishing meals and lodging to your efits are any benefits other than deferred com don't report gain or loss until it is substantially
employees. Deduct the cost in whatever cate pensation or transfers of restricted property. vested in the recipient. However, if the recipient
gory the expense falls. For example, if you op Your deduction for contributions to a welfare pays for the property, you must report any gain
erate a restaurant, deduct the cost of the meals benefit fund is limited to the fund's qualified cost at the time of the transfer up to the amount paid.
you furnish to employees as part of the cost of for the tax year. If your contributions to the fund Substantially vested means the property
goods sold. If you operate a nursing home, mo are more than its qualified cost, carry the ex isn't subject to a substantial risk of forfeiture.
tel, or rental property, deduct the cost of furnish cess over to the next tax year. This means that the recipient isn't likely to have
ing lodging to an employee as expenses for util Generally, the fund's qualified cost is the to give up his or her rights in the property in the
ities, linen service, salaries, depreciation, etc. total of the following amounts, reduced by the future.
aftertax income of the fund.
Deduction limit on meals. You can gener The cost you would have been able to de
ally deduct only 50% of the cost of furnishing duct using the cash method of accounting Reimbursements for
meals to your employees. However, you can if you had paid for the benefits directly. Business Expenses
deduct the full cost of the following meals. The contributions added to a reserve ac
Meals whose value you include in an em count that are needed to fund claims incur You can generally deduct the amount you pay
ployee's wages. red but not paid as of the end of the year. or reimburse employees for business expenses
Meals that qualify as a de minimis fringe These claims can be for supplemental un incurred for your business. However, your de
benefit as discussed in section 2 of Pub. employment benefits, severance pay, or duction may be limited.
15B. This generally includes meals you disability, medical, or life insurance bene
furnish to employees at your place of busi fits. If you make the payment under an account
ness if more than half of these employees able plan, deduct it in the category of the ex
For more information, see sections 419(c)
are provided the meals for your conven pense paid. For example, if you pay an em
and 419A of the Internal Revenue Code and the
ience. ployee for travel expenses incurred on your
related regulations.
Meals you furnish to your employees at the behalf, deduct this payment as a travel ex
work site when you operate a restaurant or pense. If you make the payment under a nonac
catering service. Loans or Advances countable plan, deduct it as wages and include
Meals you furnish to your employees as it in the employee's Form W2.
part of the expense of providing recrea You generally can deduct as wages an advance
tional or social activities, such as a com you make to an employee for services per See Reimbursement of Travel, Meals, and
pany picnic. formed if you don't expect the employee to re Entertainment, in chapter 11, for more informa
Meals you are required by federal law to pay the advance. However, if the employee per tion about deducting reimbursements and an
furnish to crew members of certain com forms no services, treat the amount you
explanation of accountable and nonaccounta
mercial vessels (or would be required to advanced as a loan. If the employee doesn't re
ble plans.
furnish if the vessels were operated at pay the loan, treat it as income to the employee.
sea). This doesn't include meals you fur
nish on vessels primarily providing luxury Below-market interest rate loans. On certain Sick and Vacation Pay
water transportation. loans you make to an employee or shareholder,
Meals you furnish on an oil or gas platform you are treated as having received interest in Sick pay. You can deduct amounts you pay to
or drilling rig located offshore or in Alaska. come and as having paid compensation or divi your employees for sickness and injury, includ
This includes meals you furnish at a sup dends equal to that interest. See Below-Market ing lumpsum amounts, as wages. However,
port camp that is near and integral to an oil Loans in chapter 4. your deduction is limited to amounts not com
or gas drilling rig located in Alaska. pensated by insurance or other means.
Property Vacation pay. Vacation pay is an employee
Employee benefit programs. Employee ben
efit programs include the following. benefit. It includes amounts paid for unused va
If you transfer property (including your compa
Accident and health plans. cation leave. You can deduct vacation pay only
ny's stock) to an employee as payment for serv
in the tax year in which the employee actually
Adoption assistance. ices, you can generally deduct it as wages. The
receives it. This rule applies regardless of
Cafeteria plans. amount you can deduct is the property's fair
whether you use the cash or accrual method of
market value on the date of the transfer less any
Dependent care assistance. accounting.
amount the employee paid for the property.
Education assistance.
You can claim the deduction only for the tax
Life insurance coverage. year in which your employee includes the prop
Welfare benefit funds. erty's value in income. Your employee is
deemed to have included the value in income if
You can generally deduct amounts you you report it on Form W2, Wage and Tax
spend on employee benefit programs on the
applicable line of your tax return. For example,
Statement, in a timely manner. 3.
if you provide dependent care by operating a You treat the deductible amount as received
dependent care facility for your employees, de in exchange for the property, and you must rec
duct your costs in whatever categories they fall
(utilities, salaries, etc.).
ognize any gain or loss realized on the transfer,
unless it is the company's stock transferred as
Rent Expense
payment for services. Your gain or loss is the
Life insurance coverage. You can't de difference between the fair market value of the
duct the cost of life insurance coverage for you, property and its adjusted basis on the date of Introduction
an employee, or any person with a financial in transfer.
terest in your business, if you are directly or in This chapter discusses the tax treatment of rent
directly the beneficiary of the policy. See Regu These rules also apply to property transfer or lease payments you make for property you
lations section 1.2641 for more information. red to an independent contractor for services, use in your business but do not own. It also dis
generally reported on Form 1099MISC, Miscel cusses how to treat other kinds of payments
Welfare benefit funds. A welfare benefit laneous Income. you make that are related to your use of this
fund is a funded plan (or a funded arrangement property. These include payments you make for
having the effect of a plan) that provides welfare Restricted property. If the property you trans taxes on the property.
benefits to your employees, independent fer for services is subject to restrictions that af

Page 8 Chapter 3 Rent Expense

Topics Canceling a lease. You generally can deduct the factors in the revenue procedure are met,
This chapter discusses: as rent an amount you pay to cancel a business including the following.
lease. The lessor must maintain a minimum un
The definition of rent conditional at risk equity investment in
Lease or purchase. There may be instances the property (at least 20% of the cost of the
Taxes on leased property in which you must determine whether your pay property) during the entire lease term.
The cost of getting a lease ments are for rent or for the purchase of the The lessee may not have a contractual
Improvements by the lessee property. You must first determine whether your right to buy the property from the lessor at
agreement is a lease or a conditional sales con less than fair market value when the right is
Capitalizing rent expenses
tract. Payments made under a conditional sales exercised.
contract are not deductible as rent expense. The lessee may not invest in the property,
Useful Items Conditional sales contract. Whether an
except as provided by Revenue Procedure
You may want to see: 200128.
agreement is a conditional sales contract de The lessee may not lend any money to the
pends on the intent of the parties. Determine in lessor to buy the property or guarantee the
Publication tent based on the provisions of the agreement loan used by the lessor to buy the prop
and the facts and circumstances that exist erty.
538 Accounting Periods and Methods
when you make the agreement. No single test, The lessor must show that it expects to re
544 Sales and Other Dispositions of or special combination of tests, always applies. ceive a profit apart from the tax deduc
Assets However, in general, an agreement may be tions, allowances, credits, and other tax at
considered a conditional sales contract rather tributes.
946 How To Depreciate Property than a lease if any of the following is true.
The agreement applies part of each pay The IRS may charge you a user fee for issu
See chapter 12 for information about getting
ment toward an equity interest you will re ing a tax ruling. For more information, see Rev
publications and forms.
ceive. enue Procedure 20151 available at
You get title to the property after you make
Rent a stated amount of required payments.
The amount you must pay to use the prop
Leveraged leases of limited-use prop-
erty. The IRS will not issue advance rulings on
erty for a short time is a large part of the
Rent is any amount you pay for the use of prop leveraged leases of socalled limiteduse prop
amount you would pay to get title to the
erty you do not own. In general, you can deduct erty. Limiteduse property is property not ex
rent as an expense only if the rent is for prop pected to be either useful to or usable by a les
You pay much more than the current fair
erty you use in your trade or business. If you sor at the end of the lease term except for
rental value of the property.
have or will receive equity in or title to the prop continued leasing or transfer to a lessee. See
You have an option to buy the property at a
erty, the rent is not deductible. Revenue Procedure 200128 for examples of
nominal price compared to the value of the
limiteduse property and property that is not
property when you may exercise the op
Unreasonable rent. You cannot take a rental limiteduse property.
tion. Determine this value when you make
deduction for unreasonable rent. Ordinarily, the the agreement.
issue of reasonableness arises only if you and Leases over $250,000. Special rules are pro
You have an option to buy the property at a
the lessor are related. Rent paid to a related vided for certain leases of tangible property.
nominal price compared to the total
person is reasonable if it is the same amount The rules apply if the lease calls for total pay
amount you have to pay under the agree
you would pay to a stranger for use of the same ments of more than $250,000 and any of the fol
property. Rent is not unreasonable just because lowing apply.
The agreement designates part of the pay
it is figured as a percentage of gross sales. For Rents increase during the lease.
ments as interest, or that part is easy to
examples of related persons, see Related per- recognize as interest. Rents decrease during the lease.
sons in chapter 2, Publication 544. Rents are deferred (rent is payable after
Leveraged leases. Leveraged lease trans the end of the calendar year following the
Rent on your home. If you rent your home actions may not be considered leases. Lever calendar year in which the use occurs and
and use part of it as your place of business, you aged leases generally involve three parties: a the rent is allocated).
may be able to deduct the rent you pay for that lessor, a lessee, and a lender to the lessor. Rents are prepaid (rent is payable before
part. You must meet the requirements for busi Usually the lease term covers a large part of the the end of the calendar year preceding the
ness use of your home. For more information, useful life of the leased property, and the les calendar year in which the use occurs and
see Business use of your home in chapter 1. see's payments to the lessor are enough to the rent is allocated).
cover the lessor's payments to the lender.
Rent paid in advance. Generally, rent paid in If you plan to take part in what appears to be These rules do not apply if your lease specifies
your trade or business is deductible in the year a leveraged lease, you may want to get an ad equal amounts of rent for each month in the
paid or accrued. If you pay rent in advance, you vance ruling. Revenue Procedure 200128 on lease term and all rent payments are due in the
can deduct only the amount that applies to your page 1156 of Internal Revenue Bulletin 200119 calendar year to which the rent relates (or in the
use of the rented property during the tax year. contains the guidelines the IRS will use to de preceding or following calendar year).
You can deduct the rest of your payment only termine if a leveraged lease is a lease for fed Generally, if the special rules apply, you
over the period to which it applies. eral income tax purposes. Revenue Procedure must use an accrual method of accounting (and
200129 on page 1160 of the same Internal time value of money principles) for your rental
Example 1. You are a calendar year tax Revenue Bulletin provides the information re expenses, regardless of your overall method of
payer and you leased a building for 5 years be quired to be furnished in a request for an ad accounting. In addition, in certain cases in
ginning July 1. Your rent is $12,000 per year. vance ruling on a leveraged lease transaction. which the IRS has determined that a lease was
You paid the first year's rent ($12,000) on June Internal Revenue Bulletin 200119 is available designed to achieve tax avoidance, you must
30. You can deduct only $6,000 (6 12 $12,000) at take rent and stated or imputed interest into ac
for the rent that applies to the first year. In general, Revenue Procedure 200128 count under a constant rental accrual method in
provides that, for advance ruling purposes only, which the rent is treated as accruing ratably
Example 2. You are a calendar year tax the IRS will consider the lessor in a leveraged over the entire lease term. For details, see sec
payer. Last January you leased property for 3 lease transaction to be the owner of the prop tion 467 of the Internal Revenue Code.
years for $6,000 a year. You paid the full erty and the transaction to be a valid lease if all
$18,000 (3 $6,000) during the first year of the
lease. Each year you can deduct only $6,000,
the part of the lease that applies to that year.

Chapter 3 Rent Expense Page 9

no option to renew, you can deduct $1,000 Loss on merchandise and fixtures. If you

Taxes on each year.

The cost of getting an existing lease of tan
sell at a loss merchandise and fixtures that you
bought solely to get a lease, the loss is a cost of
Leased Property gible property is not subject to the amortization getting the lease. You must capitalize the loss
and amortize it over the remaining term of the
rules for section 197 intangibles discussed in
chapter 8. lease.
If you lease business property, you can deduct
as additional rent any taxes you have to pay to
Option to renew. The term of the lease for
or for the lessor. When you can deduct these
taxes as additional rent depends on your ac amortization includes all renewal options plus Improvements
counting method. any other period for which you and the lessor
reasonably expect the lease to be renewed.
by Lessee
Cash method. If you use the cash method of However, this applies only if less than 75% of
the cost of getting the lease is for the term re If you add buildings or make other permanent
accounting, you can deduct the taxes as addi
maining on the purchase date (not including improvements to leased property, depreciate
tional rent only for the tax year in which you pay
any period for which you may choose to renew, the cost of the improvements using the modified
extend, or continue the lease). Allocate the accelerated cost recovery system (MACRS).
lease cost to the original term and any option Depreciate the property over its appropriate re
Accrual method. If you use an accrual method
term based on the facts and circumstances. In covery period. You cannot amortize the cost
of accounting, you can deduct taxes as addi
some cases, it may be appropriate to make the over the remaining term of the lease.
tional rent for the tax year in which you can de
termine all the following. allocation using a present value computation. If you do not keep the improvements when
That you have a liability for taxes on the For more information, see Regulations section you end the lease, figure your gain or loss
leased property. 1.1781(b)(5). based on your adjusted basis in the improve
How much the liability is. ments at that time.
Example 1. You paid $10,000 to get a
That economic performance occurred. For more information, see the discussion of
lease with 20 years remaining on it and two op
The liability and amount of taxes are deter tions to renew for 5 years each. Of this cost, MACRS in Publication 946, How To Depreciate
mined by state or local law and the lease agree you paid $7,000 for the original lease and Property.
ment. Economic performance occurs as you $3,000 for the renewal options. Because
use the property. $7,000 is less than 75% of the total $10,000 Assignment of a lease. If a longterm lessee
cost of the lease (or $7,500), you must amortize who makes permanent improvements to land
Example 1. Oak Corporation is a calendar the $10,000 over 30 years. That is the remain later assigns all lease rights to you for money
year taxpayer that uses an accrual method of ing life of your present lease plus the periods for and you pay the rent required by the lease, the
accounting. Oak leases land for use in its busi renewal. amount you pay for the assignment is a capital
ness. Under state law, owners of real property investment. If the rental value of the leased land
become liable (incur a lien on the property) for Example 2. The facts are the same as in increased since the lease began, part of your
real estate taxes for the year on January 1 of Example 1, except that you paid $8,000 for the capital investment is for that increase in the
that year. However, they do not have to pay original lease and $2,000 for the renewal op rental value. The rest is for your investment in
these taxes until July 1 of the next year (18 tions. You can amortize the entire $10,000 over the permanent improvements.
months later) when tax bills are issued. Under the 20year remaining life of the original lease. The part that is for the increased rental value
the terms of the lease, Oak becomes liable for The $8,000 cost of getting the original lease of the land is a cost of getting a lease, and you
the real estate taxes in the later year when the was not less than 75% of the total cost of the amortize it over the remaining term of the lease.
tax bills are issued. If the lease ends before the lease (or $7,500). You can depreciate the part that is for your in
tax bill for a year is issued, Oak is not liable for vestment in the improvements over the recov
the taxes for that year. Cost of a modification agreement. You may ery period of the property as discussed earlier,
Oak cannot deduct the real estate taxes as have to pay an additional rent amount over without regard to the lease term.
rent until the tax bill is issued. This is when part of the lease period to change certain provi
Oak's liability under the lease becomes fixed. sions in your lease. You must capitalize these
payments and amortize them over the remain Capitalizing
ing period of the lease. You cannot deduct the
Example 2. The facts are the same as in
Example 1 except that, according to the terms payments as additional rent, even if they are Rent Expenses
of the lease, Oak becomes liable for the real es described as rent in the agreement.
tate taxes when the owner of the property be Under the uniform capitalization rules, you must
comes liable for them. As a result, Oak will de Example. You are a calendar year taxpayer capitalize the direct costs and part of the indi
duct the real estate taxes as rent on its tax and sign a 20year lease to rent part of a build rect costs for certain production or resale activi
return for the earlier year. This is the year in ing starting on January 1. However, before you ties. Include these costs in the basis of property
which Oak's liability under the lease becomes occupy it, you decide that you really need less you produce or acquire for resale, rather than
fixed. space. The lessor agrees to reduce your rent claiming them as a current deduction. You re
from $7,000 to $6,000 per year and to release cover the costs through depreciation, amortiza
the excess space from the original lease. In ex tion, or cost of goods sold when you use, sell,
Cost of Getting a Lease change, you agree to pay an additional rent
amount of $3,000, payable in 60 monthly install
or otherwise dispose of the property.

ments of $50 each. Indirect costs include amounts incurred for

You may either enter into a new lease with the renting or leasing equipment, facilities, or land.
You must capitalize the $3,000 and amortize
lessor of the property or get an existing lease
it over the 20year term of the lease. Your amor
from another lessee. Very often when you get Uniform capitalization rules. You may be
tization deduction each year will be $150
an existing lease from another lessee, you must subject to the uniform capitalization rules if you
($3,000 20). You cannot deduct the $600 (12
pay the previous lessee money to get the lease, do any of the following, unless the property is
$50) that you will pay during each of the first 5
besides having to pay the rent on the lease. produced for your use other than in a business
years as rent.
or an activity carried on for profit.
If you get an existing lease on property or
equipment for your business, you generally Commissions, bonuses, and fees. Commis 1. Produce real property or tangible personal
must amortize any amount you pay to get that sions, bonuses, fees, and other amounts you property. For this purpose, tangible per
lease over the remaining term of the lease. For pay to get a lease on property you use in your sonal property includes a film, sound re
example, if you pay $10,000 to get a lease and business are capital costs. You must amortize cording, video tape, book, or similar
there are 10 years remaining on the lease with these costs over the term of the lease. property.

Page 10 Chapter 3 Rent Expense

2. Acquire property for resale. 550 Investment Income and Expenses Allocation period. The period for which a loan
is allocated to a particular use begins on the
However, these rules do not apply to the follow 936 Home Mortgage Interest Deduction
date the proceeds are used and ends on the
ing property. earlier of the following dates.
Form (and Instructions)
1. Personal property you acquire for resale if The date the loan is repaid.
your average annual gross receipts are Sch A (Form 1040) Itemized Deductions
The date the loan is reallocated to another
$10 million or less for the 3 prior tax years. Sch E (Form 1040) Supplemental use.
2. Property you produce if you meet either of Income and Loss
Proceeds not disbursed to borrower. Even
the following conditions. Sch K-1 (Form 1065) Partner's Share of
if the lender disburses the loan proceeds to a
Income, Deductions, Credits, etc.
a. Your indirect costs of producing the third party, the allocation of the loan is still
property are $200,000 or less. Sch K-1 (Form 1120S) Shareholder's based on your use of the funds. This applies
Share of Income, Deductions, whether you pay for property, services, or any
b. You use the cash method of account
Credits, etc. thing else by incurring a loan, or you take prop
ing and do not account for inventories.
erty subject to a debt.
1098 Mortgage Interest Statement
Example 1. You rent construction equip
3115 Application for Change in Proceeds deposited in borrower's account.
ment to build a storage facility. If you are sub
Accounting Method Treat loan proceeds deposited in an account as
ject to the uniform capitalization rules, you must
property held for investment. It does not matter
capitalize as part of the cost of the building the 4952 Investment Interest Expense
whether the account pays interest. Any interest
rent you paid for the equipment. You recover Deduction
you pay on the loan is investment interest ex
your cost by claiming a deduction for deprecia 8582 Passive Activity Loss Limitations pense. If you withdraw the proceeds of the loan,
tion on the building. you must reallocate the loan based on the use
See chapter 12 for information about getting
of the funds.
Example 2. You rent space in a facility to publications and forms.
conduct your business of manufacturing tools. If Example. Celina, a calendaryear taxpayer,
you are subject to the uniform capitalization
rules, you must include the rent you paid to oc Allocation of Interest borrows $100,000 on January 4 and immedi
ately uses the proceeds to open a checking ac
cupy the facility in the cost of the tools you pro count. No other amounts are deposited in the
duce. The rules for deducting interest vary, depending account during the year and no part of the loan
on whether the loan proceeds are used for busi principal is repaid during the year. On April 2,
More information. For more information on ness, personal, or investment activities. If you Celina uses $20,000 from the checking account
these rules, see Uniform Capitalization Rules in use the proceeds of a loan for more than one for a passive activity expenditure. On Septem
Publication 538 and the regulations under Inter type of expense, you must allocate the interest ber 4, Celina uses an additional $40,000 from
nal Revenue Code section 263A. based on the use of the loan's proceeds. the account for personal purposes.
Allocate your interest expense to the follow Under the interest allocation rules, the entire
ing categories. $100,000 loan is treated as property held for in
Nonpassive trade or business activity inter vestment for the period from January 4 through
est. April 1. From April 2 through September 3, Cel
Passive trade or business activity interest. ina must treat $20,000 of the loan as used in the

4. Investment interest.
passive activity and $80,000 of the loan as
property held for investment. From September
Portfolio interest. 4 through December 31, she must treat
Personal interest. $40,000 of the loan as used for personal purpo
Interest In general, you allocate interest on a loan the
ses, $20,000 as used in the passive activity,
and $40,000 as property held for investment.
same way you allocate the loan proceeds. You
allocate loan proceeds by tracing disburse Order of funds spent. Generally, you treat
loan proceeds deposited in an account as used
Introduction ments to specific uses.
(spent) before either of the following amounts.
The easiest way to trace disburse- Any unborrowed amounts held in the same
This chapter discusses the tax treatment of
TIP ments to specific uses is to keep the account.
business interest expense. Business interest
proceeds of a particular loan separate Any amounts deposited after these loan
expense is an amount charged for the use of
from any other funds. proceeds.
money you borrowed for business activities.

Secured loan. The allocation of loan proceeds Example. On January 9, Olena opened a
Topics checking account, depositing $500 of the pro
This chapter discusses: and the related interest is not generally affected
by the use of property that secures the loan. ceeds of Loan A and $1,000 of unborrowed
funds. The following table shows the transac
Allocation of interest Example. You secure a loan with property tions in her account during the tax year.
Interest you can deduct used in your business. You use the loan pro
Interest you cannot deduct ceeds to buy an automobile for personal use.
You must allocate interest expense on the loan
Capitalization of interest to personal use (purchase of the automobile)
When to deduct interest even though the loan is secured by business
Belowmarket loans property.
If the property that secures the loan is
Useful Items TIP your home, you generally do not allo-
You may want to see: cate the loan proceeds or the related
interest. The interest is usually deductible as
qualified home mortgage interest, regardless of
how the loan proceeds are used. For more in-
537 Installment Sales formation, see Pub. 936.

Chapter 4 Interest Page 11

Date Transaction loan proceeds treated as deposited in the ac Loan refinancing. Allocate the replacement
count. loan to the same uses to which the repaid loan
January 9 $500 proceeds of Loan A and
was allocated. Make the allocation only to the
$1,000 unborrowed funds Optional method for determining date of extent you use the proceeds of the new loan to
deposited reallocation. You can use the following repay any part of the original loan.
January 14 $500 proceeds of Loan B method to determine the date loan proceeds
deposited are reallocated to another use. You can treat all Debt-financed distribution. A debtfinanced
February 19 $800 used for personal purposes
payments from loan proceeds in the account distribution occurs when a partnership or S cor
during any month as taking place on the later of poration borrows funds and allocates those
February 27 $700 used for passive activity the following dates. funds to distributions made to partners or
June 19 $1,000 proceeds of Loan C The first day of that month. shareholders. The manner in which you report
deposited The date the loan proceeds are deposited the interest expense associated with the distrib
November 20 $800 used for an investment in the account. uted debt proceeds depends on your use of
December 18 $600 used for personal purposes However, you can use this optional method only those proceeds.
if you treat all payments from the account dur How to report. If the proceeds were used
Olena treats the $800 used for personal pur ing the same calendar month in the same way. in a nonpassive trade or business activity, re
poses as made from the $500 proceeds of Loan
Interest on a segregated account. If you port the interest on Schedule E (Form 1040),
A and $300 of the proceeds of Loan B. She
have an account that contains only loan pro line 28; enter interest expense and the name
treats the $700 used for a passive activity as
ceeds and interest earned on the account, you of the partnership or S corporation in column (a)
made from the remaining $200 proceeds of
can treat any payment from that account as be and the amount in column (h). If the proceeds
Loan B and $500 of unborrowed funds. She
ing made first from the interest. When the inter were used in a passive activity, follow the In
treats the $800 used for an investment as made
est earned is used up, any remaining payments structions for Form 8582, Passive Activity Loss
entirely from the proceeds of Loan C. She treats
are from loan proceeds. Limitations, to determine the amount of interest
the $600 used for personal purposes as made
expense that can be reported on Schedule E
from the remaining $200 proceeds of Loan C
Example. You borrowed $20,000 and used (Form 1040), line 28; enter interest expense
and $400 of unborrowed funds.
the proceeds of this loan to open a new savings and the name of the partnership in column (a)
For the periods during which loan proceeds
account. When the account had earned interest and the amount in column (f). If the proceeds
are held in the account, Olena treats them as
of $867, you withdrew $20,000 for personal pur were used in an investment activity, enter the
property held for investment.
poses. You can treat the withdrawal as coming interest on Form 4952. If the proceeds are used
Payments from checking accounts. first from the interest earned on the account, for personal purposes, the interest is generally
Generally, you treat a payment from a checking $867, and then from the loan proceeds, not deductible.
or similar account as made at the time the $19,133 ($20,000 $867). All the interest
check is written if you mail or deliver it to the charged on the loan from the time it was depos
payee within a reasonable period after you write ited in the account until the time of the with Interest You
drawal is investment interest expense. The in
it. You can treat checks written on the same day
as written in any order. terest charged on the part of the proceeds used Can Deduct
for personal purposes ($19,133) from the time
Amounts paid within 30 days. If you re you withdrew it until you either repay it or reallo You can generally deduct as a business ex
ceive loan proceeds in cash or if the loan pro cate it to another use is personal interest ex pense all interest you pay or accrue during the
ceeds are deposited in an account, you can pense. The interest charged on the loan pro tax year on debts related to your trade or busi
treat any payment (up to the amount of the pro ceeds you left in the account ($867) continues ness. Interest relates to your trade or business if
ceeds) made from any account you own, or to be investment interest expense until you ei you use the proceeds of the loan for a trade or
from cash, as made from those proceeds. This ther repay it or reallocate it to another use. business expense. It does not matter what type
applies to any payment made within 30 days of property secures the loan. You can deduct in
before or after the proceeds are received in Loan repayment. When you repay any part of terest on a debt only if you meet all the following
cash or deposited in your account. a loan allocated to more than one use, treat it as requirements.
If the loan proceeds are deposited in an ac being repaid in the following order. You are legally liable for that debt.
count, you can apply this rule even if the rules
1. Personal use. Both you and the lender intend that the
stated earlier under Order of funds spent would
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)). debtorcreditor relationship.
any payments, disregard those payments (and
3. Passive activities in connection with a
the proceeds from which they are made) when Partial liability. If you are liable for part of a
rental real estate activity in which you ac
applying the rules stated under Order of funds business debt, you can deduct only your share
tively participate.
spent. of the total interest paid or accrued.
If you received the loan proceeds in cash, 4. Former passive activities.
you can treat the payment as made on the date Example. You and your brother borrow
5. Trade or business use and expenses for
you received the cash instead of the date you money. You are liable for 50% of the note. You
certain lowincome housing projects.
actually made the payment. use your half of the loan in your business, and
Line of credit (continuous borrowings). The you make onehalf of the loan payments. You
Example. Giovanni gets a loan of $1,000 can deduct your half of the total interest pay
following rules apply if you have a line of credit
on August 4 and receives the proceeds in cash. ments as a business deduction.
or similar arrangement.
Giovanni deposits $1,500 in an account on Au
gust 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
Giovanni 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 trans funds on which interest accrues at differ to add it to the cost basis of the property as ex
actions, Giovanni can treat $1,000 of the de ent fixed or variable rates as different plained later under Capitalization of Interest.
posit he made on August 18 as being paid on loans. Treat these loans as repaid in the
August 4 from the loan proceeds. In addition, Statement. If you paid $600 or more of
order shown on the loan agreement.
Giovanni can treat the passive activity expense mortgage interest (including certain points) dur
he paid on August 28 as made from the $1,000 ing the year on any one mortgage, you

Page 12 Chapter 4 Interest

generally will receive a Form 1098 or a similar $98,500 in proceeds. The loan will mature on maximum loan charges, discount points, or pre
statement. You will receive the statement if you January 1, 2025 (a 10year term), and the mium charges. If any of these charges (points)
pay interest to a person (including a financial in $100,000 principal is payable on that date. In are solely for the use of money, they are inter
stitution or a cooperative housing corporation) terest of $10,000 is payable on January 1 of est.
in the course of that person's trade or business. each year, beginning January 1, 2016. The Because points are prepaid interest, you
A governmental unit is a person for purposes of $1,500 OID on the loan is de minimis because it generally cannot deduct the full amount in the
furnishing the statement. is less than $2,500 ($100,000 .0025 10). year paid. However, you can choose to fully de
If you receive a refund of interest you over You choose to deduct the OID on a straightline duct points in the year paid if you meet certain
paid in an earlier year, this amount will be repor basis over the term of the loan. Beginning in tests. For exceptions to the general rule, see
ted in box 3 of Form 1098. You cannot deduct 2015, you can deduct $150 each year for 10 Pub. 936.
this amount. For information on how to report years.
this refund, see Refunds of interest, later in this The points reduce the issue price of the loan
chapter. Constant-yield method. If the OID is not and result in original issue discount (OID), de
de minimis, you must use the constantyield ductible as explained in the preceding discus
Expenses paid to obtain a mortgage. method to figure how much you can deduct sion.
Certain expenses you pay to obtain a mortgage each year. You figure your deduction for the first
cannot be deducted as interest. These expen year using the following steps. Partial payments on a nontax debt. If you
ses, which include mortgage commissions, ab make partial payments on a debt (other than a
1. Determine the issue price of the loan. debt owed the IRS), the payments are applied,
stract fees, and recording fees, are capital ex
Generally, this equals the proceeds of the in general, first to interest and any remainder to
penses. If the property mortgaged is business
loan. If you paid points on the loan (as dis principal. You can deduct only the interest. This
or incomeproducing property, you can amor
tize the costs over the life of the mortgage. cussed later), the issue price generally is rule does not apply when it can be inferred that
the difference between the proceeds and the borrower and lender understood that a dif
Prepayment penalty. If you pay off your the points. ferent allocation of the payments would be
mortgage early and pay the lender a penalty for made.
2. Multiply the result in (1) by the yield to ma
doing this, you can deduct the penalty as inter
est. Installment purchase. If you make an install
3. Subtract any qualified stated interest pay ment purchase of business property, the con
Interest on employment tax deficiency. In ments from the result in (2). This is the tract between you and the seller generally pro
terest charged on employment taxes assessed OID you can deduct in the first year. vides for the payment of interest. If no interest
on your business is deductible. or a low rate of interest is charged under the
To figure your deduction in any subsequent
contract, a portion of the stated principal
Original issue discount (OID). OID is a form year, follow the above steps, except determine
amount payable under the contract may be re
of interest. A loan (mortgage or other debt) gen the adjusted issue price in step (1). To get the
characterized as interest (unstated interest).
erally has OID when its proceeds are less than adjusted issue price, add to the issue price any
The amount recharacterized as interest reduces
its principal amount. The OID is the difference OID previously deducted. Then follow steps (2)
your basis in the property and increases your
between the stated redemption price at maturity and (3) above.
interest expense. For more information on in
and the issue price of the loan. The yield to maturity is generally shown in
stallment sales and unstated interest, see Pub.
A loan's stated redemption price at maturity the literature you receive from your lender. If
is the sum of all amounts (principal and interest) you do not have this information, consult your
payable on it other than qualified stated inter lender or tax advisor. In general, the yield to
est. Qualified stated interest is stated interest maturity is the discount rate that, when used in
computing the present value of all principal and
Interest You
that is unconditionally payable in cash or prop
erty (other than another loan of the issuer) at interest payments, produces an amount equal Cannot Deduct
least annually over the term of the loan at a sin to the principal amount of the loan.
gle fixed rate. Certain interest payments cannot be deducted.
Example. The facts are the same as in the In addition, certain other expenses that may
You generally deduct OID over the term of previous example, except that you deduct the seem to be interest but are not, cannot be de
the loan. Figure the amount to deduct each year OID on a constantyield basis over the term of ducted as interest.
using the constantyield method, unless the the loan. The yield to maturity on your loan is
OID on the loan is de minimis. 10.2467%, compounded annually. For 2015, You cannot currently deduct interest that
you can deduct $93 [($98,500 .102467) must be capitalized, and you generally cannot
De minimis OID. The OID is de minimis if it $10,000]. For 2016, you can deduct $103 deduct personal interest.
is less than onefourth of 1% (.0025) of the sta [($98,593 .102467) $10,000].
ted redemption price of the loan at maturity mul Interest paid with funds borrowed from
tiplied by the number of full years from the date Loan or mortgage ends. If your loan or original lender. If you use the cash method of
of original issue to maturity (the term of the mortgage ends, you may be able to deduct any accounting, you cannot deduct interest you pay
loan). remaining OID in the tax year in which the loan with funds borrowed from the original lender
If the OID is de minimis, you can choose one or mortgage ends. A loan or mortgage may end through a second loan, an advance, or any
of the following ways to figure the amount you due to a refinancing, prepayment, foreclosure, other arrangement similar to a loan. You can
can deduct each year. or similar event. deduct the interest expense once you start
On a constantyield basis over the term of making payments on the new loan.
If you refinance with the original
the loan. When you make a payment on the new loan,
! lender, you generally cannot deduct
On a straightline basis over the term of the you first apply the payment to interest and then
the remaining OID in the year in which
loan. to the principal. All amounts you apply to the in

the refinancing occurs, but you may be able to

In proportion to stated interest payments. terest on the first loan are deductible, along with
deduct it over the term of the new mortgage or
In its entirety at maturity of the loan. any interest you pay on the second loan, sub
loan. See Interest paid with funds borrowed
ject to any limits that apply.
from original lender under Interest You Cannot
You make this choice by deducting the OID in a
Deduct, later.
manner consistent with the method chosen on Capitalized interest. You cannot currently de
your timely filed tax return for the tax year in duct interest you are required to capitalize un
which the loan is issued. Points. The term points is used to describe der the uniform capitalization rules. See Capi-
certain charges paid, or treated as paid, by a talization of Interest, later. In addition, if you buy
Example. On January 1, 2015, you took out borrower to obtain a loan or a mortgage. These property and pay interest owed by the seller (for
a $100,000 discounted loan and received charges are also called loan origination fees, example, by assuming the debt and any interest

Chapter 4 Interest Page 13

accrued on the property), you cannot deduct yond the scope of this publication. For more in
the interest. Add this interest to the basis of the
property. Capitalization formation, see sections 1.263A8 through
1.263A15 of the regulations and Notice 8899.

