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Running Header: Assignment 2: Tax Deductible Losses Assignment 2: Tax Deductible Losses Silvia Mazariegos Strayer University Instructor: Rebeca Shaffer ACC555 - Tax Planning and Research February 21, 2017 Tax Deductible Losses 2 Introduction This paper includes an explanation as to what are Tax Deductible Losses and gives some examples of them. The IRS allows Tax Deductible Losses as deductions. Under section 165 of the 26 US code-losses, for the losses to qualify deduction, the insurance company should not compensate or face it during the taxable year. Car accidents, earthquakes, fires, floods, and demolition ordered by the government because of a disaster are an example of tax deductible losses. Casualty losses are the damage caused by any destruction or loss of an asset. This disaster comes suddenly or in an unexpected event. Also, this paper will discuss a list of losses that are not allowed as deductible from the tax code and the reason behind it. The reason for the non-deduction is to protect the taxpayer from falling into activities that could lead to selfdestruction or damage to the property itself. Also, this paper will make the discussion about how the Federal Administration can take help of the alternative minimum tax to support as well as protect their financial needs. In the end, this paper analyzes the losses that generate the audit of the Internal Revenue Service. Tax-deductible losses under the U.S. Tax Code The designated, state and nearby tax frameworks in the United States have been checked by huge changes through the years according to changing circumstances and modifications in the part of the government. The types of taxes collected, their relative size and the extents of the incomes gathered are not the same as far bot the as those 50 years ago. Some of these developments are traceable to particular recorded occasions, for example. War or the sections of the Sixteenth Amendment to the Constitution that allowed the Congress the ability to demand a that on every person's salary. Different advances were more progressive, reacting to changes in Tax Deductible Losses 3 the public arena in our economy, and in the parts and obligations that legislature has taken unto itself. For the greater part of our country's history, different taxpayers from time to time had some critical contact with Federal tax powers as the vast majority of the Federal government's tax incomes were determined to retain taxes, levies, and traditions obligations( McLaughlin, N. A. (2010). When the Revolutionary War, the boundary state had just a restricted necessity for income, while each of the provinces had more amazing duties and in this manner more excellent income needs, which they met with various types of taxes. For instance, the southern provinces fundamentally taxed imports and fees, the center settlements now and again forced a property tax and a survey tax collected on every mature person male, and the New England states raised income basically through general land taxes, extracts taxes, and taxes dependent upon occupation. The 1986 Tax Reform Act was severely income unbiased, that is, it was not planned to raise or easier taxes, yet it moved a percentage of the tax load from people to organizations. A significant part of the growth of the tax on business was the consequence of an increase in the tax on business capital framing. It achieved a few unravelings for people through the disposal of such things as pay averaging, the finding for buyer interest, and the origin for state and neighborhood deals taxes. However, in many aspects, the Act added incredibly to the complexity of corporate taxation, particularly in the area of worldwide taxation (McLaughlin, N. A. (2010). As a result of 911 and Hurricane Katrina, unprecedented tax relief was generated for casualty losses. Throughout WWII, the standard deduction was an alternative tax year for those taxpayers who preferred not to keep detailed records to justify itemization. For this reason, casualty loss deduction was codified as an itemized deduction for business and individuals under section 16.According to the US tax code; a taxpayer can only deduct expenditure if the IRC (Internal Tax Deductible Losses 4 Revenue Code) allows certain deductions (Logan, D. S. (2011). The taxpayer can take some business expenses under section 162, and those established in the general guidelines. There are certain losses due to tax deductible in which the tax liability is being calculated. The IRS allows deduction on casualty, theft, loss on deposits, proof of loss and some more others. Under the article 165 of the United Code, for losses to qualify for a deduction, the insurance company