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Home , Amortization (business), Bad debt, Business loan, Cost basis, Life insurance, Tax deduction

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Publication 535 Cat. No. 15065Z Contents

Introduction ...... 1 Department of the Business What's New for 2020 ...... 2 Treasury Internal What's New for 2021 ...... 2 Service Reminders ...... 2 Chapter 1. Deducting For use in preparing Business Expenses ...... 3 Chapter 2. Employees' Pay ...... 7 Returns 2020 Chapter 3. Rent ...... 10

Chapter 4. ...... 13

Chapter 5. ...... 18

Chapter 6. ...... 20

Chapter 7. Costs You Can Deduct or Capitalize ...... 24

Chapter 8. Amortization ...... 28

Chapter 9. Depletion ...... 35

Chapter 10. Business Bad .... 40

Chapter 11. Other Expenses ...... 42

Chapter 12. How To Get Help ... 49

The Taxpayer Advocate Service (TAS) Is Here To Help You ..... 53

Index ...... 55 Introduction 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. Note. Section references within this publica- tion are to the and regu- lation references are to the Regula- tions under the Code.

Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions. You can send us comments through IRS.gov/FormComments. Or you can write to the Internal , Tax Forms and Publications, 1111 Constitution Ave. NW, IR-6526, Washington, DC 20224. Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax forms, instructions, and publi- cations. Do not send tax questions, tax returns, Get forms and other information faster and easier at: or payments to the above address. • IRS.gov (English) • IRS.gov/Korean (한국어) • IRS.gov/Spanish (Español) • IRS.gov/Russian (Pусский) Getting answers to your tax questions. • IRS.gov/Chinese (中文) • IRS.gov/Vietnamese (TiếngViệt) If you have a tax question not answered by this publication or the How To Get Tax Help section

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at the end of this publication, go to the IRS In- For more information, go to the Gig teractive Tax Assistant page at IRS.gov/ Reminders Economy Tax Center at IRS.gov/Gig. Help/ITA where you can find topics using the Photographs of missing children. The Inter- search feature or by viewing the categories lis- The following reminders and other items may nal Revenue Service is a proud partner with the ted. help you file your tax return. National Center for Missing & Exploited Getting tax forms, instructions, and pub- Children® (NCMEC). Photographs of missing lications. Visit IRS.gov/Forms to download IRS e-file (Electronic Filing) children selected by the Center may appear in current and prior-year forms, instructions, and this publication on pages that would otherwise publications. be blank. You can help bring these children home by looking at the photographs and calling Ordering tax forms, instructions, and 1-800-THE-LOST (1-800-843-5678) (24 hours publications. Go to IRS.gov/OrderForms to a day, 7 days a week) if you recognize a child. order current forms, instructions, and publica- Preventing and human trafficking. tions; call 800-829-3676 to order prior-year You can file your tax returns electronically Human trafficking is a form of modern-day slav- forms and instructions. The IRS will process using an IRS e-file option. The benefits of IRS ery, and involves the use of force, , or co- your order for forms and publications as soon e-file include faster refunds, increased ercion to exploit human beings for some type of as possible. Do not resubmit requests you've al- accuracy, and acknowledgment of IRS receipt labor or commercial sex purpose. The United ready sent us. You can get forms and publica- of your return. You can use one of the following States is a source, transit, and destination tions faster online. IRS e-file options. country for men, women, and children, both • Use an authorized IRS e-file provider. U.S. citizens and foreign nationals, who are • Use a personal computer. subjected to the injustices of slavery and hu- • Visit a Volunteer Income Tax Assistance man trafficking, including forced labor, (VITA) or Tax Counseling for the Elderly Future Developments bondage, , “mail-order” (TCE) site. For the latest information about developments marriages, and sex trafficking. Trafficking in related to Pub. 535, such as legislation enacted For details on these fast filing methods, see persons can occur in both lawful and illicit in- after it was published, go to IRS.gov/Pub535. your income tax package. dustries or markets, including in hotel services, hospitality, agriculture, , janitorial Form 1099-MISC. File Form 1099-MISC, Mis- services, construction, health and elder care, cellaneous Income, for each person to whom domestic service, brothels, massage parlors, you have paid during the year in the course of and street prostitution, among others. What's New for 2020 your trade or business at least $600 in rents, The following items highlight some changes in prizes and awards, other income payments, The President’s Interagency Task Force to the tax law for 2020. medical and health care payments, and crop in- Monitor and Combat Trafficking in Persons surance proceeds. See the Instructions for (PITF) brings together federal departments and Coronavirus (COVID-19) related employ- Forms 1099-MISC and 1099-NEC for more in- agencies to ensure a whole-of-government ap- ment tax . formation and additional reporting require- proach that addresses all aspects of human • The Families First Coronavirus Response ments. trafficking. Online resources for recognizing and Act (FFCRA), enacted on March 18, 2020, reporting trafficking activities, and assisting vic- provides certain employers with tax credits Form 1099-NEC. File Form 1099-NEC, Non- tims include the Department of Homeland Se- that reimburse them for the cost of provid- employee Compensation, for each person to curity (DHS) Blue Campaign at DHS.gov/blue- ing paid sick and family leave to whom you have paid during the year in the campaign, the Department of State Office to their employees for leave related to course of your trade or business at least $600 in Monitor and Combat Trafficking in Persons at COVID-19. services (including parts and materials), who is State.gov/j/tip, and the National Human Traf- • The Coronavirus Aid, Relief, and Eco- not your employee. See the Instructions for ficking Resource Center (NHTRC) at nomic Security Act (CARES Act), enacted Forms 1099-MISC and 1099-NEC for more in- humantraffickinghotline.org. DHS is responsible on March 27, 2020, provides eligible em- formation and additional reporting require- for investigating human trafficking, arresting ployers with an employee retention tax ments. traffickers, and protecting victims. DHS also if they keep employees on their pay- provides immigration relief to non-U.S. citizen roll, despite experiencing economic hard- Gig Economy Tax Center. The IRS Gig Econ- victims of human trafficking. DHS uses a victim- ship related to COVID-19. omy Tax Center on IRS.gov can help people in centered approach to combating human traf- this growing area meet their tax obligations For more information, see chapter 2. ficking, which places equal value on identifying through more streamlined information. and stabilizing victims and on investigating and Film, television, and live theatrical produc- The gig economy is also known as the shar- prosecuting traffickers. Victims are crucial to in- tion costs. The election to expense certain ing, on-demand, or access economy. It usually vestigations and prosecutions; each case and costs of qualified film, television, and live theat- includes businesses that operate an app or every conviction changes lives. DHS under- rical productions has been extended to include website to connect people to provide services stands how difficult it can be for victims to come costs of productions that begin before January to customers. While there are many types of gig forward and work with law enforcement due to 1, 2026. For more information, see chapter 7. economy businesses, ride-sharing and home their trauma. DHS is committed to helping vic- rentals are two of the most popular. Standard mileage rate. For tax year 2020, the tims feel stable, safe, and secure. standard mileage rate for the cost of operating The Gig Economy Tax Center streamlines To report suspected human trafficking, call your car, van, pickup, or panel truck for each various resources, making it easier for taxpay- the DHS domestic 24-hour toll-free number at mile of business use is 57.5 cents per mile. For ers to find information about the tax implications 866-DHS-2-ICE (866-347-2423) or more information, see chapter 11. for the companies that provide the services and 802-872-6199 (non-toll-free international). For the individuals who perform them. It offers tips help from the NHTRC, call the National Human and resources on a variety of topics including: Trafficking Hotline toll free at 888-373-7888 or • Filing requirements; text HELP or INFO to BeFree (233733). What's New for 2021 • Making quarterly estimated income tax The U.S. Department of the Treasury’s Fi- payments; nancial Crimes Enforcement Network (FinCEN) The following item highlights a change in the tax • Paying self- taxes; has issued a public advisory to financial institu- law for 2021. • Paying FICA, Medicare, and Additional tions that contains red flag indicators for poten- Standard mileage rate. For tax year 2021, the Medicare taxes; tial suspicious financial activity associated with standard mileage rate for the cost of operating • business expenses; and human trafficking. If warranted, financial institu- your car, van, pickup, or panel truck for each • Special rules for reporting vacation home tions should file a Suspicious Activity Report mile of business use is 56 cents per mile. rentals. (FinCEN 112) with FinCEN to report these

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activities. For more information, go to 538 538 Periods and Methods indirect costs for certain production or resale Fincen.gov/Sites/default/files/advisory/ activities. Indirect costs include rent, interest,

542 542 Corporations FIN-2014-A008.pdf. taxes, storage, purchasing, processing, repack-

547 547 Casualties, Disasters, and Thefts aging, handling, and administrative costs.

583 583 Starting a Business and Keeping This rule does not apply to small business Records taxpayers. You qualify as a small business tax-

587 587 Business Use of Your Home payer if you (a) have average annual gross re- ceipts of $26 million or less for the 3 prior tax 1. 925 925 Passive Activity and At-Risk Rules years, and (b) are not a (as defined

936 936 Home Mortgage Interest in section 448(d)(3)). If your business has not Deduction been in existence for all of the 3-tax-year period used in figuring average gross receipts, base

946 946 How To Depreciate Property Deducting your average on the period it has existed, and if your business has a predecessor entity, include Form (and Instructions) the gross receipts of the predecessor entity

Business A (Form 1040) Schedule A (Form 1040) Itemized from the 3-tax-year period when figuring aver- Deductions age gross receipts. If your business (or prede- cessor entity) had short tax years for any of the

5213 5213 Election To Postpone Expenses 3-tax-year period, annualize your business’ Determination as To Whether the gross receipts for the short tax years that are Presumption Applies That an part of the 3-tax-year period. See Pub. 538 for Activity Is Engaged in for Reminder more information. See chapter 12 for information about getting publications and forms. For more information, see the following Deduction for qualified business income. sources. For tax years beginning after 2017, you may be • —chapter 6 of Pub. entitled to take a deduction of up to 20% of your What Can I Deduct? 334. qualified business income from your qualified • Inventories—Pub. 538. trade or business, plus 20% of the aggregate • Uniform capitalization rules—Pub. 538 and To be deductible, a business expense must be amount of qualified real estate trust section 263A and the related regulations. (REIT), and qualified publicly traded partnership both ordinary and necessary. An ordinary ex- income. pense is one that is common and accepted in your . A necessary expense is one that Capital Expenses Small business taxpayers. For tax years be- is helpful and appropriate for your trade or busi- ginning after 2017, more small business taxpay- ness. An expense does not have to be indis- You must capitalize, rather than deduct, some ers may qualify to use the method of ac- pensable to be considered necessary. costs. These costs are a part of your investment counting and be exempt from capitalizing in your business and are called “capital expen- certain expenses under section 263A. In addi- Even though an expense may be ordinary ses.” Capital expenses are considered tion, small business taxpayers may not be re- and necessary, you may not be allowed to de- in your business. In general, you capitalize quired to account for inventories under section duct the expense in the year you paid or incur- three types of costs. 471 and are not subject to the business interest red it. In some cases, you may not be allowed Business start-up costs (see Tip below). expenses limitation. to deduct the expense at all. Therefore, it is im- • Business assets. portant to distinguish usual business expenses • Improvements. from expenses that include the following. • Introduction • The expenses used to figure cost of goods You can elect to deduct or amortize sold. TIP certain business start-up costs. See This chapter covers the general rules for de- • Capital expenses. chapters 7 and 8. ducting business expenses. Business expen- • Personal expenses. ses are the costs of carrying on a trade or busi- Cost recovery. Although you generally cannot ness, and they are usually deductible if the take a current deduction for a capital expense, business is operated to make a profit. Cost of Goods Sold you may be able to recover the amount you If your business manufactures products or pur- spend through , amortization, or Topics chases them for resale, you must generally depletion. These recovery methods allow you to This chapter discusses: value inventory at the beginning and end of deduct part of your cost each year. In this way, each tax year to determine your cost of goods you are able to recover your capital expense. • What you can deduct sold. Some of your business expenses may be See Amortization (chapter 8) and Depletion • How much you can deduct included in figuring cost of goods sold. Cost of (chapter 9) in this publication. A taxpayer can • When you can deduct goods sold is deducted from your gross re- elect to deduct a portion of the costs of certain • Not-for-profit activities ceipts to figure your gross profit for the year. If depreciable property as a section 179 deduc- you include an expense in the cost of goods tion. A greater portion of these costs can be de- Useful Items sold, you cannot deduct it again as a business ducted if the property is qualified disaster assis- You may want to see: expense. tance property. See Pub. 946 for details. The following are types of expenses that go Publication into figuring cost of goods sold. Going Into Business • The cost of products or raw materials, in- 334 334 Tax Guide for Small Business cluding freight. The costs of getting started in business, before • Storage. you actually begin business operations, are 463 463 Travel, Gift, and Car Expenses • Direct labor (including contributions to pen- capital expenses. These costs may include ex- penses for advertising, travel, or wages for

525 525 Taxable and Nontaxable Income sion or plans) for workers who pro- duce the products. training employees.

529 529 Miscellaneous Deductions • Factory overhead. If you go into business. When you go into

536 536 Net Operating Losses (NOLs) for Under the uniform capitalization rules, you business, treat all costs you had to get your Individuals, Estates, and Trusts must capitalize the direct costs and part of the business started as capital expenses.

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Usually, you recover costs for a particular quire or produce certain tangible business prop- Example. In 2020, you do not have an ap- through depreciation. Generally, you can- erty if: plicable and you purchase not recover other costs until you sell the busi- • You have a trade or business or are a cor- five laptop computers for use in your trade or ness or otherwise go out of business. However, poration, partnership, or S corporation that business. You paid $2,000 each for a total cost you can choose to amortize certain costs for has an applicable financial statement; of $10,000 and these amounts are substanti- setting up your business. See Starting a Busi- • You have, at the beginning of the tax year, ated in an invoice. You had an accounting pro- ness in chapter 8 for more information on busi- written accounting procedures treating as cedure in place at the beginning of 2020 to ex- ness start-up costs. an expense for nontax purposes: pense the cost of tangible property if the – Amounts paid for property costing property costs $2,000 or less. You treat each If your attempt to go into business is un- less than a certain dollar amount, or computer as an expense on your books and re- successful. If you are an individual and your – Amounts paid for property with an cords for 2020 in accordance with this policy. If attempt to go into business is not successful, economic useful life of 12 months or you elect the de minimis safe harbor in your tax the expenses you had in trying to establish less; returns for your 2020 tax year, you can deduct yourself in business fall into two categories. • You treat the amount paid during the tax the cost of each $2,000 computer. 1. The costs you had before making a deci- year for which you make the election as an sion to acquire or begin a specific busi- expense on your applicable financial state- Improvements ness. These costs are personal and non- ments in accordance with your written ac- deductible. They include any costs counting procedures; Generally, you must capitalize the costs of mak- incurred during a general search for, or • The amount paid for the property does not ing improvements to a business asset if the im- preliminary investigation of, a business or exceed $5,000 per invoice (or per item provements result in a betterment to the unit of investment possibility. substantiated by invoice); and property, restore the unit of property, or adapt • The uniform capitalization rules do not ap- the unit of property to a new or different use. 2. The costs you had in your attempt to ac- ply to the amount. quire or begin a specific business. These Some examples of improvements include costs are capital expenses and you can You do not have an applicable financial rewiring or replumbing of a building, replacing deduct them as a capital loss. statement. If you elect the de minimis safe an entire roof, increasing the production output If you are a corporation and your attempt to harbor for the tax year, you can deduct amounts of your equipment, putting an addition on your go into a new trade or business is not success- paid to acquire or produce certain tangible busi- building, strengthening the foundation of a ful, you may be able to deduct all investigatory ness property if: building so you can use it for a new purpose, or costs as a loss. • You have a trade or business, partnership, replacing a major component or substantial or S corporation that does not have an ap- The costs of any assets acquired during structural part of a machine. plicable financial statement; your unsuccessful attempt to go into business • You have, at the beginning of the tax year, are a part of your basis in the assets. You can- However, you may currently deduct the accounting procedures treating as an ex- not take a deduction for these costs. You will re- costs of repairs or maintenance that do not im- pense for nontax purposes: cover the costs of these assets when you dis- prove a unit of property. This generally includes pose of them. – Amounts paid for property costing the costs of routine repairs and maintenance to less than a certain dollar amount, or your property that result from your use of the Business Assets – Amounts paid for property with an property and that keep your property in an ordi- economic useful life of 12 months or nary, efficient operating condition. For example, There are many different kinds of business as- less; deductible repairs include costs such as paint- sets, for example, land, buildings, machinery, • You treat the amounts paid for the property ing exteriors or interiors of business buildings, furniture, trucks, patents, and franchise rights. as an expense on your books and records repairing broken windowpanes, replacing You must fully capitalize the cost of these as- in accordance with your accounting proce- worn-out minor parts, sealing cracks and leaks, sets, including freight and installation charges. dures; and changing oil or other fluids to maintain busi- • The amount paid for the property does not ness equipment. Certain property you produce for use in your exceed $2,500 per invoice (or per item trade or business must be capitalized under the substantiated by invoice); and Routine maintenance safe harbor. If you uniform capitalization rules. See Regulations • The uniform capitalization rules do not ap- determine that your cost was for an improve- section 1.263A-2 for information on these rules. ply to the amounts. ment to a building or equipment, you can de- duct your cost under the routine maintenance How to make the de minimis safe harbor De Minimis Safe Harbor for safe harbor. Under the routine maintenance election. To elect the de minimis safe harbor safe harbor, you can deduct the costs of an im- Tangible Property for the tax year, attach a statement to the tax- provement that meets all of the following crite- payer’s timely filed original tax return (including ria. Although you must generally capitalize costs to extensions) for the tax year when qualifying It is paid for recurring activities performed acquire or produce real or tangible personal • amounts were paid. The statement must be ti- on tangible property. property used in your trade or business, such tled “Section 1.263(a)-1(f) de minimis safe har- It arises from the use of the property in as buildings, equipment, or furniture, you can • bor election” and must include your name, ad- your trade or business. elect to use a de minimis safe harbor to deduct dress, taxpayer identification number (TIN), and It keeps your property in an ordinary, effi- the costs of some tangible property. Under the • a statement that you are making the de minimis cient operating condition. de minimis safe harbor for tangible property, safe harbor election under section 1.263(a)-1(f). You reasonably expect, at the time the you can deduct de minimis amounts paid to ac- • In the case of a consolidated group filing a con- property is placed in service, to perform quire or produce certain tangible business prop- solidated income tax return, the election is this activity: erty if these amounts are deducted by you for fi- made for each member of the consolidated – For buildings and building systems, nancial accounting purposes or in keeping your group. more than once during the 10-year pe- books and records. See the following for the re- In the case of a consolidated group filing a quirements for the de minimis safe harbor. riod after you place the building in consolidated income tax return, the election is service; or made for each member of the consolidated You have an applicable financial statement. – For other property, more than once group. In the case of an S corporation or a part- If you elect the de minimis safe harbor for the during the class life of the particular nership, the election is made by the S corpora- tax year, you can deduct amounts paid to ac- type of property. For class lives, see tion or the partnership and not by the share- Revenue Procedure 88-57, 1987-2 holders or partners. The election applies only C.B. 674. for the tax year for which it is made.

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Costs incurred during an improvement. Machinery parts. Unless the uniform capitali- You generally do not have to meet the ex- You must capitalize both the direct and indirect zation rules apply, the cost of replacing clusive use test for the part of your home that costs of an improvement. Indirect costs include short-lived parts of a machine to keep it in good you regularly use either for the storage of inven- repairs and other expenses that directly benefit working condition, but not to improve the ma- tory or product samples, or as a daycare facility. or are incurred by reason of your improvement. chine, is a deductible expense. Your home office qualifies as your principal For example, if you improve the electrical sys- place of business if you meet the following re- tem in your building, you must also capitalize Heating equipment. The cost of changing quirements. the costs of repairing the holes that you made in from one heating system to another is a capital • You use the office exclusively and regu- walls to install the new wiring. This rule applies expense. larly for administrative or management ac- even if this work, performed by itself, would oth- tivities of your trade or business. erwise be treated as currently deductible repair Deduction for qualified business income. • You have no other fixed location where costs. For tax years beginning after 2017, you may be you conduct substantial administrative or entitled to take a deduction of up to 20% of your management activities of your trade or Election to capitalize repair and mainte- qualified business income from your qualified business. nance costs. You can elect to capitalize and trade or business, plus 20% of the aggregate depreciate certain amounts paid for repair and amount of qualified real estate If you have more than one business loca- maintenance of tangible property, even if they (REIT), and qualified publicly traded partnership tion, determine your principal place of business do not improve your property. To qualify for this income. The deduction is subject to various lim- based on the following factors. election, you must treat these amounts as capi- itations, such as limitations based on the type of • The relative importance of the activities tal expenditures on your books and records your trade or business, your taxable income, performed at each location. used in figuring your income. If you make this the amount of W-2 wages paid with respect to • If the relative importance factor does not election, you must apply it to all repair and the qualified trade or business, and the unad- determine your principal place of business, maintenance costs of tangible property that you justed basis of qualified property held by your consider the time spent at each location. treat as capital expenditures on your books and trade or business. You will claim this deduction Optional safe harbor method. Individual records for this tax year. To make the election on Form 1040 or 1040-SR, not on Schedule C. taxpayers can use the optional safe harbor to treat repairs and maintenance as capital ex- Unlike other deductions, this deduction can be method to determine the amount of deductible penditures, attach a statement titled “Section taken in addition to the standard or itemized de- expenses attributable to certain business use of 1.263(a)-3(n) Election” to your timely filed origi- ductions. For more information, see the Instruc- a residence during the tax year. This method is nal tax return (including extensions) and include tions for Forms 1040 and 1040-SR. an alternative to the calculation, allocation, and your name and address, TIN, and a statement substantiation of actual expenses. that you elect to capitalize repair and mainte- Personal Versus Business The deduction under the optional method is nance costs under section 1.263(a)-3(n). You limited to $1,500 per year based on $5 per must treat these amounts as improvements to Expenses square foot for up to 300 square feet. Under this your tangible property and begin to depreciate method, you claim your allowable mortgage in- Generally, you cannot deduct personal, living, these amounts when the improvement is placed terest, real estate taxes, and casualty losses on or family expenses. However, if you have an ex- in service. the home as itemized deductions on Sched- pense for something that is used partly for busi- ule A (Form 1040). You are not required to allo- ness and partly for personal purposes, divide cate these deductions between personal and Capital Versus Deductible the total cost between the business and per- business use, as is required under the regular sonal parts. You can deduct the business part. Expenses method. If you use the optional method, you cannot depreciate the portion of your home To help you distinguish between capital and de- For example, if you borrow money and use used in a trade or business. ductible expenses, different examples are given 70% of it for business and the other 30% for a Business expenses unrelated to the home, below. family vacation, you can generally deduct 70% of the interest as a business expense. The re- such as advertising, supplies, and wages paid to employees, are still fully deductible. All of the Motor vehicles. You usually capitalize the maining 30% is personal interest and is gener- requirements discussed earlier under Business cost of a motor vehicle you use in your busi- ally not deductible. See chapter 4 for informa- use of your home still apply. ness. You can recover its cost through annual tion on deducting interest and the allocation For more information on the deduction for deductions for depreciation. rules. business use of your home, including the op- There are dollar limits on the depreciation Business use of your home. If you use part tional safe harbor method, see Pub. 587. you can claim each year on passenger automo- of your home for business, you may be able to biles used in your business. See Pub. 463 for If you were entitled to deduct deprecia- deduct expenses for the business use of your more information. tion on the part of your home used for home. These expenses may include mortgage ! CAUTION business, you cannot exclude the part Generally, repairs you make to your busi- interest, insurance, utilities, repairs, and depre- of the gain from the sale of your home that ness vehicle are currently deductible. However, ciation. amounts you pay to improve your business ve- equals any depreciation you deducted (or could To qualify to claim expenses for the busi- hicle are generally capital expenditures and are have deducted) for periods after May 6, 1997. ness use of your home, you must meet both of recovered through depreciation. the following tests. Business use of your car. If you use your car Roads and driveways. The cost of building a 1. The business part of your home must be exclusively in your business, you can deduct private road on your business property and the used exclusively and regularly for your car expenses. If you use your car for both busi- cost of replacing a gravel driveway with a con- trade or business. ness and personal purposes, you must divide crete one are capital expenses you may be able 2. The business part of your home must be: your expenses based on actual mileage. Gen- to depreciate. The cost of maintaining a private erally, commuting expenses between your road on your business property is a deductible a. Your principal place of business; home and your business location, within the expense. b. A place where you meet or deal with area of your tax home, are not deductible. patients, clients, or customers in the You can deduct actual car expenses, which Tools. Unless the uniform capitalization rules include depreciation (or lease payments), gas apply, amounts spent for tools used in your normal course of your trade or busi- ness; or and oil, tires, repairs, tune-ups, insurance, and business are deductible expenses if the tools registration fees. Or, instead of figuring the have a of less than 1 year or c. A separate structure (not attached to business part of these actual expenses, you they cost $200 or less per item or invoice. your home) used in connection with may be able to use the standard mileage rate to your trade or business. figure your deduction. For 2020, the standard mileage rate is 57.5 cents per mile. Beginning in

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2021, the standard mileage rate decreased to Passive activities. Generally, you are in a be determined, and economic performance oc- 56 cents per mile. passive activity if you have a trade or business curred in that year. If you are self-employed, you can also de- activity in which you do not materially partici- If you use the cash method of accounting, duct the business part of interest on your car pate, or a rental activity. In general, deductions deduct the expense on your 2021 tax return. , state and local personal on for losses from passive activities only offset in- the car, parking fees, and tolls, whether or not come from passive activities. You cannot use Prepayment. You generally cannot deduct ex- you claim the standard mileage rate. any excess deductions to offset other income. penses in advance, even if you pay them in ad- For more information on car expenses and In addition, passive activity credits can only off- vance. This applies to prepaid interest, prepaid the rules for using the standard mileage rate, set the tax on net passive income. Any excess insurance premiums, and any other prepaid ex- see Pub. 463. loss or credits are carried over to later years. pense that creates an . If you Suspended passive losses are fully deductible pay an amount that creates an intangible asset, in the year you completely dispose of the activ- then you must capitalize the amounts paid and How Much Can I ity. For more information, see Pub. 925. begin to amortize the payment over the appro- priate period. Deduct? Net operating loss (NOL). If your deduc- However, you do not have to capitalize tions are more than your income for the year, amounts for creating an intangible asset if the you may have an NOL. You can use an NOL to Generally, you can deduct the full amount of a right or benefit created does not extend beyond lower your taxes in other years. See Pub. 536 business expense if it meets the criteria of ordi- the earlier of 12 months after the date that you for more information. nary and necessary and it is not a capital ex- first receive the right or benefit or the end of the See Pub. 542 for information about NOLs of pense. tax year following the year in which you made corporations. the advance payment. If you are a cash method Recovery of amount deducted (tax benefit taxpayer and your advance payment qualifies rule). If you recover part of an expense in the for this exception, then you can generally de- same tax year in which you would have claimed When Can I duct the amount when paid. If you are an ac- a deduction, reduce your current year expense Deduct an Expense? crual method taxpayer, you cannot deduct the by the amount of the recovery. If you have a re- amount until the all-events test has been met covery in a later year, include the recovered and economic performance has occurred. When you can deduct an expense depends on amount in income in that year. However, if part your accounting method. An accounting of the deduction for the expense did not reduce Example 1. In 2020, you sign a 10-year method is a set of rules used to determine when your tax, you do not have to include that part of lease and immediately pay your rent for the first and how income and expenses are reported. the recovered amount in income. 3 years. Even though you paid the rent for The two basic methods are the cash method 2020, 2021, and 2022, you can only deduct the For more information on recoveries and the and the method. Whichever method tax benefit rule, see Pub. 525. rent for 2020 on your 2020 tax return. You can you choose must clearly reflect income. deduct the rent for 2021 and 2022 on your tax Payments in kind. If you provide services to For more information on accounting meth- returns for those years. pay a business expense, the amount you can ods, see Pub. 538. deduct is limited to your out-of-pocket costs. Example 2. You are a cash method calen- You cannot deduct the cost of your own labor. Cash method. Under the cash method of ac- dar year taxpayer. On December 1, 2020, you Similarly, if you pay a business expense in counting, you generally deduct business expen- sign a 12-month lease, effective beginning Jan- goods or other property, you can deduct only ses in the tax year you pay them. uary 1, 2021, and immediately pay your rent for what the property costs you. If these costs are the entire 12-month period that begins on Janu- included in the cost of goods sold, do not de- Accrual method. Under an accrual method of ary 1, 2021. The right or benefit attributable to duct them again as a business expense. accounting, you generally deduct business ex- the payment neither extends more than 12 penses when both of the following apply. months beyond January 1, 2021 (the first day Limits on losses. If your deductions for an in- that you are entitled to use the property) nor be- 1. The all-events test has been met. The test vestment or business activity are more than the yond the tax year ending December 31, 2021 is met when: income it brings in, you have a loss. There may (the year following the year in which you made be limits on how much of the loss you can de- a. All events have occurred that fix the the advance payment). Therefore, your prepay- duct. fact of liability, and ment does not have to be capitalized, and you can deduct the entire payment in the year you Not-for-profit limits. If you carry on your b. The liability can be determined with pay it. business activity without the of making reasonable accuracy. a profit, you cannot use a loss from it to offset 2. Economic performance has occurred. Contested liability. Under the cash method, other income. For more information, see you can deduct a contested liability only in the Not-for-Profit Activities, later. Economic performance. You generally year you pay the liability. Under the accrual cannot deduct or capitalize a business expense method, you can deduct contested liabilities At-risk limits. Generally, a deductible loss until economic performance occurs. If your ex- such as taxes (except foreign or U.S. posses- from a trade or business or other income-pro- pense is for property or services provided to sion income, war profits, and excess profits ducing activity is limited to the investment you you, or for your use of property, economic per- taxes) either in the tax year you pay the liability have “at risk” in the activity. You are at risk in formance occurs as the property or services are (or transfer money or other property to satisfy any activity for the following. provided, or the property is used. If your ex- the obligation) or in the tax year you settle the 1. The money and adjusted basis of property pense is for property or services you provide to contest. However, to take the deduction in the you contribute to the activity. others, economic performance occurs as you year of payment or transfer, you must meet cer- provide the property or services. tain conditions. See Regulations section 2. Amounts you borrow for use in the activity 1.461-2. if: Example. Your tax year is the calendar a. You are personally liable for repay- year. In December 2020, the Field Plumbing Related person. Under an accrual method of ment, or Company did some repair work at your place of accounting, you generally deduct expenses business and sent you a bill for $600. You paid when you incur them, even if you have not yet b. You pledge property (other than prop- it by check in January 2021. If you use the ac- paid them. However, if you and the person you erty used in the activity) as security for crual method of accounting, deduct the $600 on owe are related and that person uses the cash the loan. your tax return for 2020 because all events method of accounting, you must pay the ex- For more information, see Pub. 925. have occurred to “fix” the fact of liability (in this pense before you can deduct it. Your deduction case, the work was completed), the liability can is allowed when the amount is includible in

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income by the related cash method payee. For that your activity is not carried on for profit until $100, and the total of all casualty losses ex- more information, see Related Persons in Pub. 5 (or 7) years have passed since you started ceeds 10% of your adjusted 538. the activity. (AGI). See Pub. 547 for more information on The benefit gained by making this election is casualty losses. that the IRS will not immediately question Disaster tax relief. For personal casualty whether your activity is engaged in for profit. Not-for-Profit Activities losses resulting from federally declared disas- Accordingly, it will not restrict your deductions. ters that occurred before 2018, you may be en- Rather, you will gain time to earn a profit in the If you do not carry on your business or invest- titled to disaster tax relief. As a result, you may required number of years. If you show 3 (or 2) ment activity to make a profit, you cannot use a be required to figure your casualty loss differ- years of profit at the end of this period, your de- loss from the activity to offset other income. Ac- ently. For tax years beginning after 2017, casu- ductions are not limited under these rules. If you tivities you do as a hobby, or mainly for sport or alty and theft loss are allowed only to the extent do not have 3 (or 2) years of profit, the limit can recreation, are often not entered into for profit. it is attributable to a federally declared disaster. be applied retroactively to any year with a loss For more information, see Pub. 976, Disaster The limit on not-for-profit losses applies to in the 5-year (or 7-year) period. individuals, partnerships, estates, trusts, and S Relief. Filing Form 5213 automatically extends the corporations. It does not apply to corporations period of limitations on any year in the 5-year other than S corporations. Partnerships and S corporations. If a part- (or 7-year) period to 2 years after the due date nership or S corporation carries on a In determining whether you are carrying on of the tax return for the last year of the period. not-for-profit activity, these limits apply at the an activity for profit, several factors are taken The period is extended only for deductions of partnership or S corporation level. They are re- into account. No one factor alone is decisive. the activity and any related deductions that flected in the individual shareholder's or part- Among the factors to consider are whether: might be affected. ner's distributive shares. • You carry on the activity in a businesslike You must file Form 5213 within 3 years manner, TIP after the due date of your tax return More than one activity. If you have several • The time and effort you put into the activity (determined without extensions) for the undertakings, each may be a separate activity indicate you intend to make it profitable, year in which you first carried on the activity, or, or several undertakings may be combined. The • You depend on the income for your liveli- if earlier, within 60 days after receiving written following are the most significant facts and cir- hood, notice from the IRS proposing to disallow de- cumstances in making this determination. • Your losses are due to circumstances be- ductions attributable to the activity. • The degree of organizational and eco- yond your control (or are normal in the nomic interrelationship of various under- start-up phase of your type of business), takings. • You change your methods of operation in Gross Income • The business purpose that is (or might be) an attempt to improve profitability, served by carrying on the various under- • You (or your advisors) have the knowledge Gross income from a not-for-profit activity in- takings separately or together in a busi- needed to carry on the activity as a suc- cludes the total of all gains from the sale, ex- ness or investment setting. cessful business, change, or other disposition of property, and all • The similarity of the undertakings. • You were successful in making a profit in other gross receipts derived from the activity. similar activities in the past, The IRS will generally accept your charac- Gross income from the activity also includes • The activity makes a profit in some years, terization if it is supported by facts and circum- capital gains and rents received for the use of and stances. property that is held in connection with the ac- • You can expect to make a future profit from tivity. If you are carrying on two or more dif- the appreciation of the assets used in the ferent activities, keep the deductions activity. You can determine gross income from any and income from each one separate. not-for-profit activity by subtracting the cost of Figure separately whether each is a Presumption of profit. An activity is pre- goods sold from your gross receipts. However, not-for-profit activity. Then figure the limit on de- sumed carried on for profit if it produced a profit if you determine gross income by subtracting ductions and losses separately for each activity in at least 3 of the last 5 tax years, including the cost of goods sold from gross receipts, you that is not for profit. current year. Activities that consist primarily of must do so consistently, and in a manner that breeding, training, showing, or racing horses follows generally accepted methods of account- are presumed carried on for profit if they pro- ing. duced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year Limit on Deductions within this period. You have a profit when the You can no longer claim any miscella- gross income from an activity exceeds the de- neous itemized deductions. Miscella- 2. ductions. ! CAUTION neous itemized deductions are those If a taxpayer dies before the end of the deductions that would have been subject to the 5-year (or 7-year) period, the “test” period ends 2%-of-adjusted-gross-income limitation. You on the date of the taxpayer's . can still claim certain expenses as itemized de- Employees' Pay If your business or investment activity ductions on Schedule A (Form 1040). passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. This What's New means the limits discussed here will not apply. Deductions you can take for personal as well as You can take all your business deductions from for business activities are allowed in full. For in- Coronavirus (COVID-19) related employ- the activity, even for the years that you have a dividuals, all nonbusiness deductions, such as ment tax credits. loss. You can rely on this presumption unless those for home mortgage interest, taxes, and The Families First Coronavirus Response the IRS later shows it to be invalid. casualty losses, may also be deducted. Deduct • them on the appropriate lines of Schedule A Act (FFCRA), enacted on March 18, 2020, Using the presumption later. If you are start- (Form 1040). provides certain employers with tax credits ing an activity and do not have 3 (or 2) years that reimburse them for the cost of provid- For the limits that apply to home mortgage ing paid sick and family leave wages to showing a profit, you can elect to have the pre- interest, see Pub. 936. sumption made after you have the 5 (or 7) years their employees for leave related to COVID-19. The credit for qualified sick and of experience allowed by the test. Generally, you can deduct a casualty loss family leave wages is claimed on your You can elect to do this by filing Form 5213. on property you own for personal use only to 2020 employment tax return (typically Filing this form postpones any determination the extent each casualty loss is more than

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Form 941, Employer's QUARTERLY Fed- 15-A 15-A Employer's Supplemental Tax Guide Test 2—For Services eral Tax Return). You must include the full amount of the credits for qualified sick and 15-B 15-B Employer's Tax Guide to Fringe Performed family leave wages in your gross income. Benefits You must be able to prove the payment was For more information about the credit for Form (and Instructions) made for services actually performed. qualified sick and family leave wages, in-

cluding the dates for which the credit may 1099-NEC 1099-NEC Nonemployee Compensation Employee-shareholder . If a corpo- be claimed, see the instructions for your ration pays an employee who is also a share- W-2 W-2 and Tax Statement employment tax return and go to IRS.gov/ holder a that is unreasonably high con- PLC. See chapter 12 for information about getting sidering the services actually performed, the The Coronavirus Aid, Relief, and Eco- • publications and forms. excessive part of the salary may be treated as a nomic Security Act (CARES Act), enacted constructive to the employee-share- on March 27, 2020, provides eligible em- holder. The excessive part of the salary ployers with an employee retention tax Tests for Deducting Pay wouldn't be allowed as a salary deduction by credit if they keep employees on their pay- the corporation. For more information on corpo- roll, despite experiencing economic hard- rate distributions to shareholders, see Pub. 542. ship related to COVID-19. The employee To be deductible, your employees' pay must be retention credit is claimed on your 2020 an ordinary and necessary business expense employment tax return (typically Form and you must pay or incur it. These and other 941). You must reduce your deduction for requirements that apply to all business expen- Kinds of Pay wages by the amount of the employee re- ses are explained in chapter 1. tention credit. For more information about Some of the ways you may provide pay to your In addition, the pay must meet both of the the employee retention credit, including employees in addition to regular wages or salar- following tests. the dates for which the credit may be ies are discussed next. For specialized and de- • Test 1. It must be reasonable. claimed, see the instructions for your em- tailed information on employees' pay and the • Test 2. It must be for services performed. ployment tax return and go to IRS.gov/ employment tax treatment of employees' pay, ERC. The form or method of figuring the pay doesn't see Pubs. 15, 15-A, and 15-B. affect its deductibility. For example, bonuses For the latest guidance and information and commissions based on sales or earnings, about COVID-19 tax relief, go to IRS.gov/ Awards and paid under an agreement made before the Coronavirus. services were performed, are both deductible. You can generally deduct amounts you pay to your employees as awards, whether paid in Test 1—Reasonableness cash or property. If you give property to an em- Introduction ployee as an employee achievement award, You can generally deduct the amount you pay You must be able to prove that the pay is rea- your deduction may be limited. your employees for the services they perform. sonable. Whether the pay is reasonable de- The pay may be in cash, property, or services. It pends on the circumstances that existed when Achievement awards. An achievement award may include wages, salaries, bonuses, commis- you contracted for the services, not those that is an item of tangible personal property that sions, or other noncash compensation such as exist when reasonableness is questioned. If the meets all the following requirements. vacation allowances and fringe benefits. For in- pay is excessive, the excess pay is disallowed • It is given to an employee for length of formation about deducting employment taxes, as a deduction. service or safety achievement. see chapter 5. • It is awarded as part of a meaningful pre- Factors to consider. Determine the reasona- sentation. You may be able to claim employment bleness of pay by the facts and circumstances. • It is awarded under conditions and circum- TIP credits, such as the credits listed be- Generally, reasonable pay is the amount that a stances that don't create a significant likeli- low, if you meet certain requirements. similar business would pay for the same or simi- hood of disguised pay. You must reduce your deduction for employee lar services. wages by the amount of employment credits Tangible personal property. An award To determine if pay is reasonable, also con- that you claim. For more information about isn't an item of tangible personal property if it is sider the following items and any other pertinent these credits, see the form on which the credit an award of cash, cash equivalents, gift cards, facts. is claimed. gift coupons, or gift certificates (other than ar- • The duties performed by the employee. rangements granting only the right to select and • Work opportunity credit (Form 5884). • The volume of business handled. receive tangible personal property from a limi- • Empowerment zone employment credit • The character and amount of responsibil- ted assortment of items preselected or preap- (Form 8844). ity. proved by you). Also, tangible personal prop- • Indian employment credit (Form 8845). • The complexities of your business. erty doesn't include vacations, meals, lodging, • Credit for employer differential wage pay- • The amount of time required. tickets to theater or sporting events, stocks, ments (Form 8932). • The cost of living in the locality. bonds, other securities, and other similar items. • Employer credit for paid family and medi- • The ability and achievements of the indi- cal leave (Form 8994). vidual employee performing the service. Length-of-service award. An award will • The pay compared with the gross and net qualify as a length-of-service award only if ei- income of the business, as well as with dis- ther of the following applies. Topics tributions to shareholders if the business is • The employee receives the award after his This chapter discusses: a corporation. or her first 5 years of employment. • Your policy regarding pay for all your em- • The employee didn't receive another ployees. length-of-service award (other than one of • Tests for deducting pay • The history of pay for each employee. very small value) during the same year or • Kinds of pay in any of the prior 4 years. Compensation in excess of $1 million. Pub- Useful Items licly held corporations can't deduct compensa- Safety achievement award. An award for You may want to see: tion to a “covered employee” to the extent that safety achievement will qualify as an achieve- the compensation exceeds $1 million. For more ment award unless one of the following applies. Publication information, including the definition of a “cov- ered employee,” see the Instructions for Form

15 15 Employer's Tax Guide 1125-E and Regulations section 1.162-33.

