Okay. We ended up last, in our last session looking at the Social Security benefits and
the taxability of those. So what I want to do is just kind of go over that calculation,
the handwritten one that I sent you and we went over so you can understand how that works
and then we're going to go ahead and finish up the chapter. We'll finish up the chapter.
Basically as I indicate with this calculation, if you have modified AGI that is less than
the lower limit, and there's two limits based on if you are married filing jointly or single
head of household or widower. As long as it's here, it's not going to be taxable, so anything
under these lower limits is not going to be taxable. Anything between it's going to be
the taxable portion of the Social Security is going to be the lesser of 50% of the Social
Security benefits or 50% of the excess of the modified AGI over that lower limit, okay.
If your modified AGI is more than the upper limit, meaning it doesn't fall in between
but it falls above the upper limit, then your taxable Social Security benefits are going
to be the lesser of 85% of your Social Security benefits or the sum of 85% of the excess over
the upper limit or -- and the lesser of 50% of your Social Security benefits at 6,000.
So basically what you do is you say, okay, what's the smaller of 50% of my Social Security
benefits or 6,000, and I take the smaller of that, and then I'm going to add it to 85%
of the excess over the upper limit, and then I'm going to take that sum and then I'm going
to compare it to 85% of my Social Security benefits and then the lesser of the two is
going to be the portion of my Social Security benefits that are taxable.
So as I said, hopefully you have some time to go through that calculation and, therefore,
you can see the -- to me the calculation, that is a little easier than the worksheet.
But either way, you'll get the same answer. If it's easy for you to follow the worksheet
and go through the calculations, you'll be fine. If you're using a tax software, there's
one that comes with our textbook, or any one of the ones you purchase, it will go through
that calculation for you and let you know the amount of your Social Security benefits
that will be taxable. Okay. Let's continue on with the chapter.
Next, unemployment compensation. And we know unemployment rates are up. The important thing
to remember if you're receiving unemployment, it's going to be taxable. And they don't always
withhold taxes from your unemployment compensation. So just be aware if you're receiving unemployment
and you're not getting taxes withheld, it's going to be taxable to you and it's going
to cause you to have to pay tax on the amount that you receive. I don't -- I believe -- I
want to say the State of Kansas may offer you to withhold it versus the State of Missouri,
but just inquire. If you're receiving unemployment compensation, be it in Missouri or Kansas,
inquire whether they withhold tax on it for you, or you just may choose not to and just
be aware it's taxable. Next we want to look at employee fringe benefits.
Basically as employees we get certain benefits from working at certain places. It's a fringe.
It's a benefit for working there. And basically they say all these employee fringe benefits
are included in income except for these ones that we're going to discuss that are specifically
excluded, and they're on -- we start those on Page 2-21.
Okay. And so employer-provided spending accounts. These are -- this is money that's set aside
for dependent care accounts, which you can set aside $5,000, taken out pre-tax to cover
child care or aging parent care or medical flex spending accounts that help cover medical
expenses. So basically these accounts you can use for medical and for child care. They
take out pre-tax, so you get the benefit of it not being taxed, and because the employer
runs these plans for you, you do not have to pay any income or any, you know, for that
benefit. So excellent options there. Also, this is going to happen mainly in maybe
a big city where they encourage you to maybe take the subway. But if an employer provides
a spending account for public transportation, there's monthly limits that's gonna apply
and it's to cover the public transportation to work and for parking. So if all the requirements
are met, then it's going to be a tax-free reduction. So like I said, normally that's
going to happen in big major cities, New York, Chicago, where parking sometimes is an issue
if you work in downtown. So they're going to try to encourage you to catch the subway.
Next is group term life insurance. If -- a lot of employers do this offer, employers
can pay up to 50,000 for employers tax-free for group term life insurance. The thing about
that insurance, it cannot favor officers, shareholders, or highly paid. It has to be
offered to everyone, across the board. Okay. And then they have what they call no
additional cost services. These are provided at no additional cost to the employee. And
it's only allowed if it's in the employee's major line of business, major line of business.