should not cover it during the taxable year. The taxpayers must prove that an unexpected incident, unusual and or identifiable in nature, caused the losses. The losses caused by hurricanes, tornadoes, and floods are allowed as deductions. However, when the property of the taxpayer is harm due to termites, the loss suffered due to this event, is not deductible for tax purposes. Following is a list of the losses that are allowed as deductions for tax purposes: Capital losses, casualty losses, theft losses, wagering losses, disaster losses, worthless security, fire, floods, hurricanes, storms, vandalism, and volcanic eruptions (Tolan, J. E. (2016). The losses mentioned above are deductible from the gross tax base for determining the tax liability. The loss serves as a basis for tax reduction. However, special rules have been made that limit the amount of loss that the taxpayer can claim. These particular rules help to discourage taxpayers from participating in activities that are planned to generate losses. These rules are "Passive activity limits" and "Risk Rule. The rationale behind providing these losses to be deductible is to reduce the tax burden on individuals and businesses. Since some of these losses suffered by the taxpayer are due to unexpected and unusual events, the deduction of these from their taxable income reduces the tax burden imposed by the tax authorities. Therefore, the deduction of these and all other losses is reasonable. The significant tax-deductible loss Tax Deductible Losses 5 One significant tax deductible losses are \"Gambling\" Gambling loss is one of the major tax deductibles, and the IRS allows to the taxpayer this kind of loss when he/she has gambling winnings. To claim this loss, the IRS requests to keep records of all losses as well as winnings for any others games such as raffles, lotteries, dog racing, casinos, poker games, and so forth. So, gambling winning is fully taxable, and the taxpayer must report the income on his/her tax return. The IRS states that the taxpayer must keep accurate record diary of all losses winnings. Also, the winner must keep the record regarding the date and type of game in which he/she got it. As well as the name and address of the places where the game occurred. Some of the documents required to prove losses of the game are as follows: Issue a Form W-2G; this form must be reported on form 1040 as other income in line 21. Winning documents such as Wagering Pools, Bingo, Poker tournaments, Lotteries, receipts, the statements, or others records that show the amount of winning and losses. Form 5754 where shows the person's name is receiving the winnings. Financial records, concealed checks, and receipts given from gambling The amounts won or lost. Under IRC section 165 (d), taxpayers are allowed to deduct gambling losses only if itemize deductions (Schedule A) on form 1040. If the taxpayers claim the standard deduction for the losses, then cannot reduce their tax by their gambling losses. The amount of the losses cannot be greater than the amount of gambling income reported on the tax return (Beck, R. E. (2004). There are some limitations for claiming gambling deductions. The amount cannot exceed the winnings reported in the income. For example, If the taxpayer has the loss of gambling is about $ 20,000, and the winner of gambling is $ 16,000. Then the taxpayer is allowed to claim only $ 16,000 as losses from gambling. The taxpayer cannot write off the remaining $4,000, carry this loss forward to future years. Tax Deductible Losses 6 This kind of gambling loss hurts other taxpayers. If an individual does not have any loss of game; the taxpayer will not be able to offset any gains against other losses. Taxpayers with gambling loss can adjust their gain against it and can reduce their tax liability. However, taxpayers who only have won from gambling can not offset their winnings, and therefore their tax liability is more than other taxpayers who have gambling losses. Therefore, this has an adverse impact on other taxpayers. The IRS does not permit to deduct the losses from the winnings and report the net profit or loss (IRS Tip Sheet on Gambling Income and Losses. (2014). I believe that tax losses are fair and reasonable tax-deductible because help to cut the tax bill. Tax deductible losses are necessary and reasonable expenses that contribute to earning business income. Taking advantage of allowable tax deductions can benefit to small business owners in many ways. It is reasonable to other taxpayers if this deduction is eliminated, or allowed with a specific limit of deduction for all taxpayers. That is to say that regardless of gambling losses, all taxpayers who have won games can deduct a specified amount