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1. It is given to a manager, administrator, they are part of a qualified educational assis- primarily for the benefit of your employees clerical employee, or other professional tance program. Deduct them on the “Employee other than employees who are officers, employee. benefit programs” or other appropriate line of shareholders or other owners who own a your tax return. For information on educational 10% or greater interest in your business, or 2. During the tax year, more than 10% of assistance programs, see Educational Assis- other highly compensated employees. your employees, excluding those listed in tance in section 2 of Pub. 15-B. Meals you furnish to your employees at the (1), have already received a safety ach- • work site when you operate a restaurant or ievement award (other than one of very Section 2206 of the Coronavirus Aid, catering service. small value). Relief, and Economic Security Act • Meals you’re required by federal law to fur- (CARES Act) expands the definition of nish to crew members of certain commer- Deduction limit. Your deduction for the educational assistance to include certain em- cial vessels (or would be required to fur- cost of employee achievement awards given to ployer payments of student paid after nish if the vessels were operated at sea). any one employee during the tax year is limited March 27, 2020. The exclusion applies to the This doesn't include meals you furnish on to the following. payment by an employer, whether paid to the vessels primarily providing luxury water • $400 for awards that aren't qualified plan employee or to a lender, of principal or interest transportation. awards. on any qualified loan incurred by the • Meals you furnish on an oil or gas platform • $1,600 for all awards, whether or not quali- employee for the education of the employee. or drilling rig located offshore or in Alaska. fied plan awards. Qualified education loans are defined in chap- This includes meals you furnish at a sup- A qualified plan award is an achievement ter 11 of Pub. 970. This exclusion expires Janu- port camp that is near and integral to an oil award given as part of an established written ary 1, 2026, unless extended by future legisla- or gas drilling rig located in Alaska. plan or program that doesn't favor highly com- tion. pensated employees as to eligibility or benefits. P.L. 115-97, Tax Cuts and Act, A highly compensated employee is an em- ! changed the rules for the deduction of ployee who meets either of the following tests. Fringe Benefits CAUTION food or beverage expenses that are ex- cludable from employee income as a de mini- 1. The employee was a 5% owner at any A fringe benefit is a form of pay for the perform- mis fringe benefit. For amounts incurred or paid time during the year or the preceding year. ance of services. You can generally deduct the after 2017, the 50% limit on deductions for food 2. The employee received more than cost of fringe benefits. or beverage expenses also applies to food or $125,000 in pay for 2019. beverage expenses excludable from employee You may be able to exclude all or part of the income as a de minimis fringe benefit. While You can choose to ignore test (2) if the em- value of some fringe benefits from your employ- your business deduction may be limited, the ployee wasn't also in the top 20% of employees ees' pay. You also may not owe employment rules that allow you to exclude certain de mini- ranked by pay for the preceding year. taxes on the value of the fringe benefits. See mis meals and meals on your business prem- An award isn't a qualified plan award if the Table 2-1 in Pub. 15-B for details. ises from your employee's wages still apply. average cost of all the employee achievement See Meals in section 2 of Pub. 15-B. awards given during the tax year (that would be Generally, no deduction is allowed for activi- qualified plan awards except for this limit) is ties generally considered entertainment, Food and beverage expense incurred to- more than $400. To figure this average cost, ig- amusement, or recreation, or for a facility used gether with entertainment expenses. P.L. nore awards of nominal value. in connection with such activity. However, you 115-97 changed the rules for the deduction of may deduct these expenses if the goods, serv- Deduct achievement awards, up to the max- business entertainment expenses. For amounts ices, or facilities are treated as compensation to imum amounts listed earlier, as a nonwage incurred or paid after 2017, no business deduc- the recipient and reported on Form W-2 for an business expense on your return or business tion is allowed for any item generally consid- employee or on Form 1099-NEC for an inde- schedule. ered to be entertainment, amusement, or recre- pendent contractor. If the recipient is an officer, ation. As discussed earlier, you can deduct You may not owe employment taxes on director, beneficial owner (directly or indirectly), 50% of the cost of business meals. If food and TIP the value of some achievement awards or other “specified individual” (as defined in beverages are provided during or at an enter- you provide to an employee. See Pub. section 274(e)(2)(B) and Regulations section tainment activity, and the food and beverages 15-B. 1.274-9(b)), special rules apply. See section are purchased separately from the entertain- 274(e)(2) and Regulations sections 1.274-9 and ment, or the cost of the food and beverages is 1.274-10. Bonuses stated separately from the cost of the entertain- Certain fringe benefits are discussed next. ment on one or more bills, invoices, or receipts, You can generally deduct a bonus paid to an See Pub. 15-B for more details on these and you may continue to deduct 50% of the busi- employee if you intended the bonus as addi- other fringe benefits. ness meal expenses. The amount charged for tional pay for services, not as a gift, and the food or beverages on a bill, invoice, or receipt services were performed. However, the total Meals and lodging. Generally, you can de- must reflect the venue's usual selling cost for bonuses, salaries, and other pay must be rea- duct 50% of certain meal expenses and 100% those items if they were to be purchased sepa- sonable for the services performed. If the bonus of certain lodging expenses provided to your rately from the entertainment or must approxi- mate the reasonable value of those items. If you is paid in property, see Property, later. employees. If the amounts are deductible, de- duct the cost in whatever category the expense purchase food and beverages together with en- Gifts of nominal value. If, to promote em- falls. tertainment expenses and the cost of the food ployee , you distribute merchandise of and beverages isn't stated separately on the in- Deduction limit on meals. You can gen- nominal value or other de minimis items to your voice, the cost of the food and beverages is erally deduct only 50% of the cost of furnishing employees at holidays, you can deduct the cost also an entertainment expense and none of the meals to your employees. However, you can of these items as a nonwage business ex- expenses are deductible. For more information, deduct the full cost of certain meals; see sec- pense. See Pub. 15-B for additional information including details about additional requirements tion 274(n)(2) and Regulations section on de minimis fringe benefits. If you provide that must be met for a business meal to be de- 1.274-12(c) for more information. For example, food to your employees, your business deduc- ductible, see Regulations sections 1.274-11 you can deduct the full cost of the following tion may be limited; see Meals and lodging, and 1.274-12(a). meals. later. • Meals whose value you include in an em- Section 210 of the Taxpayer Certainty ployee's wages. and Disaster Tax Relief Act of 2020 Education Expenses • Meals you furnish to your employees as provides for the temporary allowance part of the expense of providing recrea- of a 100% business meal deduction for food or If you pay or reimburse education expenses for tional or social activities, such as holiday beverages provided by a restaurant and paid or an employee, you can deduct the payments if parties or annual picnics, when made

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incurred after December 31, 2020, and before are more than its qualified cost, carry the ex- to give up his or her rights in the property in the January 1, 2023. cess over to the next tax year. future. Generally, the fund's “qualified cost” is the Transportation (commuting) benefits. If total of the following amounts, reduced by the after-tax income of the fund. Reimbursements for you provide your employees with qualified Business Expenses transportation benefits, such as transportation • The cost you would’ve been able to deduct in a commuter highway vehicle, transit passes, using the cash method of accounting if you or qualified parking, you may no longer deduct had paid for the benefits directly. You can generally deduct the amount you pay these amounts. P.L. 115-97 provides that no • The contributions added to a reserve ac- or reimburse employees for business expenses deduction is allowed for qualified transportation count that are needed to fund claims incur- incurred for your business. However, your de- benefits (whether provided directly by you, red but not paid as of the end of the year. duction may be limited. through a bona fide reimbursement arrange- These claims can be for supplemental un- ment, or through a compensation reduction employment benefits, severance pay, or If you make the payment under an account- agreement) incurred or paid after 2017. Also, disability, medical, or life insurance bene- able plan, deduct it in the category of the ex- no deduction is allowed for any expense incur- fits. pense paid. For example, if you pay an em- red for providing any transportation, or any pay- For more information, see sections 419(c) ployee for travel expenses incurred on your ment or reimbursement to your employee, in and 419A and the related regulations. behalf, deduct this payment as a travel ex- connection with travel between your employee's pense. If you make the payment under a nonac- residence and place of employment, except as countable plan, deduct it as wages and include necessary for ensuring the safety of your em- Loans or Advances it on the employee's Form W-2. ployee or for qualified bicycle commuting reim- You can generally deduct as wages an advance See Reimbursement of Travel and Non-En- bursements as described in section 132(f)(5) you make to an employee for services to be tertainment Related Meals in chapter 11 for (F). While you may no longer deduct payments performed if you don't expect the employee to more information about deducting reimburse- for qualified transportation benefits, the fringe repay the advance. However, if the employee ments and an explanation of accountable and benefit exclusion rules still apply and the pay- performs no services, treat the amount you ad- nonaccountable plans. ments, except for qualified bicycle commuting vanced as a loan; if the employee doesn't repay reimbursements, may be excluded from your the loan, treat it as income to the employee. employee's wages. Although the value of a Sick and Vacation Pay qualified transportation fringe benefit is relevant Below-market loans. On cer- in determining the fringe benefit exclusion and Sick pay. You can deduct amounts you pay to tain loans you make to an employee or share- whether the section 274(e)(2) exception for ex- your employees for sickness and injury, includ- holder, you’re treated as having received inter- penses treated as compensation applies, the ing lump-sum amounts, as wages. However, est income and as having paid compensation or deduction that is disallowed relates to the ex- your deduction is limited to amounts not com- equal to that interest. See Be- pense of providing a qualified transportation pensated by insurance or other means. low-Market Loans in chapter 4. fringe, not its value. For more information, see Regulations sections 1.274-13 and 1.274-14. Vacation pay. Vacation pay is an employee See Pub. 15-B for more information about quali- Property benefit. It includes amounts paid for unused va- fied transportation benefits. cation leave. You can deduct vacation pay only If you transfer property (including your compa- in the tax year in which the employee actually Employee benefit programs. Employee ben- ny's stock) to an employee as payment for serv- receives it. This rule applies regardless of efit programs include the following. ices, you can generally deduct it as wages. The whether you use the cash or accrual method of • Accident and health plans. amount you can deduct is the property's fair accounting. • Adoption assistance. market value (FMV) on the date of the transfer • Cafeteria plans. less any amount the employee paid for the • Dependent care assistance. property. • Education assistance. • Life insurance coverage. You can claim the deduction only for the tax • Welfare benefit funds. year in which your employee includes the prop- erty's value in income. Your employee is You can generally deduct amounts you deemed to have included the value in income if 3. spend on employee benefit programs on the you report it on Form W-2 in a timely manner. applicable line of your tax return. For example, 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- Rent Expense duct your costs in whatever categories they fall ognize any gain or loss realized on the transfer, (utilities, salaries, etc.). unless it is the company's stock transferred as payment for services. Your gain or loss is the Life insurance coverage. You can't de- difference between the FMV of the property and Reminder duct the cost of life insurance coverage for you, its adjusted basis on the date of transfer. an employee, or any person with a financial in- Small business taxpayers. P.L. 115-97, Tax terest in your business if you’re directly or indi- These rules also apply to property transfer- Cuts and Jobs Act, made changes to uniform rectly the beneficiary of the policy. See Regula- red to an independent contractor for services, capitalization rules for small business taxpay- tions section 1.264-1 for more information. generally reported on Form 1099-NEC. ers. See Uniform capitalization rules, later.

Welfare benefit funds. A welfare benefit Restricted property. If the property you fund is a funded plan (or a funded arrangement transfer for services is subject to restrictions having the effect of a plan) that provides welfare that affect its value, you generally can't deduct it Introduction benefits to your employees, independent con- and don't report gain or loss until it is substan- This chapter discusses the tax treatment of rent tractors, or their beneficiaries. Welfare benefits tially vested in the recipient. However, if the re- or lease payments you make for property you are any benefits other than deferred compensa- cipient pays for the property, you must report use in your business but do not own. It also dis- tion or transfers of restricted property. any gain at the time of the transfer up to the cusses how to treat other kinds of payments Your deduction for contributions to a welfare amount paid. you make that are related to your use of this benefit fund is limited to the fund's qualified cost “Substantially vested” means the property property. These include payments you make for for the tax year. If your contributions to the fund isn't subject to a substantial risk of forfeiture. taxes on the property. This means that the recipient isn't likely to have

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Topics at a monthly rental rate of $1,000 beginning Leveraged leases. Leveraged lease trans- This chapter discusses: July 1, 2020. On June 30, 2020, you pay ad- actions may not be considered leases. Lever- vance rent of $12,000 for the last 6 months of aged leases generally involve three parties: a • The definition of rent 2020 and the first 6 months of 2021. You can lessor, a lessee, and a lender to the lessor. • Taxes on leased property deduct only $6,000 for 2020, for the right to use Usually, the lease term covers a large part of • The cost of getting a lease property in 2020. You deduct the other $6,000 the useful life of the leased property, and the • Improvements by the lessee in 2021. lessee's payments to the lessor are enough to • Capitalizing rent expenses cover the lessor's payments to the lender. Example 2. Assume the same facts as Ex- If you plan to take part in what appears to be ample 1, except you are a cash method calen- a leveraged lease, you may want to get an ad- Useful Items dar year taxpayer. You may deduct the entire vance ruling. You may want to see: $12,000 payment for 2020. The payment ap- • Revenue Procedure 2001-28 contains the plies to your right to use the property that does guidelines the IRS will use to determine if a Publication not extend beyond 12 months after the date you leveraged lease is a lease for federal in- received this right. If you deduct the $12,000 in come tax purposes.

538 538 Accounting Periods and Methods 2020, you should not deduct any part of this • Revenue Procedure 2001-29 provides the

544 544 Sales and Other Dispositions of payment in 2021. information required to be furnished in a Assets request for an advance ruling on a lever- Example 3. You are either a cash or ac- aged lease transaction.

946 946 How To Depreciate Property crual calendar year taxpayer. Last January, you These two revenue procedures can be found in leased property for 3 years for $6,000 per year. See chapter 12 for information about getting I.R.B. 2001-19, which is available at You pay the full $18,000 (3 x $6,000) during the publications and forms. IRS.gov/pub/irs-irbs/irb01-19.pdf. first year of the lease. Because this amount is a For advance ruling purposes only, the IRS prepaid expense that must be capitalized, you will consider the lessor in a leveraged lease can deduct only $6,000 per year, the amount al- transaction to be the owner of the property and Rent locable to your use of the property in each year. the transaction to be a valid lease if all the fac- tors in the revenue procedure are met, including Rent is any amount you pay for the use of prop- Canceling a lease. You can generally deduct the following. erty you do not own. In general, you can deduct as rent an amount you pay to cancel a business rent as an expense only if the rent is for prop- lease. • The lessor must maintain a minimum un- erty you use in your trade or business. If you conditional “at risk” investment in have or will receive equity in or title to the prop- Lease or purchase. There may be instances the property (at least 20% of the cost of the erty, the rent is not deductible. in which you must determine whether your pay- property) during the entire lease term. ments are for rent or for the purchase of the • The lessee may not have a contractual Unreasonable rent. You can’t take a rental property. You must first determine whether your right to buy the property from the lessor at deduction for unreasonable rent. Ordinarily, the agreement is a lease or a conditional sales con- less than FMV when the right is exercised. issue of reasonableness arises only if you and tract. Payments made under a conditional sales • The lessee may not invest in the property, the lessor are related. Rent paid to a related are not deductible as rent expense. except as provided by Revenue Procedure person is reasonable if it is the same amount 2001-28. you would pay to a stranger for use of the same Conditional sales contract. Whether an • The lessee may not lend any money to the property. Rent isn’t unreasonable just because agreement is a conditional sales contract de- lessor to buy the property or guarantee the it is figured as a percentage of gross sales. For pends on the intent of the parties. Determine in- loan used by the lessor to buy the prop- examples of related persons, see Related per- tent based on the provisions of the agreement erty. sons in chapter 2 of Pub. 544. and the facts and circumstances that exist • The lessor must show that it expects to re- when you make the agreement. No single test, ceive a profit apart from the tax deduc- Rent on your home. If you rent your home or special combination of tests, always applies. tions, allowances, credits, and other tax at- and use part of it as your place of business, you However, in general, an agreement may be tributes. may be able to deduct the rent you pay for that considered a conditional sales contract rather The IRS may charge you a user fee for issu- part. You must meet the requirements for busi- than a lease if any of the following is true. ing a tax ruling. For more information, see Rev- ness use of your home. For more information, • The agreement applies part of each pay- enue Procedure 2020-1, available at see Business use of your home in chapter 1. ment toward an equity interest you will re- IRS.gov/irb/2020-01_IRB#RP-2020-1. ceive. Rent paid in advance. Generally, rent paid for • You get title to the property after you make Leveraged leases of limited-use prop- use of property in your trade or business is de- a stated amount of required payments. erty. The IRS won’t issue advance rulings on ductible in the year paid or incurred. If you are • The amount you must pay to use the prop- leveraged leases of so-called limited-use prop- an accrual method taxpayer and pay rent in ad- erty for a short time is a large part of the erty. Limited-use property is property not ex- vance, you can deduct only the amount of rent amount you would pay to get title to the pected to be either useful to or usable by a les- that applies to your use of rented property dur- property. sor at the end of the lease term except for ing the tax year. You can deduct the rest of the • You pay much more than the current fair continued leasing or transfer to a lessee. See rent payment only over the period to which it rental value of the property. Revenue Procedure 2001-28 for examples of applies. If you are a cash method taxpayer, you • You have an option to buy the property at a limited-use property and property that isn’t limi- may deduct the entire amount of rent you paid nominal price compared to the value of the ted-use property. in advance in the year of payment if the pay- property when you may exercise the op- ment applies to the right to use property that tion. Determine this value when you make Leases over $250,000. Special rules are pro- does not extend beyond the earlier of 12 the agreement. vided for certain leases of tangible property. months after the first date you have the right to • You have an option to buy the property at a The rules apply if the lease calls for total pay- use the property or the end of the tax year fol- nominal price compared to the total ments of more than $250,000 and any of the fol- lowing the year in which you paid the advance amount you have to pay under the agree- lowing apply. rent. If your payment applies to the right to use ment. • Rents increase during the lease. property beyond this period, then you must cap- • The agreement designates part of the pay- • Rents decrease during the lease. italize the rent payment and deduct it over the ments as interest, or that part is easy to • Rents are deferred (rent is payable after period to which it applies. recognize as interest. the end of the calendar year following the calendar year in which the use occurs and Example 1. You are an accrual method the rent is allocated). calendar year taxpayer and you lease a building

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• Rents are prepaid (rent is payable before becomes liable for them. As a result, Oak will Example. You are a calendar year tax- the end of the calendar year preceding the deduct the real estate taxes as rent on its tax payer and sign a 20-year lease to rent part of a calendar year in which the use occurs and return for the earlier year. This is the year in building starting on January 1. However, before the rent is allocated). which Oak's liability under the lease becomes you occupy it, you decide that you really need These rules do not apply if your lease specifies fixed. less space. The lessor agrees to reduce your equal amounts of rent for each month in the rent from $7,000 to $6,000 per year and to re- lease term and all rent payments are due in the lease the excess space from the original lease. calendar year to which the rent relates (or in the Cost of Getting a Lease In exchange, you agree to pay an additional preceding or following calendar year). rent amount of $3,000, payable in 60 monthly installments of $50 each. Generally, if the special rules apply, you You may either enter into a new lease with the must use an accrual method of accounting (and lessor of the property or get an existing lease You must capitalize the $3,000 and amortize time value of money principles) for your rental from another lessee. Very often when you get it over the 20-year term of the lease. Your amor- expenses, regardless of your overall method of an existing lease from another lessee, you must tization deduction each year will be $150 accounting. In addition, in certain cases in pay the previous lessee money to get the lease, ($3,000 ÷ 20). You can’t deduct the $600 (12 × which the IRS has determined that a lease was besides having to pay the rent on the lease. $50) that you will pay during each of the first 5 designed to achieve , you must years as rent. take rent and stated or imputed interest into ac- If you get an existing lease on property or Commissions, bonuses, and fees. Commis- count under a constant rental accrual method in equipment for your business, you must gener- sions, bonuses, fees, and other amounts you which the rent is treated as accruing ratably ally amortize any amount you pay to get that pay to get a lease on property you use in your over the entire lease term. For details, see sec- lease over the remaining term of the lease. For business are capital costs. You must amortize tion 467. example, if you pay $10,000 to get a lease and there are 10 years remaining on the lease with these costs over the term of the lease. no option to renew, you can deduct $1,000 each year. Loss on merchandise and fixtures. If you Taxes on sell at a loss merchandise and fixtures that you Leased Property The cost of getting an existing lease of tan- bought solely to get a lease, the loss is a cost of 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 If you lease business property, you can deduct rules for section 197 intangibles discussed in lease. as additional rent any taxes you have to pay to chapter 8. or for the lessor. When you can deduct these taxes as additional rent depends on your ac- Option to renew. The term of the lease for counting method. amortization includes all renewal options plus Improvements any other period for which you and the lessor by Lessee Cash method. If you use the cash method of reasonably expect the lease to be renewed. accounting, you can deduct the taxes as addi- However, this applies only if less than 75% of If you add buildings or make other permanent tional rent only for the tax year in which you pay the cost of getting the lease is for the term re- improvements to leased property, depreciate them. maining on the purchase date (not including any period for which you may choose to renew, the cost of the improvements using the modified Accrual method. If you use an accrual extend, or continue the lease). Allocate the accelerated cost recovery system (MACRS). method of accounting, you can deduct the lease cost to the original term and any option Depreciate the property over its appropriate re- taxes as additional rent for the tax year in which term based on the facts and circumstances. In covery period. You can’t amortize the cost over you can determine all the following. some cases, it may be appropriate to make the the remaining term of the lease. allocation using a present value calculation. For • That you have a liability for taxes on the If you don’t keep the improvements when more information, see Regulations section leased property. you end the lease, figure your gain or loss 1.178-1(b)(5). • How much the liability is. based on your adjusted basis in the improve- • That economic performance occurred. ments at that time. Example 1. You paid $10,000 to get a The liability and amount of taxes are deter- lease with 20 years remaining on it and two op- For more information, see the discussion of mined by state or local law and the lease agree- tions to renew for 5 years each. Of this cost, MACRS in chapter 4 of Pub. 946. ment. Economic performance occurs as you you paid $7,000 for the original lease and use the property. $3,000 for the renewal options. Because Assignment of a lease. If a long-term lessee $7,000 is less than 75% of the total $10,000 who makes permanent improvements to land Example 1. Oak Corporation is a calendar cost of the lease (or $7,500), you must amortize later assigns all lease rights to you for money year taxpayer that uses an accrual method of the $10,000 over 30 years. That is the remain- and you pay the rent required by the lease, the accounting. Oak leases land for use in its busi- ing life of your present lease plus the periods for amount you pay for the assignment is a capital ness. Under state law, owners of real property renewal. investment. If the rental value of the leased land become liable (incur a lien on the property) for increased since the lease began, part of your real estate taxes for the year on January 1 of Example 2. The facts are the same as in capital investment is for that increase in the that year. However, they don’t have to pay Example 1, except that you paid $8,000 for the rental value. The rest is for your investment in these taxes until July 1 of the next year (18 original lease and $2,000 for the renewal op- the permanent improvements. months later) when tax bills are issued. Under tions. You can amortize the entire $10,000 over The part that is for the increased rental value the terms of the lease, Oak becomes liable for the 20-year remaining life of 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 The $8,000 cost of getting the original lease amortize it over the remaining term of the lease. tax bills are issued. If the lease ends before the was not less than 75% of the total cost of the You can depreciate the part that is for your in- tax bill for a year is issued, Oak isn’t liable for lease (or $7,500). vestment in the improvements over the recov- the taxes for that year. ery period of the property as discussed earlier, Oak cannot deduct the real estate taxes as Cost of a modification agreement. You may without regard to the lease term. rent until the tax bill is issued. This is when have to pay an additional “rent” amount over Oak's liability under the lease becomes fixed. part of the lease period to change certain provi- sions in your lease. You must capitalize these Example 2. The facts are the same as in payments and amortize them over the remain- Example 1, except that, according to the terms ing period of the lease. You can’t deduct the of the lease, Oak becomes liable for the real es- payments as additional rent, even if they are tate taxes when the owner of the property described as rent in the agreement.

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Allocate your interest expense to the follow- ing categories. Capitalizing • Nonpassive trade or business activity inter- Rent Expenses 4. est. • Passive trade or business activity interest. • Investment interest. Under the uniform capitalization rules, you must • Portfolio interest. capitalize the direct costs and part of the indi- Interest • Personal interest. rect costs for certain production or resale activi- ties. Include these costs in the basis of property In general, you allocate interest on a loan the you produce or acquire for resale, rather than same way you allocate the loan proceeds. You claiming them as a current deduction. You re- Introduction allocate loan proceeds by tracing disburse- cover the costs through depreciation, amortiza- This chapter discusses the tax treatment of ments to specific uses. tion, or cost of goods sold when you use, sell, business interest expense. Business interest The easiest way to trace disburse- or otherwise dispose of the property. expense is an amount charged for the use of TIP ments to specific uses is to keep the Indirect costs include amounts incurred for money you borrowed for business activities. proceeds of a particular loan separate renting or leasing equipment, facilities, or land. from any other funds. Topics Uniform capitalization rules. You may be This chapter discusses: . The allocation of loan proceeds subject to the uniform capitalization rules if you and the related interest is generally not affected do any of the following, unless the property is • Allocation of interest by the use of property that secures the loan. produced for your use other than in a business • Interest expense limitation or an activity carried on for profit. • Interest you can deduct Example. You secure a loan with property 1. Produce real property or tangible personal • Interest you cannot deduct used in your business. You use the loan pro- property. • Capitalization of interest ceeds to buy an automobile for personal use. • When to deduct interest You must allocate interest expense on the loan 2. Acquire property for resale. However, this • Below-market loans to personal use (purchase of the automobile) rule does not apply to personal property if even though the loan is secured by business your average annual gross receipts are property. $10 million or less. Useful Items You may want to see: P.L. 115-97, section 11043, limited the Effective for tax years beginning after 2017, ! deduction for mortgage interest paid on if you are a small business taxpayer (see Cost Publication CAUTION home equity loans and line of credit. of Goods Sold in chapter 1), you are not re- For more information, see Pub. 936. quired to capitalize costs under section 263A. 537 537 Installment Sales

See section 263A(i). 550 550 Investment Income and Expenses Allocation period. The period for which a loan

Producing property. You produce prop- 936 936 Home Mortgage Interest Deduction is allocated to a particular use begins on the erty if you construct, build, install, manufacture, date the proceeds are used and ends on the develop, improve, create, raise, or grow the Form (and Instructions) earlier of the following dates. property. Property produced for you under a • The date the loan is repaid. Schedule A (Form 1040) Schedule A (Form 1040) Itemized • The date the loan is reallocated to another contract is treated as produced by you to the Deductions extent you make payments or otherwise incur use. costs in connection with the property. Schedule E (Form 1040) Schedule E (Form 1040) Supplemental Income and Loss Proceeds not disbursed to borrower. Even Example 1. You rent construction equip- if the lender disburses the loan proceeds to a Schedule K-1 (Form 1065) Schedule K-1 (Form 1065) Partner's ment to build a storage facility. If you are sub- third party, the allocation of the loan is still Share of Income, based on your use of the funds. This applies ject to the uniform capitalization rules, you must Deductions, Credits, etc. capitalize as part of the cost of the building the whether you pay for property, services, or any- rent you paid for the equipment. You recover Schedule K-1 (Form 1120-S) Schedule K-1 (Form 1120-S) thing else by incurring a loan, or you take prop- your cost by claiming a deduction for deprecia- Shareholder's Share of Income, erty subject to a debt. tion on the building. Deductions, Credits, etc. Proceeds deposited in borrower's account.

1098 1098 Mortgage Interest Statement Example 2. You rent space in a facility to Treat loan proceeds deposited in an account as conduct your business of manufacturing tools. If 3115 3115 Application for Change in property held for investment. It does not matter you are subject to the uniform capitalization Accounting Method whether the account pays interest. Any interest rules, you must include the rent you paid to oc- you pay on the loan is investment interest ex- 4952 4952 Investment Interest Expense pense. If you withdraw the proceeds of the loan, cupy the facility in the cost of the tools you pro- Deduction duce. you must reallocate the loan based on the use

8582 8582 Passive Activity Loss Limitations of the funds. More information. For exceptions and more 8990 8990 Limitation on Business Interest Example. Celina, a calendar year taxpayer, information on these rules, see Uniform Capital- Expense Under Section 163(j) ization Rules in Pub. 538 and the regulations borrows $100,000 on January 4 and immedi- under section 263A. See chapter 12 for information about getting ately uses the proceeds to open a checking ac- publications and forms. count. No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. On April 2, Allocation of Interest Celina uses $20,000 from the checking account for a passive activity expenditure. On Septem- The rules for deducting interest vary, depending ber 4, Celina uses an additional $40,000 from on whether the loan proceeds are used for busi- the account for personal purposes. ness, personal, or investment activities. If you Under the interest allocation rules, the entire use the proceeds of a loan for more than one $100,000 loan is treated as property held for in- type of expense, you must allocate the interest vestment for the period from January 4 through based on the use of the loan's proceeds. April 1. From April 2 through September 3,

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Celina must treat $20,000 of the loan as used in the proceeds from which they are made) when 3. Passive activities in connection with a the passive activity and $80,000 of the loan as applying the rules stated earlier under Order of rental real estate activity in which you ac- property held for investment. From September funds spent. tively participate. 4 through December 31, she must treat If you received the loan proceeds in cash, 4. Former passive activities. $40,000 of the loan as used for personal purpo- you can treat the payment as made on the date ses, $20,000 as used in the passive activity, you received the cash instead of the date you 5. Trade or business use and expenses for and $40,000 as property held for investment. actually made the payment. certain low-income housing projects.

Order of funds spent. Generally, you treat Example. Giovanni gets a loan of $1,000 Line of credit (continuous borrowings). The loan proceeds deposited in an account as used on August 4 and receives the proceeds in cash. following rules apply if you have a line of credit (spent) before either of the following amounts. Giovanni deposits $1,500 in an account on Au- or similar arrangement. • Any unborrowed amounts held in the same gust 8 and on August 18 writes a check on the 1. Treat all borrowed funds on which interest account. account for a passive activity expense. Also, accrues at the same fixed or variable rate • Any amounts deposited after these loan Giovanni deposits his paycheck, deposits other as a single loan. proceeds. loan proceeds, and pays his bills during the same period. Regardless of these other trans- 2. Treat borrowed funds or parts of borrowed Example. On January 9, Olena opened a actions, Giovanni can treat $1,000 of the de- funds on which interest accrues at differ- checking account, depositing $500 of the pro- posit he made on August 8 as being paid on Au- ent fixed or variable rates as different ceeds of Loan A and $1,000 of unborrowed gust 4 from the loan proceeds. In addition, loans. Treat these loans as repaid in the funds. The following table shows the transac- Giovanni can treat the passive activity expense order shown on the loan agreement. tions in her account during the tax year. he paid on August 18 as made from the $1,000 loan proceeds treated as deposited in the ac- Loan refinancing. Allocate the replacement Date Transaction count. loan to the same uses to which the repaid loan was allocated. Make this allocation only to the January 9 $500 proceeds of Loan A and Optional method for determining date of $1,000 unborrowed funds extent you use the proceeds of the new loan to deposited reallocation. You can use the following repay any part of the original loan. method to determine the date loan proceeds January 14 $500 proceeds of Loan B are reallocated to another use. You can treat all deposited Debt-financed distribution. A debt-financed payments from loan proceeds in the account distribution occurs when a partnership or S cor- February 19 $800 used for personal purposes 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 • The first day of that month. shareholders. The manner in which you report June 19 $1,000 proceeds of Loan C • The date the loan proceeds are deposited deposited the interest expense associated with the distrib- in the account. uted debt proceeds depends on your use of November 20 $800 used for an investment However, you can use this optional method only those proceeds. December 18 $600 used for personal purposes if you treat all payments from the account dur- How to report. If the proceeds were used ing the same calendar month in the same way. Olena treats the $800 used for personal pur- 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 (i). 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 to determine the entirely from the proceeds of Loan C. She treats are from loan proceeds. amount of interest expense that can be repor- the $600 used for personal purposes as made ted on Schedule E (Form 1040), line 28; enter from the remaining $200 proceeds of Loan C Example. You borrowed $20,000 and used “interest expense” and the name of the partner- and $400 of unborrowed funds. the proceeds of this loan to open a new savings ship in column (a) and the amount in column For the periods during which loan proceeds account. When the account had earned interest (g). If the proceeds were used in an investment are held in the account, Olena treats them as of $867, you withdrew $20,000 for personal pur- activity, enter the interest on Form 4952. If the property held for investment. poses. You can treat the withdrawal as coming proceeds are used for personal purposes, the first from the interest earned on the account, interest is generally not deductible. Payments from checking accounts. $867, and then from the loan proceeds, Generally, you treat a payment from a checking $19,133 ($20,000 − $867). All the interest or similar account as made at the time the charged on the loan from the time it was depos- Interest Expense check is written if you mail or deliver it to the ited in the account until the time of the with- payee within a reasonable period after you write drawal is investment interest expense. The in- Limitation it. You can treat checks written on the same day terest charged on the part of the proceeds used as written in any order. for personal purposes ($19,133) from the time You must generally limit business interest ex- pense you pay or accrue during the tax year, Amounts paid within 30 days. If you re- you withdrew it until you either repay it or reallo- unless an exception to the limitation is met. ceive loan proceeds in cash or if the loan pro- cate it to another use is personal interest ex- pense. The interest charged on the loan pro- ceeds are deposited in an account, you can The business interest expense deduction al- treat any payment (up to the amount of the pro- ceeds you left in the account ($867) continues to be investment interest expense until you ei- lowed for a tax year is generally limited to the ceeds) made from any account you own, or sum of: from cash, as made from those proceeds. This ther repay it or reallocate it to another use. applies to any payment made within 30 days 1. Business interest income, Loan repayment. When you repay any part of before or after the proceeds are received in 2. 30% of the adjustable taxable income, and cash or deposited in your account. a loan allocated to more than one use, treat it as If the loan proceeds are deposited in an ac- being repaid in the following order. 3. Floor plan financing interest. count, you can apply this rule even if the rules 1. Personal use. If the section 163(j) limitation applies, gener- stated earlier under Order of funds spent would ally the amount of any business interest ex- otherwise require you to treat the proceeds as 2. and passive activities (other pense that is not allowed as a deduction under used for other purposes. If you apply this rule to than those included in (3)). section 163(j) for the tax year is carried forward any payments, disregard those payments (and to the following year as a disallowed business

