Meals and lodging. Deduction limit on meals. Food and beverage expense incurred together with entertainment expenses. Transportation (commuting) benefits. Employee benefit programs. Life insurance coverage. Welfare benefit funds.
Preventing slavery and human trafficking. Human trafficking is a form of modern-day slavery, and involves the use of force, fraud, or coercion to exploit human beings for some type of labor or commercial sex purpose. The United States is a source, transit, and destination country for men, women, and children, both U.S. citizens and foreign nationals, who are subjected to the injustices of slavery and human trafficking, including forced labor, debt bondage, involuntary servitude, “mail-order” marriages, and sex trafficking. Trafficking in persons can occur in both lawful and illicit industries or markets, including in hotel services, hospitality, agriculture, manufacturing, janitorial services, construction, health and elder care, domestic service, brothels, massage parlors, and street prostitution, among others. The President’s Interagency Task Force to Monitor and Combat Trafficking in Persons (PITF) brings together federal departments and agencies to ensure a whole-of-government approach that addresses all aspects of human trafficking. Online resources for recognizing and reporting trafficking activities, and assisting victims include the Department of Homeland Security (DHS) Blue Campaign at DHS.gov/blue-campaign , the Department of State Office to Monitor and Combat Trafficking in Persons at State.gov/j/tip , and the National Human Trafficking Resource Center (NHTRC) at humantraffickinghotline.org . DHS is responsible for investigating human trafficking, arresting traffickers, and protecting victims. DHS also provides immigration relief to non-U.S. citizen victims of human trafficking. DHS uses a victim-centered approach to combating human trafficking, which places equal value on identifying and stabilizing victims and on investigating and prosecuting traffickers. Victims are crucial to investigations and prosecutions; each case and every conviction changes lives. DHS understands how difficult it can be for victims to come forward and work with law enforcement due to their trauma. DHS is committed to helping victims feel stable, safe, and secure. To report suspected human trafficking, call the DHS domestic 24-hour toll-free number at 866-DHS-2-ICE (866-347-2423) or 802-872-6199 (non-toll-free international). For help from the NHTRC, call the National Human Trafficking Hotline toll free at 888-373-7888 or text HELP or INFO to BeFree (233733).The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) has issued a public advisory to financial institutions that contains red flag indicators for potential suspicious financial activity associated with human trafficking. If warranted, financial institutions should file a Suspicious Activity Report (FinCEN 112) with FinCEN to report these activities. For more information, go to Fincen.gov/Sites/default/files/advisory/FIN-2014-A008.pdf .
Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC) . Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) (24 hours a day, 7 days a week) if you recognize a child.
For more information, go to the Gig Economy Tax Center at IRS.gov/Gig .
Gig Economy Tax Center. The IRS Gig Economy Tax Center on IRS.gov can help people in this growing area meet their tax obligations through more streamlined information.The gig economy is also known as the sharing, on-demand, or access economy. It usually includes businesses that operate an app or website to connect people to provide services to customers. While there are many types of gig economy businesses, ride-sharing and home rentals are two of the most popular. The Gig Economy Tax Center streamlines various resources, making it easier for taxpayers to find information about the tax implications for the companies that provide the services and the individuals who perform them. It offers tips and resources on a variety of topics including:
Form 1099-NEC. File Form 1099-NEC, Nonemployee Compensation, for each person to whom you have paid during the year in the course of your trade or business at least $600 in services (including parts and materials), who is not your employee. See the Instructions for Forms 1099-MISC and 1099-NEC for more information and additional reporting requirements.
Form 1099-MISC. File Form 1099-MISC, Miscellaneous Income, for each person to whom you have paid during the year in the course of your trade or business at least $600 in rents, prizes and awards, other income payments, medical and health care payments, and crop insurance proceeds. See the Instructions for Forms 1099-MISC and 1099-NEC for more information and additional reporting requirements.
You can file your tax returns electronically using an IRSoption. The benefits of IRSinclude faster refunds, increased accuracy, and acknowledgment of IRS receipt of your return. You can use one of the following IRSoptions.For details on these fast filing methods, see your income tax package.
The following reminders and other items may help you file your tax return.
Standard mileage rate. For tax year 2022, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 58.5 cents per mile.
Standard mileage rate. For tax year 2021, the standard mileage rate for the cost of operating your car , van, pickup, or panel truck for each mile of business use is 56 cents per mile. For more information, see chapter 11 .
Advance payment of COVID-19 credits extended. Based on the extensions of the credit for qualified sick and family leave wages and the employee retention credit, and the new credit for COBRA premium assistance payments, discussed above, Form 7200, Advance Payment of Employer Credits Due to COVID-19, may be filed to request an advance payment. For the latest guidance and information about COVID-19 tax relief, go to IRS.gov/Coronavirus .For more information, see chapter 2 .
New credit for COBRA premium assistance payments. Section 9501 of the ARP provides for COBRA premium assistance in the form of a full reduction in the premium otherwise payable by certain individuals and their families who elect COBRA continuation coverage due to a loss of coverage as the result of a reduction in hours or an involuntary termination of employment (assistance eligible individuals). For more information, see chapter 2 .
The ARP adds new section 3134 to the Internal Revenue Code to provide an employee retention credit similar to the credit that was previously enacted under the CARES Act and amended and extended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020.
The American Rescue Plan Act of 2021 (the ARP) adds new sections 3131, 3132, and 3133 to the Internal Revenue Code to provide credits for qualified sick and family leave wages similar to the credits that were previously enacted under the FFCRA and amended and extended by the COVID-related Tax Relief Act of 2020.
The Families First Coronavirus Response Act (FFCRA) was amended by recent legislation. The FFCRA requirement that employers provide paid sick and family leave for reasons related to COVID‐19 (the employer mandate) was extended per the COVID-related Tax Relief Act of 2020.
The following items highlight some changes in the tax law for 2021.
For the latest information about developments related to Pub. 535, such as legislation enacted after it was published, go to IRS.gov/Pub535 .
Go to IRS.gov/OrderForms to order current forms, instructions, and publications; call 800-829-3676 to order prior-year forms and instructions. The IRS will process your order for forms and publications as soon as possible. Don’t resubmit requests you've already sent us. You can get forms and publications faster online.
If you have a tax question not answered by this publication or the How To Get Tax Help section at the end of this publication, go to the IRS Interactive Tax Assistant page at IRS.gov/Help/ITA where you can find topics by using the search feature or viewing the categories listed.
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You can send us comments through IRS.gov/FormComments . Or you can write to the Internal Revenue Service, Tax Forms and Publications, 1111 Constitution Ave. NW, IR-6526, Washington, DC 20224.
We welcome your comments about this publication and your suggestions for future editions.
Note. Section references within this publication are to the Internal Revenue Code and regulation references are to the Income Tax Regulations under the Code.