An example of these, if I work for an airline, the perfect example is we know people who
work for airlines have the option of maybe flying standby and being able to fly for free.
It doesn't cost you any money. It doesn't cost the employer any money to have that vacant
seat filled by you, so in that case, it's not taxable. Now, the thing about it, it has
to be in the employee's major line of business. Let's say I work for a corporation who owns
a hotel chain and they own an airline. If I work for the airline, even though the corporation
may give me a discount at the hotel and for airfare, the airfare is the only one that's
not taxable to me because that's in my line of work. I work for the airline piece. But
for the benefits that I take for the hotel, if I get free rooms or whatever, then that
is going to be included in my income. So it's only for the line of business in which I work
in. So keep that in mind. It's going to be only for the line of business that you work
in. Okay. Qualified employee discounts. We know
if you work at certain places, you can get a discount and as long as these discounts
are provided on a non-discriminatory basis and then there's certain limits to them, they
said these particular discounts are not going to be tax-free. If they're on real estate
or investment property, so if you're getting a discount on real estate or investment property,
that's not tax-free. You're going to have to include that in income. If the discount
exceeds gross mark-up of merchandise, basically if because they're selling it to you they're
selling it at a loss, that's not going to be excluded from your income. That's not going
to be tax-tree. You have to include that. If the discount exceeds 20% of customer price,
basically the exclusion is limited to 20% of the customer price. So if it's more than
that, that portion is going to have to be included in income. And once again, if it's
out of the employee's line of business, back to me at the hotel, if I'm getting a discount
and I work for the airline portion of it, it's going to be -- it's out of my line of
business. An example, I used to work for the Kansas City Royals, we had an option of getting
the Royals tickets, you know, for free. No problem going to a Royals game, I worked for
the Royals. If for some reason the same owners of the Royals owned the Chiefs and which,
you know, that's kind of a gray area because we're still in -- well, one is professional
baseball versus professional football. It would be probably challenged that my tickets
or free tickets to the Chiefs may have to be included in my income. It's not the same
line of work. I think you could argue that, you know, professional sports is professional
sports and maybe if we threw in a hotel or something, then we would begin to say, okay,
that portion is not in my same line of business. So just know you have some gray areas there
and that you could -- that would be up for discussion.
Okay. Also they have a working condition, another one, excluded -- these working conditions
benefits are excluded to the extent that the cost of the property or services would be
a deductible expense, meaning if this was something I'm going to get a deduction for
anyway, if it's a deductible expense anyway, therefore, it's not going to be included in
my income. The example is if your employer pays for your professional dues, if you belong
to the AICPA or you belong to a professional organization and your employer pays the dues
on your behalf and that is a deduction anyway. So, therefore, since it is a deductible expense,
my employer pays it for me, I wouldn't have to include it in my income, and that's because
it's already a deductible expense. Okay. These de minimis fringe benefits. These
are like little small ones, so small that we don't necessarily account for them. The
de minimis fringe benefits are excluded from income if they're too small to account for.
If they're -- if it's too tedious to try to track them, you know, they are not going to
be included in our income. Also, subsidized lunch room, if you have a lunch room on your
-- at your employer and it's subsidized, as long as it's on or near the business, and
that the revenue from the operations exceeds the cost, meaning they're operating at a profit
and that anybody can use it, it's on a nondiscriminatory basis, that subsidized lunch room, the benefits
you get from that is not going to be included in your income, so.
Okay. Tuition reductions that are given by educational institutions. For instance, here
at Johnson County we get particularly tuition reduction. So those tuition reductions are
excluded from income if it's for undergraduate and if it's available to all employees, all
say full-time employees, meaning it also is available to spouses and dependents, then
that benefit of taking classes at a tuition deduction or at no cost is not included in
income. For graduate level education not to be included, the employee has to be at an
institution that is teaching in research. So that's the way graduate level can be excluded.
