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Contents
Introduction . . . . . . . . . . . . . . . . . . 1
What's New for 2018 . . . . . . . . . . . . . 2
What's New for 2019 . . . . . . . . . . . . . 2
Reminders . . . . . . . . . . . . . . . . . . . 2
Chapter 1. Deducting
Business Expenses . . . . . . . . . . 3
Chapter 2. Employees' Pay . . . . . . . . 8
Chapter 3. Rent Expense . . . . . . . . 10
Chapter 4. Interest . . . . . . . . . . . . 13
Chapter 5. Taxes . . . . . . . . . . . . . 18
Chapter 6. Insurance . . . . . . . . . . . 20
Chapter 7. Costs You Can Deduct
or Capitalize . . . . . . . . . . . . . . 24
Chapter 8. Amortization . . . . . . . . . 28
Chapter 9. Depletion . . . . . . . . . . . 35
Chapter 10. Business Bad Debts . . . . 40
Chapter 11. Other Expenses . . . . . . 42
Chapter 12. Qualified Business
Income Deduction . . . . . . . . . . 49
Chapter 13. How To Get Tax Help . . . 58
Index . . . . . . . . . . . . . . . . . . . . . 64
Introduction
This publication discusses common business
expenses and explains what is and is not de-
ductible. The general rules for deducting busi-
ness expenses are discussed in the opening
chapter. The chapters that follow cover specific
expenses and list other publications and forms
you may need.
Note. Section references within this publica-
tion are to the Internal Revenue Code and regu-
lation references are to the Income Tax Regula-
tions under the Code.
Comments and suggestions. We welcome
your comments about this publication and your
suggestions for future editions.
You can send us comments from IRS.gov/
FormComments. Or you can write to:
Internal Revenue Service
Tax Forms and Publications
1111 Constitution Ave. NW, IR-6526
Washington, DC 20224
Although we cannot respond individually to
each comment received, we do appreciate your
feedback and will consider your comments as
we revise our tax forms, instructions, and publi-
cations.
Department
of the
Treasury
Internal
Revenue
Service
Publication 535
Cat. No. 15065Z
Business
Expenses
For use in preparing
2018 Returns
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• IRS.gov/Vietnamese (TiếngViệt)
Jul 24, 2019
Ordering forms and publications. Visit
IRS.gov/FormsPubs to download forms and
publications. Otherwise, you can go to IRS.gov/
OrderForms to order current and prior-year
forms and instructions. Your order should arrive
within 10 business days.
Tax questions. If you have a tax question
not answered by this publication, check
IRS.gov and How To Get Tax Help at the end of
this publication.
Future Developments
For the latest information about developments
related to Pub. 535, such as legislation enacted
after it was published, go to
IRS.gov/Pub535.
What's New for 2018
The following items highlight some changes in
the tax law for 2018.
Form 1040 redesigned. Form 1040 has been
redesigned for 2018. See Form 1040 and its in-
structions for more information.
Forms 1040A and 1040EZ no longer availa-
ble. Forms 1040A and 1040EZ aren't available
to file your 2018 taxes. If you used one of these
forms in the past, you will now file Form 1040.
Credit expiration. At the time this publication
was printed, certain credits expired at the end
of 2017. To find out if legislation was enacted to
extend these credits and make them available
for 2018, go to IRS.gov/FormsUpdates.
Small business taxpayers. For tax years be-
ginning after 2017, more small business taxpay-
ers may qualify to use the cash method of ac-
counting and be exempt from capitalizing
certain expenses under section 263A. In addi-
tion, small business taxpayers may not be re-
quired to account for inventories under section
471 and are not subject to the business interest
expenses limitation. See the discussion in
chapter 1.
Compensation in excess of $1 million. P.L.
115-97, Tax Cuts and Jobs Act, made signifi-
cant changes to section 162(m) which disallows
the deduction of excessive employee compen-
sation by any publicly held corporation. For
more information, see chapter 2.
Employee achievement awards. P.L. 115-97
defines items that aren't tangible personal prop-
erty for purposes of employee achievement
awards. Tangible personal property doesn't in-
clude cash, gift cards, and other nontangible
personal property. For more information, see
chapter 2.
Certain expense deductions are now limi-
ted. Certain expense deductions are now limi-
ted. P.L. 115-97 limits the deduction by employ-
ers of expenses for certain fringe benefits and
entertainment expenses. For more information,
see chapter 2.
Uniform capitalization rules. P.L. 115-97,
Tax Cuts and Jobs Act, made changes to uni-
form capitalization rules for small business tax-
payers. For more information, see chapter 3.
Alternative minimum tax (AMT). For tax
years beginning after 2017, the Tax Cuts and
Jobs Act, section 12001, repealed the corpo-
rate AMT. For more information, see chapter 7.
Standard mileage rate. Beginning in 2018,
the standard mileage rate for the cost of operat-
ing your car, van, pickup, or panel truck for
each mile of business use is 54.5 cents per
mile. For more information, see chapter 11.
No miscellaneous itemized deductions al-
lowed. You can no longer claim any miscella-
neous itemized deductions, including the de-
duction for repayments (claim of right).
Miscellaneous itemized deductions are those
deductions that would have been subject to the
2%-of-adjusted-gross-income limitation. For
more information, see chapter 11.
Certain payments made in sexual harass-
ment or sexual abuse cases. For amounts
paid or incurred after December 22, 2017, new
section 162(q) provides that no deduction is al-
lowed under section 162 for any settlement or
payment related to sexual harassment or sexual
abuse if it is subject to a nondisclosure agree-
ment. In addition, attorney’s fees related to such
a settlement or payment are not allowed as a
deduction. For more information, see chap-
ter 11.
Qualified Business Income Deduction. We
added a new chapter 12 discussing qualified
business income deduction under section
199A. For tax years beginning after 2017, indi-
vidual taxpayers and some trusts and estates
may be entitled to a deduction of up to 20% of
their Qualified Business Income (QBI) from a
trade or business, including income from a
pass-through entity, but not from a C corpora-
tion, plus 20% of qualified real estate invest-
ment trust (REIT) dividends and qualified pub-
licly traded partnership (PTP) income. The
deduction is subject to multiple limitations, such
as the type of trade or business, the taxpayer’s
taxable income, the amount of W-2 wages paid
in the trade or business, and the unadjusted ba-
sis immediately after acquisition (UBIA) of quali-
fied property held by the trade or business. The
deduction can be taken in addition to the stand-
ard or itemized deductions. For more informa-
tion, see chapter 12.
What's New for 2019
The following item highlights a change in the tax
law for 2019.
Standard mileage rate. Beginning in 2019,
the standard mileage rate for the cost of operat-
ing your car, van, pickup, or panel truck for
each mile of business use is 58 cents per mile.
Reminders
The following reminders and other items may
help you file your tax return.
IRS e-file (Electronic Filing)
You can file your tax returns electronically
using an IRS e-file option. The benefits of IRS
e-file include faster refunds, increased
accuracy, and acknowledgment of IRS receipt
of your return. You can use one of the following
IRS e-file options.
• Use an authorized IRS e-file provider.
• Use a personal computer.
• Visit a Volunteer Income Tax Assistance
(VITA) or Tax Counseling for the Elderly
(TCE) site.
For details on these fast filing methods, see
your income tax package.
Form 1099-MISC. File Form 1099-MISC, Mis-
cellaneous 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,
services (including parts and materials), prizes
and awards, other income payments, medical
and health care payments, and crop insurance
proceeds. See the Instructions for Form
1099-MISC for more information and additional
reporting requirements.
Photographs of missing children. The Inter-
nal 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
800-THE-LOST (800-843-5678) (24 hours a
day, 7 days a week) if you recognize a child.
Preventing slavery and human trafficking.
Human trafficking is a form of modern-day slav-
ery, and involves the use of force, fraud, or co-
ercion 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 hu-
man trafficking, including forced labor, debt
bondage, involuntary servitude, “mail-order”
marriages, and sex trafficking. Trafficking in
persons can occur in both lawful and illicit in-
dustries 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 ap-
proach that addresses all aspects of human
trafficking. Online resources for recognizing and
reporting trafficking activities, and assisting vic-
tims include the Department of Homeland Se-
curity (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 Traf-
ficking 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 traf-
ficking, which places equal value on identifying
and stabilizing victims and on investigating and
Page 2 Publication 535 (2018)
prosecuting traffickers. Victims are crucial to in-
vestigations and prosecutions; each case and
every conviction changes lives. DHS under-
stands how difficult it can be for victims to come
forward and work with law enforcement due to
their trauma. DHS is committed to helping vic-
tims 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 Department of Treasury’s Financial
Crimes Enforcement Network (FinCEN) has is-
sued a public advisory to financial institutions
that contains red flag indicators for potential
suspicious financial activity associated with hu-
man trafficking. If warranted, financial institu-
tions should file a Suspicious Activity Report
(FinCEN 112) with FinCEN to report these ac-
tivities. For more information, go to Fincen.gov/
Sites/default/files/advisory/FIN-2014-A008.pdf
1.
Deducting
Business
Expenses
What’s New
Form 1040 redesigned. Form 1040 has been
redesigned for 2018. See Form 1040 and its in-
structions for more information.
Forms 1040A and 1040EZ no longer availa-
ble. Forms 1040A and 1040EZ aren't available
to file your 2018 taxes. If you used one of these
forms in the past, you will now file Form 1040.
Deduction for qualified business income.
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.
Small business taxpayers. For tax years be-
ginning after 2017, more small business taxpay-
ers may qualify to use the cash method of ac-
counting and be exempt from capitalizing
certain expenses under section 263A. In addi-
tion, small business taxpayers may not be re-
quired to account for inventories under section
471 and are not subject to the business interest
expenses limitation.
Introduction
This chapter covers the general rules for de-
ducting business expenses. Business expen-
ses are the costs of carrying on a trade or busi-
ness, and they are usually deductible if the
business is operated to make a profit.
Topics
This chapter discusses:
• What you can deduct
• How much you can deduct
• When you can deduct
• Not-for-profit activities
Useful Items
You may want to see:
Publication
334 Tax Guide for Small Business
463 Travel, Gift, and Car Expenses
525 Taxable and Nontaxable Income
529 Miscellaneous Deductions
536 Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts
538 Accounting Periods and Methods
542 Corporations
547 Casualties, Disasters, and Thefts
583 Starting a Business and Keeping
Records
587 Business Use of Your Home
925 Passive Activity and At-Risk Rules
936 Home Mortgage Interest
Deduction
946 How To Depreciate Property
Form (and Instructions)
Schedule A (Form 1040) Itemized
Deductions
5213 Election To Postpone
Determination as To Whether the
Presumption Applies That an
Activity Is Engaged in for Profit
See chapter 13 for information about getting
publications and forms.
What Can I Deduct?
To be deductible, a business expense must be
both ordinary and necessary. An ordinary ex-
pense is one that is common and accepted in
your industry. A necessary expense is one that
is helpful and appropriate for your trade or busi-
ness. An expense does not have to be indis-
pensable to be considered necessary.
Even though an expense may be ordinary
and necessary, you may not be allowed to de-
duct the expense in the year you paid or
Schedule A (Form 1040)
5213
incurred it. In some cases, you may not be al-
lowed to deduct the expense at all. Therefore, it
is important to distinguish usual business ex-
penses from expenses that include the follow-
ing.
• The expenses used to figure cost of goods
sold.
• Capital expenses.
• Personal expenses.
Cost of Goods Sold
If your business manufactures products or pur-
chases them for resale, you generally must
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 re-
ceipts 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.
The following are types of expenses that go
into figuring cost of goods sold.
• The cost of products or raw materials, in-
cluding freight.
• Storage.
• Direct labor (including contributions to pen-
sion or annuity plans) for workers who pro-
duce the products.
• Factory overhead.
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, repack-
aging, handling, and administrative costs.
This rule does not apply to small business
taxpayers. You qualify as a small business tax-
payer if you (a) have average annual gross re-
ceipts of $25 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 aver-
age gross receipts. If your business (or prede-
cessor entity) had short taxable 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.
For more information, see the following
sources.
• Cost of goods sold—chapter 6 of Pub.
334.
• Inventories—Pub. 538.
• Uniform capitalization rules—Pub. 538 and
section 263A and the related regulations.
Capital Expenses
You must capitalize, rather than deduct, some
costs. These costs are a part of your investment
in your business and are called “capital expen-
ses.” Capital expenses are considered assets
Chapter 1 Deducting Business Expenses Page 3
in your business. In general, you capitalize
three types of costs.
• Business start-up costs (see Tip below).
• Business assets.
• Improvements.
You can elect to deduct or amortize
certain business start-up costs. See
chapters 7 and 8.
Cost recovery. 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 deduc-
tion. A greater portion of these costs can be de-
ducted if the property is qualified disaster assis-
tance property. See Pub. 946 for details.
Going Into Business
The costs of getting started in business, before
you actually begin business operations, are
capital expenses. These costs may include ex-
penses for advertising, travel, or wages for
training employees.
If you go into business. When you go into
business, treat all costs you had to get your
business started as capital expenses.
Usually, you recover costs for a particular
asset through depreciation. Generally, you can-
not recover other costs until you sell the busi-
ness or otherwise go out of business. However,
you can choose to amortize certain costs for
setting up your business. See Starting a Busi-
ness in chapter 8 for more information on busi-
ness start-up costs.
If your attempt to go into business is un-
successful. 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.
1. The costs you had before making a deci-
sion to acquire or begin a specific busi-
ness. These costs are personal and non-
deductible. They include any costs
incurred during a general search for, or
preliminary investigation of, a business or
investment possibility.
2. The costs you had in your attempt to ac-
quire or begin a specific business. These
costs are capital expenses and you can
deduct them as a capital loss.
If you are a corporation and your attempt to
go into a new trade or business is not success-
ful, you may be able to deduct all investigatory
costs as a loss.
The costs of any assets acquired during
your unsuccessful attempt to go into business
are a part of your basis in the assets. You can-
not take a deduction for these costs. You will re-
cover the costs of these assets when you dis-
pose of them.TIP
Business Assets
There are many different kinds of business as-
sets, for example, land, buildings, machinery,
furniture, trucks, patents, and franchise rights.
You must fully capitalize the cost of these as-
sets, including freight and installation charges.
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.
De Minimis Safe Harbor for
Tangible Property
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 ac-
quire or produce certain tangible business prop-
erty if these amounts are deducted by you for fi-
nancial accounting purposes or in keeping your
books and records. See the following for the re-
quirements for the de minimis safe harbor.
You have an applicable financial statement.
If you elect the de minimis safe harbor for the
tax year, you can deduct amounts paid to ac-
quire or produce certain tangible business prop-
erty if:
• You have a trade or business or are a cor-
poration, partnership, or S corporation that
has an applicable financial statement;
• You have, at the beginning of the tax year,
written accounting procedures treating as
an expense for nontax purposes:
– Amounts paid for property costing
less than a certain dollar amount, or
– Amounts paid for property with an
economic useful life of 12 months or
less;
• You treat the amount paid during the tax
year for which you make the election as an
expense on your applicable financial state-
ments in accordance with your written ac-
counting procedures;
• The amount paid for the property does not
exceed $5,000 per invoice (or per item
substantiated by invoice); and
• The uniform capitalization rules do not ap-
ply to the amount.
You do 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 busi-
ness property if:
• You have a trade or business, partnership,
or S corporation that does not have an ap-
plicable financial statement;
• You have, at the beginning of the tax year,
accounting procedures treating as an ex-
pense for nontax purposes:
– Amounts paid for property costing
less than a certain dollar amount, or
– Amounts paid for property with an
economic useful life of 12 months or
less;
• You treat the amounts paid for the property
as an expense on your books and records
in accordance with your accounting proce-
dures;
• The amount paid for the property does not
exceed $2,500 per invoice (or per item
substantiated by invoice); and
• The uniform capitalization rules do not ap-
ply to the amounts.
How to make the de minimis safe harbor
election. To elect the de minimis safe harbor
for the tax year, attach a statement to the tax-
payer’s timely filed original tax return (including
extensions) for the tax year when qualifying
amounts were paid. The statement must be ti-
tled “Section 1.263(a)-1(f) de minimis safe har-
bor election” and must include your name, ad-
dress, 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 con-
solidated income tax return, the election is
made for each member of the consolidated
group.
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 part-
nership, the election is made by the S corpora-
tion or the partnership and not by the share-
holders or partners. The election applies only
for the tax year for which it is made.