This publication discusses common business expenses and explains what is and is not deductible. The general rules for deducting business expenses are discussed in the opening chapter. The chapters that follow cover specific expenses and list other publications and forms you may need.
. If you are carrying on two or more different activities, keep the deductions and income from each one separate. Figure separately whether each is a not-for-profit activity. Then figure the limit on deductions and losses separately for each activity that is not for profit. .
The IRS will generally accept your characterization if it is supported by facts and circumstances.
The business purpose that is (or might be) served by carrying on the various undertakings separately or together in a business or investment setting.
If you have several undertakings, each may be a separate activity or several undertakings may be combined. The following are the most significant facts and circumstances in making this determination.
If a partnership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. They are reflected in the individual shareholder's or partner's distributive shares.
For personal casualty losses resulting from federally declared disasters that occurred before 2018, you may be entitled to disaster tax relief. As a result, you may be required to figure your casualty loss differently. For tax years beginning after 2017, casualty and theft losses are allowed only to the extent it is attributable to a federally declared disaster. For more information, see Pub. 976, Disaster Relief.
Generally, you can deduct a casualty loss on property you own for personal use only to the extent each casualty loss is more than $100, and the total of all casualty losses exceeds 10% of your adjusted gross income (AGI). See Pub. 547 for more information on casualty losses.
Deductions you can take for personal as well as for business activities are allowed in full. For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses, may also be deducted. Deduct them on the appropriate lines of Schedule A (Form 1040).
. You can no longer claim any miscellaneous itemized deductions. Miscellaneous itemized deductions are those deductions that would have been subject to the 2%-of-adjusted-gross-income limitation. You can still claim certain expenses as itemized deductions on Schedule A (Form 1040)..
You can determine gross income from any not-for-profit activity by subtracting the cost of goods sold from your gross receipts. However, if you determine gross income by subtracting cost of goods sold from gross receipts, you must do so consistently, and in a manner that follows generally accepted methods of accounting.
Gross income from a not-for-profit activity includes the total of all gains from the sale, exchange, or other disposition of property, and all other gross receipts derived from the activity. Gross income from the activity also includes capital gains and rents received for the use of property that is held in connection with the activity.
. You must file Form 5213 within 3 years after the due date of your tax return (determined without extensions) for the year in which you first carried on the activity, or, if earlier, within 60 days after receiving written notice from the IRS proposing to disallow deductions attributable to the activity. .
Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the tax return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.
The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. Accordingly, it will not restrict your deductions. Rather, you will gain time to earn a profit in the required number of years. If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period.
You can elect to do this by filing Form 5213. Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity.
If you are starting an activity and do not have 3 (or 2) years showing a profit, you can elect to have the presumption made after you have the 5 (or 7) years of experience allowed by the test.
If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. This means the limits discussed here will not apply. You can take all your business deductions from the activity, even for the years that you have a loss. You can rely on this presumption unless the IRS later shows it to be invalid.
If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death.
An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced 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 within this period. You have a profit when the gross income from an activity exceeds the deductions.
You can expect to make a future profit from the appreciation of the assets used in the activity.
You were successful in making a profit in similar activities in the past,
You (or your advisors) have the knowledge needed to carry on the activity as a successful business,
You change your methods of operation in an attempt to improve profitability,
Your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business),
The time and effort you put into the activity indicate you intend to make it profitable,
In determining whether you are carrying on an activity for profit, several factors are taken into account. No one factor alone is decisive. Among the factors to consider are whether:
The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.
If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit.
Under the accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. Your deduction is allowed when the amount is includible in income by the related cash method payee. For more information, see Related Persons in Pub. 538.
Under the cash method, you can deduct a contested liability only in the year you pay the liability. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions. See Regulations section 1.461-2.
You are a cash method calendar year taxpayer. On December 1, 2021, you sign a 12-month lease, effective beginning January 1, 2022, and immediately pay your rent for the entire 12-month period that begins on January 1, 2022. The right or benefit attributable to the payment neither extends more than 12 months beyond January 1, 2022 (the first day that you are entitled to use the property) nor beyond the tax year ending December 31, 2022 (the year following the year in which you made the advance payment). Therefore, your prepayment does not have to be capitalized, and you can deduct the entire payment in the year you pay it.
In 2021, you sign a 10-year lease and immediately pay your rent for the first 3 years. Even though you paid the rent for 2021, 2022, and 2023, you can only deduct the rent for 2021 on your 2021 tax return. You can deduct the rent for 2022 and 2023 on your tax returns for those years.
However, you do not have to capitalize amounts for creating an intangible asset if the right or benefit created does not extend beyond the earlier of 12 months after the date that you first receive the right or benefit or the end of the tax year following the year in which you made the advance payment. If you are a cash method taxpayer and your advance payment qualifies for this exception, then you can generally deduct the amount when paid. If you are an accrual method taxpayer, you cannot deduct the amount until the all-events test has been met and economic performance has occurred.
You generally cannot deduct expenses in advance, even if you pay them in advance. This applies to prepaid interest, prepaid insurance premiums, and any other prepaid expense that creates an intangible asset. If you pay an amount that creates an intangible asset, then you must capitalize the amounts paid and begin to amortize the payment over the appropriate period.
If you use the cash method of accounting, deduct the expense on your 2022 tax return.
Your tax year is the calendar year. In December 2021, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. You paid it by check in January 2022. If you use the accrual method of accounting, deduct the $600 on your tax return for 2021 because all events have occurred to “fix” the fact of liability (in this case, the work was completed), the liability can be determined, and economic performance occurred in that year.
You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services.
All events have occurred that fix the fact of liability, and
The all-events test has been met. The test is met when:
Under the accrual method of accounting, you generally deduct business expenses when both of the following apply.
Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them.
When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income.
If your deductions are more than your income for the year, you may have an NOL. You can use an NOL to lower your taxes in other years. See Pub. 536 for more information.
Generally, you are in a passive activity if you have a trade or business activity in which you do not materially participate, or a rental activity. In general, deductions for losses from passive activities only offset income from passive activities. You cannot use any excess deductions to offset other income. In addition, passive activity credits can only offset the tax on net passive income. Any excess loss or credits are carried over to later years. Suspended passive losses are fully deductible in the year you completely dispose of the activity. For more information, see Pub. 925.
You pledge property (other than property used in the activity) as security for the loan.
Amounts you borrow for use in the activity if:
The money and adjusted basis of property you contribute to the activity.
Generally, a deductible loss from a trade or business or other income-producing activity is limited to the investment you have “at risk” in the activity. You are at risk in any activity for the following.
If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. For more information, see Not-for-Profit Activities , later.
If your deductions for an investment or business activity are more than the income it brings in, you have a loss. There may be limits on how much of the loss you can deduct.
Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. If these costs are included in the cost of goods sold, do not deduct them again as a business expense.
