Question

What are Above or below of the line deductions?

What is a trade or business expense? How is it shown on the return(1040)?

What items discussed cannot be deducted?

What are the rules for illegal businesses and the differences between drugs and other illegal businesses?

What are The rules for expensing v capitalizing investigation expenses and the differences between the two terms?

What are Hobby loss rules and calculations?

Answer 1

1. What are Above or below of the line deductions?

In the above stated statement the word “line” refers to the Gross Profit. The items which are deducted to arrive at Gross Profit, are primarily referred to as Direct Costs i.e. items/ deductions directly related to the product manufactured/ sold. It includes Cost of Goods Sold, Cost of Sales or Cost of services.

Below the line items are those items which are referred to as Indirect Costs primarily incurred to arrive at Net profit. It broadly includes operating expenses like Interest, sales advertisement, salary, taxes and likewise.

An example shall be apt to suitably depict the situation;

Revenue                                            = $10000

Cost of Goods Sold

• Direct Material          = $3000
• Direct Labour             = $2000

All the deductions above this are “Above the Line Item”

_______

Gross Profit                                       = $5000

Operating expenses                        = $2000

                                                            -------------

Net Profit                                          = $3000

2. What is a trade or business expense? How is it shown on the return(1040)?

Trade Expense or Business expense refers to the expenses which are incurred ordinarily for the execution and smooth running of core activities of business. They are incurred ordinarily during the normal course of business. The best stated examples to understand the fairly stated concept is salary, advertisement, purchase of raw material and likewise.

Form 1040 is the form specified by IRS for detailing and submission of Income Tax Return. Schedule C of Form 1040 forming part of Form 1040, is an important part for small businesses. This schedule is referred to as or can be stated that it contains details in relation to ‘Profit or Loss’ from Business and is part of the tax return Form i.e. 1040.

It computed the income earned by the business for the tax year and also depicts expenses which are deductible.

3. What items discussed cannot be deducted?

Schedule C lists expenses which are claimed to be deducted to compute income chargeable to tax.

However, there are certain expenses which are not allowed to be deducted;

Equipment and Vehicle Expenses/ Interest Cost/ Depreciation

Machinery purchased for the purpose of business is allowed to be deducted while computing income chargeable to tax. Further if the machine is on rent than the rental charges are also allowed to be tax deductible.

Care has to be taken if the machinery is not completely used for business than proportionate deduction is allowed. Like wise proportionate depreciation shall be allowed to be claimed from business receipts to compute income chargeable to tax.

Broadly speaking all the expenses incurred for the purpose of business are allowed to be claimed for deduction. Further there are certain expenses which are not allowed in entirety like amount spent on meals which are expressly allowed to be deducted upto 50% of the aggregate expenditure incurred.

4. What are the rules for illegal businesses and the differences between drugs and other illegal businesses?

The Federal government does require that the money earned through illegal business activities should be reported under requisite Form and be brought under the tax net, just like any other income earned. On the IRS instructions, it has expressly been provided that money earned through illegal means must form part of form 1040 at Line item 21 or Schedule C/C-Ez as the case may be. There is no express difference between Drugs and other illegal businesses i.e. if the business of drugs is being executed in legitimate fashion, in that case the business is taxable at normal rates. However, if the business is indeed doing any illegitimate business activity than also the same shall be bound to be reported.