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interest expense carryforward. See the Instruc- Interest on employment tax deficiency. In- To figure your deduction in any subsequent tions for Form 8990, Limitation on Business In- terest charged on employment taxes assessed year, follow the steps above, except determine terest Expense Under Section 163(j), for more on your business is deductible. the adjusted issue price in step 1. To get the information. adjusted issue price, add to the issue price any Original issue discount (OID). OID is a form OID previously deducted. Then follow steps 2 of interest. A loan (mortgage or other debt) gen- and 3 above. Interest You Can Deduct erally has OID when its proceeds are less than The yield to maturity is generally shown in its principal amount. The OID is the difference the literature you receive from your lender. If Your trade or business interest expense may be between the stated redemption price at maturity you do not have this information, consult your limited. See the Instructions for Form 8990 for and the issue price of the loan. lender or tax advisor. In general, the yield to more information. Interest relates to your trade A loan's stated redemption price at maturity maturity is the discount rate that, when used in or business if you use the proceeds of the loan is the sum of all amounts (principal and interest) figuring the present value of all principal and in- for a trade or business expense. It does not payable on it other than qualified stated inter- terest payments, produces an amount equal to matter what type of property secures the loan. est. Qualified stated interest is stated interest the principal amount of the loan. You can deduct interest on a debt only if you that is unconditionally payable in cash or prop- meet all the following requirements. erty (other than another loan of the issuer) at Example. The facts are the same as in the • You are legally liable for that debt. least annually over the term of the loan at a sin- previous example, except that you deduct the • Both you and the lender intend that the gle fixed rate. OID on a constant-yield basis over the term of the loan. The yield to maturity on your loan is debt be repaid. You generally deduct OID over the term of 10.2467%, compounded annually. For 2020, • You and the lender have a true the loan. Figure the amount to deduct each year you can deduct $93 [($98,500 × 0.102467) − debtor-creditor relationship. using the constant-yield method, unless the $10,000]. For 2021, you can deduct $103 OID on the loan is de minimis. Partial liability. If you are liable for part of a [($98,593 × 0.102467) − $10,000]. De minimis OID. The OID is de minimis if it business debt, only your share of the total inter- Loan or mortgage ends. If your loan or is less than one-fourth of 1% (0.0025) of the est paid or accrued is included in your interest mortgage ends, you may be able to deduct any stated redemption price of the loan at maturity limitation calculation. remaining OID in the tax year in which the loan multiplied by the number of full years from the or mortgage ends. A loan or mortgage may end date of original issue to maturity (the term of the Example. You and your brother borrow due to a refinancing, prepayment, foreclosure, loan). money. You are liable for 50% of the note. You or similar event. use your half of the loan in your business, and If the OID is de minimis, you can choose one you make one-half of the loan payments. Your of the following ways to figure the amount you If you refinance with the original lender, business interest is half of the total interest pay- can deduct each year. ! you generally cannot deduct the re- ments. However, the current year interest ex- • On a constant-yield basis over the term of CAUTION maining OID in the year in which the re- pense deduction may be limited. the loan. financing occurs, but you may be able to deduct • On a straight-line basis over the term of the it over the term of the new mortgage or loan. Mortgage. Generally, mortgage interest paid loan. See Interest paid with funds borrowed from or accrued on real estate you own legally or • In proportion to stated interest payments. original lender under Interest You Cannot De- equitably is deductible. However, rather than • In its entirety at maturity of the loan. duct, later. deducting the interest currently, you may have You make this choice by deducting the OID in a to add it to the cost basis of the property as ex- manner consistent with the method chosen on Points. The term “points” is used to describe plained later under Capitalization of Interest. your timely filed tax return for the tax year in certain charges paid, or treated as paid, by a Statement. If you paid $600 or more of which the loan is issued. borrower to obtain a loan or a mortgage. These mortgage interest (including certain points) dur- charges are also called loan origination fees, ing the year on any one mortgage, you will gen- Example. On January 1, 2020, you took out maximum loan charges, discount points, or pre- erally receive a Form 1098 or a similar state- a $100,000 discounted loan and received mium charges. If any of these charges (points) ment. You will receive the statement if you pay $98,500 in proceeds. The loan will mature on are solely for the use of money, they are inter- interest to a person (including a financial institu- January 1, 2030 (a 10-year term), and the est. tion or a housing corporation) in the $100,000 principal is payable on that date. In- Because points are prepaid interest, you course of that person's trade or business. A terest of $10,000 is payable on January 1 of generally cannot deduct the full amount in the governmental unit is a person for purposes of each year, beginning January 1, 2021. The year paid. However, you can choose to fully de- furnishing the statement. $1,500 OID on the loan is de minimis because it duct points in the year paid if you meet certain If you receive a refund of interest you over- is less than $2,500 ($100,000 × 0.0025 × 10). tests. For exceptions to the general rule, see paid in an earlier year, this amount will be repor- You choose to deduct the OID on a straight-line Pub. 936. ted in box 4 of Form 1098. You cannot deduct basis over the term of the loan. Beginning in this amount. For information on how to report 2020, you can deduct $150 each year for 10 The points reduce the issue price of the loan this refund, see Refunds of interest, later, in this years. and result in OID, deductible as explained in the preceding discussion. chapter. Constant-yield method. If the OID is not de minimis, you must use the constant-yield Expenses paid to obtain a mortgage. Partial payments on a nontax debt. If you method to figure how much you can deduct Certain expenses you pay to obtain a mortgage make partial payments on a debt (other than a each year. You figure your deduction for the first cannot be deducted as interest. These expen- debt owed to the IRS), the payments are ap- year using the following steps. ses, which include mortgage commissions, ab- plied, in general, first to interest and any re- stract fees, and recording fees, are capital ex- 1. Determine the issue price of the loan. mainder to principal. You can deduct only the penses. If the property mortgaged is business Generally, this equals the proceeds of the interest. This rule does not apply when it can be or income-producing property, you can amor- loan. If you paid points on the loan (as dis- inferred that the borrower and lender under- tize the costs over the life of the mortgage. cussed later), the issue price is generally stood that a different allocation of the payments the difference between the proceeds and would be made. Prepayment penalty. If you pay off your the points. mortgage early and pay the lender a penalty for Installment purchase. If you make an install- 2. Multiply the result in (1) by the yield to ma- doing this, you can deduct the penalty as inter- ment purchase of business property, the con- turity. est. tract between you and the seller generally pro- 3. Subtract any qualified stated interest pay- vides for the payment of interest. If no interest ments from the result in (2). This is the or a low rate of interest is charged under the OID you can deduct in the first year. contract, a portion of the stated principal

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amount payable under the contract may be re- life insurance, annuity, or endowment contract Carrying charges. Carrying charges include characterized as interest (unstated interest). that covers any individual unless that individual taxes you pay to carry or develop real estate or The amount recharacterized as interest reduces is a key person. to carry, transport, or install personal property. your basis in the property and increases your If the policy or contract covers a key person, You can choose to capitalize carrying charges interest expense. For more information on in- you can deduct the interest on up to $50,000 of not subject to the uniform capitalization rules if stallment sales and unstated interest, see Pub. debt for that person. However, the deduction for they are otherwise deductible. For more infor- 537. any month cannot be more than the interest fig- mation, see chapter 7. ured using Moody's Composite Yield on Seas- oned Corporate Bonds (formerly known as Capitalized interest. Treat capitalized interest Interest You Moody's Corporate Yield Aver- as a cost of the property produced. You recover age—Monthly Average Corporates) (Moody's your interest when you sell or use the property. Cannot Deduct rate) for that month. If the property is inventory, recover capitalized interest through cost of goods sold. If the prop- Certain interest payments cannot be deducted. Who is a key person? A “key person” is erty is used in your trade or business, recover In addition, certain other expenses that may an officer or 20% owner. However, the number capitalized interest through an adjustment to seem to be interest, but are not, cannot be de- of individuals you can treat as key persons is basis, depreciation, amortization, or other ducted as interest. limited to the greater of the following. method. • Five individuals. You cannot currently deduct interest that • The lesser of 5% of the total officers and Partnerships and S corporations. The inter- must be capitalized, and you generally cannot employees of the company or 20 individu- est capitalization rules are applied first at the deduct personal interest. als. partnership or S corporation level. The rules are then applied at the partners' or shareholders' Exceptions for pre-June 1997 . Interest paid with funds borrowed from level to the extent the partnership or S corpora- You can generally deduct the interest if the con- original lender. If you use the cash method of tion has insufficient debt to support the produc- tract was issued before June 9, 1997, and the accounting, you cannot deduct interest you pay tion or construction costs. covered individual is someone other than an with funds borrowed from the original lender employee, officer, or someone financially inter- If you are a partner or a shareholder, you through a second loan, an advance, or any may have to capitalize interest you incur during other arrangement similar to a loan. You can ested in your business. If the contract was pur- chased before June 21, 1986, you can gener- the tax year for the production costs of the part- deduct the interest expense once you start nership or S corporation. You may also have to making payments on the new loan. ally deduct the interest no matter who is covered by the contract. capitalize interest incurred by the partnership or When you make a payment on the new loan, S corporation for your own production costs. To you first apply the payment to interest and then Interest allocated to unborrowed policy properly capitalize interest under these rules, to the principal. All amounts you apply to the in- cash value. Corporations and partnerships you must be given the required information in terest on the first loan are deductible, along with generally cannot deduct any interest expense an attachment to the Schedule K-1 you receive any interest you pay on the second loan, sub- allocable to unborrowed cash values of life in- from the partnership or S corporation. ject to any limits that apply. surance, annuity, or endowment contracts. This rule applies to contracts issued after June 8, Additional information. The procedures for Capitalized interest. You cannot currently de- 1997, that cover someone other than an officer, applying the uniform capitalization rules are be- duct interest you are required to capitalize un- director, employee, or 20% owner. For more in- yond the scope of this publication. For more in- der the uniform capitalization rules. See Capi- formation, see section 264(f). formation, see Regulations sections 1.263A-8 talization of Interest, later. In addition, if you buy through 1.263A-15 and Notice 88-99, which is property and pay interest owed by the seller (for in Cumulative Bulletin 1988-2. example, by assuming the debt and any interest Capitalization of Interest accrued on the property), you cannot deduct the interest. Add this interest to the basis of the Under the uniform capitalization rules, you must When To Deduct Interest property. generally capitalize interest on debt equal to your expenditures to produce real property or If the uniform capitalization rules, discussed un- Commitment fees or standby charges. Fees certain tangible personal property. The property der Capitalization of Interest, earlier, and the you incur to have business funds available on a must be produced by you for use in your trade business interest expense deduction limitation standby basis, but not for the actual use of the or business or for sale to customers. You can- rules discussed under Interest Expense Limita- funds, are not deductible as interest payments. not capitalize interest related to property that tion, earlier, do not apply, deduct interest as fol- You may be able to deduct them as business you acquire in any other manner. lows. expenses. If the funds are for inventory or certain prop- Interest you paid or incurred during the pro- Cash method. Under the cash method, you erty used in your business, the fees are indirect duction period must be capitalized if the prop- can generally deduct only the interest you ac- costs and you must generally capitalize them erty produced is designated property. Designa- tually paid during the tax year. You cannot de- under the uniform capitalization rules. See Cap- ted property is any of the following. duct a you gave as payment italization of Interest, later. • Real property. because it is a promise to pay and not an actual • Tangible personal property with a class life payment. Interest on income tax. Interest charged on of 20 years or more. income tax assessed on your individual income • Tangible personal property with an estima- Prepaid interest. You generally cannot de- tax return is not a business deduction even ted production period of more than 2 duct any interest paid before the year it is due. though the tax due is related to income from years. Interest paid in advance can be deducted only your trade or business. Treat this interest as a • Tangible personal property with an estima- in the tax year in which it is due. business deduction only in figuring a net operat- ted production period of more than 1 year if ing loss deduction. Discounted loan. If interest or a discount the estimated cost of production is more is subtracted from your loan proceeds, it is not a Penalties. Penalties on underpaid deficien- than $1 million. payment of interest and you cannot deduct it cies and underpaid estimated tax are not inter- when you get the loan. For more information, est. You cannot deduct them. Generally, you Property you produce. You produce property see Original issue discount (OID) under Interest cannot deduct any fines or penalties. if you construct, build, install, manufacture, de- You Can Deduct, earlier. velop, improve, create, raise, or grow it. Treat Interest on loans with respect to life insur- property produced for you under a contract as Refunds of interest. If you pay interest ance policies. You generally cannot deduct produced by you up to the amount you pay or and then receive a refund in the same tax year interest on a debt incurred with respect to any incur for the property. of any part of the interest, reduce your interest

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deduction by the refund. If you receive the re- AFRs are published by the IRS each less. This exception applies only to the follow- fund in a later tax year, include the refund in TIP month in the Internal Revenue Bulletin ing. your income to the extent the deduction for the (I.R.B.), which is available on the IRS 1. Gift loans between individuals if the loan is interest reduced your tax. website at IRS.gov/IRB. You can also contact not directly used to buy or carry in- an IRS office to get these rates. come-producing assets. Accrual method. Under an accrual method, you can deduct only interest that has accrued Loans subject to the rules. The rules for be- 2. Compensation-related loans or corpora- during the tax year. low-market loans apply to the following. tion-shareholder loans if the avoidance of any federal tax is not a principal purpose Prepaid interest. You generally cannot de- 1. Gift loans (below-market loans where the of the interest arrangement. duct any interest paid before the year it is due. forgone interest is in the nature of a gift). Interest paid in advance can be deducted only This exception does not apply to a term loan in the tax year in which it is due. 2. Compensation-related loans (below-mar- described in (2) above that was previously sub- ket loans between an employer and an ject to the below-market loan rules. Those rules Discounted loan. If interest or a discount employee or between an independent will continue to apply even if the outstanding is subtracted from your loan proceeds, it is not a contractor and a person for whom the con- balance is reduced to $10,000 or less. payment of interest and you cannot deduct it tractor provides services). when you get the loan. For more information, 3. Corporation-shareholder loans. Exceptions for loans without significant tax see Original issue discount (OID) under Interest effect. The following loans are specifically ex- You Can Deduct, earlier. 4. Tax avoidance loans (below-market loans empted from the rules for below-market loans where the avoidance of federal tax is one Tax deficiency. If you contest a federal in- because their interest arrangements do not of the main purposes of the interest ar- come tax deficiency, interest does not accrue have a significant effect on the federal tax liabil- rangement). until the tax year the final determination of liabil- ity of the borrower or the lender. ity is made. If you do not contest the deficiency, 5. Loans to qualified continuing care facilities 1. Loans made available by lenders to the then the interest accrues in the year the tax was under a continuing care contract (made af- general public on the same terms and asserted and agreed to by you. ter October 11, 1985). conditions that are consistent with the However, if you contest but pay the pro- lender's customary business practices. posed tax deficiency and interest, and you do Except as noted in (5) above, these rules not designate the payment as a cash bond, apply to demand loans (loans payable in full at 2. Loans subsidized by a federal, state, or then the interest is deductible in the year paid. any time upon the lender's demand) outstand- municipal government that are made avail- ing after June 6, 1984, and to term loans (loans able under a program of general applica- Related person. If you use an accrual that are not demand loans) made after that tion to the public. method, you cannot deduct interest owed to a date. related person who uses the cash method until 3. Certain employee-relocation loans. payment is made and the interest is includible in Treatment of gift and demand loans. If you 4. Certain loans to or from a foreign person, the gross income of that person. The relation- receive a below-market gift loan or demand unless the interest income would be effec- ship is determined as of the end of the tax year loan, you are treated as receiving an additional tively connected with the conduct of a U.S. for which the interest would otherwise be de- payment (as a gift, dividend, etc.) equal to the trade or business and not exempt from ductible. See section 267 for more information. forgone interest on the loan. You are then trea- U.S. tax under an income . ted as transferring this amount back to the lender as interest. These transfers are consid- 5. Any other loan if the taxpayer can show Below-Market Loans ered to occur annually, generally on December that the interest arrangement has no sig- 31. If you use the loan proceeds in your trade or nificant effect on the federal tax liability of business, you can deduct the forgone interest the lender or the borrower. Whether an in- If you receive a below-market gift or demand terest arrangement has a significant effect loan and use the proceeds in your trade or busi- each year as a business interest expense. The lender must report it as interest income. on the federal tax liability of the lender or ness, you may be able to deduct the forgone in- the borrower will be determined by all the terest. See Treatment of gift and demand loans, Limit on forgone interest for gift loans of facts and circumstances. Consider all the later, in this discussion. $100,000 or less. For gift loans between indi- following factors. A “below-market loan” is a loan on which no viduals, forgone interest treated as transferred a. Whether items of income and deduc- interest is charged or on which interest is back to the lender is limited to the borrower's tion generated by the loan offset each charged at a rate below the applicable federal net investment income for the year. This limit other. rate (AFR). A gift or demand loan that is a be- applies if the outstanding loans between the low-market loan is generally considered an lender and borrower total $100,000 or less. If b. The amount of the items. arm's-length transaction in which you, the bor- the borrower's net investment income is $1,000 c. The cost of complying with the be- rower, are considered as having received both or less, it is treated as zero. This limit does not low-market loan provisions if they of the following. apply to a loan if the avoidance of any federal were to apply. • A loan in exchange for a note that requires tax is one of the main purposes of the interest the payment of interest at the AFR. arrangement. d. Any reasons, other than taxes, for • An additional payment in an amount equal structuring the transaction as a be- to the forgone interest. Treatment of term loans. If you receive a be- low-market loan. low-market term loan other than a gift or de- The additional payment is treated as a gift, divi- mand loan, you are treated as receiving an ad- Exception for loans to qualified continuing dend, contribution to capital, payment of com- ditional cash payment (as a dividend, etc.) on care facilities. The below-market interest pensation, or other payment, depending on the the date the loan is made. This payment is rules do not apply to a loan owed by a qualified substance of the transaction. equal to the loan amount minus the present continuing care facility under a continuing care value, at the AFR, of all payments due under Forgone interest. For any period, forgone in- contract if the lender or lender's spouse is age the loan. The same amount is treated as OID on terest is: 62 or older by the end of the calendar year. the loan. See Original issue discount (OID) un- 1. The interest that would be payable for that der Interest You Can Deduct, earlier. A qualified continuing care facility is one or period if interest accrued on the loan at the more facilities (excluding nursing homes) meet- AFR and was payable annually on De- Exceptions for loans of $10,000 or less. ing the requirements listed below. cember 31, minus The rules for below-market loans do not apply 1. Designed to provide services under con- 2. Any interest actually payable on the loan to any day on which the total outstanding loans tinuing care contracts (defined below). for the period. between the borrower and lender is $10,000 or

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2. Includes an independent living unit, and Topics Uniform capitalization rules. Uniform capital- either an assisted living or nursing facility, This chapter discusses: ization rules apply to certain taxpayers who pro- or both. duce real property or tangible personal property for use in a trade or business or for sale to cus- 3. Substantially all of the independent living • When to deduct taxes tomers. They also apply to certain taxpayers unit residents are covered by continuing • Real estate taxes who acquire property for resale. Under these care contracts. • Income taxes • Employment taxes rules, you either include certain costs in inven- A “continuing care contract” is a written con- • Other taxes tory or capitalize certain expenses related to the tract between an individual and a qualified con- property, such as taxes. For more information, see chapter 1. tinuing care facility that includes all of the fol- Useful Items lowing conditions. You may want to see: Carrying charges. Carrying charges include 1. The individual or individual's spouse must taxes you pay to carry or develop real estate or be entitled to use the facility for the rest of Publication to carry, transport, or install personal property. their life or lives. You can elect to capitalize carrying charges not

15 15 (Circular E), Employer's Tax Guide 2. The individual or individual's spouse will subject to the uniform capitalization rules if they

be provided with housing, as appropriate 334 334 Tax Guide for Small Business are otherwise deductible. For more information, for the health of the individual or individu- see chapter 7. 510 510 Taxes al's spouse in an:

538 538 Accounting Periods and Methods Refunds of taxes. If you receive a refund for a. Independent living unit (which has ad- any taxes you deducted in an earlier year, in- ditional available facilities outside the 551 551 Basis of Assets clude the refund in income to the extent the de- unit for the provision of meals and duction reduced your federal income tax in the Form (and Instructions) other personal care), and earlier year. For more information, see Recov-

b. Assisted living or nursing facility avail- 1040 or 1040-SR 1040 or 1040-SR U.S. Individual Income ery of amount deducted (tax benefit rule) in able in the continuing care facility. Tax Return chapter 1.

3. The individual or individual's spouse will Schedule A (Form 1040) Schedule A (Form 1040) Itemized You must include in income any inter- be provided with assisted living or nursing Deductions TIP est you receive on tax refunds. care available in the continuing care fa- Schedule SE (Form 1040) Schedule SE (Form 1040) cility, as required for the health of the indi- Self-Employment Tax vidual or the individual's spouse.

3115 3115 Application for Change in Real Estate Taxes For more information, see section 7872(h). Accounting Method Deductible real estate taxes are any state, local, Sale or exchange of property. Different rules 8959 8959 Additional Medicare Tax or foreign taxes on real estate levied for the generally apply to a loan connected with the See chapter 12 for information about getting general public welfare. The taxing authority sale or exchange of property. If the loan does publications and forms. must base the taxes on the assessed value of not provide adequate stated interest, part of the the real estate and charge them uniformly principal payment may be considered interest. against all property under its jurisdiction. De- However, there are exceptions that may require ductible real estate taxes generally do not in- you to apply the below-market interest rate When To Deduct Taxes clude taxes charged for local benefits and im- rules to these loans. See Unstated Interest and provements that increase the value of the Original Issue Discount (OID) in Pub. 537. Generally, you can only deduct taxes in the year you pay them. This applies whether you property. See Taxes for local benefits, later. use the cash method or an accrual method of More information. For more information on If you use an accrual method, you generally accounting. below-market loans, see section 7872 and Reg- cannot accrue real estate taxes until you pay ulations section 1.7872-5. Under an accrual method, you can deduct a them to the government authority. However, tax before you pay it if you meet the exception you can elect to ratably accrue the taxes during for recurring items discussed under Economic the year. See Electing to ratably accrue, later. Performance in Pub. 538. You can also elect to ratably accrue real estate taxes as discussed Taxes for local benefits. Generally, you can- later under Real Estate Taxes. See also Foreign not deduct taxes charged for local benefits and income taxes, discussed later. improvements that tend to increase the value of 5. your property. These include assessments for Limit on accrual of taxes. A taxing jurisdic- streets, sidewalks, water mains, sewer lines, tion can require the use of a date for accruing and public parking facilities. You should in- taxes that is earlier than the date it originally re- crease the basis of your property by the amount Taxes quired. However, if you use an accrual method, of the assessment. and can deduct the tax before you pay it, use You can deduct taxes for these local bene- the original accrual date for the year of change fits only if the taxes are for maintenance, re- and all future years to determine when you can pairs, or interest charges related to those bene- Introduction deduct the tax. fits. If part of the tax is for maintenance, repairs, You can deduct various federal, state, local, or interest, you must be able to show how much and foreign taxes directly attributable to your Example. Your state imposes a tax on per- of the tax is for these expenses to claim a de- trade or business as business expenses. sonal property used in a trade or business con- duction for that part of the tax. ducted in the state. This tax is assessed and You cannot deduct federal income becomes a lien as of July 1 (accrual date). In Example. To improve downtown commer- ! taxes, estate and gift taxes, or state in- 2020, the state changed the assessment and cial business, Waterfront City converted a CAUTION heritance, legacy, and succession lien dates from July 1, 2021, to December 31, downtown business area street into an en- taxes. 2020, for property tax year 2021. Use the origi- closed pedestrian mall. The city assessed the nal accrual date (July 1, 2021) to determine full cost of construction, financed with 10-year when you can deduct the tax. You must also bonds, against the affected properties. The city use the July 1 accrual date for all future years to is paying the principal and interest with the an- determine when you can deduct the tax. nual payments made by the property owners.

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The assessments for construction costs are • The period to which the taxes relate. The filing of an income tax return is not not deductible as taxes or as business expen- • The calculation of the real estate tax de- TIP considered a contest and, in the ab- ses, but are depreciable capital expenses. The duction for that first year. sence of an overt act of protest, you part of the payments used to pay the interest Generally, you must file your return by the can deduct the tax in the prior year. Also, you charges on the bonds is deductible as taxes. due date (including extensions). However, if can deduct any additional taxes in the prior year you timely filed your return for the year without if you do not show some affirmative evidence of Charges for services. Water bills, sewerage, electing to ratably accrue, you can still make the denial of the liability. and other service charges assessed against election by filing an amended return within 6 However, if you consistently deduct addi- your business property are not real estate months after the due date of the return (exclud- tional assessments in the year they are paid or taxes, but are deductible as business expen- ing extensions). Attach the statement to the finally determined (including those for which ses. amended return and write “Filed pursuant to there was no contest), you must continue to do section 301.9100-2” on the statement. File the so. You cannot take a deduction in the earlier Purchase or sale of real estate. If real estate amended return at the same address where you year unless you receive permission to change is sold, the real estate taxes must be allocated filed the original return. your method of accounting. For more informa- between the buyer and the seller. tion on accounting methods, see When Can I The buyer and seller must allocate the real Form 3115. If you elect to ratably accrue Deduct an Expense in chapter 1. estate taxes according to the number of days in real estate taxes for a year after the first year in the real property tax year (the period to which which you incur real estate taxes, or if you want Foreign income taxes. Generally, you can the tax imposed relates) that each owned the to revoke your election to ratably accrue real take either a deduction or a credit for income property. Treat the seller as paying the taxes up estate taxes, file Form 3115. For more informa- taxes imposed on you by a foreign country or a to but not including the date of sale. Treat the tion, including applicable time frames for filing, U.S. possession, subject to limitations. How- buyer as paying the taxes beginning with the see the Instructions for Form 3115. ever, an individual cannot take a deduction or date of sale. You can usually find this informa- credit for foreign income taxes paid on income tion on the settlement statement you received at that is exempt from U.S. tax under the foreign closing. Income Taxes earned income exclusion or the foreign housing If you (the seller) use an accrual method and exclusion. For information on these exclusions, have not elected to ratably accrue real estate This section discusses federal, state, local, and see Pub. 54. For information on the foreign tax taxes, you are considered to have accrued your foreign income taxes. credit, see Pub. 514. part of the tax on the date you sell the property. Federal income taxes. You cannot deduct Accrual of foreign income taxes. If you Example. Alberto Verde, a calendar year federal income taxes. use an accrual method and choose to take a accrual method taxpayer, owns real estate in deduction (rather than a credit) for foreign in- Olmo County. He has not elected to ratably ac- State and local income taxes. A corporation come taxes, you can deduct the taxes in the crue property taxes. November 30 of each year or partnership can deduct state and local in- year in which the fact of the liability becomes is the assessment and lien date for the current come taxes imposed on the corporation or part- fixed and the amount of the liability can be de- real property tax year, which is the calendar nership as business expenses. termined with reasonable accuracy. Generally, year. He sold the property on June 30, 2020. An individual can deduct state and local in- this is the year with or within which the tax year Under his accounting method, he would not be come taxes only as an itemized deduction on that applies for foreign tax purposes ends or, in able to claim a deduction for the taxes because Schedule A (Form 1040), subject to limitations. the case of a contested tax, the year in which the sale occurred before November 30. He is The deduction is limited to $10,000 as a total of the contest is resolved. Different rules may ap- treated as having accrued his part of the tax, the following taxes. ply to determine when a foreign income tax is 181/365 (January 1–June 29), on June 30, and considered to accrue for purposes of the for- he can deduct it for 2020. 1. State and local income taxes or general eign . For more information on the for- sales taxes. See the Schedule A (Form eign tax credit, see Pub. 514. Electing to ratably accrue. If you use an ac- 1040) instructions. crual method, you can elect to accrue real es- 2. State and local real estate taxes. See the tate tax related to a definite period ratably over Schedule A (Form 1040) instructions. Employment Taxes that period. 3. State and local personal property taxes. If you have employees, you must withhold vari- Example. Juan Sanchez is a calendar year However, an individual can deduct a state ous taxes from your employees' pay. Most em- taxpayer who uses an accrual method. His real tax on gross income (as distinguished from net ployers must withhold their employees' share of estate taxes for the real property tax year, July income) directly attributable to a trade or busi- social security, Medicare taxes, and Additional 1, 2020, to June 30, 2021, are $1,200. July 1 is ness as a business expense. Medicare Tax (if applicable), along with state the assessment and lien date. and federal income taxes. You may also need If Juan elects to ratably accrue the taxes, Accrual of contested income taxes. If to pay certain employment taxes from your own 6 $600 will accrue in 2020 ($1,200 × /12, July 1– you use an accrual method, and you contest a funds. These include your share of social secur- December 31) and the balance will accrue in state or local income tax liability, you must ac- ity and Medicare taxes as an employer, along 2021. crue and deduct any contested amount in the with taxes. tax year in which the liability is finally deter- Separate elections. You can elect to rata- mined. Your deduction for wages paid is not re- bly accrue the taxes for each separate trade or If additional state or local income taxes for a duced by the social security and Medicare business and for nonbusiness activities if you prior year are assessed in a later year, you can taxes, Additional Medicare Tax, and income account for them separately. Once you elect to deduct the taxes in the year in which they were taxes you withhold from your employees. You ratably accrue real estate taxes, you must use originally imposed (the prior year) if the tax lia- can deduct the employment taxes you must pay that method unless you get permission from the bility is not contested. You cannot deduct them from your own funds as taxes. IRS to change. See Form 3115, later. in the year in which the liability is finally deter- Making the election. If you elect to ratably mined. Example. You pay your employee $18,000 accrue the taxes for the first year in which you a year. However, after you withhold various incur real estate taxes, attach a statement to taxes, your employee receives $14,500. You your income tax return for that year. The state- also pay an additional $1,500 in employment ment should show all the following items. taxes. You should deduct the full $18,000 as • The trades or businesses to which the wages. You can deduct the $1,500 you pay election applies and the accounting from your own funds as taxes. method or methods used.

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Additional Medicare Tax. You must withhold Sales tax. Any sales tax you pay on a service Form (and Instructions) a 0.9% Additional Medicare Tax from wages for your business, or on the purchase or use of

1040 1040 U.S. Individual Income Tax Return you pay to an employee in excess of $200,000 property in your business is treated as part of

in a calendar year. The Additional Medicare Tax the cost of the service or property. If the service 1040-NR 1040-NR U.S. Nonresident Alien Income is only imposed on the employee. There is no or the cost or use of the property is a deductible Tax Return employer share of Additional Medicare Tax. business expense, you can deduct the tax as

Schedule 1 (Form 1040) Schedule 1 (Form 1040) Additional part of that service or cost. If the property is For more information on the Additional Med- Income and Adjustments to Income icare Tax, see Form 8959 and its instructions. merchandise bought for resale, the sales tax is

part of the cost of the merchandise. If the prop- Schedule A (Form 1040) Schedule A (Form 1040) Itemized For more information on employment erty is depreciable, add the sales tax to the ba- Deductions TIP taxes, see Pub. 15 (Circular E). sis for depreciation. For more information on

Schedule C (Form 1040) Schedule C (Form 1040) Profit or Loss basis, see Pub. 551. From Business Unemployment fund taxes. As an employer, Do not deduct state and local sales Schedule F (Form 1040) Schedule F (Form 1040) Profit or Loss taxes imposed on the buyer that you you may have to make payments to a state un- ! From Farming employment compensation fund or to a state CAUTION must collect and pay over to the state disability benefit fund. Deduct these payments or local government. Also, do not include these Schedule SE (Form 1040) Schedule SE (Form 1040) as taxes. taxes in gross receipts or sales. Self-Employment Tax

Schedule K-1 (Form 1065) Schedule K-1 (Form 1065) Partner's Self-employment tax. You can deduct part of Share of Income, Deductions, your self-employment tax as a business ex- Credits, etc. pense in figuring your adjusted gross income.

This deduction only affects your income tax. It 1099-H 1099-H Health Coverage Tax Credit does not affect your net earnings from self-em- (HCTC) Advance Payments ployment or your self-employment tax. 2555 2555 Foreign Earned Income To deduct the tax, enter on Schedule 1 6.

(Form 1040), line 14, the amount shown on the 8885 8885 Health Coverage Tax Credit Deduction for one-half of self-employment tax W-2 W-2 Wage and Tax Statement line of Schedule SE (Form 1040). Insurance For more information on self-employment See chapter 12 for information about getting tax, see Pub. 334. publications and forms. Additional Medicare Tax. You may be re- quired to pay Additional Medicare Tax on Reminder self-employment income. See Form 8959 and Deductible Premiums the Instructions for Form 8959 for more informa- Premium tax credit. You may have to use the tion on the Additional Medicare Tax. worksheets in Pub. 974 instead of the work- You generally can deduct premiums you pay for sheet in this chapter. Use the worksheets in the following kinds of insurance related to your Pub. 974 if the insurance plan established, or trade or business. considered to be established, under your busi- Other Taxes 1. Insurance that covers fire, storm, theft, ac- ness was obtained through the Health Insur- cident, or similar losses. The following are other taxes you can deduct if ance Marketplace and you are claiming the pre- you incur them in the ordinary course of your mium tax credit. See Pub. 974 for details. 2. Credit insurance that covers losses from trade or business. business bad debts. 3. Group hospitalization and medical insur- Excise taxes. Generally, you can deduct as a Introduction ance for employees, including long-term business expense all excise taxes that are ordi- care insurance. nary and necessary expenses of carrying on You generally can deduct the ordinary and nec- your trade or business. However, see Fuel essary cost of insurance as a business expense a. If a partnership pays accident and taxes, later. if it is for your trade, business, or profession. premiums for its However, you may have to capitalize certain in- For more information on excise taxes, see partners, it generally can deduct them surance costs under the uniform capitalization Pub. 510. as guaranteed payments to partners. rules. For more information, see Capitalized Premiums, later. b. If an S corporation pays accident and Franchise taxes. You can deduct corporate health insurance premiums for its franchise taxes as a business expense. more-than-2% shareholder-employ- Topics ees, it generally can deduct them, but Fuel taxes. Generally, taxes on gasoline, die- This chapter discusses: also must include them in the share- sel fuel, and other motor fuels that you use in holder's wages subject to federal in- your business are included as part of the cost of • Deductible premiums come . See Pub.15-B. the fuel. Do not deduct these taxes as a sepa- • Nondeductible premiums 4. . rate item. • Capitalized premiums You may be entitled to a credit or refund for • When to deduct premiums 5. Malpractice insurance that covers your federal excise tax you paid on fuels used for personal liability for professional negli- certain purposes. For more information, see Useful Items gence resulting in injury or damage to pa- Pub. 510. You may want to see: tients or clients. Occupational taxes. You can deduct as a 6. Workers' compensation insurance set by business expense an occupational tax charged Publication state law that covers any claims for bodily at a flat rate by a locality for the privilege of injuries or -related diseases suffered by 15-B 15-B Employer's Tax Guide to Fringe working or conducting a business in the locality. employees in your business, regardless of Benefits fault.

Personal property tax. You can deduct any 525 525 Taxable and Nontaxable Income a. If a partnership pays workers' com- tax imposed by a state or local government on pensation premiums for its partners, it 538 538 Accounting Periods and Methods personal property used in your trade or busi- generally can deduct them as ness. 547 547 Casualties, Disasters, and Thefts guaranteed payments to partners.

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b. If an S corporation pays workers' • You used one of the optional methods to Take the deduction for self-employed health compensation premiums for its figure your net earnings from self-employ- insurance on Schedule 1 (Form 1040), line 16. more-than-2% shareholder-employ- ment on Schedule SE. ees, it generally can deduct them, but • You received wages in 2020 from an S cor- Qualified long-term care insurance. You also must include them in the share- poration in which you were a can include premiums paid on a qualified holder's wages. more-than-2% shareholder. Health insur- long-term care insurance contract when figuring ance premiums paid or reimbursed by the your deduction. But, for each person covered, 7. Contributions to a state unemployment in- S corporation are shown as wages on you can include only the smaller of the following surance fund are deductible as taxes if Form W-2. amounts. they are considered taxes under state law. 1. The amount paid for that person. 8. Overhead insurance that pays for busi- The insurance plan must be established, or ness overhead expenses you have during considered to be established as discussed in 2. The amount shown below. Use the per- long periods of disability caused by your the following bullets, under your business. son's age at the end of the tax year. injury or sickness. • For self-employed individuals filing a Schedule C (Form 1040) or F (Form 1040), a. Age 40 or younger–$430 9. Car and other that cov- a policy can be either in the name of the b. Age 41 to 50–$810 ers vehicles used in your business for lia- business or in the name of the individual. bility, damages, and other losses. If you • For partners, a policy can be either in the c. Age 51 to 60–$1,630 operate a vehicle partly for personal use, name of the partnership or in the name of d. Age 61 to 70–$4,350 deduct only the part of the insurance pre- the partner. You can either pay the premi- mium that applies to the business use of ums yourself or the partnership can pay e. Age 71 or older–$5,430 the vehicle. If you use the standard mile- them and report the premium amounts on Qualified long-term care insurance con- age rate to figure your car expenses, you Schedule K-1 (Form 1065) as guaranteed tract. A qualified long-term care insurance can’t deduct any car insurance premiums. payments to be included in your gross in- contract is an insurance contract that only pro- come. However, if the policy is in your 10. Life insurance covering your officers and vides coverage of qualified long-term care serv- name and you pay the premiums yourself, employees if you aren’t directly or indi- ices. The contract must meet all the following the partnership must reimburse you and rectly a beneficiary under the contract. requirements. report the premium amounts on Sched- • It must be guaranteed renewable. 11. Business interruption insurance that pays ule K-1 (Form 1065) as guaranteed pay- • It must provide that refunds, other than re- for lost profits if your business is shut ments to be included in your gross income. funds on the death of the insured or com- down due to a fire or other cause. Otherwise, the insurance plan won’t be plete surrender or of the con- considered to be established under your tract, and dividends under the contract business. Self-Employed Health may be used only to reduce future premi- For more-than-2% shareholders, a policy Insurance Deduction • ums or increase future benefits. can be either in the name of the S corpora- • It must not provide for a cash surrender tion or in the name of the shareholder. You You may be able to deduct the amount you paid value or other money that can be paid, as- can either pay the premiums yourself or for medical and dental insurance and qualified signed, pledged, or borrowed. the S corporation can pay them and report long-term care insurance for yourself, your • It generally must not pay or reimburse ex- the premium amounts on Form W-2 as wa- spouse, and your dependents. The health insur- penses incurred for services or items that ges to be included in your gross income. ance can cover your child who was under age would be reimbursed under Medicare, ex- However, if the policy is in your name and 27 at the end of 2020, even if the child wasn’t cept where Medicare is a secondary payer you pay the premiums yourself, the S cor- your dependent. A child includes your son, or the contract makes per diem or other poration must reimburse you and report daughter, stepchild, adopted child, or foster periodic payments without regard to ex- the premium amounts on Form W-2 in child. A foster child is any child placed with you penses. by an authorized placement agency or by judg- box 1 as wages to be included in your ment, decree, or other order of any court of gross income. Otherwise, the insurance Qualified long-term care services. Quali- competent jurisdiction. plan won’t be considered to be established fied long-term care services are: under your business. • Necessary diagnostic, preventive, thera- One of the following statements must be peutic, curing, treating, mitigating, and re- true. Medicare premiums you voluntarily pay to habilitative services; and You were self-employed and had a net obtain insurance in your name that is similar to • • Maintenance or personal care services. profit for the year reported on Schedule C qualifying private health insurance can be used (Form 1040) or Schedule F (Form 1040). to figure the deduction. Amounts paid for health The services must be required by a chronically • You were a partner with net earnings from insurance coverage from plan distri- ill individual and prescribed by a licensed health self-employment for the year reported on butions that were nontaxable because you are a care practitioner. Schedule K-1 (Form 1065), box 14, code retired public safety officer can’t be used to fig- A. ure the deduction.

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Worksheet 6-A. Self-Employed Health Insurance Deduction Worksheet Keep for Your Records Caution. You may have to use the worksheets in Pub. 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 Pub. 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 2020 for health insurance coverage established under your business (or the S corporation in which you were a more-than-2% shareholder) for 2020 for you, your spouse, and your dependents. Your insurance also can cover your child who was under age 27 at the end of 2020, even if the child was not your dependent. But don’t 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 2020. • Any amounts paid from retirement plan distributions that were nontaxable because you are a retired public safety officer. • Any qualified health insurance coverage payments that you included on Form 8885, line 4, to claim the HCTC or on Form 14095 to receive a reimbursement of the HCTC during the year. • Any advance monthly payments of the HCTC that your health plan administrator received from the IRS, as shown on Form 1099-H. • Any qualified health insurance coverage payments you paid for eligible coverage months for which you received the benefit of the HCTC monthly advance payment program. • Any payments for qualified long-term care insurance (see line 2) ...... 1. 2. For coverage under a qualified long-term 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. $430— if that person is age 40 or younger $810— if age 41 to 50 $1,630— if age 51 to 60 $4,350— if age 61 to 70 $5,430— if age 71 or older Don’t include payments for any month you were eligible to participate in a long-term care insurance 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 2020. 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. Don’t include Conservation Reserve Program payments exempt from self-employment 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 F (Form 1040), line 34; or Schedule K-1 (Form 1065), box 14, code A; plus any other income allocable to the profitable businesses. Don’t include Conservation Reserve Program payments exempt from self-employment tax. See the Instructions for Schedule SE (Form 1040). Don’t include any net losses shown on these schedules ...... 5. 6. Divide line 4 by line 5 ...... 6. 7. Multiply Schedule 1 (Form 1040), line 14 by the percentage on line 6 ...... 7. 8. Subtract line 7 from line 4 ...... 8. 9. Enter the amount, if any, from Schedule 1 (Form 1040), line 15 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 W-2, box 5) from an S corporation in which you are a more-than-2% 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 ...... 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 Schedule 1 (Form 1040), line 16. Don’t 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 self-employment from any business, don’t enter your net profit from the business. Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Part I, line 4b. * * Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it doesn’t include capital gain income.