If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor.
For more information on recoveries and the tax benefit rule, see Pub. 525.
If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. If you have a recovery in a later year, include the recovered amount in income in that year. However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income.
Generally, you can deduct the full amount of a business expense if it meets the criteria of ordinary and necessary and it is not a capital expense.
For more information on car expenses and the rules for using the standard mileage rate, see Pub. 463.
If you are self-employed, you can also deduct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate.
You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. For 2021, the standard mileage rate is 56 cents per mile. Beginning in 2022, the standard mileage rate increased to 58.5 cents per mile.
If you use your car exclusively in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Generally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible.
. If you were entitled to deduct depreciation on the part of your home used for business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997..
For more information on the deduction for business use of your home, including the optional safe harbor method, see Pub. 587.
Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. All of the requirements discussed earlier under Business use of your home still apply.
The deduction under the optional method is limited to $1,500 per year based on $5 per square foot for up to 300 square feet. Under this method, you claim your allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A (Form 1040). You are not required to allocate these deductions between personal and business use, as is required under the regular method. If you use the optional method, you cannot depreciate the portion of your home used in a trade or business.
Individual taxpayers can use the optional safe harbor method to determine the amount of deductible expenses attributable to certain business use of a residence during the tax year. This method is an alternative to the calculation, allocation, and substantiation of actual expenses.
If the relative importance factor does not determine your principal place of business, consider the time spent at each location.
If you have more than one business location, determine your principal place of business based on the following factors.
You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
You use the office exclusively and regularly for administrative or management activities of your trade or business.
Your home office qualifies as your principal place of business if you meet the following requirements.
You generally do not have to meet the exclusive use test for the part of your home that you regularly use either for the storage of inventory or product samples, or as a daycare facility.
A separate structure (not attached to your home) used in connection with your trade or business.
A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business; or
The business part of your home must be used exclusively and regularly for your trade or business.
To qualify to claim expenses for the business use of your home, you must meet both of the following tests.
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation.
For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can generally deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is generally not deductible. See chapter 4 for information on deducting interest and the allocation rules.
Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.
For tax years beginning after 2017, you may be entitled to take a deduction of up to 20% of your qualified business income from your qualified trade or business, plus 20% of the aggregate amount of qualified real estate investment trust (REIT) and qualified publicly traded partnership income. The deduction is subject to various limitations, such as limitations based on the type of your trade or business, your taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by your trade or business. You will claim this deduction on Form 1040 or 1040-SR, not on Schedule C. Unlike other deductions, this deduction can be taken in addition to the standard or itemized deductions. For more information, see the Instructions for Form 1040.
The cost of changing from one heating system to another is a capital expense.
Unless the uniform capitalization rules apply, the cost of replacing short-lived parts of a machine to keep it in good working condition, but not to improve the machine, is a deductible expense.
Unless the uniform capitalization rules apply, amounts spent for tools used in your business are deductible expenses if the tools have a life expectancy of less than 1 year or they cost $200 or less per item or invoice.
The cost of building a private road on your business property and the cost of replacing a gravel driveway with a concrete one are capital expenses you may be able to depreciate. The cost of maintaining a private road on your business property is a deductible expense.
Generally, repairs you make to your business vehicle are currently deductible. However, amounts you pay to improve your business vehicle are generally capital expenditures and are recovered through depreciation.
There are dollar limits on the depreciation you can claim each year on passenger automobiles used in your business. See Pub. 463 for more information.
You usually capitalize the cost of a motor vehicle you use in your business. You can recover its cost through annual deductions for depreciation.
To help you distinguish between capital and deductible expenses, different examples are given below.
You can elect to capitalize and depreciate certain amounts paid for repair and maintenance of tangible property, even if they do not improve your property. To qualify for this election, you must treat these amounts as capital expenditures on your books and records used in figuring your income. If you make this election, you must apply it to all repair and maintenance costs of tangible property that you treat as capital expenditures on your books and records for this tax year. To make the election to treat repairs and maintenance as capital expenditures, attach a statement titled “Section 1.263(a)-3(n) Election” to your timely filed original tax return (including extensions) and include your name and address, TIN, and a statement that you elect to capitalize repair and maintenance costs under section 1.263(a)-3(n). You must treat these amounts as improvements to your tangible property and begin to depreciate these amounts when the improvement is placed in service.
You must capitalize both the direct and indirect costs of an improvement. Indirect costs include repairs and other expenses that directly benefit or are incurred by reason of your improvement. For example, if you improve the electrical system in your building, you must also capitalize the costs of repairing the holes that you made in walls to install the new wiring. This rule applies even if this work, performed by itself, would otherwise be treated as currently deductible repair costs.
– For other property, more than once during the class life of the particular type of property. For class lives, see Revenue Procedure 88-57, 1987-2 C.B. 674.
– For buildings and building systems, more than once during the 10-year period after you place the building in service; or
You reasonably expect, at the time the property is placed in service, to perform this activity:
It arises from the use of the property in your trade or business.
If you determine that your cost was for an improvement to a building or equipment, you can deduct your cost under the routine maintenance safe harbor. Under the routine maintenance safe harbor, you can deduct the costs of an improvement that meets all of the following criteria.
However, you may currently deduct the costs of repairs or maintenance that do not improve a unit of property. This generally includes the costs of routine repairs and maintenance to your property that result from your use of the property and that keep your property in an ordinary, efficient operating condition. For example, deductible repairs include costs such as painting exteriors or interiors of business buildings, repairing broken windowpanes, replacing worn-out minor parts, sealing cracks and leaks, and changing oil or other fluids to maintain business equipment.
Some examples of improvements include rewiring or replumbing of a building, replacing an entire roof, increasing the production output of your equipment, putting an addition on your building, strengthening the foundation of a building so you can use it for a new purpose, or replacing a major component or substantial structural part of a machine.
Generally, you must capitalize the costs of making improvements to a business asset if the improvements result in a betterment to the unit of property, restore the unit of property, or adapt the unit of property to a new or different use.
In 2021, you do not have an applicable financial statement and you purchase five laptop computers for use in your trade or business. You paid $2,000 each for a total cost of $10,000 and these amounts are substantiated in an invoice. You had an accounting procedure in place at the beginning of 2021 to expense the cost of tangible property if the property costs $2,000 or less. You treat each computer as an expense on your books and records for 2021 in accordance with this policy. If you elect the de minimis safe harbor in your tax returns for your 2021 tax year, you can deduct the cost of each $2,000 computer.
In the case of a consolidated group filing a consolidated income tax return, the election is made for each member of the consolidated group. In the case of an S corporation or a partnership, the election is made by the S corporation or the partnership and not by the shareholders or partners. The election applies only for the tax year for which it is made.