of their income.The purpose of tax-deductible loss is to decrease the taxpayer taxable income which reduces the amount of tax owed to the federal government. So, a business loss reduces the overall income, and therefore reduced the income taxes. It is common that either large or small business have a net or loss from business. Nondeductible losses There are certain losses that the IRS do not allow to be deductible. Nondeductible losses are; A) Casualty loss when the loss is due to accidents that come from pets such as dog destroying an asset that is valuable. B) Accidental breaking. C) Progressive Deterioration D) Error committed on behalf of the taxpayer and theft losses such as robbery, embezzlement, Tax Deductible Losses 7 extortion, blackmail, and kidnapping (Fulcher, B. (1999). The IRS does not allow a taxpayer these type of losses to make deductions from taxable income.This basic rationale to be sure that taxpayer does not pamper themselves to practice in which themselves harm or damage their belongings or property and that they are not reimbursed wrongly by the income tax authorities. If losses from robbery, extortion, blackmail were allowed, then a taxpayer could avoid any of these activities and claim the tax deduction. These standards and specifications are bounded so that the income tax authority does not extremely compensate taxpayers caring for their assets and properties. If the insurance company has compensated the taxpayer for the loss he/she suffered, it will result to have double benefit to the taxpayer. I believe that this type of non-deductible loss is fair since the law does not allow this deduction and makes it possible to maintain a system in place where the taxpayer does not attempt to duplicate the dip by filing an insurance claim and taking deductions on his return (Tolan, J. E. (2016). Alternative to loss deduction An alternative to loss deductions that is fair for all taxpayers is the ATM. AMT is a substitute for the deduction of loss that supports financial needs government and is fair to all taxpayers. The AMT helps the federal authority to obtain minimum taxes and is mandatory for all taxpayers. When a taxpayer discloses his/her losses, and that taxable income is negative, then he/she is not required to pay taxes since there is no taxable income on the taxes to be paid. It is fair because individuals claiming certain tax benefits may owe Alternative Minimum Tax. AMT makes sure that taxpayers with high-income pay at least the minimum tax on any income reported during the year of the assessment. Therefore, when the taxpayer only reports losses and Tax Deductible Losses 8 any taxable income for the purpose to evade tax payments, AMT helps the federal authorities to identify these taxpayers evaders and collect a minimum amount of tax of them (Perez, W. (2014). The loss that triggers IRS audit The audit of the IRS is a review of the financial information of the accounts of individuals and corporations to ensure that the information disclosed by them is validated and the reports are filed according to the rules required by the law's taxes and as well to verify if the calculation of tax payable is accurate. Certain events that will trigger a red flag for the IRS and the chance to be audited are the following: Large business expenses and income Large charitable deductions Inaccurate W-2 or 1099 Reporting Tax Shelter Losses Extreme itemized deductions Concealment of cash receipts Tax-Shelter losses Informant Complex Business Transactions Prior tax problems or audits Home office deductions Apart from this, the event that is most triggered due to the losses reported by the taxpayer is Loss of business for self-employed or partnerships. When an individual operating under self-employed person reports losses during the first three years, it is considered common by the tax authorities. However, when they begin reporting the losses, after four or five years in the business, then this will trigger an IRS audit. The IRS will start to wonder if the taxpayer is really operating the business or is it just an entry in the book to claim deductions. Therefore, an IRS audit will be triggered. Tax Deductible Losses 9 Strategy Defense The strategy to use in defense of the client would the following: The first step is to take a good look at the details of his/her tax return. Once I have a through an understanding of the contents of the tax return, I will need to organize his/her records to support the items questioned by the IRS. Before the actual examination, I should establish a range of settlements that comfortable accepting. This will prepare me for possible settlement terms that might be discussed later by the examiner. If I see that the issues being questioned or disputed by the This publication states that casualty is any disaster occurred, due to a fire, storm, car accident or any other event. The IRS allows some deductions related to casualty loss but under some restrictions. Some of the limitations that the client must do are: 1) itemize deductions. 