Chronically ill individual. A chronically ill living are eating, toileting, transferring The certification must have been made by a li- individual is a person who has been certified as (general mobility), bathing, dressing, and censed health care practitioner within the previ- one of the following. continence. ous 12 months. • An individual who has been unable, due to • An individual who requires substantial su- loss of functional capacity for at least 90 pervision to be protected from threats to Benefits received. For information on ex- days, to perform at least two activities of health and safety due to severe cognitive cluding benefits you receive from a long-term daily living without substantial assistance impairment. care contract from gross income, see Pub. 525. from another individual. Activities of daily

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Other coverage. You can’t take the deduction More than one health plan and business. loan, you can't deduct the premiums as a for any month you were eligible to participate in If you have more than one health plan during business expense. Nor can you deduct any employer (including your spouse's) subsi- the year and each plan is established under a the premiums as interest on business dized health plan at any time during that month, different business, you must use separate work- loans or as an expense of financing loans. even if you didn’t actually participate. In addi- sheets (Worksheet 6-A) to figure each plan's In the event of death, the proceeds of the tion, if you were eligible for any month or part of net earnings limit. Include the premium you paid policy are generally not taxed as income a month to participate in any subsidized health under each plan on line 1 or line 2 of that sepa- even if they are used to liquidate the debt. plan maintained by the employer of either your rate worksheet and your net profit (or wages) dependent or your child who was under age 27 from that business on line 4 (or line 11). For a at the end of 2020, don’t use amounts paid for plan that provides long-term care insurance, the Capitalized Premiums coverage for that month to figure the deduction. total of the amounts entered for each person on line 2 of all worksheets can’t be more than the These rules are applied separately to plans Under the uniform capitalization rules, you must appropriate limit shown on line 2 for that per- that provide long-term care insurance and plans capitalize the direct costs and part of the indi- son. that don’t provide long-term care insurance. rect costs for certain production or resale activi- However, any medical insurance payments not ties. Include these costs in the basis of property deductible on Schedule 1 (Form 1040), line 16, you produce or acquire for resale, rather than can be included as medical expenses on Nondeductible claiming them as a current deduction. You re- Schedule A (Form 1040), if you itemize deduc- Premiums cover the costs through depreciation, amortiza- tions. tion, or cost of goods sold when you use, sell, or otherwise dispose of the property. Effect on itemized deductions. Subtract the You can’t deduct premiums on the following health insurance deduction from your medical kinds of insurance. Indirect costs include premiums for insur- insurance when figuring medical expenses on 1. Self-insurance reserve funds. You can’t ance on your plant or facility, machinery, equip- Schedule A (Form 1040) if you itemize deduc- deduct amounts credited to a reserve set ment, materials, property produced, or property tions. up for self-insurance. This applies even if acquired for resale. you can’t get business insurance cover- Effect on self-employment tax. You can’t Uniform capitalization rules. You may be age for certain business risks. However, subtract the self-employed health insurance de- subject to the uniform capitalization rules if you your actual losses may be deductible. See duction when figuring net earnings for your do any of the following, unless the property is Pub. 547. self-employment tax from the business under produced for your use other than in a business which the insurance plan is established, or con- 2. Loss of earnings. You can’t deduct premi- or an activity carried on for profit. sidered to be established, as discussed earlier. ums for a policy that pays for lost earnings 1. Produce real property or tangible personal For more information, see Schedule SE (Form due to sickness or disability. However, see property. For this purpose, tangible per- 1040). the discussion on overhead insurance, sonal property includes a film, sound re- item (8), under Deductible Premiums, ear- cording, video tape, book, or similar prop- How to figure the deduction. Generally, you lier. erty. can use the worksheet in the Form 1040 or 3. Certain life insurance and annuities. 1040-SR instructions to figure your deduction. 2. Acquire property for resale. However, if any of the following apply, you must a. For contracts issued before June 9, use Worksheet 6-A in this chapter. 1997, you can’t deduct the premiums However, these rules don't apply to the follow- • You had more than one source of income on a life covering ing property. subject to self-employment tax. you, an employee, or any person with 1. Personal property you acquire for resale if • You file Form 2555. a financial interest in your business if your average annual gross receipts are • You are using amounts paid for qualified you are directly or indirectly a benefi- $26 million or less for the 3 prior tax years. long-term care insurance to figure the de- ciary of the policy. You are included duction. among possible beneficiaries of the 2. Property you produce if you meet either of policy if the policy owner is obligated the following conditions. If you are claiming the HCTC, complete to repay a loan from you using the Form 8885 before you figure this deduction. a. Your indirect costs of producing the proceeds of the policy. A person has property are $200,000 or less. Health coverage tax credit. You may a financial interest in your business if elect to take this credit only if you were an eligi- the person is an owner or part owner b. You use the cash method of account- ble trade adjustment assistance (TAA) recipi- of the business or has lent money to ing and don't account for inventories. ent, alternative TAA (ATAA) recipient, reem- the business. ployment trade adjustment assistance (RTAA) More information. For more information on b. For contracts issued after June 8, recipient, or Benefit Guaranty Corpora- these rules, see Uniform Capitalization Rules in 1997, you generally can’t deduct the tion (PBGC) pension recipient. Use Form 8885 Pub. 538 and the regulations under section premiums on any life insurance policy, to figure the amount, if any, of this credit. When 263A. endowment contract, or annuity con- figuring the amount to enter on line 1 of Work- tract if you are directly or indirectly a sheet 6-A, don’t include any amounts you inclu- beneficiary. The disallowance applies ded on Form 8885, line 4. When To Deduct without regard to whom the policy There is coordination of tax benefits be- covers. Premiums tween advance monthly payments of the HCTC and the HCTC. In general, you can’t claim the c. Partners. If, as a partner in a partner- You can usually deduct insurance premiums in HCTC for a payment you made for qualifying ship, you take out an insurance policy the tax year to which they apply. health insurance when you file your tax return if on your own life and name your part- you previously received the benefit of the ad- ners as beneficiaries to induce them Cash method. If you use the cash method of vance monthly payment program for that cover- to retain their investments in the part- accounting, you generally deduct insurance age month. If you benefited from the advance nership, you are considered a benefi- premiums in the tax year you actually paid monthly payment program, you will receive a ciary. You can't deduct the insurance them, even if you incurred them in an earlier Form 1099-H that reports the amount of the premiums. year. However, see Prepayment, later. payments that were forwarded directly to your 4. Insurance to secure a loan. If you take out health plan administrator for each coverage a policy on your life or on the life of an- Accrual method. If you use an accrual month. Don’t report these amounts on Form other person with a financial interest in method of accounting, you can't deduct insur- 8885. your business to get or protect a business ance premiums before the tax year in which you

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incur a liability for them. In addition, you can't If you capitalize a cost, you may be able to each type of carrying charge. Your election is deduct insurance premiums before the tax year recover it over a period of years through peri- good for only 1 year for unimproved and unpro- in which you actually pay them (unless the ex- odic deductions for amortization, depletion, or ductive real property. You must decide whether ception for recurring items applies). For more depreciation. When you capitalize a cost, you to capitalize carrying charges each year the information about the accrual method of ac- add it to the basis of property to which it relates. property remains unimproved and unproduc- counting, see chapter 1. For information about A partnership, corporation, estate, or trust tive. For other real property, your election to the exception for recurring items, see Pub. 538. makes the election to deduct or capitalize the capitalize carrying charges remains in effect un- costs discussed in this chapter except for ex- til construction or development is completed. Prepayment. You can't deduct expenses in ploration costs for mineral deposits. Each indi- For personal property, your election is effective advance, even if you pay them in advance. This vidual partner, shareholder, or beneficiary until the date you install or first use it, whichever rule applies to any expense paid far enough in elects whether to deduct or capitalize explora- is later. advance to, in effect, create an asset with a tion costs. useful life extending substantially beyond the How to make the election. To make the elec- end of the current tax year. Individuals, estates, and trusts may be tion to capitalize a carrying charge, attach a subject to AMT if they deduct certain Expenses such as insurance are generally ! statement to your original tax return for the year CAUTION research and experimental, intangible allocable to a period of time. You can deduct in- the election is to be effective indicating which drilling, exploration, development, circulation, or surance expenses for the year to which they are charges you are electing to capitalize. However, business organizational costs. allocable. if you timely filed your return for the year without For more information on the AMT, see the making the election, you can still make the elec- Example. In 2020, you signed a 3-year in- Instructions for Form 6251 and the Instructions tion by filing an amended return within 6 months surance contract. Even though you paid the for Schedule I (Form 1041). of the due date of the return (excluding exten- premiums for 2020, 2021, and 2022 when you sions). Attach the statement to the amended re- signed the contract, you can only deduct the Topics turn and write “Filed pursuant to section premium for 2020 on your 2020 tax return. You This chapter discusses: 301.9100-2” on the statement. File the amen- can deduct in 2021 and 2022 the premium allo- ded return at the same address you filed the cable to those years. original return. • Carrying charges Dividends received. If you receive dividends • Research and experimental costs • Intangible drilling costs from business insurance and you deducted the Research and premiums in prior years, at least part of the divi- • Exploration costs dends generally are income. For more informa- • Development costs Experimental Costs tion, see Recovery of amount deducted (tax • Circulation costs benefit rule) in chapter 1 under How Much Can I • Business start-up and organizational costs The costs of research and experimentation are Deduct. • Reforestation costs generally capital expenses. However, you can • Retired asset removal costs elect to deduct these costs as a current busi- • Barrier removal costs ness expense. Your election to deduct these • Film and television production costs costs is binding for the year it is made and for • Repair and maintenance costs all later years unless you get IRS approval to make a change. Useful Items You may want to see: If you meet certain requirements, you may 7. elect to defer and amortize research and exper- imental costs. For information on electing to de- Publication fer and amortize these costs, see Research and

544 544 Sales and Other Dispositions of Experimental Costs in chapter 8. Costs You Can Assets Research and experimental costs defined. Deduct or Form (and Instructions) Research and experimental costs are reasona-

Schedule C (Form 1040) Schedule C (Form 1040) Profit or Loss ble costs you incur in your trade or business for From Business activities intended to provide information that Capitalize would eliminate uncertainty about the develop-

3468 3468 Investment Credit ment or improvement of a product. Uncertainty

6765 6765 Credit for Increasing Research exists if the information available to you does What’s New Activities not establish how to develop or improve a prod- uct or the appropriate design of a product. 8826 8826 Disabled Access Credit Whether costs qualify as research and experi- Film, television, and live theatrical produc- T (Timber) T (Timber) Forest Activities Schedule mental costs depends on the nature of the ac- tion costs. The election to expense certain See chapter 12 for information about getting tivity to which the costs relate rather than on the costs of qualified film, television, and live theat- publications and forms. nature of the product or improvement being de- rical productions has been extended to include veloped or the level of technological advance- costs of productions that begin after December ment. 31, 2020, and before January 1, 2026. See Film, Television, and Live Theatrical Production Carrying Charges The costs of obtaining a patent, including at- Costs, later. torneys' fees paid or incurred in making and Carrying charges include the taxes and interest perfecting a patent application, are research you pay to carry or develop real property or to and experimental costs. However, costs paid or Introduction carry, transport, or install personal property. incurred to obtain another's patent are not re- Certain carrying charges must be capitalized search and experimental costs. This chapter discusses costs you can elect to under the uniform capitalization rules. (For infor- Product. The term “product” includes any deduct or capitalize. mation on capitalization of interest, see chap- of the following items. You generally deduct a cost as a current ter 4.) You can elect to capitalize carrying • Formula. business expense by subtracting it from your in- charges not subject to the uniform capitalization • Invention. come in either the year you incur it or the year rules, but only if they are otherwise deductible. • Patent. you pay it. You can elect to capitalize carrying charges • Pilot model. separately for each project you have and for • Process.

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• Technique. You can elect to deduct only the costs of ure depletion or depreciation. If you do not • Property similar to the items listed above. items with no salvage value. These include wa- make this election, you can deduct the costs It also includes products used by you in your ges, fuel, repairs, hauling, and supplies related over the 10-year period beginning with the tax trade or business or held for sale, lease, or li- to drilling wells and preparing them for produc- year in which you paid or incurred them. These cense. tion. Your cost for any drilling or development rules do not apply to a nonproductive well. work done by contractors under any form of Costs not included. Research and experi- contract is also an IDC. However, see Amounts mental costs do not include expenses for any of paid to contractor that must be capitalized, Exploration Costs the following activities. later. • Advertising or promotions. The costs of determining the existence, loca- You can also elect to deduct the cost of drill- • Consumer surveys. tion, extent, or quality of any mineral deposit are ing exploratory bore holes to determine the lo- • Efficiency surveys. ordinarily capital expenditures if the costs lead cation and delineation of offshore hydrocarbon • Management studies. to the development of a mine. You recover deposits if the shaft is capable of conducting • Quality control testing. these costs through depletion as the mineral is hydrocarbons to the surface on completion. It • Research in connection with literary, his- removed from the ground. However, you can does not matter whether there is any intent to torical, or similar projects. elect to deduct domestic exploration costs paid produce hydrocarbons. • The acquisition of another's patent, model, or incurred before the beginning of the develop- production, or process. If you do not elect to deduct your IDCs as a ment of the mine (except those for oil and gas wells). When and how to elect. You make the elec- current business expense, you can elect to de- tion to deduct research and experimental costs duct them over the 60-month period beginning with the month they were paid or incurred. How to make the election. You elect to de- by deducting them on your tax return for the duct exploration costs by taking the deduction year in which you first pay or incur research and Amounts paid to contractor that must be on your income tax return, or on an amended experimental costs. If you do not make the elec- capitalized. Amounts paid to a contractor income tax return, for the first tax year for which tion to deduct research and experimental costs must be capitalized if they are either: you wish to deduct the costs paid or incurred in the first year in which you pay or incur the Amounts properly allocable to the cost of during the tax year. Your return must ade- costs, you can deduct the costs in a later year • depreciable property, or quately describe and identify each property or only with approval from the IRS. • Amounts paid only out of production or mine, and clearly state how much is being de- ducted for each one. The election applies to the Research credit. If you pay or incur qualified proceeds from production if these amounts are depletable income to the recipient. tax year you make this election and all later tax research expenses, you may be able to take the years. research credit. For more information, see Form How to make the election. You elect to de- 6765 and its instructions. Partnerships and S corporations. Each duct IDCs as a current business expense by partner, not the partnership, elects whether to tax credit. The credit is an taking the deduction on your income tax return capitalize or to deduct that partner's share of annual election made by a qualified small busi- for the first tax year you have eligible costs. No exploration costs. Each shareholder, not the S ness specifying the amount of research credit, formal statement is required. If you file Sched- corporation, elects whether to capitalize or to not to exceed $250,000, that may be used ule C (Form 1040), enter these costs under deduct that shareholder's share of exploration against the employer portion of social security “Other expenses.” costs. liability. The credit is the smallest of the current For oil and gas wells, your election is bind- year research credit, an elected amount not to ing for the year it is made and for all later years. Reduced corporate deductions for explora- exceed $250,000, or the general business For geothermal wells, your election can be re- tion costs. A corporation (other than an S cor- credit carryforward for the tax year (before the voked by the filing of an amended return on poration) can deduct only 70% of its domestic application of the payroll tax credit election for which you do not take the deduction. You can exploration costs. It must capitalize the remain- the tax year). The election must be made on or file the amended return for the year up to the ing 30% of costs and amortize them over the before the due date of the originally filed return normal time of expiration for filing a claim for 60-month period starting with the month the ex- (including extensions). An election cannot be credit or refund, generally, within 3 years after ploration costs are paid or incurred. A corpora- made for a tax year if an election was made for the date you filed the original return or within 2 tion may also elect to capitalize and amortize 5 or more preceding tax years. The election years after the date you paid the tax, whichever exploration costs over a 10-year period. made by a partnership or S corporation is made is later. For more information on this method of amorti- at the entity level. zation, see section 59(e). Energy credit for costs of geothermal wells. A qualified small business that elects to The 30% that the corporation capitalizes If you capitalize the drilling and development claim the payroll tax credit will claim the payroll cannot be added to its basis in the property to costs of geothermal wells that you place in serv- tax credit against the employer's portion of so- figure cost depletion. However, the amount ice during the tax year, you may be able to cial security tax on its employment tax return for amortized is treated as additional depreciation claim a business energy credit. See the Instruc- the first quarter that begins after it files the re- and is subject to recapture as ordinary income tions for Form 3468 for more information. turn reflecting the payroll tax election. For more on a disposition of the property. See Section information, see the Instructions for Form 6765. 1250 Property under Depreciation Recapture in Nonproductive well. If you capitalize your chapter 3 of Pub. 544. IDCs, you have another option if the well is non- These rules also apply to the deduction of productive. You can deduct the IDCs of the development costs by corporations. See Devel- Intangible Drilling Costs nonproductive well as an ordinary loss. You opment Costs, later. must indicate and clearly state your election on The costs of developing oil, gas, or geothermal your tax return for the year the well is comple- Recapture of exploration expenses. When wells are ordinarily capital expenditures. You ted. Once made, the election for oil and gas your mine reaches the producing stage, you can usually recover them through depreciation wells is binding for all later years. You can re- must recapture any exploration costs you elec- or depletion. However, you can elect to deduct voke your election for a geothermal well by filing ted to deduct. Use either of the following meth- intangible drilling costs (IDCs) as a current busi- an amended return that does not claim the loss. ness expense. These are certain drilling and ods. development costs for wells in the United Costs incurred outside the . Method 1—Include the deducted costs in States in which you hold an operating or work- You cannot deduct as a current business ex- gross income for the tax year the mine rea- ing interest. You can deduct only costs for drill- pense all the IDCs paid or incurred for an oil, ches the producing stage. Your election ing or preparing a well for the production of oil, gas, or geothermal well located outside the Uni- must be clearly indicated on the return. In- gas, or geothermal steam or hot water. ted States. However, you can elect to include crease your adjusted basis in the mine by the costs in the adjusted basis of the well to fig- the amount included in income. Generally,

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you must elect this recapture method by This election applies each tax year to expenses the due date (including extensions) of your paid or incurred in that year. Once made, the return. However, if you timely filed your re- election is binding for the year and cannot be Business Start-up and turn for the year without making the elec- revoked for any reason. Organizational Costs tion, you can still make the election by filing an amended return within 6 months of the How to make the election. The election to Business start-up and organizational costs are due date of the return (excluding exten- deduct development costs ratably as the ores generally capital expenditures. However, you sions). Make the election on your amended or minerals are sold must be made for each can elect to deduct up to $5,000 of business return and write “Filed pursuant to section mine or other natural deposit by a clear indica- start-up and $5,000 of organizational costs paid 301.9100-2” on the form where you are in- tion on your return or by a statement filed with or incurred after October 22, 2004. The $5,000 cluding the income. File the amended re- the IRS office where you file your return. Gener- deduction is reduced by the amount your total turn at the same address you filed the origi- ally, you must make the election by the due start-up or organizational costs exceed nal return. date of the return (including extensions). How- $50,000. Any remaining costs must be amor- Method 2—Do not claim any depletion de- ever, if you timely filed your return for the year tized. For information about amortizing start-up duction for the tax year the mine reaches without making the election, you can still make and organizational costs, see chapter 8. the producing stage and any later tax years the election by filing an amended return within 6 until the depletion you would have deduc- months of the due date of the return (excluding Start-up costs include any amounts paid or ted equals the exploration costs you de- extensions). Clearly indicate the election on incurred in connection with creating an active ducted. your amended return and write “Filed pursuant trade or business or investigating the creation You must also recapture deducted explora- to section 301.9100-2.” File the amended return or acquisition of an active trade or business. Or- tion costs if you receive a bonus or royalty from at the same address you filed the original re- ganizational costs include the costs of creating mine property before it reaches the producing turn. a corporation or partnership. stage. Do not claim any depletion deduction for the tax year you receive the bonus or royalty Foreign development costs. The rules dis- How to make the election. You elect to de- and any later tax years until the depletion you cussed earlier for Foreign exploration costs ap- duct the start-up or organizational costs by would have deducted equals the exploration ply to foreign development costs. claiming the deduction on your income tax re- costs you deducted. turn (filed by the due date including extensions) Reduced corporate deductions for develop- for the tax year in which the active trade or busi- Generally, if you dispose of the mine before ment costs. The rules discussed earlier for ness begins. For costs paid or incurred after you have fully recaptured the exploration costs Reduced corporate deductions for exploration September 8, 2008, you are not required to at- you deducted, recapture the balance by treating costs also apply to corporate deductions for de- tach a statement to your return to elect to de- all or part of your gain as ordinary income. Un- velopment costs. duct such costs. However, for start-up or organ- der these circumstances, you generally treat as izational costs paid or incurred before ordinary income all of your gain if it is less than September 9, 2008, you may be required to at- your adjusted exploration costs with respect to tach a statement to your return to elect to de- the mine. If your gain is more than your adjusted Circulation Costs duct such costs. If you timely filed your return exploration costs, treat as ordinary income only for the year without making the election, you a part of your gain, up to the amount of your ad- A publisher can deduct as a current business can still make the election by filing an amended justed exploration costs. expense the costs of establishing, maintaining, or increasing the circulation of a newspaper, return within 6 months of the due date of the re- Foreign exploration costs. If you pay or incur magazine, or other periodical. For example, a turn (excluding extensions). Clearly indicate the exploration costs for a mine or other natural de- publisher can deduct the cost of hiring extra election on your amended return and write posit located outside the United States, you employees for a limited time to get new sub- “Filed pursuant to section 301.9100-2.” cannot deduct all the costs in the current year. scriptions through telephone calls. Circulation File the amended return at the same ad- You can elect to include the costs (other than costs may be deducted even if they would nor- dress you filed the original return. The election for an oil, gas, or geothermal well) in the adjus- mally be capitalized. applies when figuring taxable income for the ted basis of the mineral property to figure cost current tax year and all subsequent years. Once This rule does not apply to the following made, the election is irrevocable. For more in- depletion. (Cost depletion is discussed in chap- costs that must be capitalized. ter 9.) If you do not make this election, you must formation on start-up and organizational costs, • The purchase of land or depreciable prop- see chapter 8. deduct the costs over the 10-year period begin- erty. ning with the tax year in which you pay or incur • The acquisition of circulation through the them. These rules also apply to foreign devel- purchase of any part of the business of an- opment costs. other publisher of a newspaper, magazine, Reforestation Costs or other periodical, including the purchase of another publisher's list of subscribers. Reforestation costs are generally capital expen- Development Costs ditures. However, you can elect to deduct up to Other treatment of circulation costs. If you $10,000 ($5,000 if married filing separately; $0 You can deduct costs paid or incurred during do not want to deduct circulation costs as a cur- for a trust) of qualifying reforestation costs paid the tax year for developing a mine or any other rent business expense, you can elect one of the or incurred after October 22, 2004, for each natural deposit (other than an oil or gas well) lo- following ways to recover these costs. qualified timber property. The remaining costs cated in the United States. These costs must be • Capitalize all circulation costs that are can be amortized over an 84-month period. For paid or incurred after the discovery of ores or properly chargeable to a capital account information about amortizing reforestation minerals in commercially marketable quantities. (see chapter 1). costs, see chapter 8. Development costs also include depreciation • Amortize circulation costs over the 3-year Qualifying reforestation costs are the direct on improvements used in the development of period beginning with the tax year they costs of planting or seeding for forestation or re- ores or minerals and costs incurred for you by a were paid or incurred. forestation. Qualified timber property is property contractor. Development costs do not include that contains trees in significant commercial the costs for the acquisition or improvement of How to make the election. You elect to capi- quantities. See chapter 8 for more information depreciable property. talize circulation costs by attaching a statement on qualifying reforestation costs and qualified to your return for the first tax year the election timber property. Instead of deducting development costs in applies. Your election is binding for the year it is the year paid or incurred, you can elect to treat made and for all later years, unless you get IRS If you elect to deduct qualified reforestation the costs as deferred expenses and deduct approval to revoke it. costs, create and maintain separate timber ac- them ratably as the units of produced ores or counts for each qualified timber property and in- minerals benefited by the expenses are sold. clude all reforestation costs and the dates each

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was applied. Do not include this qualified timber railroad car, that provides transportation service • Signage. property in any account (for example, depletion to the public (including service for your custom- • Alarms. block) for which depletion is allowed. ers, even if you are not in the business of pro- • Protruding objects. viding transportation services). • Symbols of accessibility. How to make the election. You elect to de- You cannot deduct any costs that you paid You can find the ADA guidelines and require- duct qualifying reforestation costs by claiming or incurred to completely renovate or build a fa- ments for architectural barrier removal at the deduction on your timely filed income tax re- cility or public transportation vehicle or to re- USDOJ.gov/crt/ada/reg3a.html. turn (including extensions) for the tax year the place depreciable property in the normal course The costs for removal of transportation barri- expenses were paid or incurred. If Form T (Tim- of business. ers from rail facilities, buses, and rapid and light ber) is required, complete Part IV of the form. If rail vehicles are deductible. You can find the Form T (Timber) is not required, attach a state- Deduction limit. The most you can deduct as guidelines and requirements for transportation ment containing the following information for a cost of removing barriers to the disabled and barrier removal at transit.dot.gov. each qualified timber property for which an the elderly for any tax year is $15,000. How- election is being made. Also, you can access the ADA website at ever, you can add any costs over this limit to the ADA.gov for additional information. • The unique stand identification numbers. basis of the property and depreciate these ex- • The total number of acres reforested dur- cess costs. Other barrier removals. To be deductible, ing the tax year. expenses of removing any barrier not covered • The nature of the reforestation treatments. Partners and partnerships. The $15,000 limit by the above standards must meet all three of • The total amounts of qualified reforestation applies to a partnership and also to each part- the following tests. expenditures eligible to be amortized or ner in the partnership. A partner can allocate 1. The removed barrier must be a substantial deducted. the $15,000 limit in any manner among the part- barrier to access or use of a facility or pub- ner's individually incurred costs and the part- If you timely filed your return for the year lic transportation vehicle by persons who ner's distributive share of partnership costs. If without making the election, you can still make have a disability or are elderly. 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 partnership costs, the partnership can add any 2. The removed barrier must have been a extensions). Clearly indicate the election on costs not deducted to the basis of the improved barrier for at least one major group of per- your amended return and write “Filed pursuant property. sons who have a disability or are elderly to section 301.9100-2.” File the amended return A partnership must be able to show that any (such as people who are blind, deaf, or at the same address you filed the original re- amount added to basis was not deducted by wheelchair users). turn. The election applies when figuring taxable the partner and that it was over a partner's 3. The barrier must be removed without cre- income for the current tax year and all subse- $15,000 limit (as determined by the partner). If ating any new barrier that significantly im- quent years. the partnership cannot show this, it is presumed pairs access to or use of the facility or ve- For additional information on reforestation that the partner was able to deduct the distribu- hicle by a major group of persons who costs, see chapter 8. tive share of the partnership's costs in full. have a disability or are elderly.

Recapture. This deduction may have to be re- Example. Emilio Azul's distributive share of How to make the election. If you elect to de- captured as ordinary income under section ABC partnership's deductible expenses for the duct your costs for removing barriers to the dis- 1245 when you sell or otherwise dispose of the removal of architectural barriers was $14,000. abled or the elderly, claim the deduction on property that would have received an addition Emilio had $12,000 of similar expenses in his your income tax return (partnership return for to basis if you had not elected to deduct the ex- sole proprietorship. He elected to deduct partnerships) for the tax year the expenses penditure. For more information on recapturing $7,000 of them. Emilio allocated the remaining were paid or incurred. Identify the deduction as the deduction, see Depreciation Recapture in $8,000 of the $15,000 limit to his share of a separate item. The election applies to all the Pub. 544. ABC's expenses. Emilio can add the excess qualifying costs you have during the year, up to $5,000 of his own expenses to the basis of the the $15,000 limit. If you make this election, you property used in his business. Also, if ABC can must maintain adequate records to support your Retired Asset Removal show that Emilio could not deduct $6,000 deduction. ($14,000 – $8,000) of his share of the partner- For your election to be valid, you must gen- Costs ship's expenses because of how Emilio applied erally file your return by its due date, including the limit, ABC can add $6,000 to the basis of its extensions. However, if you timely filed your re- If you retire and remove a depreciable asset in property. turn for the year without making the election, connection with the installation or production of you can still make the election by filing an a replacement asset, you can deduct the costs Qualification standards. You can deduct amended return within 6 months of the due date of removing the retired asset. However, if you your costs as a current expense only if the bar- of the return (excluding extensions). Clearly in- replace a component (part) of a depreciable as- rier removal meets the guidelines and require- dicate the election on your amended return and set, capitalize the removal costs if the replace- ments issued by the Architectural and Trans- write “Filed pursuant to section 301.9100-2.” ment is an improvement and deduct the costs if portation Barriers Compliance Board under the File the amended return at the same address the replacement is a repair. Americans with Disabilities Act (ADA) of 1990. you filed the original return. Your election is ir- You can view the ADA at ADA.gov/pubs/ revocable after the due date, including exten- ada.htm. sions, of your return. Barrier Removal Costs The following is a list of some architectural barrier removal costs that can be deducted. Disabled access credit. If you make your The cost of an improvement to a business asset • Ground and floor surfaces. business accessible to persons with disabilities is normally a capital expense. However, you • Walks. and your business is an eligible small business, can elect to deduct the costs of making a facility • Parking lots. you may be able to claim the disabled access or public transportation vehicle more accessible • Ramps. credit. If you choose to claim the credit, you to and usable by those who are disabled or eld- • Entrances. must reduce the amount you deduct or capital- erly. You must own or lease the facility or vehi- • Doors and doorways. ize by the amount of the credit. Stairs. cle for use in connection with your trade or busi- • For more information, see Form 8826. ness. • Floors. • Toilet rooms. A facility is all or any part of buildings, struc- • Water fountains. tures, equipment, roads, walks, parking lots, or • Public telephones. similar real or personal property. A public trans- • Elevators. portation vehicle is a vehicle, such as a bus or • Controls.

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amortize a lease. In 2020, you began to amor- tize a second lease. Report amortization from Film, Television, and the new lease on line 42 of your 2020 Form Live Theatrical 8. 4562. Report amortization from the 2019 lease on line 43 of your 2020 Form 4562. Production Costs If you don't have any new amortizable ex- Amortization penses for the current year, you aren't required Film, television, and theatrical production costs to complete Form 4562 (unless you are claim- are generally capital expenses. However, you ing depreciation). Report the current year's de- can elect to deduct certain costs of a qualified duction for amortization that began in a prior film, television, or live theatrical production Introduction year directly on the “Other deduction” or “Other commencing before January 1, 2026 (after De- expense ” line of your return. cember 31, 2015, and before January 1, 2026, Amortization is a method of recovering (deduct- for a live theatrical production), if the aggregate ing) certain capital costs over a fixed period of cost of the production doesn't exceed $15 mil- time. It is similar to the straight line method of lion. There is a higher dollar limitation for pro- depreciation. Starting a Business ductions in certain areas. The deduction is sub- The various amortizable costs covered in ject to recapture under section 1245 if the this chapter are included in the list below. How- When you start a business, treat all eligible election is voluntarily revoked or the production ever, this chapter doesn't discuss amortization costs you incur before you begin operating the fails to meet the requirements for the deduction. of bond premium. For information on that topic, business as capital expenditures that are part of For more information, see section 181 and the see chapter 3 of Pub. 550, Investment Income your basis in the business. Generally, you re- related regulations. and Expenses. cover costs for particular assets through depre- ciation deductions. However, you generally Certain qualified film, television, or live the- Topics can't recover other costs until you sell the busi- atrical productions acquired and placed in serv- This chapter discusses: ness or otherwise go out of business. For a dis- ice after September 27, 2017, may be eligible cussion on how to treat these costs, see If your for the special depreciation allowance under Deducting amortization attempt to go into business is unsuccessful un- section 168(k). For more information, see Pub. • Amortizing costs of starting a business der Capital Expenses in chapter 1. 946, How To Depreciate Property. • • Amortizing costs of getting a lease For costs paid or incurred after September Note. No other depreciation or amortization • Amortizing costs of section 197 intangibles 8, 2008, you can deduct a limited amount of deduction is allowed for costs of qualified film or • Amortizing reforestation costs start-up and organizational costs. The costs television production or any qualified live theat- • Amortizing costs of geological and that aren't deducted currently can be amortized rical production if an election is made to deduct geophysical costs ratably over a 180-month period. The amortiza- such costs. • Amortizing costs of pollution control tion period starts with the month you begin op- facilities erating your active trade or business. You aren't • Amortizing costs of research and required to attach a statement to make this Repair and Maintenance experimentation election. You can choose to forgo this election • Amortizing costs of certain tax preferences by affirmatively electing to capitalize your Costs start-up costs on your income tax return filed by Useful Items the due date (including extensions) for the tax Generally, you can deduct amounts paid for re- You may want to see: year in which the active trade or business be- pairs and maintenance to tangible property if gins. Once made, the election to either amortize the amounts paid are not otherwise required to Publication or capitalize start-up costs is irrevocable and be capitalized. However, you may elect to capi- applies to all start-up costs that are related to talize amounts paid for repair and maintenance 544 544 Sales and Other Dispositions of your trade or business. See Regulations sec- consistent with the treatment on your books and Assets tions 1.195-1, 1.248-1, and 1.709-1. records. If you make this election, it applies to 550 550 Investment Income and Expenses all amounts paid for repair and maintenance to For costs paid or incurred after October 22, tangible property that you treat as capital ex- 946 946 How To Depreciate Property 2004, and before September 9, 2008, you can penditures on your books and records for the elect to deduct a limited amount of business tax year. Form (and Instructions) start-up and organizational costs in the year your active trade or business begins. Any costs 3115 3115 Application for Change in not deducted can be amortized ratably over a How to make the election. To make the elec- Accounting Method tion to treat repairs and maintenance as capital 180-month period, beginning with the month expenditures, attach a statement titled “Section 4562 4562 Depreciation and Amortization you begin business. If the election is made, you 1.263(a)-3(n) Election” to your timely filed return must attach any statement required by Regula-

6251 6251 Alternative Minimum (including extensions). For more information on tions sections 1.195-1(b), 1.248-1(c), and Tax—Individuals what to include in the statement, see Regula- 1.709-1(c), as in effect before September 9, tions section 1.263(a)-3(n). If you timely filed See chapter 12 for information about getting 2008. your return without making the election, you can publications and forms. still make the election by filing an amended re- Note. You can apply the provisions of Reg- turn within 6 months of the due date of the re- ulations sections 1.195-1, 1.248-1, and 1.709-1 turn (excluding extensions). Attach the state- How To Deduct to all business start-up and organizational costs ment to the amended return and write “Filed paid or incurred after October 22, 2004, provi- pursuant to section 301.9100-2” on the state- Amortization ded the period of limitations on assessment ment. File the amended return at the same ad- hasn't expired for the year of the election. Oth- dress you filed the original return. To deduct amortization that begins during the erwise, for business start-up 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 1.195-1(b), To report amortization from previous years, 1.248-1(c), and 1.709-1(c), as in effect before in addition to amortization that begins in the cur- September 9, 2008, will apply. rent year, list on Form 4562 each item sepa- For costs paid or incurred before October rately. For example, in 2019, you began to 23, 2004, you can elect to amortize business

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start-up and organizational costs over an amor- All amounts paid or incurred to investigate see Cash method partnership under How tization period of 60 months or more. See How the business before October 22 are amortizable To Amortize, later. To Make the Election, later. investigative costs. Amounts paid on or after • It is for a type of item normally expected to The cost must qualify as one of the follow- that date relate to the attempt to purchase the benefit the partnership throughout its entire ing. business and therefore must be capitalized. life. • A business start-up cost. Organizational costs include the following Disposition of business. If you completely • An organizational cost for a corporation. fees. dispose of your business before the end of the • An organizational cost for a partnership. • Legal fees for services incident to the or- amortization period, you can deduct any re- ganization of the partnership, such as ne- maining deferred start-up costs. However, you gotiation and preparation of the partner- Business Start-up Costs can deduct these deferred start-up costs only to ship agreement. the extent they qualify as a loss from a busi- Start-up costs are amounts paid or incurred for • Accounting fees for services incident to the ness. (a) creating an active trade or business, or (b) organization of the partnership. investigating the creation or acquisition of an • Filing fees. active trade or business. Start-up costs include Costs of Organizing a amounts paid or incurred in connection with an Corporation Nonqualifying costs. The following costs existing activity engaged in for profit, and for the can't 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- nership. Qualifying costs. A start-up 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 • Chargeable to a capital account (see chap- • The cost of making a contract concerning trade or business (in the same field as the ter 1), the operation of the partnership trade or one you entered into). • Amortized over the life of the corporation if business, including a contract between a • It is a cost you pay or incur before the day the corporation had a fixed life, and partner and the partnership. your active trade or business begins. • Incurred before the end of the first tax year • The costs for issuing and marketing inter- ests in the partnership such as brokerage, Start-up costs include amounts paid for the in which the corporation is in business. registration, and legal fees and printing following. A corporation using the cash method of ac- costs. These “syndication fees” are capital • An analysis or survey of potential markets, counting can amortize organizational costs in- expenses that can't be depreciated or products, labor supply, transportation fa- curred within the first tax year, even if it doesn't amortized. cilities, etc. pay them in that year. Advertisements for the opening of the busi- • Examples of organizational costs include Liquidation of partnership. If a partnership ness. the following. is liquidated before the end of the amortization Salaries and wages for employees who are • • The cost of temporary directors. period, 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- Nonqualifying costs. The following items are sultants, or for similar professional serv- capital expenses that can't be amortized. ices. • Costs for issuing and selling stock or se- How To Amortize curities, such as commissions, professio- Nonqualifying costs. Start-up costs don't in- nal fees, and printing costs. Deduct start-up and organizational costs in clude deductible interest, taxes, or research • Costs associated with the transfer of as- equal amounts over the applicable amortization and experimental costs. See Research and Ex- sets to the corporation. period (discussed earlier under Business perimental Costs, later. Start-up Costs). You can choose an amortiza- tion period for start-up costs that is different Purchasing an active trade or business. Costs of Organizing a from the period you choose for organizational Amortizable start-up costs for purchasing an ac- Partnership costs, as long as both aren't less than the appli- tive trade or business include only investigative cable amortization period. Once you choose an costs incurred in the course of a general search The costs to organize a partnership are the di- amortization period, you can't change it. for or preliminary investigation of the business. rect costs of creating the partnership. To figure your deduction, divide your total These are costs that help you decide whether start-up or organizational costs by the months in to purchase a business. Costs you incur in an Qualifying costs. A partnership can amortize the amortization period. The result is the attempt to purchase a specific business are an organizational cost only if it meets all the fol- amount you can deduct for each month. capital expenses that you can't amortize. lowing tests. • It is for the creation of the partnership and Cash method partnership. A partnership us- Example. On June 1, you hired an ac- not for starting or operating the partnership ing the cash method of accounting can deduct counting firm and a law firm to assist you in the trade or business. an organizational cost only if it has been paid by potential purchase of XYZ, Inc. They re- • It is chargeable to a capital account (see the end of the tax year. However, any cost the searched XYZ's industry and analyzed the fi- chapter 1). partnership could have deducted as an organi- nancial projections of XYZ, Inc. In September, • It could be amortized over the life of the zational cost in an earlier tax year (if it had been the law firm prepared and submitted a letter of partnership if the partnership had a fixed paid that year) can be deducted in the tax year intent to XYZ, Inc. The letter stated that a bind- life. of payment. ing commitment would result only after a pur- • It is incurred by the due date of the partner- chase agreement was signed. The law firm and ship return (excluding extensions) for the accounting firm continued to provide services, first tax year in which the partnership is in How To Make the Election including a review of XYZ's books and records business. However, if the partnership uses and the preparation of a purchase agreement. the cash method of accounting and pays To elect to amortize start-up or organizational On October 22, you signed a purchase agree- the cost after the end of its first tax year, costs, you must complete and attach Form ment with XYZ, Inc. 4562 to your return for the first tax year you are in business. You may also be required to attach