To elect the de minimis safe harbor for the tax year, attach a statement to the taxpayer’s timely filed original tax return (including extensions) for the tax year when qualifying amounts were paid. The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and must include your name, address, taxpayer identification number (TIN), and a statement that you are making the de minimis safe harbor election under section 1.263(a)-1(f). In the case of a consolidated group filing a consolidated income tax return, the election is made for each member of the consolidated group.
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The amount paid for the property does not exceed $2,500 per invoice (or per item substantiated by invoice); and
You treat the amounts paid for the property as an expense on your books and records in accordance with your accounting procedures;
– Amounts paid for property with an economic useful life of 12 months or less;
You have, at the beginning of the tax year, accounting procedures treating as an expense for nontax purposes:
You have a trade or business, partnership, or S corporation that does not have an applicable financial statement;
If you elect the de minimis safe harbor for the tax year, you can deduct amounts paid to acquire or produce certain tangible business property if:
You do not have an applicable financial statement.
The amount paid for the property does not exceed $5,000 per invoice (or per item substantiated by invoice); and
You treat the amount paid during the tax year for which you make the election as an expense on your applicable financial statements in accordance with your written accounting procedures;
– Amounts paid for property with an economic useful life of 12 months or less;
You have, at the beginning of the tax year, written accounting procedures treating as an expense for nontax purposes:
You have a trade or business or are a corporation, partnership, or S corporation that has an applicable financial statement;
If you elect the de minimis safe harbor for the tax year, you can deduct amounts paid to acquire or produce certain tangible business property if:
Although you must generally capitalize costs to acquire or produce real or tangible personal property used in your trade or business, such as buildings, equipment, or furniture, you can elect to use a de minimis safe harbor to deduct the costs of some tangible property. Under the de minimis safe harbor for tangible property, you can deduct de minimis amounts paid to acquire or produce certain tangible business property if these amounts are deducted by you for financial accounting purposes or in keeping your books and records. See the following for the requirements for the de minimis safe harbor.
Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. See Regulations section 1.263A-2 for information on these rules.
There are many different kinds of business assets, for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. You must fully capitalize the cost of these assets, including freight and installation charges.
The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. You cannot take a deduction for these costs. You will recover the costs of these assets when you dispose of them.
If you are a corporation and your attempt to go into a new trade or business is not successful, you may be able to deduct all investigatory costs as a loss.
The costs you had in your attempt to acquire or begin a specific business. These costs are capital expenses and you can deduct them as a capital loss.
The costs you had before making a decision to acquire or begin a specific business. These costs are personal and nondeductible. They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility.
If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories.
If your attempt to go into business is unsuccessful.
Usually, you recover costs for a particular asset through depreciation. Generally, you cannot recover other costs until you sell the business or otherwise go out of business. However, you can choose to amortize certain costs for setting up your business. See Starting a Business in chapter 8 for more information on business startup costs.
When you go into business, treat all costs you had to get your business started as capital expenses.
The costs of getting started in business, before you actually begin business operations, are capital expenses. These costs may include expenses for advertising, travel, or wages for training employees.
Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. These recovery methods allow you to deduct part of your cost each year. In this way, you are able to recover your capital expense. See Amortization (chapter 8) and Depletion (chapter 9) in this publication. A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduction. A greater portion of these costs can be deducted if the property is qualified disaster assistance property. See Pub. 946 for details.
. You can elect to deduct or amortize certain business startup costs. See chapters 7 and 8 ..
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called “capital expenses.” Capital expenses are considered assets in your business. In general, you capitalize three types of costs.
This rule does not apply to small business taxpayers. You qualify as a small business taxpayer if you (a) have average annual gross receipts of $26 million or less for the 3 prior tax years, and (b) are not a tax shelter (as defined in section 448(d)(3)). If your business has not been in existence for all of the 3-tax-year period used in figuring average gross receipts, base your average on the period it has existed, and if your business has a predecessor entity, include the gross receipts of the predecessor entity from the 3-tax-year period when figuring average gross receipts. If your business (or predecessor entity) had short tax years for any of the 3-tax-year period, annualize your business’ gross receipts for the short tax years that are part of the 3-tax-year period. See Pub. 538 for more information.
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs.
The following are types of expenses that go into figuring cost of goods sold.
If your business manufactures products or purchases them for resale, you must generally value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your business expenses may be included in figuring cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.
Even though an expense may be ordinary and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. In some cases, you may not be allowed to deduct the expense at all. Therefore, it is important to distinguish usual business expenses from expenses that include the following.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit
This chapter covers the general rules for deducting business expenses. Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit.
Vacation pay is an employee benefit. It includes amounts paid for unused vacation leave. You can deduct vacation pay only in the tax year in which the employee actually receives it. This rule applies regardless of whether you use the cash or accrual method of accounting.
You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. However, your deduction is limited to amounts not compensated by insurance or other means.
See Reimbursement of Travel and Non-Entertainment Related Meals in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans.
If you make the payment under an accountable plan, deduct it in the category of the expense paid. For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. If you make the payment under a nonaccountable plan, deduct it as wages and include it on the employee's Form W-2.
You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. However, your deduction may be limited.
“Substantially vested” means the property isn't subject to a substantial risk of forfeiture. This means that the recipient isn't likely to have to give up his or her rights in the property in the future.
If the property you transfer for services is subject to restrictions that affect its value, you generally can't deduct it and don't report gain or loss until it is substantially vested in the recipient. However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid.
These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-NEC.
You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Your gain or loss is the difference between the FMV of the property and its adjusted basis on the date of transfer.
You can claim the deduction only for the tax year in which your employee includes the property's value in income. Your employee is deemed to have included the value in income if you report it on Form W-2 in a timely manner.
If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. The amount you can deduct is the property's fair market value (FMV) on the date of the transfer less any amount the employee paid for the property.
On certain loans you make to an employee or shareholder, you’re treated as having received interest income and as having paid compensation or dividends equal to that interest. See Below-Market Loans in chapter 4 .
You can generally deduct as wages an advance you make to an employee for services to be performed if you don't expect the employee to repay the advance. However, if the employee performs no services, treat the amount you advanced as a loan; if the employee doesn't repay the loan, treat it as income to the employee.
For more information, see sections 419(c) and 419A and the related regulations.
The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits.
The cost you would’ve been able to deduct using the cash method of accounting if you had paid for the benefits directly.
Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund.
Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year.
A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Welfare benefits are any benefits other than deferred compensation or transfers of restricted property.
You can't deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business if you’re directly or indirectly the beneficiary of the policy. See Regulations section 1.264-1 for more information.
You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc.).