Commitment fees or standby charges. Fees

of Interest Notice 8899 is in Cumulative Bulletin 19882.

you incur to have business funds available on a

standby basis, but not for the actual use of the
Under the uniform capitalization rules, you gen
erally must capitalize interest on debt equal to When To
funds, are not deductible as interest payments.
You may be able to deduct them as business
your expenditures to produce real property or
certain tangible personal property. The property
Deduct Interest
must be produced by you for use in your trade If the uniform capitalization rules, discussed un
If the funds are for inventory or certain prop or business or for sale to customers. You can
erty used in your business, the fees are indirect der Capitalization of Interest, earlier, do not ap
not capitalize interest related to property that ply to you, deduct interest as follows.
costs and you generally must capitalize them you acquire in any other manner.
under the uniform capitalization rules. See Cap-
italization of Interest, later. Interest you paid or incurred during the pro Cash method. Under the cash method, you
duction period must be capitalized if the prop can generally deduct only the interest you ac
Interest on income tax. Interest charged on erty produced is designated property. Designa tually paid during the tax year. You cannot de
income tax assessed on your individual income ted property is any of the following. duct a promissory note you gave as payment
tax return is not a business deduction even Real property. because it is a promise to pay and not an actual
though the tax due is related to income from Tangible personal property with a class life payment.
your trade or business. Treat this interest as a of 20 years or more. Prepaid interest. You generally cannot de
business deduction only in figuring a net operat Tangible personal property with an estima duct any interest paid before the year it is due.
ing loss deduction. ted production period of more than 2 Interest paid in advance can be deducted only
years. in the tax year in which it is due.
Penalties. Penalties on underpaid deficien Tangible personal property with an estima
cies and underpaid estimated tax are not inter ted production period of more than 1 year if Discounted loan. If interest or a discount
est. You cannot deduct them. Generally, you the estimated cost of production is more is subtracted from your loan proceeds, it is not a
cannot deduct any fines or penalties. than $1 million. payment of interest and you cannot deduct it
when you get the loan. For more information,
Interest on loans with respect to life insur- Property you produce. You produce property see Original issue discount (OID) under Interest
ance policies. You generally cannot deduct if you construct, build, install, manufacture, de You Can Deduct, earlier.
interest on a debt incurred with respect to any velop, improve, create, raise, or grow it. Treat
life insurance, annuity, or endowment contract Refunds of interest. If you pay interest
property produced for you under a contract as
that covers any individual unless that individual and then receive a refund in the same tax year
produced by you up to the amount you pay or
is a key person. of any part of the interest, reduce your interest
incur for the property.
If the policy or contract covers a key person, deduction by the refund. If you receive the re
you can deduct the interest on up to $50,000 of Carrying charges. Carrying charges include fund in a later tax year, include the refund in
debt for that person. However, the deduction for taxes you pay to carry or develop real estate or your income to the extent the deduction for the
any month cannot be more than the interest fig to carry, transport, or install personal property. interest reduced your tax.
ured using Moody's Composite Yield on Seas You can choose to capitalize carrying charges
oned Corporate Bonds (formerly known as Accrual method. Under an accrual method,
not subject to the uniform capitalization rules if
Moody's Corporate Bond Yield Aver you can deduct only interest that has accrued
they are otherwise deductible. For more infor
ageMonthly Average Corporates) (Moody's during the tax year.
mation, see chapter 7.
rate) for that month. Prepaid interest. See Prepaid interest,
Capitalized interest. Treat capitalized interest earlier.
Who is a key person? A key person is an as a cost of the property produced. You recover
officer or 20% owner. However, the number of your interest when you sell or use the property. Discounted loan. See Discounted loan,
individuals you can treat as key persons is limi If the property is inventory, recover capitalized earlier.
ted to the greater of the following. interest through cost of goods sold. If the prop
Five individuals. Tax deficiency. If you contest a federal in
erty is used in your trade or business, recover
come tax deficiency, interest does not accrue
The lesser of 5% of the total officers and capitalized interest through an adjustment to
until the tax year the final determination of liabil
employees of the company or 20 individu basis, depreciation, amortization, or other
ity is made. If you do not contest the deficiency,
als. method.
then the interest accrues in the year the tax was
Exceptions for pre-June 1997 contracts. asserted and agreed to by you.
Partnerships and S corporations. The inter
You can generally deduct the interest if the con However, if you contest but pay the pro
est capitalization rules are applied first at the
tract was issued before June 9, 1997, and the posed tax deficiency and interest, and you do
partnership or S corporation level. The rules are
covered individual is someone other than an not designate the payment as a cash bond,
then applied at the partners' or shareholders'
employee, officer, or someone financially inter then the interest is deductible in the year paid.
level to the extent the partnership or S corpora
ested in your business. If the contract was pur tion has insufficient debt to support the produc Related person. If you use an accrual
chased before June 21, 1986, you can gener tion or construction costs. method, you cannot deduct interest owed to a
ally deduct the interest no matter who is If you are a partner or a shareholder, you related person who uses the cash method until
covered by the contract. may have to capitalize interest you incur during payment is made and the interest is includible in
Interest allocated to unborrowed policy the tax year for the production costs of the part the gross income of that person. The relation
cash value. Corporations and partnerships nership or S corporation. You may also have to ship is determined as of the end of the tax year
generally cannot deduct any interest expense capitalize interest incurred by the partnership or for which the interest would otherwise be de
allocable to unborrowed cash values of life in S corporation for your own production costs. To ductible. See section 267 of the Internal Reve
surance, annuity, or endowment contracts. This properly capitalize interest under these rules, nue Code for more information.
rule applies to contracts issued after June 8, you must be given the required information in
1997, that cover someone other than an officer, an attachment to the Schedule K1 you receive
director, employee, or 20% owner. For more in from the partnership or S corporation.
formation, see section 264(f) of the Internal
Additional information. The procedures for
Revenue Code.
applying the uniform capitalization rules are be

Page 14 Chapter 4 Interest

loan, you are treated as receiving an additional 4. Certain loans to or from a foreign person,

Below-Market Loans payment (as a gift, dividend, etc.) equal to the

forgone interest on the loan. You are then
unless the interest income would be effec
tively connected with the conduct of a U.S.
treated as transferring this amount back to the trade or business and not exempt from
If you receive a belowmarket gift or demand lender as interest. These transfers are consid U.S. tax under an income tax treaty.
loan and use the proceeds in your trade or busi ered to occur annually, generally on December
ness, you may be able to deduct the forgone in 5. Any other loan if the taxpayer can show
31. If you use the loan proceeds in your trade or
terest. See Treatment of gift and demand loans, that the interest arrangement has no sig
business, you can deduct the forgone interest
later, in this discussion. nificant effect on the federal tax liability of
each year as a business interest expense. The
the lender or the borrower. Whether an in
lender must report it as interest income.
A belowmarket loan is a loan on which no terest arrangement has a significant effect
interest is charged or on which interest is Limit on forgone interest for gift loans of on the federal tax liability of the lender or
charged at a rate below the applicable federal $100,000 or less. For gift loans between indi the borrower will be determined by all the
rate. A gift or demand loan that is a belowmar viduals, forgone interest treated as transferred facts and circumstances. Consider all the
ket loan generally is considered an arm'slength back to the lender is limited to the borrower's following factors.
transaction in which you, the borrower, are con net investment income for the year. This limit a. Whether items of income and deduc
sidered as having received both the following. applies if the outstanding loans between the tion generated by the loan offset each
A loan in exchange for a note that requires lender and borrower total $100,000 or less. If other.
the payment of interest at the applicable the borrower's net investment income is $1,000
federal rate. or less, it is treated as zero. This limit does not b. The amount of the items.
An additional payment in an amount equal apply to a loan if the avoidance of any federal c. The cost of complying with the be
to the forgone interest. tax is one of the main purposes of the interest lowmarket loan provisions if they
The additional payment is treated as a gift, divi arrangement. were to apply.
dend, contribution to capital, payment of com
Treatment of term loans. If you receive a be d. Any reasons, other than taxes, for
pensation, or other payment, depending on the
lowmarket term loan other than a gift or de structuring the transaction as a be
substance of the transaction.
mand loan, you are treated as receiving an ad lowmarket loan.
Forgone interest. For any period, forgone in ditional cash payment (as a dividend, etc.) on
the date the loan is made. This payment is Exception for loans to qualified continuing
terest is:
equal to the loan amount minus the present care facilities. The belowmarket interest
1. The interest that would be payable for that value, at the applicable federal rate, of all pay rules do not apply to a loan owed by a qualified
period if interest accrued on the loan at the ments due under the loan. The same amount is continuing care facility under a continuing care
applicable federal rate and was payable treated as original issue discount on the loan. contract if the lender or lender's spouse is age
annually on December 31, See Original issue discount (OID) under Interest 62 or older by the end of the calendar year.
minus You Can Deduct, earlier.
A qualified continuing care facility is one or
2. Any interest actually payable on the loan more facilities (excluding nursing homes) meet
Exceptions for loans of $10,000 or less.
for the period. ing the requirements listed below.
The rules for belowmarket loans do not apply
Applicable federal rates are published to any day on which the total outstanding loans 1. Designed to provide services under con
TIP by the IRS each month in the Internal between the borrower and lender is $10,000 or tinuing care contracts (defined below).
Revenue Bulletin. Internal Revenue less. This exception applies only to the follow
ing. 2. Includes an independent living unit, and
Bulletins are available on the IRS web site at
either an assisted living or nursing facility, You can also contact an IRS
1. Gift loans between individuals if the loan is or both.
office to get these rates.
not directly used to buy or carry in
comeproducing assets. 3. Substantially all of the independent living
Loans subject to the rules. The rules for be unit residents are covered by continuing
2. Compensationrelated loans or corpora care contracts.
lowmarket loans apply to the following.
tionshareholder loans if the avoidance of
1. Gift loans (belowmarket loans where the any federal tax is not a principal purpose A continuing care contract is a written con
forgone interest is in the nature of a gift). of the interest arrangement. tract between an individual and a qualified con
tinuing care facility that includes all of the fol
2. Compensationrelated loans (belowmar This exception does not apply to a term loan lowing conditions.
ket loans between an employer and an described in (2) above that was previously sub
employee or between an independent ject to the belowmarket loan rules. Those rules 1. The individual or individual's spouse must
contractor and a person for whom the con will continue to apply even if the outstanding be entitled to use the facility for the rest of
tractor provides services). balance is reduced to $10,000 or less. their life or lives.

3. Corporationshareholder loans. 2. The individual or individual's spouse will

Exceptions for loans without significant tax be provided with housing, as appropriate
4. Tax avoidance loans (belowmarket loans effect. The following loans are specifically ex for the health of the individual or individu
where the avoidance of federal tax is one empted from the rules for belowmarket loans al's spouse in an:
of the main purposes of the interest ar because their interest arrangements do not
rangement). have a significant effect on the federal tax liabil a. independent living unit (which has ad
ity of the borrower or the lender. ditional available facilities outside the
5. Loans to qualified continuing care facilities unit for the provision of meals and
under a continuing care contract (made af 1. Loans made available by lenders to the other personal care), and
ter October 11, 1985). general public on the same terms and
conditions that are consistent with the b. assisted living or nursing facility avail
Except as noted in (5) above, these rules able in the continuing care facility.
lender's customary business practices.
apply to demand loans (loans payable in full at
any time upon the lender's demand) outstand 2. Loans subsidized by a federal, state, or 3. The individual or individual's spouse will
ing after June 6, 1984, and to term loans (loans municipal government that are made avail be provided with assisted living or nursing
that are not demand loans) made after that able under a program of general applica care available in the continuing care fa
date. tion to the public. cility, as required for the health of the indi
vidual or the individual's spouse.
3. Certain employeerelocation loans.
Treatment of gift and demand loans. If you
receive a belowmarket gift loan or demand

Chapter 4 Interest Page 15

For more information, see section 7872(h) of 8959 Additional Medicare Tax
the Internal Revenue Code.
See chapter 12 for information about getting Real Estate Taxes
Sale or exchange of property. Different rules publications and forms.
generally apply to a loan connected with the Deductible real estate taxes are any state, local,
sale or exchange of property. If the loan does or foreign taxes on real estate levied for the
not provide adequate stated interest, part of the When To general public welfare. The taxing authority
principal payment may be considered interest.
However, there are exceptions that may require
Deduct Taxes must base the taxes on the assessed value of
the real estate and charge them uniformly
you to apply the belowmarket interest rate against all property under its jurisdiction. De
rules to these loans. See Unstated Interest and Generally, you can only deduct taxes in the ductible real estate taxes generally do not in
Original Issue Discount (OID) in Pub. 537. year you pay them. This applies whether you clude taxes charged for local benefits and im
use the cash method or an accrual method of provements that increase the value of the
More information. For more information on accounting. property. See Taxes for local benefits, later.
belowmarket loans, see section 7872 of the In Under an accrual method, you can deduct a
ternal Revenue Code and section 1.78725 of If you use an accrual method, you generally
tax before you pay it if you meet the exception
the regulations. cannot accrue real estate taxes until you pay
for recurring items discussed under Economic
them to the government authority. However,
Performance in Publication 538. You can also
you can elect to ratably accrue the taxes during
elect to ratably accrue real estate taxes as dis
the year. See Electing to ratably accrue, later.
cussed later under Real Estate Taxes.
Taxes for local benefits. Generally, you can
Limit on accrual of taxes. A taxing jurisdic
not deduct taxes charged for local benefits and
tion can require the use of a date for accruing
5. taxes that is earlier than the date it originally re
improvements that tend to increase the value of
your property. These include assessments for
quired. However, if you use an accrual method,
streets, sidewalks, water mains, sewer lines,
and can deduct the tax before you pay it, use
and public parking facilities. You should in
Taxes the original accrual date for the year of change
and all future years to determine when you can
crease the basis of your property by the amount
of the assessment.
deduct the tax.
You can deduct taxes for these local bene
fits only if the taxes are for maintenance, re
Introduction Example. Your state imposes a tax on per
sonal property used in a trade or business con pairs, or interest charges related to those bene
ducted in the state. This tax is assessed and fits. If part of the tax is for maintenance, repairs,
You can deduct various federal, state, local,
becomes a lien as of July 1 (accrual date). In or interest, you must be able to show how much
and foreign taxes directly attributable to your
2015, the state changed the assessment and of the tax is for these expenses to claim a de
trade or business as business expenses.
lien dates from July 1, 2016, to December 31, duction for that part of the tax.
You cannot deduct federal income 2015, for property tax year 2016. Use the origi
taxes, estate and gift taxes, or state in- nal accrual date (July 1, 2016) to determine Example. To improve downtown commer
CAUTION heritance, legacy, and succession when you can deduct the tax. You must also cial business, Waterfront City converted a
taxes. use the July 1 accrual date for all future years to downtown business area street into an en
determine when you can deduct the tax. closed pedestrian mall. The city assessed the
full cost of construction, financed with 10year
Topics Uniform capitalization rules. Uniform capital bonds, against the affected properties. The city
This chapter discusses: ization rules apply to certain taxpayers who pro is paying the principal and interest with the an
duce real property or tangible personal property nual payments made by the property owners.
When to deduct taxes for use in a trade or business or for sale to cus The assessments for construction costs are
Real estate taxes tomers. They also apply to certain taxpayers not deductible as taxes or as business expen
who acquire property for resale. Under these ses, but are depreciable capital expenses. The
Income taxes part of the payments used to pay the interest
rules, you either include certain costs in inven
Employment taxes tory or capitalize certain expenses related to the charges on the bonds is deductible as taxes.
Other taxes property, such as taxes. For more information,
see chapter 1. Charges for services. Water bills, sewerage,
and other service charges assessed against
Useful Items Carrying charges. Carrying charges include your business property are not real estate
You may want to see: taxes you pay to carry or develop real estate or taxes, but are deductible as business expen
to carry, transport, or install personal property. ses.
Publication You can elect to capitalize carrying charges not
subject to the uniform capitalization rules if they Purchase or sale of real estate. If real estate
15 (Circular E), Employer's Tax Guide are otherwise deductible. For more information, is sold, the real estate taxes must be allocated
see chapter 7. between the buyer and the seller.
334 Tax Guide for Small Business
The buyer and seller must allocate the real
510 Excise Taxes Refunds of taxes. If you receive a refund for estate taxes according to the number of days in
any taxes you deducted in an earlier year, in the real property tax year (the period to which
538 Accounting Periods and Methods clude the refund in income to the extent the de the tax imposed relates) that each owned the
551 Basis of Assets duction reduced your federal income tax in the property. Treat the seller as paying the taxes up
earlier year. For more information, see Recov- to but not including the date of sale. Treat the
Form (and Instructions) ery of amount deducted (tax benefit rule) in buyer as paying the taxes beginning with the
chapter 1. date of sale. You can usually find this informa
Sch A (Form 1040) Itemized Deductions tion on the settlement statement you received at
You must include in income any inter- closing.
Sch SE (Form 1040) SelfEmployment TIP est you receive on tax refunds.
Tax If you (the seller) use an accrual method and
have not elected to ratably accrue real estate
3115 Application for Change in taxes, you are considered to have accrued your
Accounting Method part of the tax on the date you sell the property.

Page 16 Chapter 5 Taxes

Example. Alberto Verde, a calendar year Federal income taxes. You cannot deduct Your deduction for wages paid is not re
accrual method taxpayer, owns real estate in federal income taxes. duced by the social security and Medicare
Olmo County. He has not elected to ratably ac taxes, Additional Medicare Tax, and income
crue property taxes. November 30 of each year State and local income taxes. A corporation taxes you withhold from your employees. You
is the assessment and lien date for the current or partnership can deduct state and local in can deduct the employment taxes you must pay
real property tax year, which is the calendar come taxes imposed on the corporation or part from your own funds as taxes.
year. He sold the property on June 30, 2015. nership as business expenses. An individual
Under his accounting method he would not be can deduct state and local income taxes only as Example. You pay your employee $18,000
able to claim a deduction for the taxes because an itemized deduction on Schedule A (Form a year. However, after you withhold various
the sale occurred before November 30. He is 1040). taxes, your employee receives $14,500. You
treated as having accrued his part of the tax, However, an individual can deduct a state also pay an additional $1,500 in employment
365 (January 1June 29), on June 30, and he tax on gross income (as distinguished from net taxes. You should deduct the full $18,000 as
can deduct it for 2015. income) directly attributable to a trade or busi wages. You can deduct the $1,500 you pay
ness as a business expense. from your own funds as taxes.
Electing to ratably accrue. If you use an ac
crual method, you can elect to accrue real es Accrual of contested income taxes. If Additional Medicare Tax. You must withhold
tate tax related to a definite period ratably over you use an accrual method, and you contest a a 0.9% Additional Medicare Tax from wages
that period. state or local income tax liability, you must ac you pay to an employee in excess of $200,000
crue and deduct any contested amount in the in a calendar year. The Additional Medicare Tax
Example. Juan Sanchez is a calendar year tax year in which the liability is finally deter is only imposed on the employee. There is no
taxpayer who uses an accrual method. His real mined. employer share of Additional Medicare Tax.
estate taxes for the real property tax year, July If additional state or local income taxes for a For more information on the Additional Med
1, 2015, to June 30, 2016, are $1,200. July 1 is prior year are assessed in a later year, you can icare Tax see Form 8959, Additional Medicare
the assessment and lien date. deduct the taxes in the year in which they were Tax, and its instructions.
If Juan elects to ratably accrue the taxes, originally imposed (the prior year) if the tax lia
bility is not contested. You cannot deduct them For more information on employment
$600 will accrue in 2015 ($1,200 6 12, July 1
in the year in which the liability is finally deter TIP taxes, see Publication 15 (Circular E).
December 31) and the balance will accrue in
2016. mined.

Separate elections. You can elect to rata The filing of an income tax return is not Unemployment fund taxes. As an employer,
bly accrue the taxes for each separate trade or TIP considered a contest and, in the ab- you may have to make payments to a state un
business and for nonbusiness activities if you sence of an overt act of protest, you employment compensation fund or to a state
account for them separately. Once you elect to can deduct the tax in the prior year. Also, you disability benefit fund. Deduct these payments
ratably accrue real estate taxes, you must use can deduct any additional taxes in the prior year as taxes.
that method unless you get permission from the if you do not show some affirmative evidence of
IRS to change. See Form 3115, later. denial of the liability. Self-employment tax. You can deduct part of
your selfemployment tax as a business ex
Making the election. If you elect to ratably However, if you consistently deduct addi pense in figuring your adjusted gross income.
accrue the taxes for the first year in which you tional assessments in the year they are paid or This deduction only affects your income tax. It
incur real estate taxes, attach a statement to finally determined (including those for which does not affect your net earnings from selfem
your income tax return for that year. The state there was no contest), you must continue to do ployment or your selfemployment tax.
ment should show all the following items. so. You cannot take a deduction in the earlier To deduct the tax, enter on Form 1040,
The trades or businesses to which the year unless you receive permission to change line 27, the amount shown on the Deduction for
election applies and the accounting your method of accounting. For more informa onehalf of selfemployment tax line of Sched
method or methods used. tion on accounting methods, see When Can I ule SE (Form 1040).
The period to which the taxes relate. Deduct an Expense in chapter 1. For more information on selfemployment
The computation of the real estate tax de tax, see Publication 334.
duction for that first year. Foreign income taxes. Generally, you can Additional Medicare Tax. You may be re
take either a deduction or a credit for income quired to pay Additional Medicare Tax on
Generally, you must file your return by the taxes imposed on you by a foreign country or a selfemployment income. See Form 8959 and
due date (including extensions). However, if U.S. possession. However, an individual cannot the Instructions for Form 8959 for more informa
you timely filed your return for the year without take a deduction or credit for foreign income tion on the Additional Medicare Tax.
electing to ratably accrue, you can still make the taxes paid on income that is exempt from U.S.
election by filing an amended return within 6 tax under the foreign earned income exclusion
months after the due date of the return (exclud
ing extensions). Attach the statement to the
or the foreign housing exclusion. For informa
tion on these exclusions, see Publication 54,
Other Taxes
amended return and write Filed pursuant to Tax Guide for U.S. Citizens and Resident Aliens
section 301.91002 on the statement. File the The following are other taxes you can deduct if
Abroad. For information on the foreign tax you incur them in the ordinary course of your
amended return at the same address where you credit, see Publication 514, Foreign Tax Credit
filed the original return. trade or business.
for Individuals.
Form 3115. If you elect to ratably accrue Excise taxes. Generally, you can deduct as a
real estate taxes for a year after the first year in business expense all excise taxes that are ordi
which you incur real estate taxes, or if you want Employment Taxes nary and necessary expenses of carrying on
to revoke your election to ratably accrue real your trade or business. However, see Fuel
estate taxes, file Form 3115. For more informa If you have employees, you must withhold vari taxes, later.
tion, including applicable time frames for filing, ous taxes from your employees' pay. Most em For more information on excise taxes, see
see the Instructions for Form 3115. ployers must withhold their employees' share of Publication 510.
social security, Medicare taxes, and Additional
Medicare Tax (if applicable) along with state Franchise taxes. You can deduct corporate
Income Taxes and federal income taxes. You may also need franchise taxes as a business expense.
to pay certain employment taxes from your own
This section discusses federal, state, local, and funds. These include your share of social secur Fuel taxes. Generally, taxes on gasoline, die
foreign income taxes. ity and Medicare taxes as an employer, along sel fuel, and other motor fuels that you use in
with unemployment taxes. your business are included as part of the cost of

Chapter 5 Taxes Page 17

the fuel. Do not deduct these taxes as a sepa PTC are different tax credits that have dif a. If a partnership pays accident and
rate item. ferent eligibility rules. You cannot take health insurance premiums for its
You may be entitled to a credit or refund for both the HCTC and PTC for the same partners, it generally can deduct them
federal excise tax you paid on fuels used for month for the same coverage. For more in as guaranteed payments to partners.
certain purposes. For more information, see formation, see Form 8885 and its instruc
b. If an S corporation pays accident and
Publication 510. tions.
health insurance premiums for its
morethan2% shareholderemploy
Occupational taxes. You can deduct as a
business expense an occupational tax charged Reminder ees, it generally can deduct them, but
must also include them in the share
at a flat rate by a locality for the privilege of holder's wages subject to federal in
working or conducting a business in the locality. Premium tax credit. You may have to use the come tax withholding. See Publication
worksheets in Publication 974 instead of the 15B.
Personal property tax. You can deduct any worksheet in this chapter if the insurance plan
tax imposed by a state or local government on established, or considered to be established, 4. Liability insurance.
personal property used in your trade or busi under your business was obtained through the 5. Malpractice insurance that covers your
ness. Health Insurance Marketplace and you are personal liability for professional negli
claiming the premium tax credit. See Publica gence resulting in injury or damage to pa
Sales tax. Any sales tax you pay on a service tion 974 for details. tients or clients.
for your business, or on the purchase or use of
property in your business is treated as part of 6. Workers' compensation insurance set by
the cost of the service or property. If the service
or the cost or use of the property is a deductible
Introduction state law that covers any claims for bodily
injuries or jobrelated diseases suffered by
business expense, you can deduct the tax as You generally can deduct the ordinary and nec employees in your business, regardless of
part of that service or cost. If the property is essary cost of insurance as a business expense fault.
merchandise bought for resale, the sales tax is if it is for your trade, business, or profession. a. If a partnership pays workers' com
part of the cost of the merchandise. If the prop However, you may have to capitalize certain in pensation premiums for its partners, it
erty is depreciable, add the sales tax to the ba surance costs under the uniform capitalization generally can deduct them as guaran
sis for depreciation. For more information on rules. For more information, see Capitalized teed payments to partners.
basis, see Publication 551. Premiums, later.
b. If an S corporation pays workers'
Do not deduct state and local sales compensation premiums for its
taxes imposed on the buyer that you
Topics morethan2% shareholderemploy
CAUTION must collect and pay over to the state
This chapter discusses:
ees, it generally can deduct them, but
or local government. Also, do not include these must also include them in the share
taxes in gross receipts or sales. Deductible premiums holder's wages.
Nondeductible premiums
7. Contributions to a state unemployment in
Capitalized premiums surance fund are deductible as taxes if
When to deduct premiums they are considered taxes under state law.
8. Overhead insurance that pays for busi
Useful Items ness overhead expenses you have during
6. You may want to see: long periods of disability caused by your
injury or sickness.
Publication 9. Car and other vehicle insurance that cov

Insurance 15-B Employer's Tax Guide to Fringe

ers vehicles used in your business for lia
bility, damages, and other losses. If you
operate a vehicle partly for personal use,
525 Taxable and Nontaxable Income deduct only the part of the insurance pre

What's New 538 Accounting Periods and Methods

mium that applies to the business use of
the vehicle. If you use the standard mile
age rate to figure your car expenses, you
Health Coverage Tax Credit (HCTC) exten- 547 Casualties, Disasters, and Thefts
cannot deduct any car insurance premi
ded. The HCTC, which expired at the end of ums.
Form (and Instructions)
2013, has been reinstated retroactive to the be
10. Life insurance covering your officers and
ginning of 2014. You can take the HCTC for 1040 U.S. Individual Income Tax Return employees if you are not directly or indi
2015 if you were an eligible trade adjustment
See chapter 12 for information about getting rectly a beneficiary under the contract.
assistance (TAA) recipient, alternative TAA re
cipient, reemployment TAA recipient, Pension publications and forms. 11. Business interruption insurance that pays
Benefit Guaranty Corporation pension payee, or for lost profits if your business is shut
qualifying family member. down due to a fire or other cause.
Eligibility for the HCTC is generally the same Deductible Premiums
as in 2013 with the following changes. Self-Employed Health
You generally can deduct premiums you pay for
The HCTC is now an election. Once you
elect to take the HCTC for a month, the the following kinds of insurance related to your
Insurance Deduction
election applies for all subsequent months trade or business.
You may be able to deduct the amount you paid
during your tax year unless you no longer 1. Insurance that covers fire, storm, theft, ac for medical and dental insurance and qualified
qualify to take the HCTC. cident, or similar losses. longterm care insurance for yourself, your
For 2015, you can take the HCTC for a spouse, and your dependents. The insurance
qualified health plan purchased through a 2. Credit insurance that covers losses from
can also cover your child who was under age
Health Insurance Marketplace. This insur business bad debts.
27 at the end of 2015, even if the child was not
ance coverage also qualifies for the pre 3. Group hospitalization and medical insur your dependent. A child includes your son,
mium tax credit taken on Form 8962, Pre ance for employees, including longterm daughter, stepchild, adopted child, or foster
mium Tax Credit (PTC). The HCTC and care insurance. child. A foster child is any child placed with you

Page 18 Chapter 6 Insurance

by an authorized placement agency or by judg report the premium amounts on Sched a. Age 40 or younger$380
ment, decree, or other order of any court of ule K1 (Form 1065) as guaranteed pay
b. Age 41 to 50$710
competent jurisdiction. ments to be included in your gross income.
One of the following statements must be Otherwise, the insurance plan will not be c. Age 51 to 60$1,430
true. considered to be established under your
d. Age 61 to 70$3,800
You were selfemployed and had a net business.
profit for the year reported on Schedule C For morethan2% shareholders, a policy e. Age 71 or older$4,750
(Form 1040), Profit or Loss From Busi can be either in the name of the S corpora
tion or in the name of the shareholder. You Qualified long-term care insurance con-
ness; Schedule CEZ (Form 1040), Net tract. A qualified longterm care insurance
Profit From Business; or Schedule F (Form can either pay the premiums yourself or
the S corporation can pay them and report contract is an insurance contract that only pro
1040), Profit or Loss From Farming. vides coverage of qualified longterm care serv
You were a partner with net earnings from the premium amounts on Form W2 as wa
ges to be included in your gross income. ices. The contract must meet all the following
selfemployment for the year reported on requirements.
Schedule K1 (Form 1065), Partner's However, if the policy is in your name and
you pay the premiums yourself, the S cor It must be guaranteed renewable.
Share of Income, Deductions, Credits,
etc., box 14, code A. poration must reimburse you and report It must provide that refunds, other than re
You used one of the optional methods to the premium amounts on Form W2 in funds on the death of the insured or com
figure your net earnings from selfemploy box 1 as wages to be included in your plete surrender or cancellation of the con
ment on Schedule SE. gross income. Otherwise, the insurance tract, and dividends under the contract
You received wages in 2015 from an S cor plan will not be considered to be estab may be used only to reduce future premi
poration in which you were a lished under your business. ums or increase future benefits.
morethan2% shareholder. Health insur It must not provide for a cash surrender
Medicare premiums you voluntarily pay to value or other money that can be paid, as
ance premiums paid or reimbursed by the
obtain insurance in your name that is similar to signed, pledged, or borrowed.
S corporation are shown as wages on
qualifying private health insurance can be used It generally must not pay or reimburse ex
Form W2, Wage and Tax Statement.
to figure the deduction. Amounts paid for health penses incurred for services or items that
The insurance plan must be established, or insurance coverage from retirement plan distri would be reimbursed under Medicare, ex
considered to be established as discussed in butions that were nontaxable because you are a cept where Medicare is a secondary payer
the following bullets, under your business. retired public safety officer cannot be used to or the contract makes per diem or other
For selfemployed individuals filing a figure the deduction. periodic payments without regard to ex
Schedule C, CEZ, or F, a policy can be ei penses.
ther in the name of the business or in the Take the deduction on Form 1040, line 29.
name of the individual. Qualified long-term care services. Quali
For partners, a policy can be either in the Qualified long-term care insurance. You fied longterm care services are:
name of the partnership or in the name of can include premiums paid on a qualified Necessary diagnostic, preventive, thera
the partner. You can either pay the premi longterm care insurance contract when figuring peutic, curing, treating, mitigating, and re
ums yourself or the partnership can pay your deduction. But, for each person covered, habilitative services; and
them and report the premium amounts on you can include only the smaller of the following Maintenance or personal care services.
Schedule K1 (Form 1065) as guaranteed amounts.
payments to be included in your gross in The services must be required by a chronically
1. The amount paid for that person. ill individual and prescribed by a licensed health
come. However, if the policy is in your
name and you pay the premiums yourself, 2. The amount shown below. Use the per care practitioner.
the partnership must reimburse you and son's age at the end of the tax year.

