Question

1. [LO 1] Q1 What is an “ordinary and necessary” business expenditure?

2. [LO 1] Q2 Explain how cost of goods sold is treated when a business sells inventory.

3. [LO 1] Q3 Whether a business expense is “reasonable in amount” is often a difficult question. Explain why determining reasonableness is difficult and describe a circumstance where reasonableness is likely to be questioned by the IRS.

4. [LO 2] Q5 What kinds of deductions are prohibited as a matter of public policy? Why might Congress deem it important to disallow deductions for expenditures against public policy?

5. [LO 2] Q6 Provide an example of an expense associated with the production of taxexempt income, and explain what might happen if Congress repealed the prohibition against deducting expenses incurred to produce tax-exempt income.

6. [LO 2] Q7 {Research} Peggy is a rodeo clown, and this year she expended $1,000 on special “funny” clothes and outfits. Peggy would like to deduct the cost of these clothes as work-related because she refuses to wear the clothes unless she is working. Under what circumstances can Peggy deduct the cost of her clown clothes?

7. [LO 1, LO 2] Q11 What expenses are deductible when a taxpayer combines both business and personal activities on a trip? How do the rules for international travel differ from the rules for domestic travel?

8. [LO 2] Q13 Describe the record-keeping requirements for business deductions expenses including mixed-motive expenditures.

9. [LO 2] Q14 Describe the computation of the limit placed on the business interest deduction. Is the disallowed interest ever deductible? 10. [LO 3] Q16 How do casualty loss deductions differ when a business asset is completely destroyed as opposed to the destruction of a personal-use asset?

Answer 1

1) An ordinary expense refers to those expenses which are common and accepted in the business. A necessary expense refers to those expenses which are appropriate and helpful in the business. To be deductible, a business expense must be ordinary as well as necessary; and these expenses incurred in business or primary employment are typically tax deductible in the year in which these are incurred

2) Under the principal of return of capital, cost of goods sold represents a reduction in gross income instead of a business expense. For example, when a taxpayer sells inventory for $500,000 and reports a cost of goods sold of $160,000, the business’s gross income is $340,000 (=$500,000 - $160,000) not $500,000