If you provide your employees with qualified transportation benefits, such as transportation in a commuter highway vehicle, transit passes, or qualified parking, you may no longer deduct these amounts. P.L. 115-97 provides that no deduction is allowed for qualified transportation benefits (whether provided directly by you, through a bona fide reimbursement arrangement, or through a compensation reduction agreement) incurred or paid after 2017. Also, no deduction is allowed for any expense incurred for providing any transportation, or any payment or reimbursement to your employee, in connection with travel between your employee's residence and place of employment, except as necessary for ensuring the safety of your employee or for qualified bicycle commuting reimbursements as described in section 132(f)(5)(F). While you may no longer deduct payments for qualified transportation benefits, the fringe benefit exclusion rules still apply and the payments, except for qualified bicycle commuting reimbursements, may be excluded from your employee's wages. Although the value of a qualified transportation fringe benefit is relevant in determining the fringe benefit exclusion and whether the section 274(e)(2) exception for expenses treated as compensation applies, the deduction that is disallowed relates to the expense of providing a qualified transportation fringe, not its value. For more information, see Regulations sections 1.274-13 and 1.274-14. See Pub. 15-B for more information about qualified transportation benefits.
. Section 210 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 provides for the temporary allowance of a 100% business meal deduction for food or beverages provided by a restaurant and paid or incurred after December 31, 2020, and before January 1, 2023. For more information, see Notice 2021-25, 2021-17 I.R.B. 1118, available at IRS.gov/irb/2021-17_IRB#NOT-2021-25 ; and Notice 2021-63, 2021-49 I.R.B. 835, available at IRS.gov/irb/2021-49_IRB#NOT-2021-63 ..
P.L. 115-97 changed the rules for the deduction of business entertainment expenses. For amounts incurred or paid after 2017, no business deduction is allowed for any item generally considered to be entertainment, amusement, or recreation. As discussed earlier, you can deduct 50% of the cost of business meals. If food and beverages are provided during or at an entertainment activity, and the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts, you may continue to deduct 50% of the business meal expenses. The amount charged for food or beverages on a bill, invoice, or receipt must reflect the venue's usual selling cost for those items if they were to be purchased separately from the entertainment or must approximate the reasonable value of those items. If you purchase food and beverages together with entertainment expenses and the cost of the food and beverages isn't stated separately on the invoice, the cost of the food and beverages is also an entertainment expense and none of the expenses are deductible. For more information, including details about additional requirements that must be met for a business meal to be deductible, see Regulations sections 1.274-11 and 1.274-12(a).
. P.L. 115-97, Tax Cuts and Jobs Act, changed the rules for the deduction of food or beverage expenses that are excludable from employee income as a de minimis fringe benefit. For amounts incurred or paid after 2017, the 50% limit on deductions for food or beverage expenses also applies to food or beverage expenses excludable from employee income as a de minimis fringe benefit. While your business deduction may be limited, the rules that allow you to exclude certain de minimis meals and meals on your business premises from your employee's wages still apply. See Meals in section 2 of Pub. 15-B. .
Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska.
Meals you’re required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). This doesn't include meals you furnish on vessels primarily providing luxury water transportation.
Meals you furnish to your employees at the work site when you operate a restaurant or catering service.
Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as holiday parties or annual picnics, when made primarily for the benefit of your employees other than employees who are officers, shareholders or other owners who own a 10% or greater interest in your business, or other highly compensated employees.
You can generally deduct only 50% of the cost of furnishing meals to your employees. However, you can deduct the full cost of certain meals; see section 274(n)(2) and Regulations section 1.274-12(c) for more information. For example, you can deduct the full cost of the following meals.
Generally, you can deduct 50% of certain meal expenses and 100% of certain lodging expenses provided to your employees. If the amounts are deductible, deduct the cost in whatever category the expense falls.
Certain fringe benefits are discussed next. See Pub. 15-B for more details on these and other fringe benefits.
Generally, no deduction is allowed for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such activity. However, you may deduct these expenses if the goods, services, or facilities are treated as compensation to the recipient and reported on Form W-2 for an employee or on Form 1099-NEC for an independent contractor. If the recipient is an officer, director, beneficial owner (directly or indirectly), or other “specified individual” (as defined in section 274(e)(2)(B) and Regulations section 1.274-9(b)), special rules apply. See section 274(e)(2) and Regulations sections 1.274-9 and 1.274-10.
You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. You also may not owe employment taxes on the value of the fringe benefits. See Table 2-1 in Pub. 15-B for details.
A fringe benefit is a form of pay for the performance of services. You can generally deduct the cost of fringe benefits.
. Section 2206 of the CARES Act expands the definition of educational assistance to include certain employer payments of student loans paid after March 27, 2020. The exclusion applies to the payment by an employer, whether paid to the employee or to a lender, of principal or interest on any qualified education loan incurred by the employee for the education of the employee. Qualified education loans are defined in chapter 10 of Pub. 970. This exclusion expires January 1, 2026, unless extended by future legislation..
If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. For information on educational assistance programs, see Educational Assistance in section 2 of Pub. 15-B.
If, to promote employee goodwill, you distribute merchandise of nominal value or other de minimis items to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. See Pub. 15-B for additional information on de minimis fringe benefits. If you provide food to your employees, your business deduction may be limited; see Meals and lodging , later.
You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. However, the total bonuses, salaries, and other pay must be reasonable for the services performed. If the bonus is paid in property, see Property , later.
. You may not owe employment taxes on the value of some achievement awards you provide to an employee. See Pub. 15-B..
Deduct achievement awards, up to the maximum amounts listed earlier, as a nonwage business expense on your return or business schedule.
An award isn't a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. To figure this average cost, ignore awards of nominal value.
You can choose to ignore test (2) if the employee wasn't also in the top 20% of employees ranked by pay for the preceding year.
The employee was a 5% owner at any time during the year or the preceding year.
A highly compensated employee is an employee who meets either of the following tests.
A qualified plan award is an achievement award given as part of an established written plan or program that doesn't favor highly compensated employees as to eligibility or benefits.
Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following.
During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value).
It is given to a manager, administrator, clerical employee, or other professional employee.
An award for safety achievement will qualify as an achievement award unless one of the following applies.
The employee didn't receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years.
The employee receives the award after his or her first 5 years of employment.
An award will qualify as a length-of-service award only if either of the following applies.
An award isn't an item of tangible personal property if it is an award of cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than arrangements granting only the right to select and receive tangible personal property from a limited assortment of items preselected or preapproved by you). Also, tangible personal property doesn't include vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.
It is awarded under conditions and circumstances that don't create a significant likelihood of disguised pay.
It is given to an employee for length of service or safety achievement.
An achievement award is an item of tangible personal property that meets all the following requirements.
You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. If you give property to an employee as an employee achievement award, your deduction may be limited.
Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Pubs. 15, 15-A, and 15-B.
If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. The excessive part of the salary wouldn't be allowed as a salary deduction by the corporation. For more information on corporate distributions to shareholders, see Pub. 542.
You must be able to prove the payment was made for services actually performed.