Athletic facilities, we have an athletic facility, a lot of companies have athletic facilities
on campus or on their -- on the job site. That cost is excluded if the cost to operate
the facility is used primarily for employees. So if it's used primarily for employees, it's
not an outside place, then it -- that cost of using that facility for free would not
be included in your income.
And then a lot of times companies offer a -- offer to provide some retirement planning,
you know. They may have a company come on-site and give some free advice on retirement planning.
If it's provided, value is going to be excluded from gross income, now, that's just a retirement
planning piece. If you have the ability to for free go get your taxes done or some type
of accounting fees or accounting services or legal and brokerage services, those don't
apply. Only retirement planning services. So tax prep, you have to include that value
in your income. Any accounting services, you -- if you're getting those for free and your
job is providing them, then you're going to have to include the value of those in your
income and you're going to have to include the value of those in your income.
Okay. That brings us to the end of Chapter 2 that dealt with gross income and exclusions.
We dealt with a lot of things that we looked at. First, what was included in income, and
the IRS, remember, they say everything is included, not unless it's specifically excluded.
Then we begin to look at specific items that were not included, that were partially taxable,
and so we begin to look at specific items like that. So that is Chapter 2 that dealt
with gross income and exclusions. Okay. We want to go ahead and move on to Chapter
3, which is going to deal with business expenses and retirement plans. This session is going
to deal with the beginning part of that, which is this, your business expenses. So in your
packet that I sent you, you should have a handout that in this particular one we're
not going to do it by PowerPoint, but it's all by notes. We have notes that you're going
to be writing and filling out on a handout that I sent you that says Chapter 2, business
expenses and retirement. So let me get a blank one and we will get started.
Okay. So that is the handout that you should have for Chapter 3. And so we have a lot of
notes for this chapter. There's a lot to cover in here. And we're going to basically cover
it all this way. So there's no PowerPoint that goes with this chapter. But it's going
to be all done by notes. We want to start with our rental income. We want to start with
rental income. Rental income is going to be taxable, okay. Rental income is taxable. Okay.
It's going to be taxable on Schedule E, okay. And then it's possible that it's going to
be treated as a business and possibly be taxable on Schedule C, meaning if there is some cleaning
and maid service being provided on this rental property. And probably what we're distinguishing
between is rental property that people live in versus hotels, hotels and bed and breakfasts
where there's cleaning and maintenance services are coming in, then that's more of a business
and Schedule C to where if it's rental, strictly rental property with someone, you rent out
a piece of property, then that's going to be Schedule E. So that's the difference there.
With Schedule C, this is going to be subject to self-employment tax. Okay. That's going
to be subject to self-employment tax. So that's your distinction between those two, okay.
And so we want to start off on Page 3-2 where they talk about vacation homes. Basically
vacation homes can be both personal and rental use. As we know, if I have a vacation home
up in Colorado where I ski, I am probably not going to just leave it vacant if I can
when I'm not there, I would like to have it rented out, okay. So when we have vacation
homes that are both personal and rental, the use of that property, then what we're going
to need to do is allocate the expenses. We're not going to be able to take the, you know,
just deduct the whole thing, because you gotta remember there's some personal piece in there,
okay. So the way they separate it out, if you begin
to look on Page 3-2, there is rental that is -- there's going to be considered primarily
personal. So we have rental that's considered primarily personal. Then we have rental that
is considered primarily rental, meaning when we look at it, that's really personal. And
when we look at it, that's really rental, primarily rental use, with not much, if any,
personal. And then we have the rental that is personal and rental. So it has dual use.
Okay. So let's look at what qualifies for these
items. How does a home qualify as primarily personal use and then how is it taxed or how
is it treated? Okay. So when we're talking about property that is primarily personal
use, it's going to be rented for less than 15 days. So it's going to be rented for less
than 15 days. So 10, 12, but less than 15 days is it's going to be rented. Not equal
to. Less than. Okay. So if that's the case, it's going to be treated as personal. Treated
as personal. Okay. And then the rental income for that particular property is not taxable.