Chapter 6 Insurance Page 19

Worksheet 6A. Self-Employed Health Insurance Deduction Worksheet Keep for Your Records
Caution. You may have to use the worksheets in Publication 974 instead of this worksheet if the insurance plan
established, or considered to be established, under your business was obtained through the Health Insurance
Marketplace and you are claiming the premium tax credit. See Publication 974 for details.
Note. Use a separate worksheet for each trade or business under which an insurance plan is established.
1. Enter the total amount paid in 2015 for health insurance coverage established under your
business (or the S corporation in which you were a morethan2% shareholder) for 2015 for you,
your spouse, and your dependents. Your insurance can also cover your child who was under age
27 at the end of 2015, 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 the employer of either your dependent or your child who was
under the age of 27 at the end of 2015.
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 payments for qualified longterm care insurance (see line 2) . . . . . . . . . . . . . . . . . . . . . . 1.
2. For coverage under a qualified longterm 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.
$380 if that person is age 40 or younger
$710 if age 41 to 50
$1,430 if age 51 to 60
$3,800 if age 61 to 70
$4,750 if age 71 or older
Do not include payments for any month you were eligible to participate in a longterm care
insurance plan subsidized by your or your spouses employer or the employer of either your
dependent or your child who was under the age of 27 at the end of 2015. 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 selfemployment 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 CEZ (Form
1040), line 3; Schedule F (Form 1040), line 34; or Schedule K1 (Form 1065), box 14, code A;
plus any other income allocable to the profitable businesses. Do not include Conservation
Reserve Program payments exempt from selfemployment 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.
7. Multiply Form 1040 (or Form 1040NR), line 27, by the percentage on line 6 . . . . . . . . . . . . . . . . . 7.
8. Subtract line 7 from line 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.
9. Enter the amount, if any, from Form 1040 (or Form 1040NR), 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 W2, box 5) from an S corporation in which you are a
morethan2% 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 2555EZ, line 18, attributable to the amount entered on line 11
above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 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 (or Form 1040NR), 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 selfemployment 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.

Chronically ill individual. A chronically ill (general mobility), bathing, dressing, and Benefits received. For information on ex
individual is a person who has been certified as continence. cluding benefits you receive from a longterm
one of the following. An individual who requires substantial su care contract from gross income, see Publica
An individual who has been unable, due to pervision to be protected from threats to tion 525.
loss of functional capacity for at least 90 health and safety due to severe cognitive
days, to perform at least two activities of impairment. Other coverage. You cannot take the deduc
daily living without substantial assistance tion for any month you were eligible to partici
The certification must have been made by a li
from another individual. Activities of daily pate in any employer (including your spouse's)
censed health care practitioner within the previ
living are eating, toileting, transferring subsidized health plan at any time during that
ous 12 months.

Page 20 Chapter 6 Insurance

month, even if you did not actually participate. appropriate limit shown on line 2 for that
In addition, if you were eligible for any month or
part of a month to participate in any subsidized
Capitalized Premiums
health plan maintained by the employer of ei
ther your dependent or your child who was un Under the uniform capitalization rules, you must
der age 27 at the end of 2015, do not use Nondeductible capitalize the direct costs and part of the indi
amounts paid for coverage for that month to fig
ure the deduction.
Premiums rect costs for certain production or resale activi
ties. Include these costs in the basis of property
These rules are applied separately to plans you produce or acquire for resale, rather than
You cannot deduct premiums on the following claiming them as a current deduction. You re
that provide longterm care insurance and plans
kinds of insurance. cover the costs through depreciation, amortiza
that do not provide longterm care insurance.
However, any medical insurance payments not 1. Selfinsurance reserve funds. You cannot tion, or cost of goods sold when you use, sell,
deductible on Form 1040, line 29, can be inclu deduct amounts credited to a reserve set or otherwise dispose of the property.
ded as medical expenses on Schedule A (Form up for selfinsurance. This applies even if
Indirect costs include premiums for insur
1040), Itemized Deductions, if you itemize de you cannot get business insurance cover
ance on your plant or facility, machinery, equip
ductions. age for certain business risks. However,
ment, materials, property produced, or property
your actual losses may be deductible. See
acquired for resale.
Effect on itemized deductions. Subtract the Publication 547.
health insurance deduction from your medical
2. Loss of earnings. You cannot deduct pre Uniform capitalization rules. You may be
insurance when figuring medical expenses on
miums for a policy that pays for lost earn subject to the uniform capitalization rules if you
Schedule A (Form 1040) if you itemize deduc
ings due to sickness or disability. How do any of the following, unless the property is
ever, see the discussion on overhead produced for your use other than in a business
insurance, item (8), under Deductible Pre- or an activity carried on for profit.
Effect on self-employment tax. For tax years
beginning before or after 2010, you cannot sub miums, earlier.
1. Produce real property or tangible personal
tract the selfemployed health insurance deduc 3. Certain life insurance and annuities. property. For this purpose, tangible per
tion when figuring net earnings for your selfem sonal property includes a film, sound re
ployment tax from the business under which the a. For contracts issued before June 9,
cording, video tape, book, or similar prop
insurance plan is established, or considered to 1997, you cannot deduct the premi
be established as discussed earlier. For more ums on a life insurance policy cover
ing you, an employee, or any person 2. Acquire property for resale.
information, see Schedule SE (Form 1040).
with a financial interest in your busi
ness if you are directly or indirectly a However, these rules do not apply to the follow
How to figure the deduction. Generally, you ing property.
can use the worksheet in the Form 1040 in beneficiary of the policy. You are in
structions to figure your deduction. However, if cluded among possible beneficiaries 1. Personal property you acquire for resale if
any of the following apply, you must use Work of the policy if the policy owner is obli your average annual gross receipts are
sheet 6A in this chapter. gated to repay a loan from you using $10 million or less for the 3 prior tax years.
You had more than one source of income the proceeds of the policy. A person
has a financial interest in your busi 2. Property you produce if you meet either of
subject to selfemployment tax. the following conditions.
You file Form 2555, Foreign Earned In ness if the person is an owner or part
come, or Form 2555EZ, Foreign Earned owner of the business or has lent a. Your indirect costs of producing the
Income Exclusion. money to the business. property are $200,000 or less.
You are using amounts paid for qualified b. For contracts issued after June 8, b. You use the cash method of account
longterm care insurance to figure the de 1997, you generally cannot deduct ing and do not account for inventories.
duction. the premiums on any life insurance
If you are claiming the health coverage tax policy, endowment contract, or annu More information. For more information on
credit, complete Form 8885 before you figure ity contract if you are directly or indi these rules, see Uniform Capitalization Rules in
this deduction. rectly a beneficiary. The disallowance Publication 538 and the regulations under Inter
applies without regard to whom the nal Revenue Code section 263A.
Health coverage tax credit. You elect to policy covers.
take this credit only if you were an eligible trade
adjustment assistance (TAA) recipient, alterna
tive TAA (ATAA) recipient, reemployment trade
c. Partners. If, as a partner in a partner
ship, you take out an insurance policy When To Deduct
adjustment assistance (RTAA) recipient, or on your own life and name your part
ners as beneficiaries to induce them
Pension Benefit Guaranty Corporation (PBGC)
pension recipient. Use Form 8885 to figure the to retain their investments in the part
You can usually deduct insurance premiums in
amount, if any, of this credit. When figuring the nership, you are considered a benefi
the tax year to which they apply.
amount to enter on line 1 of Worksheet 6A, do ciary. You cannot deduct the insur
not include any amounts you included on Form ance premiums.
Cash method. If you use the cash method of
8885, line 4. 4. Insurance to secure a loan. If you take out accounting, you generally deduct insurance
a policy on your life or on the life of an premiums in the tax year you actually paid
More than one health plan and business.
other person with a financial interest in them, even if you incurred them in an earlier
If you have more than one health plan during
your business to get or protect a business year. However, see Prepayment, later.
the year and each plan is established under a
loan, you cannot deduct the premiums as
different business, you must use separate work
a business expense. Nor can you deduct Accrual method. If you use an accrual method
sheets (Worksheet 6A) to figure each plan's
the premiums as interest on business of accounting, you cannot deduct insurance
net earnings limit. Include the premium you paid
loans or as an expense of financing loans. premiums before the tax year in which you incur
under each plan on line 1 or line 2 of that sepa
In the event of death, the proceeds of the a liability for them. In addition, you cannot de
rate worksheet and your net profit (or wages)
policy are generally not taxed as income duct insurance premiums before the tax year in
from that business on line 4 (or line 11). For a
even if they are used to liquidate the debt. which you actually pay them (unless the excep
plan that provides longterm care insurance, the
tion for recurring items applies). For more infor
total of the amounts entered for each person on
mation about the accrual method of accounting,
line 2 of all worksheets cannot be more than the
see chapter 1. For information about the excep
tion for recurring items, see Publication 538.

Chapter 6 Insurance Page 21

Prepayment. You cannot deduct expenses in individual partner, shareholder, or beneficiary unproductive. For other real property, your elec
advance, even if you pay them in advance. This elects whether to deduct or capitalize explora tion to capitalize carrying charges remains in ef
rule applies to any expense paid far enough in tion costs. fect until construction or development is com
advance to, in effect, create an asset with a pleted. For personal property, your election is
useful life extending substantially beyond the You may be subject to the alternative effective until the date you install or first use it,
end of the current tax year. ! minimum tax (AMT) if you deduct re- whichever is later.
search and experimental, intangible
Expenses such as insurance are generally

drilling, exploration, development, circulation, or How to make the election. To make the elec
allocable to a period of time. You can deduct in
business organizational costs. tion to capitalize a carrying charge, attach a
surance expenses for the year to which they are
allocable. statement to your original tax return for the year
For more information on the alternative mini- the election is to be effective indicating which
Example. In 2015, you signed a 3year in mum tax, see the instructions for the following charges you are electing to capitalize. However,
surance contract. Even though you paid the forms. if you timely filed your return for the year without
premiums for 2015, 2016, and 2017 when you Form 6251, Alternative Minimum TaxIn- making the election, you can still make the elec
signed the contract, you can only deduct the dividuals. tion by filing an amended return within 6 months
premium for 2015 on your 2015 tax return. You Form 4626, Alternative Minimum of the due date of the return (excluding exten
can deduct in 2016 and 2017 the premium allo TaxCorporations. sions). Attach the statement to the amended re
cable to those years. turn and write Filed pursuant to section
Topics 301.91002 on the statement. File the amen
Dividends received. If you receive dividends This chapter discusses: ded return at the same address you filed the
from business insurance and you deducted the original return.
premiums in prior years, at least part of the divi Carrying charges
dends generally are income. For more informa
tion, see Recovery of amount deducted (tax Research and experimental costs
Research and
benefit rule) in chapter 1 under How Much Can I Intangible drilling costs
Deduct. Exploration costs Experimental Costs
Development costs
The costs of research and experimentation are
Circulation costs generally capital expenses. However, you can
Business startup and organizational costs elect to deduct these costs as a current busi
ness expense. Your election to deduct these
Reforestation costs
costs is binding for the year it is made and for
7. Retired asset removal costs
Barrier removal costs
all later years unless you get IRS approval to
make a change.
Film and television production costs
If you meet certain requirements, you may
Costs You Repair and maintenance costs elect to defer and amortize research and exper
imental costs. For information on electing to de
Can Deduct Useful Items
You may want to see:
fer and amortize these costs, see Research and
Experimental Costs in chapter 8.

or Capitalize Publication
Research and experimental costs defined.
Research and experimental costs are reasona
544 Sales and Other Dispositions of ble costs you incur in your trade or business for
Assets activities intended to provide information that
What's New would eliminate uncertainty about the develop
Form (and Instructions) ment or improvement of a product. Uncertainty
Film and television production costs. The exists if the information available to you does
3468 Investment Credit not establish how to develop or improve a prod
election to expense qualified film and television
production costs apply to certain costs of quali 8826 Disabled Access Credit uct or the appropriate design of a product.
fied film, television, and live theatrical produc Whether costs qualify as research and experi
tions commencing before January 1, 2017 (after See chapter 12 for information about getting mental costs depends on the nature of the ac
December 31, 2015, and before January 1, publications and forms. tivity to which the costs relate rather than on the
2017, for live theatrical productions). See Film nature of the product or improvement being de
and Television Production Costs, later. veloped or the level of technological advance
Carrying Charges ment.
The costs of obtaining a patent, including at
Introduction Carrying charges include the taxes and interest torneys' fees paid or incurred in making and
you pay to carry or develop real property or to perfecting a patent application, are research
This chapter discusses costs you can elect to carry, transport, or install personal property. and experimental costs. However, costs paid or
deduct or capitalize. Certain carrying charges must be capitalized incurred to obtain another's patent are not re
You generally deduct a cost as a current under the uniform capitalization rules. (For infor search and experimental costs.
business expense by subtracting it from your in mation on capitalization of interest, see chap
come in either the year you incur it or the year Product. The term product includes any
ter 4.) You can elect to capitalize carrying
you pay it. of the following items.
charges not subject to the uniform capitalization
If you capitalize a cost, you may be able to Formula.
rules, but only if they are otherwise deductible.
recover it over a period of years through peri Invention.
odic deductions for amortization, depletion, or You can elect to capitalize carrying charges
depreciation. When you capitalize a cost, you separately for each project you have and for
add it to the basis of property to which it relates. each type of carrying charge. Your election is Pilot model.
A partnership, corporation, estate, or trust good for only 1 year for unimproved and unpro Process.
makes the election to deduct or capitalize the ductive real property. You must decide whether Technique.
costs discussed in this chapter except for ex to capitalize carrying charges each year the
ploration costs for mineral deposits. Each property remains unimproved and Property similar to the items listed above.

Page 22 Chapter 7 Costs You Can Deduct or Capitalize

It also includes products used by you in your Deducting or Amortizing Research and Experimentation Costs
trade or business or held for sale, lease, or li
cense. IF you . . . THEN . . .
Costs not included. Research and experi Elect to deduct research and Deduct all research and experimental costs in the first
mental costs do not include expenses for any of experimental costs as a current year you pay or incur the costs and all later years.
the following activities. business expense
Advertising or promotions.
Do not deduct research and If you meet the requirements, amortize them over at
Consumer surveys. experimental costs as a current least 60 months, starting with the month you first
Efficiency surveys. business expense receive an economic benefit from the research. See
Management studies. Research and Experimental Costs in chapter 8.
Quality control testing.
Amounts paid to contractor that must be
Research in connection with literary, his
torical, or similar projects.
capitalized. Amounts paid to a contractor
must be capitalized if they are either: Exploration Costs
The acquisition of another's patent, model, Amounts properly allocable to the cost of
production, or process. depreciable property, or The costs of determining the existence, loca
Amounts paid only out of production or tion, extent, or quality of any mineral deposit are
When and how to elect. You make the elec proceeds from production if these amounts ordinarily capital expenditures if the costs lead
tion to deduct research and experimental costs are depletable income to the recipient. to the development of a mine. You recover
by deducting them on your tax return for the these costs through depletion as the mineral is
year in which you first pay or incur research and How to make the election. You elect to de removed from the ground. However, you can
experimental costs. If you do not make the elec duct IDCs as a current business expense by elect to deduct domestic exploration costs paid
tion to deduct research and experimental costs taking the deduction on your income tax return or incurred before the beginning of the develop
in the first year in which you pay or incur the for the first tax year you have eligible costs. No ment stage of the mine (except those for oil and
costs, you can deduct the costs in a later year formal statement is required. If you file Sched gas wells).
only with approval from the IRS. ule C (Form 1040), enter these costs under
Other expenses. How to make the election. You elect to de
Research credit. If you pay or incur qualified For oil and gas wells, your election is bind duct exploration costs by taking the deduction
research expenses, you may be able to take the ing for the year it is made and for all later years. on your income tax return, or on an amended
research credit. For more information, see Form For geothermal wells, your election can be re income tax return, for the first tax year for which
6765, Credit for Increasing Research Activities, voked by the filing of an amended return on you wish to deduct the costs paid or incurred
and the Instructions for Form 6765. which you do not take the deduction. You can during the tax year. Your return must ade
file the amended return for the year up to the quately describe and identify each property or
normal time of expiration for filing a claim for mine, and clearly state how much is being de
Intangible credit or refund, generally, within 3 years after ducted for each one. The election applies to the
tax year you make this election and all later tax
Drilling Costs the date you filed the original return or within 2
years after the date you paid the tax, whichever years.
is later. Partnerships and S corporations. Each
The costs of developing oil, gas, or geothermal
wells are ordinarily capital expenditures. You partner, not the partnership, elects whether to
Energy credit for costs of geothermal wells.
can usually recover them through depreciation capitalize or to deduct that partner's share of
If you capitalize the drilling and development
or depletion. However, you can elect to deduct exploration costs. Each shareholder, not the S
costs of geothermal wells that you place in serv
intangible drilling costs (IDCs) as a current busi corporation, elects whether to capitalize or to
ice during the tax year, you may be able to
ness expense. These are certain drilling and deduct that shareholder's share of exploration
claim a business energy credit. See the Instruc
development costs for wells in the United costs.
tions for Form 3468 for more information.
States in which you hold an operating or work
Reduced corporate deductions for explora-
ing interest. You can deduct only costs for drill Nonproductive well. If you capitalize your
tion costs. A corporation (other than an S cor
ing or preparing a well for the production of oil, IDCs, you have another option if the well is non
poration) can deduct only 70% of its domestic
gas, or geothermal steam or hot water. productive. You can deduct the IDCs of the
exploration costs. It must capitalize the remain
nonproductive well as an ordinary loss. You
ing 30% of costs and amortize them over the
You can elect to deduct only the costs of must indicate and clearly state your election on
60month period starting with the month the ex
items with no salvage value. These include wa your tax return for the year the well is comple
ploration costs are paid or incurred. A corpora
ges, fuel, repairs, hauling, and supplies related ted. Once made, the election for oil and gas
tion may also elect to capitalize and amortize
to drilling wells and preparing them for produc wells is binding for all later years. You can re
mining exploration costs over a 10year period.
tion. Your cost for any drilling or development voke your election for a geothermal well by filing
For more information on this method of amorti
work done by contractors under any form of an amended return that does not claim the loss.
zation, see Internal Revenue Code section
contract is also an IDC. However, see Amounts
paid to contractor that must be capitalized, Costs incurred outside the United States.
later. You cannot deduct as a current business ex The 30% the corporation capitalizes cannot
pense all the IDCs paid or incurred for an oil, be added to its basis in the property to figure
You can also elect to deduct the cost of drill gas, or geothermal well located outside the Uni cost depletion. However, the amount amortized
ing exploratory bore holes to determine the lo ted States. However, you can elect to include is treated as additional depreciation and is sub
cation and delineation of offshore hydrocarbon the costs in the adjusted basis of the well to fig ject to recapture as ordinary income on a dispo
deposits if the shaft is capable of conducting ure depletion or depreciation. If you do not sition of the property. See Section 1250 Prop-
hydrocarbons to the surface on completion. It make this election, you can deduct the costs erty under Depreciation Recapture in chapter 3
does not matter whether there is any intent to over the 10year period beginning with the tax of Pub. 544.
produce hydrocarbons. year in which you paid or incurred them. These These rules also apply to the deduction of
rules do not apply to a nonproductive well. development costs by corporations. See Devel-
If you do not elect to deduct your IDCs as a opment Costs, later.
current business expense, you can elect to de
duct them over the 60month period beginning Recapture of exploration expenses. When
with the month they were paid or incurred. your mine reaches the producing stage, you
must recapture any exploration costs you

Chapter 7 Costs You Can Deduct or Capitalize Page 23

elected to deduct. Use either of the following contractor. Development costs do not include How to make the election. You elect to capi
methods. the costs for the acquisition or improvement of talize circulation costs by attaching a statement
Method 1Include the deducted costs in depreciable property. to your return for the first tax year the election
gross income for the tax year the mine rea applies. Your election is binding for the year it is
Instead of deducting development costs in
ches the producing stage. Your election made and for all later years, unless you get IRS
the year paid or incurred, you can elect to treat
must be clearly indicated on the return. In approval to revoke it.
the costs as deferred expenses and deduct
crease your adjusted basis in the mine by them ratably as the units of produced ores or
the amount included in income. Generally,
you must elect this recapture method by
minerals benefited by the expenses are sold.
This election applies each tax year to expenses Business Start-Up and
the due date (including extensions) of your
return. However, if you timely filed your re
paid or incurred in that year. Once made, the
election is binding for the year and cannot be
Organizational Costs
turn for the year without making the elec revoked for any reason.
tion, you can still make the election by filing Business startup and organizational costs are
an amended return within 6 months of the generally capital expenditures. However, you
How to make the election. The election to
due date of the return (excluding exten can elect to deduct up to $5,000 of business
deduct development costs ratably as the ores
sions). Make the election on your amended startup and $5,000 of organizational costs paid
or minerals are sold must be made for each
return and write Filed pursuant to section or incurred after October 22, 2004. The $5,000
mine or other natural deposit by a clear indica
301.91002 on the form where you are in deduction is reduced by the amount your total
tion on your return or by a statement filed with
cluding the income. File the amended re startup or organizational costs exceed
the IRS office where you file your return. Gener
turn at the same address you filed the origi $50,000. Any remaining costs must be amor
ally, you must make the election by the due
nal return. tized. For information about amortizing startup
date of the return (including extensions). How
Method 2Do not claim any depletion de and organizational costs, see chapter 8.
ever, if you timely filed your return for the year
duction for the tax year the mine reaches without making the election, you can still make Startup costs include any amounts paid or
the producing stage and any later tax years the election by filing an amended return within 6 incurred in connection with creating an active
until the depletion you would have deduc months of the due date of the return (excluding trade or business or investigating the creation
ted equals the exploration costs you de extensions). Clearly indicate the election on or acquisition of an active trade or business. Or
ducted. your amended return and write Filed pursuant ganizational costs include the costs of creating
You also must recapture deducted explora to section 301.91002. File the amended return a corporation or partnership.
tion costs if you receive a bonus or royalty from at the same address you filed the original re
mine property before it reaches the producing turn. How to make the election. You elect to de
stage. Do not claim any depletion deduction for duct the startup or organizational costs by
the tax year you receive the bonus or royalty Foreign development costs. The rules dis claiming the deduction on your income tax re
and any later tax years until the depletion you cussed earlier for foreign exploration costs ap turn (filed by the due date including extensions)
would have deducted equals the exploration ply to foreign development costs. for the tax year in which the active trade or busi
costs you deducted. ness begins. For costs paid or incurred after
Reduced corporate deductions for develop-
Generally, if you dispose of the mine before September 8, 2008, you are not required to at
ment costs. The rules discussed earlier for re
you have fully recaptured the exploration costs tach a statement to your return to elect to de
duced corporate deductions for exploration
you deducted, recapture the balance by treating duct such costs. However, for startup or organ
costs also apply to corporate deductions for de
all or part of your gain as ordinary income. Un izational costs paid or incurred before
velopment costs.
der these circumstances, you generally treat as September 9, 2008, you may be required to at
ordinary income all of your gain if it is less than tach a statement to your return to elect to de
your adjusted exploration costs with respect to
the mine. If your gain is more than your adjusted Circulation Costs duct such costs. If you timely filed your return
for the year without making the election, you
exploration costs, treat as ordinary income only can still make the election by filing an amended
a part of your gain, up to the amount of your ad A publisher can deduct as a current business return within 6 months of the due date of the re
justed exploration costs. expense the costs of establishing, maintaining, turn (excluding extensions). Clearly indicate the
or increasing the circulation of a newspaper, election on your amended return and write
Foreign exploration costs. If you pay or incur magazine, or other periodical. For example, a Filed pursuant to section 301.91002.
exploration costs for a mine or other natural de publisher can deduct the cost of hiring extra File the amended return at the same ad
posit located outside the United States, you employees for a limited time to get new sub dress you filed the original return. The election
cannot deduct all the costs in the current year. scriptions through telephone calls. Circulation applies when computing taxable income for the
You can elect to include the costs (other than costs may be deducted even if they normally current tax year and all subsequent years. Once
for an oil, gas, or geothermal well) in the adjus would be capitalized. made, the election is irrevocable. For more in
ted basis of the mineral property to figure cost This rule does not apply to the following formation on startup and organizational costs,
depletion. (Cost depletion is discussed in chap costs that must be capitalized. see chapter 8.
ter 9.) If you do not make this election, you must The purchase of land or depreciable prop
deduct the costs over the 10year period begin erty.
ning with the tax year in which you pay or incur
them. These rules also apply to foreign devel
The acquisition of circulation through the Reforestation Costs
purchase of any part of the business of an
opment costs. other publisher of a newspaper, magazine, Reforestation costs are generally capital expen
or other periodical, including the purchase ditures. However, you can elect to deduct up to
of another publisher's list of subscribers.
Development Costs $10,000 ($5,000 if married filing separately; $0
for a trust) of qualifying reforestation costs paid
Other treatment of circulation costs. If you or incurred after October 22, 2004, for each
You can deduct costs paid or incurred during do not want to deduct circulation costs as a cur qualified timber property. The remaining costs
the tax year for developing a mine or any other rent business expense, you can elect one of the can be amortized over an 84month period. For
natural deposit (other than an oil or gas well) lo following ways to recover these costs. information about amortizing reforestation
cated in the United States. These costs must be Capitalize all circulation costs that are costs, see chapter 8.
paid or incurred after the discovery of ores or properly chargeable to a capital account
minerals in commercially marketable quantities. (see chapter 1). Qualifying reforestation costs are the direct
Development costs also include depreciation Amortize circulation costs over the 3year costs of planting or seeding for forestation or re
on improvements used in the development of period beginning with the tax year they forestation. Qualified timber property is property
ores or minerals and costs incurred for you by a were paid or incurred. that contains trees in significant commercial

Page 24 Chapter 7 Costs You Can Deduct or Capitalize

quantities. See chapter 8 for more information to and usable by those who are disabled or eld Ramps.
on qualifying reforestation costs and qualified erly. You must own or lease the facility or vehi Entrances.
timber property. cle for use in connection with your trade or busi
ness. Doors and doorways.
If you elect to deduct qualified reforestation Stairs.
costs, create and maintain separate timber ac A facility is all or any part of buildings, struc
tures, equipment, roads, walks, parking lots, or Floors.
counts for each qualified timber property and in
clude all reforestation costs and the dates each similar real or personal property. A public trans Toilet rooms.
was applied. Do not include this qualified timber portation vehicle is a vehicle, such as a bus or Water fountains.
property in any account (for example, depletion railroad car, that provides transportation service
Public telephones.
block) for which depletion is allowed. to the public (including service for your custom
ers, even if you are not in the business of pro Elevators.
How to make the election. You elect to de viding transportation services). Controls.
duct qualifying reforestation costs by claiming Signage.
You cannot deduct any costs that you paid
the deduction on your timely filed income tax re
or incurred to completely renovate or build a fa Alarms.
turn (including extensions) for the tax year the
cility or public transportation vehicle or to re
expenses were paid or incurred. If Form T (Tim Protruding objects.
place depreciable property in the normal course
ber), Forest Activities Schedule, is required, Symbols of accessibility.
of business.
complete Part IV of Form T. If Form T is not re
quired, attach a statement containing the follow You can find the ADA guidelines and require
Deduction limit. The most you can deduct as
ing information for each qualified timber prop ments for architectural barrier removal at
a cost of removing barriers to the disabled and
erty for which an election is being made.
the elderly for any tax year is $15,000. How
The unique stand identification numbers. The costs for removal of transportation barri
ever, you can add any costs over this limit to the
The total number of acres reforested dur basis of the property and depreciate these ex ers from rail facilities, buses, and rapid and light
ing the tax year. cess costs. rail vehicles are deductible. You can find the
The nature of the reforestation treatments. guidelines and requirements for transportation
Partners and partnerships. The $15,000 limit barrier removal at
The total amounts of qualified reforestation
applies to a partnership and also to each part Also, you can access the ADA website at
expenditures eligible to be amortized or
ner in the partnership. A partner can allocate for additional information.
the $15,000 limit in any manner among the part Other barrier removals. To be deductible,
If you timely filed your return for the year ner's individually incurred costs and the part
without making the election, you can still make expenses of removing any barrier not covered
ner's distributive share of partnership costs. If by the above standards must meet all three of
the election by filing an amended return within 6 the partner cannot deduct the entire share of
months of the due date of the return (excluding the following tests.
partnership costs, the partnership can add any
extensions). Clearly indicate the election on costs not deducted to the basis of the improved 1. The removed barrier must be a substantial
your amended return and write Filed pursuant property. barrier to access or use of a facility or pub
to section 301.91002. File the amended return lic transportation vehicle by persons who
A partnership must be able to show that any
at the same address you filed the original re have a disability or are elderly.
amount added to basis was not deducted by
turn. The election applies when computing taxa
the partner and that it was over a partner's 2. The removed barrier must have been a
ble income for the current tax year and all sub $15,000 limit (as determined by the partner). If
sequent years. barrier for at least one major group of per
the partnership cannot show this, it is presumed sons who have a disability or are elderly
For additional information on reforestation that the partner was able to deduct the distribu
costs, see chapter 8. (such as people who are blind, deaf, or
tive share of the partnership's costs in full. wheelchair users).
Recapture. This deduction may have to be re Example. Emilio Azul's distributive share of 3. The barrier must be removed without cre
captured as ordinary income under section ABC partnership's deductible expenses for the ating any new barrier that significantly im
1245 when you sell or otherwise dispose of the removal of architectural barriers was $14,000. pairs access to or use of the facility or ve
property that would have received an addition Emilio had $12,000 of similar expenses in his hicle by a major group of persons who
to basis if you had not elected to deduct the ex sole proprietorship. He elected to deduct have a disability or are elderly.
penditure. For more information on recapturing $7,000 of them. Emilio allocated the remaining
the deduction, see Depreciation Recapture in $8,000 of the $15,000 limit to his share of How to make the election. If you elect to de
Pub. 544. ABC's expenses. Emilio can add the excess duct your costs for removing barriers to the dis
$5,000 of his own expenses to the basis of the abled or the elderly, claim the deduction on
property used in his business. Also, if ABC can your income tax return (partnership return for
Retired Asset Removal show that Emilio could not deduct $6,000 partnerships) for the tax year the expenses

Costs ($14,000 $8,000) of his share of the partner

ship's expenses because of how Emilio applied
were paid or incurred. Identify the deduction as
a separate item. The election applies to all the
the limit, ABC can add $6,000 to the basis of its qualifying costs you have during the year, up to
If you retire and remove a depreciable asset in property. the $15,000 limit. If you make this election, you
connection with the installation or production of must maintain adequate records to support your
a replacement asset, you can deduct the costs Qualification standards. You can deduct deduction.
of removing the retired asset. However, if you your costs as a current expense only if the bar For your election to be valid, you generally
replace a component (part) of a depreciable as rier removal meets the guidelines and require must file your return by its due date, including
set, capitalize the removal costs if the replace ments issued by the Architectural and Trans extensions. However, if you timely filed your re
ment is an improvement and deduct the costs if portation Barriers Compliance Board under the turn for the year without making the election,
the replacement is a repair. Americans with Disabilities Act (ADA) of 1990. you can still make the election by filing an
You can view the Americans with Disabilities amended return within 6 months of the due date
Act at of the return (excluding extensions). Clearly in
Barrier Removal Costs The following is a list of some architectural dicate the election on your amended return and
barrier removal costs that can be deducted. write Filed pursuant to section 301.91002.
The cost of an improvement to a business asset Ground and floor surfaces. File the amended return at the same address
is normally a capital expense. However, you Walks. you filed the original return. Your election is ir
can elect to deduct the costs of making a facility revocable after the due date, including exten
or public transportation vehicle more accessible Parking lots. sions, of your return.