Example. In 2018, you do not have an ap-
plicable 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 substanti-
ated in an invoice. You had an accounting pro-
cedure in place at the beginning of 2018 to ex-
pense the cost of tangible property if the
property costs $2,000 or less. You treat each
computer as an expense on your books and re-
cords for 2018 in accordance with this policy. If
you elect the de minimis safe harbor in your tax
returns for your 2018 tax year, you can deduct
the cost of each $2,000 computer.
Improvements
Generally, you must capitalize the costs of mak-
ing improvements to a business asset if the im-
provements 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.
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.
However, you may currently deduct the
costs of repairs or maintenance that do not im-
prove 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 properly in an ordi-
nary efficient operating condition. For example,
deductible repairs include costs such as
Page 4 Chapter 1 Deducting Business Expenses
painting exteriors or interiors of business build-
ings, repairing broken window panes, replacing
worn-out minor parts, sealing cracks and leaks,
and changing oil or other fluids to maintain busi-
ness equipment.
Routine maintenance safe harbor. If you de-
termine that your cost was for an improvement
to a building or equipment, you can deduct your
cost under the routine maintenance safe har-
bor. Under the routine maintenance safe har-
bor, you can deduct the costs of an improve-
ment that meets all of the following criteria.
• It is paid for recurring activities performed
on tangible property.
• It arises from the use of the property in
your trade or business.
• It keeps your property in an ordinarily effi-
cient operating condition.
• You reasonably expect, at the time the
property is placed in service, to perform
this activity:
For buildings and building systems,
more than once during the 10-year pe-
riod after you place the building in
service; or
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.
Costs incurred during an improvement.
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 sys-
tem 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 oth-
erwise be treated as currently deductible repair
costs.
Election to capitalize repair and mainte-
nance costs. 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 capi-
tal 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 ex-
penditures, attach a statement titled “Section
1.263(a)-3(n) Election” to your timely filed origi-
nal tax return (including extensions) and include
your name and address, TIN, and a statement
that you elect to capitalize repair and mainte-
nance 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.
Capital Versus Deductible
Expenses
To help you distinguish between capital and de-
ductible expenses, different examples are given
below.
Motor vehicles. You usually capitalize the
cost of a motor vehicle you use in your busi-
ness. You can recover its cost through annual
deductions for depreciation.
There are dollar limits on the depreciation
you can claim each year on passenger automo-
biles used in your business. See Pub. 463 for
more information.
Generally, repairs you make to your busi-
ness vehicle are currently deductible. However,
amounts you pay to improve your business ve-
hicle are generally capital expenditures and are
recovered through depreciation.
Roads and driveways. The cost of building a
private road on your business property and the
cost of replacing a gravel driveway with a con-
crete 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.
Tools. 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.
Machinery parts. Unless the uniform capitali-
zation rules apply, the cost of replacing
short-lived parts of a machine to keep it in good
working condition, but not to improve the ma-
chine, is a deductible expense.
Heating equipment. The cost of changing
from one heating system to another is a capital
expense.
Deduction for qualified business income.
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 lim-
itations, 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 unad-
justed basis of qualified property held by your
trade or business. You will claim this deduction
on Form 1040, not on Schedule C or C-EZ. Un-
like other deductions, this deduction can be
taken in addition to the standard or itemized de-
ductions. For more information, see the Instruc-
tions for Form 1040 and Pub. 535.
Personal Versus Business
Expenses
Generally, you cannot deduct personal, living,
or family expenses. However, if you have an ex-
pense for something that is used partly for busi-
ness and partly for personal purposes, divide
the total cost between the business and per-
sonal parts. You can deduct the business part.
For example, if you borrow money and use
70% of it for business and the other 30% for a
family vacation, you generally can deduct 70%
of the interest as a business expense. The re-
maining 30% is personal interest and generally
is not deductible. See chapter 4 for information
on deducting interest and the allocation rules.
Business use of your home. 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 depre-
ciation.
To qualify to claim expenses for the busi-
ness use of your home, you must meet both of
the following tests.
1. The business part of your home must be
used exclusively and regularly for your
trade or business.
2. The business part of your home must be:
a. Your principal place of business; or
b. A place where you meet or deal with
patients, clients, or customers in the
normal course of your trade or busi-
ness; or
c. A separate structure (not attached to
your home) used in connection with
your trade or business.
You generally do not have to meet the ex-
clusive use test for the part of your home that
you regularly use either for the storage of inven-
tory or product samples, or as a daycare facility.
Your home office qualifies as your principal
place of business if you meet the following re-
quirements.
• You use the office exclusively and regu-
larly for administrative or management ac-
tivities of your trade or business.
• You have no other fixed location where
you conduct substantial administrative or
management activities of your trade or
business.
If you have more than one business loca-
tion, determine your principal place of business
based on the following factors.
• The relative importance of the activities
performed at each location.
• If the relative importance factor does not
determine your principal place of business,
consider the time spent at each location.
Optional safe harbor method. 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.
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 in-
terest, real estate taxes, and casualty losses on
the home as itemized deductions on Sched-
ule A (Form 1040). You are not required to allo-
cate these deductions between personal and
business use, as is required under the regular
Chapter 1 Deducting Business Expenses Page 5
method. If you use the optional method, you
cannot depreciate the portion of your home
used in a trade or business.
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.
For more information on the deduction for
business use of your home, including the op-
tional safe harbor method, see Pub. 587.
If you were entitled to deduct deprecia-
tion 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.
Business use of your car. If you use your car
exclusively in your business, you can deduct
car expenses. If you use your car for both busi-
ness and personal purposes, you must divide
your expenses based on actual mileage. Gen-
erally, commuting expenses between your
home and your business location, within the
area of your tax home, are not deductible.
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 2018, the standard
mileage rate is 54.5 cents per mile. Beginning in
2019, the standard mileage rate increases to 58
cents per mile.
If you are self-employed, you can also de-
duct 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.
For more information on car expenses and
the rules for using the standard mileage rate,
see Pub. 463.
How Much Can I
Deduct?
Generally, you can deduct the full amount of a
business expense if it meets the criteria of ordi-
nary and necessary and it is not a capital ex-
pense.
Recovery of amount deducted (tax benefit
rule). 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 re-
covery 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.
For more information on recoveries and the
tax benefit rule, see Pub. 525.
Payments in kind. 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.CAUTION
!
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 de-
duct them again as a business expense.
Limits on losses. If your deductions for an in-
vestment 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 de-
duct.
Not-for-profit limits. 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.
At-risk limits. Generally, a deductible loss
from a trade or business or other income-pro-
ducing activity is limited to the investment you
have “at risk” in the activity. You are at risk in
any activity for the following.
1. The money and adjusted basis of property
you contribute to the activity.
2. Amounts you borrow for use in the activity
if:
a. You are personally liable for repay-
ment, or
b. You pledge property (other than prop-
erty used in the activity) as security for
the loan.
For more information, see Pub. 925.
Passive activities. Generally, you are in a
passive activity if you have a trade or business
activity in which you do not materially partici-
pate, or a rental activity. In general, deductions
for losses from passive activities only offset in-
come from passive activities. You cannot use
any excess deductions to offset other income.
In addition, passive activity credits can only off-
set 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 activ-
ity. For more information, see Pub. 925.
Net operating loss (NOL). If your deduc-
tions 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.
See Pub. 542 for information about NOLs of
corporations.
When Can I
Deduct an Expense?
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.
For more information on accounting meth-
ods, see Pub. 538.
Cash method. Under the cash method of ac-
counting, you generally deduct business expen-
ses in the tax year you pay them.
Accrual method. Under an accrual method of
accounting, you generally deduct business ex-
penses when both of the following apply.
1. The all-events test has been met. The test
is met when:
a. All events have occurred that fix the
fact of liability, and
b. The liability can be determined with
reasonable accuracy.
2. Economic performance has occurred.
Economic performance. You generally
cannot deduct or capitalize a business expense
until economic performance occurs. If your ex-
pense is for property or services provided to
you, or for your use of property, economic per-
formance occurs as the property or services are
provided, or the property is used. If your ex-
pense is for property or services you provide to
others, economic performance occurs as you
provide the property or services.
Example. Your tax year is the calendar
year. In December 2018, 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 2019. If you use the ac-
crual method of accounting, deduct the $600 on
your tax return for 2018 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 oc-
curred in that year.
If you use the cash method of accounting,
deduct the expense on your 2019 tax return.
Prepayment. You generally cannot deduct ex-
penses in advance, even if you pay them in ad-
vance. This applies to prepaid interest, prepaid
insurance premiums, and any other prepaid ex-
pense 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 appro-
priate period.
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 de-
duct the amount when paid. If you are an ac-
crual method taxpayer, you cannot deduct the
amount until the all-events test has been met
and economic performance has occurred.
Example 1. In 2018, you sign a 10-year
lease and immediately pay your rent for the first
3 years. Even though you paid the rent for
2018, 2019, and 2020, you can only deduct the
rent for 2018 on your 2018 tax return. You can
deduct the rent for 2019 and 2020 on your tax
returns for those years.
Page 6 Chapter 1 Deducting Business Expenses
Example 2. You are a cash method calen-
dar year taxpayer. On December 1, 2018, you
sign a 12-month lease, effective beginning Jan-
uary 1, 2019, and immediately pay your rent for
the entire 12-month period that begins on Janu-
ary 1, 2019. The right or benefit attributable to
the payment neither extends more than 12
months beyond January 1, 2019 (the first day
that you are entitled to use the property) nor be-
yond the tax year ending December 31, 2019
(the year following the year in which you made
the advance payment). Therefore, your prepay-
ment does not have to be capitalized, and you
can deduct the entire payment in the year you
pay it.
Contested liability. 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. posses-
sion 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 cer-
tain conditions. See Regulations section
1.461-2.
Related person. Under an 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 ex-
pense before you can deduct it. Your deduction
is allowed when the amount is includible in in-
come by the related cash method payee. For
more information, see Related Persons in Pub.
538.
Not-for-Profit Activities
If you do not carry on your business or invest-
ment activity to make a profit, you cannot use a
loss from the activity to offset other income. Ac-
tivities you do as a hobby, or mainly for sport or
recreation, are often not entered into for profit.
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.
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:
• You carry on the activity in a businesslike
manner,
• The time and effort you put into the activity
indicate you intend to make it profitable,
• You depend on the income for your liveli-
hood,
• Your losses are due to circumstances be-
yond your control (or are normal in the
start-up phase of your type of business),
• You change your methods of operation in
an attempt to improve profitability,
• You (or your advisors) have the knowledge
needed to carry on the activity as a suc-
cessful business,
• You were successful in making a profit in
similar activities in the past,
• The activity makes a profit in some years,
and
• You can expect to make a future profit from
the appreciation of the assets used in the
activity.
Presumption of profit. An activity is pre-
sumed 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 pro-
duced a profit in at least 2 of the last 7 tax
years, including the current year. The activity
must be substantially the same for each year
within this period. You have a profit when the
gross income from an activity exceeds the de-
ductions.
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.
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.
Using the presumption later. If you are start-
ing an activity and do not have 3 (or 2) years
showing a profit, you can elect to have the pre-
sumption made after you have the 5 (or 7) years
of experience allowed by the test.
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.
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 de-
ductions 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.
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.
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 de-
ductions attributable to the activity.
Gross Income
Gross income from a not-for-profit activity in-
cludes the total of all gains from the sale,TIP
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 ac-
tivity.
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 account-
ing.
Limit on Deductions
You can no longer claim any miscella-
neous itemized deductions. Miscella-
neous 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 de-
ductions on Schedule A (Form 1040).
Deductions you can take for personal as well as
for business activities are allowed in full. For in-
dividuals, 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).
For the limits that apply to home mortgage
interest, see Pub. 936.
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 ex-
ceeds 10% of your adjusted gross income
(AGI). See Pub. 547 for more information on
casualty losses.
Disaster tax relief. For personal casualty
losses resulting from federally declared disas-
ters that occurred before 2018, you may be en-
titled to disaster tax relief. As a result, you may
be required to figure your casualty loss differ-
ently. Beginning in 2018, casualty and theft loss
are allowed only to the extent it is attributable to
a federally declared disaster. For more informa-
tion, see Pub. 976, Disaster Relief.
Partnerships and S corporations. If a part-
nership or S corporation carries on a
not-for-profit activity, these limits apply at the
partnership or S corporation level. They are re-
flected in the individual shareholder's or part-
ner's distributive shares.
More than one activity. 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 cir-
cumstances in making this determination.
• The degree of organizational and eco-
nomic interrelationship of various under-
takings.
• The business purpose that is (or might be)
served by carrying on the various under-
takings separately or together in a busi-
ness or investment setting.
• The similarity of the undertakings.CAUTION
!
Chapter 1 Deducting Business Expenses Page 7
The IRS will generally accept your charac-
terization if it is supported by facts and circum-
stances.
If you are carrying on two or more dif-
ferent 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 de-
ductions and losses separately for each activity
that is not for profit.
2.
Employees' Pay
What’s New
Compensation in excess of $1 million. P.L.
115-97, Tax Cuts and Jobs Act, made signifi-
cant changes to section 162(m) which disallows
the deduction of excessive employee compen-
sation by any publicly held corporation. See
Compensation in excess of $1 million, later.
Employee achievement awards. P.L. 115-97
defines items that aren't tangible personal prop-
erty for purposes of employee achievement
awards. Tangible personal property doesn't in-
clude cash, gift cards, and other nontangible
personal property. See Achievement awards,
later.
Certain expense deductions are now limi-
ted. P.L. 115-97 limits the deduction by em-
ployers of expenses for certain fringe benefits
and entertainment expenses. For more informa-
tion, see the Caution under Meals and lodging,
later. Also see Food and beverage expense in-
curred together with entertainment expenses.
and Transportation (commuting) benefits, later.
At the time this publication was printed,
the empowerment zone employment
credit and the Indian employment
credit expired at the end of 2017. To find out if
legislation was enacted to extend these credits
and make them available for 2018, go to
IRS.gov/FormsUpdates.
Introduction
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, commis-
sions, or other non-cash compensation such as
vacation allowances and fringe benefits. For in-
formation about deducting employment taxes,
see chapter 5.
You may be able to claim employment
credits, such as the credits listed be-
low, 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 aboutTIPCAUTION
!TIP
these credits, see the form on which the credit
is claimed; you can find a list of these forms in
Form (and Instructions) under Useful Items,
later.
• Work opportunity credit.
• Credit for employer differential wage pay-
ments.
• Employer credit for paid family and medi-
cal leave.
Topics
This chapter discusses:
• Tests for deducting pay
• Kinds of pay
Useful Items
You may want to see:
Publication
15 Employer's Tax Guide
15-A Employer's Supplemental Tax Guide
15-B Employer's Tax Guide to Fringe
Benefits
Form (and Instructions)
1099-MISC Miscellaneous Income
5884 Work Opportunity Credit
8932 Credit for Employer Differential
Wage Payments
8994 Employer Credit for Paid Family and
Medical Leave
W-2 Wage and Tax Statement
See chapter 13 for information about getting
publications and forms.
Tests for Deducting Pay
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 expen-
ses are explained in chapter 1.
In addition, the pay must meet both of the
following tests.
• Test 1. It must be reasonable.
• Test 2. It must be for services performed.
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.
Test 1—Reasonableness
You must be able to prove that the pay is rea-
sonable. Whether the pay is reasonable de-
pends 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.
Factors to consider. Determine the reasona-
bleness of pay by the facts and circumstances.
15-A
15-B
1099-MISC
5884
8932
8994
W-2
Generally, reasonable pay is the amount that a
similar business would pay for the same or simi-
lar services.
To determine if pay is reasonable, also con-
sider the following items and any other pertinent
facts.
• The duties performed by the employee.
• The volume of business handled.
• The character and amount of responsibil-
ity.
• The complexities of your business.
• The amount of time required.
• The cost of living in the locality.
• The ability and achievements of the indi-
vidual employee performing the service.
• The pay compared with the gross and net
income of the business, as well as with dis-
tributions to shareholders if the business is
a corporation.
• Your policy regarding pay for all your em-
ployees.
• The history of pay for each employee.
Compensation in excess of $1 million. Pub-
licly held corporations can't deduct compensa-
tion to a “covered employee” to the extent that
the compensation exceeds $1 million. For more
information, including the definition of a “cov-
ered employee,” see the Instructions for Form
1125-E. Also see Notice 2018-68, 2018-36
I.R.B. 418, available at IRS.gov/irb/
2018-36_IRB#NOT-2018-68.