It's not taxable. Okay. So the mortgage interest and taxes on that
particular property are going to be deductible on Schedule A. So we're going to be able to
take those deductions. And any other expenses are not deductible because they're personal,
because we deemed it not to be rental property. So even though I can't deduct any of the other
expenses, guess what? The income is not taxable. The perfect example of this is we just went
through the inauguration and I had an opportunity to go to the inauguration and there was lots
of advertisements regarding people renting out their personal homes for the inauguration
week or weekend or whatever the case may be. I had the opportunity to get a hotel room,
so I didn't have to do that, but you think about it. And some of them were renting them
for huge amounts of money. So if let's say that I decided to rent out my home for the
weekend at a rate of $5,000, well, I rented it for less than 15 days, so that's going
to be considered personal. None of that income is taxable to me. None of that income is taxable
to me. So keep that in mind when it's primarily for personal, as long as it's less than 15
days, income is not taxable. Now, any expenses they incurred, you know,
to get it ready for rent or whatever the case may, be that's not deductible. But they can
still deduct their mortgage interest and taxes. So that's a perfect example of personal property
that I did get some rental income on that I don't have to, you know, claim on my tax
return. Okay. What qualifies property as primarily
rental use? What qualifies property as primarily rental use? And this is when it's rented for
greater than or equal to 15 days, okay. So I got that in. I rented it more than 15 days,
or equal to that. And -- there's an "and" in this -- and the personal use does not exceed.
So there's a personal use does not exceed, okay, the greater of
either 14 days or 10% of the rental days. Okay. So we have to look at the personal days
and the rental days. So if I've rented my property for more than or equal to 15 days,
and the personal use days does not exceed either the greater of 14 or 10% of the rental
days, or 10% of the rental days. So long as that happens, then this is going
to be considered primarily rental use property, okay. When it's primary rental use property,
I want to allocate the expenses between rental and personal. They're still not going to let
you take those personal expenses. Okay. And then I'm going to do that allocation based
on the rental days divided by the total days used, okay. So I'm going to take the rental
days, the number of days that I actually rent it, I'm going to divide it by the total days
used, and that's going to equal my rental percentage.
And then I'm going to take the expenses and I'm going to multiply them by this rental
percentage. And that's going to equal the deductions I'm going to be able to take.
Okay. And then for the personal piece, the personal days divided by the total days used,
that equals my personal percentage. And then, in that case, the personal part is not going
to be deductible. Okay. The good thing about when it's primarily rental
use, if I go through my Schedule E and I report my income minus my expenses and it ends up
with a rental loss, that rental loss is allowed, I can deduct a rental loss. So a rental loss
is allowed on my Schedule E. Okay. So that is the benefit of your primarily
rental use property, is that if it's primarily rental, you end up with a loss, then it's
a deductible loss. You can take the loss. So that's the good thing about that one. So
primarily personal, I have income, I don't have to report. Primarily rental, I can deduct
the personal percentage of my expenses and if I end up with a loss, then that loss is
fully deductible. Okay. Next is what if we have property that
we consider a rental-personal split, or a dual use, meaning I've used it a little bit
of both? So what qualifies a piece of property for that? Qualifies a piece of property for
that? The way that one works, if it's rented for less -- greater than or equal to 15 days
and the personal use -- the personal use exceeds. Remember, in the
other one we said that greater than or equal to 15 days and the personal use does not exceed.
So now we're at "and the personal use exceeds." So and the personal use exceeds the greater
of or of 14 days or 10% of the rental days. Okay. So if you go through that calculation
and that applies, my personal use exceeds the greater of those, then that -- in that
case it's going to be a rental/personal split, okay. And so what you're going to do is you're
going to -- the allocated -- you want to allocate the expenses between the rental and the personal.
You want to allocate the expenses between the -- just like we did before, you want to
make that allocation. Now, the thing that to note and remember that
there's no loss allowed. So if I go through the calculations, I got my income, these are
all my expenses and I end up with a loss, I can't take that loss. The only thing I can
do is deduct expenses in the following order up to income. So basically up to where I have
a net income of zero, meaning I'm going to -- if my expenses, if my income is $5,000,
I can only take $5,000 of expenses. Okay. But they're going to make me take them in
this order. I'm going to first have to deduct taxes and interest. So I'm going to do that
first. Taxes and interest. That mortgage interest and taxes, I deduct those first. Now, if after
I deduct those and I end up with a loss, then that's okay. Now, these can create a loss.