Chapter 7 Costs You Can Deduct or Capitalize Page 25

Disabled access credit. If you make your current year, list on Form 4562 each item sepa
business accessible to persons with disabilities rately. For example, in 2014, you began to am
and your business is an eligible small business,
you may be able to claim the disabled access 8. ortize a lease. In 2015, you began to amortize a
second lease. Report amortization from the new
credit. If you choose to claim the credit, you lease on line 42 of your 2015 Form 4562. Re
must reduce the amount you deduct or capital port amortization from the 2014 lease on line 43
ize by the amount of the credit.
For more information, see Form 8826, Disa
Amortization of your 2015 Form 4562.
If you do not have any new amortizable ex
bled Access Credit.
penses for the current year, you are not re
Introduction quired to complete Form 4562 (unless you are
Film and Television Amortization is a method of recovering (deduct
claiming depreciation). Report the current
year's deduction for amortization that began in
Production Costs ing) certain capital costs over a fixed period of a prior year directly on the Other deduction or
Other expense line of your return.
time. It is similar to the straight line method of
Film and television production costs are gener depreciation.
The various amortizable costs covered in
ally capital expenses. However, you can elect
to deduct certain costs of qualified film, televi this chapter are included in the list below. How Starting a Business
sion, and live theatrical productions that begin ever, this chapter does not discuss amortization
before January 1, 2017 (after December 31, of bond premium. For information on that topic, When you start a business, treat all eligible
2015, and before January 1, 2017, for live the see chapter 3 of Publication 550, Investment In costs you incur before you begin operating the
atrical productions). The date that a qualified come and Expenses. business as capital expenditures which are part
theatrical production begins is the date of the of your basis in the business. Generally, you re
first performance of the production for a paying Topics cover costs for particular assets through depre
audience. For more information, see section This chapter discusses: ciation deductions. However, you generally
181 of the Internal Revenue Code and the rela cannot recover other costs until you sell the
ted Regulations. business or otherwise go out of business. For a
Deducting amortization
discussion on how to treat these costs, see If
Amortizing costs of starting a business your attempt to go into business is unsuccessful
Repair and Maintenance Amortizing costs of getting a lease under Capital Expenses in chapter 1.

Costs Amortizing costs of section 197 intangibles

Amortizing reforestation costs
For costs paid or incurred after September
8, 2008, you can deduct a limited amount of
Amortizing costs of geological and startup and organizational costs. The costs
Generally, you can deduct amounts paid for re
geophysical costs that are not deducted currently can be amor
pairs and maintenance to tangible property if
Amortizing costs of pollution control tized ratably over a 180month period. The am
the amounts paid are not otherwise required to
facilities ortization period starts with the month you begin
be capitalized. However, you may elect to capi
Amortizing costs of research and operating your active trade or business. You are
talize amounts paid for repair and maintenance
experimentation not required to attach a statement to make this
consistent with the treatment on your books and
Amortizing costs of certain tax preferences election. You can choose to forgo this election
records. If you make this election, it applies to
by affirmatively electing to capitalize your
all amounts paid for repair and maintenance to
startup costs on your income tax return filed by
tangible property that you treat as capital ex
penditures on your books and records for the
Useful Items the due date (including extensions) for the tax
You may want to see: year in which the active trade or business be
tax year.
gins. Once made, the election to either amortize
Publication or capitalize startup costs is irrevocable and
How to make the election. To make the elec
applies to all startup costs that are related to
tion to treat repairs and maintenance as capital 544 Sales and Other Dispositions of your trade or business. See Regulations sec
expenditures, attach a statement titled Section Assets tions 1.1951, 1.2481, and 1.7091.
1.263(a)3(n) Election to your timely filed return
(including extensions). For more information on 550 Investment Income and Expenses For costs paid or incurred after October 22,
what to include in the statement, see Regula 946 How To Depreciate Property 2004, and before September 9, 2008, you can
tions section 1.263(a)3(n). If you timely filed elect to deduct a limited amount of business
your return without making the election, you can Form (and Instructions) startup and organizational costs in the year
still make the election by filing an amended re your active trade or business begins. Any costs
turn within 6 months of the due date of the re 4562 Depreciation and Amortization not deducted can be amortized ratably over a
turn (excluding extensions). Attach the state 4626 Alternative Minimum 180month period, beginning with the month
ment to the amended return and write Filed TaxCorporations you begin business. If the election is made, you
pursuant to section 301.91002 on the state must attach any statement required by Regula
ment. File the amended return at the same ad 6251 Alternative Minimum tions sections 1.1951(b), 1.2481(c), and
dress you filed the original return. TaxIndividuals 1.7091(c), as in effect before September 9,
See chapter 12 for information about getting 2008.
publications and forms.
Note. You can apply the provisions of Reg
ulations sections 1.1951, 1.2481, and 1.7091
How To Deduct to all business startup and organizational costs
paid or incurred after October 22, 2004, provi
Amortization ded the period of limitations on assessment has
not expired for the year of the election. Other
To deduct amortization that begins during the wise, for business startup and organizational
current tax year, complete Part VI of Form 4562 costs paid or incurred after October 22, 2004,
and attach it to your income tax return. and before September 9, 2008, the provisions
under Regulations sections 1.1951(b),
To report amortization from previous years, 1.2481(c), and 1.7091(c), as in effect before
in addition to amortization that begins in the September 9, 2008, will apply.

Page 26 Chapter 8 Amortization

For costs paid or incurred before October and the preparation of a purchase agreement. business. However, if the partnership uses
23, 2004, you can elect to amortize business On October 22nd, you signed a purchase the cash method of accounting and pays
startup and organization costs over an amorti agreement with XYZ, Inc. the cost after the end of its first tax year,
zation period of 60 months or more. See How All amounts paid or incurred to investigate see Cash method partnership under How
To Make the Election, later. the business before October 22nd are amortiza To Amortize, later.
The cost must qualify as one of the follow ble investigative costs. Amounts paid on or after It is for a type of item normally expected to
ing. that date relate to the attempt to purchase the benefit the partnership throughout its entire
A business startup cost. business and therefore must be capitalized. life.
An organizational cost for a corporation. Organizational costs include the following
Disposition of business. If you completely fees.
An organizational cost for a partnership. dispose of your business before the end of the Legal fees for services incident to the or
amortization period, you can deduct any re ganization of the partnership, such as ne
Business Start-Up Costs maining deferred startup costs. However, you
can deduct these deferred startup costs only to
gotiation and preparation of the partner
ship agreement.
the extent they qualify as a loss from a busi Accounting fees for services incident to the
Startup costs are amounts paid or incurred for:
ness. organization of the partnership.
(a) creating an active trade or business; or (b)
investigating the creation or acquisition of an Filing fees.
active trade or business. Startup costs include Costs of Organizing
amounts paid or incurred in connection with an a Corporation Nonqualifying costs. The following costs
existing activity engaged in for profit; and for the cannot be amortized.
production of income in anticipation of the activ Amounts paid to organize a corporation are the The cost of acquiring assets for the part
ity becoming an active trade or business. direct costs of creating the corporation. nership or transferring assets to the part
Qualifying costs. A startup cost is amortiza Qualifying costs. To qualify as an organiza The cost of admitting or removing partners,
ble if it meets both of the following tests. tional cost, it must be: other than at the time the partnership is
It is a cost you could deduct if you paid or For the creation of the corporation, first organized.
incurred it to operate an existing active The cost of making a contract concerning
trade or business (in the same field as the Chargeable to a capital account (see chap the operation of the partnership trade or
one you entered into). ter 1), business including a contract between a
It is a cost you pay or incur before the day Amortized over the life of the corporation if partner and the partnership.
your active trade or business begins. the corporation had a fixed life, and The costs for issuing and marketing inter
Incurred before the end of the first tax year ests in the partnership such as brokerage,
Startup costs include amounts paid for the in which the corporation is in business.
following: registration, and legal fees and printing
An analysis or survey of potential markets, A corporation using the cash method of ac costs. These syndication fees are capital
products, labor supply, transportation fa counting can amortize organizational costs in expenses that cannot be depreciated or
cilities, etc. curred within the first tax year, even if it does amortized.
Advertisements for the opening of the busi not pay them in that year.
Examples of organizational costs include: Liquidation of partnership. If a partnership is
The cost of temporary directors. liquidated before the end of the amortization pe
Salaries and wages for employees who are
riod, the unamortized amount of qualifying or
being trained and their instructors. The cost of organizational meetings.
ganizational costs can be deducted in the part
Travel and other necessary costs for se State incorporation fees. nership's final tax year. However, these costs
curing prospective distributors, suppliers,
The cost of legal services. can be deducted only to the extent they qualify
or customers.
as a loss from a business.
Salaries and fees for executives and con
sultants, or for similar professional serv Nonqualifying costs. The following items are
ices. capital expenses that cannot be amortized: How To Amortize
Costs for issuing and selling stock or se
Nonqualifying costs. Startup costs do not in curities, such as commissions, professio Deduct startup and organizational costs in
clude deductible interest, taxes, or research nal fees, and printing costs. equal amounts over the applicable amortization
and experimental costs. See Research and Ex- Costs associated with the transfer of as period (discussed earlier). You can choose an
perimental Costs, later. sets to the corporation. amortization period for startup costs that is dif
ferent from the period you choose for organiza
Purchasing an active trade or business. tional costs, as long as both are not less than
Amortizable startup costs for purchasing an ac
Costs of Organizing the applicable amortization period. Once you
tive trade or business include only investigative a Partnership choose an amortization period, you cannot
costs incurred in the course of a general search change it.
for or preliminary investigation of the business. The costs to organize a partnership are the di
These are costs that help you decide whether rect costs of creating the partnership. To figure your deduction, divide your total
to purchase a business. Costs you incur in an startup or organizational costs by the months in
attempt to purchase a specific business are Qualifying costs. A partnership can amortize the amortization period. The result is the
capital expenses that you cannot amortize. an organizational cost only if it meets all the fol amount you can deduct for each month.
lowing tests.
Example. On June 1st, you hired an ac It is for the creation of the partnership and Cash method partnership. A partnership us
counting firm and a law firm to assist you in the not for starting or operating the partnership ing the cash method of accounting can deduct
potential purchase of XYZ, Inc. They re trade or business. an organizational cost only if it has been paid by
searched XYZ's industry and analyzed the fi It is chargeable to a capital account (see the end of the tax year. However, any cost the
nancial projections of XYZ, Inc. In September, chapter 1). partnership could have deducted as an organi
the law firm prepared and submitted a letter of It could be amortized over the life of the zational cost in an earlier tax year (if it had been
intent to XYZ, Inc. The letter stated that a bind partnership if the partnership had a fixed paid that year) can be deducted in the tax year
ing commitment would result only after a pur life. of payment.
chase agreement was signed. The law firm and It is incurred by the due date of the partner
accounting firm continued to provide services ship return (excluding extensions) for the
including a review of XYZ's books and records first tax year in which the partnership is in

Chapter 8 Amortization Page 27

How To Make the Election Filing the statement early. You can elect

To elect to amortize startup or organizational

to amortize your startup costs by filing the
statement with a return for any tax year before Section 197 Intangibles
costs, you must complete and attach Form the year your active business begins. If you file
4562 to your return for the first tax year you are the statement early, the election becomes ef Generally, you may amortize the capitalized
in business. You may also be required to attach fective in the month of the tax year your active costs of section 197 intangibles (defined later)
an accompanying statement (described later) to business begins. ratably over a 15year period. You must amor
your return. tize these costs if you hold the section 197 in
Revised statement. You can file a revised tangibles in connection with your trade or busi
For startup or organizational costs paid or statement to include any startup costs not in ness or in an activity engaged in for the
incurred after September 8, 2008, an accompa cluded in your original statement. However, you production of income.
nying statement is not required. Generally, for cannot include on the revised statement any
cost you previously treated on your return as a You may not be able to amortize sec-
startup or organizational costs paid or incurred
cost other than a startup cost. You can file the ! tion 197 intangibles acquired in a
before September 9, 2008, and after October
revised statement with a return filed after the re transaction that did not result in a sig-
22, 2004, unless you choose to apply Regula

turn on which you elected to amortize your nificant change in ownership or use. See
tions sections 1.1951, 1.2481, and 1.7091,
startup costs. AntiChurning Rules, later.
you must also attach an accompanying state
ment to elect to amortize the costs.
Organizational costs election statement. If Your amortization deduction each year is
you elect to amortize your corporation's or part the applicable part of the intangible's adjusted
If you have both startup and organizational
nership's organizational costs, attach a sepa basis (for purposes of determining gain), fig
costs, attach a separate statement (if required)
rate statement (if required) that contains the fol ured by amortizing it ratably over 15 years (180
to your return for each type of cost. See Starting
lowing information. months). The 15year period begins with the
a Business, earlier, for more information.
A description of each cost. later of:
The month the intangible is acquired, or
Generally, you must file the return by the The amount of each cost.
due date (including any extensions). However, The month the trade or business or activity
The date each cost was incurred.
if you timely filed your return for the year without engaged in for the production of income
making the election, you can still make the elec The month your corporation or partnership begins.
tion by filing an amended return within 6 months began active business (or acquired the
You cannot deduct amortization for the month
of the due date of the return (excluding exten business).
you dispose of the intangible.
sions). For more information, see the instruc The number of months in your amortization
tions for Part VI of Form 4562. period (which is generally 180 months). If you pay or incur an amount that increases
Partnerships. The statement prepared for the basis of an amortizable section 197 intangi
You can choose to forgo the election to am a cash basis partnership must also indicate the ble after the 15year period begins, amortize it
ortize by affirmatively electing to capitalize your amount paid before the end of the year for each over the remainder of the 15year period begin
startup or organizational costs on your income cost. ning with the month the basis increase occurs.
tax return filed by the due date (including exten You do not need to separately list any part
sions) for the tax year in which the active trade You are not allowed any other depreciation
nership organizational cost that is less than or amortization deduction for an amortizable
or business begins. $10. Instead, you can list the total amount of section 197 intangible.
these costs with the dates the first and last
Note. The election to either amortize or
costs were incurred. Tax-exempt use property subject to a lease.
capitalize startup or organizational costs is ir
After a partnership makes the election to The amortization period for any section 197 in
revocable and applies to all startup and organi
amortize organizational costs, it can later file an tangible leased under a lease agreement en
zational costs that are related to the trade or
amended return to include additional organiza tered into after March 12, 2004, to a taxexempt
tional costs not included in the partnership's organization, governmental unit, or foreign per
original return and statement. son or entity (other than a partnership), shall not
If your business is organized as a corpora
tion or partnership, only the corporation or part be less than 125 percent of the lease term.
nership can elect to amortize its startup or or
ganizational costs. A shareholder or partner Getting a Lease Cost attributable to other property. The
cannot make this election. You, as a share rules for section 197 intangibles do not apply to
holder or partner, cannot amortize any costs If you get a lease for business property, you any amount that is included in determining the
you incur in setting up your corporation or part may recover the cost of acquiring the lease by cost of property that is not a section 197 intangi
nership. Only the corporation or partnership can amortizing it over the term of the lease. The ble. For example, if the cost of computer soft
amortize these costs. term of the lease for amortization purposes gen ware is not separately stated from the cost of
erally includes all renewal options (and any hardware or other tangible property and you
However, you, as an individual, can elect to other period for which you and the lessor rea consistently treat it as part of the cost of the
amortize costs you incur to investigate an inter sonably expect the lease to be renewed). How hardware or other tangible property, these rules
est in an existing partnership. These costs qual ever, renewal periods are not included if 75% or do not apply. Similarly, none of the cost of ac
ify as business startup costs if you acquire the more of the cost of acquiring the lease is for the quiring real property held for the production of
partnership interest. term of the lease remaining on the acquisition rental income is considered the cost of good
date (not including any period for which you will, going concern value, or any other section
Start-up costs election statement. If you may choose to renew, extend, or continue the 197 intangible.
elect to amortize your startup costs, attach a lease).
separate statement (if required) that contains Section 197 Intangibles
For more information on the costs of getting
the following information.
A description of the business to which the a lease, see Cost of Getting a Lease in
startup costs relate. chapter 3.
The following assets are section 197 intangibles
A description of each startup cost incur
How to amortize. Enter your deduction in Part and must be amortized over 180 months:
The month your active business began (or VI of Form 4562 if you are deducting amortiza 1. Goodwill;
was acquired). tion that begins during the current year, or on
the appropriate line of your tax return if you are 2. Going concern value;
The number of months in your amortization
period (which is generally 180 months). not otherwise required to file Form 4562. 3. Workforce in place;

Page 28 Chapter 8 Amortization

4. Business books and records, operating Patents, copyrights, etc. This includes pack reasonable compensation for those services or
systems, or any other information base, in age design, computer software, and any inter for that property or its use.
cluding lists or other information concern est in a film, sound recording, videotape, book,
ing current or prospective customers; or other similar property, except as discussed Franchise, trademark, or trade name. A
later under Assets That Are Not Section 197 In- franchise, trademark, or trade name is a section
5. A patent, copyright, formula, process, de
tangibles. 197 intangible. You must amortize its purchase
sign, pattern, knowhow, format, or similar
or renewal costs, other than certain contingent
item; Customer-based intangible. This is the com payments that you can deduct currently. For in
6. A customerbased intangible; position of market, market share, and any other formation on currently deductible contingent
value resulting from the future provision of payments, see chapter 11.
7. A supplierbased intangible; goods or services because of relationships with
customers in the ordinary course of business. Professional sports franchise. A fran
8. Any item similar to items (3) through (7);
For example, you must amortize the part of the chise engaged in professional sports and any
9. A license, permit, or other right granted by purchase price of a business that is for the exis intangible assets acquired in connection with
a governmental unit or agency (including tence of the following intangibles. acquiring the franchise (including player con
issuances and renewals); A customer base. tracts) is a section 197 intangible amortizable
over a 15year period.
10. A covenant not to compete entered into in A circulation base.
connection with the acquisition of an inter An undeveloped market or market growth. Contract for the use of, or a term interest in,
est in a trade or business;
Insurance in force. a section 197 intangible. Section 197 intangi
11. Any franchise, trademark, or trade name; bles include any right under a license, contract,
A mortgage servicing contract.
and or other arrangement providing for the use of
An investment management contract. any section 197 intangible. It also includes any
12. A contract for the use of, or a term interest
Any other relationship with customers in term interest in any section 197 intangible,
in, any item in this list.
volving the future provision of goods or whether the interest is outright or in trust.
You cannot amortize any of the intan- services.
! gibles listed in items (1) through (8) Accounts receivable or other similar rights to Assets That Are Not
that you created rather than acquired

unless you created them in acquiring assets

income for goods or services provided to cus Section 197 Intangibles
tomers before the acquisition of a trade or busi
that make up a trade or business or a substan- ness are not section 197 intangibles.
tial part of a trade or business. The following assets are not section 197 intan
Supplier-based intangible. A supplierbased gibles.
Goodwill. This is the value of a trade or busi intangible is the value resulting from the future 1. Any interest in a corporation, partnership,
ness based on expected continued customer acquisitions, (through contract or other relation trust, or estate.
patronage due to its name, reputation, or any ships with suppliers in the ordinary course of
business) of goods or services that you will sell 2. Any interest under an existing futures con
other factor. tract, foreign currency contract, notional
or use. The amount you pay or incur for sup
plierbased intangibles includes, for example, principal contract, interest rate swap, or
Going concern value. This is the additional
any portion of the purchase price of an acquired similar financial contract.
value of a trade or business that attaches to
property because the property is an integral trade or business that is attributable to the exis 3. Any interest in land.
part of an ongoing business activity. It includes tence of a favorable relationship with persons
providing distribution services (such as a favor 4. Most computer software. (See Computer
value based on the ability of a business to con
able shelf or display space or a retail outlet), or software, later.)
tinue to function and generate income even
though there is a change in ownership (but the existence of favorable supply contracts. Do 5. Any of the following assets not acquired in
does not include any other section 197 intangi not include any amount required to be paid for connection with the acquisition of a trade
ble). It also includes value based on the imme the goods or services to honor the terms of the or business or a substantial part of a trade
diate use or availability of an acquired trade or agreement or other relationship. Also, see As- or business.
business, such as the use of earnings during sets That Are Not Section 197 Intangibles be
low. a. An interest in a film, sound recording,
any period in which the business would not oth
video tape, book, or similar property.
erwise be available or operational.
Government-granted license, permit, etc. b. A right to receive tangible property or
Workforce in place, etc. This includes the This is any right granted by a governmental unit services under a contract or from a
composition of a workforce (for example, its ex or an agency or instrumentality of a governmen governmental agency.
perience, education, or training). It also includes tal unit. For example, you must amortize the
capitalized costs of acquiring (including issuing c. An interest in a patent or copyright.
the terms and conditions of employment,
whether contractual or otherwise, and any other or renewing) a liquor license, a taxicab medal d. Certain rights that have a fixed dura
value placed on employees or any of their at lion or license, or a television or radio broad tion or amount. (See Rights of fixed
tributes. casting license. duration or amount, later.)
For example, you must amortize the part of 6. An interest under either of the following.
Covenant not to compete. Section 197 intan
the purchase price of a business that is for the
gibles include a covenant not to compete (or
existence of a highly skilled workforce. Also, a. An existing lease or sublease of tangi
similar arrangement) entered into in connection
you must amortize the cost of acquiring an ex ble property.
with the acquisition of an interest in a trade or
isting employment contract or relationship with business, or a substantial portion of a trade or b. A debt that was in existence when the
employees or consultants. business. An interest in a trade or business in interest was acquired.
cludes an interest in a partnership or a corpora
Business books and records, etc. This in 7. A right to service residential mortgages
tion engaged in a trade or business.
cludes the intangible value of technical man unless the right is acquired in connection
An arrangement that requires the former
uals, training manuals or programs, data files, with the acquisition of a trade or business
owner to perform services (or to provide prop
and accounting or inventory control systems. It or a substantial part of a trade or business.
erty or the use of property) is not similar to a
also includes the cost of customer lists, sub
covenant not to compete to the extent the 8. Certain transaction costs incurred by par
scription lists, insurance expirations, patient or
amount paid under the arrangement represents ties to a corporate organization or reorgan
client files, and lists of newspaper, magazine,
ization in which any part of a gain or loss is
radio, and television advertisers.
not recognized.

Chapter 8 Amortization Page 29

Intangible property that is not amortizable transaction. You may amortize these costs rata Related person. For purposes of the
under the rules for section 197 intangibles can bly over a 15year period beginning on the first antichurning rules, the following are related
be depreciated if it meets certain requirements. day of the second half of the tax year in which persons.
You generally must use the straight line method you properly write off the costs for financial ac An individual and his or her brothers, sis
over its useful life. For certain intangibles, the counting purposes. If, during the 15year pe ters, halfbrothers, halfsisters, spouse, an
depreciation period is specified in the law and riod, you dispose of the creative property rights, cestors (parents, grandparents, etc.), and
regulations. For example, the depreciation pe you must continue to amortize the costs over lineal descendants (children, grandchil
riod for computer software that is not a section the remainder of the 15year period. dren, etc.).
197 intangible is generally 36 months. A corporation and an individual who owns,
Creative property costs include costs paid or directly or indirectly, more than 20% of the
For more information on depreciating intan incurred to acquire and develop screenplays, value of the corporation's outstanding
gible property, see Intangible Property under scripts, story outlines, motion picture production stock.
What Method Can You Use To Depreciate Your rights to books and plays, and other similar Two corporations that are members of the
Property? in chapter 1 of Publication 946. properties for purposes of potential future film same controlled group as defined in sec
development, production, and exploitation. tion 1563(a) of the Internal Revenue Code,
Computer software. Section 197 intangibles except that more than 20% is substituted
do not include the following types of computer Amortize these costs using the rules of Rev for at least 80% in that definition and the
software. enue Procedure 200436. For more information, determination is made without regard to
see Revenue Procedure 200436, 200424
1. Software that meets all the following re subsections (a)(4) and (e)(3)(C) of section
I.R.B. 1063, available at
quirements. 1563. (For an exception, see section
1.1972(h)(6)(iv) of the regulations.)
a. It is, or has been, readily available for A trust fiduciary and a corporation if more
A change in the treatment of creative
purchase by the general public. than 20% of the value of the corporation's
! property costs is a change in method
b. It is subject to a nonexclusive license. CAUTION of accounting. outstanding stock is owned, directly or in
directly, by or for the trust or grantor of the
c. It has not been substantially modified. trust.
This requirement is considered met if
the cost of all modifications is not
Anti-Churning Rules The grantor and fiduciary, and the fiduciary
and beneficiary, of any trust.
more than the greater of 25% of the The fiduciaries of two different trusts, and
price of the publicly available unmodi Antichurning rules prevent you from amortizing
most section 197 intangibles if the transaction the fiduciaries and beneficiaries of two dif
fied software or $2,000. ferent trusts, if the same person is the
in which you acquired them did not result in a
2. Software that is not acquired in connection significant change in ownership or use. These grantor of both trusts.
with the acquisition of a trade or business rules apply to goodwill and going concern The executor and beneficiary of an estate.
or a substantial part of a trade or business. value, and to any other section 197 intangible A taxexempt educational or charitable or
that is not otherwise depreciable or amortizable. ganization and a person who directly or in
Computer software defined. Computer
directly controls the organization (or whose
software includes all programs designed to Under the antichurning rules, you cannot family members control it).
cause a computer to perform a desired function. use 15year amortization for the intangible if any A corporation and a partnership if the
It also includes any database or similar item that of the following conditions apply. same persons own more than 20% of the
is in the public domain and is incidental to the
1. You or a related person (defined later) value of the outstanding stock of the cor
operation of qualifying software.
held or used the intangible at any time poration and more than 20% of the capital
Rights of fixed duration or amount. Section from July 25, 1991, through August 10, or profits interest in the partnership.
197 intangibles do not include any right under a 1993. Two S corporations, and an S corporation
contract or from a governmental agency if the and a regular corporation, if the same per
2. You acquired the intangible from a person sons own more than 20% of the value of
right is acquired in the ordinary course of a who held it at any time during the period in
trade or business (or in an activity engaged in the outstanding stock of each corporation.
(1) and, as part of the transaction, the user Two partnerships if the same persons own,
for the production of income) but not as part of a did not change.
purchase of a trade or business and either: directly or indirectly, more than 20% of the
Has a fixed life of less than 15 years, or 3. You granted the right to use the intangible capital or profits interests in both partner
to a person (or a person related to that ships.
Is of a fixed amount that, except for the A partnership and a person who owns, di
person) who held or used it at any time
rules for section 197 intangibles, would be rectly or indirectly, more than 20% of the
during the period in (1). This applies only if
recovered under a method similar to the capital or profits interests in the partner
the transaction in which you granted the
unitofproduction method of cost recov ship.
right and the transaction in which you ac
ery. Two persons who are engaged in trades or
quired the intangible are part of a series of
However, this does not apply to the following in related transactions. See Related person, businesses under common control (as de
tangibles. later, for more information. scribed in section 41(f)(1) of the Internal
Goodwill. Revenue Code).
Going concern value. Exceptions. The antichurning rules do not ap
When to determine relationship. Persons
ply in the following situations.
A covenant not to compete. are treated as related if the relationship existed
You acquired the intangible from a dece
A franchise, trademark, or trade name. at the following time.
dent and its basis was stepped up to its fair
In the case of a single transaction, immedi
A customerrelated information base, cus market value.
ately before or immediately after the trans
tomerbased intangible, or similar item. The intangible was amortizable as a sec
action in which the intangible was ac
tion 197 intangible by the seller or trans
feror you acquired it from. This exception
Safe Harbor for Creative does not apply if the transaction in which
In the case of a series of related transac
Property Costs you acquired the intangible and the trans
tions (or a series of transactions that com
prise a qualified stock purchase under sec
action in which the seller or transferor ac
tion 338(d)(3) of the Internal Revenue
If you are engaged in the trade or business of quired it are part of a series of related
Code), immediately before the earliest
film production, you may be able to amortize the transactions.
creative property costs for properties not set for The gainrecognition exception, discussed transaction or immediately after the last
production within 3 years of the first capitalized later, applies. transaction.