Test 2—For Services
Performed
You must be able to prove the payment was
made for services actually performed.
Employee-shareholder salaries. If a corpo-
ration pays an employee who is also a share-
holder a salary that is unreasonably high con-
sidering the services actually performed, the
excessive part of the salary may be treated as a
constructive dividend to the employee-share-
holder. The excessive part of the salary
wouldn't be allowed as a salary deduction by
the corporation. For more information on corpo-
rate distributions to shareholders, see Pub. 542.
Kinds of Pay
Some of the ways you may provide pay to your
employees in addition to regular wages or salar-
ies are discussed next. For specialized and de-
tailed information on employees' pay and the
employment tax treatment of employees' pay,
see Pubs. 15, 15-A, and 15-B.
Awards
You can generally deduct amounts you pay to
your employees as awards, whether paid in
cash or property. If you give property to an em-
ployee as an employee achievement award,
your deduction may be limited.
Achievement awards. An achievement award
is an item of tangible personal property that
meets all the following requirements.
• It is given to an employee for length of
service or safety achievement.
Page 8 Chapter 2 Employees' Pay
• It is awarded as part of a meaningful pre-
sentation.
• It is awarded under conditions and circum-
stances that don't create a significant likeli-
hood of disguised pay.
Tangible personal property. 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 ar-
rangements granting only the right to select and
receive tangible personal property from a limi-
ted assortment of items preselected or preap-
proved by you). Also, tangible personal prop-
erty doesn't include vacations, meals, lodging,
tickets to theater or sporting events, stocks,
bonds, other securities, and other similar items.
Length-of-service award. An award will
qualify as a length-of-service award only if ei-
ther of the following applies.
• The employee receives the award after his
or her first 5 years of employment.
• 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.
Safety achievement award. An award for
safety achievement will qualify as an achieve-
ment award unless one of the following applies.
1. It is given to a manager, administrator,
clerical employee, or other professional
employee.
2. During the tax year, more than 10% of
your employees, excluding those listed in
(1), have already received a safety ach-
ievement award (other than one of very
small value).
Deduction limit. Your deduction for the
cost of employee achievement awards given to
any one employee during the tax year is limited
to the following.
• $400 for awards that aren't qualified plan
awards.
• $1,600 for all awards, whether or not quali-
fied plan awards.
A qualified plan award is an achievement
award given as part of an established written
plan or program that doesn't favor highly com-
pensated employees as to eligibility or benefits.
A highly compensated employee is an em-
ployee who meets either of the following tests.
1. The employee was a 5% owner at any
time during the year or the preceding year.
2. The employee received more than
$120,000 in pay for 2017.
You can choose to ignore test (2) if the em-
ployee wasn't also in the top 20% of employees
ranked by pay for the preceding year.
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, ig-
nore awards of nominal value.
Deduct achievement awards, up to the max-
imum amounts listed earlier, as a nonwage
business expense on your return or business
schedule.
You may not owe employment taxes on
the value of some achievement awards
you provide to an employee. See Pub.
15-B.
Bonuses
You can generally deduct a bonus paid to an
employee if you intended the bonus as addi-
tional pay for services, not as a gift, and the
services were performed. However, the total
bonuses, salaries, and other pay must be rea-
sonable for the services performed. If the bonus
is paid in property, see Property, later.
Gifts of nominal value. If, to promote em-
ployee 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 ex-
pense. See Pub. 15-B for additional information
on de minimis fringe benefits. If you provide
food to your employees, your business deduc-
tion may be limited; see Meals and lodging,
later.
Education Expenses
If you pay or reimburse education expenses for
an employee, you can deduct the payments if
they are part of a qualified educational assis-
tance program. Deduct them on the “Employee
benefit programs” or other appropriate line of
your tax return. For information on educational
assistance programs, see Educational Assis-
tance in section 2 of Pub. 15-B.
Fringe Benefits
A fringe benefit is a form of pay for the perform-
ance of services. You can generally deduct the
cost of fringe benefits.
You may be able to exclude all or part of the
value of some fringe benefits from your employ-
ees' 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.
Generally, no deduction is allowed for activi-
ties 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, serv-
ices, or facilities are treated as compensation to
the recipient and reported on Form W-2 for an
employee or on Form 1099-MISC for an inde-
pendent 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.
Certain fringe benefits are discussed next.
See Pub. 15-B for more details on these and
other fringe benefits.
Meals and lodging. Generally, you can de-
duct 50% of certain meal expenses and 100%
of certain lodging expenses provided to your
employees. If the amounts are deductible, de-TIP
duct the cost in whatever category the expense
falls.
Deduction limit on meals. You can gener-
ally deduct only 50% of the cost of furnishing
meals to your employees. However, you can
deduct the full cost of certain meals; see sec-
tion 274(n)(2) for more information. For exam-
ple, you can deduct the full cost of the following
meals.
• Meals whose value you include in an em-
ployee's wages.
• Meals you furnish to your employees as
part of the expense of providing recrea-
tional or social activities, such as holiday
parties or annual picnics, when made pri-
marily 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.
• Meals you’re required by federal law to fur-
nish to crew members of certain commer-
cial vessels (or would be required to fur-
nish if the vessels were operated at sea).
This doesn't include meals you furnish on
vessels primarily providing luxury water
transportation.
• Meals you furnish on an oil or gas platform
or drilling rig located offshore or in Alaska.
This includes meals you furnish at a sup-
port camp that is near and integral to an oil
or gas drilling rig located in Alaska.
P.L. 115-97 changed the rules for the
deduction of food or beverage expen-
ses 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 expen-
ses also applies to food or beverage expenses
excludable from employee income as a de mini-
mis fringe benefit. While your business deduc-
tion 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.
Food and beverage expense incurred to-
gether with entertainment expenses. P.L.
115-97 changed the rules for the deduction of
business entertainment expenses. For amounts
incurred or paid after 2017, no business deduc-
tion is allowed for any item generally consid-
ered to be entertainment, amusement, or recre-
ation. As discussed earlier, you can deduct
50% of the cost of business meals. If food and
beverages are provided during or at an enter-
tainment activity, and the food and beverages
are purchased separately from the entertain-
ment, or the cost of the food and beverages is
stated separately from the cost of the entertain-
ment on one or more bills, invoices, or receipts,
you may continue to deduct 50% of the busi-
ness meal expenses. However, if you purchase
food and beverages together with entertain-
ment expenses and the cost of the food and
beverages isn't stated separately on the in-
voice, the cost of the food and beverages are
also an entertainment expense and none of the
expenses are deductible. For more information,
including details about four additional require-
ments that must be met for a business meal to
be deductible, see Notice 2018-76, 2018-42CAUTION
!
Chapter 2 Employees' Pay Page 9
I.R.B. 599, available at IRS.gov/irb/
2018-42_IRB#NOT-2018-76.
Transportation (commuting) benefits. 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 arrange-
ment, or through a compensation reduction
agreement) incurred or paid after 2017. Also,
no deduction is allowed for any expense incur-
red for providing any transportation, or any pay-
ment 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 em-
ployee or for qualified bicycle commuting reim-
bursements 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 pay-
ments, except for qualified bicycle commuting
reimbursements, may be excluded from your
employee's wages. See Pub. 15-B for more in-
formation about qualified transportation bene-
fits.
Tax-exempt organizations may need to in-
crease their unrelated business taxable income
by the amount of certain disallowed fringe ben-
efits. For more information, see the Instructions
for Form 990-T. Also see Notice 2018-99,
2018-52 I.R.B. 1067, available at IRS.gov/irb/
2018-52_IRB#NOT-2018-99 and Notice
2018-100, 2018-52 I.R.B. 1074, available at
IRS.gov/irb/2018-52_IRB#NOT-2018-100.
Employee benefit programs. Employee ben-
efit programs include the following.
• Accident and health plans.
• Adoption assistance.
• Cafeteria plans.
• Dependent care assistance.
• Education assistance.
• Life insurance coverage.
• Welfare benefit funds.
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, de-
duct your costs in whatever categories they fall
(utilities, salaries, etc.).
Life insurance coverage. You can't de-
duct the cost of life insurance coverage for you,
an employee, or any person with a financial in-
terest in your business, if you’re directly or indi-
rectly the beneficiary of the policy. See Regula-
tions section 1.264-1 for more information.
Welfare benefit funds. 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 con-
tractors, or their beneficiaries. Welfare benefits
are any benefits other than deferred compensa-
tion or transfers of restricted property.
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 ex-
cess over to the next tax year.
Generally, the fund's “qualified cost” is the
total of the following amounts, reduced by the
after-tax income of the fund.
• The cost you would’ve been able to deduct
using the cash method of accounting if you
had paid for the benefits directly.
• The contributions added to a reserve ac-
count that are needed to fund claims incur-
red but not paid as of the end of the year.
These claims can be for supplemental un-
employment benefits, severance pay, or
disability, medical, or life insurance bene-
fits.
For more information, see sections 419(c)
and 419A and the related regulations.
Loans or Advances
You generally can deduct as wages an advance
you make to an employee for services per-
formed if you don't expect the employee to re-
pay the advance. However, if the employee per-
forms no services, treat the amount you
advanced as a loan. If the employee doesn't re-
pay the loan, treat it as income to the employee.
Below-market interest rate loans. On certain
loans you make to an employee or shareholder,
you’re treated as having received interest in-
come and as having paid compensation or divi-
dends equal to that interest. See Below-Market
Loans in chapter 4.
Property
If you transfer property (including your compa-
ny's stock) to an employee as payment for serv-
ices, 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.
You can claim the deduction only for the tax
year in which your employee includes the prop-
erty'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.
You treat the deductible amount as received
in exchange for the property, and you must rec-
ognize 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.
These rules also apply to property transfer-
red to an independent contractor for services,
generally reported on Form 1099-MISC.
Restricted property. If the property you trans-
fer for services is subject to restrictions that af-
fect 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.
“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.
Reimbursements for
Business Expenses
You can generally deduct the amount you pay
or reimburse employees for business expenses
incurred for your business. However, your de-
duction may be limited.
If you make the payment under an account-
able plan, deduct it in the category of the ex-
pense paid. For example, if you pay an em-
ployee for travel expenses incurred on your
behalf, deduct this payment as a travel ex-
pense. If you make the payment under a nonac-
countable plan, deduct it as wages and include
it in the employee's Form W-2.
See Reimbursement of Travel, Meals, and
Entertainment, in chapter 11, for more informa-
tion about deducting reimbursements and an
explanation of accountable and nonaccounta-
ble plans.
Sick and Vacation Pay
Sick pay. You can deduct amounts you pay to
your employees for sickness and injury, includ-
ing lump-sum amounts, as wages. However,
your deduction is limited to amounts not com-
pensated by insurance or other means.
Vacation pay. Vacation pay is an employee
benefit. It includes amounts paid for unused va-
cation 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.
3.
Rent Expense
What’s New
Small business taxpayers. P.L. 115-97, Tax
Cuts and Jobs Act, made changes to uniform
capitalization rules for small business taxpay-
ers. See Uniform capitalization rules, later.
Introduction
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 dis-
cusses 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.
Page 10 Chapter 3 Rent Expense
Topics
This chapter discusses:
• The definition of rent
• Taxes on leased property
• The cost of getting a lease
• Improvements by the lessee
• Capitalizing rent expenses
Useful Items
You may want to see:
Publication
538 Accounting Periods and Methods
544 Sales and Other Dispositions of
Assets
946 How To Depreciate Property
See chapter 13 for information about getting
publications and forms.
Rent
Rent is any amount you pay for the use of prop-
erty you do not own. In general, you can deduct
rent as an expense only if the rent is for prop-
erty you use in your trade or business. If you
have or will receive equity in or title to the prop-
erty, the rent is not deductible.
Unreasonable rent. 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 per-
sons in chapter 2 of Pub. 544.
Rent on your home. 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 busi-
ness use of your home. For more information,
see Business use of your home in chapter 1.
Rent paid in advance. Generally, rent paid for
use of property in your trade or business is de-
ductible in the year paid or incurred. If you are
an accrual method taxpayer and pay rent in ad-
vance, you can deduct only the amount of rent
that applies to your use of rented property dur-
ing 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 pay-
ment applies to 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 prop-
erty or the end of the tax year following the year
in which you paid the advance rent. If your pay-
ment 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.
Example 1. You are an accrual method cal-
endar year taxpayer and you lease a building at
a monthly rental rate of $1,000 beginning July
1, 2018. On June 30, 2018, you pay advance
rent of $12,000 for the last 6 months of 2018
and the first 6 months of 2019. You can deduct
only $6,000 for 2018, for the right to use prop-
erty in 2018. You deduct the other $6,000 in
2019.
Example 2. Assume the same facts as Ex-
ample 1, except you are a cash method calen-
dar year taxpayer. You may deduct the entire
$12,000 payment for 2018. The payment ap-
plies 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
2018, you should not deduct any part of this
payment in 2019.
Example 3. You are either a cash or ac-
crual 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 al-
locable to your use of the property in each year.
Canceling a lease. You generally can deduct
as rent an amount you pay to cancel a business
lease.
Lease or purchase. There may be instances
in which you must determine whether your pay-
ments are for rent or for the purchase of the
property. You must first determine whether your
agreement is a lease or a conditional sales con-
tract. Payments made under a conditional sales
contract are not deductible as rent expense.
Conditional sales contract. Whether an
agreement is a conditional sales contract de-
pends on the intent of the parties. Determine in-
tent 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.
• The agreement applies part of each pay-
ment toward an equity interest you will re-
ceive.
• You get title to the property after you make
a stated amount of required payments.
• The amount you must pay to use the prop-
erty for a short time is a large part of the
amount you would pay to get title to the
property.
• You pay much more than the current fair
rental value of the property.
• You have an option to buy the property at a
nominal price compared to the value of the
property when you may exercise the op-
tion. Determine this value when you make
the agreement.
• You have an option to buy the property at a
nominal price compared to the total
amount you have to pay under the agree-
ment.
• The agreement designates part of the pay-
ments as interest, or that part is easy to
recognize as interest.
Leveraged leases. Leveraged lease trans-
actions may not be considered leases. Lever-
aged 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.
If you plan to take part in what appears to be
a leveraged lease, you may want to get an ad-
vance ruling.
• Revenue Procedure 2001-28 contains the
guidelines the IRS will use to determine if a
leveraged lease is a lease for federal in-
come tax purposes.
• Revenue Procedure 2001-29 provides the
information required to be furnished in a
request for an advance ruling on a lever-
aged lease transaction.
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.
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 fac-
tors in the revenue procedure are met, including
the following.
• The lessor must maintain a minimum un-
conditional “at risk” equity investment in
the property (at least 20% of the cost of the
property) during the entire lease term.
• 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 lessee may not invest in the property,
except as provided by Revenue Procedure
2001-28.
• 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 prop-
erty.
• The lessor must show that it expects to re-
ceive a profit apart from the tax deduc-
tions, allowances, credits, and other tax at-
tributes.
The IRS may charge you a user fee for issu-
ing a tax ruling. For more information, see Rev-
enue Procedure 2018-1, available at
IRS.gov/irb/2018-1_IRB#RP-2018-1.
Leveraged leases of limited-use prop-
erty. The IRS won’t issue advance rulings on
leveraged leases of so-called limited-use prop-
erty. Limited-use property is property not ex-
pected to be either useful to or usable by a les-
sor 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 limi-
ted-use property.
Leases over $250,000. Special rules are pro-
vided for certain leases of tangible property.
The rules apply if the lease calls for total pay-
ments of more than $250,000 and any of the fol-
lowing apply.
• Rents increase during the lease.
• Rents decrease during the lease.
• 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).
Chapter 3 Rent Expense Page 11
• 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).
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).
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 ac-
count under a constant rental accrual method in
which the rent is treated as accruing ratably
over the entire lease term. For details, see sec-
tion 467.
Taxes on
Leased Property
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 ac-
counting method.
Cash method. If you use the cash method of
accounting, you can deduct the taxes as addi-
tional rent only for the tax year in which you pay
them.
Accrual method. If you use an accrual method
of accounting, you can deduct the taxes as ad-
ditional rent for the tax year in which you can
determine all the following.
• That you have a liability for taxes on the
leased property.
• How much the liability is.
• That economic performance occurred.
The liability and amount of taxes are deter-
mined by state or local law and the lease agree-
ment. Economic performance occurs as you
use the property.