Okay. Create a loss. They're allowed to create a loss. So, for instance, if my income was
5,000, if my taxes and interest equal 6,000, which makes me have a $1,000 loss, I can take
it. Now, I'm not going to get any utilities or
depreciation, because I've already consumed all my income. Now, utilities and maintenance
would be deducted next. And then any depreciation, okay. Now, on this personal/rental split,
that personal percentage of mortgage and interest -- so mortgage interest -- I'm sorry, and
taxes, they can go to Schedule A. They are deductible on Schedule A.
Okay. When it was primarily rental, that personal percentage I didn't get to do anything with
that. But in this case, the personal percentage is going to get to go on Schedule A.
So let's review this one. This is deemed or determined to be a rental/personal split based
on that the rented days are greater than or equal to 15 days and my personal days exceed
the greater of 14 days or 10% of the rental. So what I'm going to do is allocate still
between my rental and my personal portion. If I come up with a loss, I cannot take that
loss. No loss is allowed. I can only take expenses up to my income. I take my expenses
in this order. I deduct my taxes and interest from the rental property. If I still have
income left I'm going to deduct my utilities and maintenance. And if I still have income
left, I'll deduct depreciation. You have to do it in this order. The personal percentages
then of your mortgage interest and taxes are going to be deductible on Schedule A, so you
don't -- you don't lose those. You do not lose those.
Okay. Now, an interesting thing is this alternative allocation method. There's an IRS method and
then there is a tax court method, okay. On Page 3-4, it should be noted that the U.S.
Tax Court has allowed taxpayers to use 365 days for the allocation of interest and taxes
instead of what I spoke of here. Here I said take your rental days, divided by the total
days used, okay. This is considered the IRS way of doing it. If we take -- to get my rental
percentage, if I take the rental days and I divide by the total days used, okay. The
alternative approach would be take -- would be to take the rental days
and divide them by 365, the whole year, and get the rental percentage. So the question
is, why is that a big deal? And this is for my interest and taxes allocation. This is
-- you know, so that I can deduct or allocate my personal versus my rental. So the question
is, why is that a big deal? What's the big deal? Why does it matter? When we do this
we come up with a smaller percentage than if we did it the rental days divided by the
total days, the total days used, okay. Because we may have some vacant days. If it's not
used every day, we're going to have some vacant days. You're going to come up with a smaller
percentage. We like this because what happens is that when I come up with this smaller percentage,
okay, then I'm going to have a smaller amount deducted on my Schedule E, okay. So basically
when I go through this process, this is a small amount, which lets me take more here,
so that if this is smaller, then it's going to allow me to deduct larger utilities and
a maintenance amount and maybe get some of that depreciation, okay.
If I use the IRS approach, this number is going to be larger, so I'm going to -- I'm
going to consume all of this with my taxes and interest, so that means I lose this.
The thing about it is, you're going to get the taxes and interest. Either they're going
to be on Schedule E or they're going to be on Schedule A. So what this does is it pushes
more of those to Schedule E -- I mean, I'm sorry, Schedule A. And what it does, I get
a smaller deduction on Schedule E and it pushes more of those expenses, basically moves more
of your taxes and interest to Schedule A. Okay. It moves more of those to Schedule A.
So that's a bigger benefit. So that's a bigger benefit.
So of course the IRS wants you to use their method. We want you to use -- we would like
to use the tax court method. We would like to use the tax court method. And on Page 3-4,
the last little sentence, it tells us that there's controversy between the tax court
decision and the IRS. It hasn't been resolved, okay. So people routinely go take the tax
court method and it's held up in court. The IRS would like for us to take the IRS method.