Page 30 Chapter 8 Amortization

Ownership of stock. In determining a correction for that year by filing an amended 3115. Also, see the Instructions for Form 3115
whether an individual directly or indirectly owns return. See Amended Return next. If you are not for more information on getting approval, auto
any of the outstanding stock of a corporation, allowed to make the correction on an amended matic approval procedures, and a list of excep
the following rules apply. return, you can change your accounting method tions to the automatic approval process.
to claim the correct amortization. See Changing
Rule 1. Stock directly or indirectly owned Your Accounting Method, later. For more information, see Revenue Proce
by or for a corporation, partnership, estate, or dure 201513, or any successor. See Revenue
trust is considered owned proportionately by or Procedure 201513, 20155 I.R.B. 419, availa
for its shareholders, partners, or beneficiaries. Amended Return
ble at
Rule 2. An individual is considered to own If you deducted an incorrect amount for amorti
the stock directly or indirectly owned by or for zation, you can file an amended return to cor Disposition of
his or her family. Family includes only brothers rect the following.
and sisters, halfbrothers and halfsisters, A mathematical error made in any year.
Section 197 Intangibles
spouse, ancestors, and lineal descendants. A posting error made in any year. A section 197 intangible is treated as deprecia
Rule 3. An individual owning (other than by An amortization deduction for a section ble property used in your trade or business. If
applying Rule 2) any stock in a corporation is 197 intangible for which you have not you held the intangible for more than 1 year,
considered to own the stock directly or indi adopted a method of accounting. any gain on its disposition, up to the amount of
rectly owned by or for his or her partner. allowable amortization, is ordinary income (sec
When to file. If an amended return is allowed, tion 1245 gain). If multiple section 197 intangi
Rule 4. For purposes of applying Rule 1, 2, you must file it by the later of the following bles are disposed of in a single transaction or a
or 3, treat stock constructively owned by a per dates. series of related transactions, treat all of the
son under Rule 1 as actually owned by that per 3 years from the date you filed your original section 197 intangibles as if they were a single
son. Do not treat stock constructively owned by return for the year in which you did not de asset for purposes of determining the amount of
an individual under Rule 2 or 3 as owned by the duct the correct amount. (A return filed gain that is ordinary income. Any remaining
individual for reapplying Rule 2 or 3 to make an early is considered filed on the due date.) gain, or any loss, is a section 1231 gain or loss.
other person the constructive owner of the 2 years from the time you paid your tax for If you held the intangible 1 year or less, any
stock. that year. gain or loss on its disposition is an ordinary gain
or loss. For more information on ordinary or
Gain-recognition exception. This exception
to the antichurning rules applies if the person
Changing Your capital gain or loss on business property, see
you acquired the intangible from (the transferor)
Accounting Method chapter 3 in Publication 544.
meets both of the following requirements. Nondeductible loss. You cannot deduct any
Generally, you must get IRS approval to change
That person would not be related to you loss on the disposition or worthlessness of a
your method of accounting. File Form 3115, Ap
(as described under Related person, ear section 197 intangible that you acquired in the
plication for Change in Accounting Method, to
lier) if the 20% test for ownership of stock same transaction (or series of related transac
request a change to a permissible method of
and partnership interests were replaced by tions) as other section 197 intangibles you still
accounting for amortization.
a 50% test. have. Instead, increase the adjusted basis of
That person chose to recognize gain on each remaining amortizable section 197 intangi
The following are examples of a change in
the disposition of the intangible and pay in ble by a proportionate part of the nondeductible
method of accounting for amortization.
come tax on the gain at the highest tax loss. Figure the increase by multiplying the non
A change in the amortization method, pe
rate. See chapter 2 in Publication 544 for riod of recovery, or convention of an amor deductible loss on the disposition of the intangi
information on making this choice. tizable asset. ble by the following fraction.
If this exception applies, the antichurning A change in the accounting for amortizable The numerator is the adjusted basis of
rules apply only to the amount of your adjusted assets from a single asset account to a each remaining intangible on the date of
basis in the intangible that is more than the gain multiple asset account (pooling), or vice the disposition.
recognized by the transferor. versa. The denominator is the total adjusted
A change in the accounting for amortizable bases of all remaining amortizable section
Notification. If the person you acquired the assets from one type of multiple asset ac 197 intangibles on the date of the disposi
intangible from chooses to recognize gain un count to a different type of multiple asset tion.
der the rules for this exception, that person account.
must notify you in writing by the due date of the Covenant not to compete. A covenant not to
return on which the choice is made. Changes in amortization that are not a compete, or similar arrangement, is not consid
change in method of accounting include the fol ered disposed of or worthless before you dis
Anti-abuse rule. You cannot amortize any lowing: pose of your entire interest in the trade or busi
section 197 intangible acquired in a transaction A change in computing amortization in the ness for which you entered into the covenant.
for which the principal purpose was either of the tax year in which your use of the asset
following. changes. Nonrecognition transfers. If you acquire a
To avoid the requirement that the intangi An adjustment in the useful life of an amor section 197 intangible in a nonrecognition trans
ble be acquired after August 10, 1993. tizable asset. fer, you are treated as the transferor with re
To avoid any of the antichurning rules. Generally, the making of a late amortiza spect to the part of your adjusted basis in the in
tion election or the revocation of a timely tangible that is not more than the transferor's
More information. For more information about valid amortization election. adjusted basis. You amortize this part of the ad
the antichurning rules, including additional Any change in the placedinservice date justed basis over the intangible's remaining am
rules for partnerships, see Regulations section of an amortizable asset. ortization period in the hands of the transferor.
1.1972(h). Nonrecognition transfers include transfers to a
See Regulations section 1.4461(e)(2)(ii)(a) corporation, partnership contributions and dis
tributions, likekind exchanges, and involuntary
Incorrect Amount of for more information and examples.
Amortization Deducted Automatic approval. In some instances, you In a likekind exchange or involuntary con
may be able to get automatic approval from the version of a section 197 intangible, you must
If you later discover that you deducted an incor IRS to change your method of accounting for continue to amortize the part of your adjusted
rect amount for amortization for a section 197 amortization. For a list of automatic accounting basis in the acquired intangible that is not more
intangible in any year, you may be able to make method changes, see the Instructions for Form than your adjusted basis in the exchanged or

Chapter 8 Amortization Page 31

converted intangible over the remaining amorti the commercial production of timber prod Send the application to:
zation period of the exchanged or converted in ucts.
tangible. Amortize over a new 15year period It consists of at least one acre planted with Internal Revenue Service
the part of your adjusted basis in the acquired tree seedlings in the manner normally used Associate Chief Counsel
intangible that is more than your adjusted basis in forestation or reforestation. Passthroughs and Special Industries
in the exchanged or converted intangible. CC:PSI:6
Qualified timber property does not include 1111 Constitution Ave. NW, IR5300
Example. You own a section 197 intangible property on which you have planted shelter Washington, DC 20224
you have amortized for 4 full years. It has a re belts or ornamental trees, such as Christmas
maining unamortized basis of $30,000. You ex trees.
change the asset plus $10,000 for a likekind
Amortization period. The 84month amortiza
section 197 intangible. The nonrecognition pro
visions of likekind exchanges apply. You amor tion period starts on the first day of the first Geological and
tize $30,000 of the $40,000 adjusted basis of
the acquired intangible over the 11 years re
month of the second half of the tax year you in
cur the costs (July 1 for a calendar year tax Geophysical Costs
maining in the original 15year amortization pe payer), regardless of the month you actually in
cur the costs. You can claim amortization You can amortize the cost of geological and ge
riod for the transferred asset. You amortize the
deductions for no more than 6 months of the ophysical expenses paid or incurred in connec
other $10,000 of adjusted basis over a new
first and last (eighth) tax years of the period. tion with oil and gas exploration or development
15year period. For more information, see Reg
within the United States. These costs can be
ulations section 1.1972(g).
Life tenant and remainderman. If one person amortized ratably over a 24month period be
holds the property for life with the remainder go ginning on the midpoint of the tax year in which

Reforestation Costs ing to another person, the life tenant is entitled

to the full amortization for qualifying reforesta
the expenses were paid or incurred. For major
integrated oil companies (as defined in section
tion costs incurred by the life tenant. Any re 167(h)(5)), these costs must be amortized rata
You can elect to deduct a limited amount of re mainder interest in the property is ignored for bly over a 5year period for costs paid or incur
forestation costs paid or incurred during the tax amortization purposes. red after May 17, 2006 (a 7year period for
year. See Reforestation Costs in chapter 7. You costs paid or incurred after December 19,
can elect to amortize the qualifying costs that Recapture. If you dispose of qualified timber 2007).
are not deducted currently over an 84month property within 10 years after the tax year you
period. There is no limit on the amount of your incur qualifying reforestation expenses, report If you retire or abandon the property during
amortization deduction for reforestation costs any gain as ordinary income up to the amortiza the amortization period, no amortization deduc
paid or incurred during the tax year. tion you took. See chapter 3 of Publication 544 tion is allowed in the year of retirement or aban
for more information. donment.
The election to amortize reforestation costs
incurred by a partnership, S corporation, or es
How to make the election. To elect to amor
tate must be made by the partnership, corpora
tion, or estate. A partner, shareholder, or bene tize qualifying reforestation costs, complete Part Pollution Control
ficiary cannot make that election. VI of Form 4562 and attach a statement that
contains the following information.
A partner's or shareholder's share of amor A description of the costs and the dates
tizable costs is figured under the general rules you incurred them. You can elect to amortize the cost of a certified
for allocating items of income, loss, deduction, A description of the type of timber being pollution control facility over 60 months. How
etc., of a partnership or S corporation. The am grown and the purpose for which it is ever, see Atmospheric pollution control facili-
ortizable costs of an estate are divided between grown. ties, later, for an exception. The cost of a pollu
the estate and the income beneficiary based on tion control facility that is not eligible for
the income of the estate allocable to each. Attach a separate statement for each property amortization can be depreciated under the reg
for which you amortize reforestation costs. ular rules for depreciation. Also, you can claim a
Qualifying costs. Reforestation costs are the Generally, you must make the election on a special depreciation allowance on a certified
direct costs of planting or seeding for foresta timely filed return (including extensions) for the pollution control facility that is qualified property
tion or reforestation. Qualifying costs include tax year in which you incurred the costs. How even if you elect to amortize its cost. You must
only those costs you must capitalize and in ever, if you timely filed your return for the year reduce its cost (amortizable basis) by the
clude in the adjusted basis of the property. without making the election, you can still make amount of any special allowance you claim.
They include costs for the following items. the election by filing an amended return within 6 See chapter 3 of Publication 946.
Site preparation. months of the due date of the return (excluding
extensions). Attach Form 4562 and the state A certified pollution control facility is a new
Seeds or seedlings. identifiable treatment facility used in connection
ment to the amended return and write Filed
Labor. pursuant to section 301.91002 on Form 4562. with a plant or other property in operation be
Tools. File the amended return at the same address fore 1976, to reduce or control water or atmos
you filed the original return. pheric pollution or contamination. The facility
Depreciation on equipment used in plant must do so by removing, changing, disposing,
ing and seeding. storing, or preventing the creation or emission
Revoking the election. You must get IRS ap
Qualifying costs do not include costs for proval to revoke your election to amortize quali of pollutants, contaminants, wastes, or heat.
which the government reimburses you under a fying reforestation costs. Your application to re The facility must be certified by state and fed
costsharing program, unless you include the voke the election must include your name, eral certifying authorities.
reimbursement in your income. address, the years for which your election was
The facility must not significantly increase
in effect, and your reason for revoking it. Please
Qualified timber property. Qualified timber the output or capacity, extend the useful life, or
provide your daytime telephone number (op
property is property that contains trees in signif reduce the total operating costs of the plant or
tional), in case we need to contact you. You, or
icant commercial quantities. It can be a woodlot other property. Also, it must not significantly
your duly authorized representative, must sign
or other site that you own or lease. The property change the nature of the manufacturing or pro
the application and file it at least 90 days before
qualifies only if it meets all of the following re duction process or facility.
the due date (without extensions) for filing your
quirements. income tax return for the first tax year for which The federal certifying authority will not certify
It is located in the United States. your election is to end. your property to the extent it appears you will
It is held for the growing and cutting of tim recover (over the property's useful life) all or
ber you will either use in, or sell for use in, part of its cost from the profit based on its

Page 32 Chapter 8 Amortization

operation (such as through sales of recovered You are not deducting the costs currently. the rare and unusual circumstances that would
wastes). The federal certifying authority will de justify granting revocation. If the request for rev
scribe the nature of the potential cost recovery. How to make the election. To elect to amor ocation is approved, any unamortized costs are
You must then reduce the amortizable basis of tize research and experimental costs, complete deductible in the year the revocation is effec
the facility by this potential recovery. Part VI of Form 4562 and attach it to your in tive.
New identifiable treatment facility. A come tax return. Generally, you must file the re
new identifiable treatment facility is tangible de turn by the due date (including extensions).
preciable property that is identifiable as a treat However, if you timely filed your return for the
ment facility. It does not include a building and year without making the election, you can still
its structural components unless the building is make the election by filing an amended return
exclusively a treatment facility. within 6 months of the due date of the return
(excluding extensions). Attach Form 4562 to 9.
Atmospheric pollution control facilities. the amended return and write Filed pursuant to
Certain atmospheric pollution control facilities section 301.91002 on Form 4562. File the
can be amortized over 84 months. To qualify,
the following must apply.
amended return at the same address you filed
the original return. Depletion
The facility must be acquired and placed in Your election is binding for the year it is
service after April 11, 2005. If acquired, the made and for all later years unless you obtain
original use must begin with you after April approval from the IRS to change to a different
11, 2005.
The facility must be used in connection Depletion is the using up of natural resources
with an electric generation plant or other by mining, drilling, quarrying stone, or cutting
property placed in operation after Decem Optional Write-off timber. The depletion deduction allows an
owner or operator to account for the reduction
ber 31, 1975, that is primarily coal fired.
If you construct, reconstruct, or erect the of Certain Tax of a product's reserves.
facility, only the basis attributable to the
construction, reconstruction, or erection
Preferences There are two ways of figuring depletion:
cost depletion and percentage depletion. For
completed after April 11, 2005, qualifies. mineral property, you generally must use the
You can elect to amortize certain tax preference method that gives you the larger deduction. For
items over an optional period beginning in the standing timber, you must use cost depletion.
Basis reduction for corporations. A corpora
tax year in which you incurred the costs. If you
tion must reduce the amortizable basis of a pol
make this election, there is no AMT adjustment.
lution control facility by 20% before figuring the
The applicable costs and the optional recovery
amortization deduction. This chapter discusses:
periods are as follows:
More information. For more information on Circulation costs 3 years,
Who can claim depletion
the amortization of pollution control facilities, Intangible drilling and development
see Code sections 169 and 291(c) and the rela costs 60 months, Mineral property
ted regulations. Mining exploration and development Timber
costs 10 years, and
Research and experimental costs 10
Research and years. Useful Items
You may want to see:
Experimental Costs How to make the election. To elect to amor
tize qualifying costs over the optional recovery Publication
You can elect to amortize your research and ex period, complete Part VI of Form 4562 and at
544 Sales and Other Dispositions of
perimental costs, deduct them as current busi tach a statement containing the following infor
ness expenses, or write them off over a 10year mation to your return for the tax year in which
period (see Optional write-off method below). the election begins: 551 Basis of Assets
Your name, address, and taxpayer identifi
If you elect to amortize these costs, deduct cation number; and See chapter 12 for information about getting
them in equal amounts over 60 months or more. The type of cost and the specific amount of publications and forms.
The amortization period begins the month you the cost for which you are making the elec
first receive an economic benefit from the costs. tion.
For a definition of research and experimen Generally, the election must be made on a
Who Can
tal costs and information on deducting them as timely filed return (including extensions) for the Claim Depletion?
current business expenses, see chapter 7. tax year in which you incurred the costs. How
ever, if you timely filed your return for the year If you have an economic interest in mineral
Optional write-off method. Rather than am without making the election, you can still make property or standing timber, you can take a de
ortize these costs or deduct them as a current the election by filing an amended return within 6 duction for depletion. More than one person
expense, you have the option of deducting months of the due date of the return (excluding can have an economic interest in the same min
(writing off) research and experimental costs extensions). Attach Form 4562 to the amended eral deposit or timber. In the case of leased
ratably over a 10year period beginning with the return and write Filed pursuant to section property, the depletion deduction is divided be
tax year in which you incurred the costs. For 301.91002 on Form 4562. File the amended tween the lessor and the lessee.
more information, see Optional Write-off of Cer- return at the same address you filed the original
tain Tax Preferences, later, and section 59(e) of return. You have an economic interest if both the
the Internal Revenue Code. following apply.
Revoking the election. You must obtain con You have acquired by investment any in
Costs you can amortize. You can amortize sent from the IRS to revoke your election. Your terest in mineral deposits or standing tim
costs chargeable to a capital account (see request to revoke the election must be submit ber.
chapter 1) if you meet both of the following re ted to the IRS in the form of a letter ruling before You have a legal right to income from the
quirements. the end of the tax year in which the optional re extraction of the mineral or cutting of the
You paid or incurred the costs in your trade covery period ends. The request must contain timber to which you must look for a return
or business. all of the information necessary to demonstrate of your capital investment.

Chapter 9 Depletion Page 33

A contractual relationship that allows you an and minus certain deductions such as depletion 200419 on page 563 of Internal Revenue Bul
economic or monetary advantage from prod allowed or allowable and casualty losses. Your letin 200410, available at
ucts of the mineral deposit or standing timber is adjusted basis can never be less than zero. See 2004-10_IRB/ar15.html.
not, in itself, an economic interest. A production Publication 551, Basis of Assets, for more infor To make the election, attach a statement to
payment carved out of, or retained on the sale mation on adjusted basis. your timely filed (including extensions) original
of, mineral property is not an economic interest. return for the first tax year for which the safe
Total recoverable units. The total recovera harbor is elected. The statement must indicate
Individuals, corporations, estates, and ble units is the sum of the following. that you are electing the safe harbor provided
! trusts who claim depletion deductions The number of units of mineral remaining by Revenue Procedure 200419. The election, if
may be liable for alternative minimum at the end of the year (including units re made, is effective for the tax year in which it is

tax. covered but not sold). made and all later years. It cannot be revoked
The number of units of mineral sold during for the tax year in which it is elected, but may be
Basis adjustment for depletion. You must the tax year (determined under your revoked in a later year. Once revoked, it cannot
reduce the basis of your property by the deple method of accounting, as explained next). be reelected for the next 5 years.
tion allowed or allowable, whichever is greater. You must estimate or determine recoverable
units (tons, pounds, ounces, barrels, thousands Percentage Depletion
of cubic feet, or other measure) of mineral prod
Mineral Property ucts using the current industry method and the
To figure percentage depletion, you multiply a
most accurate and reliable information you can
certain percentage, specified for each mineral,
Mineral property includes oil and gas wells, obtain. You must include ores and minerals that
by your gross income from the property during
mines, and other natural deposits (including ge are developed, in sight, blocked out, or as
the tax year.
othermal deposits). For this purpose, the term sured. You must also include probable or pro
property means each separate interest you spective ores or minerals that are believed to The rates to be used and other rules for oil
own in each mineral deposit in each separate exist based on good evidence. But see Elective and gas wells are discussed later under Inde-
tract or parcel of land. You can treat two or safe harbor for owners of oil and gas property, pendent Producers and Royalty Owners and
more separate interests as one property or as later. under Natural Gas Wells. Rates and other rules
separate properties. See section 614 of the In for percentage depletion of other specific miner
ternal Revenue Code and the related regula Number of units sold. You determine the als are found later in Mines and Geothermal De-
tions for rules on how to treat separate mineral number of units sold during the tax year based posits.
interests. on your method of accounting. Use the follow
ing table to make this determination. Gross income. When figuring percentage de
There are two ways of figuring depletion on pletion, subtract from your gross income from
mineral property. IF you THEN the units sold during the property the following amounts.
Cost depletion. use ... the year are ... Any rents or royalties you paid or incurred
Percentage depletion. for the property.
The cash The units sold for which you
method of receive payment during the tax The part of any bonus you paid for a lease
Generally, you must use the method that gives accounting year (regardless of the year of on the property allocable to the product
you the larger deduction. However, unless you sale). sold (or that otherwise gives rise to gross
are an independent producer or royalty owner, An accrual The units sold based on your
income) for the tax year.
you generally cannot use percentage depletion method of inventories and method of A bonus payment includes amounts you paid as
for oil and gas wells. See Oil and Gas Wells, accounting accounting for inventory. a lessee to satisfy a production payment re
later. tained by the lessor.
The number of units sold during the tax year
Use the following fraction to figure the part
does not include any for which depletion deduc
Cost Depletion tions were allowed or allowable in earlier years.
of the bonus you must subtract.

To figure cost depletion you must first deter Figuring the cost depletion deduction. No. of units sold in the tax year Bonus

mine the following. Once you have figured your property's basis for Recoverable units from the property Payments
The property's basis for depletion. depletion, the total recoverable units, and the
For oil and gas wells and geothermal depos
The total recoverable units of mineral in the number of units sold during the tax year, you
its, more information about the definition of
property's natural deposit. can figure your cost depletion deduction by tak
gross income from the property is under Oil and
The number of units of mineral sold during ing the following steps.
Gas Wells, later. For other property, more infor
the tax year.
mation about the definition of gross income
Basis for depletion. To figure the property's Step Action Result from the property is under Mines and Geother-
basis for depletion, subtract all the following 1 Divide your property's Rate per unit. mal Deposits, later.
from the property's adjusted basis. basis for depletion by
total recoverable units. Taxable income limit. The percentage deple
1. Amounts recoverable through: tion deduction generally cannot be more than
2 Multiply the rate per Cost depletion
a. Depreciation deductions, unit by units sold deduction. 50% (100% for oil and gas property) of your tax
during the tax year. able income from the property figured without
b. Deferred expenses (including defer the depletion deduction and the domestic pro
red exploration and development You must keep accounts for the depletion of duction activities deduction.
costs), and each property and adjust these accounts each Taxable income from the property means
c. Deductions other than depletion. year for units sold and depletion claimed. gross income from the property minus all allow
able deductions (except any deduction for de
2. The residual value of land and improve Elective safe harbor for owners of oil and pletion or domestic production activities) attrib
ments at the end of operations. gas property. Instead of using the method de utable to mining processes, including mining
3. The cost or value of land acquired for pur scribed earlier to determine the total recovera transportation. These deductible items include,
poses other than mineral production. ble units, you can use an elective safe harbor. If but are not limited to, the following.
you choose the elective safe harbor, the total Operating expenses.
Adjusted basis. The adjusted basis of recoverable units equal 105% of a property's Certain selling expenses.
your property is your original cost or other ba proven reserves (both developed and undevel
sis, plus certain additions and improvements, oped). For details, see Revenue Procedure Administrative and financial overhead.

Page 34 Chapter 9 Depletion

Depreciation. ery runs for the tax year by the total number of Related person. To determine if you and
Intangible drilling and development costs. days in the tax year. another person are related persons, see Rela-
ted person under Refiners who cannot claim
Exploration and development expendi Related person. You and another person percentage depletion, earlier.
tures. are related persons if either of you holds a sig
Deductible taxes (see chapter 5), but not nificant ownership interest in the other person Sales through a related person. You are
taxes that you capitalize or take as a credit. or if a third person holds a significant ownership considered to be selling through a related per
Losses sustained. interest in both of you. son if any sale by the related person produces
gross income from which you may benefit be
The following rules apply when figuring your cause of your direct or indirect ownership inter
For example, a corporation, partnership, es
taxable income from the property for purposes est in the person.
tate, or trust and anyone who holds a significant
of the taxable income limit. You are not considered to be selling
ownership interest in it are related persons. A
Do not deduct any net operating loss de through a related person who is a retailer if all
partnership and a trust are related persons if
duction from the gross income from the the following apply.
one person holds a significant ownership inter
property. You do not have a significant ownership in
est in each of them.
Corporations do not deduct charitable con terest in the retailer.
tributions from the gross income from the You sell your production to persons who
property. For purposes of the related person rules,
significant ownership interest means direct or are not related to either you or the retailer.
If, during the year, you dispose of an item The retailer does not buy oil or natural gas
of section 1245 property that was used in indirect ownership of 5% or more in any one of
the following. from your customers or persons related to
connection with mineral property, reduce your customers.
any allowable deduction for mining expen There are no arrangements for the retailer
ses by the part of any gain you must report The value of the outstanding stock of a
to acquire oil or natural gas you produced
as ordinary income that is allocable to the corporation.
for resale or made available for purchase
mineral property. See section 1.6135(b) The interest in the profits or capital of a
by the retailer.
(1) of the regulations for information on partnership.
Neither you nor the retailer knows of or
how to figure the ordinary gain allocable to The beneficial interests in an estate or
controls the final disposition of the oil or
the property. trust.
natural gas you sold or the original source
of the petroleum products the retailer ac
Oil and Gas Wells Any interest owned by or for a corporation, quired for resale.
partnership, trust, or estate is considered to be
You cannot claim percentage depletion for an owned directly both by itself and proportionately Transferees who cannot claim percentage
oil or gas well unless at least one of the follow by its shareholders, partners, or beneficiaries. depletion. You cannot claim percentage de
ing applies. pletion if you received your interest in a proven
Retailers who cannot claim percentage de- oil or gas property by transfer after 1974 and
You are either an independent producer or
pletion. You cannot claim percentage deple before October 12, 1990. For a definition of the
a royalty owner.
tion if both the following apply. term transfer, see section 1.613A7(n) of the
The well produces natural gas that is either
sold under a fixed contract or produced 1. You sell oil or natural gas or their byprod regulations. For a definition of the term interest
from geopressured brine. ucts directly or through a related person in in proven oil or gas property, see section
any of the following situations. 1.613A7(p) of the regulations.
If you are an independent producer or roy
alty owner, see Independent Producers and a. Through a retail outlet operated by Figuring percentage depletion. Generally,
Royalty Owners next. you or a related person. as an independent producer or royalty owner,
b. To any person who is required under you figure your percentage depletion by com
For information on the depletion deduction puting your average daily production of domes
an agreement with you or a related
for wells that produce natural gas that is either tic oil or gas and comparing it to your depletable
person to use a trademark, trade
sold under a fixed contract or produced from oil or gas quantity. If your average daily produc
name, or service mark or name
geopressured brine, see Natural Gas Wells, tion does not exceed your depletable oil or gas
owned by you or a related person in
later. quantity, you figure your percentage depletion
marketing or distributing oil, natural
gas, or their byproducts. by multiplying the gross income from the oil or
Independent Producers and gas property (defined later) by 15%. If your
Royalty Owners c. To any person given authority under average daily production of domestic oil or gas
an agreement with you or a related exceeds your depletable oil or gas quantity, you
If you are an independent producer or royalty person to occupy any retail outlet must make an allocation as explained later un
owner, you figure percentage depletion using a owned, leased, or controlled by you or der Average daily production.
rate of 15% of the gross income from the prop a related person. In addition, there is a limit on the percentage
erty based on your average daily production of 2. The combined gross receipts from sales depletion deduction. See Taxable income limit,
domestic crude oil or domestic natural gas up to (not counting resales) of oil, natural gas, or later.
your depletable oil or natural gas quantity. How their byproducts by all retail outlets taken
ever, certain refiners, as explained next, and into account in (1) are more than $5 million Average daily production. Figure your aver
certain retailers and transferees of proven oil for the tax year. age daily production by dividing your total do
and gas properties, as explained next, cannot mestic production of oil or gas for the tax year
claim percentage depletion. For information on For the purpose of determining if this rule by the number of days in your tax year.
figuring the deduction, see Figuring percentage applies, do not count the following.
depletion, later. Bulk sales (sales in very large quantities) Partial interest. If you have a partial inter
of oil or natural gas to commercial or indus est in the production from a property, figure
Refiners who cannot claim percentage de- trial users. your share of the production by multiplying total
pletion. You cannot claim percentage deple Bulk sales of aviation fuels to the Depart production from the property by your percent
tion if you or a related person refine crude oil ment of Defense. age of interest in the revenues from the prop
and you and the related person refined more Sales of oil or natural gas or their byprod erty.
than 75,000 barrels on any day during the tax ucts outside the United States if none of You have a partial interest in the production
year based on average (rather than actual) daily your domestic production or that of a rela from a property if you have a net profits interest
refinery runs for the tax year. The average daily ted person is exported during the tax year in the property. To figure the share of produc
refinery run is computed by dividing total refin or the prior tax year. tion for your net profits interest, you must first

Chapter 9 Depletion Page 35

determine your percentage participation (as 1563(a) of the Internal Revenue Code, except Partnerships and S Corporations
measured by the net profits) in the gross reve that, for this purpose, the stock ownership re
nue from the property. To figure this percent quirement in that definition is more than 50% Generally, each partner or S corporation share
age, you divide the income you receive for your rather than at least 80%. holder, and not the partnership or S corpora
net profits interest by the gross revenue from tion, figures the depletion allowance separately.
the property. Then multiply the total production Gross income from the property. For purpo (However, see Electing large partnerships must
from the property by your percentage participa ses of percentage depletion, gross income from figure depletion allowance, later.) Each partner
tion to figure your share of the production. the property (in the case of oil and gas wells) is or shareholder must decide whether to use cost
the amount you receive from the sale of the oil or percentage depletion. If a partner or share
Example. Javier Robles owns oil property or gas in the immediate vicinity of the well. If holder uses percentage depletion, he or she
in which Pablo Olmos owns a 20% net profits you do not sell the oil or gas on the property, must apply the 65%oftaxableincome limit us
interest. During the year, the property produced but manufacture or convert it into a refined ing his or her taxable income from all sources.
10,000 barrels of oil, which Javier sold for product before sale or transport it before sale,
$200,000. Javier had expenses of $90,000 at the gross income from the property is the repre Partner's or shareholder's adjusted basis.
tributable to the property. The property gener sentative market or field price (RMFP) of the oil The partnership or S corporation must allocate
ated a net profit of $110,000 ($200,000 or gas, before conversion or transportation. to each partner or shareholder his or her share
$90,000). Pablo received income of $22,000 If you sold gas after you removed it from the of the adjusted basis of each oil or gas property
($110,000 .20) for his net profits interest. premises for a price that is lower than the held by the partnership or S corporation. The
Pablo determined his percentage participa RMFP, determine gross income from the prop partnership or S corporation makes the alloca
tion to be 11% by dividing $22,000 (the income erty for percentage depletion purposes without tion as of the date it acquires the oil or gas
he received) by $200,000 (the gross revenue regard to the RMFP. property.
from the property). Pablo determined his share Gross income from the property does not in Each partner's share of the adjusted basis of
of the oil production to be 1,100 barrels (10,000 clude lease bonuses, advance royalties, or the oil or gas property generally is figured ac
barrels 11%). other amounts payable without regard to pro cording to that partner's interest in partnership
duction from the property. capital. However, in some cases, it is figured
Depletable oil or natural gas quantity. Gen according to the partner's interest in partnership
erally, your depletable oil quantity is 1,000 bar Average daily production exceeds depleta- income.
rels. Your depletable natural gas quantity is ble quantities. If your average daily produc The partnership or S corporation adjusts the
6,000 cubic feet multiplied by the number of tion for the year is more than your depletable oil partner's or shareholder's share of the adjusted
barrels of your depletable oil quantity that you or natural gas quantity, figure your allowance for basis of the oil and gas property for any capital
choose to apply. If you claim depletion on both depletion for each domestic oil or natural gas expenditures made for the property and for any
oil and natural gas, you must reduce your de property as follows. change in partnership or S corporation inter
pletable oil quantity (1,000 barrels) by the num
1. Figure your average daily production of oil ests.
ber of barrels you use to figure your depletable
natural gas quantity. or natural gas for the year.
Recordkeeping. Each partner or
2. Figure your depletable oil or natural gas shareholder must separately keep re
Example. You have both oil and natural quantity for the year. RECORDS cords of his or her share of the adjus
gas production. To figure your depletable natu ted basis in each oil and gas property of the
ral gas quantity, you choose to apply 360 bar 3. Figure depletion for all oil or natural gas
partnership or S corporation. The partner or
rels of your 1000barrel depletable oil quantity. produced from the property using a per
shareholder must reduce his or her adjusted
Your depletable natural gas quantity is 2.16 mil centage depletion rate of 15%.
basis by the depletion allowed or allowable on
lion cubic feet of gas (360 6,000). You must 4. Multiply the result figured in (3) by a frac the property each year. The partner or share
reduce your depletable oil quantity to 640 bar tion, the numerator of which is the result holder must use that reduced adjusted basis to
rels (1,000 360). figured in (2) and the denominator of figure cost depletion or his or her gain or loss if
If you have production from marginal wells, which is the result figured in (1). This is the partnership or S corporation disposes of the
see section 613A(c)(6) of the Internal Revenue your depletion allowance for that property property.
Code to figure your depletable oil or natural gas for the year.
quantity. Also, see Notice 201250, available at
Reporting the deduction. Information that Taxable income limit. If you are an independ
you, as a partner or shareholder, use to figure
ent producer or royalty owner of oil and gas,
Business entities and family members. your depletion deduction on oil and gas proper
your deduction for percentage depletion is limi
You must allocate the depletable oil or gas ties is reported by the partnership or S corpora
ted to the smaller of the following.
quantity among the following related persons in tion on Schedule K1 (Form 1065) or on Sched
100% of your taxable income from the
proportion to each entity's or family member's property figured without the deduction for ule K1 (Form 1120S). Deduct oil and gas
production of domestic oil or gas for the year. depletion and the deduction for domestic depletion for your partnership or S corporation
Corporations, trusts, and estates if 50% or production activities under section 199 of interest on Schedule E (Form 1040). The deple
more of the beneficial interest is owned by the Internal Revenue Code. For a definition tion deducted on Schedule E is included in fig
the same or related persons (considering of taxable income from the property, see uring income or loss from rental real estate or
only persons that own at least 5% of the Taxable income limit, earlier, under Min- royalty properties. The instructions for Sched
beneficial interest). eral Property. ule E explain where to report this income or loss
You and your spouse and minor children. 65% of your taxable income from all sour and whether you need to file either of the follow
ces, figured without the depletion allow ing forms.
A related person is anyone mentioned in the re Form 6198, AtRisk Limitations.
lated persons discussion under Nondeductible ance, the deduction for domestic produc
loss in chapter 2 of Publication 544, except that tion activities, any net operating loss Form 8582, Passive Activity Loss Limita
for purposes of this allocation, item (1) in that carryback, and any capital loss carryback. tions.
discussion includes only an individual, his or You can carry over to the following year any
her spouse, and minor children. Electing large partnerships must figure de-
amount you cannot deduct because of the
pletion allowance. An electing large partner
65%oftaxableincome limit. Add it to your de
Controlled group of corporations. Mem ship, rather than each partner, generally must
pletion allowance (before applying any limits)
bers of the same controlled group of corpora figure the depletion allowance. The partnership
for the following year.
tions are treated as one taxpayer when figuring figures the depletion allowance without taking
the depletable oil or natural gas quantity. They into account the 65%oftaxableincome limit
share the depletable quantity. A controlled and the depletable oil or natural gas quantity.
group of corporations is defined in section Also, the adjusted basis of a partner's interest in