Example 1. Oak Corporation is a calendar
year taxpayer that uses an accrual method of
accounting. Oak leases land for use in its busi-
ness. 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.
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.
Example 2. The facts are the same as in
Example 1, except that, according to the terms
of the lease, Oak becomes liable for the real es-
tate 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.
Cost of Getting a Lease
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.
If you get an existing lease on property or
equipment for your business, you generally
must 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.
The cost of getting an existing lease of tan-
gible property is not subject to the amortization
rules for section 197 intangibles discussed in
chapter 8.
Option to renew. 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 re-
maining 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).
Example 1. You paid $10,000 to get a
lease with 20 years remaining on it and two op-
tions 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 remain-
ing life of your present lease plus the periods for
renewal.
Example 2. 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 op-
tions. 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).
Cost of a modification agreement. You may
have to pay an additional “rent” amount over
part of the lease period to change certain provi-
sions in your lease. You must capitalize these
payments and amortize them over the remain-
ing period of the lease. You can’t deduct the
payments as additional rent, even if they are
described as rent in the agreement.
Example. You are a calendar year taxpayer
and sign a 20-year lease to rent part of a build-
ing 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 ex-
change, you agree to pay an additional rent
amount of $3,000, payable in 60 monthly install-
ments of $50 each.
You must capitalize the $3,000 and amortize
it over the 20-year term of the lease. Your amor-
tization 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.
Commissions, bonuses, and fees. Commis-
sions, 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.
Loss on merchandise and fixtures. 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.
Improvements
by Lessee
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 re-
covery period. You can’t amortize the cost over
the remaining term of the lease.
If you don’t keep the improvements when
you end the lease, figure your gain or loss
based on your adjusted basis in the improve-
ments at that time.
For more information, see the discussion of
MACRS in chapter 4 of Pub. 946.
Assignment of a lease. 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.
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 in-
vestment in the improvements over the recov-
ery period of the property as discussed earlier,
without regard to the lease term.
Page 12 Chapter 3 Rent Expense
Capitalizing
Rent Expenses
Under the uniform capitalization rules, you must
capitalize the direct costs and part of the indi-
rect costs for certain production or resale activi-
ties. Include these costs in the basis of property
you produce or acquire for resale, rather than
claiming them as a current deduction. You re-
cover the costs through depreciation, amortiza-
tion, or cost of goods sold when you use, sell,
or otherwise dispose of the property.
Indirect costs include amounts incurred for
renting or leasing equipment, facilities, or land.
Uniform capitalization rules. 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.
1. Produce real property or tangible personal
property.
2. Acquire property for resale.
Effective for tax years beginning after
12/31/2017, if you are a small business tax-
payer (see Cost of Goods Sold in chapter 1),
you are not required to capitalize costs under
section 263A. See section 263A(i).
Producing property. You produce prop-
erty 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.
Example 1. You rent construction equip-
ment to build a storage facility. If you are sub-
ject 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 deprecia-
tion on the building.
Example 2. 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 oc-
cupy the facility in the cost of the tools you pro-
duce.
More information. For exceptions and more
information on these rules, see Uniform Capital-
ization Rules in Pub. 538 and the regulations
under section 263A.
4.
Interest
Introduction
This chapter discusses the tax treatment of
business interest expense. Business interest
expense is an amount charged for the use of
money you borrowed for business activities.
Topics
This chapter discusses:
• Allocation of interest
• Interest expense limitation
• Interest you can deduct
• Interest you cannot deduct
• Capitalization of interest
• When to deduct interest
• Below-market loans.
Useful Items
You may want to see:
Publication
537 Installment Sales
550 Investment Income and Expenses
936 Home Mortgage Interest Deduction
Form (and Instructions)
Schedule A (Form 1040) Itemized
Deductions
Schedule E (Form 1040) Supplemental
Income and Loss
Schedule K-1 (Form 1065) Partner's
Share of Income, Deductions,
Credits, etc.
Schedule K-1 (Form 1120S)
Shareholder's Share of Income,
Deductions, Credits, etc.
1098 Mortgage Interest Statement
3115 Application for Change in
Accounting Method
4952 Investment Interest Expense
Deduction
8582 Passive Activity Loss Limitations
8990 Limitation on Business Interest
Expense Under Section 163(j)
See chapter 13 for information about getting
publications and forms.
Allocation of Interest
The rules for deducting interest vary, depending
on whether the loan proceeds are used for busi-
ness, personal, or investment activities. If you
use the proceeds of a loan for more than one
type of expense, you must allocate the interest
based on the use of the loan's proceeds.
Schedule A (Form 1040)
Schedule E (Form 1040)
Schedule K-1 (Form 1065)
Schedule K-1 (Form 1120S)
1098
3115
4952
8582
8990
Allocate your interest expense to the follow-
ing categories.
• Nonpassive trade or business activity inter-
est.
• Passive trade or business activity interest.
• Investment interest.
• Portfolio interest.
• Personal interest.
In general, you allocate interest on a loan the
same way you allocate the loan proceeds. You
allocate loan proceeds by tracing disburse-
ments to specific uses.
The easiest way to trace disburse-
ments to specific uses is to keep the
proceeds of a particular loan separate
from any other funds.
Secured loan. The allocation of loan proceeds
and the related interest is not generally affected
by the use of property that secures the loan.
Example. You secure a loan with property
used in your business. You use the loan pro-
ceeds to buy an automobile for personal use.
You must allocate interest expense on the loan
to personal use (purchase of the automobile)
even though the loan is secured by business
property.
P.L. 115-97 sec. 11043 limited the de-
duction for mortgage interest paid on
home equity loans and line of credit.
For more information, see Pub. 936.
Allocation period. The period for which a loan
is allocated to a particular use begins on the
date the proceeds are used and ends on the
earlier of the following dates.
• The date the loan is repaid.
• The date the loan is reallocated to another
use.
Proceeds not disbursed to borrower. Even
if the lender disburses the loan proceeds to a
third party, the allocation of the loan is still
based on your use of the funds. This applies
whether you pay for property, services, or any-
thing else by incurring a loan, or you take prop-
erty subject to a debt.
Proceeds deposited in borrower's account.
Treat loan proceeds deposited in an account as
property held for investment. It does not matter
whether the account pays interest. Any interest
you pay on the loan is investment interest ex-
pense. If you withdraw the proceeds of the loan,
you must reallocate the loan based on the use
of the funds.
Example. Celina, a calendar year taxpayer,
borrows $100,000 on January 4 and immedi-
ately uses the proceeds to open a checking ac-
count. No other amounts are deposited in the
account during the year and no part of the loan
principal is repaid during the year. On April 2,
Celina uses $20,000 from the checking account
for a passive activity expenditure. On Septem-
ber 4, Celina uses an additional $40,000 from
the account for personal purposes.
Under the interest allocation rules, the entire
$100,000 loan is treated as property held for in-
vestment for the period from January 4 through
April 1. From April 2 through September 3,TIPCAUTION
!
Chapter 4 Interest Page 13
Celina must treat $20,000 of the loan as used in
the passive activity and $80,000 of the loan as
property held for investment. From September
4 through December 31, she must treat
$40,000 of the loan as used for personal purpo-
ses, $20,000 as used in the passive activity,
and $40,000 as property held for investment.
Order of funds spent. Generally, you treat
loan proceeds deposited in an account as used
(spent) before either of the following amounts.
• Any unborrowed amounts held in the same
account.
• Any amounts deposited after these loan
proceeds.
Example. On January 9, Olena opened a
checking account, depositing $500 of the pro-
ceeds of Loan A and $1,000 of unborrowed
funds. The following table shows the transac-
tions in her account during the tax year.
Date Transaction
January 9 $500 proceeds of Loan A and
$1,000 unborrowed funds
deposited
January 14 $500 proceeds of Loan B
deposited
February 19 $800 used for personal purposes
February 27 $700 used for passive activity
June 19 $1,000 proceeds of Loan C
deposited
November 20 $800 used for an investment
December 18 $600 used for personal purposes
Olena treats the $800 used for personal pur-
poses as made from the $500 proceeds of Loan
A and $300 of the proceeds of Loan B. She
treats the $700 used for a passive activity as
made from the remaining $200 proceeds of
Loan B and $500 of unborrowed funds. She
treats the $800 used for an investment as made
entirely from the proceeds of Loan C. She treats
the $600 used for personal purposes as made
from the remaining $200 proceeds of Loan C
and $400 of unborrowed funds.
For the periods during which loan proceeds
are held in the account, Olena treats them as
property held for investment.
Payments from checking accounts.
Generally, you treat a payment from a checking
or similar account as made at the time the
check is written if you mail or deliver it to the
payee within a reasonable period after you write
it. You can treat checks written on the same day
as written in any order.
Amounts paid within 30 days. If you re-
ceive loan proceeds in cash or if the loan pro-
ceeds are deposited in an account, you can
treat any payment (up to the amount of the pro-
ceeds) made from any account you own, or
from cash, as made from those proceeds. This
applies to any payment made within 30 days
before or after the proceeds are received in
cash or deposited in your account.
If the loan proceeds are deposited in an ac-
count, you can apply this rule even if the rules
stated earlier under Order of funds spent would
otherwise require you to treat the proceeds as
used for other purposes. If you apply this rule to
any payments, disregard those payments (and
the proceeds from which they are made) when
applying the rules stated earlier under Order of
funds spent.
If you received the loan proceeds in cash,
you can treat the payment as made on the date
you received the cash instead of the date you
actually made the payment.
Example. Giovanni gets a loan of $1,000
on August 4 and receives the proceeds in cash.
Giovanni deposits $1,500 in an account on Au-
gust 18 and on August 28 writes a check on the
account for a passive activity expense. Also,
Giovanni deposits his paycheck, deposits other
loan proceeds, and pays his bills during the
same period. Regardless of these other trans-
actions, Giovanni can treat $1,000 of the de-
posit he made on August 18 as being paid on
August 4 from the loan proceeds. In addition,
Giovanni can treat the passive activity expense
he paid on August 28 as made from the $1,000
loan proceeds treated as deposited in the ac-
count.
Optional method for determining date of
reallocation. You can use the following
method to determine the date loan proceeds
are reallocated to another use. You can treat all
payments from loan proceeds in the account
during any month as taking place on the later of
the following dates.
• The first day of that month.
• The date the loan proceeds are deposited
in the account.
However, you can use this optional method only
if you treat all payments from the account dur-
ing the same calendar month in the same way.
Interest on a segregated account. If you
have an account that contains only loan pro-
ceeds and interest earned on the account, you
can treat any payment from that account as be-
ing made first from the interest. When the inter-
est earned is used up, any remaining payments
are from loan proceeds.
Example. You borrowed $20,000 and used
the proceeds of this loan to open a new savings
account. When the account had earned interest
of $867, you withdrew $20,000 for personal pur-
poses. You can treat the withdrawal as coming
first from the interest earned on the account,
$867, and then from the loan proceeds,
$19,133 ($20,000 − $867). All the interest
charged on the loan from the time it was depos-
ited in the account until the time of the with-
drawal is investment interest expense. The in-
terest charged on the part of the proceeds used
for personal purposes ($19,133) from the time
you withdrew it until you either repay it or reallo-
cate it to another use is personal interest ex-
pense. The interest charged on the loan pro-
ceeds you left in the account ($867) continues
to be investment interest expense until you ei-
ther repay it or reallocate it to another use.
Loan repayment. When you repay any part of
a loan allocated to more than one use, treat it as
being repaid in the following order.
1. Personal use.
2. Investments and passive activities (other
than those included in (3)).
3. Passive activities in connection with a
rental real estate activity in which you ac-
tively participate.
4. Former passive activities.
5. Trade or business use and expenses for
certain low-income housing projects.
Line of credit (continuous borrowings). The
following rules apply if you have a line of credit
or similar arrangement.
1. Treat all borrowed funds on which interest
accrues at the same fixed or variable rate
as a single loan.
2. Treat borrowed funds or parts of borrowed
funds on which interest accrues at differ-
ent fixed or variable rates as different
loans. Treat these loans as repaid in the
order shown on the loan agreement.
Loan refinancing. Allocate the replacement
loan to the same uses to which the repaid loan
was allocated. Make the allocation only to the
extent you use the proceeds of the new loan to
repay any part of the original loan.
Debt-financed distribution. A debt-financed
distribution occurs when a partnership or S cor-
poration borrows funds and allocates those
funds to distributions made to partners or
shareholders. The manner in which you report
the interest expense associated with the distrib-
uted debt proceeds depends on your use of
those proceeds.
How to report. If the proceeds were used
in a nonpassive trade or business activity, re-
port the interest on Schedule E (Form 1040),
line 28; enter “interest expense” and the name
of the partnership or S corporation in column (a)
and the amount in column (h). If the proceeds
were used in a passive activity, follow the In-
structions for Form 8582 to determine the
amount of interest expense that can be repor-
ted on Schedule E (Form 1040), line 28; enter
“interest expense” and the name of the partner-
ship in column (a) and the amount in column (f).
If the proceeds were used in an investment ac-
tivity, enter the interest on Form 4952. If the pro-
ceeds are used for personal purposes, the in-
terest is generally not deductible.
Interest Expense
Limitation
You generally must limit business interest ex-
pense you pay or accrue during the tax year,
unless an exception to the limitation is met.
The business interest expense deduction al-
lowed for a taxable year is generally limited to
the sum of:
1. Business interest income,
2. 30% of the adjustable taxable income, and
3. Floor plan financing interest.
If the section 163(j) limitation applies, gener-
ally the amount of any business interest ex-
pense that is not allowed as a deduction under
section 163(j) for the tax year is carried forward
to the following year as a disallowed business
Page 14 Chapter 4 Interest
interest expense carryforward. See Instructions
to Form 8990, Limitation on Business Interest
Expense Under Section 163(j), for more infor-
mation.
Interest You Can Deduct
Your trade or business interest expense may be
limited. See Instructions to Form 8990, for more
information. Interest relates to your trade or
business if you use the proceeds of the loan for
a trade or business expense. It does not matter
what type of property secures the loan. You can
deduct interest on a debt only if you meet all the
following requirements.
• You are legally liable for that debt.
• Both you and the lender intend that the
debt be repaid.
• You and the lender have a true
debtor-creditor relationship.
Partial liability. If you are liable for part of a
business debt, only your share of the total inter-
est paid or accrued is included in your interest
limitation calculation.
Example. You and your brother borrow
money. You are liable for 50% of the note. You
use your half of the loan in your business, and
you make one-half of the loan payments. Your
business interest is half of the total interest pay-
ments. However, the current year interest ex-
pense deduction may be limited.
Mortgage. Generally, mortgage interest paid
or accrued on real estate you own legally or
equitably is deductible. However, rather than
deducting the interest currently, you may have
to add it to the cost basis of the property as ex-
plained later under Capitalization of Interest.
Statement. If you paid $600 or more of
mortgage interest (including certain points) dur-
ing the year on any one mortgage, you gener-
ally will receive a Form 1098 or a similar state-
ment. You will receive the statement if you pay
interest to a person (including a financial institu-
tion or a cooperative housing corporation) in the
course of that person's trade or business. A
governmental unit is a person for purposes of
furnishing the statement.
If you receive a refund of interest you over-
paid in an earlier year, this amount will be repor-
ted in box 4 of Form 1098. You cannot deduct
this amount. For information on how to report
this refund, see Refunds of interest, later in this
chapter.
Expenses paid to obtain a mortgage.
Certain expenses you pay to obtain a mortgage
cannot be deducted as interest. These expen-
ses, which include mortgage commissions, ab-
stract fees, and recording fees, are capital ex-
penses. If the property mortgaged is business
or income-producing property, you can amor-
tize the costs over the life of the mortgage.
Prepayment penalty. If you pay off your
mortgage early and pay the lender a penalty for
doing this, you can deduct the penalty as inter-
est.
Interest on employment tax deficiency. In-
terest charged on employment taxes assessed
on your business is deductible.
Original issue discount (OID). OID is a form
of interest. A loan (mortgage or other debt) gen-
erally has OID when its proceeds are less than
its principal amount. The OID is the difference
between the stated redemption price at maturity
and the issue price of the loan.
A loan's stated redemption price at maturity
is the sum of all amounts (principal and interest)
payable on it other than qualified stated inter-
est. Qualified stated interest is stated interest
that is unconditionally payable in cash or prop-
erty (other than another loan of the issuer) at
least annually over the term of the loan at a sin-
gle fixed rate.