Publicly held corporations can't deduct compensation to a “covered employee” to the extent that the compensation for the tax year exceeds $1 million. For more information, including the definition of a “covered employee,” see the Instructions for Form 1125-E and Regulations section 1.162-33.
The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation.
To determine if pay is reasonable, also consider the following items and any other pertinent facts.
Determine the reasonableness of pay by the facts and circumstances. Generally, reasonable pay is the amount that a similar business would pay for the same or similar services.
You must be able to prove that the pay is reasonable. Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. If the pay is excessive, the excess pay is disallowed as a deduction.
The form or method of figuring the pay doesn't affect its deductibility. For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible.
In addition, the pay must meet both of the following tests.
To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. These and other requirements that apply to all business expenses are explained in chapter 1 .
. You may be able to claim employment credits, such as the credits listed below, if you meet certain requirements. You must reduce your deduction for employee wages by the amount of employment credits that you claim. For more information about these credits, see the form on which the credit is claimed..
You can generally deduct the amount you pay your employees for the services they perform. The pay may be in cash, property, or services. It may include wages, salaries, bonuses, commissions, or other noncash compensation such as vacation allowances and fringe benefits. For information about deducting employment taxes, see chapter 5 .
Advance payment of COVID-19 credits extended. Based on the extensions of the credit for qualified sick and family leave wages and the employee retention credit, and the new credit for COBRA premium assistance payments, discussed above, Form 7200, Advance Payment of Employer Credits Due to COVID-19, may be filed to request an advance payment. For more information, including information on which employers are eligible to request an advance payment, the deadlines for requesting an advance, and the amount that can be advanced, see the Instructions for Form 7200.For the latest guidance and information about COVID-19 tax relief, go to IRS.gov/Coronavirus .
New credit for COBRA premium assistance payments. Section 9501 of the ARP provides for COBRA premium assistance in the form of a full reduction in the premium otherwise payable by certain individuals and their families who elect COBRA continuation coverage due to a loss of coverage as the result of a reduction in hours or an involuntary termination of employment (assistance eligible individuals). For more information on COBRA premium assistance payments and the credit, see Notice 2021-31, 2021-23 I.R.B. 1173, available at IRS.gov/irb/2021-23_IRB#NOT-2021-31 , and Notice 2021-46, 2021-33 I.R.B. 303, available at IRS.gov/irb/2021-33_IRB#NOT-2021-46 .
The ARP adds new section 3134 to the Internal Revenue Code to provide an employee retention credit similar to the credit that was previously enacted under the CARES Act and amended and extended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020. The employee retention credit is claimed on your 2021 employment tax return (typically Form 941). For more information about the employee retention credit, including the dates for which the credit may be claimed, see the instructions for your employment tax return and go to IRS.gov/ERC .
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was amended by recent legislation. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 modifies the calculation of the employee retention credit and extends the date through which the credit may be claimed to qualified wages paid before July 1, 2021.
The American Rescue Plan Act of 2021 (the ARP) adds new sections 3131, 3132, and 3133 to the Internal Revenue Code to provide credits for qualified sick and family leave wages similar to the credits that were previously enacted under the FFCRA and amended and extended by the COVID-related Tax Relief Act of 2020. The credits under sections 3131 and 3132 are available for qualified leave wages paid for leave taken after March 31, 2021, and before October 1, 2021. The credit for qualified sick and family leave wages is claimed on your 2021 employment tax return (typically Form 941, Employer's QUARTERLY Federal Tax Return). You must include the full amount (both the nonrefundable and refundable portions) of the credit for qualified sick and family leave wages in your gross income for the tax year that includes the last day of any calendar quarter in which a credit is allowed. For more information about the credit for qualified sick and family leave wages, see the instructions for your employment tax return and go to IRS.gov/PLC .
The Families First Coronavirus Response Act (FFCRA) was amended by recent legislation. The FFCRA requirement that employers provide paid sick and family leave for reasons related to COVID‐19 (the employer mandate) expired on December 31, 2020; however, the COVID-related Tax Relief Act of 2020 extends the periods for which employers providing leave that otherwise meets the requirements of the FFCRA may continue to claim tax credits for qualified sick and family leave wages paid for leave taken before April 1, 2021.
For exceptions and more information on these rules, see Uniform Capitalization Rules in Pub. 538 and the regulations under section 263A.
You rent space in a facility to conduct your business of manufacturing tools. If you are subject to the uniform capitalization rules, you must include the rent you paid to occupy the facility in the cost of the tools you produce.
You rent construction equipment to build a storage facility. If you are subject to the uniform capitalization rules, you must capitalize as part of the cost of the building the rent you paid for the equipment. You recover your cost by claiming a deduction for depreciation on the building.
You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow the property. Property produced for you under a contract is treated as produced by you to the extent you make payments or otherwise incur costs in connection with the property.
Effective for tax years beginning after 2017, if you are a small business taxpayer (see Cost of Goods Sold in chapter 1), you are not required to capitalize costs under section 263A. See section 263A(i).
Acquire property for resale. However, this rule does not apply to personal property if your average annual gross receipts are $26 million or less.
You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.
Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.
The part that is for the increased rental value of the land is a cost of getting a lease, and you amortize it over the remaining term of the lease. You can depreciate the part that is for your investment in the improvements over the recovery period of the property as discussed earlier, without regard to the lease term.
If a long-term lessee who makes permanent improvements to land later assigns all lease rights to you for money and you pay the rent required by the lease, the amount you pay for the assignment is a capital investment. If the rental value of the leased land increased since the lease began, part of your capital investment is for that increase in the rental value. The rest is for your investment in the permanent improvements.
For more information, see the discussion of MACRS in chapter 4 of Pub. 946.
If you don’t keep the improvements when you end the lease, figure your gain or loss based on your adjusted basis in the improvements at that time.
If you add buildings or make other permanent improvements to leased property, depreciate the cost of the improvements using the modified accelerated cost recovery system (MACRS). Depreciate the property over its appropriate recovery period. You can’t amortize the cost over the remaining term of the lease.
If you sell at a loss merchandise and fixtures that you bought solely to get a lease, the loss is a cost of getting the lease. You must capitalize the loss and amortize it over the remaining term of the lease.
Commissions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. You must amortize these costs over the term of the lease.
How much is $45000 in hours?
That means, if you work the standard 40 hour work week, 52 weeks per year, you'd need to divide $45,000 by 2,080 hours (40 * 52). If this is your...
You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Your amortization deduction each year will be $150 ($3,000 ÷ 20). You can’t deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent.
You are a calendar year taxpayer and sign a 20-year lease to rent part of a building starting on January 1. However, before you occupy it, you decide that you really need less space. The lessor agrees to reduce your rent from $7,000 to $6,000 per year and to release the excess space from the original lease. In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each.