Page 36 Chapter 9 Depletion

the partnership is not affected by the depletion The following is a list of the percentage de processes must be applied by the mine owner
allowance. pletion rates for the more common minerals. or operator. For a listing of treatment processes
An electing large partnership is one that considered as mining, see section 613(c)(4) of
meets both the following requirements. DEPOSITS RATE the Internal Revenue Code and the related reg
The partnership had 100 or more partners ulations.
in the preceding year. Sulphur, uranium, and, if from deposits in
the United States, asbestos, lead ore, Transportation of more than 50 miles. If
The partnership chooses to be an electing
zinc ore, nickel ore, and mica . . . . . . . . 22% the IRS finds that the ore or mineral must be
large partnership.
transported more than 50 miles to plants or
Gold, silver, copper, iron ore, and certain
Disqualified persons. An electing large oil shale, if from deposits in the United
mills to be treated because of physical and
partnership does not figure the depletion allow States . . . . . . . . . . . . . . . . . . . . . . . 15% other requirements, the additional authorized
ance of its partners that are disqualified per transportation is considered mining and inclu
Borax, granite, limestone, marble,
sons. Disqualified persons must figure it them ded in the computation of gross income from
mollusk shells, potash, slate, soapstone,
selves, as explained earlier. and carbon dioxide produced from a mining.
All the following are disqualified persons. well . . . . . . . . . . . . . . . . . . . . . . . . . . 14%
If you wish to include transportation of
Refiners who cannot claim percentage de
Coal, lignite, and sodium chloride . . . . . 10% more than 50 miles in the computation
pletion (discussed under Independent Pro-
Clay and shale used or sold for use in of gross income from mining, request
ducers and Royalty Owners, earlier).
making sewer pipe or bricks or used or an advance ruling from the IRS. Include in the
Retailers who cannot claim percentage de
sold for use as sintered or burned request the facts about the physical and other
pletion (discussed under Independent Pro- 71 2%
lightweight aggregates . . . . . . . . . . . . requirements that prevented the construction
ducers and Royalty Owners, earlier).
Clay used or sold for use in making and operation of the plant within 50 miles of the
Any partner whose average daily produc
drainage and roofing tile, flower pots, point of extraction. For more information about
tion of domestic crude oil and natural gas
and kindred products, and gravel, sand, requesting an advance ruling, see Revenue
is more than 500 barrels during the tax and stone (other than stone used or sold Procedure 20151, available at
year in which the partnership tax year for use by a mine owner or operator as 2015-1_IRB/ar07.html.
ends. Average daily production is dis dimension or ornamental stone) . . . . . . 5%
cussed earlier.
You can find a complete list of minerals and Disposal of coal or iron ore. You cannot take
their percentage depletion rates in section a depletion deduction for coal (including lignite)
Natural Gas Wells
613(b) of the Internal Revenue Code. or iron ore mined in the United States if both the
You can use percentage depletion for a well following apply.
Corporate deduction for iron ore and You disposed of it after holding it for more
that produces natural gas that is either: coal. The percentage depletion deduction of a
Sold under a fixed contract, or than 1 year.
corporation for iron ore and coal (including lig You disposed of it under a contract under
Produced from geopressured brine. nite) is reduced by 20% of: which you retain an economic interest in
The percentage depletion deduction for the coal or iron ore.
Natural gas sold under a fixed contract. the tax year (figured without this reduc
tion), minus Treat any gain on the disposition as a capital
Natural gas sold under a fixed contract qualifies
The adjusted basis of the property at the gain.
for a percentage depletion rate of 22%. This is
domestic natural gas sold by the producer un close of the tax year (figured without the Disposal to related person. This rule
der a contract that does not provide for a price depletion deduction for the tax year). does not apply if you dispose of the coal or iron
increase to reflect any increase in the seller's ore to one of the following persons.
tax liability because of the repeal of percentage Gross income from the property. For prop A related person (as listed in chapter 2 of
depletion for gas. The contract must have been erty other than a geothermal deposit or an oil or Publication 544).
in effect from February 1, 1975, until the date of gas well, gross income from the property A person owned or controlled by the same
sale of the gas. Price increases after February means the gross income from mining. Mining interests that own or control you.
1, 1975, are presumed to take the increase in includes all the following.
tax liability into account unless demonstrated Extracting ores or minerals from the Geothermal deposits. Geothermal deposits
otherwise by clear and convincing evidence. ground. located in the United States or its possessions
Applying certain treatment processes de qualify for a percentage depletion rate of 15%.
Natural gas from geopressured brine. scribed later. A geothermal deposit is a geothermal reservoir
Qualified natural gas from geopressured brine Transporting ores or minerals (generally, of natural heat stored in rocks or in a watery liq
is eligible for a percentage depletion rate of not more than 50 miles) from the point of uid or vapor. For percentage depletion purpo
10%. This is natural gas that is both the follow extraction to the plants or mills in which the ses, a geothermal deposit is not considered a
ing. treatment processes are applied. gas well.
Produced from a well you began to drill af Figure gross income from the property for a
Excise tax. Gross income from mining in
ter September 1978 and before 1984. geothermal steam well in the same way as for
cludes the separately stated excise tax re
Determined in accordance with section oil and gas wells. See Gross income from the
ceived by a mine operator from the sale of coal
503 of the Natural Gas Policy Act of 1978 property, earlier, under Oil and Gas Wells. Per
to compensate the operator for the excise tax
to be produced from geopressured brine. centage depletion on a geothermal deposit can
the mine operator must pay to finance black
lung benefits. not be more than 50% of your taxable income
Mines and Geothermal Extraction. Extracting ores or minerals
from the property.
Deposits from the ground includes extraction by mine
owners or operators of ores or minerals from Lessor's Gross Income
Certain mines, wells, and other natural depos the waste or residue of prior mining. This does
its, including geothermal deposits, qualify for not apply to extraction from waste or residue of In the case of leased property, the depletion de
percentage depletion. prior mining by the purchaser of the waste or duction is divided between the lessor and the
residue or the purchaser of the rights to extract lessee.
Mines and other natural deposits. For a nat ores or minerals from the waste or residue.
ural deposit, the percentage of your gross in A lessor's gross income from the property
come from the property that you can deduct as Treatment processes. The processes in that qualifies for percentage depletion usually is
depletion depends on the type of deposit. cluded as mining depend on the ore or mineral the total of the royalties received from the lease.
mined. To qualify as mining, the treatment

Chapter 9 Depletion Page 37

Bonuses and advanced royalties. Bonuses Figuring cost depletion. To figure your cost adjusted basis for depletion from the fair market
and advanced royalties are payments a lessee depletion allowance, you multiply the number of value of the timber on the first day of the tax
makes before production to a lessor for the timber units cut by your depletion unit. year in which you cut it to figure the gain or loss
grant of rights in a lease or for minerals, gas, or on the cutting. You generally report the gain as
oil to be extracted from leased property. If you Timber units. When you acquire timber longterm capital gain. The fair market value
property, you must make an estimate of the then becomes your basis for figuring your ordi
are the lessor, your income from bonuses and
quantity of marketable timber that exists on the nary gain or loss on the sale or other disposition
advanced royalties received is subject to an al
property. You measure the timber using board of the products cut from the timber. For more in
lowance for depletion, as explained in the next
feet, log scale, cords, or other units. If you later
two paragraphs. formation, see Timber in chapter 2 of Publica
determine that you have more or less units of
tion 544, Sales and Other Dispositions of As
Figuring cost depletion. To figure cost timber, you must adjust the original estimate.
depletion on a bonus, multiply your adjusted ba The term timber property means your eco
You may revoke an election to treat the cut
sis in the property by a fraction, the numerator nomic interest in standing timber in each tract or
ting of timber as a sale or exchange without the
of which is the bonus and the denominator of block representing a separate timber account.
IRS's consent. The prior election (and revoca
which is the total bonus and royalties expected
Depletion unit. You figure your depletion tion) is disregarded for purposes of making a
to be received. To figure cost depletion on ad
unit each year by taking the following steps. subsequent election. See Form T (Timber), For
vanced royalties, use the computation ex est Activities Schedule, for more information.
plained earlier under Cost Depletion, treating 1. Determine your cost or adjusted basis of
the number of units for which the advanced roy the timber on hand at the beginning of the Form T. Complete and attach Form T (Timber)
alty is received as the number of units sold. year. Adjusted basis is defined under Cost to your income tax return if you claim a deduc
Depletion in the discussion on Mineral tion for timber depletion, choose to treat the cut
Figuring percentage depletion. In the Property.
case of mines, wells, and other natural deposits ting of timber as a sale or exchange, or make an
other than gas, oil, or geothermal property, you 2. Add to the amount determined in (1) the outright sale of timber.
may use the percentage rates discussed earlier cost of any timber units acquired during
under Mines and Geothermal Deposits. Any bo the year and any additions to capital.
nus or advanced royalty payments are gener 3. Figure the number of timber units to take
ally part of the gross income from the property into account by adding the number of tim
to which the rates are applied in making the cal ber units acquired during the year to the
culation. However, for oil, gas, or geothermal
property, gross income does not include lease
number of timber units on hand in the ac
count at the beginning of the year and 10.
bonuses, advanced royalties, or other amounts then adding (or subtracting) any correction
payable without regard to production from the to the estimate of the number of timber
property. units remaining in the account. Business
Ending the lease. If you receive a bonus 4. Divide the result of (2) by the result of (3).
on a lease that ends or is abandoned before
you derive any income from mineral extraction,
This is your depletion unit.
Bad Debts
include in income the depletion deduction you Example. You bought a timber tract for
took. Do this for the year the lease ends or is $160,000 and the land was worth as much as
abandoned. Also increase your adjusted basis
in the property to restore the depletion deduc
the timber. Your basis for the timber is $80,000.
Based on an estimated one million board feet
tion you previously subtracted. (1,000 MBF) of standing timber, you figure your You have a bad debt if you cannot collect
For advanced royalties, include in income depletion unit to be $80 per MBF ($80,000 money owed to you. A bad debt is either a busi
the depletion claimed on minerals for which the 1,000). If you cut 500 MBF of timber, your de ness bad debt or a nonbusiness bad debt. This
advanced royalties were paid if the minerals pletion allowance would be $40,000 (500 MBF chapter discusses only business bad debts.
were not produced before the lease ended. In $80). Generally, a business bad debt is one that
clude this amount in income for the year the comes from operating your trade or business.
lease ends. Increase your adjusted basis in the When to claim depletion. Claim your deple You can deduct business bad debts on Sched
property by the amount you include in income. tion allowance as a deduction in the year of sale ule C (Form 1040) or your applicable business
or other disposition of the products cut from the income tax return.
Delay rentals. These are payments for defer timber, unless you choose to treat the cutting of All other bad debts are nonbusiness bad
ring development of the property. Since delay timber as a sale or exchange (explained below). debts and are deductible only as shortterm
rentals are ordinary rent, they are ordinary in Include allowable depletion for timber products capital losses. For more information on nonbus
come that is not subject to depletion. These not sold during the tax year the timber is cut as iness bad debts, see Pub. 550.
rentals can be avoided by either abandoning a cost item in the closing inventory of timber
products for the year. The inventory is your ba
the lease, beginning development operations, Topics
or obtaining production. sis for determining gain or loss in the tax year This chapter discusses:
you sell the timber products.

Timber Example. The facts are the same as in the

previous example except that you sold only half
Definition of business bad debt
When a debt becomes worthless
of the timber products in the cutting year. You How to claim a business bad debt
You can figure timber depletion only by the cost
would deduct $20,000 of the $40,000 depletion
method. Percentage depletion does not apply Recovery of a bad debt
that year. You would add the remaining $20,000
to timber. Base your depletion on your cost or
depletion to your closing inventory of timber
other basis in the timber. Your cost does not in
products. Useful Items
clude the cost of land or any amounts recovera
ble through depreciation. You may want to see:
Electing to treat the cutting of timber as a
sale or exchange. You can elect, under cer
Depletion takes place when you cut stand Publication
tain circumstances, to treat the cutting of timber
ing timber. You can figure your depletion de held for more than 1 year as a sale or ex
duction when the quantity of cut timber is first 525 Taxable and Nontaxable Income
change. You must make the election on your in
accurately measured in the process of exploita come tax return for the tax year to which it ap 536 Net Operating Losses (NOLs) for
tion. plies. If you make this election, subtract the Individuals, Estates, and Trusts

Page 38 Chapter 10 Business Bad Debts

544 Sales and Other Dispositions of If you qualify, you can use the nonac cumstances, the loan is actually a contribution
Assets crualexperience method of accounting dis to capital.
cussed later. Under this method, you do not
550 Investment Income and Expenses have to accrue income that, based on your ex Debts of an insolvent partner. If your busi
556 Examination of Returns, Appeal perience, you do not expect to collect. ness partnership breaks up and one of your for
Rights, and Claims for Refund mer partners becomes insolvent, you may have
Cash method. If you use the cash method to pay more than your pro rata share of the part
of accounting, you generally report income nership's debts. If you pay any part of the insol
Form (and Instructions)
when you receive payment. You cannot claim a vent partner's share of the debts, you can claim
Schedule C (Form 1040) Profit or Loss bad debt deduction for amounts owed to you a bad debt deduction for the amount you paid
From Business because you never included those amounts in that is attributable to the insolvent partner's
income. For example, a cash basis architect share.
1040X Amended U.S. Individual Income cannot claim a bad debt deduction if a client
Tax Return fails to pay the bill because the architect's fee Business loan guarantee. If you guarantee a
1045 Application for Tentative Refund was never included in income. debt that subsequently becomes worthless, the
debt can qualify as a business bad debt if all the
1139 Corporation Application for Debts from a former business. If you sell following requirements are met.
Tentative Refund your business but retain its receivables, these You made the guarantee in the course of
debts are business debts because they arose your trade or business.
3115 Application for Change in
out of your trade or business. If any of these re You have a legal duty to pay the debt.
Accounting Method
ceivables subsequently become worthless, the
You made the guarantee before the debt
See chapter 12 for information about getting loss is still a business bad debt.
became worthless. You meet this require
publications and forms. ment if you reasonably expected you
Debt acquired from a decedent. The
character of a loss from debts of a business ac would not have to pay the debt without full
reimbursement from the borrower.
Definition of Business quired from a decedent is determined in the
same way as debts acquired on the purchase of You received reasonable consideration for
Bad Debt a business. The executor of the decedent's es
tate treats any loss from the debts as a busi
making the guarantee. You meet this re
quirement if you made the guarantee in ac
ness bad debt if the debts were closely related cord with normal business practice or for a
A business bad debt is a loss from the worth good faith business purpose.
to the decedent's trade or business when they
lessness of a debt that was either:
became worthless. Otherwise, a loss from
Created or acquired in your trade or busi Example. Jane Zayne owns the Zayne
these debts becomes a nonbusiness bad debt
ness, or Dress Company. She guaranteed payment of a
Closely related to your trade or business for the decedent's estate.
$20,000 note for Elegant Fashions, a dress out
when it became partly or totally worthless. Liquidation. If you liquidate your business let. Elegant Fashions is one of Zayne's largest
and some of the accounts receivable that you clients. Elegant Fashions later defaulted on the
A debt is closely related to your trade or
retain become worthless, they are treated as loan. As a result, Ms. Zayne paid the remaining
business if your primary motive for incurring the
business bad debts. balance of the loan in full to the bank.
debt is business related. Bad debts of a corpo
She can claim a business bad debt deduc
ration (other than an S corporation) are always
business bad debts. Types of Business Bad tion only for the amount she paid, since her
guarantee was made in the course of her trade
Debts or business for a good faith business purpose.
Credit sales. Business bad debts are mainly She was motivated by the desire to retain one
the result of credit sales to customers. Goods Business bad debts may result from the follow of her better clients and keep a sales outlet.
that have been sold, but not yet paid for, and ing.
Deductible in the year paid. If you make a
services that have been performed, but not yet
Loans to clients and suppliers. If you loan payment on a loan you guaranteed, you can de
paid for, are recorded in your books as either
money to a client, supplier, employee, or distrib duct it in the year paid, unless you have rights
accounts receivable or notes receivable. After a
utor for a business reason and you are unable against the borrower.
reasonable period of time, if you have tried to
collect the amount due, but are unable to do so, to collect the loan after attempting to do so, you Rights against a borrower. When you
the uncollectible part becomes a business bad have a business bad debt. make payment on a loan you guaranteed, you
debt. may have the right to take the place of the
Accounts or notes receivable valued at fair Debts owed by political parties. If a political lender. The debt is then owed to you. If you
market value (FMV) when received are deducti party (or other organization that accepts contri have this right, or some other right to demand
ble only at that value, even though the FMV butions or spends money to influence elections) payment from the borrower, you cannot claim a
may be less than the face value. If you pur owes you money and the debt becomes worth bad debt deduction until these rights become
chased an account receivable for less than its less, you can claim a bad debt deduction only if partly or totally worthless.
face value, and the receivable subsequently be all of the following requirements are met.
comes worthless, the most you are allowed to 1. You use the accrual method of account Joint debtor. If two or more debtors jointly
deduct is the amount you paid to acquire it. ing. owe you money, your inability to collect from
one does not enable you to deduct a propor
You can claim a business bad debt 2. The debt arose from the sale of goods or tionate amount as a bad debt.
! deduction only if the amount owed to services in the ordinary course of your
CAUTION you was previously included in gross trade or business. Sale of mortgaged property. If mortgaged or
income. This applies to amounts owed to you pledged property is sold for less than the debt,
3. More than 30% of your receivables ac
from all sources of taxable income, including the unpaid, uncollectible balance of the debt is
crued in the year of the sale were from
sales, services, rents, and interest. a bad debt.
sales to political parties.
Accrual method. If you use the accrual 4. You made substantial and continuing ef
method of accounting, you generally report in forts to collect on the debt.
come as you earn it. You can only claim a bad
debt deduction for an uncollectible receivable if Loan or capital contribution. You cannot
you have previously included the uncollectible claim a bad debt deduction for a loan you made
amount in income. to a corporation if, based on the facts and cir

Chapter 10 Business Bad Debts Page 39

Deduction disallowed. Generally, you can Nonaccrual-Experience
When a Debt Becomes claim a partial bad debt deduction only in the
year you make the chargeoff on your books. If,
Worthless under audit, the IRS does not allow your deduc
tion and the debt becomes partly worthless in a
If you use an accrual method of accounting and
qualify under the rules explained in this section,
later tax year, you can deduct the amount you
A debt becomes worthless when there is no you can use the nonaccrualexperience method
charged off in that year plus the disallowed
longer any chance the amount owed will be for bad debts. Under this method, you do not
amount charged off in the earlier year. The
paid. This may occur when the debt is due or accrue service related income you expect to be
chargeoff in the earlier year, unless reversed
prior to that date. uncollectible. Because the expected uncollecti
on your books, fulfills the chargeoff require
ble amounts are not included in income, these
To demonstrate worthlessness, you must ment for the later year.
amounts are not later deducted from income.
only show that you have taken reasonable
Totally worthless debts. If a debt becomes Generally, you can use the nonaccrualex
steps to collect the debt but were unable to do
totally worthless in the current tax year, you can perience method for accounts receivable for
so. It is not necessary to go to court if you can
deduct the entire amount, less any amount de services you performed only if:
show that a judgment from the court would be
ducted in an earlier tax year when the debt was The services are provided in the fields of
uncollectible. Bankruptcy of your debtor is gen
only partly worthless. accounting, actuarial science, architecture,
erally good evidence of the worthlessness of at
You do not have to make an actual consulting, engineering, health, law, or the
least a part of an unsecured and unpreferred
chargeoff on your books to claim a bad debt performing arts; or
deduction for a totally worthless debt. However, You meet the $5 million gross receipts test
you may want to do so. If you do not and the for all prior years.
Property received for debt. If you receive
property in partial settlement of a debt, reduce IRS later rules the debt is only partly worthless,
you will not be allowed a deduction for the debt Service related income. You can use the
the debt by the property's FMV, which becomes
in that tax year because a deduction of a partly nonaccrualexperience method only for
the property's basis. You can deduct the re
worthless bad debt is limited to the amount ac amounts earned by performing services. You
maining debt as a bad debt if and when it be
tually charged off. See Partly worthless debts, cannot use this method for amounts owed to
comes worthless. you from activities such as lending money, sell
If you later sell the property for more than its ing goods, or acquiring receivables or other
basis, any gain on the sale is due to the appre Filing a claim for refund. If you did not de rights to receive payment.
ciation of the property. It is not a recovery of a duct a bad debt on your original return for the
bad debt. For information on the sale of an as year it became worthless, you can file a claim Gross receipts test. To find out if you meet
set, see Pub. 544. for a credit or refund. If the bad debt was totally the $5 million gross receipts test for all prior
worthless, you must file the claim by the later of years, you must figure the average annual
the following dates. gross receipts for each prior year. If your aver
How To Claim a 7 years from the date your original return age annual gross receipts for any year exceeds
Business Bad Debt was due (not including extensions).
2 years from the date you paid the tax.
$5 million, you cannot use the nonaccrualexpe
rience method.
The average annual gross receipts for any
There are two methods to claim a business bad If the claim is for a partly worthless bad debt, year is the average of gross receipts from the
debt. you must file the claim by the later of the follow year in question and the 2 previous years. For
The specific chargeoff method. ing dates. example, if you were figuring the average an
The nonaccrualexperience method. 3 years from the date you filed your original nual gross receipts for 2015, you would aver
return. age your gross receipts for 2013, 2014, and
Generally, you must use the specific chargeoff 2 years from the date you paid the tax. 2015.
method. However, you may use the nonac
crualexperience method if you meet the re You may have longer to file the claim if you
Interest or penalty charged. Generally, you
quirements discussed later under Nonac- were unable to manage your financial affairs
cannot use the nonaccrualexperience method
crual-Experience Method. due to a physical or mental impairment. Such
for amounts due on which you charge interest
an impairment requires proof of existence.
or a late payment penalty. However, do not
For details and more information about filing
Specific Charge-Off Method a claim, see Pub. 556. Use one of the following
treat a discount offered for early payment as the
charging of interest or a penalty if both the fol
forms to file a claim. For more information, see lowing apply.
If you use the specific chargeoff method, you the instructions for the applicable form. You otherwise accrue the full amount due
can deduct specific business bad debts that be
as gross income at the time you provide
come either partly or totally worthless during the Table 101. Forms Used To File a the services.
tax year. However, with respect to partly worth
Claim You treat the discount allowed for early
less bad debts, your deduction is limited to the
payment as an adjustment to gross income
amount you charged off on your books during IF you filed as THEN file... in the year of payment.
the year. a...
Change in accounting method. Generally,
Partly worthless debts. You can deduct spe Sole proprietor
Form 1040X you must obtain consent to change to a nonac
cific bad debts that become partly uncollectible or farmer crualexperience method (other than one of the
during the tax year. Your tax deduction is limi
Corporation Form 1120X safe harbor methods) or to change from one
ted to the amount you charge off on your books
method to another. See Form 3115 and the In
during the year. You do not have to charge off S corporation Form 1120S and check structions for Form 3115 for more information
and deduct your partly worthless debts annu box H(4) and exceptions.
ally. You can delay the charge off until a later
year. However, you cannot deduct any part of a Partnership Form 1065X if filing on
paper or
debt after the year it becomes totally worthless.
Form 1065 and check box Recovery of a Bad Debt
Significantly modified debt. An exception G(5) if filing electronically
to the chargeoff rule exists for debt which has If you claim a deduction for a bad debt on your
been significantly modified and on which the income tax return and later recover (collect) all
holder recognized gain. For more information, or part of it, you may have to include all or part
see Regulations section 1.1663(a)(3). of the recovery in gross income. The amount

Page 40 Chapter 10 Business Bad Debts

you include is limited to the amount you actually 526 Charitable Contributions reimbursement, you must specify the amount of
deducted. However, you can exclude the the reimbursement and report it accordingly.
529 Miscellaneous Deductions
amount deducted that did not reduce your tax. See Table 111. Reporting Reimbursements.
Report the recovery as Other income on the 544 Sales and Other Dispositions of
appropriate business form or schedule. Assets Accountable Plans
See Recoveries in Publication 525 for more 946 How To Depreciate Property
information. An accountable plan requires your employees
970 Tax Benefits for Education to meet all of the following requirements. Each
Net operating loss (NOL) carryover. If a employee must:
bad debt deduction increases an NOL carry See chapter 12 for information about getting
over that has not expired before the beginning publications and forms. 1. Have paid or incurred deductible expen
of the tax year in which the recovery takes ses while performing services as your em
place, you treat the deduction as having re ployee,
duced your tax. A bad debt deduction that con Reimbursement of 2. Adequately account to you for these ex
tributes to an NOL helps lower taxes in the year
to which you carry the NOL. For more informa
Travel, Meals, and penses within a reasonable period of time,
tion about NOLs, see Pub. 536. Also, see the Entertainment 3. Return any excess reimbursement or al
Instructions for Form 1045, and the Instructions
for Form 1139. lowance within a reasonable period of
The following discussion explains how to han time.
dle any reimbursements or allowances you may
provide to your employees under a reimburse An arrangement under which you advance
ment or allowance arrangement for travel, money to employees is treated as meeting (3)
meals, and entertainment expenses. If you are above only if the following requirements are
selfemployed and report your income and ex also met.
11. penses on Schedule C or CEZ (Form 1040),
see Pub. 463.
The advance is reasonably calculated not
to exceed the amount of anticipated ex
To be deductible for tax purposes, expen
You make the advance within a reasonable
Other Expenses ses incurred for travel, meals, and entertain
ment must be ordinary and necessary expen
period of time of your employee paying or
incurring the expense.
ses incurred while carrying on your trade or
business. Generally, you also must show that
If any expenses reimbursed under this ar
What's New entertainment expenses (including meals) are
directly related to, or associated with, the con
rangement are not substantiated, or an excess
reimbursement is not returned within a reasona
duct of your trade or business. For more infor
ble period of time by an employee, you cannot
Standard mileage rate. Beginning in 2015, mation on travel, meals, and entertainment, in
treat these expenses as reimbursed under an
the standard mileage rate for the cost of operat cluding deductibility, see Pub. 463.
accountable plan. Instead, treat the reimbursed
ing your car, van, pickup, or panel truck for
expenses as paid under a nonaccountable
business use is 57.5 cents per mile. For more
information, see Car and truck expenses under
Reimbursements plan, discussed later.
Miscellaneous Expenses.
A reimbursement or allowance arrangement Adequate accounting. Your employees must
provides for payment of advances, reimburse adequately account to you for their travel,
Introduction ments, and allowances for travel, meals, and
entertainment expenses incurred by your em
meals, and entertainment expenses. They must
give you documentary evidence of their travel,
This chapter covers business expenses that ployees during the ordinary course of business. mileage, and other employee business expen
may not have been explained to you, as a busi If the expenses are substantiated, you can de ses. This evidence should include items such
ness owner, in previous chapters of this publi duct the allowable amount on your tax return. as receipts, along with either a statement of ex
cation. Because of differences between accounting penses, an account book, a dayplanner, or
methods and tax law, the amount you can de similar record in which the employee entered
duct for tax purposes may not be the same as each expense at or near the time the expense
the amount you deduct on your business books was incurred.
This chapter discusses:
and records. For example, you can deduct
100% of the cost of meals on your business Excess reimbursement or allowance. An
Travel, meals, and entertainment books and records. However, only 50% of excess reimbursement or allowance is any
Bribes and kickbacks these costs are allowed by law as a tax deduc amount you pay to an employee that is more
Charitable contributions tion. than the businessrelated expenses for which
the employee adequately accounted. The em
Education expenses How you deduct a business expense under ployee must return any excess reimbursement
Lobbying expenses a reimbursement or allowance arrangement de or other expense allowance to you within a rea
pends on whether you have: sonable period of time.
Penalties and fines
An accountable plan, or
Repayments (claim of right) Reasonable period of time. A reasonable pe
A nonaccountable plan.
Other miscellaneous expenses riod of time depends on the facts and circum
If you reimburse these expenses under an ac stances. Generally, actions that take place
countable plan, deduct them as travel, meals, within the times specified in the following list will
Useful Items or entertainment expenses. be treated as taking place within a reasonable
You may want to see:
period of time.
If you reimburse these expenses under a
Publication nonaccountable plan, report the reimburse 1. You give an advance within 30 days of the
ments as wages on Form W2, Wage and Tax time the employee pays or incurs the ex
15-B Employer's Tax Guide to Fringe Statement, and deduct them as wages on the pense.
Benefits appropriate line of your tax return. If you make a
463 Travel, Entertainment, Gift, and Car single payment to your employees and it in
Expenses cludes both wages and an expense

Chapter 11 Other Expenses Page 41

2. Your employees adequately account for Table 111. Reporting Reimbursements
their expenses within 60 days after the ex
penses were paid or incurred. IF the type of reimbursement (or other expense
allowance) arrangement is under THEN the employer reports on Form W-2
3. Your employees return any excess reim
bursement within 120 days after the ex An accountable plan with:
penses were paid or incurred. Actual expense reimbursement: No amount.
Adequate accounting made and excess returned
4. You give a periodic statement (at least
quarterly) to your employees that asks Actual expense reimbursement: The excess amount as wages in box 1.
them to either return or adequately ac Adequate accounting and return of excess both required
but excess not returned
count for outstanding advances and they
comply within 120 days of the date of the Per diem or mileage allowance up to the federal rate: No amount.
statement. Adequate accounting made and excess returned
Per diem or mileage allowance up to the federal rate: The excess amount as wages in box 1. The amount up to
How to deduct. You can claim a deduction for Adequate accounting and return of excess both required the federal rate is reported only in box 12it is not
travel, meals, and entertainment expenses if but excess not returned reported in box 1.
you reimburse your employees for these expen Per diem or mileage allowance exceeds the federal rate: The excess amount as wages in box 1. The amount up to
ses under an accountable plan. Generally, the Adequate accounting made up to the federal rate only and the federal rate is reported only in box 12it is not
amount you can deduct for meals and entertain excess not returned reported in box 1.
ment is subject to a 50% limit, discussed later. If A nonaccountable plan with:
you are a sole proprietor, or are filing as a single
Either adequate accounting or return of excess, or both, not The entire amount as wages in box 1.
member limited liability company, deduct the required by plan
travel reimbursement on line 24a and the de
No reimbursement plan The entire amount as wages in box 1.
ductible part of the meals and entertainment re
imbursement on line 24b, Schedule C (Form
(such as gas, oil, etc.) plus a flat amount to Internet access. Per diem rates are availa
1040) or line 2, Schedule CEZ (Form 1040).
cover your employees' fixed costs (such as de ble on the Internet. You can access per diem
If you are filing an income tax return for a
preciation, insurance, etc.). For information on rates at
corporation, include the reimbursement on the
using a FAVR allowance, see Revenue Proce
Other deductions line of Form 1120, U.S. Cor High-low method. This is a simplified
dure 201051, available at
poration Income Tax Return. If you are filing any method of computing the federal per diem rate
2010-51_IRB/ar14.html and Notice 201479,
other business income tax return, such as a for travel within the continental United States. It
available at
partnership or S corporation return, deduct the eliminates the need to keep a current list of the
reimbursement on the appropriate line of the re per diem rate for each city.
turn as provided in the instructions for that re Per diem allowance. If your employee ac Under the highlow method, the per diem
turn. tually substantiates to you the other elements amount for travel during January through Sep
(discussed earlier) of the expenses reimbursed tember of 2015 is $259 ($65 for M&IE) for cer
Per Diem and Car Allowances using the per diem allowance, how you report tain highcost locations. All other areas have a
and deduct the allowance depends on whether per diem amount of $172 ($52 for M&IE). The
You can reimburse your employees under an the allowance is for lodging and meal expenses highcost localities eligible for the higher per
accountable plan based on travel days, miles, or for meal expenses only and whether the al diem amount under the highlow method are lis
or some other fixed allowance. In these cases, lowance is more than the federal rate. ted in Notice 201563 available at
your employee is considered to have accounted 2015-40_IRB/ar09.html.
to you for the amount of the expense that does Regular federal per diem rate. The regu Effective October 1, 2015, the per diem rate
not exceed the rates established by the federal lar federal per diem rate is the highest amount for highcost locations increased to $275 ($68
government. Your employee must actually sub the federal government will pay to its employ for M&IE). The rate for all other locations in
stantiate to you the other elements of the ex ees while away from home on travel. It has two creased to $185 ($57 for M&IE). For October,
pense, such as time, place, and business pur components: November, and December 2015, you can either
pose. 1. Lodging expense, and continue to use the rates described in the pre
ceding paragraph or change to the new rates.
Federal rate. The federal rate can be figured 2. Meal and incidental expense (M&IE). However, you must use the same rate for all
using any one of the following methods. employees reimbursed under the highlow
The rates are different for different locations.
1. For car expenses: See for the per diem
rates in the continental United States. For more information about the highlow
a. The standard mileage rate. method, see Notice 201563, available at
Standard meal allowance. The federal See
b. A fixed and variable rate (FAVR).
rate for meal and incidental expenses (M&IE) is for the current per diem
2. For per diem amounts: the standard meal allowance. You can pay only rates for all locations.
an M&IE allowance to employees who travel
a. The regular federal per diem rate. Reporting per diem and car allowances.
away from home if:
b. The standard meal allowance. You pay the employee for actual expenses The following discussion explains how to report
for lodging based on receipts submitted to per diem and car allowances. The manner in
c. The highlow rate. which you report them depends on how the al
You provide for the lodging, lowance compares to the federal rate. See Ta
Car allowance. Your employee is considered
You pay for the actual expense of the lodg ble 111.
to have accounted to you for car expenses that
do not exceed the standard mileage rate. Be ing directly to the provider, Allowance less than or equal to the fed-
ginning in 2015, the standard business mileage You do not have a reasonable belief that eral rate. If your allowance for the employee is
rate is 57.5 cents per mile. lodging expenses were incurred by the less than or equal to the appropriate federal
You can choose to reimburse your employ employee, or rate, that allowance is not included as part of
ees using a fixed and variable rate (FAVR) al The allowance is computed on a basis the employee's pay in box 1 of the employee's
lowance. This is an allowance that includes a similar to that used in computing the em Form W2. Deduct the allowance as travel ex
combination of payments covering fixed and ployee's wages (that is, number of hours penses (including meals that may be subject to
variable costs, such as a centspermile rate to worked or miles traveled). the 50% limit, discussed later). See How to de-
cover your employees' variable operating costs duct under Accountable Plans, earlier.