You generally deduct OID over the term of
the loan. Figure the amount to deduct each year
using the constant-yield method, unless the
OID on the loan is de minimis.
De minimis OID. The OID is de minimis if it
is less than one-fourth of 1% (0.0025) of the
stated redemption price of the loan at maturity
multiplied by the number of full years from the
date of original issue to maturity (the term of the
loan).
If the OID is de minimis, you can choose one
of the following ways to figure the amount you
can deduct each year.
• On a constant-yield basis over the term of
the loan.
• On a straight-line basis over the term of the
loan.
• In proportion to stated interest payments.
• In its entirety at maturity of the loan.
You make this choice by deducting the OID in a
manner consistent with the method chosen on
your timely filed tax return for the tax year in
which the loan is issued.
Example. On January 1, 2018, you took out
a $100,000 discounted loan and received
$98,500 in proceeds. The loan will mature on
January 1, 2028 (a 10-year term), and the
$100,000 principal is payable on that date. In-
terest of $10,000 is payable on January 1 of
each year, beginning January 1, 2019. The
$1,500 OID on the loan is de minimis because it
is less than $2,500 ($100,000 × 0.0025 × 10).
You choose to deduct the OID on a straight-line
basis over the term of the loan. Beginning in
2018, you can deduct $150 each year for 10
years.
Constant-yield method. If the OID is not
de minimis, you must use the constant-yield
method to figure how much you can deduct
each year. You figure your deduction for the first
year using the following steps.
1. Determine the issue price of the loan.
Generally, this equals the proceeds of the
loan. If you paid points on the loan (as dis-
cussed later), the issue price generally is
the difference between the proceeds and
the points.
2. Multiply the result in (1) by the yield to ma-
turity.
3. Subtract any qualified stated interest pay-
ments from the result in (2). This is the
OID you can deduct in the first year.
To figure your deduction in any subsequent
year, follow the above steps, except determine
the adjusted issue price in step (1). To get the
adjusted issue price, add to the issue price any
OID previously deducted. Then follow steps (2)
and (3) above.
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
figuring the present value of all principal and in-
terest payments, produces an amount equal to
the principal amount of the loan.
Example. 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 2018,
you can deduct $93 [($98,500 × 0.102467) −
$10,000]. For 2019, you can deduct $103
[($98,593 × 0.102467) − $10,000].
Loan or mortgage ends. 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.
If you refinance with the original lender,
you generally cannot deduct the re-
maining OID in the year in which the re-
financing 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 De-
duct, later.
Points. 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 pre-
mium charges. If any of these charges (points)
are solely for the use of money, they are inter-
est.
Because points are prepaid interest, you
generally cannot deduct the full amount in the
year paid. However, you can choose to fully de-
duct points in the year paid if you meet certain
tests. For exceptions to the general rule, see
Pub. 936.
The points reduce the issue price of the loan
and result in OID, deductible as explained in the
preceding discussion.
Partial payments on a nontax debt. If you
make partial payments on a debt (other than a
debt owed 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 dif-
ferent allocation of the payments would be
made.
Installment purchase. If you make an install-
ment purchase of business property, the con-
tract between you and the seller generally pro-
vides for the payment of interest. If no interest
or a low rate of interest is charged under the
contract, a portion of the stated principalCAUTION
!
Chapter 4 Interest Page 15
amount payable under the contract may be re-
characterized as interest (unstated interest).
The amount recharacterized as interest reduces
your basis in the property and increases your
interest expense. For more information on in-
stallment sales and unstated interest, see Pub.
537.
Interest You
Cannot Deduct
Certain interest payments cannot be deducted.
In addition, certain other expenses that may
seem to be interest but are not cannot be de-
ducted as interest.
You cannot currently deduct interest that
must be capitalized, and you generally cannot
deduct personal interest.
Interest paid with funds borrowed from
original lender. 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.
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 in-
terest on the first loan are deductible, along with
any interest you pay on the second loan, sub-
ject to any limits that apply.
Capitalized interest. You cannot currently de-
duct interest you are required to capitalize un-
der the uniform capitalization rules. See Capi-
talization 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.
Commitment fees or standby charges. 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.
If the funds are for inventory or certain prop-
erty used in your business, the fees are indirect
costs and you generally must capitalize them
under the uniform capitalization rules. See Cap-
italization of Interest, later.
Interest on income tax. 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 an NOL de-
duction.
Penalties. Penalties on underpaid deficien-
cies and underpaid estimated tax are not inter-
est. You cannot deduct them. Generally, you
cannot deduct any fines or penalties.
Interest on loans with respect to life insur-
ance policies. 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.
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 fig-
ured using Moody's Composite Yield on Seas-
oned Corporate Bonds (formerly known as
Moody's Corporate Bond Yield Aver-
age—Monthly Average Corporates) (Moody's
rate) for that month.
Who is a key person? A key person is an
officer or 20% owner. However, the number of
individuals you can treat as key persons is limi-
ted to the greater of the following.
• Five individuals.
• The lesser of 5% of the total officers and
employees of the company or 20 individu-
als.
Exceptions for pre-June 1997 contracts.
You can generally deduct the interest if the con-
tract was issued before June 9, 1997, and the
covered individual is someone other than an
employee, officer, or someone financially inter-
ested in your business. If the contract was pur-
chased before June 21, 1986, you can gener-
ally deduct the interest no matter who is
covered by the contract.
Interest allocated to unborrowed policy
cash value. Corporations and partnerships
generally cannot deduct any interest expense
allocable to unborrowed cash values of life in-
surance, 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 in-
formation, see section 264(f).
Capitalization of Interest
Under the uniform capitalization rules, you gen-
erally must 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 can-
not capitalize interest related to property that
you acquire in any other manner.
Interest you paid or incurred during the pro-
duction period must be capitalized if the prop-
erty produced is designated property. Designa-
ted property is any of the following.
• Real property.
• Tangible personal property with a class life
of 20 years or more.
• Tangible personal property with an estima-
ted production period of more than 2
years.
• Tangible personal property with an estima-
ted production period of more than 1 year if
the estimated cost of production is more
than $1 million.
Property you produce. You produce property
if you construct, build, install, manufacture, de-
velop, 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.
Carrying charges. 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 infor-
mation, see chapter 7.
Capitalized interest. 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 prop-
erty is used in your trade or business, recover
capitalized interest through an adjustment to
basis, depreciation, amortization, or other
method.
Partnerships and S corporations. The inter-
est 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 corpora-
tion has insufficient debt to support the produc-
tion or construction costs.
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 part-
nership 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.
Additional information. The procedures for
applying the uniform capitalization rules are be-
yond the scope of this publication. For more in-
formation, see sections 1.263A-8 through
1.263A-15 of the regulations and Notice 88-99.
Notice 88-99 is in Cumulative Bulletin 1988-2.
When To Deduct Interest
If the uniform capitalization rules, discussed un-
der Capitalization of Interest, earlier, and the
business interest expense deduction limitation
rules discussed under Interest Expense Limita-
tion, earlier, do not apply, deduct interest as fol-
lows.
Cash method. Under the cash method, you
can generally deduct only the interest you ac-
tually paid during the tax year. You cannot de-
duct a promissory note you gave as payment
because it is a promise to pay and not an actual
payment.
Prepaid interest. You generally cannot de-
duct 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.
Discounted loan. 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.
Refunds of interest. If you pay interest
and then receive a refund in the same tax year
of any part of the interest, reduce your interest
Page 16 Chapter 4 Interest
deduction by the refund. If you receive the re-
fund in a later tax year, include the refund in
your income to the extent the deduction for the
interest reduced your tax.
Accrual method. Under an accrual method,
you can deduct only interest that has accrued
during the tax year.
Prepaid interest. You generally cannot de-
duct 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.
Discounted loan. 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.
Tax deficiency. If you contest a federal in-
come tax deficiency, interest does not accrue
until the tax year the final determination of liabil-
ity 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.
However, if you contest but pay the pro-
posed tax deficiency and interest, and you do
not designate the payment as a cash bond,
then the interest is deductible in the year paid.
Related person. 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 relation-
ship is determined as of the end of the tax year
for which the interest would otherwise be de-
ductible. See section 267 for more information.
Below-Market Loans
If you receive a below-market gift or demand
loan and use the proceeds in your trade or busi-
ness, you may be able to deduct the forgone in-
terest. See Treatment of gift and demand loans,
later, in this discussion.
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 be-
low-market loan generally is considered an
arm's-length transaction in which you, the bor-
rower, are considered as having received both
the following.
• A loan in exchange for a note that requires
the payment of interest at the AFR.
• An additional payment in an amount equal
to the forgone interest.
The additional payment is treated as a gift, divi-
dend, contribution to capital, payment of com-
pensation, or other payment, depending on the
substance of the transaction.
Forgone interest. For any period, forgone in-
terest is:
1. The interest that would be payable for that
period if interest accrued on the loan at the
AFR and was payable annually on De-
cember 31, minus
2. Any interest actually payable on the loan
for the period.
AFRs are published by the IRS each
month in the I.R.B. I.R.B.s are available
on the IRS web site at IRS.gov/irb. You
can also contact an IRS office to get these
rates.
Loans subject to the rules. The rules for be-
low-market loans apply to the following.
1. Gift loans (below-market loans where the
forgone interest is in the nature of a gift).
2. Compensation-related loans (below-mar-
ket loans between an employer and an
employee or between an independent
contractor and a person for whom the con-
tractor provides services).
3. Corporation-shareholder loans.
4. Tax avoidance loans (below-market loans
where the avoidance of federal tax is one
of the main purposes of the interest ar-
rangement).
5. Loans to qualified continuing care facilities
under a continuing care contract (made af-
ter October 11, 1985).
Except as noted in (5) above, these rules
apply to demand loans (loans payable in full at
any time upon the lender's demand) outstand-
ing after June 6, 1984, and to term loans (loans
that are not demand loans) made after that
date.
Treatment of gift and demand loans. 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 trea-
ted as transferring this amount back to the
lender as interest. These transfers are consid-
ered 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.
Limit on forgone interest for gift loans of
$100,000 or less. For gift loans between indi-
viduals, 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.
Treatment of term loans. If you receive a be-
low-market term loan other than a gift or de-
mand loan, you are treated as receiving an ad-
ditional 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) un-
der Interest You Can Deduct, earlier.
Exceptions for loans of $10,000 or less.
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 orTIP
less. This exception applies only to the follow-
ing.
1. Gift loans between individuals if the loan is
not directly used to buy or carry in-
come-producing assets.
2. Compensation-related loans or corpora-
tion-shareholder loans if the avoidance of
any federal tax is not a principal purpose
of the interest arrangement.
This exception does not apply to a term loan
described in (2) above that was previously sub-
ject to the below-market loan rules. Those rules
will continue to apply even if the outstanding
balance is reduced to $10,000 or less.
Exceptions for loans without significant tax
effect. The following loans are specifically ex-
empted from the rules for below-market loans
because their interest arrangements do not
have a significant effect on the federal tax liabil-
ity of the borrower or the lender.
1. 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.
2. Loans subsidized by a federal, state, or
municipal government that are made avail-
able under a program of general applica-
tion to the public.
3. Certain employee-relocation loans.
4. Certain loans to or from a foreign person,
unless the interest income would be effec-
tively connected with the conduct of a U.S.
trade or business and not exempt from
U.S. tax under an income tax treaty.
5. Any other loan if the taxpayer can show
that the interest arrangement has no sig-
nificant effect on the federal tax liability of
the lender or the borrower. Whether an in-
terest 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.
a. Whether items of income and deduc-
tion generated by the loan offset each
other.
b. The amount of the items.
c. The cost of complying with the be-
low-market loan provisions if they
were to apply.
d. Any reasons, other than taxes, for
structuring the transaction as a be-
low-market loan.
Exception for loans to qualified continuing
care facilities. 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.
A qualified continuing care facility is one or
more facilities (excluding nursing homes) meet-
ing the requirements listed below.
1. Designed to provide services under con-
tinuing care contracts (defined below).
Chapter 4 Interest Page 17
2. Includes an independent living unit, and
either an assisted living or nursing facility,
or both.
3. Substantially all of the independent living
unit residents are covered by continuing
care contracts.
A continuing care contract is a written con-
tract between an individual and a qualified con-
tinuing care facility that includes all of the fol-
lowing conditions.
1. The individual or individual's spouse must
be entitled to use the facility for the rest of
their life or lives.
2. The individual or individual's spouse will
be provided with housing, as appropriate
for the health of the individual or individu-
al's spouse in an:
a. Independent living unit (which has ad-
ditional available facilities outside the
unit for the provision of meals and
other personal care), and
b. Assisted living or nursing facility avail-
able in the continuing care facility.
3. The individual or individual's spouse will
be provided with assisted living or nursing
care available in the continuing care fa-
cility, as required for the health of the indi-
vidual or the individual's spouse.
For more information, see section 7872(h).
Sale or exchange of property. 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.
More information. For more information on
below-market loans, see section 7872 and sec-
tion 1.7872-5 of the regulations.
5.
Taxes
Introduction
You can deduct various federal, state, local,
and foreign taxes directly attributable to your
trade or business as business expenses.
You cannot deduct federal income
taxes, estate and gift taxes, or state in-
heritance, legacy, and succession
taxes.CAUTION
!
Topics
This chapter discusses:
• When to deduct taxes
• Real estate taxes
• Income taxes
• Employment taxes
• Other taxes
Useful Items
You may want to see:
Publication
15 (Circular E), Employer's Tax Guide
334 Tax Guide for Small Business
510 Excise Taxes
538 Accounting Periods and Methods
551 Basis of Assets
Form (and Instructions)
1040 U.S. Individual Income Tax Return
Schedule A (Form 1040) Itemized
Deductions
Schedule SE (Form 1040)
Self-Employment Tax
3115 Application for Change in
Accounting Method
8959 Additional Medicare Tax
See chapter 13 for information about getting
publications and forms.
When To
Deduct Taxes
Generally, you can only deduct taxes in the
year you pay them. This applies whether you
use the cash method or an accrual method of
accounting.
Under an accrual method, you can deduct a
tax before you pay it if you meet the exception
for recurring items discussed under Economic
Performance in Pub. 538. You can also elect to
ratably accrue real estate taxes as discussed
later under Real Estate Taxes.
Limit on accrual of taxes. A taxing jurisdic-
tion can require the use of a date for accruing
taxes that is earlier than the date it originally re-
quired. However, if you use an accrual method,
and can deduct the tax before you pay it, use
the original accrual date for the year of change
and all future years to determine when you can
deduct the tax.
Example. Your state imposes a tax on per-
sonal property used in a trade or business con-
ducted in the state. This tax is assessed and
becomes a lien as of July 1 (accrual date). In
2018, the state changed the assessment and
lien dates from July 1, 2019, to December 31,
2018, for property tax year 2019. Use the origi-
nal accrual date (July 1, 2019) to determine
when you can deduct the tax. You must also
use the July 1 accrual date for all future years to
determine when you can deduct the tax.
1040
Schedule A (Form 1040)
Schedule SE (Form 1040)
3115
8959
Uniform capitalization rules. Uniform capital-
ization rules apply to certain taxpayers who pro-
duce real property or tangible personal property
for use in a trade or business or for sale to cus-
tomers. They also apply to certain taxpayers
who acquire property for resale. Under these
rules, you either include certain costs in inven-
tory or capitalize certain expenses related to the
property, such as taxes. For more information,
see chapter 1.
Carrying charges. Carrying charges include
taxes you pay to carry or develop real estate or
to carry, transport, or install personal property.
You can elect to capitalize carrying charges not
subject to the uniform capitalization rules if they
are otherwise deductible. For more information,
see chapter 7.
Refunds of taxes. If you receive a refund for
any taxes you deducted in an earlier year, in-
clude the refund in income to the extent the de-
duction reduced your federal income tax in the
earlier year. For more information, see Recov-
ery of amount deducted (tax benefit rule) in
chapter 1.
You must include in income any inter-
est you receive on tax refunds.
Real Estate Taxes
Deductible real estate taxes are any state, local,
or foreign taxes on real estate levied for the
general public welfare. The taxing authority
must base the taxes on the assessed value of
the real estate and charge them uniformly
against all property under its jurisdiction. De-
ductible real estate taxes generally do not in-
clude taxes charged for local benefits and im-
provements that increase the value of the
property. See Taxes for local benefits, later.