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an organizational costs election statement (de- the statement early, the election becomes ef- 197 Intangibles Defined, later) ratably over a scribed later) to your return. fective in the month of the tax year your active 15-year period. You must amortize these costs business begins. if you hold the section 197 intangibles in con- For start-up or organizational costs paid or nection with your trade or business or in an ac- Revised statement. You can file a revised tivity engaged in for the production of income. incurred after September 8, 2008, an accompa- statement to include any start-up costs not in- nying statement isn't required. Generally, for cluded in your original statement. However, you You may not be able to amortize sec- start-up or organizational costs paid or incurred can't include on the revised statement any cost ! tion 197 intangibles acquired in a trans- before September 9, 2008, and after October you previously treated on your return as a cost CAUTION action that didn't result in a significant 22, 2004, unless you choose to apply Regula- other than a start-up cost. You can file the re- change in ownership or use. See Anti-Churning tions sections 1.195-1, 1.248-1, and 1.709-1, vised statement with a return filed after the re- Rules, later. you must also attach an accompanying state- turn on which you elected to amortize your ment to elect to amortize the costs. start-up costs. Your amortization deduction each year is the applicable part of the intangible's adjusted If you have both start-up and organizational Organizational costs election statement. If basis (for purposes of determining gain), fig- costs, attach a separate statement (if required) you elect to amortize your corporation's or part- ured by amortizing it ratably over 15 years (180 to your return for each type of cost. See Starting nership's organizational costs, attach a sepa- months). The 15-year period begins with the a Business, earlier, for more information. rate statement (if required) that contains the fol- later of: lowing information. • The month the intangible is acquired, or The month the trade or business or activity Generally, you must file the return by the • A description of each cost. • engaged in for the production of income due date (including any extensions). However, • The amount of each cost. begins. if you timely filed your return for the year without • The date each cost was incurred. making the election, you can still make the elec- • The month your corporation or partnership You can't deduct amortization for the month you tion by filing an amended return within 6 months began active business (or acquired the dispose of the intangible. business). of the due date of the return (excluding exten- If you pay or incur an amount that increases • The number of months in your amortization sions). For more information, see the instruc- the basis of an amortizable section 197 intangi- period (which is generally 180 months). tions for Part VI of Form 4562. ble after the 15-year period begins, amortize it Partnerships. The statement prepared for over the remainder of the 15-year period begin- You can choose to forgo the election to am- a cash basis partnership must also indicate the ning with the month the basis increase occurs. ortize by affirmatively electing to capitalize your amount paid before the end of the year for each You aren't allowed any other depreciation or start-up or organizational costs on your income cost. amortization deduction for an amortizable sec- tax return filed by the due date (including exten- You don't need to separately list any part- tion 197 intangible. sions) for the tax year in which the active trade nership organizational cost that is less than or business begins. $10. Instead, you can list the total amount of Tax-exempt use property subject to a lease. these costs with the dates the first and last The amortization period for any section 197 in- Note. The election to either amortize or costs were incurred. tangible leased under a lease agreement en- capitalize start-up or organizational costs is ir- After a partnership makes the election to tered into after March 12, 2004, to a tax-exempt revocable and applies to all start-up and organi- amortize organizational costs, it can later file an organization, governmental unit, or foreign per- zational costs that are related to the trade or amended return to include additional organiza- son or entity (other than a partnership), shall not business. tional costs not included in the partnership's be less than 125% of the lease term. original return and statement. If your business is organized as a corpora- Cost attributable to other property. The tion or partnership, only the corporation or part- rules for section 197 intangibles don't apply to nership can elect to amortize its start-up or or- Getting a Lease any amount that is included in determining the ganizational costs. A shareholder or partner cost of property that isn't a section 197 intangi- can't make this election. You, as a shareholder If you get a lease for business property, you ble. For example, if the cost of computer soft- or partner, can't amortize any costs you incur in may recover the cost of acquiring the lease by ware isn't separately stated from the cost of setting up your corporation or partnership. Only amortizing it over the term of the lease. The hardware or other tangible property and you the corporation or partnership can amortize term of the lease for amortization purposes gen- consistently treat it as part of the cost of the these costs. erally includes all renewal options (and any hardware or other tangible property, these rules other period for which you and the lessor rea- don't apply. Similarly, none of the cost of acquir- However, you, as an individual, can elect to sonably expect the lease to be renewed). How- ing real property held for the production of amortize costs you incur to investigate an inter- ever, renewal periods aren't included if 75% or rental income is considered the cost of good- est in an existing partnership. These costs qual- more of the cost of acquiring the lease is for the will, going concern value, or any other section ify as business start-up costs if you acquire the term of the lease remaining on the acquisition 197 intangible. partnership interest. date (not including any period for which you may choose to renew, extend, or continue the Section 197 Intangibles Start-up costs election statement. If you lease). elect to amortize your start-up costs, attach a Defined separate statement (if required) that contains For more information on the costs of getting the following information. a lease, see Cost of Getting a Lease in The following assets are section 197 intangibles • A description of the business to which the chapter 3. and must be amortized over 180 months. start-up costs relate. 1. Goodwill. • A description of each start-up cost incur- How to amortize. Enter your deduction in 2. Going concern value. red. Part VI of Form 4562 if you are deducting amor- • The month your active business began (or tization that begins during the current year, or 3. Workforce in place. was acquired). on the appropriate line of your tax return if you 4. Business books and records, operating The number of months in your amortization aren't otherwise required to file Form 4562. • systems, or any other information base, in- period (which is generally 180 months). cluding lists or other information concern- Filing the statement early. You can elect Section 197 Intangibles ing current or prospective customers. to amortize your start-up costs by filing the 5. A patent, copyright, formula, process, de- statement with a return for any tax year before Generally, you may amortize the capitalized sign, pattern, know-how, format, or similar the year your active business begins. If you file costs of “section 197 intangibles” (see Section item.

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6. A customer-based intangible. other value resulting from the future provision of intangible assets acquired in connection with goods or services because of relationships with acquiring the franchise (including player con- 7. A supplier-based intangible. customers in the ordinary course of business. tracts) is a section 197 intangible amortizable 8. Any item similar to items 3 through 7. For example, you must amortize the part of the over a 15-year period. purchase price of a business that is for the exis- 9. A license, permit, or other right granted by tence of the following intangibles. Contract for the use of, or a term interest in, a governmental unit or agency (including • A customer base. a section 197 intangible. Section 197 intan- issuances and renewals). • A circulation base. gibles include any right under a license, con- 10. A covenant not to compete entered into in • An undeveloped market or market growth. tract, or other arrangement providing for the use connection with the acquisition of an inter- • Insurance in force. of any section 197 intangible. It also includes est in a trade or business. • A mortgage servicing contract. any term interest in any section 197 intangible, • An investment management contract. whether the interest is outright or in trust. 11. Any franchise, trademark, or trade name. • Any other relationship with customers in- 12. A contract for the use of, or a term interest volving the future provision of goods or Assets That Aren't Section in, any item in this list. services. 197 Intangibles You can't amortize any of the intangi- or other similar rights to ! bles listed in items 1 through 8 that you income for goods or services provided to cus- The following assets aren't section 197 intangi- CAUTION created rather than acquired unless tomers before the acquisition of a trade or busi- bles. you created them in acquiring assets that make ness aren't section 197 intangibles. 1. Any interest in a corporation, partnership, up a trade or business or a substantial part of a trust, or estate. trade or business. Supplier-based intangible. A supplier-based intangible is the value resulting from the future 2. Any interest under an existing futures con- acquisitions (through contract or other relation- tract, foreign currency contract, notional Goodwill. This is the value of a trade or busi- ships with suppliers in the ordinary course of ness based on expected continued customer principal contract, interest rate swap, or business) of goods or services that you will sell similar financial contract. patronage due to its name, reputation, or any or use. The amount you pay or incur for sup- other factor. plier-based intangibles includes, for example, 3. Any interest in land. any portion of the purchase price of an acquired Going concern value. This is the additional 4. Most computer software. (See Computer trade or business that is attributable to the exis- software, later.) value of a trade or business that attaches to tence of a favorable relationship with persons property because the property is an integral providing distribution services (such as a favor- 5. Any of the following assets not acquired in part of an ongoing business activity. It includes able shelf or display space or a outlet), or connection with the acquisition of a trade value based on the ability of a business to con- the existence of favorable supply contracts. or business or a substantial part of a trade tinue to function and generate income even Don't include any amount required to be paid or business. though there is a change in ownership (but for the goods or services to honor the terms of a. An interest in a film, sound recording, doesn't include any other section 197 intangi- the agreement or other relationship. Also, see videotape, book, or similar property. ble). It also includes value based on the imme- Assets That Aren't Section 197 Intangibles, diate use or availability of an acquired trade or later. b. A right to receive tangible property or business, such as the use of earnings during services under a contract or from a any period in which the business wouldn't other- Government-granted license, permit, etc. governmental agency. wise be available or operational. This is any right granted by a governmental unit c. An interest in a patent or copyright. or an agency or instrumentality of a governmen- Workforce in place, etc. This includes the tal unit. For example, you must amortize the d. Certain rights that have a fixed dura- composition of a workforce (for example, its ex- capitalized costs of acquiring (including issuing tion or amount. (See Rights of fixed perience, education, or training). It also includes or renewing) a liquor license, a taxicab medal- duration or amount, later.) the terms and conditions of employment, lion or license, or a television or radio broad- 6. An interest under either of the following. whether contractual or otherwise, and any other casting license. value placed on employees or any of their at- a. An existing lease or sublease of tangi- tributes. Covenant not to compete. Section 197 intan- ble property. For example, you must amortize the part of gibles include a covenant not to compete (or b. A debt that was in existence when the the purchase price of a business that is for the similar arrangement) entered into in connection interest was acquired. existence of a highly skilled workforce. Also, with the acquisition of an interest in a trade or you must amortize the cost of acquiring an ex- business, or a substantial portion of a trade or 7. A right to service residential mortgages isting or relationship with business. An interest in a trade or business in- unless the right is acquired in connection employees or consultants. cludes an interest in a partnership or a corpora- with the acquisition of a trade or business tion engaged in a trade or business. or a substantial part of a trade or business. Business books and records, etc. This in- An arrangement that requires the former 8. Certain transaction costs incurred by par- cludes the intangible value of technical man- owner to perform services (or to provide prop- ties to a corporate organization or reorgan- uals, training manuals or programs, data files, erty or the use of property) isn't similar to a cov- ization in which any part of a gain or loss and accounting or inventory control systems. It enant not to compete to the extent the amount isn't recognized. also includes the cost of customer lists; sub- paid under the arrangement represents reason- scription lists; insurance expirations; patient or able compensation for those services or for that Intangible property that isn't amortizable un- client files; and lists of newspaper, magazine, property or its use. der the rules for section 197 intangibles can be radio, and television advertisers. depreciated if it meets certain requirements. Franchise, trademark, or trade name. A You must generally use the straight line method Patents, copyrights, etc. This includes pack- franchise, trademark, or trade name is a section over its useful life. For certain intangibles, the age design, computer software, and any inter- 197 intangible. You must amortize its purchase depreciation period is specified in the law and est in a film, sound recording, videotape, book, or renewal costs, other than certain contingent regulations. For example, the depreciation pe- or other similar property, except as discussed payments that you can deduct currently. For in- riod for computer software that isn't a section later under Assets That Aren't Section 197 In- formation on currently deductible contingent 197 intangible is generally 36 months. tangibles. payments, see chapter 11. For more information on depreciating intan- gible property, see Intangible Property under Customer-based intangible. This is the Professional sports franchise. A fran- What Method Can You Use To Depreciate Your composition of market, market share, and any chise engaged in professional sports and any Property? in chapter 1 of Pub. 946.

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Computer software. Section 197 intangibles see Revenue Procedure 2004-36, 2004-24 (C) of section 1563. For an exception, see don’t include the following types of computer I.R.B. 1063, available at IRS.gov/irb/ section 1.197-2(h)(6)(iv) of the regulations. software. 2004-24_IRB#RP-2004-36. • A trust and a corporation if more than 20% of the value of the corporation's 1. Software that meets all the following re- A change in the treatment of creative outstanding stock is owned, directly or in- quirements. property costs is a change in method of ! directly, by or for the trust or grantor of the CAUTION accounting. a. It is, or has been, readily available for trust. purchase by the general public. • The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. b. It is subject to a nonexclusive license. Anti-Churning Rules • The of two different trusts, and c. It hasn't been substantially modified. Anti-churning rules prevent you from amortizing the fiduciaries and beneficiaries of two dif- This requirement is considered met if most section 197 intangibles if the transaction ferent trusts, if the same person is the the cost of all modifications isn't more in which you acquired them didn't result in a sig- grantor of both trusts. than the greater of 25% of the price of nificant change in ownership or use. These • The executor and beneficiary of an estate. the publicly available unmodified soft- rules apply to goodwill and going concern • A tax-exempt educational or charitable or- ware or $2,000. value, and to any other section 197 intangible ganization and a person who directly or in- directly controls the organization (or whose 2. Software that isn't acquired in connection that isn't otherwise depreciable or amortizable. family members control it). with the acquisition of a trade or business Under the anti-churning rules, you can't use A corporation and a partnership if the or a substantial part of a trade or business. • 15-year amortization for the intangible if any of same persons own more than 20% of the Computer software defined. Computer the following conditions apply. value of the outstanding stock of the cor- poration and more than 20% of the capital software includes all programs designed to 1. You or a related person (defined later) or profits interest in the partnership. cause a computer to perform a desired function. held or used the intangible at any time • Two S corporations, and an S corporation It also includes any database or similar item that from July 25, 1991, through August 10, and a regular corporation, if the same per- is in the public domain and is incidental to the 1993. operation of qualifying software. sons own more than 20% of the value of 2. You acquired the intangible from a person the outstanding stock of each corporation. Rights of fixed duration or amount. Section who held it at any time during the period in • Two partnerships if the same persons own, 197 intangibles don't include any right under a (1) and, as part of the transaction, the user directly or indirectly, more than 20% of the contract or from a governmental agency if the didn't change. capital or profits in both partner- right is acquired in the ordinary course of a ships. 3. You granted the right to use the intangible trade or business (or in an activity engaged in • A partnership and a person who owns, di- to a person (or a person related to that for the production of income) but not as part of a rectly or indirectly, more than 20% of the person) who held or used it at any time purchase of a trade or business and either: capital or profits interests in the partner- during the period in (1). This applies only if Has a fixed life of less than 15 years; or ship. • the transaction in which you granted the Is of a fixed amount that, except for the • Two persons who are engaged in trades or • right and the transaction in which you ac- rules for section 197 intangibles, would be businesses under common control (as de- quired the intangible are part of a series of recovered under a method similar to the scribed in section 41(f)(1)). related transactions. See Related person, unit-of-production method of cost recov- later, for more information. When to determine relationship. Per- ery. sons are treated as related if the relationship However, this doesn't apply to the following in- Exceptions. The anti-churning rules don't ap- existed at the following time. tangibles. ply in the following situations. • In the case of a single transaction, immedi- • Goodwill. • You acquired the intangible from a dece- ately before or immediately after the trans- • Going concern value. dent and its basis was stepped up to its action in which the intangible was ac- • A covenant not to compete. FMV. quired. • A franchise, trademark, or trade name. • The intangible was amortizable as a sec- • In the case of a series of related transac- • A customer-related information base, cus- tion 197 intangible by the seller or trans- tions (or a series of transactions that com- tomer-based intangible, or similar item. feror you acquired it from. This exception prise a qualified stock purchase under sec- doesn't apply if the transaction in which tion 338(d)(3)), immediately before the Safe Harbor for Creative you acquired the intangible and the trans- earliest transaction or immediately after the action in which the seller or transferor ac- last transaction. Property Costs quired it are part of a series of related transactions. Ownership of stock. In determining If you are engaged in the trade or business of • The gain-recognition exception, discussed whether an individual directly or indirectly owns film production, you may be able to amortize the later, applies. any of the outstanding stock of a corporation, creative property costs for properties not set for the following rules apply. production within 3 years of the first capitalized Related person. For purposes of the Rule 1. Stock directly or indirectly owned transaction. You may amortize these costs rata- anti-churning rules, the following are related by or for a corporation, partnership, estate, or bly over a 15-year period beginning on the first persons. trust is considered owned proportionately by or day of the second half of the tax year in which An individual and his or her brothers, sis- • for its shareholders, partners, or beneficiaries. you properly write off the costs for financial ac- ters, half-brothers, half-sisters, spouse, an- counting purposes. If, during the 15-year pe- cestors (parents, grandparents, etc.), and Rule 2. An individual is considered to own riod, you dispose of the creative property rights, lineal descendants (children, grandchil- the stock directly or indirectly owned by or for you must continue to amortize the costs over dren, etc.). his or her family. Family includes only brothers the remainder of the 15-year period. • A corporation and an individual who owns, and sisters, half-brothers and half-sisters, Creative property costs include costs paid or directly or indirectly, more than 20% of the spouse, ancestors, and lineal descendants. incurred to acquire and develop screenplays, value of the corporation's outstanding stock. Rule 3. An individual owning (other than by scripts, story outlines, motion picture production applying Rule 2) any stock in a corporation is rights to books and plays, and other similar • Two corporations that are members of the same controlled group as defined in sec- considered to own the stock directly or indi- properties for purposes of potential future film rectly owned by or for his or her partner. development, production, and exploitation. tion 1563(a), except that “more than 20%” is substituted for “at least 80%” in that defi- Amortize these costs using the rules of Rev- nition and the determination is made with- enue Procedure 2004-36. For more information, out regard to subsections (a)(4) and (e)(3)

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Rule 4. For purposes of applying Rule 1, 2, When to file. If an amended return is allowed, If you held the intangible 1 year or less, any or 3, treat stock constructively owned by a per- you must file it by the later of the following gain or loss on its disposition is an ordinary gain son under Rule 1 as actually owned by that per- dates. or loss. For more information on ordinary or son. Don't treat stock constructively owned by • 3 years from the date you filed your original capital gain or loss on business property, see an individual under Rule 2 or 3 as owned by the return for the year in which you didn't de- chapter 3 in Pub. 544. individual for reapplying Rule 2 or 3 to make an- duct the correct amount. (A return filed other person the constructive owner of the early is considered filed on the due date.) Nondeductible loss. You can't deduct any stock. • 2 years from the time you paid your tax for loss on the disposition or worthlessness of a that year. section 197 intangible that you acquired in the Gain-recognition exception. This exception same transaction (or series of related transac- to the anti-churning rules applies if the person Changing Your Accounting Method tions) as other section 197 intangibles you still you acquired the intangible from (the transferor) have. Instead, increase the adjusted basis of meets both of the following requirements. Generally, you must get IRS approval to change each remaining amortizable section 197 intangi- • That person wouldn't be related to you (as your method of accounting. File Form 3115 to ble by a proportionate part of the nondeductible described under Related person, earlier) if request a change to a permissible method of loss. Figure the increase by multiplying the non- the 20% test for ownership of stock and accounting for amortization. deductible loss on the disposition of the intangi- partnership interests were replaced by a ble by the following fraction. 50% test. The following are examples of a change in • The numerator is the adjusted basis of • That person chose to recognize gain on method of accounting for amortization. each remaining intangible on the date of the disposition of the intangible and pay in- • A change in the amortization method, pe- the disposition. come tax on the gain at the highest tax riod of recovery, or convention of an amor- • The denominator is the total adjusted basis rate. See chapter 2 in Pub. 544 for infor- tizable asset. of all remaining amortizable section 197 in- mation on making this choice. • A change in the accounting for amortizable tangibles on the date of the disposition. If this exception applies, the anti-churning assets from a single asset account to a Covenant not to compete. A covenant not to rules apply only to the amount of your adjusted multiple asset account (pooling), or vice compete, or similar arrangement, isn't consid- basis in the intangible that is more than the gain versa. ered disposed of or worthless before you dis- recognized by the transferor. • A change in the accounting for amortizable pose of your entire interest in the trade or busi- assets from one type of multiple asset ac- ness for which you entered into the covenant. Notification. If the person you acquired count to a different type of multiple asset the intangible from chooses to recognize gain account. under the rules for this exception, that person Nonrecognition transfers. If you acquire a must notify you in writing by the due date of the section 197 intangible in a nonrecognition trans- Changes in amortization that aren't a return on which the choice is made. fer, you are treated as the transferor with re- change in method of accounting include the fol- spect to the part of your adjusted basis in the in- lowing. Anti-abuse rule. You can't amortize any sec- tangible that isn't more than the transferor's A change in figuring amortization in the tax tion 197 intangible acquired in a transaction for • adjusted basis. You amortize this part of the ad- year in which your use of the asset which the principal purpose was either of the justed basis over the intangible's remaining am- changes. following. ortization period in the hands of the transferor. • An adjustment in the useful life of an amor- • To avoid the requirement that the intangi- Nonrecognition transfers include transfers to a tizable asset. ble be acquired after August 10, 1993. corporation, partnership contributions and dis- • Generally, the making of a late amortiza- • To avoid any of the anti-churning rules. tributions, like-kind exchanges, and involuntary tion election or the revocation of a timely conversions. valid amortization election. More information. For more information In a like-kind exchange or involuntary con- Any change in the placed-in-service date about the anti-churning rules, including addi- • version of a section 197 intangible, you must of an amortizable asset. tional rules for partnerships, see Regulations continue to amortize the part of your adjusted section 1.197-2(h). basis in the acquired intangible that isn't more See Regulations section 1.446-1(e)(2)(ii)(a) than your adjusted basis in the exchanged or for more information and examples. Incorrect Amount of converted intangible over the remaining amorti- zation period of the exchanged or converted in- Amortization Deducted Automatic approval. In some instances, you tangible. Amortize over a new 15-year period may be able to get automatic approval from the the part of your adjusted basis in the acquired If you later discover that you deducted an incor- IRS to change your method of accounting for intangible that is more than your adjusted basis rect amount for amortization for a section 197 amortization. For a list of automatic accounting in the exchanged or converted intangible. intangible in any year, you may be able to make method changes, see the Instructions for Form a correction for that year by filing an amended 3115. Also, see the Instructions for Form 3115 Example. You own a section 197 intangi- return. See Amended Return next. If you aren't for more information on getting approval, auto- ble you have amortized for 4 full years. It has a allowed to make the correction on an amended matic approval procedures, and a list of excep- remaining unamortized basis of $30,000. You return, you can change your accounting method tions to the automatic approval process. exchange the asset plus $10,000 for a like-kind to claim the correct amortization. See Changing section 197 intangible. The nonrecognition pro- Your Accounting Method, later. Disposition of Section 197 visions of like-kind exchanges apply. You amor- Intangibles tize $30,000 of the $40,000 adjusted basis of Amended Return the acquired intangible over the 11 years re- maining in the original 15-year amortization pe- A section 197 intangible is treated as deprecia- If you deducted an incorrect amount for amorti- riod for the transferred asset. You amortize the ble property used in your trade or business. If zation, you can file an amended return to cor- other $10,000 of adjusted basis over a new you held the intangible for more than 1 year, rect the following. 15-year period. For more information, see Reg- any gain on its disposition, up to the amount of • A mathematical error made in any year. ulations section 1.197-2(g). allowable amortization, is ordinary income (sec- • A posting error made in any year. tion 1245 gain). If multiple section 197 intangi- • An amortization deduction for a section bles are disposed of in a single transaction or a 197 intangible for which you haven't adop- series of related transactions, treat all of the Reforestation Costs ted a method of accounting. section 197 intangibles as if they were a single asset for purposes of determining the amount of You can elect to deduct a limited amount of re- gain that is ordinary income. Any remaining forestation costs paid or incurred during the tax gain, or any loss, is a section 1231 gain or loss. year. See Reforestation Costs in chapter 7. You

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can elect to amortize the qualifying costs that incur qualifying reforestation expenses, report If you retire or abandon the property during aren't deducted currently over an 84-month pe- any gain as ordinary income up to the amortiza- the amortization period, no amortization deduc- riod. There is no limit on the amount of your am- tion you took. See chapter 3 of Pub. 544 for tion is allowed in the year of retirement or aban- ortization deduction for reforestation costs paid more information. donment. or incurred during the tax year. How to make the election. To elect to amor- The election to amortize reforestation costs tize qualifying reforestation costs, complete Part incurred by a partnership, S corporation, or es- Pollution Control VI of Form 4562 and attach a statement that tate must be made by the partnership, corpora- contains the following information. Facilities tion, or estate. A partner, shareholder, or bene- A description of the costs and the dates ficiary can't make that election. • you incurred them. You can elect to amortize the cost of a certified A partner's or shareholder's share of amor- • A description of the type of timber being pollution control facility over 60 months. How- tizable costs is figured under the general rules grown and the purpose for which it is ever, see Atmospheric pollution control facili- for allocating items of income, loss, deduction, grown. ties, later, for an exception. The cost of a pollu- etc., of a partnership or S corporation. The am- Attach a separate statement for each property tion control facility that isn't eligible for ortizable costs of an estate are divided between for which you amortize reforestation costs. amortization can be depreciated under the reg- the estate and the income beneficiary based on ular rules for depreciation. Also, you can claim a Generally, you must make the election on a the income of the estate allocable to each. special depreciation allowance on a certified timely filed return (including extensions) for the pollution control facility that is qualified property tax year in which you incurred the costs. How- Qualifying costs. Reforestation costs are the even if you elect to amortize its cost. You must ever, if you timely filed your return for the year direct costs of planting or seeding for foresta- reduce its cost (amortizable basis) by the without making the election, you can still make tion or reforestation. Qualifying costs include amount of any special allowance you claim. the election by filing an amended return within 6 only those costs you must capitalize and in- See chapter 3 of Pub. 946. clude in the adjusted basis of the property. months of the due date of the return (excluding They include costs for the following items. extensions). Attach Form 4562 and the state- A certified pollution control facility is a new • Site preparation. ment to the amended return and write “Filed identifiable treatment facility used in connection • Seeds or seedlings. pursuant to section 301.9100-2” on Form 4562. with a plant or other property in operation be- • Labor. File the amended return at the same address fore 1976 to reduce or control water or atmos- • Tools. you filed the original return. pheric pollution or contamination. The facility • Depreciation on equipment used in plant- must do so by removing, changing, disposing, Revoking the election. You must get IRS ap- ing and seeding. storing, or preventing the creation or emission proval to revoke your election to amortize quali- of pollutants, contaminants, wastes, or heat. Qualifying costs don't include costs for fying reforestation costs. Your application to re- The facility must be certified by state and fed- which the government reimburses you under a voke the election must include your name, eral certifying authorities. cost-sharing program, unless you include the address, the years for which your election was reimbursement in your income. in effect, and your reason for revoking it. Please The facility must not significantly increase provide your daytime telephone number (op- the output or capacity, extend the useful life, or Qualified timber property. Qualified timber tional), in case we need to contact you. You, or property is property that contains trees in signif- reduce the total operating costs of the plant or your duly authorized representative, must sign other property. Also, it must not significantly icant commercial quantities. It can be a woodlot the application and file it at least 90 days before or other site that you own or lease. The property change the nature of the manufacturing or pro- the due date (without extensions) for filing your duction process or facility. qualifies only if it meets all of the following re- income tax return for the first tax year for which quirements. your election is to end. • It is located in the United States. The federal certifying authority won't certify • It is held for the growing and cutting of tim- Send the application to: your property to the extent it appears you will ber you will either use in, or sell for use in, recover (over the property's useful life) all or the commercial production of timber prod- part of its cost from the profit based on its oper- ucts. ation (such as through sales of recovered • It consists of at least one acre planted with wastes). The federal certifying authority will de- tree seedlings in the manner normally used Associate Chief Counsel scribe the nature of the potential cost recovery. in forestation or reforestation. Passthroughs and Special Industries You must then reduce the amortizable basis of CC:PSI:6 the facility by this potential recovery. Qualified timber property doesn't include 1111 Constitution Ave. NW, IR-5300 New identifiable treatment facility. A property on which you have planted shelter Washington, DC 20224 belts or ornamental trees, such as Christmas new identifiable treatment facility is tangible de- trees. preciable property that is identifiable as a treat- ment facility. It doesn't include a building and its Amortization period. The 84-month amorti- Geological and structural components unless the building is ex- zation period starts on the first day of the first clusively a treatment facility. month of the second half of the tax year you in- Geophysical Costs cur the costs (July 1 for a calendar year tax- Atmospheric pollution control facilities. payer), regardless of the month you actually in- You can amortize the cost of geological and ge- Certain atmospheric pollution control facilities cur the costs. You can claim amortization ophysical expenses paid or incurred in connec- can be amortized over 84 months. To qualify, deductions for no more than 6 months of the tion with oil and gas exploration or development the following must apply. first and last (eighth) tax years of the period. within the United States. These costs can be • The facility must be acquired and placed in amortized ratably over a 24-month period be- service after April 11, 2005. If acquired, the Life tenant and remainderman. If one per- ginning on the midpoint of the tax year in which original use must begin with you after April son holds the property for life with the remain- the expenses were paid or incurred. For major 11, 2005. der going to another person, the life tenant is integrated oil companies (as defined in section • The facility must be used in connection entitled to the full amortization for qualifying re- 167(h)(5)), these costs must be amortized rata- with an electric generation plant or other forestation costs incurred by the life tenant. Any bly over a 7-year period for costs paid or incur- property placed in operation after Decem- remainder interest in the property is ignored for red after December 19, 2007 (a 5-year period ber 31, 1975, that is primarily coal fired. amortization purposes. for costs paid or incurred after May 17, 2006, • If you construct, reconstruct, or erect the and before December 20, 2007). facility, only the basis attributable to the Recapture. If you dispose of qualified timber construction, reconstruction, or erection property within 10 years after the tax year you completed after April 11, 2005, qualifies.

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Basis reduction for corporations. A corpo- The applicable costs and the optional recovery that gives you the larger deduction. For stand- ration must reduce the amortizable basis of a periods are as follows. ing timber, you must use cost depletion. pollution control facility by 20% before figuring • Circulation costs—3 years. the amortization deduction. • Intangible drilling and development Topics costs—60 months. This chapter discusses: More information. For more information on • Mining exploration and development the amortization of pollution control facilities, costs—10 years. see sections 169 and 291(c) and the related • Research and experimental costs—10 • Who can claim depletion regulations. years. • Mineral property • Timber How to make the election. To elect to amor- Research and tize qualifying costs over the optional recovery Useful Items period, complete Part VI of Form 4562 and at- You may want to see: Experimental Costs tach a statement containing the following infor- mation to your return for the tax year in which Publication You can elect to amortize your research and ex- the election begins. perimental costs, deduct them as current busi- • Your name, address, and taxpayer identifi- 544 544 Sales and Other Dispositions of ness expenses, or write them off over a 10-year cation number. Assets period (see Optional write-off method below). • The type of cost and the specific amount of 551 551 Basis of Assets the cost for which you are making the elec- If you elect to amortize these costs, deduct tion. them in equal amounts over 60 months or more. Form (and Instructions) The amortization period begins the month you Generally, the election must be made on a Schedule E (Form 1040) Schedule E (Form 1040) Supplemental timely filed return (including extensions) for the first receive an economic benefit from the costs. Income and Loss tax year in which you incurred the costs. How- For a definition of “research and experimen- ever, if you timely filed your return for the year Schedule K-1 (Form 1065) Schedule K-1 (Form 1065) Partner's tal costs” and information on deducting them as without making the election, you can still make Share of Income, Deductions, current business expenses, see chapter 7. the election by filing an amended return within 6 Credits, etc. months of the due date of the return (excluding Optional write-off method. Rather than am- extensions). Attach Form 4562 to the amended Schedule K-1 (Form 1120-S) Schedule K-1 (Form 1120-S) ortize these costs or deduct them as a current return and write “Filed pursuant to section Shareholder's Share of Income, expense, you have the option of deducting 301.9100-2” on Form 4562. File the amended Deductions, Credits, etc. (writing off) research and experimental costs return at the same address you filed the original 6198 6198 At-Risk Limitations ratably over a 10-year period beginning with the return. tax year in which you incurred the costs. For 8582 8582 Passive Activity Loss Limitations more information, see Optional Write-off of Cer- Revoking the election. You must obtain con-

T (Timber) T (Timber) Forest Activities Schedule tain Tax Preferences, later, and section 59(e). sent from the IRS to revoke your election. Your request to revoke the election must be submit- See chapter 12 for information about getting Costs you can amortize. You can amortize ted to the IRS in the form of a letter ruling before publications and forms. costs chargeable to a capital account (see the end of the tax year in which the optional re- chapter 1) if you meet both of the following re- covery period ends. The request must contain quirements. all of the information necessary to demonstrate Who Can Claim • You paid or incurred the costs in your trade the rare and unusual circumstances that would or business. justify granting revocation. If the request for rev- Depletion? • You aren't deducting the costs currently. ocation is approved, any unamortized costs are deductible in the year the revocation is effec- If you have an economic interest in mineral How to make the election. To elect to amor- tive. property or standing timber, you can take a de- tize research and experimental costs, complete duction for depletion. More than one person Part VI of Form 4562 and attach it to your in- can have an economic interest in the same min- come tax return. Generally, you must file the re- eral deposit or timber. In the case of leased turn by the due date (including extensions). property, the depletion deduction is divided be- However, if you timely filed your return for the tween the lessor and the lessee. year without making the election, you can still make the election by filing an amended return You have an economic interest if both the within 6 months of the due date of the return 9. following apply. (excluding extensions). Attach Form 4562 to • You have acquired by investment any in- the amended return and write “Filed pursuant to terest in mineral deposits or standing tim- section 301.9100-2” on Form 4562. File the Depletion ber. amended return at the same address you filed • You have a legal right to income from the the original return. extraction of the mineral or cutting of the Your election is binding for the year it is timber to which you must look for a return made and for all later years unless you obtain Introduction of your capital investment. approval from the IRS to change to a different A contractual relationship that allows you an method. Depletion is the using up of natural resources extracted from a mineral property by mining, economic or monetary advantage from prod- drilling, quarrying stone, or cutting timber. The ucts of the mineral deposit or standing timber is Optional Write-off of depletion deduction allows an owner or opera- not, in itself, an economic interest. tor to account for the reduction of the mineral Individuals, estates, and trusts who Certain Tax Preferences property’s value or basis as a result of the ex- claim depletion deductions may be lia- traction of the natural resource. ! CAUTION ble for the AMT. For tax years begin- You can elect to amortize certain tax preference There are two ways of figuring depletion: ning after 2017, the Tax Cuts and Jobs Act, items over an optional period beginning in the cost depletion and percentage depletion. For oil section 12001, repealed the corporate AMT. tax year in which you incurred the costs. If you and gas wells, mines, other natural deposits (in- make this election, there is no AMT adjustment. cluding geothermal deposits), and mineral property, you must generally use the method Basis adjustment for depletion. You must reduce the basis of your property by the

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depletion allowed or allowable, whichever is of cubic feet, or other measure) of mineral prod- Percentage Depletion greater, but not below zero. ucts using the current industry method and the most accurate and reliable information you can To figure percentage depletion, you multiply a obtain. You must include ores and minerals that certain percentage, specified for each mineral, Mineral Property are developed, in sight, blocked out, or as- by your gross income from the property during sured. You must also include probable or pro- the tax year. Mineral property includes oil and gas wells, spective ores or minerals that are believed to The rates to be used and other rules for oil mines, and other natural deposits (including ge- exist based on good evidence. But see Elective and gas wells are discussed later under Inde- othermal deposits). For this purpose, the term safe harbor for owners of oil and gas property, pendent Producers and Royalty Owners and “property” means each separate interest you later. under Natural Gas Wells. Rates and other rules own in each mineral deposit in each separate for percentage depletion of other specific miner- tract or parcel of land. You can treat two or Number of units sold during the tax year. als are found later under Mines and Geothermal more separate interests as one property or as You determine the number of units sold during Deposits. separate properties. See section 614 and the the tax year based on your method of account- related regulations for rules on how to treat sep- ing. Use the following table to make this deter- Gross income. When figuring percentage de- arate mineral interests. mination. pletion, subtract from your gross income from There are two ways of figuring depletion on the property the following amounts. mineral property. IF you THEN the units sold during • Any rents or royalties you paid or incurred • Cost depletion. use ... the tax year are ... for the property. • Percentage depletion. the cash method the units sold for which you • The part of any bonus you paid for a lease of accounting receive payment during the tax Generally, you must use the method that gives on the property allocable to the product year (regardless of the year of sold (or that otherwise gives rise to gross you the larger deduction. However, unless you sale). are an independent producer or royalty owner, income) for the tax year. an accrual the units sold based on your 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 Cost Depletion does not include any for which depletion deduc- of the bonus you must subtract. tions were allowed or allowable in earlier years. To figure cost depletion, you must first deter- No. of units sold in the tax year Bonus Figuring the cost depletion deduction. × mine the following. Recoverable units from the property Payments Once you have figured your property's basis for • 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 from the property is under Mines and Geother- Basis for depletion. To figure the property's Step Action Result mal Deposits, later. basis for depletion, subtract all the following 1 Divide your property's Depletion unit. from the property's adjusted basis. basis for depletion by Taxable income limit. The percentage deple- 1. Amounts recoverable through: total recoverable units. tion deduction generally cannot be more than 2 Multiply the depletion Cost depletion 50% (100% for oil and gas property) of your tax- a. Depreciation deductions, unit by units sold deduction. able income from the property figured without b. Deferred expenses (including defer- during the tax year. the depletion deduction and the domestic pro- red exploration and development duction activities deduction. costs), and You must keep accounts for the depletion of Taxable income from the property means each property and adjust these accounts each gross income from the property minus all allow- c. Deductions other than depletion. year for units sold and depletion claimed. able deductions (except any deduction for de- 2. The residual value of land and improve- pletion or domestic production activities) attrib- ments at the end of operations. Elective safe harbor for owners of oil and utable to mining processes, including limited gas property. Instead of using the method de- mining transportation. These deductible items 3. The cost or value of land acquired for pur- scribed earlier to determine the total recovera- poses other than mineral production. include, but are not limited to, the following. ble units, you can use an elective safe harbor. If • Operating expenses. Adjusted basis. The adjusted basis of you choose the elective safe harbor, the total • Certain selling expenses. your property is your original cost or other ba- recoverable units equal 105% of a property's • Administrative and financial overhead. sis, plus certain additions and improvements, proven reserves (both developed and undevel- • Depreciation. and minus certain deductions such as depletion oped). For details, see Revenue Procedure • Intangible drilling and development costs. allowed or allowable and casualty losses. Your 2004-19 on page 563 of I.R.B. 2004-10, availa- • Exploration and development expendi- adjusted basis can never be less than zero. See ble at IRS.gov/irb/2004-10_IRB/RP-2004-19. tures. Pub. 551 for more information on adjusted ba- To make the election, attach a statement to • Deductible taxes (see chapter 5), but not sis. your timely filed (including extensions) original taxes that you capitalize or take as a credit. return for the first tax year for which the safe • Losses sustained. harbor is elected. The statement must indicate Total recoverable units. The total recovera- The following rules apply when figuring your that you are electing the safe harbor provided ble units is the sum of the following. taxable income from the property for purposes by Revenue Procedure 2004-19. The election, if • The number of units of mineral remaining of the taxable income limit. made, is effective for the tax year in which it is at the end of the year (including units re- Do not deduct any NOL deduction from the made and all later years. It cannot be revoked • covered but not sold). gross income from the property. for the tax year in which it is elected, but it may • The number of units of mineral sold during Corporations do not deduct charitable con- be revoked in a later year. Once revoked, it • the tax year (determined under your tributions from the gross income from the cannot be re-elected for the next 5 years. method of accounting, as explained next). property. You must estimate or determine recoverable • If, during the year, you dispose of an item units (tons, pounds, ounces, barrels, thousands of section 1245 property that was used in