You may have to pay an additional “rent” amount over part of the lease period to change certain provisions in your lease. You must capitalize these payments and amortize them over the remaining period of the lease. You can’t deduct the payments as additional rent, even if they are described as rent in the agreement.
The facts are the same as in Example 1, except that you paid $8,000 for the original lease and $2,000 for the renewal options. You can amortize the entire $10,000 over the 20-year remaining life of the original lease. The $8,000 cost of getting the original lease was not less than 75% of the total cost of the lease (or $7,500).
You paid $10,000 to get a lease with 20 years remaining on it and two options to renew for 5 years each. Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. Because $7,000 is less than 75% of the total $10,000 cost of the lease (or $7,500), you must amortize the $10,000 over 30 years. That is the remaining life of your present lease plus the periods for renewal.
The term of the lease for amortization includes all renewal options plus any other period for which you and the lessor reasonably expect the lease to be renewed. However, this applies only if less than 75% of the cost of getting the lease is for the term remaining on the purchase date (not including any period for which you may choose to renew, extend, or continue the lease). Allocate the lease cost to the original term and any option term based on the facts and circumstances. In some cases, it may be appropriate to make the allocation using a present value calculation. For more information, see Regulations section 1.178-1(b)(5).
The cost of getting an existing lease of tangible property is not subject to the amortization rules for section 197 intangibles discussed in chapter 8 .
If you get an existing lease on property or equipment for your business, you must generally amortize any amount you pay to get that lease over the remaining term of the lease. For example, if you pay $10,000 to get a lease and there are 10 years remaining on the lease with no option to renew, you can deduct $1,000 each year.
You may either enter into a new lease with the lessor of the property or get an existing lease from another lessee. Very often when you get an existing lease from another lessee, you must pay the previous lessee money to get the lease, besides having to pay the rent on the lease.
The facts are the same as in Example 1, except that, according to the terms of the lease, Oak becomes liable for the real estate taxes when the owner of the property becomes liable for them. As a result, Oak will deduct the real estate taxes as rent on its tax return for the earlier year. This is the year in which Oak's liability under the lease becomes fixed.
Oak cannot deduct the real estate taxes as rent until the tax bill is issued. This is when Oak's liability under the lease becomes fixed.
Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Oak leases land for use in its business. Under state law, owners of real property become liable (incur a lien on the property) for real estate taxes for the year on January 1 of that year. However, they don’t have to pay these taxes until July 1 of the next year (18 months later) when tax bills are issued. Under the terms of the lease, Oak becomes liable for the real estate taxes in the later year when the tax bills are issued. If the lease ends before the tax bill for a year is issued, Oak isn’t liable for the taxes for that year.
The liability and amount of taxes are determined by state or local law and the lease agreement. Economic performance occurs as you use the property.
That you have a liability for taxes on the leased property.
If you use an accrual method of accounting, you can deduct the taxes as additional rent for the tax year in which you can determine all the following.
If you use the cash method of accounting, you can deduct the taxes as additional rent only for the tax year in which you pay them.
If you lease business property, you can deduct as additional rent any taxes you have to pay to or for the lessor. When you can deduct these taxes as additional rent depends on your accounting method.
Generally, if the special rules apply, you must use an accrual method of accounting (and time value of money principles) for your rental expenses, regardless of your overall method of accounting. In addition, in certain cases in which the IRS has determined that a lease was designed to achieve tax avoidance, you must take rent and stated or imputed interest into account under a constant rental accrual method in which the rent is treated as accruing ratably over the entire lease term. For details, see section 467.
These rules do not apply if your lease specifies equal amounts of rent for each month in the lease term and all rent payments are due in the calendar year to which the rent relates (or in the preceding or following calendar year).
Rents are prepaid (rent is payable before the end of the calendar year preceding the calendar year in which the use occurs and the rent is allocated).
Rents are deferred (rent is payable after the end of the calendar year following the calendar year in which the use occurs and the rent is allocated).
Special rules are provided for certain leases of tangible property. The rules apply if the lease calls for total payments of more than $250,000 and any of the following apply.
The IRS won’t issue advance rulings on leveraged leases of so-called limited-use property. Limited-use property is property not expected to be either useful to or usable by a lessor at the end of the lease term except for continued leasing or transfer to a lessee. See Revenue Procedure 2001-28 for examples of limited-use property and property that isn’t limited-use property.
The IRS may charge you a user fee for issuing a tax ruling. For more information, see Revenue Procedure 2021-1, available at IRS.gov/irb/2021-01_IRB#RP-2021-01 .
The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes.
The lessee may not lend any money to the lessor to buy the property or guarantee the loan used by the lessor to buy the property.
The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28.
The lessee may not have a contractual right to buy the property from the lessor at less than FMV when the right is exercised.
The lessor must maintain a minimum unconditional “at risk” equity investment in the property (at least 20% of the cost of the property) during the entire lease term.
For advance ruling purposes only, the IRS will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction to be a valid lease if all the factors in the revenue procedure are met, including the following.
These two revenue procedures can be found in I.R.B. 2001-19, which is available at IRS.gov/pub/irs-irbs/irb01-19.pdf
Revenue Procedure 2001-29 provides the information required to be furnished in a request for an advance ruling on a leveraged lease transaction.
Revenue Procedure 2001-28 contains the guidelines the IRS will use to determine if a leveraged lease is a lease for federal income tax purposes.
If you plan to take part in what appears to be a leveraged lease, you may want to get an advance ruling.
Leveraged lease transactions may not be considered leases. Leveraged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Usually, the lease term covers a large part of the useful life of the leased property, and the lessee's payments to the lessor are enough to cover the lessor's payments to the lender.
The agreement designates part of the payments as interest, or that part is easy to recognize as interest.
You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement.
You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.
You pay much more than the current fair rental value of the property.
The amount you must pay to use the property for a short time is a large part of the amount you would pay to get title to the property.
You get title to the property after you make a stated amount of required payments.
The agreement applies part of each payment toward an equity interest you will receive.
Whether an agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies. However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.
There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.
You can generally deduct as rent an amount you pay to cancel a business lease.
You are either a cash or accrual calendar year taxpayer. Last January, you leased property for 3 years for $6,000 per year. You pay the full $18,000 (3 x $6,000) during the first year of the lease. Because this amount is a prepaid expense that must be capitalized, you can deduct only $6,000 per year, the amount allocable to your use of the property in each year.
Assume the same facts as Example 1, except you are a cash method calendar year taxpayer. You may deduct the entire $12,000 payment for 2021. The payment applies to your right to use the property that does not extend beyond 12 months after the date you received this right. If you deduct the $12,000 in 2021, you should not deduct any part of this payment in 2022.