If you use an accrual method, you generally
cannot accrue real estate taxes until you pay
them to the government authority. However,
you can elect to ratably accrue the taxes during
the year. See Electing to ratably accrue, later.
Taxes for local benefits. Generally, you can-
not deduct taxes charged for local benefits and
improvements that tend to increase the value of
your property. These include assessments for
streets, sidewalks, water mains, sewer lines,
and public parking facilities. You should in-
crease the basis of your property by the amount
of the assessment.
You can deduct taxes for these local bene-
fits only if the taxes are for maintenance, re-
pairs, or interest charges related to those bene-
fits. If part of the tax is for maintenance, repairs,
or interest, you must be able to show how much
of the tax is for these expenses to claim a de-
duction for that part of the tax.
Example. To improve downtown commer-
cial business, Waterfront City converted a
downtown business area street into an en-
closed pedestrian mall. The city assessed the
full cost of construction, financed with 10-year
bonds, against the affected properties. The city
is paying the principal and interest with the an-
nual payments made by the property owners.TIP
Page 18 Chapter 5 Taxes
The assessments for construction costs are
not deductible as taxes or as business expen-
ses, but are depreciable capital expenses. The
part of the payments used to pay the interest
charges on the bonds is deductible as taxes.
Charges for services. Water bills, sewerage,
and other service charges assessed against
your business property are not real estate
taxes, but are deductible as business expen-
ses.
Purchase or sale of real estate. If real estate
is sold, the real estate taxes must be allocated
between the buyer and the seller.
The buyer and seller must allocate the real
estate taxes according to the number of days in
the real property tax year (the period to which
the tax imposed relates) that each owned the
property. Treat the seller as paying the taxes up
to but not including the date of sale. Treat the
buyer as paying the taxes beginning with the
date of sale. You can usually find this informa-
tion on the settlement statement you received at
closing.
If you (the seller) use an accrual method and
have not elected to ratably accrue real estate
taxes, you are considered to have accrued your
part of the tax on the date you sell the property.
Example. Alberto Verde, a calendar year
accrual method taxpayer, owns real estate in
Olmo County. He has not elected to ratably ac-
crue property taxes. November 30 of each year
is the assessment and lien date for the current
real property tax year, which is the calendar
year. He sold the property on June 30, 2018.
Under his accounting method, he would not be
able to claim a deduction for the taxes because
the sale occurred before November 30. He is
treated as having accrued his part of the tax,
181/366 (January 1–June 29), on June 30, and
he can deduct it for 2018.
Electing to ratably accrue. If you use an ac-
crual method, you can elect to accrue real es-
tate tax related to a definite period ratably over
that period.
Example. Juan Sanchez is a calendar year
taxpayer who uses an accrual method. His real
estate taxes for the real property tax year, July
1, 2018, to June 30, 2019, are $1,200. July 1 is
the assessment and lien date.
If Juan elects to ratably accrue the taxes,
$600 will accrue in 2018 ($1,200 × 6/12, July 1–
December 31) and the balance will accrue in
2019.
Separate elections. You can elect to rata-
bly accrue the taxes for each separate trade or
business and for nonbusiness activities if you
account for them separately. Once you elect to
ratably accrue real estate taxes, you must use
that method unless you get permission from the
IRS to change. See Form 3115, later.
Making the election. If you elect to ratably
accrue the taxes for the first year in which you
incur real estate taxes, attach a statement to
your income tax return for that year. The state-
ment should show all the following items.
• The trades or businesses to which the
election applies and the accounting
method or methods used.
• The period to which the taxes relate.
• The calculation of the real estate tax de-
duction for that first year.
Generally, you must file your return by the
due date (including extensions). However, if
you timely filed your return for the year without
electing to ratably accrue, you can still make the
election by filing an amended return within 6
months after the due date of the return (exclud-
ing extensions). Attach the statement to the
amended return and write “Filed pursuant to
section 301.9100-2” on the statement. File the
amended return at the same address where you
filed the original return.
Form 3115. If you elect to ratably accrue
real estate taxes for a year after the first year in
which you incur real estate taxes, or if you want
to revoke your election to ratably accrue real
estate taxes, file Form 3115. For more informa-
tion, including applicable time frames for filing,
see the Instructions for Form 3115.
Income Taxes
This section discusses federal, state, local, and
foreign income taxes.
Federal income taxes. You cannot deduct
federal income taxes.
State and local income taxes. A corporation
or partnership can deduct state and local in-
come taxes imposed on the corporation or part-
nership as business expenses.
An individual can deduct state and local in-
come taxes only as an itemized deduction on
Schedule A (Form 1040), subject to limitations.
The deduction is limited to $10,000 as a total of
the following taxes.
1. State and local income taxes or general
sales taxes. See the Schedule A (Form
1040) instructions.
2. State and local real estate taxes. See the
Schedule A (Form 1040) instructions.
3. State and local personal property taxes.
4. Other taxes. See the Schedule A (Form
1040) instructions.
However, an individual can deduct a state
tax on gross income (as distinguished from net
income) directly attributable to a trade or busi-
ness as a business expense.
Accrual of contested income taxes. If
you use an accrual method, and you contest a
state or local income tax liability, you must ac-
crue and deduct any contested amount in the
tax year in which the liability is finally deter-
mined.
If additional state or local income taxes for a
prior year are assessed in a later year, you can
deduct the taxes in the year in which they were
originally imposed (the prior year) if the tax lia-
bility is not contested. You cannot deduct them
in the year in which the liability is finally deter-
mined.
The filing of an income tax return is not
considered a contest and, in the ab-
sence of an overt act of protest, you
can deduct the tax in the prior year. Also, you
can deduct any additional taxes in the prior year
if you do not show some affirmative evidence of
denial of the liability.
However, if you consistently deduct addi-
tional assessments in the year they are paid or
finally determined (including those for which
there was no contest), you must continue to do
so. You cannot take a deduction in the earlier
year unless you receive permission to change
your method of accounting. For more informa-
tion on accounting methods, see When Can I
Deduct an Expense in chapter 1.
Foreign income taxes. Generally, you can
take either a deduction or a credit for income
taxes imposed on you by a foreign country or a
U.S. possession, subject to limitations. How-
ever, an individual cannot take a deduction or
credit for foreign income taxes paid on income
that is exempt from U.S. tax under the foreign
earned income exclusion or the foreign housing
exclusion. For information on these exclusions,
see Pub. 54. For information on the foreign tax
credit, see Pub. 514.
Employment Taxes
If you have employees, you must withhold vari-
ous taxes from your employees' pay. Most em-
ployers must withhold their employees' share of
social security, Medicare taxes, and Additional
Medicare Tax (if applicable), along with state
and federal income taxes. You may also need
to pay certain employment taxes from your own
funds. These include your share of social secur-
ity and Medicare taxes as an employer, along
with unemployment taxes.
Your deduction for wages paid is not re-
duced by the social security and Medicare
taxes, Additional Medicare Tax, and income
taxes you withhold from your employees. You
can deduct the employment taxes you must pay
from your own funds as taxes.
Example. You pay your employee $18,000
a year. However, after you withhold various
taxes, your employee receives $14,500. You
also pay an additional $1,500 in employment
taxes. You should deduct the full $18,000 as
wages. You can deduct the $1,500 you pay
from your own funds as taxes.
Additional Medicare Tax. You must withhold
a 0.9% Additional Medicare Tax from wages
you pay to an employee in excess of $200,000
in a calendar year. The Additional Medicare Tax
is only imposed on the employee. There is no
employer share of Additional Medicare Tax.
For more information on the Additional Med-
icare Tax, see Form 8959 and its instructions.
For more information on employment
taxes, see Pub. 15 (Circular E).
Unemployment fund taxes. As an employer,
you may have to make payments to a state un-
employment compensation fund or to a stateTIPTIP
Chapter 5 Taxes Page 19
disability benefit fund. Deduct these payments
as taxes.
Self-employment tax. You can deduct part of
your self-employment tax as a business ex-
pense in figuring your adjusted gross income.
This deduction only affects your income tax. It
does not affect your net earnings from self-em-
ployment or your self-employment tax.
To deduct the tax, enter on Schedule 1
(Form 1040), line 27, the amount shown on the
Deduction for one-half of self-employment tax
line of Schedule SE (Form 1040).
For more information on self-employment
tax, see Pub. 334.
Additional Medicare Tax. You may be re-
quired to pay Additional Medicare Tax on
self-employment income. See Form 8959 and
the Instructions for Form 8959 for more informa-
tion on the Additional Medicare Tax.
Other Taxes
The following are other taxes you can deduct if
you incur them in the ordinary course of your
trade or business.
Excise taxes. Generally, you can deduct as a
business expense all excise taxes that are ordi-
nary and necessary expenses of carrying on
your trade or business. However, see Fuel
taxes, later.
For more information on excise taxes, see
Pub. 510.
Franchise taxes. You can deduct corporate
franchise taxes as a business expense.
Fuel taxes. Generally, taxes on gasoline, die-
sel fuel, and other motor fuels that you use in
your business are included as part of the cost of
the fuel. Do not deduct these taxes as a sepa-
rate item.
You may be entitled to a credit or refund for
federal excise tax you paid on fuels used for
certain purposes. For more information, see
Pub. 510.
Occupational taxes. You can deduct as a
business expense an occupational tax charged
at a flat rate by a locality for the privilege of
working or conducting a business in the locality.
Personal property tax. You can deduct any
tax imposed by a state or local government on
personal property used in your trade or busi-
ness.
Sales tax. Any sales tax you pay on a service
for your business, or on the purchase or use of
property in your business is treated as part of
the cost of the service or property. If the service
or the cost or use of the property is a deductible
business expense, you can deduct the tax as
part of that service or cost. If the property is
merchandise bought for resale, the sales tax is
part of the cost of the merchandise. If the prop-
erty is depreciable, add the sales tax to the ba-
sis for depreciation. For more information on
basis, see Pub. 551.
Do not deduct state and local sales
taxes imposed on the buyer that you
must collect and pay over to the state
or local government. Also, do not include these
taxes in gross receipts or sales.
6.
Insurance
Reminder
Premium tax credit. You may have to use the
worksheets in Pub. 974 instead of the work-
sheet in this chapter if the insurance plan estab-
lished, or considered to be established, under
your business was obtained through the Health
Insurance Marketplace and you are claiming
the premium tax credit. See Pub. 974 for de-
tails.
Introduction
You generally can deduct the ordinary and nec-
essary cost of insurance as a business expense
if it is for your trade, business, or profession.
However, you may have to capitalize certain in-
surance costs under the uniform capitalization
rules. For more information, see Capitalized
Premiums, later.
Topics
This chapter discusses:
• Deductible premiums
• Nondeductible premiums
• Capitalized premiums
• When to deduct premiums
Useful Items
You may want to see:
Publication
15-B Employer's Tax Guide to Fringe
Benefits
525 Taxable and Nontaxable Income
538 Accounting Periods and Methods
547 Casualties, Disasters, and Thefts
Form (and Instructions)
1040 U.S. Individual Income Tax Return
1040-NR U.S. Nonresident Alien Income
Tax Return
Schedule A (Form 1040) Itemized
Deductions
Schedule C (Form 1040) Profit or Loss
From Business
Schedule C-EZ (Form 1040) Net Profit
From BusinessCAUTION
!
15-B
1040
1040-NR
Schedule A (Form 1040)
Schedule C (Form 1040)
Schedule C-EZ (Form 1040)
Schedule F (Form 1040) Profit or Loss
From Farming
Schedule SE (Form 1040)
Self-Employment Tax
Schedule K-1 (Form 1065) Partner's
Share of Income, Deductions,
Credits, etc.
1099-H Health Coverage Tax Credit
(HCTC) Advance Payments
2555 Foreign Earned Income
2555-EZ Foreign Earned Income
Exclusion
8885 Health Coverage Tax Credit
W-2 Wage and Tax Statement
See chapter 13 for information about getting
publications and forms.
Deductible Premiums
You generally can deduct premiums you pay for
the following kinds of insurance related to your
trade or business.
1. Insurance that covers fire, storm, theft, ac-
cident, or similar losses.
2. Credit insurance that covers losses from
business bad debts.
3. Group hospitalization and medical insur-
ance for employees, including long-term
care insurance.
a. If a partnership pays accident and
health insurance premiums for its
partners, it generally can deduct them
as guaranteed payments to partners.
b. If an S corporation pays accident and
health insurance premiums for its
more-than-2% shareholder-employ-
ees, it generally can deduct them, but
also must include them in the share-
holder's wages subject to federal in-
come tax withholding. See Pub.15-B.
4. Liability insurance.
5. Malpractice insurance that covers your
personal liability for professional negli-
gence resulting in injury or damage to pa-
tients or clients.
6. Workers' compensation insurance set by
state law that covers any claims for bodily
injuries or job-related diseases suffered by
employees in your business, regardless of
fault.
a. If a partnership pays workers' com-
pensation premiums for its partners, it
generally can deduct them as guaran-
teed payments to partners.
b. If an S corporation pays workers'
compensation premiums for its
more-than-2% shareholder-employ-
ees, it generally can deduct them, but
also must include them in the share-
holder's wages.
7. Contributions to a state unemployment in-
surance fund are deductible as taxes if
they are considered taxes under state law.
Schedule F (Form 1040)
Schedule SE (Form 1040)
Schedule K-1 (Form 1065)
1099-H
2555
2555-EZ
8885
W-2
Page 20 Chapter 6 Insurance
8. Overhead insurance that pays for busi-
ness overhead expenses you have during
long periods of disability caused by your
injury or sickness.
9. Car and other vehicle insurance that cov-
ers vehicles used in your business for lia-
bility, damages, and other losses. If you
operate a vehicle partly for personal use,
deduct only the part of the insurance pre-
mium that applies to the business use of
the vehicle. If you use the standard mile-
age rate to figure your car expenses, you
can’t deduct any car insurance premiums.
10. Life insurance covering your officers and
employees if you aren’t directly or indi-
rectly a beneficiary under the contract.
11. Business interruption insurance that pays
for lost profits if your business is shut
down due to a fire or other cause.
Self-Employed Health
Insurance Deduction
You may be able to deduct the amount you paid
for medical and dental insurance and qualified
long-term care insurance for yourself, your
spouse, and your dependents. The insurance
also can cover your child who was under age
27 at the end of 2018, even if the child wasn’t
your dependent. A child includes your son,
daughter, stepchild, adopted child, or foster
child. A foster child is any child placed with you
by an authorized placement agency or by judg-
ment, decree, or other order of any court of
competent jurisdiction.
One of the following statements must be
true.
• You were self-employed and had a net
profit for the year reported on Schedule C
(Form 1040), Schedule C-EZ (Form 1040),
or Schedule F (Form 1040).
• You were a partner with net earnings from
self-employment for the year reported on
Schedule K-1 (Form 1065), box 14, code
A.
• You used one of the optional methods to
figure your net earnings from self-employ-
ment on Schedule SE.
• You received wages in 2018 from an S cor-
poration in which you were a
more-than-2% shareholder. Health insur-
ance premiums paid or reimbursed by the
S corporation are shown as wages on
Form W-2.
The insurance plan must be established, or
considered to be established as discussed in
the following bullets, under your business.
• For self-employed individuals filing a
Schedule C, C-EZ, or F, a policy can be ei-
ther in the name of the business or in the
name of the individual.
• For partners, a policy can be either in the
name of the partnership or in the name of
the partner. You can either pay the premi-
ums yourself or the partnership can pay
them and report the premium amounts on
Schedule K-1 (Form 1065) as guaranteed
payments to be included in your gross in-
come. However, if the policy is in your
name and you pay the premiums yourself,
the partnership must reimburse you and
report the premium amounts on Sched-
ule K-1 (Form 1065) as guaranteed pay-
ments to be included in your gross income.
Otherwise, the insurance plan won’t be
considered to be established under your
business.
• For more-than-2% shareholders, a policy
can be either in the name of the S corpora-
tion or in the name of the shareholder. You
can either pay the premiums yourself or
the S corporation can pay them and report
the premium amounts on Form W-2 as wa-
ges to be included in your gross income.
However, if the policy is in your name and
you pay the premiums yourself, the S cor-
poration must reimburse you and report
the premium amounts on Form W-2 in
box 1 as wages to be included in your
gross income. Otherwise, the insurance
plan won’t be considered to be established
under your business.