Page 42 Chapter 11 Other Expenses

Allowance more than the federal rate. If Meal expenses when subject to hours of b. You include that amount on a Form
your employee's allowance is more than the ap service limits. You can deduct 80% of the 1099 issued to the recipient, if a Form
propriate federal rate, you must report the al cost of reimbursed meals your employees con 1099 is required.
lowance as two separate items. sume while away from their tax home on busi
Include the allowance amount up to the fed ness during, or incident to, any period subject to Sales of meals or entertainment. You can
eral rate in box 12 (code L) of the employee's the Department of Transportation's hours of deduct the cost of meals or entertainment (in
Form W2. Deduct it as travel expenses (as ex service limits. cluding the use of facilities) you sell to the pub
plained above). This part of the allowance is See Pub. 463 for a detailed discussion of in lic. For example, if you run a nightclub, your ex
treated as reimbursed under an accountable dividuals subject to the Department of Trans pense for the entertainment you furnish to your
plan. portation's hours of service limits. customers, such as a floor show, is a business
Include the amount that is more than the expense that is fully deductible. The 50% limit
federal rate in box 1 (and in boxes 3 and 5 if De minimis (minimal) fringe benefit. The does not apply to this expense.
they apply) of the employee's Form W2. De 50% limit does not apply to an expense for food
duct it as wages subject to income tax withhold or beverage that is excluded from the gross in Providing meals or entertainment to gen-
ing, social security, Medicare, and federal un come of an employee because it is a de minimis eral public to promote goodwill. You can
employment taxes. This part of the allowance is fringe benefit. See Pub.15B for additional infor deduct the cost of providing meals, entertain
treated as reimbursed under a nonaccountable mation on de minimis fringe benefits. ment, or recreational facilities to the general
plan as explained later under Nonaccountable public as a means of advertising or promoting
Plans. Company cafeteria or executive dining goodwill in the community. The 50% limit does
room. The cost of food and beverages you not apply to this expense.
Meals and Entertainment provide primarily to your employees on your
business premises is deductible. This includes Director, stockholder, or employee meet-
Under an accountable plan, you can generally the cost of maintaining the facilities for provid ings. You can deduct entertainment expenses
deduct only 50% of any otherwise deductible ing the food and beverages. These expenses directly related to business meetings of your
businessrelated meal and entertainment ex are subject to the 50% limit unless they qualify employees, partners, stockholders, agents, or
penses you reimburse your employees. The de as a de minimis fringe benefit, as just dis directors. You can provide some minor social
duction limit applies even if you reimburse them cussed, or unless they are compensation to activities, but the main purpose of the meeting
your employees (explained later). must be your company's business. These ex
for 100% of the expenses.
penses are subject to the 50% limit.
Application of the 50% limit. The 50% de Employee activities. The expense of provid
ing recreational, social, or similar activities (in Trade association meetings. You can deduct
duction limit applies to reimbursements you
cluding the use of a facility) for your employees expenses directly related to and necessary for
make to your employees for expenses they in
is deductible and is not subject to the 50% limit. attending business meetings or conventions of
cur for meals while traveling away from home
The benefit must be primarily for your employ certain taxexempt organizations. These organi
on business and for entertaining business cus
ees who are not highly compensated. zations include business leagues, chambers of
tomers at your place of business, a restaurant,
For this purpose, a highly compensated em commerce, real estate boards, and trade and
or another location. It applies to expenses in
ployee is an employee who meets either of the professional associations.
curred at a business convention or reception,
business meeting, or business luncheon at a following requirements.
club. The deduction limit may also apply to 1. Owned a 10% or more interest in the busi
Nonaccountable Plans
meals you furnish on your premises to your em ness during the year or the preceding
ployees. A nonaccountable plan is an arrangement that
year. An employee is treated as owning
does not meet the requirements for an account
Related expenses. Taxes and tips relating any interest owned by his or her brother,
able plan. All amounts paid, or treated as paid,
to a meal or entertainment activity you reim sister, spouse, ancestors, and lineal de
under a nonaccountable plan are reported as
burse to your employee under an accountable scendants.
wages on Form W2. The payments are subject
plan are included in the amount subject to the 2. Received more than $120,000 in pay for to income tax withholding, social security, Medi
50% limit. Reimbursements you make for ex the preceding year. You can choose to in care, and federal unemployment taxes. You can
penses, such as cover charges for admission to clude only employees who were also in deduct the reimbursement as compensation or
a nightclub, rent paid for a room to hold a dinner the top 20% of employees when ranked by wages only to the extent it meets the deductibil
or cocktail party, or the amount you pay for pay for the preceding year. ity tests for employees' pay in chapter 2. Deduct
parking at a sports arena, are all subject to the the allowable amount as compensation or wa
50% limit. However, the cost of transportation to For example, the expenses for food, bever ges on the appropriate line of your income tax
and from an otherwise allowable business meal ages, and entertainment for a companywide return, as provided in its instructions.
or a businessrelated entertainment activity is picnic are not subject to the 50% limit.
not subject to the 50% limit.

Amount subject to 50% limit. If you provide

Meals or entertainment treated as compen-
sation. The 50% limit does not apply to either
Miscellaneous Expenses
your employees with a per diem allowance only of the following.
In addition to travel, meal, and entertainment
for meal and incidental expenses, the amount 1. Expenses for meals or entertainment that expenses, there are other expenses you can
treated as an expense for food and beverages you treat as: deduct.
is the lesser of the following.
The per diem allowance. a. Compensation to an employee who
Advertising expenses. You generally can de
was the recipient of the meals or en
The federal rate for M&IE. duct reasonable advertising expenses that are
tertainment, and
directly related to your business activities. Gen
If you provide your employees with a per b. Wages subject to withholding of fed erally, you cannot deduct amounts paid to influ
diem allowance that covers lodging, meals, and eral income tax. ence legislation (i.e., lobbying). See Lobbying
incidental expenses, you must treat an amount expenses, later.
equal to the federal M&IE rate for the area of 2. Expenses for meals or entertainment if:
You can usually deduct as a business ex
travel as an expense for food and beverages. If a. A recipient of the meals or entertain pense the cost of institutional or goodwill adver
the per diem allowance you provide is less than ment who is not your employee has to tising to keep your name before the public if it
the federal per diem rate for the area of travel, include the expenses in gross income relates to business you reasonably expect to
you can treat 40% of the per diem allowance as as compensation for services or as a gain in the future. For example, the cost of ad
the amount for food and beverages. prize or award, and vertising that encourages people to contribute

Chapter 11 Other Expenses Page 43

to the Red Cross, to buy U.S. Savings Bonds, Charitable contributions. Cash payments to a special deduction. The deduction applies only
or to participate in similar causes is usually de an organization, charitable or otherwise, may to amounts recovered for actual economic in
ductible. be deductible as business expenses if the pay jury, not any additional amount. The deduction
ments are not charitable contributions or gifts is the smaller of the following.
Anticipated liabilities. Anticipated liabilities or and are directly related to your business. If the The amount you received or accrued for
reserves for anticipated liabilities are not deduc payments are charitable contributions or gifts, damages in the tax year reduced by the
tible. For example, assume you sold 1year TV you cannot deduct them as business expenses. amount you paid or incurred in the year to
service contracts this year totaling $50,000. However, corporations (other than S corpora recover that amount.
From experience, you know you will have ex tions) can deduct charitable contributions on Your losses from the injury you have not
penses of about $15,000 in the coming year for their income tax returns, subject to limitations. deducted.
these contracts. You cannot deduct any of the See the Instructions for Form 1120 for more in
$15,000 this year by charging expenses to a re formation. Sole proprietors, partners in a part Demolition expenses or losses. Amounts
serve or liability account. You can deduct your nership, or shareholders in an S corporation paid or incurred to demolish a structure are not
expenses only when you actually pay or accrue may be able to deduct charitable contributions deductible. These amounts are added to the
them, depending on your accounting method. made by their business on Schedule A (Form basis of the land where the demolished struc
1040). ture was located. Any loss for the remaining un
Bribes and kickbacks. Engaging in the pay depreciated basis of a demolished structure
ment of bribes or kickbacks is a serious criminal Example. You paid $15 to a local church would not be recognized until the property is
matter. Such activity could result in criminal for a halfpage ad in a program for a concert it is disposed of.
prosecution. Any payments that appear to have sponsoring. The purpose of the ad was to en
been made, either directly or indirectly, to an of courage readers to buy your products. Your Education expenses. Ordinary and neces
ficial or employee of any government or an payment is not a charitable contribution. You sary expenses paid for the cost of the education
agency or instrumentality of any government can deduct it as an advertising expense. and training of your employees are deductible.
are not deductible for tax purposes and are in See Education Expenses in chapter 2.
violation of the law. Example. You made a $100,000 donation You can also deduct the cost of your own
Payments paid directly or indirectly to a per to a committee organized by the local Chamber education (including certain related travel) rela
son in violation of any federal or state law (but of Commerce to bring a convention to your city, ted to your trade or business. You must be able
only if that state law is generally enforced, de intended to increase business activity, including to show the education maintains or improves
fined below) that provides for a criminal penalty yours. Your payment is not a charitable contri skills required in your trade or business, or that
or for the loss of a license or privilege to engage bution. You can deduct it as a business ex it is required by law or regulations, for keeping
in a trade or business are also not allowed as a pense. your license to practice, status, or job. For ex
deduction for tax purposes. ample, an attorney can deduct the cost of at
See Pub. 526 for a discussion of donated in
Meaning of generally enforced. A state ventory, including capital gain property. tending Continuing Legal Education (CLE)
law is considered generally enforced unless it is classes that are required by the state bar asso
never enforced or enforced only for infamous Club dues and membership fees. Generally, ciation to maintain his or her license to practice
persons or persons whose violations are extra you cannot deduct amounts paid or incurred for law.
ordinarily flagrant. For example, a state law is membership in any club organized for business, Education expenses you incur to meet the
generally enforced unless proper reporting of a pleasure, recreation, or any other social pur minimum requirements of your present trade or
violation of the law results in enforcement only pose. This includes country clubs, golf and ath business, or those that qualify you for a new
under unusual circumstances. letic clubs, hotel clubs, sporting clubs, airline trade or business, are not deductible. This is
clubs, and clubs operated to provide meals un true even if the education maintains or improves
Kickbacks. A kickback is a payment for re der circumstances generally considered to be skills presently required in your business. For
ferring a client, patient, or customer. The com more information on education expenses, see
conducive to business discussions.
mon kickback situation occurs when money or Pub. 970.
property is given to someone as payment for in Exception. The following organizations are
fluencing a third party to purchase from, use the not treated as clubs organized for business, Franchise, trademark, trade name. If you
services of, or otherwise deal with the person pleasure, recreation, or other social purpose buy a franchise, trademark, or trade name, you
who pays the kickback. In many cases, the per unless one of the main purposes is to conduct can deduct the amount you pay or incur as a
son whose business is being sought or enjoyed entertainment activities for members or their business expense only if your payments are
by the person who pays the kickback is not guests or to provide members or their guests part of a series of payments that are:
aware of the payment. with access to entertainment facilities.
For example, the Yard Corporation is in the Boards of trade. 1. Contingent on productivity, use, or dispo
business of repairing ships. It returns 10% of sition of the item,
Business leagues.
the repair bills as kickbacks to the captains and 2. Payable at least annually for the entire
chief officers of the vessels it repairs. Although Chambers of commerce.
term of the transfer agreement, and
this practice is considered an ordinary and nec Civic or public service organizations.
essary expense of getting business, it is clearly 3. Substantially equal in amount (or payable
Professional organizations such as bar as
a violation of a state law that is generally en under a fixed formula).
sociations and medical associations.
forced. These expenditures are not deductible Real estate boards. When determining the term of the transfer
for tax purposes, whether or not the owners of
Trade associations. agreement, include all renewal options and any
the shipyard are subsequently prosecuted.
other period for which you and the transferrer
Form 1099-MISC. It does not matter Credit card convenience fees. Credit card reasonably expect the agreement to be re
whether any kickbacks paid during the tax year companies charge a fee to businesses who ac newed.
are deductible on your income tax return in re cept their cards. This fee when paid or incurred A franchise includes an agreement that
gards to information reporting. See Form by the business can be deducted as a business gives one of the parties to the agreement the
1099MISC for more information. expense. right to distribute, sell, or provide goods, serv
ices, or facilities within a specified area.
Car and truck expenses. The costs of operat Damages recovered. Special rules apply to
ing a car, truck, or other vehicle in your busi compensation you receive for damages sus Impairment-related expenses. If you are dis
ness are deductible. For more information on tained as a result of patent infringement, breach abled, you can deduct expenses necessary for
how to figure your deduction, see Pub. 463. of contract or fiduciary duty, or antitrust viola you to be able to work (impairmentrelated ex
tions. You must include this compensation in penses) as a business expense, rather than as
your income. However, you may be able to take a medical expense.

Page 44 Chapter 11 Other Expenses

You are disabled if you have either of the fol Tax preparation fees. The cost of hiring a a. Is serving in a position in Level I of the
lowing. tax professional, such as a C.P.A., to prepare Executive Schedule under section
A physical or mental disability (for exam that part of your tax return relating to your busi 5312 of title 5, United States Code,
ple, blindness or deafness) that function ness as a sole proprietor is deductible on
b. Has been designated by the Presi
ally limits your being employed. Schedule C or Schedule CEZ. Any remaining
dent as having Cabinetlevel status,
A physical or mental impairment that sub cost may be deductible on Schedule A (Form
stantially limits one or more of your major 1040) if you itemize deductions.
life activities. You can also claim a business deduction for c. Is an immediate deputy of an individ
amounts paid or incurred in resolving asserted ual listed in item (a) or (b).
The expense qualifies as a business ex
pense if all the following apply. tax deficiencies for your business operated as a
Exceptions to denial of deduction. The
Your work clearly requires the expense for sole proprietor.
general denial of the deduction does not apply
you to satisfactorily perform that work. to the following.
Licenses and regulatory fees. Licenses and
The goods or services purchased are Expenses of appearing before, or commu
regulatory fees for your trade or business paid
clearly not needed or used, other than inci nicating with, any committee or member of
annually to state or local governments generally
dentally, in your personal activities. any local council or similar governing body
are deductible. Some licenses and fees may
Their treatment is not specifically provided concerning its legislation (local legislation)
have to be amortized. See chapter 8 for more
for under other tax law provisions. if the legislation is of direct interest to you
or to you and an organization of which you
Example. You are blind. You must use a are a member. An Indian tribal government
Lobbying expenses. Generally, lobbying ex
reader to do your work, both at and away from is treated as a local council or similar gov
penses are not deductible. Lobbying expenses
your place of work. The reader's services are erning body.
include amounts paid or incurred for any of the
only for your work. You can deduct your expen Any inhouse expenses for influencing leg
following activities.
ses for the reader as a business expense. islation and communicating directly with a
Influencing legislation.
covered executive branch official if those
Internet-related expenses. Generally, you Participating in or intervening in any politi expenses for the tax year do not exceed
can deduct internetrelated expenses including cal campaign for, or against, any candidate $2,000 (excluding overhead expenses).
domain registrations fees and webmaster con for public office. Expenses incurred by taxpayers engaged
sulting costs. If you are starting a business you Attempting to influence the general public, in the trade or business of lobbying (pro
may have to amortize these expenses as or segments of the public, about elections, fessional lobbyists) on behalf of another
startup costs. For more information about am legislative matters, or referendums. person (but does apply to payments by the
ortizing startup and organizational costs, see Communicating directly with covered ex other person to the lobbyist for lobbying
chapter 8. ecutive branch officials (defined later) in activities).
any attempt to influence the official actions
Interview expense allowances. Reimburse or positions of those officials. Moving machinery. Generally, the cost of
ments you make to job candidates for transpor Researching, preparing, planning, or coor moving machinery from one city to another is a
tation or other expenses related to interviews dinating any of the preceding activities. deductible expense. So is the cost of moving
for possible employment are not wages. You Your expenses for influencing legislation machinery from one plant to another, or from
can deduct the reimbursements as a business and communicating directly with a covered ex one part of your plant to another. You can de
expense. However, expenses for food, bever ecutive branch official include a portion of your duct the cost of installing the machinery in the
ages, and entertainment are subject to the 50% new location. However, you must capitalize the
labor costs and general and administrative
limit discussed earlier under Meals and Enter- costs of installing or moving newly purchased
costs of your business. For information on mak
tainment. machinery.
ing this allocation, see section 1.16228 of the
Legal and professional fees. Fees charged Outplacement services. The costs of out
You cannot claim a charitable or business placement services you provide to your employ
by accountants and attorneys that are ordinary
expense deduction for amounts paid to an or ees to help them find new employment, such as
and necessary expenses directly related to op
ganization if both of the following apply. career counseling, rsum assistance, skills as
erating your business are deductible as busi
The organization conducts lobbying activi sessment, etc. are deductible.
ness expenses. However, usually legal fees
ties on matters of direct financial interest to
you pay to acquire business assets are not de The costs of outplacement services may
your business.
ductible. These costs are added to the basis of cover more than one deduction category. For
A principal purpose of your contribution is example, deduct as a utilities expense the cost
the property.
to avoid the rules discussed earlier that of telephone calls made under this service and
Fees that include payments for work of a
prohibit a business deduction for lobbying deduct as rental expense the cost of renting
personal nature (such as drafting a will, or dam
expenses. machinery and equipment for this service.
ages arising from a personal injury) are not al
lowed as a business deduction on Schedule C If a taxexempt organization, other than a For information on whether the value of out
or CEZ. If the invoice includes both business section 501(c)(3) organization, provides you placement services is includable in your em
and personal charges, compute the business with a notice on the part of dues that is allocable ployees' income, see Pub. 15B.
portion as follows: multiply the total amount of to nondeductible lobbying and political expen
the bill by a fraction, the numerator of which is ses, you cannot deduct that part of the dues. Penalties and fines. Penalties paid for late
the amount attributable to business matters, the performance or nonperformance of a contract
Covered executive branch official. For are generally deductible. For instance, you own
denominator of which is the total amount paid.
purposes of this discussion, a covered execu and operate a construction company. Under a
The result is the portion of the invoice attributa
tive branch official is any of the following. contract, you are to finish construction of a
ble to business expenses. The portion attributa
ble to personal matters is the difference be 1. The President. building by a certain date. Due to construction
tween the total amount and the business delays, the building is not completed and ready
2. The Vice President. for occupancy on the date stipulated in the con
portion (computed above).
Legal fees relating to personal tax advice 3. Any officer or employee of the White tract. You are now required to pay an additional
may be deductible on Schedule A (Form 1040), House Office of the Executive Office of the amount for each day that completion is delayed
if you itemize deductions. However, the deduc President and the two most senior level of beyond the completion date stipulated in the
tion is subject to the 2% limitation on miscella ficers of each of the other agencies in the contract. These additional costs are deductible
Executive Office. business expenses.
neous itemized deductions. For more informa
tion, see Pub. 529. 4. Any individual who:

Chapter 11 Other Expenses Page 45

On the other hand, penalties or fines paid to the cost must be capitalized and depreciated. 3. Subtract the tax in (2) from the tax shown
any government agency or instrumentality be See Form 4562 and its instructions for how to on your return for the earlier year. This is
cause of a violation of any law are not deducti compute and claim the depreciation deduction. the amount of your credit.
ble. These fines or penalties include the follow The cost of repairs includes the costs of la 4. Subtract the answer in (3) from the tax for
ing amounts. bor, supplies, and certain other items. The 2015 figured without the deduction (step
Paid because of a conviction for a crime or value of your own labor is not deductible. Exam 1).
after a plea of guilty or no contest in a crim ples of repairs include:
inal proceeding. Reconditioning floors (but not replace If Method 1 results in less tax, deduct the
Paid as a penalty imposed by federal, ment), amount repaid as discussed earlier under Type
state, or local law in a civil action, including Repainting the interior and exterior walls of of deduction.
certain additions to tax and additional a building, If Method 2 results in less tax, claim the
amounts and assessable penalties im Cleaning and repairing roofs and gutters, credit on line 73 of Form 1040, and write I.R.C.
posed by the Internal Revenue Code. and 1341 next to line 73.
Paid in settlement of actual or possible lia Fixing plumbing leaks (but not replacement
bility for a fine or penalty, whether civil or of fixtures). Example. For 2014, you filed a return and
criminal. reported your income on the cash method. In
Forfeited as collateral posted for a pro Repayments. If you had to repay an amount 2015, you repaid $5,000 included in your 2014
ceeding that could result in a fine or pen you included in your income in an earlier year, gross income under a claim of right. Your filing
alty. you may be able to deduct the amount repaid status in 2015 and 2014 is single. Your income
Examples of nondeductible penalties and for the year in which you repaid it. Or, if the and tax for both years are as follows:
fines include the following. amount you repaid is more than $3,000, you
Fines for violating city housing codes. may be able to take a credit against your tax for
2014 2014
the year in which you repaid it.
Fines paid by truckers for violating state With Income Without
maximum highway weight laws. Type of deduction. The type of deduction Income
Fines for violating air quality laws. you are allowed in the year of repayment de Taxable
Civil penalties for violating federal laws re pends on the type of income you included in the Income $15,000 $10,000
garding mining safety standards and dis earlier year. For instance, if you repay an
amount you previously reported as a capital Tax $ 1,800 $ 1,050
charges into navigable waters.
gain, deduct the repayment as a capital loss on
A fine or penalty does not include any of the Form 8949. If you reported it as selfemploy 2015 2015
following. ment income, deduct it as a business deduction Without With Deduction
Legal fees and related expenses to defend on Schedule C or Schedule CEZ (Form 1040) Deduction
yourself in a prosecution or civil action for a or Schedule F (Form 1040). Taxable
violation of the law imposing the fine or civil If you reported the amount as wages, unem Income $49,950 $44,950
penalty. ployment compensation, or other nonbusiness Tax $8,288 $7,038
Court costs or stenographic and printing ordinary income, enter it on Schedule A (Form
charges. 1040) as a miscellaneous itemized deduction Your tax under Method 1 is $7,038. Your tax un
Compensatory damages paid to a govern that is subject to the 2% limitation. However, if der Method 2 is $7,538, figured as follows:
ment. the repayment is over $3,000 and Method 1
(discussed later) applies, deduct it on Sched
Political contributions. Contributions or gifts ule A (Form 1040) as a miscellaneous itemized Tax previously determined for $ 1,800
paid to political parties or candidates are not deduction that is not subject to the 2% limita 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . .
deductible. In addition, expenses paid or incur tion. Less: Tax as refigured . . . . . . . . . . . 1,050
red to take part in any political campaign of a
Repayment$3,000 or less. If the Decrease in 2014 tax $750
candidate for public office are not deductible.
amount you repaid was $3,000 or less, deduct it Regular tax liability for 2015 . . . . . . . $8,288
Indirect political contributions. You can from your income in the year you repaid it. Less: Decrease in 2014 tax . . . . . . . 750
not deduct indirect political contributions and Refigured tax for 2015 $ 7,538
costs of taking part in political activities as busi Repaymentover $3,000. If the amount
ness expenses. Examples of nondeductible ex you repaid was more than $3,000, you can de
duct the repayment, as described earlier. How Because you pay less tax under Method 1, you
penses include the following.
ever, you can instead choose to take a tax should take a deduction for the repayment in
Advertising in a convention program of a
credit for the year of repayment if you included 2015.
political party, or in any other publication if
any of the proceeds from the publication the income under a claim of right. This means Repayment does not apply. This discus
are for, or intended for, the use of a politi that at the time you included the income, it ap sion does not apply to the following.
cal party or candidate. peared that you had an unrestricted right to it. If Deductions for bad debts.
Admission to a dinner or program (includ you qualify for this choice, figure your tax under
both methods and use the method that results Deductions from sales to customers, such
ing, but not limited to, galas, dances, film
in less tax. as returns and allowances, and similar
presentations, parties, and sporting
events) if any of the proceeds from the
Method 1. Figure your tax for 2015 claim Deductions for legal and other expenses of
function are for, or intended for, the use of
ing a deduction for the repaid amount. contesting the repayment.
a political party or candidate.
Admission to an inaugural ball, gala, pa Method 2. Figure your tax for 2015 claim Year of deduction (or credit). If you use
rade, concert, or similar event if identified ing a credit for the repaid amount. Follow these the cash method of accounting, you can take
with a political party or candidate. steps. the deduction (or credit, if applicable) for the tax
year in which you actually make the repayment.
Repairs. The cost of repairing or improving 1. Figure your tax for 2015 without deducting
If you use any other accounting method, you
property used in your trade or business is either the repaid amount.
can deduct the repayment or claim a credit for it
a deductible or capital expense. Routine main 2. Refigure your tax from the earlier year only for the tax year in which it is a proper de
tenance that keeps your property in a normal ef without including in income the amount duction under your accounting method. For ex
ficient operating condition, but that does not you repaid in 2015. ample, if you use the accrual method, you are
materially increase the value or substantially entitled to the deduction or credit in the tax year
prolong the useful life of the property, is deduc
tible in the year that it is incurred. Otherwise,

Page 46 Chapter 11 Other Expenses

in which the obligation for the repayment ac by business type such as sole proprietor, cor Enter TCE in the search box, download
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You can also deduct the cost of books, pro
dividuals providing services are employees choose to have someone prepare your tax re
fessional instruments, equipment, etc., if you
or independent contractors. turn, choose that preparer wisely. A paid tax re
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Self-Employed Individuals Tax Center. The turn preparer is primarily responsible for the
usefulness of these items extends substantially
basics on selfemployment, filing require overall substantive accuracy of your tax return
beyond the year they are placed in service, you
ments, and reporting responsibilities for in and, by law, is required to sign the return and
generally must recover their costs through de
preciation. For more information regarding de dependent contractors. include their preparer tax identification number
preciation, see Pub. 946. Information Return Filing Requirements. If (PTIN) on it. Although the tax return preparer
you made or received a payment as a signs the return, you are ultimately responsible
Utilities. Business expenses for heat, lights, small business or selfemployed (individ for the accuracy of every item reported on your
power, telephone service, and water and sew ual), you are most likely required to file an return. Anyone paid to prepare tax returns for
erage are deductible. However, any part due to information return to the IRS. others should have a thorough understanding of
personal use is not deductible. IRS Video Portal. Video, webinars, and au tax matters and is required to have a PTIN. You
dio presentations for small businesses, in may want to ask friends, coworkers, or your
Telephone. You cannot deduct the cost of dividuals, and tax pros. employer for help in selecting a competent tax
basic local telephone service (including any Small Business Events. Workshops and return preparer.
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your home, even if you have an office in your businesses. online database for all Authorized IRS efile
home. However, charges for business longdis Online Tools & Educational Products. Providers that choose to be included in the da
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cost of a second line into your home used ex ing the Tax Calendar desktop tool, to help IRS efile Providers in your area where you can
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Subscribe to e-News. A free electronic vides IRS efile, see Authorized IRS e-file
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efile Provider locator tool above, you can also
find professional help through the IRS Tax
Help Preparing and filing your tax return. On you can find free options to prepare
Professional Partner page at
and file your return in your local community if
Do you need help with a tax issue or preparing Choose a tax return preparer you will be
you qualify.
your tax return, or do you need a free publica able to contact in case the IRS examines your
Go to and click on the Filing tab to
tion or form? return and has questions regarding how your
see your options.
return was prepared. You can designate your
Enter Free File in the search box to use
Small Business and Self-Employed (SB/SE) paid tax return preparer or another third party to
brand name software to prepare and e-file
Tax Center. SB/SE serves taxpayers who file speak to the IRS concerning the preparation of
your federal tax return for free.
Form 1040, Schedules C, E, F, or Form 2106, your return, payment/refund issues, and mathe
Enter VITA in the search box, download
as well as small businesses with assets under matical errors. The third party authorization
the free IRS2Go app, or call toll free
$10 million. checkbox on Form 1040, Form 1040A, and
18009069887 to find the nearest Volun
Form 1040EZ gives the designated party the
teer Income Tax Assistance (VITA) or Tax
A-Z Index for Business. Find it fast! Know authority to receive and inspect returns and re
Counseling for the Elderly (TCE) location
what you're looking for and want to find it fast? turn information for one year from the original
for free tax preparation.
Select business topics using our AZ listing, or due date of your return (without regard to