But of course we want to get more of those expenses deducted on Schedule A, and that
frees up me to be able to end up deducting my other one. So just a real brief review
before we move on to the next subject. Rental is taxable either on Schedule E or C. If your
home is deemed primarily personal use, meaning I rented it less than 15 days, then it's going
to be treated as personal use, or personal, and I'm not going to have to report any rental
income and I deduct the mortgage interest and taxes on Schedule A. And that's like a
second home, you can take mortgage and interest on a second home. If it's deemed primarily
rental use, meaning I rented it more than or equal to 15 days and my personal use did
not exceed the greater of 14 days or 10% of the rental, I need to allocate my expenses
between rental and personal, either based off the IRS or the tax court method, and the
rental portion is going to be on Schedule E. The personal portion I don't end up getting
because this is not deemed -- once it's deemed primarily the rental, this is not a second
home for me; this is rental property. So I can only deduct that interest and taxes on
Schedule A for a second home. So this is not a second home. So that personal use basically
is lost. I'm going to lose that. And the good thing about this is, though, I can end up
deducting a rental loss on Schedule E because it's a business and they're going to let me
take that loss. Okay. Next, if we deem the property to be
a rental/personal split. If we deem it to be a rental/personal split, that means I rented
it for more than or equal to 15 days, and the personal use exceeds greater of 14 days
or 10% of the rental, and I'm going to still allocate between rental and personal, once
again using the tax court method or the IRS method. And the one thing here is that there's
no loss allowed. So if you have more expenses than income, you deduct your expenses in this
order, first deducting taxes and interest, utilities and maintenance, and then depreciation,
up until the income that you have. The personal portion of your mortgage and interest, because
now this is deemed as a second home, then is going to be deductible on Schedule A. It's
going to be deductible on Schedule A. So that is your rental property. That's your
rental property. Okay. Let's move on. Still kind of dealing
with this is passive activity losses. And they call them PALS. Passive activity losses.
We pick that up at the bottom of Page 3-4, okay. So the question is, we initially talked
about passive versus active income versus portfolio income. So when we're looking at
passive losses, we're going to be concerned about our passive income. We want to be concerned
about our passive income. Passive activity losses, basically we're dealing with passive
losses, is what we're looking at, okay. Passive losses may not be used to offset active income.
So basically I can't use a passive loss to offset my salary. Salary is considered active
income. So I cannot use a passive loss to offset my salary because it is active income.
Okay. So the question is, what is basically a passive loss? These are ventures that a
taxpayer is involved in, but they're not actively. So a taxpayer is not -- they may just be an
investor, they're not actively involved. So they have a passive role. So if that venture
generates a loss, that's considered a passive loss. Okay.
Losses, passive losses can only offset passive income. Okay. So if I have a passive loss,
I have to be able to have a passive income in order to get it to offset it, okay.
Any excess losses, because I don't have enough income to take all my losses, any excess losses
are carried forward. So any excess losses are carried forward or I can deduct them when
I sell the investment, because maybe it never generates any income. So I will just hold
on to those losses until I sell the investment. Okay. So that's a brief overview of passive
losses. They do -- they are a lot more detailed than that, but I just kind of want to briefly
cover them. Now, on Page 3-7, they talk about real estate
rental, which we just talked about rental activity. They consider the rental of real
estate a passive activity. Okay. So we just talked about rental and, you know, the deductions
of losses, so they consider real estate rental a passive activity. So the question is, now
do I have to follow these passive loss rules? Well, there's some special rules for rental.