Medicare premiums you voluntarily pay to
obtain insurance in your name that is similar to
qualifying private health insurance can be used
to figure the deduction. Amounts paid for health
insurance coverage from retirement plan distri-
butions that were nontaxable because you are a
retired public safety officer can’t be used to fig-
ure the deduction.
Take the deduction on Schedule 1 (Form
1040), line 29.
Qualified long-term care insurance. You
can include premiums paid on a qualified
long-term care insurance contract when figuring
your deduction. But, for each person covered,
you can include only the smaller of the following
amounts.
1. The amount paid for that person.
2. The amount shown below. Use the per-
son's age at the end of the tax year.
a. Age 40 or younger–$420
b. Age 41 to 50–$780
c. Age 51 to 60–$1,560
d. Age 61 to 70–$4,160
e. Age 71 or older–$5,200
Qualified long-term care insurance con-
tract. A qualified long-term care insurance
contract is an insurance contract that only pro-
vides coverage of qualified long-term care serv-
ices. The contract must meet all the following
requirements.
• It must be guaranteed renewable.
• It must provide that refunds, other than re-
funds on the death of the insured or com-
plete surrender or cancellation of the con-
tract, and dividends under the contract
may be used only to reduce future premi-
ums or increase future benefits.
• It must not provide for a cash surrender
value or other money that can be paid, as-
signed, pledged, or borrowed.
• It generally must not pay or reimburse ex-
penses incurred for services or items that
would be reimbursed under Medicare, ex-
cept where Medicare is a secondary payer
or the contract makes per diem or other
periodic payments without regard to ex-
penses.
Qualified long-term care services. Quali-
fied long-term care services are:
• Necessary diagnostic, preventive, thera-
peutic, curing, treating, mitigating, and re-
habilitative services; and
• Maintenance or personal care services.
The services must be required by a chronically
ill individual and prescribed by a licensed health
care practitioner.
Chapter 6 Insurance Page 21
Worksheet 6-A. Self-Employed Health Insurance Deduction Worksheet Keep for Your Records
Caution. You may have to use the worksheets in Pub. 974 instead of this worksheet if the insurance plan established, or
considered to be established, under your business was obtained through the Health Insurance Marketplace and you are
claiming the premium tax credit. See Pub. 974 for details.
Note. Use a separate worksheet for each trade or business under which an insurance plan is established.
1. Enter the total amount paid in 2018 for health insurance coverage established under your
business (or the S corporation in which you were a more-than-2% shareholder) for 2018 for you,
your spouse, and your dependents. Your insurance also can cover your child who was under age
27 at the end of 2018, even if the child was not your dependent. But don’t include the following.
• Amounts for any month you were eligible to participate in a health plan subsidized by your or
your spouse’s employer or the employer of either your dependent or your child who was
under the age of 27 at the end of 2018.
• Any amounts paid from retirement plan distributions that were nontaxable because you are a
retired public safety officer.
• Any qualified health insurance coverage payments that you included on Form 8885, line 4, to
claim the HCTC or on Form 14095 to receive a reimbursement of the HCTC during the year.
• Any advance monthly payments of the HCTC that your health plan administrator received
from the IRS, as shown on Form 1099-H.
• Any qualified health insurance coverage payments you paid to for eligible coverage months
for which you received the benefit of the HCTC monthly advance payment program.
• Any payments for qualified long-term care insurance (see line 2) . . . . . . . . . . . . . . . . . . . . . . 1.
2. For coverage under a qualified long-term care insurance contract, enter for each person covered
the smaller of the following amounts.
a) Total payments made for that person during the year.
b) The amount shown below. Use the person's age at the end of the tax year.
$420— if that person is age 40 or younger
$780— if age 41 to 50
$1,560— if age 51 to 60
$4,160— if age 61 to 70
$5,200— if age 71 or older
Don’t include payments for any month you were eligible to participate in a long-term care
insurance plan subsidized by your or your spouse’s employer or the employer of either your
dependent or your child who was under the age of 27 at the end of 2018. If more than one
person is covered, figure separately the amount to enter for each person. Then enter the
total of those amounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.
3. Add lines 1 and 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.
4. Enter your net profit* and any other earned income** from the trade or business under which the
insurance plan is established. Don’t include Conservation Reserve Program payments exempt
from self-employment tax. If the business is an S corporation, skip to line 11 . . . . . . . . . . . . . . . . 4.
5. Enter the total of all net profits* from: Schedule C (Form 1040), line 31; Schedule C-EZ (Form
1040), line 3; Schedule F (Form 1040), line 34; or Schedule K-1 (Form 1065), box 14, code A;
plus any other income allocable to the profitable businesses. Don’t include Conservation
Reserve Program payments exempt from self-employment tax. See the Instructions for
Schedule SE (Form 1040). Don’t include any net losses shown on these schedules . . . . . . . . . . 5.
6. Divide line 4 by line 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.
7. Multiply Schedule 1 (Form 1040), (or Form 1040NR), line 27, by the percentage on line 6 . . . . . . 7.
8. Subtract line 7 from line 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.
9. Enter the amount, if any, from Schedule 1 (Form 1040), (or Form 1040NR), line 28, attributable to
the same trade or business in which the insurance plan is established . . . . . . . . . . . . . . . . . . . . . . 9.
10. Subtract line 9 from line 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.
11. Enter your Medicare wages (Form W-2, box 5) from an S corporation in which you are a
more-than-2% shareholder and in which the insurance plan is established . . . . . . . . . . . . . . . . . . 11.
12. Enter any amount from Form 2555, line 45, attributable to the amount entered on line 4 or 11
above, or any amount from Form 2555-EZ, line 18, attributable to the amount entered on line 11
above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.
13. Subtract line 12 from line 10 or 11, whichever applies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.
14. Enter the smaller of line 3 or line 13 here and on Schedule 1 (Form 1040), (or Form 1040NR),
line 29. Don’t include this amount when figuring any medical expense deduction on Schedule A
(Form 1040) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.
* If you used either optional method to figure your net earnings from self-employment from any business, don’t enter your net profit from the
business. Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Section B, line 4b.
* * Earned Income includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it doesn’t include
capital gain income.
Chronically ill individual. A chronically ill
individual is a person who has been certified as
one of the following.
• An individual who has been unable, due to
loss of functional capacity for at least 90
days, to perform at least two activities of
daily living without substantial assistance
from another individual. Activities of daily
living are eating, toileting, transferring
(general mobility), bathing, dressing, and
continence.
• An individual who requires substantial su-
pervision to be protected from threats to
health and safety due to severe cognitive
impairment.
Page 22 Chapter 6 Insurance
The certification must have been made by a li-
censed health care practitioner within the previ-
ous 12 months.
Benefits received. For information on ex-
cluding benefits you receive from a long-term
care contract from gross income, see Pub. 525.
Other coverage. You can’t take the deduction
for any month you were eligible to participate in
any employer (including your spouse's) subsi-
dized health plan at any time during that month,
even if you didn’t actually participate. In addi-
tion, if you were eligible for any month or part of
a month to participate in any subsidized health
plan maintained by the employer of either your
dependent or your child who was under age 27
at the end of 2018, don’t use amounts paid for
coverage for that month to figure the deduction.
These rules are applied separately to plans
that provide long-term care insurance and plans
that don’t provide long-term care insurance.
However, any medical insurance payments not
deductible on Schedule 1 (Form 1040), line 29,
can be included as medical expenses on
Schedule A (Form 1040), if you itemize deduc-
tions.
Effect on itemized deductions. Subtract the
health insurance deduction from your medical
insurance when figuring medical expenses on
Schedule A (Form 1040) if you itemize deduc-
tions.
Effect on self-employment tax. For tax years
beginning before or after 2010, you can’t sub-
tract the self-employed health insurance deduc-
tion when figuring net earnings for your self-em-
ployment tax from the business under which the
insurance plan is established, or considered to
be established, as discussed earlier. For more
information, see Schedule SE (Form 1040).
How to figure the deduction. Generally, you
can use the worksheet in the Form 1040 in-
structions to figure your deduction. However, if
any of the following apply, you must use Work-
sheet 6-A in this chapter.
• You had more than one source of income
subject to self-employment tax.
• You file Form 2555 or Form 2555-EZ.
• You are using amounts paid for qualified
long-term care insurance to figure the de-
duction.
If you are claiming the HCTC, complete
Form 8885 before you figure this deduction.
Health coverage tax credit. You elect to
take this credit only if you were an eligible trade
adjustment assistance (TAA) recipient, alterna-
tive TAA (ATAA) recipient, reemployment trade
adjustment assistance (RTAA) recipient, or
Pension Benefit Guaranty Corporation (PBGC)
pension recipient. Use Form 8885 to figure the
amount, if any, of this credit. When figuring the
amount to enter on line 1 of Worksheet 6-A,
don’t include any amounts you included on
Form 8885, line 4.
There is coordination of tax benefits be-
tween advance monthly payments of the HCTC
and the HCTC. In general, you can’t claim the
HCTC for a payment you made for qualifying
health insurance when you file your tax return if
you previously received the benefit of the
advance monthly payment program for that cov-
erage month. If you benefited from the advance
monthly payment program, you will receive a
Form 1099-H that reports the amount of the
payments that were forwarded directly to your
health plan administrator for each coverage
month. Don’t report these amounts on Form
8885.
More than one health plan and business.
If you have more than one health plan during
the year and each plan is established under a
different business, you must use separate work-
sheets (Worksheet 6-A) to figure each plan's
net earnings limit. Include the premium you paid
under each plan on line 1 or line 2 of that sepa-
rate worksheet and your net profit (or wages)
from that business on line 4 (or line 11). For a
plan that provides long-term care insurance, the
total of the amounts entered for each person on
line 2 of all worksheets can’t be more than the
appropriate limit shown on line 2 for that per-
son.
Nondeductible
Premiums
You can’t deduct premiums on the following
kinds of insurance.
1. Self-insurance reserve funds. You can’t
deduct amounts credited to a reserve set
up for self-insurance. This applies even if
you can’t get business insurance cover-
age for certain business risks. However,
your actual losses may be deductible. See
Pub. 547.
2. Loss of earnings. You can’t deduct premi-
ums for a policy that pays for lost earnings
due to sickness or disability. However, see
the discussion on overhead insurance,
item (8), under Deductible Premiums, ear-
lier.
3. Certain life insurance and annuities.
a. For contracts issued before June 9,
1997, you can’t deduct the premiums
on a life insurance policy covering
you, an employee, or any person with
a financial interest in your business if
you are directly or indirectly a benefi-
ciary of the policy. You are included
among possible beneficiaries of the
policy if the policy owner is obligated
to repay a loan from you using the
proceeds of the policy. A person has
a financial interest in your business if
the person is an owner or part owner
of the business or has lent money to
the business.
b. For contracts issued after June 8,
1997, you generally can’t deduct the
premiums on any life insurance policy,
endowment contract, or annuity con-
tract if you are directly or indirectly a
beneficiary. The disallowance applies
without regard to whom the policy
covers.
c. Partners. If, as a partner in a partner-
ship, you take out an insurance policy
on your own life and name your part-
ners as beneficiaries to induce them
to retain their investments in the part-
nership, you are considered a benefi-
ciary. You can't deduct the insurance
premiums.
4. Insurance to secure a loan. If you take out
a policy on your life or on the life of an-
other person with a financial interest in
your business to get or protect a business
loan, you can't deduct the premiums as a
business expense. Nor can you deduct
the premiums as interest on business
loans or as an expense of financing loans.
In the event of death, the proceeds of the
policy are generally not taxed as income
even if they are used to liquidate the debt.
Capitalized Premiums
Under the uniform capitalization rules, you must
capitalize the direct costs and part of the indi-
rect costs for certain production or resale activi-
ties. Include these costs in the basis of property
you produce or acquire for resale, rather than
claiming them as a current deduction. You re-
cover the costs through depreciation, amortiza-
tion, or cost of goods sold when you use, sell,
or otherwise dispose of the property.
Indirect costs include premiums for insur-
ance on your plant or facility, machinery, equip-
ment, materials, property produced, or property
acquired for resale.
Uniform capitalization rules. 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.
1. Produce real property or tangible personal
property. For this purpose, tangible per-
sonal property includes a film, sound re-
cording, video tape, book, or similar prop-
erty.
2. Acquire property for resale.
However, these rules don't apply to the follow-
ing property.
1. Personal property you acquire for resale if
your average annual gross receipts are
$25 million or less for the 3 prior tax years.
2. Property you produce if you meet either of
the following conditions.
a. Your indirect costs of producing the
property are $200,000 or less.
b. You use the cash method of account-
ing and don't account for inventories.
More information. For more information on
these rules, see Uniform Capitalization Rules in
Pub. 538 and the regulations under section
263A.
When To Deduct
Premiums
You can usually deduct insurance premiums in
the tax year to which they apply.
Chapter 6 Insurance Page 23
Cash method. If you use the cash method of
accounting, you generally deduct insurance
premiums in the tax year you actually paid
them, even if you incurred them in an earlier
year. However, see Prepayment, later.
Accrual method. If you use an accrual method
of accounting, you can't deduct insurance pre-
miums before the tax year in which you incur a
liability for them. In addition, you can't deduct
insurance premiums before the tax year in
which you actually pay them (unless the excep-
tion for recurring items applies). For more infor-
mation about the accrual method of accounting,
see chapter 1. For information about the excep-
tion for recurring items, see Pub. 538.
Prepayment. You can't deduct expenses in
advance, even if you pay them in advance. This
rule applies to any expense paid far enough in
advance to, in effect, create an asset with a
useful life extending substantially beyond the
end of the current tax year.
Expenses such as insurance are generally
allocable to a period of time. You can deduct in-
surance expenses for the year to which they are
allocable.
Example. In 2018, you signed a 3-year in-
surance contract. Even though you paid the
premiums for 2018, 2019, and 2020 when you
signed the contract, you can only deduct the
premium for 2018 on your 2018 tax return. You
can deduct in 2019 and 2020 the premium allo-
cable to those years.
Dividends received. If you receive dividends
from business insurance and you deducted the
premiums in prior years, at least part of the divi-
dends generally are income. For more informa-
tion, see Recovery of amount deducted (tax
benefit rule) in chapter 1 under How Much Can I
Deduct.
7.
Costs You
Can Deduct
or Capitalize
What’s New
Alternative minimum tax (AMT). For tax
years beginning after 2017, the Tax Cuts and
Jobs Act, section 12001, repealed the corpo-
rate AMT.
Introduction
This chapter discusses costs you can elect to
deduct or capitalize.
You generally deduct a cost as a current
business expense by subtracting it from your in-
come in either the year you incur it or the year
you pay it.
If you capitalize a cost, you may be able to
recover it over a period of years through peri-
odic deductions for amortization, depletion, or
depreciation. When you capitalize a cost, you
add it to the basis of property to which it relates.
A partnership, corporation, estate, or trust
makes the election to deduct or capitalize the
costs discussed in this chapter except for ex-
ploration costs for mineral deposits. Each indi-
vidual partner, shareholder, or beneficiary
elects whether to deduct or capitalize explora-
tion costs.
You may be subject to AMT if you de-
duct certain research and experimen-
tal, intangible drilling, exploration, de-
velopment, circulation, or business
organizational costs.
For more information on the AMT, see the
Instructions for Form 6251, Alternative Mini-
mum Tax—Individuals.
Topics
This chapter discusses:
• Carrying charges
• Research and experimental costs
• Intangible drilling costs
• Exploration costs
• Development costs
• Circulation costs
• Business start-up and organizational costs
• Reforestation costs
• Retired asset removal costs
• Barrier removal costs
• Film and television production costs
• Repair and maintenance costs
Useful Items
You may want to see:
Publication
544 Sales and Other Dispositions of
Assets
Form (and Instructions)
Schedule C (Form 1040) Profit or Loss
From Business (Sole Proprietorship)
3468 Investment Credit
6765 Credit for Increasing Research
Activities
8826 Disabled Access Credit
T (Timber) Forest Activities Schedule
See chapter 13 for information about getting
publications and forms.
Carrying Charges
Carrying charges include the taxes and interest
you pay to carry or develop real property or to
carry, transport, or install personal property.
Certain carrying charges must be capitalized
under the uniform capitalization rules. (For infor-
mation on capitalization of interest, seeCAUTION
!
Schedule C (Form 1040)
3468
6765
8826
T (Timber)
chapter 4.) You can elect to capitalize carrying
charges not subject to the uniform capitalization
rules, but only if they are otherwise deductible.