You are an accrual method calendar year taxpayer and you lease a building at a monthly rental rate of $1,000 beginning July 1, 2021. On June 30, 2021, you pay advance rent of $12,000 for the last 6 months of 2021 and the first 6 months of 2022. You can deduct only $6,000 for 2021, for the right to use property in 2021. You deduct the other $6,000 in 2022.
Generally, rent paid for use of property in your trade or business is deductible in the year paid or incurred. If you are an accrual method taxpayer and pay rent in advance, you can deduct only the amount of rent that applies to your use of rented property during the tax year. You can deduct the rest of the rent payment only over the period to which it applies. If you are a cash method taxpayer, you may deduct the entire amount of rent you paid in advance in the year of payment if the payment applies to the right to use property that does not extend beyond the earlier of 12 months after the first date you have the right to use the property or the end of the tax year following the year in which you paid the advance rent. If your payment applies to the right to use property beyond this period, then you must capitalize the rent payment and deduct it over the period to which it applies.
If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. You must meet the requirements for business use of your home. For more information, see Business use of your home in chapter 1 .
You can’t take a rental deduction for unreasonable rent. Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Rent isn’t unreasonable just because it is figured as a percentage of gross sales. For examples of related persons, see Related persons in chapter 2 of Pub. 544.
Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
This chapter discusses the tax treatment of rent or lease payments you make for property you use in your business but do not own. It also discusses how to treat other kinds of payments you make that are related to your use of this property. These include payments you make for taxes on the property.
Small business taxpayers. P.L. 115-97, Tax Cuts and Jobs Act, made changes to uniform capitalization rules for small business taxpayers. See Uniform capitalization rules , later.
Different rules generally apply to a loan connected with the sale or exchange of property. If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. See Unstated Interest and Original Issue Discount (OID) in Pub. 537.
The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse.
Independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and
The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an:
The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives.
A “continuing care contract” is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions.
Includes an independent living unit, and either an assisted living or nursing facility, or both.
A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below.
The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year.
Any reasons, other than taxes, for structuring the transaction as a below-market loan.
The cost of complying with the below-market loan provisions if they were to apply.
Whether items of income and deduction generated by the loan offset each other.
Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Consider all the following factors.
Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U.S. trade or business and not exempt from U.S. tax under an income tax treaty.
Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public.
Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices.
The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender.
This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less.
Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement.
Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets.
The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. This exception applies only to the following.
If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc.) on the date the loan is made. This payment is equal to the loan amount minus the present value, at the AFR, of all payments due under the loan. The same amount is treated as OID on the loan. See Original issue discount (OID) under Interest You Can Deduct, earlier.
For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. If the borrower's net investment income is $1,000 or less, it is treated as zero. This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement.
If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc.) equal to the forgone interest on the loan. You are then treated as transferring this amount back to the lender as interest. These transfers are considered to occur annually, generally on December 31. If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. The lender must report it as interest income.
Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date.
Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement).
Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services).
Gift loans (below-market loans where the forgone interest is in the nature of a gift).
. AFRs are published by the IRS each month in the Internal Revenue Bulletin (I.R.B.), which is available on the IRS website at IRS.gov/IRB . You can also contact an IRS office to get these rates..
Any interest actually payable on the loan for the period.
The interest that would be payable for that period if interest accrued on the loan at the AFR and was payable annually on December 31, minus
The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction.
A loan in exchange for a note that requires the payment of interest at the AFR.
A “below-market loan” is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate (AFR). A gift or demand loan that is a below-market loan is generally considered an arm's-length transaction in which you, the borrower, are considered as having received both of the following.
If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. See Treatment of gift and demand loans , later, in this discussion.
If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. See section 267 for more information.
However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid.
If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you.
If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.
You generally cannot deduct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.
Under an accrual method, you can deduct only interest that has accrued during the tax year.
If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax.
If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.
You generally cannot deduct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.
Under the cash method, you can generally deduct only the interest you actually paid during the tax year. You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment.
If the uniform capitalization rules, discussed under Capitalization of Interest , earlier, and the business interest expense deduction limitation rules discussed under Interest Expense Limitation , earlier, do not apply, deduct interest as follows.
The procedures for applying the uniform capitalization rules are beyond the scope of this publication. For more information, see Regulations sections 1.263A-8 through 1.263A-15 and Notice 88-99, which is in Cumulative Bulletin 1988-2.
If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation.
The interest capitalization rules are applied first at the partnership or S corporation level. The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs.
Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the property. If the property is inventory, recover capitalized interest through cost of goods sold. If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method.
Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information, see chapter 7 .
You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property.
Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million.
Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Designated property is any of the following.
Under the uniform capitalization rules, you must generally capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. The property must be produced by you for use in your trade or business or for sale to customers. You cannot capitalize interest related to property that you acquire in any other manner.
Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. For more information, see section 264(f).
You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract.
The lesser of 5% of the total officers and employees of the company or 20 individuals.
A “key person” is an officer or 20% owner. However, the number of individuals you can treat as key persons is limited to the greater of the following.
If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average—Monthly Average Corporates) (Moody's rate) for that month.
You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person.
Penalties on underpaid deficiencies and underpaid estimated tax are not interest. You cannot deduct them. Generally, you cannot deduct any fines or penalties.
Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Treat this interest as a business deduction only in figuring a net operating loss deduction.
If the funds are for inventory or certain property used in your business, the fees are indirect costs and you must generally capitalize them under the uniform capitalization rules. See Capitalization of Interest , later.
Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. You may be able to deduct them as business expenses.
You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. See Capitalization of Interest , later. In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Add this interest to the basis of the property.
When you make a payment on the new loan, you first apply the payment to interest and then to the principal. All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply.
If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. You can deduct the interest expense once you start making payments on the new loan.
You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest.
Certain interest payments cannot be deducted. In addition, certain other expenses that may seem to be interest, but are not, cannot be deducted as interest.
If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). The amount recharacterized as interest reduces your basis in the property and increases your interest expense. For more information on installment sales and unstated interest, see Pub. 537.
If you make partial payments on a debt (other than a debt owed to the IRS), the payments are applied, in general, first to interest and any remainder to principal. You can deduct only the interest. This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made.
The points reduce the issue price of the loan and result in OID, deductible as explained in the preceding discussion.
Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. However, you can choose to fully deduct points in the year paid if you meet certain tests. For exceptions to the general rule, see Pub. 936.
The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. If any of these charges (points) are solely for the use of money, they are interest.
. If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct , later..
If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event.
The facts are the same as in the previous example, except that you deduct the OID on a constant-yield basis over the term of the loan. The yield to maturity on your loan is 10.2467%, compounded annually. For 2021, you can deduct $93 [($98,500 × 0.102467) − $10,000]. For 2022, you can deduct $103 [($98,593 × 0.102467) − $10,000].
The yield to maturity is generally shown in the literature you receive from your lender. If you do not have this information, consult your lender or tax advisor. In general, the yield to maturity is the discount rate that, when used in
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