Tag Archives: Deduction

Caughlin Fire Reminds of Deductions from Losses

The following article appeared in the December 19th edition of Northern Nevada Business Weekly, available here http://goo.gl/ktL1v:

View of Downtown RenoOn Nov. 18, thousands of homes, offices and properties were threatened by a fire originating near Caughlin Ranch in Reno. The unusually dry autumn weather coupled with very strong winds created conditions which could have resulted in catastrophic losses. Although several homes were lost, the coordinated, diligent response by local fire protection agencies kept the losses from being far greater than they otherwise could have been. Despite the wonderful efforts of many community members to protect and preserve one another’s property, wrongdoers sought to prey on those affected by the fire. Just days after the fire, burglars targeted homes and vehicles in the disturbed neighborhoods. Officials warned residents to verify the credentials of those offering assistance. Scammers can cause additional harm by posing as insurance adjusters, carpet cleaners or contractors. Based on the recent events, taxpayers should be mindful of helpful tax deductions arising from casualty, disaster and theft losses. A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Deductible casualty losses can result from a number of different causes, including fires, floods, storms, and vandalism.

A theft is the illegal taking of another’s property. Theft includes the taking of money or property by burglary, larceny, looting, fraud and robbery.

To deduct a casualty or theft loss, the taxpayer must show that there was a casualty or theft and must support the amount taken as a deduction. Specifically, for a casualty loss the following must be established: 1. The type of casualty (fire, storm, etc.) and the date it occurred; 2. The loss directly resulted from the casualty; 3. The taxpayer owned the property, or leased and was contractually liable for the damage; and 4. Whether the taxpayer has a reasonable expectation of recovery on a claim for reimbursement.

For a theft loss, the taxpayer must establish the following: 1. Date it was discovered that the property was missing; 2. The property was stolen; 3. The taxpayer owned the property; 4. Whether the taxpayer had a reasonable expectation of recovery on a claim for reimbursement.

To determine the allowable deduction for a casualty or theft loss: 1. Determine the adjusted basis in the property before the casualty or theft. 2. Determine the decrease in fair market value of the property as a result of the casualty or theft. 3. Take the smaller of the amounts determined in the first two steps, and subtract any insurance or other reimbursement received or to be received.

For business or income-producing property, such as rental property, which is stolen or completely destroyed, the decrease in fair market value is not considered. The allowable loss equals the adjusted basis in the property, less any salvage value, less any insurance or other reimbursement received.

There are two ways to deduct a casualty or theft loss of inventory, including items held for sale to customers. One way is to simply deduct the loss through the increase in the cost of goods sold by properly reporting the opening and closing inventories. The loss cannot again be claimed as a casualty or theft loss. If this approach is followed, the taxpayer must include in gross income any insurance or other reimbursement received.

The other way is to deduct the casualty or theft loss separately. If deducted separately, the affected inventory items must be eliminated from the cost of goods sold by making a downward adjustment to opening inventory or purchases. The loss must be reduced by any reimbursement received. Do not include the reimbursement in gross income. If the reimbursement is not received by the end of the year, the loss must still be reduced by the amount of reimbursement for which there is a reasonable expectation of recovery.

If the taxpayer is liable for casualty damage to leased property, the loss is the cost to repair the property less any insurance or other reimbursement.

If insurance or other type of reimbursement is received, the loss is reduced to the extent of the reimbursement. A claim for insurance reimbursement must be filed in a timely fashion or the casualty or theft loss may be lost.

After the loss amount is determined, the taxpayer must next determine how much of the loss is deductible. The deduction for casualty and theft losses of employee property and personal-use property is limited. A loss on employee property is subject to the 2 percent rule. Employee property is property used in performing services as an employee. The casualty and theft loss deduction for employee property, when added to other miscellaneous itemized deductions, must be reduced by 2 percent of adjusted gross income.

A loss on personal use property is subject to the $100 and 10 percent rules. After determining the casualty or theft loss on personal-use property, the loss is reduced by $100. The total of all casualty or theft losses on personal-use property is reduced by 10 percent of the taxpayer’s adjusted gross income. Losses on business property (other than employee property) and income-producing property are not subject to the 2 percent and 10 percent rules.

However, if the casualty or theft loss involved a home used for business or as a rental, the deductible loss may be limited. The casualty or theft loss deductions must be figured separately for property used for both personal and business or income-producing purposes. The taxpayer must allocate the total cost or basis, the fair market value before and after the casualty or theft loss, and the insurance or other reimbursement between the business and personal use of the property. Just as property owners should seek qualified professionals in making repairs or improvements to damaged property, those looking to claim casualty and theft loss deductions should consult with a professional tax advisor.

By: Jason C. Morris, Esq. and Don L. Ross, Esq.

Rising Gas Prices Lead to Larger Deductions

Who says rising gas prices hurt everyone?  Office runner and couriers will cheer the increase to their reimbursements for business trips. The IRS has announced that the mileage allowance for vehicles will increase 4.5¢ from 51¢ to 55.5¢ per mile for business travel from July 1, 2011 to December 31, 2011.  The mileage rate varies based on the annual study of the fixed and variable costs of operating an automobile.

Employees who drive their own vehicles for business purposes may receive reimbursement for business mileage whether the autos are owned or leased.  The rate of reimbursement must not exceed the business mileage allowance.  The employee receives the funds as a tax-free reimbursement if they substantiate the time, place, business purpose and mileage of each trip.

Also, the rate for using a car to receive medical care or in connection with a move that qualified for the moving expense deduction increases to 23.5¢ per mile.

Deductibility of Legal Fees for Estate Planning

**UPDATE: Tax Cuts and Jobs Act (TCJA) enacted on December 22, 2017, provided, “[n]otwithstanding subsection (a) [subjecting certain miscellaneous itemized deductions to the 2 percent floor], no miscellaneous itemized deductions shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.”**

Section 212 of the Internal Revenue Code (the “Code”) provides that a deduction is available for all the ordinary and necessary expenses paid or incurred during the taxable year:

1. for the production or collection of income;

2. for the management, conservation, or maintenance of property held for the production of income; or

3. in connection with the determination, collection, or refund of any tax.

Section 212 is limited by the two percent (2%) floor under § 67 of the Code. Section 67 provides an individual’s “miscellaneous itemized deductions” may only be deducted to the extent that the aggregate of the deductions exceed two (2%) percent of adjusted gross income. IRC §67(a).  Because of the itemized deductions floor, most clients will not benefit from a deduction for legal expenses incurred in estate planning.

The Tax Court has considered numerous cases to determine whether legal fees incurred in estate planning are deductible.  One of the first cases to allow a deduction for estate planning fees, Bagley v. Commissioner, found that the law firm provided deductible legal services under §212(2).  The law firm consulted the clients with regard to tax-favorable investments, loans to the corporation owned by the client family, and the review and creation of estate plans for the family members.

In Merians v. Commissioner, the court allowed a §212(3) deduction for legal fees allocated to tax advice.  The court narrowly construed their decision to a deduction for only the portion of services which it considered tax advice.  The attorney did not maintain accurate time entry or billing records reflecting the amount of time spent on tax-related aspects of his representation.

The Tax Court has disallowed deductions for legal fees paid for estate planning and general business guidance when the taxpayer does not have any evidence of how the fees relate to the §212 categories.  The mere preparation of a will or testamentary trust will not be deductible.  However, an argument can be made that the creation of a revocable living trust is a tax-motivated transaction for the management and conservation of property.  Similarly, the taxpayer could argue the fees were incurred in connection with the determination (minimization) of the taxpayer’s future tax liability. Therefore, the fees should be deductible under §§212(2) and 212(3).