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connection with mineral property, reduce indirect ownership of 5% or more in any one of • You sell your production to persons who any allowable deduction for mining expen- the following. are not related to either you or the retailer. ses by the part of any gain you must report • The retailer does not buy oil or natural gas as ordinary income that is allocable to the • The value of the outstanding stock of a from your customers or persons related to mineral property. See Regulations section corporation. your customers. 1.613-5(b)(1) for information on how to fig- • The interest in the profits or capital of a • There are no arrangements for the retailer ure the ordinary gain allocable to the prop- partnership. to acquire oil or natural gas you produced erty. • The beneficial interests in an estate or for resale or made available for purchase trust. by the retailer. • Neither you nor the retailer knows of, or Oil and Gas Wells controls, the final disposition of the oil or Any interest owned by or for a corporation, natural gas you sold or the original source partnership, trust, or estate is considered to be You cannot claim percentage depletion for an of the petroleum products the retailer ac- owned directly both by itself and proportionately oil or gas well unless at least one of the follow- quired for resale. ing applies. by its shareholders, partners, or beneficiaries. • You are either an independent producer or Transferees who cannot claim percentage Retailers who cannot claim percentage de- a royalty owner. depletion. You cannot claim percentage de- pletion. You cannot claim percentage deple- • The well produces one of the following: pletion if you received your interest in a proven tion if both the following apply. regulated natural gas, natural gas sold un- oil or gas property by transfer after 1974 and der a fixed contract, or natural gas from ge- 1. You sell oil or natural gas or their by-prod- before October 12, 1990. For a definition of the opressured brine. ucts directly or through a related person in term “transfer,” see Regulations section any of the following situations. 1.613A-7(n). For a definition of the term “inter- If you are an independent producer or roy- est in proven oil or gas property,” see Regula- a. Through a retail outlet operated by alty owner, see Independent Producers and tions section 1.613A-7(p). Royalty Owners next. you or a related person. b. To any person who is required under Figuring percentage depletion. Generally, For information on the depletion deduction an agreement with you or a related as an independent producer or royalty owner, for wells that produce regulated natural gas, person to use a trademark, trade you figure your percentage depletion by figuring natural gas sold under a fixed contract, or natu- name, or service mark or name your average daily production of domestic oil or ral gas from geopressured brine, see Natural owned by you or a related person in gas and comparing it to your depletable oil or Gas Wells, later. marketing or distributing oil, natural gas quantity. If your average daily production gas, or their byproducts. does not exceed your depletable oil or gas quantity, you figure your percentage depletion Independent Producers and c. To any person given authority under Royalty Owners by multiplying the gross income from the oil or an agreement with you or a related gas property (as defined under Gross income person to occupy any retail outlet If you are an independent producer or royalty from the property, later) by 15% (0.15). If your owned, leased, or controlled by you or owner, you figure percentage depletion using a average daily production of domestic oil or gas a related person. rate of 15% of the gross income from the prop- exceeds your depletable oil or gas quantity, you erty based on your average daily production of 2. The combined gross receipts from sales must make an allocation as explained later un- domestic crude oil or domestic natural gas up to (not counting resales) of oil, natural gas, or der Average daily production. your depletable oil or natural gas quantity. How- their by-products by all retail outlets taken In addition, there is a limit on the percentage ever, an independent producer or royalty owner into account in (1) are more than $5 million depletion deduction. See Taxable income limit, that also acts as a retailer or refiner may be ex- for the tax year. later. cluded from claiming percentage depletion. For information on figuring the deduction, see Figur- For the purpose of determining if this rule Average daily production. Figure your aver- ing percentage depletion, later. applies, do not count the following. age daily production by dividing your total do- • Bulk sales (sales in very large quantities) mestic production of oil or gas for the tax year Refiners who cannot claim percentage de- of oil or natural gas to commercial or indus- by the number of days in your tax year. pletion. You cannot claim percentage deple- trial users. tion if you or a related person refines crude oil • Bulk sales of aviation fuels to the Depart- Partial interest. If you have a partial inter- and you and the related person refined more ment of Defense. est in the production from a property, figure than 75,000 barrels on any day during the tax • Sales of oil or natural gas or their by-prod- your share of the production by multiplying total year based on average (rather than actual) daily ucts outside the United States if none of production from the property by your percent- refinery runs for the tax year. The average daily your domestic production or that of a rela- age participation in the from the prop- refinery run is figured by dividing total refinery ted person is exported during the tax year erty. runs for the tax year by the total number of days or the prior tax year. You have a partial interest in the production in the tax year. from a property if you have a net profits interest Related person. To determine if you and in the property. To figure the share of produc- Related person. You and another person another person are related persons, see Rela- tion for your net profits interest, you must first are related persons if either of you holds a sig- ted person under Refiners who cannot claim determine your percentage participation (as nificant ownership interest in the other person percentage depletion, earlier. measured by the net profits) in the gross reve- or if a third person holds a significant ownership Sales through a related person. You are nue from the property. To figure this percent- interest in both of you. considered to be selling oil or natural gas (or a age, you divide the income you receive for your product derived therefrom) through a related net profits interest by the gross revenue from For example, a corporation, partnership, es- person if any sale by the related person produ- the property. Then multiply the total production tate, or trust and anyone who holds a significant ces gross income from which you may benefit from the property by your percentage participa- ownership interest in it are related persons. A because of your direct or indirect ownership in- tion to figure your share of the production. partnership and a trust are related persons if terest in the related person. one person holds a significant ownership inter- You are not considered to be selling oil or Example. Javier Robles owns oil property est in each of them. natural gas (or a product derived therefrom) in which Pablo Olmos owns a 20% net profits through a related person who is a retailer if all of interest. During the year, the property produced 10,000 barrels of oil, which Javier sold for For purposes of the related person rules, the following apply. significant ownership interest means direct or • You do not own a significant ownership in- terest in the retailer.

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$200,000. Javier had expenses of $90,000 at- before sale, or transport it before sale, the gross Partner's or shareholder's adjusted basis. tributable to the property. The property gener- income from the property is the representative The partnership or S corporation must allocate ated a net profit of $110,000 ($200,000 − market or field price (RMFP) of the oil or gas to each partner or shareholder his or her share $90,000). Pablo received income of $22,000 before conversion or transportation. of the adjusted basis of each oil or gas property ($110,000 × 20% (0.20)) for his net profits inter- If you sold gas after you removed it from the held by the partnership or S corporation. The est. premises for a price that is lower than the partnership or S corporation makes the alloca- Pablo determined his percentage participa- RMFP, determine gross income from the prop- tion as of the date it acquires the oil or gas tion to be 11% by dividing $22,000 (the income erty for percentage depletion purposes without property. he received) by $200,000 (the gross revenue regard to the RMFP. Each partner's share of the adjusted basis of from the property). Pablo determined his share Gross income from the property does not in- the oil or gas property is generally figured ac- of the oil production to be 1,100 barrels (10,000 clude lease bonuses, advance royalties, or cording to that partner's interest in partnership barrels × 11% (0.11)). other amounts payable without regard to pro- capital. However, in some cases, it is figured duction from the property. according to the partner's interest in partnership Depletable oil or natural gas quantity. Gen- income. erally, your depletable oil quantity is 1,000 bar- Average daily production exceeds depleta- The partnership or S corporation adjusts the rels. Your depletable natural gas quantity is ble quantities. If your average daily produc- partner's or shareholder's share of the adjusted 6,000 cubic feet multiplied by the number of tion for the year is more than your depletable oil basis of the oil and gas property for any capital barrels of your depletable oil quantity that you or natural gas quantity, figure your allowance for expenditures made for the property and for any choose to apply. If you claim depletion on both depletion for each domestic oil or natural gas change in partnership or S corporation inter- oil and natural gas, you must reduce your de- property as follows. ests. pletable oil quantity (1,000 barrels) by the num- ber of barrels you use to figure your depletable 1. Figure your average daily production of oil Recordkeeping. Each partner or natural gas quantity. or natural gas for the year. shareholder must separately keep re- RECORDS cords of his or her share of the adjus- 2. Figure your depletable oil or natural gas ted basis in each oil and gas property of the Example. You have both oil and natural quantity for the year. gas production. To figure your depletable natu- partnership or S corporation. The partner or ral gas quantity, you choose to apply 360 bar- 3. Figure depletion for all oil or natural gas shareholder must reduce his or her adjusted rels of your 1,000-barrel depletable oil quantity. produced from the property using a per- basis by the depletion allowed or allowable on Your depletable natural gas quantity is 2.16 mil- centage depletion rate of 15% (0.15). the property each year. The partner or share- holder must use that reduced adjusted basis to lion cubic feet of gas (360 × 6,000). You must 4. Multiply the result figured in (3) by a frac- figure cost depletion, or his or her gain or loss, if reduce your depletable oil quantity to 640 bar- tion, the numerator of which is the result the partnership or S corporation disposes of the rels (1,000 – 360). figured in (2) and the denominator of property. If you have production from marginal wells, which is the result figured in (1). This is see section 613A(c)(6) to figure your depletable your depletion allowance for that property oil or natural gas quantity. Also, see Notice for the year. Reporting the deduction. Information that 2020-30, available at IRS.gov/irb/ you, as a partner or shareholder, use to figure 2020-19_IRB#NOT-2020-30. Taxable income limit. If you are an independ- your depletion deduction on oil and gas proper- Business entities and family members. ent producer or royalty owner of oil and gas, ties is reported by the partnership or S corpora- You must allocate the depletable oil or gas your deduction for percentage depletion is limi- tion on Schedule K-1 (Form 1065) or on Sched- quantity among the following related persons in ted to the smaller of the following. ule K-1 (Form 1120-S). Deduct oil and gas proportion to each business entity's or family • 100% of your taxable income from the depletion for your partnership or S corporation member's production of domestic oil or gas for property figured without the deduction for interest on Schedule E (Form 1040). The deple- the year. depletion and the deduction for qualified tion deducted on Schedule E is included in fig- • Corporations, trusts, and estates if 50% or business income under section 199A. For uring income or loss from rental real estate or more of the beneficial interest is owned by a definition of taxable income from the royalty properties. The Instructions for Sched- the same or related persons (considering property, see Taxable income limit, earlier, ule E (Form 1040) explain where to report this only persons that own at least 5% of the under Mineral Property. income or loss and whether you need to file ei- beneficial interest). • 65% of your taxable income for the year ther of the following forms. • You and your spouse and minor children. figured without the deduction for depletion, • Form 6198. the deduction for qualified business in- • Form 8582. A related person is anyone mentioned in the re- come under section 199A, any net operat- lated persons discussion under Nondeductible ing loss carryback to the tax year under Natural Gas Wells loss in chapter 2 of Pub. 544, except that for section 172, any capital loss carryback to purposes of this allocation, item (1) in that dis- the tax year under section 1212, and in the You can use percentage depletion for a well cussion includes only an individual, his or her case of a trust, any distribution to its bene- that produces natural gas that is either: spouse, and minor children. ficiary (with certain exceptions). • Regulated natural gas, Controlled group of corporations. Mem- You can carry over to the following year any • Sold under a fixed contract, or bers of the same controlled group of corpora- amount you cannot deduct because of the • Produced from geopressured brine. tions are treated as one taxpayer when figuring 65%-of-taxable-income limit. Add it to your de- the depletable oil or natural gas quantity. They pletion allowance (before applying any limits) Regulated natural gas. Regulated natural gas share the depletable quantity. A controlled for the following year. qualifies for a percentage depletion rate of 22%. group of corporations is defined in section Regulated natural gas is domestic natural gas 1563(a), except that, for this purpose, the stock Partnerships and S Corporations produced and sold by the producer before July ownership requirement in that definition is 1, 1976, and is regulated by the Federal Power Commission. The price for regulated gas can- “more than 50%” rather than “at least 80%.” Generally, each partner or S corporation share- not be adjusted to reflect any increase in the holder, and not the partnership or S corpora- seller’s tax liability because of the repeal of per- Gross income from the property. For purpo- tion, figures the depletion allowance separately. centage depletion for gas. Price increases after ses of percentage depletion, gross income from Each partner or shareholder must decide February 1, 1975, are presumed to take the in- the property (in the case of oil and gas wells) is whether to use cost or percentage depletion. If crease in tax liability into account unless dem- the amount you receive from the sale of the oil a partner or shareholder uses percentage de- onstrated otherwise by clear and convincing or gas in the immediate vicinity of the well. If pletion, he or she must apply the 65%-of-taxa- evidence. you do not sell the oil or gas on the property but ble-income limit using his or her taxable income manufacture or convert it into a refined product from all sources.

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Natural gas sold under a fixed contract. owners or operators of ores or minerals from Lessor's Gross Income Natural gas sold under a fixed contract qualifies the waste or residue of prior mining. This does for a percentage depletion rate of 22%. Natural not apply to extraction from waste or residue of In the case of leased property, the depletion de- gas sold under a fixed contract is domestic nat- prior mining by the purchaser of the waste or duction is divided between the lessor and the ural gas sold by the producer under a contract residue or the purchaser of the rights to extract lessee. that does not provide for a price increase to re- ores or minerals from the waste or residue. flect any increase in the seller's tax liability be- A lessor's gross income from the property cause of the repeal of percentage depletion for Treatment processes. The processes in- that qualifies for percentage depletion is usually gas. The contract must have been in effect from cluded as mining depend on the ore or mineral the total of the royalties received from the lease. February 1, 1975, until the date of sale of the mined. To qualify as mining, the treatment pro- gas. Price increases after February 1, 1975, are cesses must be applied by the mine owner or Bonuses and advanced royalties. Bonuses presumed to take the increase in tax liability into operator. For a listing of treatment processes and advanced royalties are payments a lessee account unless demonstrated otherwise by considered as mining, see section 613(c)(4) makes before production to a lessor for the clear and convincing evidence. and the related regulations. grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. If you Transportation of more than 50 miles. If are the lessor, your income from bonuses and Natural gas from geopressured brine. ore or mineral must be transported more than advanced royalties received is subject to an al- Qualified natural gas from geopressured brine 50 miles to plants or mills to be treated because lowance for depletion, as explained in the next is eligible for a percentage depletion rate of of physical and other requirements, the addi- two paragraphs. 10%. This is natural gas that meets both of the tional authorized transportation may be consid- following conditions. ered mining and included in the calculation of Figuring cost depletion. To figure cost Produced from a well you began to drill af- • gross income from mining if authorized by the depletion on a bonus, multiply your adjusted ba- ter September 1978 and before 1984. IRS. sis in the property by a fraction, the numerator Determined in accordance with section • of which is the bonus and the denominator of 503 of the Natural Gas Policy Act of 1978 If you wish to include transportation of which is the total bonus and royalties expected to be produced from geopressured brine. more than 50 miles in the calculation of gross income from mining, request an to be received. To figure cost depletion on ad- advance ruling from the IRS. Include in the re- vanced royalties, use the calculation explained Mines and Geothermal quest the facts about the physical and other re- earlier under Cost Depletion, treating the num- Deposits quirements that prevented the construction and ber of units for which the advanced royalty is re- operation of the plant (in which mining pro- ceived as the number of units sold. Certain mines, oil and gas wells, and other nat- cesses are applied) within 50 miles of the point Figuring percentage depletion. In the ural deposits, including geothermal deposits, of extraction. For more information about re- case of mines, wells, and other natural deposits qualify for percentage depletion. questing an advance ruling, see Revenue Pro- other than gas, oil, or geothermal property, you cedure 2020-1, available at IRS.gov/irb/ may use the percentage rates discussed earlier Mines, oil and gas wells, and other natural 2020-01_IRB#REV-PROC-2020-1. under Mines and Geothermal Deposits. Any bo- deposits. The percentage of your gross in- nus or advanced royalty payments are gener- come from the property that you can deduct as Disposal of coal or iron ore. You cannot take ally part of the gross income from the property depletion depends on the type of deposit. a depletion deduction for coal (including lignite) to which the rates are applied in making the cal- See section 613(b) and Regulations section or iron ore mined in the United States if both of culation. However, for oil, gas, or geothermal 1.613-2 for the percentage depletion rates. the following apply. property, gross income does not include lease Corporate deduction for iron ore and • You disposed of it after holding it for more bonuses, advanced royalties, or other amounts coal. The percentage depletion deduction of a than 1 year. payable without regard to production from the corporation for iron ore and coal (including lig- • You disposed of it under a contract under property. which you retain an economic interest in nite) is reduced by 20% (0.20) of: Ending the lease. If you receive a bonus the coal or iron ore. • The percentage depletion deduction for on a lease that ends or is abandoned before the tax year (figured without this reduc- Treat any gain on the disposition as a capital you derive any income from mineral extraction tion), minus gain. or the cutting of timber, include in income the • The adjusted basis of the property at the depletion deduction you took on the bonus. Do Disposal to related person. This rule close of the tax year (figured without the this for the year the lease ends or is aban- does not apply if you dispose of the coal or iron depletion deduction for the tax year). doned. Also, increase your adjusted basis in the ore to one of the following persons. property to restore the depletion deduction you A related person (as listed in chapter 2 of Gross income from the property. For prop- • previously subtracted. Pub. 544). erty other than a geothermal deposit or an oil or For advanced royalties, include in income A person owned or controlled by the same gas well, gross income from the property • the depletion claimed on minerals for which the interests that own or control you. means the gross income from mining. Mining advanced royalties were paid if the minerals includes all of the following. were not produced or any timber cut before the Geothermal deposits. Geothermal deposits • Extracting ores or minerals from the lease ended. Include this amount in income for located in the United States or its possessions ground. the year the lease ends. Increase your adjusted qualify for a percentage depletion rate of 15%. • Applying certain treatment processes de- basis in the property by the amount you include A geothermal deposit is a geothermal reservoir scribed below. in income. • Transporting ores or minerals (generally, of natural heat stored in rocks or in a watery liq- uid or vapor (whether or not under pressure). not more than 50 miles) from the point of Delay rentals. These are payments for defer- For percentage depletion purposes, a geother- extraction to the plants or mills in which the ring development of the property. Since delay mal deposit is not considered a gas well. treatment processes are applied. rentals are ordinary rent, they are ordinary in- Figure gross income from the property for a Excise tax. Gross income from mining in- come to the payee that is not subject to deple- geothermal steam well in the same way as for tion. These rentals can be avoided by either cludes the separately stated excise tax re- oil and gas wells. See Gross income from the ceived by a mine operator from the sale of coal abandoning the lease, beginning development property, earlier, under Oil and Gas Wells. Per- operations, or obtaining production. to compensate the operator for the excise tax centage depletion on a geothermal deposit can- the mine benefits provided under the Black not be more than 50% of your taxable income Lung Benefits Revenue Act of 1977. from the property. Extraction. Extracting ores or minerals from the ground includes extraction by mine

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sis for determining gain or loss in the tax year Topics Timber you sell the timber products. This chapter discusses: Example. The facts are the same as in the • Definition of business You can figure timber depletion only by the cost previous example, except that you sold only • When a debt becomes worthless method. Percentage depletion does not apply half of the timber products in the cutting year. • How to claim a business bad debt to timber. Base your depletion on your cost or You would deduct $20,000 of the $40,000 de- • Recovery of a bad debt other basis in the timber. Your cost does not in- pletion that year. You would add the remaining clude the cost of land or any amounts recovera- $20,000 depletion to your closing inventory of ble through depreciation. timber products. Useful Items You may want to see: Depletion takes place when you cut stand- Electing to treat the cutting of timber as a ing timber. You can figure your depletion de- sale or exchange. You can elect, under cer- Publication duction when the quantity of cut timber is first tain circumstances, to treat the cutting of timber accurately measured in the process of exploita- 525 525 Taxable and Nontaxable Income held for more than 1 year as a sale or ex- tion.

change. You must make the election on your in- 536 536 Net Operating Losses (NOLs) for Figuring cost depletion. To figure your cost come tax return for the tax year to which it ap- Individuals, Estates, and Trusts depletion allowance, you multiply the number of plies. If you make this election, subtract the 544 544 Sales and Other Dispositions of timber units cut by your depletion unit. adjusted basis for depletion from the FMV of the timber on the first day of the tax year in Assets

Timber units. When you acquire timber which you cut it to figure the gain or loss on the 550 550 Investment Income and Expenses property, you must make an estimate of the cutting. You generally report the gain as quantity of marketable timber reasonably long-term capital gain. The FMV then becomes 556 556 Examination of Returns, Appeal known, or on good evidence believed to exist your basis for figuring your ordinary gain or loss Rights, and Claims for Refund on the property. You measure the timber using on the sale or other disposition of the products board feet, log scale, cords, or other units. If cut from the timber. For more information, see Form (and Instructions) Timber in chapter 2 of Pub. 544. you later determine that you have more or less Schedule C (Form 1040) Schedule C (Form 1040) Profit or Loss units of timber, you must adjust the original esti- You may revoke an election to treat the cut- From Business mate. ting of timber as a sale or exchange without the The term “timber property” means your eco- IRS's consent. The prior election (and revoca- 1040-X 1040-X Amended U.S. Individual Income nomic interest in standing timber in each tract or tion) is disregarded for purposes of making a Tax Return block representing a separate timber account. subsequent election. See Form T (Timber) for 1045 1045 Application for Tentative Refund more information. Depletion unit. You figure your depletion 1065 1065 U.S. Return of Partnership Income unit each year by taking the following steps. Form T (Timber). Complete and attach Form 1065-X 1065-X Amended Return or 1. Determine your cost or adjusted basis of T (Timber) to your income tax return if you claim Administrative Adjustment Request the timber on hand at the beginning of the a deduction for timber depletion, choose to treat (AAR) year. Adjusted basis is defined under Cost the cutting of timber as a sale or exchange, or

Depletion in the discussion on Mineral make an outright sale of timber. 1120-S 1120-S U.S. Income Tax Return for an S Property, earlier. Corporation

2. Add to the amount determined in (1) the 1120-X 1120-X Amended U.S. Corporation cost of any timber units acquired during Income Tax Return the year and any additions to capital.

1139 1139 Corporation Application for 3. Figure the number of timber units to take Tentative Refund into account by adding the number of tim-

10. 3115 3115 Application for Change in ber units acquired during the year to the Accounting Method number of timber units on hand in the ac- count at the beginning of the year and See chapter 12 for information about getting then adding (or subtracting) any correction Business Bad publications and forms. to the estimate of the number of timber units remaining in the account. Debts 4. Divide the result of (2) by the result of (3). Definition of Business This is your depletion unit. Bad Debt Example. You bought a timber tract for Introduction $160,000 and the land was worth as much as A business bad debt is a loss from the worth- You have a bad debt if you cannot collect the timber. Your basis for the timber is $80,000. lessness of a debt that was either: money owed to you. A bad debt is either a busi- Based on an estimated 1 million board feet • Created or acquired in your trade or busi- ness bad debt or a nonbusiness bad debt. This (FBM) or (1,000 MFBM) of standing timber, you ness, or chapter discusses only business bad debts. figure your depletion unit to be $80 per MFBM • Closely related to your trade or business Generally, a business bad debt is one that ($80,000 ÷ 1,000). If you cut 500 MFBM of tim- when it became partly or totally worthless. comes from operating your trade or business. ber, your depletion allowance would be $40,000 You can deduct business bad debts on Sched- A debt is closely related to your trade or (500 MFBM × $80). ule C (Form 1040) or your applicable business business if your primary motive for incurring the income tax return. debt is business related. Bad debts of a corpo- When to claim depletion. Claim your deple- All other bad debts are nonbusiness bad ration (other than an S corporation) are always tion allowance as a deduction in the year of sale debts and are deductible only as short-term business bad debts. or other disposition of the products cut from the capital losses. For more information on nonbus- timber, unless you choose to treat the cutting of iness bad debts, see Pub. 550. timber as a sale or exchange (explained below). Credit sales. Business bad debts are mainly Include allowable depletion for timber products the result of credit sales to customers. Goods not sold during the tax year the timber is cut as that have been sold, but not yet paid for, and a cost item in the closing inventory of timber services that have been performed, but not yet products for the year. The inventory is your ba- paid for, are recorded in your books as either

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accounts receivable or notes receivable. After a utor for a business reason and you’re unable to Rights against a borrower. When you reasonable period of time, if you have tried to collect the loan after attempting to do so, you make payment on a loan you guaranteed, you collect the amount due, but are unable to do so, have a business bad debt. may have the right to take the place of the the uncollectible part becomes a business bad lender. The debt is then owed to you. If you debt. Debts owed by political parties. If a political have this right, or some other right to demand Accounts or notes receivable valued at fair party (or other organization that accepts contri- payment from the borrower, you can’t claim a market value (FMV) when received are deducti- butions or spends money to influence elections) bad debt deduction until these rights become ble only at that value, even though the FMV owes you money and the debt becomes worth- partly or totally worthless. may be less than the . If you pur- less, you can claim a bad debt deduction only if chased an account receivable for less than its all of the following requirements are met. Joint debtor. If two or more debtors jointly owe you money, your inability to collect from face value, and the receivable subsequently be- 1. You use an accrual method of accounting. comes worthless, the most you’re allowed to one doesn’t enable you to deduct a proportion- deduct is the amount you paid to acquire it. 2. The debt arose from the sale of goods or ate amount as a bad debt. services in the ordinary course of your You can claim a business bad debt de- trade or business. Sale of mortgaged property. If mortgaged or ! duction only if the amount owed to you pledged property is sold for less than the debt, CAUTION 3. More than 30% of your receivables ac- was previously included in gross in- the unpaid, uncollectible balance of the debt is crued in the year of the sale were from come. This applies to amounts owed to you a bad debt. from all sources of taxable income, including sales to political parties. sales, services, rents, and interest. 4. You made substantial and continuing ef- forts to collect on the debt. When a Debt Becomes Accrual method. If you use an accrual method of accounting, you generally report in- Loan or capital contribution. You cannot Worthless come as you earn it. You can only claim a bad claim a bad debt deduction for a loan you made debt deduction for an uncollectible receivable if to a corporation if, based on the facts and cir- A debt becomes worthless when there is no you have previously included the uncollectible cumstances, the loan is actually a contribution longer any chance the amount owed will be amount in income. to capital. paid. This may occur on the date the debt is If you qualify, you can use the nonac- due or prior to that date. crual-experience method of accounting, dis- Debts of an insolvent partner. If your busi- cussed later. Under this method, you don’t have ness partnership breaks up and one of your for- To demonstrate worthlessness, you must to accrue income that, based on your experi- mer partners becomes insolvent, you may have only show that you have taken reasonable ence, you don’t expect to collect. to pay more than your share of the part- steps to collect the debt but were unable to do nership's debts. If you pay any part of the insol- so. It isn’t necessary to go to court if you can Cash method. If you use the cash method vent partner's share of the debts, you can claim show that a judgment from the court would be of accounting, you generally report income a bad debt deduction for the amount you paid uncollectible. of your debtor is gen- when you receive payment. You can’t claim a that is attributable to the insolvent partner's erally good evidence of the worthlessness of at bad debt deduction for amounts owed to you share. least a part of an unsecured and unpreferred because you never included those amounts in debt. income. For example, a cash basis architect guarantee. If you guarantee a can’t claim a bad debt deduction if a client fails debt that subsequently becomes worthless, the Property received for debt. If you receive to pay the bill because the architect's fee was debt can qualify as a business bad debt if all of property in partial settlement of a debt, reduce never included in income. the following requirements are met. the debt by the property's FMV, which becomes You made the guarantee in the course of the property's basis. You can deduct the re- Debts from a former business. If you sell • your trade or business. maining debt as a bad debt if and when it be- your business but retain its receivables, these You have a legal duty to pay the debt. comes worthless. debts are business debts because they arose • You made the guarantee before the debt out of your trade or business. If any of these re- • If you later sell the property for more than its became worthless. You meet this require- ceivables subsequently become worthless, the basis, any gain on the sale is due to the appre- ment if you reasonably expected you loss is still a business bad debt. ciation of the property. It isn’t a recovery of a wouldn’t have to pay the debt without full bad debt. For information on the sale of an as- Debt acquired from a decedent. The reimbursement from the borrower. set, see Pub. 544. character of a loss from debts of a business ac- • You received reasonable consideration for quired from a decedent is determined in the making the guarantee. You meet this re- same way as debts acquired on the purchase of quirement if you made the guarantee ac- How To Claim a a business. The executor of the decedent's es- cording to normal business practice or for tate treats any loss from the debts as a busi- a good faith business purpose. Business Bad Debt ness bad debt if the debts were closely related to the decedent's trade or business when they Example. Jane Zayne owns the Zayne There are two methods to claim a business bad became worthless. Otherwise, a loss from Dress Company. She guaranteed payment of a debt. these debts becomes a nonbusiness bad debt $20,000 note for Elegant , a dress out- • The specific charge-off method. for the decedent's estate. let. Elegant Fashions is one of Zayne's largest • The nonaccrual-experience method. clients. Elegant Fashions later defaulted on the Generally, you must use the specific charge-off Liquidation. If you liquidate your business loan. As a result, Ms. Zayne paid the remaining method. However, you may use the nonac- and some of the accounts receivable that you balance of the loan in full to the . crual-experience method if you meet the re- retain become worthless, they’re treated as She can claim a business bad debt deduc- quirements discussed later under Nonac- business bad debts. tion only for the amount she paid because her crual-Experience Method. guarantee was made in the course of her trade Types of Business Bad or business for a good faith business purpose. She was motivated by the desire to retain one Specific Charge-off Method Debts of her better clients and keep a sales outlet. If you use the specific charge-off method, you Business bad debts may result from the follow- Deductible in the year paid. If you make can deduct specific business bad debts that be- ing. a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have come either partly or totally worthless during the Loans to clients and suppliers. If you loan rights against the borrower. tax year. However, with respect to partly worth- money to a client, supplier, employee, or distrib- less bad debts, your deduction is limited to the

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amount you charged off on your books during the year. Claim

Partly worthless debts. You can deduct spe- IF you filed as THEN file... 11. cific bad debts that become partly uncollectible a... during the tax year. Your tax deduction is limi- sole proprietor ted to the amount you charge off on your books Form 1040-X. during the year. You don’t have to charge off or farmer Other Expenses and deduct your partly worthless debts annu- corporation Form 1120-X. ally. You can delay the charge-off until a later S corporation Form 1120-S and check year. However, you can’t deduct any part of a box H(4). What's New debt after the year it becomes totally worthless. partnership Form 1065-X if filing on Significantly modified debt. An excep- Standard mileage rate. For tax year 2020, the paper or tion to the charge-off rule exists for debt that standard mileage rate for the cost of operating Form 1065 and check box has been significantly modified and on which your car, van, pickup, or panel truck for busi- G(5) if filing electronically. the holder recognized gain. For more informa- ness use is 57.5 cents per mile. For more infor- tion, see Regulations section 1.166-3(a)(3). mation, see Car and truck expenses under Mis- cellaneous Expenses, later. Deduction disallowed. Generally, you Nonaccrual-Experience can claim a partial bad debt deduction only in Method the year you make the charge-off on your Reminders books. If, under , the IRS doesn’t allow Generally, a person using accrual accounting your deduction and the debt becomes partly isn’t required to accrue a service-provided re- No miscellaneous itemized deductions al- worthless in a later tax year, you can deduct the ceivable that experience shows won't be collec- lowed. You can no longer claim any miscella- amount you charged off in that year plus the ted if: neous itemized deductions, including the de- disallowed amount charged off in the earlier • The service provided is health, law, engi- duction for repayments (claim of right). year. The charge-off in the earlier year, unless neering, architecture, accounting, actuarial Miscellaneous itemized deductions are those reversed on your books, fulfills the charge-off science, performing arts, or consulting; or deductions that would have been subject to the requirement for the later year. • The person's average annual gross re- 2%-of-adjusted-gross-income limitation. ceipts for all previous 3-tax-year periods Totally worthless debts. If a debt becomes doesn’t exceed $26 million. Qualified business income deduction. For totally worthless in the current tax year, you can tax years beginning after 2017, individual tax- deduct the entire amount minus any amount de- See section 448 for details and exceptions. payers and some trusts and estates may be en- ducted in an earlier tax year when the debt was titled to a deduction of up to 20% of their Quali- only partly worthless. fied Business Income (QBI) from a trade or You don’t have to make an actual charge-off Recovery of a Bad Debt business, including income from a pass-through on your books to claim a bad debt deduction for entity, but not from a , plus 20% of a totally worthless debt. However, you may If you claim a deduction for a bad debt on your qualified real estate investment trust (REIT) div- want to do so. If you don’t and the IRS later income tax return and later recover (collect) all idends and qualified publicly traded partnership rules the debt is only partly worthless, you will or part of it, you may have to include all or part (PTP) income. The deduction is subject to mul- not be allowed a deduction for the debt in that of the recovery in gross income. The amount tiple limitations, such as the type of trade or tax year because a deduction of a partly worth- you include is limited to the amount you actually business, the taxpayer’s taxable income, the less bad debt is limited to the amount actually deducted. However, you can exclude the amount of W-2 wages paid in the trade or busi- charged off. See Partly worthless debts, earlier. amount deducted that did not reduce your tax. ness, and the unadjusted basis immediately af- Report the recovery as “Other income” on the ter acquisition (UBIA) of qualified property held Filing a claim for refund. If you didn’t deduct appropriate business form or schedule. by the trade or business. The deduction can be a bad debt on your original return for the year it taken in addition to the standard or itemized de- became worthless, you can file a claim for a See Recoveries in Pub. 525 for more infor- ductions. See the Instructions for Form 8995 credit or refund. If the bad debt was totally mation. and the Instructions for Form 8995-A for more worthless, you must file the claim by the later of NOL carryover. If a bad debt deduction in- information. the following dates. creases an NOL carryover that has not expired Travel, meals, and entertainment. In gen- • 7 years from the date your original return before the beginning of the tax year in which the was due (not including extensions). eral, entertainment expenses are no longer de- recovery takes place, you treat the deduction as ductible. For more information on travel and • 2 years from the date you paid the tax. having reduced your tax. A bad debt deduction non-entertainment related meals, including de- If the claim is for a partly worthless bad debt, that contributes to an NOL helps lower taxes in ductibility, see Pub. 463. you must file the claim by the later of the follow- the year to which you carry the NOL. For more ing dates. information about NOLs for individuals, see Certain payments made in sexual harass- • 3 years from the date you filed your original Pub. 536. Also, see the Instructions for Form ment or sexual abuse cases. For amounts return. 1045, and the Instructions for Form 1139. paid or incurred after December 22, 2017, new • 2 years from the date you paid the tax. section 162(q) provides that no deduction is al- lowed under section 162 for any settlement or You may have longer to file the claim if you payment related to or sexual were unable to manage your financial affairs abuse if it is subject to a nondisclosure agree- due to a physical or mental impairment. Such ment. In addition, attorney’s fees related to such an impairment requires proof of existence. a settlement or payment aren’t allowed as a de- For details and more information about filing duction. a claim, see Pub. 556. Use one of the following forms to file a claim. For more information, see the instructions for the applicable form. Introduction Table 10-1. Forms Used To File a This chapter covers business expenses that may not have been explained to you, as a busi- ness owner, in previous chapters of this publi- cation.

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Topics To be deductible for tax purposes, expen- • You make the advance within a reasonable This chapter discusses: ses incurred for travel and non-entertainment period of time of your employee paying or related meals must be ordinary and necessary incurring the expense. • Travel and non-entertainment related expenses incurred while carrying on your trade meals or business. Generally, you must also show that If any expenses reimbursed under this ar- • Bribes and kickbacks non-entertainment related meals expenses are rangement aren’t substantiated, or an excess • Charitable contributions directly related to, or associated with, the con- reimbursement isn’t returned within a reasona- • Education expenses duct of your trade or business. For more infor- ble period of time by an employee, you can’t • Lobbying expenses mation on travel and non-entertainment related treat these expenses as reimbursed under an • Penalties and fines meals, including deductibility, see Pub. 463. accountable plan. Instead, treat the reimbursed • Repayments (claim of right) expenses as paid under a nonaccountable • Other miscellaneous expenses Reimbursements plan, discussed later. Adequate accounting. Your employees must Useful Items A “reimbursement or allowance arrangement” You may want to see: adequately account to you for their travel and provides for payment of advances, reimburse- non-entertainment related meals expenses. ments, and allowances for travel and non-enter- They must give you documentary evidence of Publication tainment related meals expenses incurred by their travel, mileage, and other employee busi- your employees during the ordinary course of

15-B ness expenses. This evidence should include 15-B Employer's Tax Guide to Fringe business. If the expenses are substantiated, Benefits items such as receipts, along with either a you can deduct the allowable amount on your statement of expenses, an account book, a 463 463 Travel, Gift, and Car Expenses tax return. Because of differences between ac- day-planner, or similar record in which the em- counting methods and tax law, the amount you

526 526 Charitable Contributions ployee entered each expense at or near the can deduct for tax purposes may not be the time the expense was incurred.

529 529 Miscellaneous Deductions same as the amount you deduct on your busi- ness books and records. For example, you can Excess reimbursement or allowance. An 544 544 Sales and Other Dispositions of deduct 100% of the cost of meals on your busi- Assets excess reimbursement or allowance is any ness books and records. However, only 50% of amount you pay to an employee that is more

946 946 How To Depreciate Property these costs are allowed by law as a tax deduc- than the business-related expenses for which tion. the employee adequately accounted. The em- 970 970 Tax Benefits for Education ployee must return any excess reimbursement How you deduct a business expense under Form (and Instructions) or other expense allowance to you within a rea- a reimbursement or allowance arrangement de- sonable period of time.