2) Make an evaluation of the fair market value before and after of the disaster. 3) If there is any deductible, the loss is reduced by $100; any remainder is deductible to the extent it exceeds ten% of the AGI. For example, if the AGI is 40,000 and the personal portion of the loss is 11,000, then the deductible portion in 2016 is 4,089.00 (11,000-100-4,000). However, if the loss is 500, there is not a deductible loss if AGI is over 4,000. I agree that a car loss accident that is caused intentionally by negligence or on behalf of the taxpayer continue to be disallowed as not deductible. This type of casualty even though is damage, destruction or loss of property may not be unexpected, sudden, or unusual. So, the car accident loss to be deductible, the victim must be unexpected, sudden or caused by an Tax Deductible Losses 10 identifiable event. Unfortunately, some taxpayers want to take advantage of the IRS and do so intentionally to cut taxes, and this is unfair. According to IRS; a casualty loss is not deductible if the damage was caused by negligence or someone acting for the taxpayer, caused the accident intentionally (Tolan, J. E. (2016). I do not suggest that a taxpayer uses this kind of deduction because it may trigger an audit by the IRS. The IRS has more audits of tax returns when there are casualty loss deductions that any other single type of deduction. There are some reasons on why casualty loss is disallowed. One reason is that the taxpayer fails to substantiate the amount of the loss. Another reason is that casualty loss is no sustainable because the taxpayer does not have a remaining cost basis in the property. There is a dilemma in the casualty loss deduction. A significant example is found in the deduction allowed to an individual taxpayer for non-business losses. The 1913 code allowed a deduction for non-business or non-income of property resulting from storm, fire or shipwreck. Later, in 1916, the statute was amended. Another case where the deduction was denied is the damage of the car that came as a result of a traffic accident.The courts have adhered to a highly restricted definition of loss by an automobile accident and refuse a deduction where the loss was caused by fraud. Another example of a fraudulent case is, for instance, a taxpayer who paid $ $1,600 for an item that the seller fraudulently represented to be an original attempted to cut the loss. The court denies the deduction, stating that this was not \"theft.\" Therefore, I agreed that car accident is a nondeductible tax loss because the insurance covers damages resulting from these casualties. A taxpayer claiming a deduction must setup the amount of the loss and keep records to proof such damages.Under the rule, the amount of the deductible loss is the difference between the Tax Deductible Losses 11 value of the property immediately before and immediately after the casualty, not to exceed its basis and diminished by insurance or other compensation realized. References Beck, R. E. (2004). CANCELLATION OF DEBT AND OTHER INCIDENTAL ITEMS OF INCOME: PURITAN TAX RULES IN THE U.S. New York Law School Law Review, 49(2), 695-715. Fulcher, B. (1999). Casualty Losses Can Be Deductible. National Public Accountant, 44(5), 46. IRS Summertime (2015). Reporting gambling and losses on your tax return. Retrieved from https://www.irs.gov/uac/reporting-gambling-income-and-losses-on-your-tax-return. IRS Tip Sheet on Gambling Income and Losses. (2014). Hudson Valley Business Journal, 3(31), 4. Retrieved from http://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer? Logan, D. S. (2011). Summary of latest federal individual income tax data, Tax Foundation McLaughlin, N. A. (2010). INTERNAL REVENUE CODE SECTION 170(h): NATIONAL PERPETUITY STANDARDS FOR FEDERALLY SUBSIDIZED CONSERVATION EASEMENTS. Real Property, Trust & Estate Law Journal, 45(3), 473-527. Retrieved from http://eds.a.ebscohost.com/eds/detail/detail?vid=2&sid=5df73eee-4977. Perez, W. (2014). About.com Tax Planning U.S. Retrieved, from about .com Tax Planning US: http://taxes.about.com/od/1040/a/minimum_tax.htm Tax Topic 419 (2012).Gambling Income and Losses-Five important tips on Gambling Income and Losses. https://www.irs.gov/taxtopics/tc419.html Tax Deductible Losses 12 Tolan, J. E. (2016). Time to Change the Casualty Loss Deduction. ABA Tax Times, 36(1), 34-40. Retrieved from https://eds.a.ebscohost.com/ehost/detail/detail?vid=4&sid=c0317