Chapter 12 How To Get Tax Help Page 47

extensions). You can extend the authority to re paper form mailed to you, go to
ceive and inspect returns and return information to order online. Types-and-Ways-to-Order-Them. To order your
to a third party using Form 8821, Tax You can also call toll free transcript, you can use one of the following con
Information Authorization. 1800TAXFORM (18008293676) or venient options.
The following points will assist you when se 18008294059 for TTY/TDD to place an Go to and click on Get Transcript
lecting a tax return preparer. order. For more information, go to How Do of Your Tax Records under Tools.
Check the preparers qualifications. All You Report Suspected Tax Fraud Activity? Request a return or account transcript us
paid tax return preparers are required to on ing Get Transcript at
have a PTIN. Individuals/Get-Transcript
Check the preparers history. You can Getting answers to your tax law questions. Download the free IRS2Go app to your
check with the Better Business Bureau to and IRS2Go are ready when you smart phone and use it to order transcripts
find out if a preparer has a questionable are24 hours a day, 7 days a week. of your tax returns or tax account.
history. Check for disciplinary actions and Enter ITA in the search box on Call the automated transcript tollfree line
the license status for credentialed prepar for the Interactive Tax Assistant, a tool that at 18009089946 to receive your tran
ers. For Certified Public Accountants will ask you questions on a number of tax script by mail.
(CPAs), check with the State Board of Ac law topics and provide answers. You can Go to Get Transcript, at
countancy. For attorneys, check with the print the entire interview and the final re Individuals/Get-Transcript, and click on
State Bar Association. For Enrolled sponse. Get Transcript by Mail. You will need
Agents, go to and search for ver Enter Tax Map or Tax Trails in the your Social Security number (SSN) or your
ify enrolled agent status. search box for detailed information by tax Individual Tax Identification Number (ITIN),
Ask about service fees. Avoid preparers topic. date of birth, and address from your latest
who base their fee on a percentage of your Enter Pub 17 in the search box to get tax return. Transcripts arrive in 5 to 10 cal
refund or those who say they can get Pub. 17, Your Federal Income Tax for Indi endar days at the address we have on file
larger refunds than others can. Always viduals, which features details on taxsav for you.
make sure any refund due is sent directly ing opportunities, 2015 tax changes, and Mail Form 4506-T, Request for Transcript
to you or deposited into your bank ac thousands of interactive links to help you of Tax Return, or Form 4506T-EZ, Short
count. You should not have your refund find answers to your questions. Form Request for Individual Tax Return
deposited into a preparers bank account. Access tax law information in your elec Transcript (both available on
Ask to e-file your return. Make sure your tronic filing software. The IRS never sends email requesting that
preparer offers IRS e-file. Any paid pre Go to and click on the Help & Re you obtain or access your transcripts. If you re
parer who prepares and files more than 10 sources tab for more information. ceive such an email, please forward it to our
returns generally must e-file their clients fraud group at
returns. The IRS has safely processed Getting tax forms and publications. You can A transcript isnt a photocopy of your return.
more than 1.3 billion e-filed tax returns. download or print all of the forms and publica If you need a copy of your original return, com
Make sure the preparer is available. tions you may need from plete and mail Form 4506, Request for Copy of
You need to ensure that you can contact formspubs. Otherwise, you can: Tax Return, available at
the tax preparer after you file your return. Go to to place an pdf/f4506.pdf, along with the applicable fee.
Thats true even after the April 15 due order and have forms mailed to you; or
date. You may need to contact the pre Call 1800TAXFORM (18008293676) Using online tools to help prepare your re-
parer if questions come up about your tax or 18008294059 toll free for TTY/TDD to turn. Go to and click on the Tools bar
return at a later time. order currentyear forms, instructions, pub to use these and other selfservice options.
Provide tax records. A good preparer will lications, and prioryear forms and instruc The Earned Income Tax Credit Assistant
ask to see your records and receipts. They tions (limited to 5 years). determines if you are eligible for the
ask you questions to report your total in Earned Income Credit (EIC).
come and the tax benefits youre entitled to You should receive your order within 10 busi
ness days. The First Time Homebuyer Credit Account
claim. These may include tax deductions, Look-up tool provides information on your
tax credits, and other items. Do not use a repayments and account balance.
preparer who is willing to e-file your return Getting a transcript or copy of a return. You
can get a transcript by mail to view your tax ac The Alternative Minimum Tax (AMT)
using your last pay stub instead of your Assistant determines whether you may be
Form W-2 . This is against IRS e-file rules. count transactions or linebyline tax return in
formation for a specific tax year. The method subject to AMT.
Never sign a blank tax return. Do not The Online EIN Application helps you get
use a tax preparer who asks you to sign a you used to file your return and whether you
have a refund or balance due, affects your cur an Employer Identification Number.
blank tax form. The IRS Withholding Calculator estimates
Review your return before signing. Be rent year transcript availability. Generally, these
transcript types are available for the current tax the amount you should have withheld from
fore you sign your tax return, review it thor your paycheck for federal income tax pur
oughly. Ask questions if something is not year and three prior years. IRS transcripts are
best and most often used to validate past in poses.
clear to you. Make sure youre comfortable The Electronic Filing PIN Request helps to
with the information on the return before come and tax filing status for mortgage, stu
dent, and small business loan applications, and verify your identity when you do not have
you sign it. your prioryear adjusted gross income
Preparer must sign and include their to help with tax preparation. If you need an ac
count transcript for an older tax year, a wage (AGI) or prioryear selfselected personal
PTIN. Paid preparers must sign returns identification number (PIN) available.
and include their PTIN as required by law. and income transcript or a verification of nonfil
The preparer must also give you a copy of ing letter, youll need to complete Form 4506-T,
Where to file your tax return.
the return. Request for Transcript of Tax Return, and send
There are many ways to file your return
Report abusive tax preparers to the it to us as instructed on the form. If you made
electronically. Its safe, quick, and easy.
IRS. You can report abusive tax preparers estimated tax payments and/or applied your
See Preparing and filing your tax return,
and suspected tax fraud to the IRS. Use overpayment from a prior year tax return to your
earlier, for more information.
Form 14157, Complaint: Tax Return current year tax return, you can request a tax
See your tax return instructions to deter
Preparer. If you suspect a return preparer account transcript to confirm these payments or
mine where to mail your completed paper
filed or changed the return without your credits a few weeks after the beginning of the
tax return.
consent, you should also file Form 14157- calendar year prior to filing your current year re
A, Return Preparer Fraud or Misconduct turn. For the list of the various types of tran
Affidavit. You can download and print scripts available for you to order, see Transcript
these forms from If you need a Types and Ways to Order Them at

Page 48 Chapter 12 How To Get Tax Help

Understanding identity (ID) theft issues. maintained by the FTC, and are made available Please add IRS Telephone
Go to to enforcers and regulators in countries with Scam to the comments of your complaint.
for information and videos. participating agencies. Those agencies may
Remember, too, the IRS does not use
If your social security number (SSN) has use the complaints to investigate crossborder
email, text messages, or any social media to
been lost or stolen or you suspect you are issues, uncover new scams, pursue regulatory
discuss your personal tax issue involving bills or
a victim of taxrelated ID theft, visit or enforcement actions, and spot consumer
refunds. If you get a phone call from someone to learn what trends.
claiming to be from the IRS regarding a refund
steps you should take. owed to you and asking you for your social se
To report ID theft, access the IRS ID Theft Recognizing and reporting tax scams. The
curity number and bank account information, do
Tool Kit at Dirty Dozen is compiled annually by the IRS
not give them this information. You should
to-Identity-Theft. This page also provides a and lists a variety of common scams taxpayers
make notes of all information regarding the call
list of helpful tollfree telephone numbers may encounter any time during the year. Many
and/or the caller, for example, any caller ID in
and links to other resources for reporting of these con games peak during filing season
formation, and report this scam. For more infor
ID or data theft. as people prepare their tax returns or hire
mation on reporting tax scams, go to
The IRS stops and flags suspicious or du someone to do so. Aggressive and threatening
and type scam in the search box. You can ver
plicate federal tax returns that falsely rep phone calls by criminals impersonating IRS
ify any potential refunds owed to you by con
resent your identity, such as your name or agents remain near the top of the annual Dirty
tacting the IRS directly.
social security number. If the IRS suspects Dozen list of tax scams for the 2015 filing sea
son. Additional information about tax scams is
tax ID theft, the agency will send a 5071C
available on IRS social media sites, including
letter to your home address. If you receive Scammers are able to alter caller identifica
YouTube,, and
this letter, verify your identity at tion (caller ID) numbers to make it look like the
Tumblr,, or call the tollfree number IRS is calling. They use fake names and bogus
where people can search scam to find all the
listed in the letter. IRS identification or badge numbers. They often
scamrelated posts.
If you are a victim of state tax ID theft, con leave urgent callback requests. They prey on
tact your state's taxation department or the most vulnerable people, such as the elderly,
Checking on the status of a refund.
comptroller's office about the next steps newly arrived immigrants, and those whose first
The Wheres My Refund? tool is a fast and
you need to take. language is not English. Scammers have been
easy way to check on your tax refund on
You should protect the information that you known to impersonate agents of IRS Criminal
keep, and properly dispose of what you no Investigation as well.
Go to
longer need. And, of course, you should Be cautious when receiving suspicious calls
create a plan to respond to security inci at home or at work from sources claiming to be Download the free IRS2Go app to your
dents. As part of its longstanding efforts to from the IRS, other agencies or outside sources smart phone and use it to check your re
promote good data security practices, the asking for money, credit card information or fund status.
Federal Trade Commission (FTC) has un threatening to have you arrested for not paying. Call the automated refund hotline toll free
dertaken extensive efforts to educate busi These callers may demand money or may say at 18008291954.
nesses and has brought more than 50 law you have a refund due and try to trick you into
enforcement actions related to data secur sharing private information. These con artists Making a tax payment. You can make elec
ity issues. For more information, see Pro can sound convincing when they call. They may tronic payments online, by phone, or from a mo
tecting Personal Information: A Guide for know a lot about you. bile device. Paying electronically is safe and se
Business, available at cure. The IRS uses the latest encryption
Here are five things the scammers often do
advice/business-center/guidance/ technology and does not store banking informa
but the IRS will not do. Any one of these five
protecting-personal-information-guide- tion. Its easy and secure and much quicker
things is a telltale sign of a scam.
business, for practical tips on creating and than mailing in a check or money order. Go to
The IRS will never do any of the follow- and click on the Payments tab or the
implementing a plan for safeguarding per ing.
sonal information used in your business. Pay Your Tax Bill icon to make a payment us
Call to demand immediate payment, nor ing the following options.
Most recently, the FTC released Start with will the agency call about taxes owed with
Security: A Guide for Business, available Direct Pay (only if you are an individual
out first having mailed you a bill. who has a checking or savings account).
at Demand that you pay taxes without giving
center/guidance/start-security-guide- Pay directly from your bank account. If
you the opportunity to question or appeal you're an individual taxpayer, IRS Direct
business?utm_source=govdelivery, which the amount they say you owe. Pay offers you a free, secure payment
draws on the lessons learned from the Require you to use a specific payment method.
FTC's enforcement actions. method for your taxes, such as a prepaid Debit or credit card. Choose an approved
The FTC works for consumers to prevent debit card. payment processor to make a secure tax
fraudulent, deceptive, and unfair business prac Ask for credit or debit card numbers over payment online or by phone. Your payment
tices and to provide information to help spot, the phone. will be processed by a payment processor
stop, and avoid them. To file a complaint, for Threaten to bring in local police or other who will charge a processing fee. The fees
example, to report someone falsely claiming to lawenforcement groups to have you arres vary by service provider and may be tax
be from the government, a business, or a family ted for not paying. deductible. No part of the service fee goes
member, visit the FTCs online Complaint If you get a phone call from someone claim to the IRS. Note: You usually cant cancel
Assistant or call 1877FTCHELP ing to be from the IRS and asking for money, payments. You cant make Federal Tax
(18773824357). The FTC enters complaints heres what you should do. Deposits. You can't get an immediate re
into Consumer Sentinel, a secure, online data If you know you owe taxes or think you lease of a Federal Tax Lien.
base available to more than 2,000 civil and might owe, call the IRS toll free at Electronic Federal Tax Payment System
criminal law enforcement agencies in the U.S. 18008291040. The IRS assistors can (EFTPS). EFTPS is a system for pay
and abroad. Complaints from consumers help help you with a payment issue. ing federal taxes electronically using the in
the FTC detect patterns of fraud and abuse. If you know you dont owe taxes or have no ternet, or by phone using the EFTPS
The FTCs website provides free information on reason to believe that you do, report the in Voice Response System. EFTPS is of
a variety of consumer topics, in English and in cident to the Treasury Inspector General fered free by the U.S. Department of
Spanish. for Tax Administration (TIGTA) toll free at Treasury. You can use EFTPS to make
Consumer complaints regarding interna 18003664484 or at all your federal tax payments, including in
tional scams can be reported online through If youve been targeted by this scam, also come, employment, estimated and excise These are also entered into contact the Federal Trade Commission taxes. You can initiate your tax payment
Consumer Sentinel, the complaint database and use their FTC Complaint Assistant at from your home or office, 24/7. Businesses

Chapter 12 How To Get Tax Help Page 49

and individuals can schedule payments up tions you may be entitled to receive. We will correspondence to explain why you disagree. If
to 365 days in advance. Scheduled pay send you a Notice of Deficiency CP3219N you write, allow at least 30 days for our re
ments can be changed or cancelled up to (90day letter) proposing a tax assessment. sponse. Keep a copy of all correspondence
two business days in advance of the You will have 90 days to file your past due tax with your tax records.
scheduled payment date. return or file a petition in Tax Court. If you do
Check or money order. neither, we will proceed with our proposed as Collection and enforcement actions. The
sessment. If you have received a Notice of Defi return we prepare for you (our proposed as
What if I cant pay now? Click on the Pay ciency CP3219N, you can not request an exten sessment) will lead to a tax bill, which, if unpaid,
ments tab or the Pay Your Tax Bill icon on sion to file. will trigger the collection process. This can in to find more information about these If any of the income listed is incorrect, you clude such actions as a levy on your wages or
additional options. may do the following. bank account or the filing of a notice of federal
An online payment agreement determines Contact us toll free at 18666814271 to tax lien. If you repeatedly do not file, you could
if you are eligible to apply for an installment let us know. be subject to additional enforcement measures,
agreement if you cannot pay your taxes in Contact the payer (source) of the income such as additional penalties and/or criminal
full today. With the needed information, to request a corrected Form W2 or 1099. prosecution.
you can complete the application in about Attach the corrected forms when you send
30 minutes, and get immediate approval. us your completed tax returns. Visiting the IRS. Locate the nearest Taxpayer
An offer in compromise (OIC) allows you to Assistance Center (TAC) using the Office Loca
If the IRS files a substitute return, it is still in tor tool on Enter office locator in the
settle your tax debt for less than the full your best interest to file your own tax return to
amount you owe. Use the Offer in search box. Or choose the Contact Us option
take advantage of any exemptions, credits, and on the IRS2Go app and search Local Offices.
Compromise Pre-Qualifier to confirm your deductions you are entitled to receive. The IRS
eligibility. Before you visit, use the Locator tool to check
will generally adjust your account to reflect the hours and services available.
correct figures. If you filed a past due return and
Checking the status of an amended return. have received a notice, you should send us a
Go to and click on the Tools tab and Watching IRS videos. The IRS Video Portal,
copy of the past due return to the indicated ad, contains video and audio
then Wheres My Amended Return? to check dress. It takes approximately 6 weeks for us to
the status of your amended return. presentations on topics of interest to individu
process an accurately completed past due tax als, small businesses, and tax professionals.
return. Youll find video clips of tax topics, archived ver
Filing past due tax returns. File all tax re
turns that are due, regardless of whether or not sions of live panel discussions and webinars,
Understanding an IRS notice or letter. Enter and audio archives of tax practitioner phone fo
you can pay in full. File your past due return the Understanding your notice in the search box
same way and to the same location where you rums.
on or go to
would file an ontime return. If you have re Understanding-Your-IRS-Notice-or-Letter to
ceived a notice, make sure to send your past Getting tax information in other languages.
find additional information about your IRS For taxpayers whose native language is not
due return to the location indicated on the no notice or letter. We will send you a notice or let
tice you received. If you have a past due return, English, we have the following resources availa
ter if any of the following applies. ble.
filing your past due return now can help you do You have a balance due.
the following. 1. Taxpayers can find information on
Avoid interest and penalties. File your You are due a larger or smaller refund.
in the following languages.
past due return and pay now to limit inter We have a question about your tax return.
est charges and late payment penalties. a. Spanish.
We need to verify your identity.
Claim a refund. You risk losing your re b. Chinese.
fund if you don't file your return. If you are We need additional information.
due a refund for withholding or estimated We changed your return. c. Vietnamese.
taxes, you must file your return to claim it We are notifying you of delays in process d. Korean.
within 3 years of the return due date. The ing your return.
same rule applies to a right to claim tax e. Russian.
credits such as the EIC. We hold income When you receive correspondence from us,
2. The IRS TACs provide overthephone in
tax refunds in cases where our records read the entire notice or letter carefully. Typi
terpreter service in over 170 languages,
show that one or more income tax returns cally, we only need a response if you dont
and the service is available free to taxpay
are past due. We hold them until we get agree with the information, we need additional
the past due return or receive an accepta information, or you have a balance due. If we
ble reason for not filing a past due return. changed your tax return, compare the informa
tion we provided in the notice or letter with the
Protect social security benefits. If you
are selfemployed and do not file your fed information in your original return. If we receive The Taxpayer Advocate
eral income tax return, any selfemploy
ment income you earned will not be repor
a return that we suspect is identity theft, we will
ask you to verify your identity using the web ad
Service Is Here To Help
ted to the Social Security Administration dress provided in the letter. You
and you will not receive credits toward so If we ask for a response within a specific
cial security retirement or disability bene timeframe, you must respond on time to mini
fits. mize additional interest and penalty charges or What is the Taxpayer
Avoid issues obtaining loans. Loan ap to preserve your appeal rights if you dont Advocate Service?
provals may be delayed if you don't file agree. Pay as much as you can, even if you
your return. Copies of filed tax returns must cant pay the full amount you owe. You can pay The Taxpayer Advocate Service (TAS) is an in-
be submitted to financial institutions, mort online or apply for an Online Payment Agree dependent organization within the IRS that
gage lenders/brokers, etc., whenever you ment or Offer in Compromise. See What if I helps taxpayers and protects taxpayer rights.
want to buy or refinance a home, get a loan cant pay now? above or visit our payments Our job is to ensure that every taxpayer is
for a business, or apply for federal aid for page,, for more informa treated fairly and that you know and understand
higher education. tion. your rights under the Taxpayer Bill of Rights.
We provide our contact phone number on The Taxpayer Bill of Rights groups the existing
Substitute return. If you fail to file voluntarily, the top righthand corner of our correspond rights in the tax code into ten fundamental
we may file a substitute return for you, based on ence. Be sure you have your tax return and any rights, and makes them clear, understandable,
income reported to the IRS. This return might related documentation available when you call. and accessible. See How Can You Learn About
not give you credit for deductions and exemp You can also write to us at the address in the Your Taxpayer Rights? below.

Page 50 Chapter 12 How To Get Tax Help

What Can the TAS Do For You? 3. The Right To Pay No More Than the 10. The Right to a Fair and Just Tax Sys-
Correct Amount of Tax. Taxpayers have tem. Taxpayers have the right to expect
We can help you resolve problems that you the right to pay only the amount of tax le the tax system to consider facts and cir
cant resolve with the IRS. And our service is gally due, including interest and penalties, cumstances that might affect their underly
free. If you qualify for our assistance, you will be and to have the IRS apply all tax payments ing liabilities, ability to pay, or ability to pro
assigned to one advocate who will work with properly. vide information timely. Taxpayers have
you throughout the process and will do every the right to receive assistance from the
4. The Right To Challenge the IRSs Posi-
thing possible to resolve your issue. The TAS Taxpayer Advocate Service if they are ex
tion and Be Heard. Taxpayers have the
can help you if: periencing financial difficulty or if the IRS
right to raise objections and provide addi
Your problem is causing financial difficulty has not resolved their tax issues properly
tional documentation in response to formal
for you, your family, or your business; and timely through its normal channels.
IRS actions or proposed actions, to expect
You face (or your business is facing) an
that the IRS will consider their timely ob
immediate threat of adverse action; or The IRS is trying to increase the number of
jections and documentation promptly and
Youve tried repeatedly to contact the IRS Americans who know and understand their
fairly, and to receive a response if the IRS
but no one has responded, or the IRS rights under the tax law. To expand awareness,
does not agree with their position.
hasnt responded by the date promised. the IRS is making Publication 1 available in mul
5. The Right To Appeal an IRS Decision tiple languages on This important pub
How Can You Reach Us? in an Independent Forum. Taxpayers lication is available in the following languages.
are entitled to a fair and impartial adminis English, Your Rights as a Taxpayer, at
We have offices in every state, the District of trative appeal of most IRS decisions, in
Columbia, and Puerto Rico. Your local advo cluding many penalties, and have the right Chinese, Chinese- Your Rights as a
cates number is in your local directory and at to receive a written response regarding Taxpayer (Pub 1) , at You can also the Office of Appeals decision. Taxpayers Chinese.
call us toll free at 18777774778. generally have the right to take their cases Korean, Korean- Your Rights as a
to court. Taxpayer (Pub 1), at
How Can You Learn About Your 6. The Right to Finality. Taxpayers have
( 1),
Taxpayer Rights? the right to know the maximum amount of
time they have to challenge the IRSs posi
Spanish, Publicacin 1SP, Derechos del
The Taxpayer Bill of Rights describes ten basic tion as well as the maximum amount of
Contribuyente, at
rights that all taxpayers have when dealing with time the IRS has to audit a particular tax
Vietnamese, Quyn Hn ca Ngi ng
the IRS. Our Tax Toolkit at year or collect a tax debt. Taxpayers have
Thu , Your Rights as a Taxpayer (Pub1), can help you the right to know when the IRS has fin
understand what these rights mean to you and ished an audit.
how they apply. These are your rights. Know The IRS will include Publication 1 when sending
7. The Right to Privacy. Taxpayers have notices to taxpayers on a range of issues, such
them. Use them.
the right to expect that any IRS inquiry, ex as an audit or collection matter. All IRS facilities
amination, or enforcement action will com will publicly display the rights for taxpayers and
The IRS released the Taxpayer Bill of Rights
ply with the law and be no more intrusive employees to see.
following extensive discussions with the Tax
than necessary, and will respect all due
payer Advocate Service. You can find a list of
process rights, including search and seiz
your rights and the IRSs obligations to protect
ure protections, and will provide, where How Else Does the TAS Help
them in Publication 1, Your Rights as a
applicable, a collection due process hear Taxpayers?
Taxpayer. It includes the following.
1. The Right To Be Informed. Taxpayers The TAS works to resolve largescale problems
8. The Right to Confidentiality. Taxpayers that affect many taxpayers. If you know of one
have the right to know what they need to
have the right to expect that any informa of these broad issues, please report it to us at
do to comply with the tax laws. They are
tion they provide to the IRS will not be dis
entitled to clear explanations of the laws
closed unless authorized by the taxpayer
and IRS procedures in all tax forms, in
or by law. Taxpayers have the right to ex
structions, publications, notices, and cor
pect appropriate action will be taken Low Income Taxpayer
respondence. They have the right to be in
formed of IRS decisions about their tax
against employees, return preparers, and Clinics (LITCs)
others who wrongfully use or disclose tax
accounts and to receive clear explana
payer return information. LITCs serve individuals whose income is below
tions of the outcomes.
a certain level and need to resolve tax problems
2. The Right to Quality Service. Taxpayers 9. The Right To Retain Representation. such as audits, appeals, and tax collection dis
have the right to receive prompt, courte Taxpayers have the right to retain an au putes. Some LITCs can provide information
ous, and professional assistance in their thorized representative of their choice to about taxpayer rights and responsibilities in dif
dealings with the IRS, to be spoken to in a represent them in their dealings with the ferent languages for individuals who speak
way they can easily understand, to receive IRS. Taxpayers have the right to seek as English as a second language. To find an LITC
clear and easily understandable communi sistance from a Low Income Taxpayer near you, visit or see IRS Publi
cations from the IRS, and to speak to a su Clinic if they cannot afford representation. cation 4134, Low Income Taxpayer Clinic List.
pervisor about inadequate service.

Chapter 12 How To Get Tax Help Page 51

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.

Choosing a tax return Unemployment fund 17 Independent Contractor

A preparer 47 e-News 47 (Self-Employed) or
Advertising 43 Circulation costs, newspapers Entertainment 41 Employee? 47
Alternative Minimum Tax (AMT) and periodicals 24 Experimentation costs 22, 33 Information Return Filing
Assistant 48 Claim a refund 50 Exploration costs 23 Requirements 47
Amortization: Club dues 44 Insurance:
Antiabuse rule 31 Collection and enforcement Capitalized premiums 21
Antichurning rules 30 actions 50 F Deductible premiums 18
Atmospheric pollution control Commitment fees 14 Federal Relay Service 47 Nondeductible premiums 21
facilities 32 Computer software 30 Fees: Selfemployed individuals 18
Corporate organization costs 27 Constant-yield method, OID 13 Commitment 14 Intangible drilling costs 23
Dispositions of section 197 Contested liability 5 Legal and professional 45 Intangibles, amortization 28
intangibles 31 Contributions: Regulatory 45 Interactive Tax Assistant 48
Experimental costs 33 Charitable 44 Tax return preparation 45 Interest 15
Geological and geophysical Political 46 Filing past due tax returns 50 Allocation of 11
costs 32 Copyrights 29 Fines 45 Belowmarket 15
How to deduct 26 Cost depletion 34 First Time Homebuyer Credit Business expense for 11
Incorrect amount deducted 31 Cost of getting lease 10, 28 Account Look-up 48 Capitalized 13, 14
Partnership organization Cost of goods sold 3 Forgone 15 Carrying charge 22
costs 27 Cost recovery 3 Forgone interest 15 Deductible 12
Pollution control facilities 32 Covenant not to compete 29 Form: Life insurance policies 14
Reforestation costs 32 Credit card convenience fees 44 3115 31 Not deductible 13
Reforestation expenses 24 4562 26 Refunds of 14
Related person 30 5213 5 When to deduct 14
Research costs 33 D 8826 26 Internet-related expenses 45
Section 197 intangibles Debt-financed distributions 12 T 38 Interview expenses 45
defined 28 Definitions: Franchise 29, 44 IRS Tax Professional
Starting a businesscosts 26 Business bad debt 39 Fringe benefits 7 Partners 47
Startup costs 27 Necessary expense 3 IRS Video Portal 47
Anticipated liabilities 44 Ordinary expense 3
Assistance (See Tax help) Section 197 intangibles 28 G
At-risk limits 4 De minimis OID 13 Gas wells 37 K
Attorney fees 45 Demolition expenses 44 Geological and geophysical Key person 14
Authorized IRS e-file Depletion: costs: Kickbacks 44
providers 47 Mineral property 34 Development, oil and gas 32
Awards 7 Oil and gas wells 35 Exploration, oil and gas 32
A-Z Index for Business 47 Percentage table 37 Geothermal wells 23, 37 L
Timber 38 Gifts, nominal value 7 Leases:
Who can claim 33 Going into business 3, 26 Canceling 9
B Depreciation (See Cost recovery) Goodwill 29 Cost of getting 10, 28
Bad debts: Development costs, miners 24 Gross income, not-for-profit Improvements by lessee 10
Defined 39 Direct Pay 49 activity 5 Leveraged 9
How to treat 40 Dirty Dozen 49 Mineral 38
Recovery 40 Disabled, improvements for 25 Oil and gas 38
Types of 39 Drilling and development H Sales distinguished 9
When worthless 40 costs 23 Health Coverage Tax Credit Taxes on 10
Bonuses: Dues, membership 44 (HCTC) 18 Legal and professional fees 45
Employee 7 Health insurance, deduction for Letter 5071C 49
Royalties 38 self-employed 18 Licenses 29, 45
Bribes 44 E Heating equipment 4 Life insurance coverage 8
Business: Earned Income Tax Credit Home, business use of 4 Limit on deductions 5
Assets 3 Assistant 48 Line of credit 12
Books and records 29 Economic interest 33 Loans:
Meal expenses 43 Economic performance 5 I Belowmarket interestrate 15
Use of car 4, 44 Education expenses 7, 44 Identity (ID) theft issues 49 Discounted 14
Use of home 4 e-File Form 940, 941, or 944 for Impairment-related expenses 44 Loans or Advances 8
Small Businesses 47 Improvements 3 Lobbying expenses 45
Elderly, improvements for 25 By lessee 10 Long-term care insurance 19
C Electronic Federal Tax Payment For disabled and elderly 25 Losses 4, 5
Campaign contribution 46 System (EFTPS) 49 Income Taxes 17 Atrisk limits 4
Capital expenses 3 Electronic Filing PIN Request 48 Accrual of contested income Net operating 5
Capitalization of interest 14 Employee benefit programs 8 taxes 17 Passive activities 4
Car allowance 42 Employer ID Numbers (EINs) 47 Federal income taxes 17 Low Income Taxpayer Clinics
Car and truck expenses 44 Employment taxes 17 Foreign income taxes 17 (LITCs) 51
Carrying charges 22 Employment Taxes 47 State and local income taxes 17
Charitable contributions 44 Additional Medicare Tax 17 Incorrect amount of amortization
Checking amended return Selfemployment tax: deducted 31 M
status 50 Additional Medicare Tax 17 Machinery parts 4

Page 52 Publication 535 (2015)

Making a tax payment 49 Occupational taxes 18 Reforestation costs 24, 32 Leased property 10
Meals 41 Personal property taxes 18 Regulatory fees 45 When To Deduct Taxes 16
Meals and entertainment 43 Sales taxes 18 Reimbursements 41 Tax forms and publications 48
Meals and lodging 8 Outplacement services 45 Business expenses 8 Tax help 47
Methods of accounting 5 Over-the-phone interpreter Mileage 42 Tax information in other
Mining: service 50 Nonaccountable plan 43 languages 50
Depletion 37 Per diem 42 Tax law questions 48
Development costs 24 Related persons: Taxpayer Advocate Service
Exploration costs 23 P Antichurning rules 30 (TAS) 50
Mortgage 12, 13 Passive activities 4 Coal or iron ore 37 Taxpayer Assistance Center
Moving expenses, machinery 45 Payments in kind 4 Payments to 5, 14 (TAC) locator 50
Penalties 13 Refiners 35 Taxpayer Bill of Rights 50
Deductible 45 Unreasonable rent 9 Tax preparation 47
N Nondeductible 45 Removal 25 Tax preparation fees 45
Natural gas 37 Prepayment 13 Rent expense, capitalizing 10 Tax scams 49
Nonqualifying intangibles 29 Percentage depletion 34 Repairs 46 Telephone 47
Not-for-profit activities 5 Per diem and car allowances 42 Repayments (claim of right) 46 Timber 32, 38
Not-for-profit activity, gross Political contributions 46 Reporting abusive tax Tools 4
income 5 Pollution control facilities 32 preparers 48 Trademark, trade name 29, 44
Notice of Deficiency Prepaid expense 5 Research costs 22, 33 transcript or copy of a return 48
CP3219N 50 Extends useful life 22 Travel 41
Interest 14 TTY/TDD information 47
Rent 9 S
O Prepayment penalty 13 Scammers 49
Offer in compromise (OIC) 50 Presumption of profit 5 Section 179 expense U
Office in home 4 Pub 974 18 deduction (See Cost recovery) Understanding an IRS notice or
Oil and gas wells: Publication 1, Your Rights as a Self-employed health insurance letter 50
Depletion 35 Taxpayer 51 deduction 18 Unpaid expenses, related
Drilling costs 23 Publications (See Tax help) Self-Employed Individuals Tax person 14
Partnerships 36 Center 47 Utilities 47
S corporations 36 Self-insurance, reserve for 21
Online EIN Application 48 R Sick pay 8
Online payment agreement 50 Real EstateTaxes 16 Small Business and V
Online Tools & Educational Assessments Local 16 Self-Employed (SB/SE) Tax Vacation pay 8
Products 47 Charges for services 16 Center 47
Optional safe harbor method 4 Electing to ratably accrue to a Small Business Events 47
Optional write-off method: definite period 17 Small Business Forms and W
Circulation costs 33 Form 3115 17 Publications 47 Wages:
Experimental costs 33 Making the election to ratably Standard meal allowance 42 Property 8
Intangible drilling and accrue the taxes 17 Standard mileage Tests for deducting pay 6
development costs 33 Purchase or sale of real rate (See Business use of your Welfare benefit funds 8
Mining exploration and estate 16 car) When To Deduct Taxes:
development costs 33 Separate elections to ratably Standby charges 14 Carrying charges 16
Research costs 33 accrue for each separate Starting, Operating, or Closing a Limit on accrual of taxes 16
Organizational costs 24 trade or business and for Business 47 Refunds of taxes 16
Organization costs: nonbusiness activities 17 Start-up costs 24, 27 Uniform capitalization rules 16
Corporate 27 Recapture: Subscriptions 47 Where to file 48
Partnership 27 Exploration expenses 23 Substitute return 50 Wheres My Refund? 49
Original issue discount 13 Timber property 32 Supplies and materials 47 Withholding Calculator 48
Other Taxes 17 Recordkeeping 36
Excise taxes 17 Recovery of amount deducted 4
Franchise taxes 17 Refiners who cannot claim T
Fuel taxes 17 percentage depletion 35 Taxes 10, 16
Carrying charge 22

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