Schedule A (Form 1040) Schedule A (Form 1040) Itemized pends on whether you have: Deductions • An accountable plan, or Reasonable period of time. A reasonable • A nonaccountable plan. period of time depends on the facts and circum- Schedule C (Form 1040) Schedule C (Form 1040) Profit or Loss From Business If you reimburse these expenses under an ac- stances. Generally, actions that take place countable plan, deduct them as travel and within the times specified in the following list will

Schedule F (Form 1040) Schedule F (Form 1040) Profit or Loss non-entertainment related meals expenses. be treated as taking place within a reasonable From Farming period of time. If you reimburse these expenses under a 1099-MISC 1099-MISC Miscellaneous Income 1. You give an advance within 30 days of the nonaccountable plan, report the reimburse- time the employee pays or incurs the ex- 1120 1120 U.S. Corporation Income Tax ments as wages on Form W-2, and deduct pense. Return them as wages on the appropriate line of your tax return. If you make a single payment to your 2. Your employees adequately account for 4562 4562 Depreciation and Amortization employees and it includes both wages and an their expenses within 60 days after the ex-

8949 8949 Sales and Other Dispositions of expense reimbursement, you must specify the penses were paid or incurred. Capital Assets amount of the reimbursement and report it ac- 3. Your employees return any excess reim- cordingly. See Table 11-1. 8995 8995 Qualified Business Income bursement within 120 days after the ex- Deduction Simplified Computation penses were paid or incurred. Accountable Plans 8995-A 8995-A Qualified Business Income 4. You give a periodic statement (at least Deduction An accountable plan requires your employees quarterly) to your employees that asks them to either return or adequately ac- W-2 W-2 Wage and Tax Statement to meet all of the following requirements. Each employee must: count for outstanding advances and they See chapter 12 for information about getting comply within 120 days of the date of the publications and forms. 1. Have paid or incurred deductible expen- statement. ses while performing services as your em- ployee, How to deduct. You can claim a deduction for Reimbursement of 2. Adequately account to you for these ex- travel and non-entertainment related meals ex- penses within a reasonable period of time, penses if you reimburse your employees for Travel and and these expenses under an accountable plan. Generally, the amount you can deduct for Non-Entertainment 3. Return any excess reimbursement or al- non-entertainment related meals is subject to a Related Meals lowance within a reasonable period of 50% limit, discussed later. If you are a sole pro- time. prietor, or are filing as a single member limited The following discussion explains how to han- liability company, deduct the travel reimburse- dle any reimbursements or allowances you may An arrangement under which you advance ment on line 24a and the deductible part of the provide to your employees under a reimburse- money to employees is treated as meeting (3) non-entertainment related meals reimburse- ment or allowance arrangement for travel and above only if the following requirements are ment on line 24b of Schedule C (Form 1040). non-entertainment related meals expenses. If also met. If you are filing an income tax return for a you are self-employed and report your income • The advance is reasonably calculated not corporation, include the reimbursement on the and expenses on Schedule C (Form 1040), see to exceed the amount of anticipated ex- Other deductions line of Form 1120. If you are Pub. 463. penses. filing any other business income tax return,

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such as a partnership or S corporation return, Table 11-1. Reporting Reimbursements deduct the reimbursement on the appropriate line of the return as provided in the instructions IF the type of reimbursement (or other expense for that return. allowance) arrangement is under THEN the employer reports on Form W-2 An accountable plan with: Per Diem and Car Allowances Actual expense reimbursement: No amount. Adequate accounting made and excess returned You can reimburse your employees under an accountable plan based on travel days, miles, Actual expense reimbursement: The excess amount as wages in box 1. Adequate accounting and return of excess both required or some other fixed allowance. In these cases, but excess not returned your employee is considered to have accounted to you for the amount of the expense that Per diem or mileage allowance up to the federal rate: No amount. doesn’t exceed the rates established by the Adequate accounting made and excess returned federal government. Your employee must ac- Per diem or mileage allowance up to the federal rate: The excess amount as wages in box 1. The amount up to tually substantiate to you the other elements of Adequate accounting and return of excess both required the federal rate is reported only in box 12—it isn’t the expense, such as time, place, and business but excess not returned reported in box 1. purpose. Per diem or mileage allowance exceeds the federal rate: The excess amount as wages in box 1. The amount up to Adequate accounting made up to the federal rate only and the federal rate is reported only in box 12—it isn’t Federal rate. The federal rate can be figured excess not returned reported in box 1. using any one of the following methods. A nonaccountable plan with: 1. For car expenses: Either adequate accounting or return of excess, or both, not The entire amount as wages in box 1. required by plan a. The standard mileage rate. No reimbursement plan The entire amount as wages in box 1. b. A fixed and variable rate (FAVR). You can pay only an M&IE allowance to em- Reporting per diem and car allowances. 2. For per diem amounts: ployees who travel away from home if: The following discussion explains how to report a. The regular federal per diem rate. • You pay the employee for actual expenses per diem and car allowances. The manner in for lodging based on receipts submitted to which you report them depends on how the al- b. The standard meal allowance. you, lowance compares to the federal rate. See Ta- c. The high-low rate. • You provide for the lodging, ble 11-1. • You pay for the actual expense of the lodg- Allowance less than or equal to the fed- Car allowance. Your employee is considered ing directly to the provider, eral rate. If your allowance for the employee is to have accounted to you for car expenses that • You don’t have a reasonable belief that less than or equal to the appropriate federal don’t exceed the standard mileage rate. For tax lodging expenses were incurred by the rate, that allowance isn’t included as part of the year 2020, the standard business mileage rate employee, or employee's pay in box 1 of the employee's is 57.5 cents per mile. • The allowance is figured on a basis similar Form W-2. Deduct the allowance as travel ex- You can choose to reimburse your employ- to that used in figuring the employee's wa- penses (including meals that may be subject to ees using an FAVR allowance. This is an allow- ges (that is, number of hours worked or the 50% limit, discussed later). See How to de- ance that includes a combination of payments miles traveled). duct under Accountable Plans, earlier. covering fixed and variable costs, such as a Per diem rates online. You can access cents-per-mile rate to cover your employees' per diem rates at GSA.gov/perdiem. Allowance more than the federal rate. If variable operating costs (such as gas, oil, etc.) your employee's allowance is more than the ap- plus a flat amount to cover your employees' High-low method. This is a simplified propriate federal rate, you must report the al- fixed costs (such as depreciation, insurance, method of figuring the federal per diem rate for lowance as two separate items. etc.). For information on using an FAVR allow- travel within the continental United States. It Include the allowance amount up to the fed- ance, see Revenue Procedure 2019-46, availa- eliminates the need to keep a current list of the eral rate in box 12 (code L) of the employee's ble at IRS.gov/irb/2019-49_IRB#RP-2019-46, per diem rate for each city. Form W-2. Deduct it as travel expenses (ex- and Notice 2020-05, available at IRS.gov/irb/ Under the high-low method, the per diem plained above). This part of the allowance is 2020-04_IRB#NOT-2020-5. amount for travel during January through Sep- treated as reimbursed under an accountable tember of 2020 is $297 ($71 for M&IE) for cer- plan. Per diem allowance. If your employee ac- tain high-cost locations. All other areas have a Include the amount that is more than the tually substantiates to you the other elements per diem amount of $200 ($60 for M&IE). The federal rate in box 1 (and in boxes 3 and 5 if (discussed earlier) of the expenses reimbursed high-cost localities eligible for the higher per they apply) of the employee's Form W-2. De- using the per diem allowance, how you report diem amount under the high-low method are lis- duct it as wages subject to income tax withhold- and deduct the allowance depends on whether ted in Notice 2019-55, available at IRS.gov/irb/ ing, social security, Medicare, and federal un- the allowance is for lodging and meal expenses 2019-42_IRB#Notice-2019-55. employment taxes. This part of the allowance is or for meal expenses only and whether the al- Effective October 1, 2020, the per diem rate treated as reimbursed under a nonaccountable lowance is more than the federal rate. for high-cost locations decreased to $292 ($71 plan (explained later) under Nonaccountable for M&IE). The rate for all other locations de- Plans. Regular federal per diem rate. The regu- creased to $198 ($60 for M&IE). For October, lar federal per diem rate is the highest amount November, and December 2020, you can either the federal government will pay to its employ- Meals continue to use the rates described in the pre- ees while away from home on travel. It has the ceding paragraph or change to the new rates. following two components. Under an accountable plan, you can generally However, you must use the same rate for all deduct only 50% of any otherwise deductible 1. Lodging expense. employees reimbursed under the high-low business-related meal expenses you reimburse method. 2. Meal and incidental expense (M&IE). your employees. The deduction limit applies For more information about the high-low even if you reimburse them for 100% of the ex- The rates are different for different locations. method, see Notice 2020-71, available at penses. See GSA.gov/perdiem for the per diem rates in IRS.gov/irb/2020-40_IRB#NOT-2020-71. See the continental United States. GSA.gov/perdiem for the current per diem rates Application of the 50% limit. The 50% de- for all locations. duction limit applies to reimbursements you Standard meal allowance. The federal make to your employees for expenses they in- rate for M&IE is the standard meal allowance. cur for meals while traveling away from home

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on business and meals for business customers The benefit must be primarily for your employ- These organizations include business leagues, at your place of business, a restaurant, or an- ees who aren’t highly compensated. chambers of commerce, real estate boards, other location. It applies to expenses incurred at For this purpose, a highly compensated em- and trade and professional associations. a business convention or reception, business ployee is an employee who meets either of the meeting, or business luncheon at a club. The following requirements. Nonaccountable Plans deduction limit may also apply to meals you fur- nish on your premises to your employees. 1. Owned a 5%-or-more interest in the busi- ness during the year or the preceding A nonaccountable plan is an arrangement that Related expenses. Taxes and tips relat- year. An employee is treated as owning doesn’t meet the requirements for an accounta- ing to a meal you reimburse to your employee any interest owned by his or her brother, ble plan. All amounts paid, or treated as paid, under an accountable plan are included in the sister, spouse, ancestors, and lineal de- under a nonaccountable plan are reported as amount subject to the 50% limit. However, the scendants. wages on Form W-2. The payments are subject cost of transportation to and from an otherwise to income tax withholding, social security, Medi- 2. Received more than $130,000 in pay for allowable business meal isn’t subject to the care, and federal unemployment taxes. You can the preceding year. You can choose to in- 50% limit. deduct the reimbursement as compensation or clude only employees who were also in wages only to the extent it meets the deductibil- the top 20% of employees when ranked by Amount subject to 50% limit. If you provide ity tests for employees' pay in chapter 2. Deduct pay for the preceding year. your employees with a per diem allowance only the allowable amount as compensation or wa- ges on the appropriate line of your income tax for meal and incidental expenses, the amount For example, the expenses for food, bever- return, as provided in its instructions. treated as an expense for food and beverages ages, and entertainment for a company-wide is the lesser of the following. picnic aren’t subject to the 50% or 100% limit. • The per diem allowance. • The federal rate for M&IE. Meals or entertainment treated as compen- Miscellaneous Expenses If you provide your employees with a per sation. The 50% limit doesn’t apply to either of In addition to travel, meal, and certain entertain- diem allowance that covers lodging, meals, and the following. ment expenses, there are other expenses you incidental expenses, you must treat an amount 1. Expenses for meals or entertainment that can deduct. equal to the federal M&IE rate for the area of you treat as: travel as an expense for food and beverages. If Advertising expenses. You generally can de- the per diem allowance you provide is less than a. Compensation to an employee who duct reasonable advertising expenses that are the federal per diem rate for the area of travel, was the recipient of the meals or en- directly related to your business activities. Gen- you can treat 40% of the per diem allowance as tertainment, and erally, you can’t deduct amounts paid to influ- the amount for food and beverages. b. Wages subject to withholding of fed- ence legislation (for example, lobbying). For eral income tax. more information, see Lobbying expenses, Meal expenses when subject to “hours of later. service” limits. You can deduct 80% of the 2. Expenses for meals or entertainment if: You can usually deduct as a business ex- cost of reimbursed meals your employees con- a. A recipient of the meals or entertain- pense the cost of institutional or goodwill adver- sume while away from their tax home on busi- ment who isn’t your employee has to tising to keep your name before the public if it ness during, or incident to, any period subject to include the expenses in gross income relates to business you reasonably expect to the Department of Transportation's “hours of as compensation for services or as a gain in the future. For example, the cost of ad- service” limits. prize or award; and vertising that encourages people to contribute See Pub. 463 for a detailed discussion of in- to the Red Cross, to buy U.S. savings bonds, or dividuals subject to the Department of Trans- b. You include that amount on a Form to participate in similar causes is usually deduc- portation's “hours of service” limits. 1099-MISC issued to the recipient, if a Form 1099-MISC is required. tible. De minimis (minimal) fringe benefit. P.L. Anticipated liabilities. Anticipated liabilities or 115-97, Tax Cuts and Jobs Act, changed the Sales of meals or entertainment. You can reserves for anticipated liabilities aren’t deducti- rules for the deduction of food or beverage ex- deduct the cost of meals or entertainment (in- ble. For example, assume you sold 1-year TV penses that are excludable from employee in- cluding the use of facilities) you sell to the pub- service contracts this year totaling $50,000. come as a de minimis fringe benefit. For lic. For example, if you run a nightclub, your ex- From experience, you know you will have ex- amounts incurred or paid after 2017, the 50% pense for the entertainment you furnish to your penses of about $15,000 in the coming year for limit on deductions for food or beverage expen- customers, such as a floor show, is a business these contracts. You can’t deduct any of the ses also applies to food or beverage expenses expense that is fully deductible. The 100% limit $15,000 this year by charging expenses to a re- excludable from employee income as a de mini- doesn’t apply to this expense. serve or liability account. You can deduct your mis fringe benefit. While your business deduc- Providing meals or entertainment to gen- expenses only when you actually pay or accrue tion may be limited, the rules that allow you to eral public to promote goodwill. You can them, depending on your accounting method. exclude certain de minimis meals and meals on deduct the cost of providing meals, entertain- your business premises from your employee's ment, or recreational facilities to the general Bribes and kickbacks. Engaging in the pay- wages still apply. See Meals in section 2 of public as a means of advertising or promoting ment of bribes or kickbacks is a serious criminal Pub. 15-B. goodwill in the community. The 50% or 100% matter. Such activity could result in criminal prosecution. Any payments that appear to have Company cafeteria or executive dining limit doesn’t apply to this expense. been made, either directly or indirectly, to an of- room. The cost of food and beverages you Director, stockholder, or employee meet- ficial or employee of any government or an provide primarily to your employees on your ings. You can deduct entertainment expenses agency or instrumentality of any government business premises is deductible. This includes directly related to business meetings of your aren’t deductible for tax purposes and are in vi- the cost of maintaining the facilities for provid- employees, partners, stockholders, agents, or olation of the law. ing the food and beverages. These expenses directors. You can provide some minor social are subject to the 50% limit unless they are Payments paid directly or indirectly to a per- activities, but the main purpose of the meeting compensation to your employees (explained son in violation of any federal or state law (but must be your company's business. These ex- later). only if that state law is generally enforced, de- penses are subject to the 100% limit. fined below) that provides for a criminal penalty Employee activities. The expense of provid- or for the loss of a license or privilege to engage Trade association meetings. You can de- ing recreational, social, or similar activities (in- in a trade or business aren’t allowed as a de- duct expenses directly related to, and neces- cluding the use of a facility) for your employees duction for tax purposes. sary for, attending business meetings or con- is deductible and isn’t subject to the 50% limit. ventions of certain tax-exempt organizations.

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Meaning of “generally enforced.” A state Club dues and membership fees. Generally, Education expenses you incur to meet the law is considered generally enforced unless it is you can’t deduct amounts paid or incurred for minimum requirements of your present trade or never enforced or enforced only for infamous membership in any club organized for business, business, or those that qualify you for a new persons or persons whose violations are extra- pleasure, recreation, or any other social pur- trade or business, aren’t deductible. This is true ordinarily flagrant. For example, a state law is pose. This includes country clubs, golf and ath- even if the education maintains or improves generally enforced unless proper reporting of a letic clubs, hotel clubs, sporting clubs, airline skills presently required in your business. For violation of the law results in enforcement only clubs, and clubs operated to provide meals un- more information on education expenses, see under unusual circumstances. der circumstances generally considered to be Pub. 970. conducive to business discussions. Kickbacks. A kickback is a payment for re- Franchise, trademark, trade name. If you ferring a client, patient, or customer. The com- Exception. The following organizations buy a franchise, trademark, or trade name, you mon kickback situation occurs when money or aren’t treated as clubs organized for business, can deduct the amount you pay or incur as a property is given to someone as payment for in- pleasure, recreation, or other social purpose business expense only if your payments are fluencing a third party to purchase from, use the unless one of the main purposes is to conduct part of a series of payments that are: services of, or otherwise deal with the person entertainment activities for members or their who pays the kickback. In many cases, the per- guests or to provide members or their guests 1. Contingent on productivity, use, or dispo- son whose business is being sought or enjoyed with access to entertainment facilities. sition of the item; by the person who pays the kickback isn’t • Boards of trade. 2. Payable at least annually for the entire aware of the payment. • Business leagues. term of the transfer agreement; and For example, the Yard Corporation is in the • Chambers of commerce. business of repairing ships. It returns 10% of • Civic or public service organizations. 3. Substantially equal in amount (or payable the repair bills as kickbacks to the captains and • Professional organizations such as bar as- under a fixed formula). chief officers of the vessels it repairs. Although sociations and medical associations. When determining the term of the transfer this practice is considered an ordinary and nec- • Real estate boards. agreement, include all renewal options and any essary expense of getting business, it is clearly • Trade associations. other period for which you and the transferor a violation of a state law that is generally en- reasonably expect the agreement to be re- forced. These expenditures aren’t deductible Credit card convenience fees. Credit card newed. for tax purposes, whether or not the owners of companies charge a fee to businesses who ac- A franchise includes an agreement that the shipyard are subsequently prosecuted. cept their cards. This fee when paid or incurred gives one of the parties to the agreement the by the business can be deducted as a business right to distribute, sell, or provide goods, serv- Form 1099-MISC. It doesn’t matter expense. whether any kickbacks paid during the tax year ices, or facilities within a specified area. are deductible on your income tax return in re- Damages recovered. Special rules apply to Impairment-related expenses. If you are dis- gards to information reporting. See Form compensation you receive for damages sus- abled, you can deduct expenses necessary for 1099-MISC for more information. tained as a result of patent infringement, breach you to be able to work (impairment-related ex- of contract or fiduciary duty, or antitrust viola- penses) as a business expense, rather than as Car and truck expenses. The costs of operat- tions. You must include this compensation in a medical expense. ing a car, truck, or other vehicle in your busi- your income. However, you may be able to take ness may be deductible. For more information a special deduction. The deduction applies only You are disabled if you have either of the fol- on how to figure your deduction, see Pub. 463. to amounts recovered for actual economic in- lowing. jury, not any additional amount. The deduction • A physical or mental disability (for exam- Charitable contributions. Cash payments to is the smaller of the following. ple, blindness or deafness) that function- an organization, charitable or otherwise, may • The amount you received or accrued for ally limits your being employed. be deductible as business expenses if the pay- damages in the tax year reduced by the • A physical or mental impairment that sub- ments aren’t charitable contributions or gifts amount you paid or incurred in the year to stantially limits one or more of your major and are directly related to your business. If the recover that amount. life activities. payments are charitable contributions or gifts, • Your losses from the injury you haven’t de- The expense qualifies as a business ex- you can’t deduct them as business expenses. ducted. pense if all the following apply. However, corporations (other than S corpora- • Your work clearly requires the expense for tions) can deduct charitable contributions on Demolition expenses or losses. Amounts you to satisfactorily perform that work. their income tax returns, subject to limitations. paid or incurred to demolish a structure aren’t • The goods or services purchased are See the Instructions for Form 1120 for more in- deductible. These amounts are added to the clearly not needed or used, other than inci- formation. Sole proprietors, partners in a part- basis of the land where the demolished struc- dentally, in your personal activities. nership, or shareholders in an S corporation ture was located. Any loss for the remaining un- • Their treatment isn’t specifically provided may be able to deduct charitable contributions depreciated basis of a demolished structure for under other tax law provisions. made by their business on Schedule A (Form wouldn’t be recognized until the property is dis- 1040). posed of. Example. You are blind. You must use a reader to do your work, both at and away from Example. You paid $15 to a local church Education expenses. Ordinary and neces- your place of work. The reader's services are for a half-page ad in a program for a concert it is sary expenses paid for the cost of the education only for your work. You can deduct your expen- sponsoring. The purpose of the ad was to en- and training of your employees are deductible. ses for the reader as a business expense. courage readers to buy your products. Your See Education Expenses in chapter 2. payment isn’t a charitable contribution. You can You can also deduct the cost of your own Internet-related expenses. Generally, you deduct it as an advertising expense. education (including certain related travel) rela- can deduct Internet-related expenses including ted to your trade or business. You must be able domain registration fees and webmaster con- Example. You made a $100,000 donation to show the education maintains or improves sulting costs. If you are starting a business, you to a committee organized by the local Chamber skills required in your trade or business, or that may have to amortize these expenses as of Commerce to bring a convention to your city, it is required by law or regulations, for keeping start-up costs. For more information about am- intended to increase business activity, including your license to practice, status, or job. For ex- ortizing start-up and organizational costs, see yours. Your payment isn’t a charitable contribu- ample, an attorney can deduct the cost of at- chapter 8. tion. You can deduct it as a business expense. tending Continuing Legal Education (CLE) See Pub. 526 for a discussion of donated in- classes that are required by the state bar asso- Interview expense allowances. Reimburse- ventory, including capital gain property. ciation to maintain his or her license to practice ments you make to job candidates for transpor- law. tation or other expenses related to interviews for possible employment aren’t wages. You can

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deduct the reimbursements as a business ex- • Participating in or intervening in any politi- Moving machinery. Generally, the cost of pense. However, expenses for food and bever- cal campaign for, or against, any candidate moving machinery from one city to another is a ages are subject to the 50% limit discussed ear- for public office. deductible expense. So is the cost of moving lier under Meals and Entertainment. • Attempting to influence the general public, machinery from one plant to another, or from or segments of the public, about elections, one part of your plant to another. You can de- Legal and professional fees. Fees charged legislative matters, or referendums. duct the cost of installing the machinery in the by and attorneys that are ordinary • Communicating directly with covered ex- new location. However, you must capitalize the and necessary expenses directly related to op- ecutive branch officials (defined later) in costs of installing or moving newly purchased erating your business are deductible as busi- any attempt to influence the official actions machinery. ness expenses. However, legal fees you pay to or positions of those officials. acquire business assets usually aren’t deducti- • Researching, preparing, planning, or coor- Outplacement services. The costs of out- ble. These costs are added to the basis of the dinating any of the preceding activities. placement services you provide to your employ- property. ees to help them find new employment, such as Your expenses for influencing legislation counseling, resume assistance, skills as- Fees that include payments for work of a and communicating directly with a covered ex- sessment, etc., are deductible. personal nature (such as drafting a will or dam- ecutive branch official include a portion of your ages arising from a personal injury) aren’t al- labor costs and general and administrative The costs of outplacement services may lowed as a business deduction on Schedule C costs of your business. For information on mak- cover more than one deduction category. For (Form 1040). If the invoice includes both busi- ing this allocation, see section 1.162-28 of the example, deduct as a utilities expense the cost ness and personal charges, figure the business regulations. of telephone calls made under this service and portion as follows: multiply the total amount of deduct as a rental expense the cost of renting You can’t claim a charitable or business ex- the bill by a fraction, the numerator of which is machinery and equipment for this service. pense deduction for amounts paid to an organi- the amount attributable to business matters, the zation if both of the following apply. For information on whether the value of out- denominator of which is the total amount paid. • The organization conducts lobbying activi- placement services is includible in your employ- The result is the portion of the invoice attributa- ties on matters of direct financial interest to ees' income, see Pub. 15-B. ble to business expenses. The portion attributa- your business. ble to personal matters is the difference be- • A principal purpose of your contribution is Penalties and fines. Penalties paid for late tween the total amount and the business to avoid the rules discussed earlier that performance or nonperformance of a contract portion (figured above). prohibit a business deduction for lobbying are generally deductible. For instance, you own Legal fees related to doing or keeping your expenses. and operate a construction company. Under a job, such as those you paid to defend yourself contract, you are to finish construction of a against criminal charges arising out of your If a tax-exempt organization, other than a building by a certain date. Due to construction trade or business, may be deductible on Sched- section 501(c)(3) organization, provides you delays, the building isn’t completed and ready ule A (Form 1040), if you itemize deductions. with a notice on the part of dues that is allocable for occupancy on the date stipulated in the con- For more information, see Pub. 529. to nondeductible lobbying and political expen- tract. You are now required to pay an additional ses, you can’t deduct that part of the dues. amount for each day that completion is delayed Certain payments made in sexual har- beyond the completion date stipulated in the Covered executive branch official. For assment or sexual abuse cases. For contract. These additional costs are deductible purposes of this discussion, a “covered execu- amounts paid or incurred after December 22, business expenses. tive branch official” is any of the following. 2017, new section 162(q) provides that no de- On the other hand, generally, no deduction duction is allowed under section 162 for any 1. The President. is allowed for penalties and fines paid to a gov- settlement or payment related to sexual harass- 2. The Vice President. ernment or specified nongovernmental entity for ment or sexual abuse if it is subject to a nondi- the violation of any law except the following. sclosure agreement. In addition, attorney’s fees 3. Any officer or employee of the White • Amounts that constitute restitution. related to such a settlement or payment aren’t House Office of the Executive Office of the • Amounts paid to come into compliance allowed as a deduction. President and the two most senior level of- with the law. Tax preparation fees. The cost of hiring a ficers of each of the other agencies in the • Amounts paid or incurred as the result of tax professional, such as a certified public ac- Executive Office. certain court orders in which no govern- countant (CPA), to prepare that part of your tax 4. Any individual who: ment or specified nongovernmental return relating to your business as a sole pro- agency is a party. prietor is deductible on Schedule C (Form a. Is serving in a position in Level I of the • Amounts paid or incurred for taxes due. Executive Schedule under section 1040). Deduct expenses of preparing tax On or after December 22, 2017, no deduc- 5312 of title 5, United States Code; schedules relating to rentals or royalties tion is allowed for the restitution amount or (Schedule E), or farm income and expenses b. Has been designated by the Presi- amount paid to come into compliance with the (Schedule F) on the appropriate schedule. Ex- dent as having Cabinet-level status; law unless the amounts are specifically identi- penses for completing the remainder of the re- or fied in the settlement agreement or court order. turn are miscellaneous deductions and are no Also, any amount paid or incurred as reim- c. Is an immediate deputy of an individ- longer deductible. bursement to a government for the costs of any ual listed in item (a) or (b). You can also claim a business deduction for investigation or litigation aren’t eligible for the amounts paid or incurred in resolving asserted Exceptions to denial of deduction. The exceptions and are nondeductible. tax deficiencies for your business operated as a general denial of the deduction doesn’t apply to See section 162(f), as amended by P.L. sole proprietor. the following. 115-97, section 13306. • Any in-house expenses for influencing leg- Examples of nondeductible penalties and Licenses and regulatory fees. Licenses and islation and communicating directly with a fines include the following. regulatory fees for your trade or business paid covered executive branch official if those • Amounts paid because of a conviction for annually to state or local governments are gen- expenses for the tax year don’t exceed a crime or after a plea of guilty or no con- erally deductible. Some licenses and fees may $2,000 (excluding overhead expenses). test in a criminal proceeding. have to be amortized. See chapter 8 for more • Expenses incurred by taxpayers engaged • Amounts paid as a penalty imposed by information. in the trade or business of lobbying (pro- federal, state, or local law in a civil action, fessional lobbyists) on behalf of another including certain additions to tax and addi- Lobbying expenses. Generally, lobbying ex- person (but does apply to payments by the tional amounts and assessable penalties penses aren’t deductible. Lobbying expenses other person to the lobbyist for lobbying imposed by the Internal Revenue Code. include amounts paid or incurred for any of the activities). following activities. • Influencing legislation.

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• Amounts paid in settlement of actual or Repayments. If you had to repay an amount If Method 2 results in less tax, claim the possible liability for a fine or penalty, you included in your income in an earlier year, credit on Schedule 3 (Form 1040), line 12d, and whether civil or criminal. you may be able to deduct the amount repaid write “I.R.C. 1341” next to line 12d. • Amounts forfeited as posted for a for the year in which you repaid it. Or, if the proceeding that could result in a fine or amount you repaid is more than $3,000, you Example. For 2019, you filed a return and penalty. may be able to take a credit against your tax for reported your income on the cash method. In • Fines paid for violating city housing codes. the year in which you repaid it. In most cases, 2020, you repaid $5,000 included in your 2019 • Fines paid by truckers for violating state you can claim a deduction or credit only if the gross income under a claim of right. Your filing maximum highway weight laws. repayment qualifies as an expense or loss in- status in 2020 and 2019 is single. Your income • Fines paid for violating air quality laws. curred in your trade or business or in a for-profit and tax for both years are as follows: • Civil penalties paid for violating federal transaction. laws regarding mining safety standards 2019 2019 and discharges into navigable waters. Type of deduction. The type of deduction you are allowed in the year of repayment de- With Income Without A fine or penalty doesn’t include any of the pends on the type of income you included in the Income following. earlier year. For instance, if you repay an Taxable • Legal fees and related expenses to defend amount you previously reported as a capital Income $15,000 $10,000 yourself in a prosecution or civil action for a gain, deduct the repayment as a capital loss as Tax $ 1,609 $ 1,009 violation of the law imposing the fine or civil explained in the Instructions for Schedule D penalty. (Form 1040). If you reported it as self-employ- 2020 2020 • Court costs or stenographic and printing ment income, deduct it as a business expense charges. on Schedule C (Form 1040), or a farm expense Without With Deduction • Compensatory damages paid to a govern- on Schedule F (Form 1040). Deduction ment. If you reported the amount as wages, unem- Taxable ployment compensation, or other nonbusiness Income $49,950 $44,950 Political contributions. Contributions or gifts ordinary income, you may be able to deduct it Tax $6,785 $5,685 paid to political parties or candidates aren’t de- as an other itemized deduction if the amount re- ductible. In addition, expenses paid or incurred paid is over $3,000. Your tax under Method 1 is $5,685. Your tax un- to take part in any political campaign of a candi- der Method 2 is $6,185, figured as follows: date for public office aren’t deductible. Beginning in 2018, due to the suspen- ! sion of miscellaneous itemized deduc- Indirect political contributions. You CAUTION tions subject to the 2% floor under sec- Tax previously determined for can’t deduct indirect political contributions and tion 67(a), your aren’t able to deduct the 2019 ...... $ 1,609 costs of taking part in political activities as busi- repayment as an itemized deduction if it is Less: Tax as refigured ...... − 1,009 ness expenses. Examples of nondeductible ex- $3,000 or less. penses include the following. Decrease in 2019 tax ...... $600 • Advertising in a convention program of a Repayment—$3,000 or less. If the Regular tax liability for 2020 ...... $6,785 political party, or in any other publication if amount you repaid was $3,000 or less, deduct it Less: Decrease in 2019 tax ...... − 600 any of the proceeds from the publication from your income in the year you repaid it. Refigured tax for 2020 ...... $6,185 are for, or intended for, the use of a politi- cal party or candidate. Repayment—Over $3,000. If the amount Because you pay less tax under Method 1, you • Admission to a dinner or program (includ- you repaid was more than $3,000, you can de- should take a deduction for the repayment in ing, but not limited to, galas, dances, film duct the repayment as an other itemized deduc- 2020. presentations, parties, and sporting tion on Schedule A (Form 1040), line 16, if you events) if any of the proceeds from the included the income under a “claim of right.” Repayment does not apply. This discus- function are for, or intended for, the use of This means that at the time you included the in- sion doesn’t apply to the following. a political party or candidate. come, it appeared that you had an unrestricted • Deductions for bad debts. • Admission to an inaugural ball, gala, pa- right to it. However, you can choose to take a • Deductions from sales to customers, such rade, concert, or similar event if identified credit for the year of repayment. Figure your tax as returns and allowances, and similar with a political party or candidate. under both methods and use the method that items. results in less tax. • Deductions for legal and other expenses of Repairs. The cost of repairing or improving Method 1. Figure your tax for 2020 claim- contesting the repayment. property used in your trade or business is either ing a deduction for the repaid amount. a deductible or capital expense. Routine main- Year of deduction (or credit). If you use tenance that keeps your property in a normal ef- Method 2. Figure your tax for 2020 claim- the cash method of accounting, you can take ficient operating condition, but that doesn’t ma- ing a credit for the repaid amount. Follow these the deduction (or credit, if applicable) for the tax terially increase the value or substantially steps. year in which you actually make the repayment. prolong the useful life of the property, is deduc- If you use any other accounting method, you tible in the year that it is incurred. Otherwise, 1. Figure your tax for 2020 without deducting can deduct the repayment or claim a credit for it the cost must be capitalized and depreciated. the repaid amount. only for the tax year in which it is a proper de- See Form 4562 and its instructions for how to 2. Refigure your tax from the earlier year duction under your accounting method. For ex- figure and claim the depreciation deduction. without including in income the amount ample, if you use the accrual method, you are The cost of repairs includes the costs of la- you repaid in 2020. entitled to the deduction or credit in the tax year bor, supplies, and certain other items. The in which the obligation for the repayment ac- 3. Subtract the tax in (2) from the tax shown value of your own labor isn’t deductible. Exam- crues. on your return for the earlier year. This is ples of repairs include: the amount of your credit. • Reconditioning floors (but not replace- Supplies and materials. Unless you have de- ment), 4. Subtract the answer in (3) from the tax for ducted the cost in any earlier year, you can gen- • Repainting the interior and exterior walls of 2020 figured without the deduction (step erally deduct the cost of materials and supplies a building, 1). actually consumed and used during the tax • Cleaning and repairing roofs and gutters, year. and If Method 1 results in less tax, deduct the If you keep incidental materials and supplies • Fixing plumbing leaks (but not replacement amount repaid as discussed earlier under Type on hand, you can deduct the cost of the inci- of fixtures). of deduction. dental materials and supplies you bought during

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the tax year if all the following requirements are (Forms 1099), you have several options to A–Z index for business. Find it fast! Know met. choose from to prepare and file your tax return. what you're looking for and want to find it fast? • You don’t keep a record of when they are You can prepare the tax return yourself, see if Select business topics using our A–Z listing, or used. you qualify for free tax preparation, or hire a tax by business type such as sole proprietor, cor- • You don’t take an inventory of the amount professional to prepare your return. poration, etc. We also provide links to major on hand at the beginning and end of the business subjects, such as Business Expenses, tax year. Free options for tax preparation. You can which provide a gateway to all related informa- • This method doesn’t distort your income. go to IRS.gov to see your options for preparing tion on those subjects. and filing your return, which include the follow- You can also deduct the cost of books, pro- • Small Business Forms and Publications. ing. fessional instruments, equipment, etc., if you You can download forms and publications normally use them within a year. However, if the • Free File. This program lets you prepare for small businesses and self-employed in- usefulness of these items extends substantially and file your federal individual income tax dividuals. beyond the year they are placed in service, you return for free using brand-name tax-prep- • Employer ID Numbers (EINs). Find out must generally recover their costs through de- aration-and-filing software or Free File filla- about EINs or apply for one online. preciation. For more information regarding de- ble forms. However, state tax preparation • e-File Form 940, 941, 944, or 945 for Small preciation, see Pub. 946. may not be available through Free File. Go Businesses. Learn your options for e-filing to IRS.gov/FreeFile to see if you qualify to Form 940, 941, 944, or 945 for small busi- Utilities. Business expenses for heat, lights, use brand-name software to prepare and nesses. power, telephone service, and water and sew- e-file your federal tax return for free. • Starting, Operating, or Closing a Business. erage are deductible. However, any part due to • VITA. The Volunteer Income Tax Assis- Important tax information related to the personal use isn’t deductible. tance (VITA) program offers free tax help various stages of owning a business. to people with low-to-moderate incomes, • Employment Taxes. Federal income tax, Telephone. You can’t deduct the cost of persons with disabilities, and limited-Eng- social security and Medicare taxes, FUTA, basic local telephone service (including any lish-speaking taxpayers who need help self-employment tax, and more. taxes) for the first telephone line you have in preparing their own tax returns. Go to • Independent Contractor (Self-Employed) your home, even if you have an office in your IRS.gov/VITA, download the free IRS2Go or Employee. It is critical that you, the em- home. However, charges for business long-dis- app, or call 800-906-9887 for information ployer, correctly determine whether the in- tance phone calls on that line, as well as the on free tax return preparation. dividuals providing services are employees cost of a second line into your home used ex- • TCE. The Tax Counseling for the Elderly or independent contractors. clusively for business, are deductible business (TCE) program offers free tax help for all • Self-Employed Individuals Tax Center. The expenses. taxpayers, particularly those who are 60 basics on self-employment, filing require- years of age and older. TCE volunteers ments, and reporting responsibilities for in- specialize in answering questions about dependent contractors. and retirement-related issues • Information Return Filing Requirements. If unique to seniors. Go to IRS.gov/TCE, you made or received a payment as a download the free IRS2Go app, or call small business or self-employed individual, 888-227-7669 for information on free tax you are most likely required to file an infor- 12. return preparation. mation return with the IRS. • MilTax. Members of the U.S. Armed • IRS Video Portal. Video, webinars, and au- Forces and qualified veterans may use Mil- dio presentations for small businesses, in- Tax, a free tax service offered by the De- dividuals, and tax pros. How To Get Tax partment of Defense through Military One- • Small Business Events. Workshops and Source. webinars on a variety of topics for small businesses. Also, the IRS offers Free Fillable Forms, Help Online Tools & Educational Products. which can be completed online and then filed • Choose from a variety of products, includ- electronically regardless of income. If you have questions about a tax issue, need ing the Tax Calendar desktop tool, to help help preparing your tax return, or want to down- Employers can register to use Business you learn about business taxes on your load free publications, forms, or instructions, go Services Online. The Social Security Adminis- own time, and at your own pace. to IRS.gov and find resources that can help you tration (SSA) offers online service at SSA.gov/ • Subscribe to e-News. A free electronic right away. Employer for fast, free, and secure online W-2 mail service keeping you up to date on tax topics. People who are deaf, hard of hearing, or have a filing options to CPAs, accountants, enrolled agents, and individuals who process Forms speech disability and who have access to Requirements for filing. If you made or re- W-2, Wage and Tax Statement, and Forms TTY/TDD equipment can call toll free ceived a payment during the calendar year as a W-2c, Corrected Wage and Tax Statement. 800-829-4059 to ask tax questions or to order small business or self-employed individual, you forms and publications. Deaf or hard-of-hearing are most likely required to file an information re- individuals can contact the IRS through relay . Tax reform legislation affects indi- turn with the IRS. For more information, see Am services such as the Federal Relay Service, viduals, businesses, and tax-exempt and gov- I Required To File a Form 1099 or Other available at GSA.gov/FedRelay. ernment entities. Go to IRS.gov/TaxReform for information and updates on how this legislation Information Return? on IRS.gov. Coronavirus. Go to IRS.gov/Coronavirus for affects your taxes. Getting answers to your tax ques- links to information on the impact of the corona- tions. On IRS.gov, you can get virus, as well as tax relief available for individu- Tax reform provisions that affect busi- up-to-date information on current als and families, small and large businesses, nesses. Business owners can refer to events and changes in tax law. and tax-exempt organizations. IRS.gov/Newsroom/Businesses for updates and resources on business-related changes re- • IRS.gov/Help: A variety of tools to help you Preparing and filing your tax return. After sulting from tax law changes. get answers to some of the most common receiving your wage and earning statements tax questions. (Form W-2, W-2G, 1099-R, 1099-MISC, Small Business and Self-Employed (SB/SE) • IRS.gov/ITA: The Interactive Tax Assistant, 1099-NEC, etc.); unemployment compensation tax center. SB/SE serves taxpayers who file a tool that will ask you questions on a num- statements (by mail or in a digital format) or Form 1040 or 1040-SR; Schedules C, E, or F; ber of tax law topics and provide answers. other government payment statements (Form or Form 2106, as well as small businesses with • IRS.gov/Forms: Find forms, instructions, 1099-G); and interest, dividend, and retirement assets under $10 million. and publications. You will find details on statements from and investment firms 2020 tax changes and hundreds of