There's some special rules for rental and then they even determine what's considered
a trade or business, meaning I'm in the business. That's what I do. I rent out real estate,
that's all I do. Or is it truly a passive activity for me? Is it truly passive activity
for me? If you look at the bottom of Page 3-7, taxpayers who are heavily involved in
estate or rental activities, they may be able to qualify theirs as a trade or a business
rather than as a passive activity. So if you are heavily involved and that's your business,
that's what you do, then you're saying, well, that's not a passive activity for me, I'm
actively. So that income and losses from that activity won't have to meet these passive
loss limitations. In order for you to say that you're actively
involved and that they're not passive, so in order for you to say -- let's put this
in parentheses, that they're not passive, then you want to meet those requirements that's
on Page 3-7. And it says that more than 50% of the individual's personal service during
the tax year is performed in the real property trade or business. So more than 50% of what
you do is in this trade or business. And then number 2, that the individual performs
more than 750 hours of service in the real property trade or business in which he or
she claims material participation. So the taxpayer must materially participate in the
activity. To satisfy that, it has to be more than 50%. And then the individual performs
more than 750 hours, okay. So that's very important. Income from passive
investments, so in that case it's not passive, I can take it as a trade or a business. It's
not an issue, I get to take the deduction. Any loss, it's not considered passive, okay.
For real estate, just real briefly, for real estate property that's considered passive,
they have allowed you to take a deduction. You may deduct up to 25,000 of losses against
other income. So even though they're going to deem it to be passive, they do allow you
to take a $25,000 loss. Now, if you are a high income taxpayer, you
may lose some of that loss. You may lose some of that loss. So keep that in mind. And then,
once again, like I said, if it's not passive, then there's no loss limitations and just
long as you meet those requirements, you should be well okay.
Okay. So if the real estate is -- the real estate rental equals a trade or a business,
meaning it's not passive and you've met those rules, then you have no loss limitations and
it's not considered passive. So you just want to make sure you follow those rules that's
on Page 3-7. Okay. Let's move on to your bad debts. Move
on to your bad debts that's on Page 3-8. Your bad debts.
Okay. For instance, if we're talking businesses and we're talking bad debts, these are the
situations we're probably kind of talking about is when you have uncollectible accounts
receivables, okay. So if we have uncollectible accounts receivable, then we have a deduction,
our deduction is going to be limited to what we previously included in income. What we
previously included in income. And the example is, it's just let's say that I have a sale
and let's say I have, I don't know, $50,000 worth of income versus sales and I report
that, and of those $50,000 worth of sales, I have 20,000 that's our accounts receivable.
I report the 50,000 and I show the 20,000 as accounts receivable. If 3,000 of those
accounts receivable become uncollectible, because I've reported the income piece to
it, then I can deduct it. Now, if you are a cash basis taxpayer, okay, if you are a
cash basis taxpayer, meaning that you're not going to report your income until you receive
it, so even though you have an account receivable, you never report it until you receive it as
income. So, therefore, since it never was reported as income, it is not a bad debt;
you cannot take a bad debt. So cash basis taxpayer are not allowed the bad debt. And
that's because it was never included in income if you are a cash basis taxpayer, because
cash basis, they're going to report their income when they receive it, not when it's
earned. Okay. And so with these bad debts, you want to -- you
can take the deduction. You want to use the specific charge-off method to do so,
as you take these bad debts. Okay. And so basically you want to deduct them as they
become partially or completely worthless. Okay.
So basically it gives you a benefit that, you know, I had this income, I reported my
income, I never got it. It's not fair because I paid taxes on it. So, therefore, you can
take a bad debt deduction for those uncollectible accounts receivable just as long as you've
included them in your income. Okay. So now if we have the business versus the
non-business portion of that, the business versus the non-business portion of that. The
business, okay, the business portion of that is any debt from a trade or business, okay.
And so when we're talking about a debt from a trade or business, similar to what we were
talking about up here, this is a ordinary deduction. It's an ordinary deduction. And
you can take it against ordinary income. So it gets to offset -- this
bad debt, it's going to get to offset ordinary income and basically is going to appear on
Schedule C. It's going to appear on Schedule C, okay.
So what we'll do is in our next session we'll start with our non-business bad debts and
talk about those, and then we will probably have enough time to finish up Chapter 3. So
we will look at business -- continue to look at business expenses, and then we will look
at retirements, if we have some time. So that's the end of this session. Make sure
you're looking through Chapter 3. We finished up 2, so you need to make sure you do your
multiple choice questions for Chapter 2 and get those sent to me. So that's it until our
next session. (Music.)