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interactive links to help you find answers to Need someone to prepare your tax return? (EAs), go to IRS.gov/Tax-Professionals/ your questions. There are various types of tax return preparers, Verify-the-Status-of-an-Enrolled-Agent and • You may also be able to access tax law in- including tax preparers, enrolled agents, certi- follow the instructions for requesting EA formation in your electronic filing software. fied public accountants (CPAs), attorneys, and status verification. many others who don't have professional cre- • Ask about service fees. Avoid preparers dentials. If you choose to have someone pre- who base their fee on a percentage of your IRS social media. Go to IRS.gov/SocialMedia pare your tax return, choose that preparer refund or those who say they can get to see the various social media tools the IRS wisely. A paid tax preparer is: larger refunds than others can. Always uses to share the latest information on tax • Primarily responsible for the overall sub- make sure any refund due is sent directly changes, scam alerts, initiatives, products, and stantive accuracy of your return, to you or deposited into your bank ac- services. At the IRS, privacy and security are • Required to sign the return, and count. You should not have your refund paramount. We use these tools to share public • Required to include their preparer tax iden- deposited into a preparer’s bank account. information with you. Don’t post your SSN or tification number (PTIN). • Ask to e-file your return. Make sure your other confidential information on social media Although the tax preparer always signs the preparer offers IRS e-file. Any paid pre- sites. Always protect your identity when using parer who prepares and files more than 10 any social networking site. return, you're ultimately responsible for provid- ing all the information required for the preparer returns must generally e-file their clients’ The following IRS YouTube channels pro- to accurately prepare your return. Anyone paid returns. The IRS has safely processed vide short, informative videos on various tax-re- to prepare tax returns for others should have a more than 1.3 billion e-filed tax returns. lated topics in English, Spanish, and ASL. thorough understanding of tax matters. For • Make sure the preparer is available. • Youtube.com/irsvideos. more information on how to choose a tax pre- You need to ensure that you can contact • Youtube.com/irsvideosmultilingua. parer, go to Tips for Choosing a Tax Preparer the tax preparer after you file your return. • Youtube.com/irsvideosASL. on IRS.gov. That’s true even after the April 15, 2021, due date for individual returns. The due For your convenience, the IRS provides an Watching IRS videos. The IRS Video portal date for partnerships and S corporations online database for all Authorized IRS e-file (IRSVideos.gov) contains video and audio pre- using a calendar year is March 15, 2021. Providers that choose to be included in the da- sentations for individuals, small businesses, You may need to contact the preparer if tabase. You can locate the closest Authorized and tax professionals. questions come up about your tax return at IRS e-file Providers in your area where you can a later time. electronically file your tax return. For more infor- Online tax information in other languages. • Provide tax records. A good preparer will mation on finding a tax return preparer who pro- You can find information on IRS.gov/ ask to see your records and receipts. They vides IRS e-file, see Authorized IRS e-file MyLanguage if English isn't your native lan- ask you questions to report your total in- Providers for Individuals on IRS.gov, or go to guage. come and the tax benefits you’re entitled to IRS.gov/uac/Authorized-IRS-e-file-Providers- claim. These may include tax deductions, for-Individuals. The inclusion in this database Free interpreter service. Multilingual assis- tax credits, and other items. Do not use a does not constitute any endorsement by the tance, provided by the IRS, is available at Tax- preparer who is willing to e-file your return IRS of the e-file Providers listed in this database payer Assistance Centers (TACs) and other using your last pay stub instead of your or any of the products or services that they pro- IRS offices. Over-the-phone interpreter service Form W-2. This is against IRS e-file rules. vide. You should always be sure to conduct is accessible in more than 350 languages. • Never sign a blank tax return. Do not your own due diligence when selecting an e-file use a tax preparer who asks you to sign a Provider. In addition to the Authorized IRS e-file Getting tax forms and publications. Go to blank tax form. Provider locator tool above, you can also find IRS.gov/Forms to view, download, or print all of • Review your return before signing. Be- professional help through the IRS Tax the forms, instructions, and publications you fore you sign your tax return, review it thor- Professional Partner page at IRS.gov/Tax- may need. You can also download and view oughly. Ask questions if something is not Professionals/IRSTaxProAssociationPartners. popular tax publications and instructions (in- clear to you. Make sure you’re comfortable cluding the 1040 and 1040-SR instructions) on Choose a tax return preparer you will be with the information on the return before mobile devices as an eBook at no charge at able to contact in case the IRS examines your you sign it. IRS.gov/eBooks. Or you can go to IRS.gov/ return and has questions regarding how your • Preparer must sign returns and include OrderForms to place an order and have them return was prepared. You can designate your their PTIN. A paid preparer must sign re- mailed to you within 10 business days. paid tax return preparer or another third party to turns and include his or her PTIN as re- speak to the IRS concerning the preparation of quired by law. The preparer must also give Access your online account (individual tax- your return, payment/refund issues, and mathe- you a copy of the return. payers only). Go to IRS.gov/Account to se- matical errors. The third party authorization • Report abusive tax preparers to the curely access information about your federal tax checkbox on Form 1040 or 1040-SR gives the IRS. You can report abusive tax preparers account. designated party the authority to receive and in- and suspected tax fraud to the IRS. Use • View the amount you owe, pay online, or spect returns and return information for 1 year Form 14157, Complaint: Tax Return set up an online payment agreement. from the original due date of your return (without Preparer. If you suspect a return preparer • Access your tax records online. regard to extensions). You can extend the au- filed or changed the return without your • Review the past 24 months of your pay- thority to receive and inspect returns and return consent, you should also file Form 14157- ment history. information to a third party using Form 8821, A, Return Preparer Fraud or Misconduct • Go to IRS.gov/SecureAccess to review the Tax Information Authorization. Affidavit. You can download and print required identity authentication process. The following points will assist you when se- these forms from IRS.gov. If you need a lecting a tax return preparer. paper form mailed to you, go to IRS.gov/ Using direct deposit. The fastest way to re- • Check the preparer’s qualifications. All OrderForms to order online. For more in- ceive a is to file electronically and paid tax return preparers are required to formation, go to How Do You Report choose direct deposit, which securely and elec- have a PTIN. Suspected Tax Fraud Activity? on IRS.gov. tronically transfers your refund directly into your • Check the preparer’s history. You can financial account. Direct deposit also avoids the check with the Better Business Bureau to Using online tools to help prepare your re- possibility that your check could be lost, stolen, find out if a preparer has a questionable turn. Go to IRS.gov/Tools for the following. or returned undeliverable to the IRS. Eight in 10 history. Check for disciplinary actions and • The Earned Income Tax Credit Assistant taxpayers use direct deposit to receive their re- the license status for credentialed prepar- (IRS.gov/EITCAssistant) determines if fund. The IRS issues more than 90% of refunds ers. For Certified Public Accountants you’re eligible for the EIC. in less than 21 days. (CPAs), check with the State Board of Ac- • The Online EIN Application (IRS.gov/EIN) countancy. For attorneys, check with the helps you get an employer identification State Bar Association. For Enrolled Agents number.

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• The Tax Withholding Estimator (IRS.gov/ current-year return. For the list of the various agency will send a 5071C letter to your W4app) makes it easier for everyone to types of transcripts available for you to order, home address. If you receive this letter, pay the correct amount of tax during the see Transcript Types and Ways to Order Them verify your identity at IDVerify.IRS.gov or year. The tool is a convenient, online way at IRS.gov/Individuals/Tax-Return-Transcript- call the toll-free number listed in the letter. to check and tailor your withholding. It’s Types-and-Ways-to-Order-Them. To order your If you did not receive an IRS notice but be- user-friendly for taxpayers, including retir- transcript, you can choose from one of the fol- lieve you’ve been the victim of ID theft, ees and self-employed individuals. The lowing convenient options. contact the IRS Identity Protection Special- features include the following. • Request a return or account transcript us- ized Unit at 800-908-4490 right away so – Easy to understand language. ing Get Transcript at IRS.gov/Individuals/ we can take steps to secure your tax ac- – The ability to switch between screens, Get-Transcript. count and match your SSN or ITIN. correct previous entries, and skip • Download the free IRS2Go app to your • Also, fill out and submit the IRS Form screens that don’t apply. mobile device and use it to order tran- 14039, Identity Theft Affidavit. Please write – Tips and links to help you determine if scripts of your tax returns or tax account. legibly and follow the directions on the you qualify for tax credits and deduc- • Call the automated transcript toll-free line back of the form that relate to your specific tions. at 800-908-9946 to receive your transcript circumstances. – A progress tracker. by mail. • If you are a victim of state tax ID theft, con- – A self-employment tax feature. • Go to Get Transcript at IRS.gov/ tact your state's taxation department or – Automatic calculation of taxable social Individuals/Get-Transcript, and click on comptroller's office about the next steps security benefits. “Get Transcript by Mail.” You will need you need to take. • The First Time Homebuyer Credit Account your social security number (SSN) or your • You should protect the information that you Look-up (IRS.gov/HomeBuyer) tool pro- individual taxpayer identification number keep, and properly dispose of what you no vides information on your repayments and (ITIN), date of birth, and address from your longer need. And, of course, you should account balance. latest tax return. Transcripts arrive in 5 to create a plan to respond to security inci- • The Sales Tax Deduction Calculator 10 calendar days at the address we have dents. As part of its long-standing efforts to (IRS.gov/SalesTax) figures the amount you on file for you. promote good data security practices, the can claim if you itemize deductions on • Mail Form 4506-T, Request for Transcript Federal Trade Commission (FTC) has un- Schedule A (Form 1040). of Tax Return, or Form 4506T-EZ, Short dertaken extensive efforts to educate busi- nesses and has brought more than 50 law • Go to IRS.gov/Pub17 to get Pub. 17, Your Form Request for Individual Tax Return enforcement actions related to data secur- Federal Income Tax for Individuals, which Transcript (both available on IRS.gov). ity issues. For more information, see Pro- features details on tax-saving opportuni- The IRS never sends email requesting that tecting Personal Information: A Guide for ties, 2020 tax changes, and thousands of you obtain or access your transcripts. Report all Business, available at interactive links to help you find answers to unsolicited email claiming to be from the IRS or FTC.gov/Tips- your questions. View it online in HTML or an IRS-related function to [email protected]. advice/business-center/guidance/ protecting-personal-information-guide- as a PDF or, better yet, download it to your A transcript isn’t a photocopy of your return. business, for practical tips on creating and mobile device to enjoy eBook features. If you need a photocopy of your original return, implementing a plan for safeguarding per- • You may also be able to access tax law in- complete and mail Form 4506, Request for sonal information used in your business. formation in your electronic filing software. Copy of Tax Return, available at IRS.gov/Pub/ Most recently, the FTC released Start with • Go to IRS.gov and click on the Help & Re- irs-pdf/F4506.pdf, along with the applicable fee. sources tab for more information. Security: A Guide for Business, available at FTC.gov/Tips-advice/business-center/ Resolving tax-related identity theft issues. guidance/start-security-guide-business? Getting a transcript or copy of a return. Tax • Tax-related identity theft happens when utm_source=govdelivery, which draws on transcripts are summaries of tax returns. IRS someone steals your personal information the lessons learned from the FTC's en- transcripts are best and most often used to vali- to commit tax fraud. Your taxes can be af- forcement actions. date past income and tax filing status for mort- fected if your SSN is used to file a fraudu- gage, student, and small business loan applica- lent return or to claim a refund or credit. The IRS, the states, and the tax industry tions, and to help with tax preparation. • The IRS doesn't initiate contact with tax- joined together to enact new safeguards and Taxpayers can also use transcripts to obtain payers by email, text messages, telephone take additional actions to combat tax-related their prior-year adjusted gross income (AGI), calls, or social media channels to request identity theft. Many of these safeguards will be which they need in order to e-file their tax re- personal or financial information. This in- invisible to you, but invaluable to our fight turns. You can get a transcript by mail to view cludes requests for personal identification against these criminal syndicates. If you pre- your tax account transactions or line-by-line tax numbers (PINs), passwords, or similar in- pare your own return with tax software, you will return information for a specific tax year. The formation for credit cards, banks, or other see new log-on standards. Some states also method you used to file your return and whether financial accounts. have taken additional steps. See your state you have a refund or balance due affects your • Go to IRS.gov/IdentityTheft, the IRS Iden- revenue agency’s web site for additional de- current tax year transcript availability. Gener- tity Theft Central webpage, for information tails. ally, these transcript types are available for the on identity theft and data security protec- The FTC works for consumers to prevent current tax year and 3 prior years. The quickest tion for taxpayers, tax professionals, and fraudulent, deceptive, and unfair business prac- way to get a copy of your tax transcript is to go businesses. If your SSN has been lost or tices and to provide information to help spot, to IRS.gov/Transcripts. Click on either "Get stolen or you suspect you're a victim of stop, and avoid them. To file a complaint, for Transcript Online" or "Get Transcript by Mail" to tax-related identity theft, you can learn example, to report someone falsely claiming to order a copy of your transcript. If you need an what steps you should take. be from the government, a business, or a family account transcript for an older tax year, a wage • Get an Identity Protection PIN (IP PIN). IP member, visit the FTC’s online Complaint and income transcript, or a verification of nonfil- PINs are six-digit numbers assigned to eli- Assistant or call 877-FTC-HELP ing letter, you’ll need to complete Form 4506-T, gible taxpayers to help prevent the misuse (877-382-4357). The FTC enters complaints Request for Transcript of Tax Return, available of their SSNs on fraudulent federal income into Consumer Sentinel, a secure, online data- at IRS.gov/Forms-Pubs/About-Form-4506-T- tax returns. When you have an IP PIN, it base available to more than 2,000 civil and Request-for-Transcript-of-Tax-Return, prevents someone else from filing a tax re- criminal law enforcement agencies in the United and send it to us as instructed on the form. If turn with your SSN. To learn more, go to States and abroad. Complaints from consumers you made estimated tax payments and/or ap- IRS.gov/IPPIN. help the FTC detect patterns of fraud and plied your overpayment from a prior-year tax re- • The IRS stops and flags suspicious or du- abuse. The FTC’s website provides free infor- turn to your current-year tax return, you can re- plicate federal tax returns that falsely rep- mation on a variety of consumer topics, in Eng- quest a tax account transcript to confirm these resent your identity, such as your name or lish and in Spanish. payments or credits a few weeks after the be- SSN. If the IRS suspects tax ID theft, the ginning of the calendar year prior to filing your

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Consumer complaints regarding interna- What if I can’t pay now? Go to IRS.gov/ gage lenders/brokers, etc., whenever you tional scams can be reported online through Payments for more information about your op- want to buy or refinance a home, get a loan Econsumer.gov. These are also entered into tions. for a business, or apply for federal aid for Consumer Sentinel, the complaint database • Apply for an online payment agreement higher education. maintained by the FTC, and are made available (OPA) (IRS.gov/OPA) to meet your tax ob- For more information, go to Filing Past Due to enforcers and regulators in countries with ligation in monthly installments if you can’t Tax Returns on IRS.gov. participating agencies. Those agencies may pay your taxes in full today. Once you com- use the complaints to investigate cross-border plete the online process, you will receive Substitute return. If you fail to file voluntarily, issues, uncover new scams, pursue regulatory immediate notification of whether your we may file a substitute return for you, based on or enforcement actions, and spot consumer agreement has been approved. income reported to the IRS. This return might trends. • Use the Offer in Compromise Pre-Qualifier not give you credit for deductions and exemp- to see if you can settle your tax debt for tions you may be entitled to receive. We will Checking on the status of your refund. less than the full amount you owe. For send you a Notice of Deficiency CP3219N • Go to IRS.gov/Refunds. more information on the Offer in Compro- (90-day letter) proposing a tax assessment. • The IRS can’t issue refunds before mise (OIC) program, go to IRS.gov/OIC. If You will have 90 days to file your past due tax mid-February 2021 for returns that claimed you are a sole proprietor or independent return or file a petition in Tax Court. If you do the EIC or the additional contractor, apply for a payment agreement neither, we will proceed with our proposed as- (ACTC). This applies to the entire refund, as an individual. sessment. If you have received a Notice of Defi- not just the portion associated with these ciency CP3219N, you can't request an exten- credits. Filing an amended return. You can now file sion to file. Call us if you think you don't have to • Download the official IRS2Go app to your Form 1040-X electronically with tax filing soft- file. mobile device to check your refund status. ware to amend 2019 Forms 1040 and 1040-SR. If any of the income listed is incorrect, you • Call the automated refund hotline at To do so, you must have e-filed your original may do the following. 800-829-1954. 2019 return. Amended returns for all prior years Contact us toll free at 866-681-4271 to let must be mailed. See Tips for taxpayers who • us know. Making a tax payment. The IRS uses the lat- need to file an amended tax return and go to Contact the payer (source) of the income est encryption technology to ensure your elec- IRS.gov/Form1040X for information and up- • to request a corrected Form W-2 or 1099. tronic payments are safe and secure. You can dates. make electronic payments online, by phone, • Attach the corrected forms when you send and from a mobile device using the IRS2Go Checking the status of an amended return. us your completed tax returns. app. Paying electronically is quick, easy, and Go to IRS.gov/WMAR to track the status of If the IRS files a substitute return, it is still in faster than mailing in a check or money order. Form 1040-X amended returns. Please note your best interest to file your own tax return to Go to IRS.gov/Payments for information on how that it can take up to 3 weeks from the date you take advantage of any exemptions, credits, and to make a payment using any of the following filed your amended return for it to show up in deductions you are entitled to receive. The IRS options. our system, and processing it can take up to 16 will generally adjust your account to reflect the • IRS Direct Pay: Pay your individual tax bill weeks. correct figures. If you filed a past due return and or estimated tax payment directly from have received a notice, you should send us a your checking or savings account at no Filing past due tax returns. File all tax re- copy of the past due return to the address con- cost to you. turns that are due, regardless of whether or not tained in the notice. It takes approximately 6 • Debit or Credit Card: Choose an approved you can pay in full. File your past due return the weeks for us to process an accurately comple- payment processor to pay online, by same way and to the same location where you ted past due tax return. phone, and by mobile device. would file an on-time return. If you have re- • Electronic Funds Withdrawal: Offered only ceived a notice, make sure to send your past Understanding an IRS notice or letter. Go to when filing your federal taxes using tax re- due return to the location indicated on the no- IRS.gov/Notices to find additional information turn preparation software or through a tax tice you received. If you have a past due return, about responding to an IRS notice or letter. We professional. filing your past due return now can help you do will send you a notice or letter if any of the fol- • Electronic Federal Tax Payment System the following. lowing apply. (EFTPS®). EFTPS® is a system for pay- • Avoid interest and penalties. File your • You have a balance due. ing federal taxes electronically online, or past due return and pay now to limit inter- • You are due a larger or smaller refund. by phone using the EFTPS® Voice Re- est charges and late payment penalties. • We have a question about your tax return. sponse System. EFTPS® is offered free • Claim a refund. You risk losing your re- • We need to verify your identity. by the U.S. Department of the Treasury. fund if you don't file your return. If you are • We need additional information. You can use EFTPS® to make all your fed- due a refund for withholding or estimated • We changed your return. eral tax payments, including income, em- taxes, you must file your return to claim it • We are notifying you of delays in process- ployment, estimated, and excise taxes. It is within 3 years of the return due date. The ing your return. same rule applies to a right to claim tax the best option for businesses. Enrollment When you receive correspondence from us, credits such as the EIC. We hold income is required. You can initiate your tax pay- read the entire notice or letter carefully. Typi- tax refunds in cases where our records ment from your home or office, 24/7. Busi- cally, we only need a response if you don’t show that one or more income tax returns nesses and individuals can schedule pay- agree with the information, we need additional are past due. We hold them until we get ments up to 365 days in advance. information, or you have a balance due. If we the past due return or receive an accepta- Scheduled payments can be changed or changed your tax return, compare the informa- ble reason for not filing a past due return. canceled up to 2 business days in advance tion we provided in the notice or letter with the Protect social security benefits. If you of the scheduled payment date. • information in your original return. If we receive are self-employed and do not file your fed- • Check or Money Order: Mail your payment a return that we suspect is ID theft, we will ask eral income tax return, any self-employ- to the address listed on the notice or in- you to verify your identity using the web ad- ment income you earned will not be repor- structions. dress provided in the letter. Cash: You may be able to pay your taxes ted to the Social Security Administration • If we ask for a response within a specific with cash at a participating retail store. and you will not receive credits toward so- timeframe, you must respond on time to mini- Same-Day Wire: You may be able to do cial security retirement or disability bene- • mize additional interest and penalty charges or same-day wire from your financial institu- fits. to preserve your appeal rights if you don’t tion. Contact your financial institution for • Avoid issues obtaining loans. Loan ap- agree. Pay as much as you can, even if you availability, cost, and cut-off times. provals may be delayed if you don't file can’t pay the full amount you owe. You can pay your return. Copies of filed tax returns must online or apply for an OPA or OIC. See What if I be submitted to financial institutions, mort-

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can’t pay now?, earlier, or visit our payments The IRS will never do any of the follow- How Can You Learn About Your page, IRS.gov/Payments, for more information. ing. Taxpayer Rights? We provide our contact phone number on • Call to demand immediate payment, nor the top right-hand corner of our correspond- will the agency call about taxes owed with- The Taxpayer Bill of Rights describes 10 basic ence. Be sure you have your tax return and any out first having mailed you a bill. rights that all taxpayers have when dealing with related documentation available when you call. • Demand that you pay taxes without giving the IRS. Go to TaxpayerAdvocate.IRS.gov to You can also write to us at the address in the you the opportunity to question or appeal help you understand what these rights mean to correspondence to explain why you disagree. If the amount they say you owe. you and how they apply. These are your rights. you write, allow at least 30 days for our re- • Require you to use a specific payment Know them. Use them. sponse. Keep a copy of all correspondence method for your taxes, such as a prepaid with your tax records. debit card. You can find a list of your rights and the • Ask for credit or debit card numbers over IRS’s obligations to protect them in Pub. 1, Your Collection and enforcement actions. The the phone. Rights as a Taxpayer. It includes the following. return we prepare for you (our proposed as- • Threaten to bring in local police or other 1. The Right To Be Informed. Taxpayers sessment) will lead to a tax bill, which, if unpaid, law-enforcement groups to have you arres- have the right to know what they need to will trigger the collection process. This can in- ted for not paying. do to comply with the tax laws. They are clude such actions as a levy on your wages or If you get a phone call from someone claim- entitled to clear explanations of the laws bank account or the filing of a notice of federal ing to be from the IRS and asking for money, do and IRS procedures in all tax forms, in- tax lien. If you repeatedly do not file, you could not disclose your personal information. You structions, publications, notices, and cor- be subject to additional enforcement measures, should make notes of all information regarding respondence. They have the right to be in- such as additional penalties and/or criminal the call and/or the caller, for example, any caller formed of IRS decisions about their tax prosecution. ID information, then hang up immediately and accounts and to receive clear explana- do the following. tions of the outcomes. Contacting your local IRS office. Keep in • If you know you owe taxes or think you mind, many questions can be answered on might owe, call the IRS toll free at 2. The Right to Quality Service. Taxpayers IRS.gov without visiting an IRS Taxpayer Assis- 800-829-1040. The IRS assistors can help have the right to receive prompt, courte- tance Center (TAC). Go to IRS.gov/LetUsHelp you with a payment issue. ous, and professional assistance in their for the topics people ask about most. If you still • If you know you don’t owe taxes or have no dealings with the IRS, to be spoken to in a need help, IRS TACs provide tax help when a reason to believe that you do, report the in- way they can easily understand, to receive tax issue can’t be handled online or by phone. cident to the Treasury Inspector General clear and easily understandable communi- All TACs now provide service by appointment for Tax Administration (TIGTA) toll free at cations from the IRS, and to speak to a su- so you’ll know in advance that you can get the 800-366-4484 or at TIGTA.gov. pervisor about inadequate service. service you need without long wait times. Be- • If you’ve been targeted by this scam, also 3. The Right To Pay No More Than the fore you visit, go to IRS.gov/TACLocator to find contact the FTC and use their FTC Correct Amount of Tax. Taxpayers have the nearest TAC, check hours, available serv- Complaint Assistant at FTC.gov. Please the right to pay only the amount of tax le- ices, and appointment options. Or, on the add “IRS Telephone Scam” to the com- gally due, including interest and penalties, IRS2Go app, under the Stay Connected tab, ments of your complaint. and to have the IRS apply all tax payments choose the Contact Us option and click on “Lo- properly. cal Offices.” Remember, too, the IRS does not use email, text messages, or any social media to 4. The Right To Challenge the IRS’s Posi- Recognizing and reporting tax scams. The discuss your personal tax issue involving bills or tion and Be Heard. Taxpayers have the Dirty Dozen is compiled annually by the IRS refunds. If you get a phone call from someone right to raise objections and provide addi- and lists a variety of common scams taxpayers claiming to be from the IRS regarding a refund tional documentation in response to formal may encounter any time during the year. Many owed to you and asking you for your SSN and IRS actions or proposed actions, to expect of these con games peak during filing season bank account information, do not give them this that the IRS will consider their timely ob- as people prepare their tax returns or hire information. You should make notes of all infor- jections and documentation promptly and someone to do so. Aggressive and threatening mation regarding the call and/or the caller, for fairly, and to receive a response if the IRS phone calls by criminals impersonating IRS example, any caller ID information, and report does not agree with their position. agents remain near the top of the annual Dirty this scam. For more information on reporting tax 5. The Right To Appeal an IRS Decision Dozen list of tax scams for the 2020 filing sea- scams, go to IRS.gov and type “scam” in the in an Independent Forum. Taxpayers son. search box. You can verify any potential re- are entitled to a fair and impartial adminis- Scammers are able to alter caller identifica- funds owed to you by contacting the IRS di- trative appeal of most IRS decisions, in- tion (caller ID) numbers to make it look like the rectly. cluding many penalties, and have the right IRS is calling. They use fake names and bogus For additional information about tax scams, to receive a written response regarding IRS identification or badge numbers. They often go to IRS.gov/newsroom/use-irs-social-media- the Office of Appeals’ decision. Taxpayers leave “urgent” callback requests. They prey on tools, where you can search “scam” to find all generally have the right to take their cases the most vulnerable people, such as the elderly, the scam-related posts. to court. newly arrived immigrants, and those whose first language is not English. Scammers have been 6. The Right to Finality. Taxpayers have known to impersonate agents of IRS Criminal The Taxpayer Advocate the right to know the maximum amount of Investigation as well. time they have to challenge the IRS’s posi- Be cautious when receiving suspicious calls Service (TAS) Is Here To tion as well as the maximum amount of at home or at work from sources claiming to be Help You time the IRS has to audit a particular tax from the IRS, other agencies, or outside sour- year or collect a tax debt. Taxpayers have ces asking for money or credit card information, the right to know when the IRS has fin- or threatening to have you arrested for not pay- What Is TAS? ished an audit. ing. These callers may demand money or may 7. The Right to Privacy. Taxpayers have TAS is an independent organization within the say you have a refund due and try to trick you the right to expect that any IRS inquiry, ex- IRS that helps taxpayers and protects taxpayer into sharing private information. These con ar- amination, or enforcement action will com- rights. Their job is to ensure that every taxpayer tists can sound convincing when they call. They ply with the law and be no more intrusive is treated fairly and that you know and under- may know a lot about you. than necessary, and will respect all due stand your rights under the Taxpayer Bill of Here are five things the scammers often do process rights, including search and seiz- Rights. but the IRS will not do. Any one of these five ure protections, and will provide, where things is a tell-tale sign of a scam.

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applicable, a collection due process hear- • Korean, Korean- Your Rights as a How Else Does TAS Help ing. Taxpayer (Pub 1), at IRS.gov/Korean. Taxpayers? Russian, Ваши права в качестве 8. The Right to Confidentiality. Taxpayers • налогоплательщика (Публикацию № 1), have the right to expect that any informa- TAS works to resolve large-scale problems that at IRS.gov/Russian. tion they provide to the IRS will not be dis- affect many taxpayers. If you know of one of Spanish, Publicación 1SP, Derechos del closed unless authorized by the taxpayer • these broad issues, please report it to them at Contribuyente, at IRS.gov/Spanish. or by law. Taxpayers have the right to ex- IRS.gov/SAMS. Vietnamese, Quyền Hạn của Người Đóng pect appropriate action will be taken • Thuế, Your Rights as a Taxpayer (Pub 1), TAS also has a website, Tax Reform against employees, return preparers, and at IRS.gov/Vietnamese. Changes, which shows you how the new tax others who wrongfully use or disclose tax- law may change your future tax filings and helps payer return information. The IRS will include Pub. 1 when sending noti- ces to taxpayers on a range of issues, such as you plan for these changes. The information is 9. The Right To Retain Representation. an audit or collection matter. All IRS facilities categorized by tax topic in the order of the IRS Taxpayers have the right to retain an au- will publicly display the rights for taxpayers and Form 1040 or 1040-SR. Go to TaxChanges.us thorized representative of their choice to employees to see. for more information. represent them in their dealings with the IRS. Taxpayers have the right to seek as- TAS for Tax Professionals sistance from a Low Income Taxpayer What Can TAS Do For You? Clinic if they cannot afford representation. TAS can help you resolve problems that you TAS can provide a variety of information for tax 10. The Right to a Fair and Just Tax Sys- can’t resolve with the IRS. And their service is professionals, including tax law updates and tem. Taxpayers have the right to expect free. If you qualify for their assistance, you will guidance, TAS programs, and ways to let TAS the tax system to consider facts and cir- be assigned to one advocate who will work with know about systemic problems you’ve seen in cumstances that might affect their underly- you throughout the process and will do every- your practice. ing liabilities, ability to pay, or ability to pro- thing possible to resolve your issue. TAS can vide information timely. Taxpayers have help you if: Low Income Taxpayer the right to receive assistance from the • Your problem is causing financial difficulty Clinics (LITCs) TAS if they are experiencing financial diffi- for you, your family, or your business; culty or if the IRS has not resolved their tax • You face (or your business is facing) an LITCs are independent from the IRS. LITCs issues properly and timely through its nor- immediate threat of adverse action; or mal channels. represent individuals whose income is below a • You’ve tried repeatedly to contact the IRS certain level and need to resolve tax problems but no one has responded, or the IRS with the IRS, such as , appeals, and tax The IRS is working to increase the number hasn’t responded by the date promised. of Americans who know and understand their collection disputes. In addition, clinics can pro- rights under the tax law. To expand awareness, vide information about taxpayer rights and re- the IRS makes Pub. 1 available in multiple lan- How Can You Reach TAS? sponsibilities in different languages for individu- guages on IRS.gov. This important publication als who speak English as a second language. is available in the following languages. TAS has offices in every state, the District of Services are offered for free or a small fee. To • English, Your Rights as a Taxpayer, at Columbia, and Puerto Rico. Your local advo- find a clinic near you, visit IRS.gov/LITC or see IRS.gov/Pub/irs-pdf/P1.pdf. cate’s number is in your local directory and at IRS Pub. 4134, Low Income Taxpayer Clinic • Chinese, Chinese- Your Rights as a TaxpayerAdvocate.IRS.gov/Contact-Us. You List. Taxpayer (Pub 1), at IRS.gov/Chinese. can also call them at 877-777-4778.

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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 20 Independent Contractor A preparer 50 e-News 49 (Self-Employed) or Advertising 45 Circulation costs, newspapers Entertainment 44 Employee? 49 Amortization: and periodicals 26 Entertainment expenses 9 Information Return Filing Anti-abuse rule 33 Claim a refund 52 Experimentation costs 24, 35 Requirements 49 Anti-churning rules 32 Club dues 46 Exploration costs 25 Insurance 23 Atmospheric pollution control Collection and enforcement Capitalized premiums 23 facilities 34 actions 53 Deductible premiums 20 Corporate organization costs 29 Commitment fees 16 F Nondeductible premiums 23 Dispositions of section 197 Compensation in excess of $1 Federal Relay Service 49 Intangible drilling costs 25 intangibles 33 million 8 Fees: Intangibles, amortization 30 Experimental costs 35 Computer software 32 Commitment 16 Interest 17 Geological and geophysical Constant-yield method, OID 15 Legal and professional 47 Allocation of 13 costs 34 Contested liability 6 Regulatory 47 Below-market 17 How to deduct 28 Contributions: Tax return preparation 47 Business expense for 13 Incorrect amount deducted 33 Charitable 46 Filing past due tax returns 52 Capitalized 16 Partnership organization Political 48 Fines 47 Carrying charge 24 costs 29 Copyrights 31 Forgone 17 Deductible 15 Pollution control facilities 34 Coronavirus (COVID-19) related Forgone interest 17 Life insurance policies 16 Reforestation costs 33 employment tax credits 7 Form: Limitation 14 Reforestation expenses 26 Cost depletion 36 3115 33 Not deductible 16 Related person 32 Cost of getting lease 12, 30 4562 28 Refunds of 16 Research costs 35 Cost of goods sold 3 5213 7 When to deduct 16 Section 197 intangibles Cost recovery 3 8826 27, 28 Internet-related expenses 46 defined 30 Covenant not to compete 31 T 40 Interview expenses 46 Starting a businesscosts 28 Credit card convenience fees 46 Franchise 31, 46 IRS social media 50 Start-up costs 29 Fringe benefits 9 IRS Tax Professional Anticipated liabilities 45 Partners 50 Assistance (See Tax help) D IRS Video Portal 49 At-risk limits 6 Debt-financed distributions 14 G Attorney fees 47 Definitions: Gas wells 38 Authorized IRS e-file Business bad debt 40 Geological and geophysical K providers 50 Necessary expense 3 costs: Key person 16 Awards 8 Ordinary expense 3 Development, oil and gas 34 Kickbacks 45 A-Z Index for Business 49 Section 197 intangibles 30 Exploration, oil and gas 34 De minimis OID 15 Geothermal wells 25, 39 Demolition expenses 46 Gifts, nominal value 9 L B Depletion: Going into business 3, 28 Leases: Bad debts: Mineral property 36 Goodwill 31 Canceling 11 Defined 40 Oil and gas wells 37 Gross income, not-for-profit Cost of getting 12, 30 How to treat 41 Timber 40 activity 7 Improvements by lessee 12 Recovery 42 Who can claim 35 Leveraged 11 Types of 41 Depreciation (See Cost recovery) Mineral 39 When worthless 41 Development costs, miners 26 H Oil and gas 39 Bonuses: Direct Pay 52 Health coverage tax credit Sales distinguished 11 Employee 9 Dirty Dozen 53 (HCTC) 23 Taxes on 12 Royalties 39 Disabled, improvements for 27 Health plan 23 Legal and professional fees 47 Bribes 45 Drilling and development Heating equipment 5 Letter 5071C 51 Business: costs 25 Home, business use of 5 Licenses 31, 47 Assets 4 Dues, membership 46 Life insurance coverage 10 Books and records 31 Limit on deductions 7 Meal expenses 44 I Line of credit 14 Use of car 5, 46 E Identity theft 51 Loans: Use of home 5 Economic interest 35 Identity theft issues 51 Below-market 17 Business Services Online 49 Economic performance 6 Impairment-related expenses 46 Discounted 16 Education expenses 9, 46 Improvements 4 Loans or advances 10 e-File Form 940, 941, or 944 for By lessee 12 Lobbying expenses 47 C Small Businesses 49 For disabled and elderly 27 Long-term care insurance 21 Campaign contribution 48 Elderly, improvements for 27 Income Taxes 19 Losses 6, 7 Capital expenses 3, 5 Electronic Federal Tax Payment Accrual of contested income At-risk limits 6 Capitalization of interest 16 System (EFTPS®) 52 taxes 19 Net operating 6 Car allowance 44 Employee benefit programs 10 Federal income taxes 19 Passive activities 6 Car and truck expenses 46 Employer ID Numbers (EINs) 49 Foreign income taxes 19 Low Income Taxpayer Clinics Carrying charges 24 Employment taxes 19 State and local income taxes 19 (LITCs) 54 Charitable contributions 46 Employment Taxes 49 Incorrect amount of amortization Checking amended return Additional Medicare Tax 20 deducted 33 status 52 Self-employment tax: M Additional Medicare Tax 20 Machinery parts 5

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Making a tax payment 52 Personal property taxes 20 Timber property 34 Substitute return 52 Meals 43 Sales taxes 20 Recordkeeping 38 Supplies and materials 48 Meals and entertainment 44 Outplacement services 47 Recovery of amount deducted 6 Meals and lodging 9 Refiners who cannot claim Methods of accounting 6 percentage depletion 37 T Mining: P Reforestation costs 26, 33 Taxes 12, 18 Depletion 39 Passive activities 6 Regulatory fees 47 Carrying charge 24 Development costs 26 Payments in kind 6 Reimbursements 43 Leased property 12 Exploration costs 25 Penalties 15 Business expenses 10 When To Deduct Taxes 18 More than one health plan and Deductible 47 Mileage 44 Tax help 49 business 23 Nondeductible 47 Nonaccountable plan 45 Tax information in other Mortgage 15 Prepayment 15 Per diem 44 languages 50 Moving expenses, machinery 47 Percentage depletion 36 Related persons: Taxpayer Advocate Service Per diem and car allowances 44 Anti-churning rules 32 (TAS) 53 Political contributions 48 Coal or iron ore 39 Taxpayer Assistance Center N Pollution control facilities 34 Payments to 6, 17 (TAC) locator 53 Natural gas 38 Prepaid expense 6 Refiners 37 Tax preparation 49 Nonqualifying intangibles 31 Extends useful life 24 Unreasonable rent 11 Tax preparation fees 47 Not-for-profit activities 7 Interest 16, 17 Reminder: Tax questions 49 Not-for-profit activity, gross Rent 11 Premium tax credit 20 Tax scams 53 income 7 Prepayment penalty 15 Removal 27 Telephone 49 Notice of Deficiency Presumption of profit 7 Rent expense, capitalizing 13 Timber 33, 40 CP3219N 52 Publication 1, Your Rights as a Repairs 48 Tools 5 Taxpayer 53 Repayments (claim of right) 48 Trademark, trade name 31, 46 Publications (See Tax help) Reporting abusive tax transcript or copy of a return 51 O preparers 50 Transportation (commuting) Office in home 5 Research costs 24, 35 benefits 10 Oil and gas wells: Q Travel 43 Depletion 37 Qualified long-term care Drilling costs 25 insurance: S Partnerships 38 Benefits received 22 Scammers 53 U S corporations 38 Chronically ill individual 22 Section 179 expense Understanding an IRS notice or Online payment agreement 52 Qualified long-term care deduction (See Cost recovery ) letter 52 Online Tools & Educational insurance contract 21 Self-employed health insurance Unpaid expenses, related Products 49 Qualified long-term care deduction 21 person 17 Optional safe harbor method 5 services 21 Self-Employed Health Insurance Utilities 49 Optional write-off method: Deduction Worksheet 22 Circulation costs 35 Self-Employed Individuals Tax Experimental costs 35 R Center 49 V Intangible drilling and Real Estate Taxes 18 Self-insurance, reserve for 23 Vacation pay 10 development costs 35 Assessments Local 18 Sick pay 10 Mining exploration and Charges for services 19 Small Business and development costs 35 Electing to ratably accrue to a Self-Employed (SB/SE) Tax W Research costs 35 definite period 19 Center 49 Wages: Organizational costs 26 Form 3115 19 Small Business Events 49 Property 10 Organization costs: Making the election to ratably Small Business Forms and Tests for deducting pay 8 Corporate 29 accrue the taxes 19 Publications 49 Welfare benefit funds 10 Partnership 29 Purchase or sale of real Standard meal allowance 44 When To Deduct Premiums 23 Original issue discount 15 estate 19 Standard mileage When To Deduct Taxes: Other coverage 23 Separate elections to ratably rate (See Business use of your Carrying charges 18 Other Taxes 20 accrue for each separate car) Limit on accrual of taxes 18 Excise taxes 20 trade or business and for Standby charges 16 Refunds of taxes 18 Franchise taxes 20 nonbusiness activities 19 Starting, Operating, or Closing a Uniform capitalization rules 18 Fuel taxes 20 Recapture: Business 49 Occupational taxes 20 Exploration expenses 25 Start-up costs 26, 29

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