You can elect to capitalize carrying charges
separately for each project you have and for
each type of carrying charge. Your election is
good for only 1 year for unimproved and unpro-
ductive real property. You must decide whether
to capitalize carrying charges each year the
property remains unimproved and unproduc-
tive. For other real property, your election to
capitalize carrying charges remains in effect un-
til construction or development is completed.
For personal property, your election is effective
until the date you install or first use it, whichever
is later.
How to make the election. To make the elec-
tion to capitalize a carrying charge, attach a
statement to your original tax return for the year
the election is to be effective indicating which
charges you are electing to capitalize. However,
if you timely filed your return for the year without
making the election, you can still make the elec-
tion by filing an amended return within 6 months
of the due date of the return (excluding exten-
sions). Attach the statement to the amended re-
turn and write “Filed pursuant to section
301.9100-2” on the statement. File the amen-
ded return at the same address you filed the
original return.
Research and
Experimental Costs
The costs of research and experimentation are
generally capital expenses. However, you can
elect to deduct these costs as a current busi-
ness expense. Your election to deduct these
costs is binding for the year it is made and for
all later years unless you get IRS approval to
make a change.
If you meet certain requirements, you may
elect to defer and amortize research and exper-
imental costs. For information on electing to de-
fer and amortize these costs, see Research and
Experimental Costs in chapter 8.
Research and experimental costs defined.
Research and experimental costs are reasona-
ble costs you incur in your trade or business for
activities intended to provide information that
would eliminate uncertainty about the develop-
ment or improvement of a product. Uncertainty
exists if the information available to you does
not establish how to develop or improve a prod-
uct or the appropriate design of a product.
Whether costs qualify as research and experi-
mental costs depends on the nature of the ac-
tivity to which the costs relate rather than on the
nature of the product or improvement being de-
veloped or the level of technological advance-
ment.
The costs of obtaining a patent, including at-
torneys' fees paid or incurred in making and
perfecting a patent application, are research
and experimental costs. However, costs paid or
incurred to obtain another's patent are not re-
search and experimental costs.
Page 24 Chapter 7 Costs You Can Deduct or Capitalize
Product. The term “product” includes any
of the following items.
• Formula.
• Invention.
• Patent.
• Pilot model.
• Process.
• Technique.
• Property similar to the items listed above.
It also includes products used by you in your
trade or business or held for sale, lease, or li-
cense.
Costs not included. Research and experi-
mental costs do not include expenses for any of
the following activities.
• Advertising or promotions.
• Consumer surveys.
• Efficiency surveys.
• Management studies.
• Quality control testing.
• Research in connection with literary, his-
torical, or similar projects.
• The acquisition of another's patent, model,
production, or process.
When and how to elect. You make the elec-
tion to deduct research and experimental costs
by deducting them on your tax return for the
year in which you first pay or incur research and
experimental costs. If you do not make the elec-
tion to deduct research and experimental costs
in the first year in which you pay or incur the
costs, you can deduct the costs in a later year
only with approval from the IRS.
Research credit. If you pay or incur qualified
research expenses, you may be able to take the
research credit. For more information, see Form
6765 and its instructions.
Payroll tax credit. The payroll tax credit is an
annual election made by a qualified small busi-
ness specifying the amount of research credit,
not to exceed $250,000, that may be used
against the employer portion of social security
liability. The credit is the smallest of the current
year research credit, an elected amount not to
exceed $250,000, or the general business
credit carryforward for the tax year. The election
must be made on or before the due date of the
originally filed return (including extensions). An
election cannot be made for a tax year if an
election was made for 5 or more preceding tax
years. The election made by a partnership or S
corporation is made at the entity level.
A qualified small business that elects to
claim the payroll tax credit and files quarterly
employment tax returns, will claim the payroll
tax credit on its employment tax return for the
first quarter that begins after it files the return re-
flecting the payroll tax election. For more infor-
mation, see Form 6765 and its instructions.
Intangible
Drilling Costs
The costs of developing oil, gas, or geothermal
wells are ordinarily capital expenditures. You
can usually recover them through depreciation
or depletion. However, you can elect to deduct
intangible drilling costs (IDCs) as a current
business expense. These are certain drilling
and development costs for wells in the United
States in which you hold an operating or work-
ing interest. You can deduct only costs for drill-
ing or preparing a well for the production of oil,
gas, or geothermal steam or hot water.
You can elect to deduct only the costs of
items with no salvage value. These include wa-
ges, fuel, repairs, hauling, and supplies related
to drilling wells and preparing them for produc-
tion. Your cost for any drilling or development
work done by contractors under any form of
contract is also an IDC. However, see Amounts
paid to contractor that must be capitalized,
later.
You can also elect to deduct the cost of drill-
ing exploratory bore holes to determine the lo-
cation and delineation of offshore hydrocarbon
deposits if the shaft is capable of conducting
hydrocarbons to the surface on completion. It
does not matter whether there is any intent to
produce hydrocarbons.
If you do not elect to deduct your IDCs as a
current business expense, you can elect to de-
duct them over the 60-month period beginning
with the month they were paid or incurred.
Amounts paid to contractor that must be
capitalized. Amounts paid to a contractor
must be capitalized if they are either:
• Amounts properly allocable to the cost of
depreciable property, or
• Amounts paid only out of production or
proceeds from production if these amounts
are depletable income to the recipient.
How to make the election. You elect to de-
duct IDCs as a current business expense by
taking the deduction on your income tax return
for the first tax year you have eligible costs. No
formal statement is required. If you file Sched-
ule C (Form 1040), enter these costs under
“Other expenses.”
For oil and gas wells, your election is bind-
ing for the year it is made and for all later years.
For geothermal wells, your election can be re-
voked by the filing of an amended return on
which you do not take the deduction. You can
file the amended return for the year up to the
normal time of expiration for filing a claim for
credit or refund, generally, within 3 years after
the date you filed the original return or within 2
years after the date you paid the tax, whichever
is later.
Energy credit for costs of geothermal wells.
If you capitalize the drilling and development
costs of geothermal wells that you place in serv-
ice during the tax year, you may be able to
claim a business energy credit. See the Instruc-
tions for Form 3468 for more information.
Nonproductive well. If you capitalize your
IDCs, you have another option if the well is non-
productive. You can deduct the IDCs of the
nonproductive well as an ordinary loss. You
must indicate and clearly state your election on
your tax return for the year the well is comple-
ted. Once made, the election for oil and gas
wells is binding for all later years. You can re-
voke your election for a geothermal well by filing
an amended return that does not claim the loss.
Costs incurred outside the United States.
You cannot deduct as a current business ex-
pense all the IDCs paid or incurred for an oil,
gas, or geothermal well located outside the Uni-
ted States. However, you can elect to include
the costs in the adjusted basis of the well to fig-
ure depletion or depreciation. If you do not
make this election, you can deduct the costs
over the 10-year period beginning with the tax
year in which you paid or incurred them. These
rules do not apply to a nonproductive well.
Exploration Costs
The costs of determining the existence, loca-
tion, extent, or quality of any mineral deposit are
ordinarily capital expenditures if the costs lead
to the development of a mine. You recover
these costs through depletion as the mineral is
removed from the ground. However, you can
elect to deduct domestic exploration costs paid
or incurred before the beginning of the develop-
ment stage of the mine (except those for oil and
gas wells).
How to make the election. You elect to de-
duct exploration costs by taking the deduction
on your income tax return, or on an amended
income tax return, for the first tax year for which
you wish to deduct the costs paid or incurred
during the tax year. Your return must ade-
quately describe and identify each property or
mine, and clearly state how much is being de-
ducted for each one. The election applies to the
tax year you make this election and all later tax
years.
Partnerships and S corporations. Each
partner, not the partnership, elects whether to
capitalize or to deduct that partner's share of
exploration costs. Each shareholder, not the S
corporation, elects whether to capitalize or to
deduct that shareholder's share of exploration
costs.
Reduced corporate deductions for explora-
tion costs. A corporation (other than an S cor-
poration) can deduct only 70% of its domestic
exploration costs. It must capitalize the remain-
ing 30% of costs and amortize them over the
60-month period starting with the month the ex-
ploration costs are paid or incurred. A corpora-
tion may also elect to capitalize and amortize
mining exploration costs over a 10-year period.
For more information on this method of amorti-
zation, see section 59(e).
The 30% that the corporation capitalizes
cannot be added to its basis in the property to
figure cost depletion. However, the amount
amortized is treated as additional depreciation
and is subject to recapture as ordinary income
on a disposition of the property. See Section
1250 Property under Depreciation Recapture in
chapter 3 of Pub. 544.
These rules also apply to the deduction of
development costs by corporations. See Devel-
opment Costs, later.
Recapture of exploration expenses. When
your mine reaches the producing stage, you
Chapter 7 Costs You Can Deduct or Capitalize Page 25
must recapture any exploration costs you elec-
ted to deduct. Use either of the following meth-
ods.
Method 1—Include the deducted costs in
gross income for the tax year the mine rea-
ches the producing stage. Your election
must be clearly indicated on the return. In-
crease your adjusted basis in the mine by
the amount included in income. Generally,
you must elect this recapture method by
the due date (including extensions) of your
return. However, if you timely filed your re-
turn for the year without making the elec-
tion, you can still make the election by filing
an amended return within 6 months of the
due date of the return (excluding exten-
sions). Make the election on your amended
return and write “Filed pursuant to section
301.9100-2” on the form where you are in-
cluding the income. File the amended re-
turn at the same address you filed the origi-
nal return.
Method 2—Do not claim any depletion de-
duction for the tax year the mine reaches
the producing stage and any later tax years
until the depletion you would have deduc-
ted equals the exploration costs you de-
ducted.
You also must recapture deducted explora-
tion costs if you receive a bonus or royalty from
mine property before it reaches the producing
stage. Do not claim any depletion deduction for
the tax year you receive the bonus or royalty
and any later tax years until the depletion you
would have deducted equals the exploration
costs you deducted.
Generally, if you dispose of the mine before
you have fully recaptured the exploration costs
you deducted, recapture the balance by treating
all or part of your gain as ordinary income. Un-
der these circumstances, you generally treat as
ordinary income all of your gain if it is less than
your adjusted exploration costs with respect to
the mine. If your gain is more than your adjusted
exploration costs, treat as ordinary income only
a part of your gain, up to the amount of your ad-
justed exploration costs.
Foreign exploration costs. If you pay or incur
exploration costs for a mine or other natural de-
posit located outside the United States, you
cannot deduct all the costs in the current year.
You can elect to include the costs (other than
for an oil, gas, or geothermal well) in the adjus-
ted basis of the mineral property to figure cost
depletion. (Cost depletion is discussed in chap-
ter 9.) If you do not make this election, you must
deduct the costs over the 10-year period begin-
ning with the tax year in which you pay or incur
them. These rules also apply to foreign devel-
opment costs.
Development Costs
You can deduct costs paid or incurred during
the tax year for developing a mine or any other
natural deposit (other than an oil or gas well) lo-
cated in the United States. These costs must be
paid or incurred after the discovery of ores or
minerals in commercially marketable quantities.
Development costs also include depreciation
on improvements used in the development of
ores or minerals and costs incurred for you by a
contractor. Development costs do not include
the costs for the acquisition or improvement of
depreciable property.
Instead of deducting development costs in
the year paid or incurred, you can elect to treat
the costs as deferred expenses and deduct
them ratably as the units of produced ores or
minerals benefited by the expenses are sold.
This election applies each tax year to expenses
paid or incurred in that year. Once made, the
election is binding for the year and cannot be
revoked for any reason.
How to make the election. The election to
deduct development costs ratably as the ores
or minerals are sold must be made for each
mine or other natural deposit by a clear indica-
tion on your return or by a statement filed with
the IRS office where you file your return. Gener-
ally, you must make the election by the due
date of the return (including extensions). How-
ever, if you timely filed your return for the year
without making the election, you can still make
the election by filing an amended return within 6
months of the due date of the return (excluding
extensions). Clearly indicate the election on
your amended return and write “Filed pursuant
to section 301.9100-2.” File the amended return
at the same address you filed the original re-
turn.
Foreign development costs. The rules dis-
cussed earlier for Foreign exploration costs ap-
ply to foreign development costs.
Reduced corporate deductions for develop-
ment costs. The rules discussed earlier for
Reduced corporate deductions for exploration
costs also apply to corporate deductions for de-
velopment costs.
Circulation Costs
A publisher can deduct as a current business
expense the costs of establishing, maintaining,
or increasing the circulation of a newspaper,
magazine, or other periodical. For example, a
publisher can deduct the cost of hiring extra
employees for a limited time to get new sub-
scriptions through telephone calls. Circulation
costs may be deducted even if they normally
would be capitalized.
This rule does not apply to the following
costs that must be capitalized.
• The purchase of land or depreciable prop-
erty.
• The acquisition of circulation through the
purchase of any part of the business of an-
other publisher of a newspaper, magazine,
or other periodical, including the purchase
of another publisher's list of subscribers.
Other treatment of circulation costs. If you
do not want to deduct circulation costs as a cur-
rent business expense, you can elect one of the
following ways to recover these costs.
• Capitalize all circulation costs that are
properly chargeable to a capital account
(see chapter 1).
• Amortize circulation costs over the 3-year
period beginning with the tax year they
were paid or incurred.
How to make the election. You elect to capi-
talize circulation costs by attaching a statement
to your return for the first tax year the election
applies. Your election is binding for the year it is
made and for all later years, unless you get IRS
approval to revoke it.
Business Start-Up and
Organizational Costs
Business start-up and organizational costs are
generally capital expenditures. However, you
can elect to deduct up to $5,000 of business
start-up and $5,000 of organizational costs paid
or incurred after October 22, 2004. The $5,000
deduction is reduced by the amount your total
start-up or organizational costs exceed
$50,000. Any remaining costs must be amor-
tized. For information about amortizing start-up
and organizational costs, see chapter 8.
Start-up costs include any amounts paid or
incurred in connection with creating an active
trade or business or investigating the creation
or acquisition of an active trade or business. Or-
ganizational costs include the costs of creating
a corporation or partnership.
How to make the election. You elect to de-
duct the start-up or organizational costs by
claiming the deduction on your income tax re-
turn (filed by the due date including extensions)
for the tax year in which the active trade or busi-
ness begins. For costs paid or incurred after
September 8, 2008, you are not required to at-
tach a statement to your return to elect to de-
duct such costs. However, for start-up or organ-
izational costs paid or incurred before
September 9, 2008, you may be required to at-
tach a statement to your return to elect to de-
duct such costs. If you timely filed your return
for the year without making the election, you
can still make the election by filing an amended
return within 6 months of the due date of the re-
turn (excluding extensions). Clearly indicate the
election on your amended return and write
“Filed pursuant to section 301.9100-2.”
File the amended return at the same ad-
dress you filed the original return. The election
applies when figuring taxable income for the
current tax year and all subsequent years. Once
made, the election is irrevocable. For more in-
formation on start-up and organizational costs,
see chapter 8.
Reforestation Costs
Reforestation costs are generally capital expen-
ditures. However, you can elect to deduct up to
$10,000 ($5,000 if married filing separately; $0
for a trust) of qualifying reforestation costs paid
or incurred after October 22, 2004, for each
qualified timber property. The remaining costs
can be amortized over an 84-month period. For
information about amortizing reforestation
costs, see chapter 8.
Page 26 Chapter 7 Costs You Can Deduct or Capitalize
Qualifying reforestation costs are the direct
costs of planting or seeding for forestation or re-
forestation. Qualified timber property is property
that contains trees in significant commercial
quantities. See chapter 8 for more information
on qualifying reforestation costs and qualified
timber property.
If you elect to deduct qualified reforestation
costs, create and maintain separate timber ac-
counts for each qualified timber property and in-
clude all reforestation costs and the dates each
was applied. Do not include this qualified timber
property in any account (for example, depletion
block) for which depletion is allowed.
How to make the election. You elect to de-
duct qualifying reforestation costs by claiming
the deduction on your timely filed income tax re-
turn (including extensions) for the tax year the
expenses were paid or incurred. If Form T (Tim-
ber) is required, complete Part IV of the form. If
Form T (Timber) is not required, attach a state-
ment containing the following information for
each qualified timber property for which an
election is being made.
• The unique stand identification numbers.
• The total number of acres reforested dur-
ing the tax year.
• The nature of the reforestation treatments.
• The total amounts of qualified reforestation
expenditures eligible to be amortized or
deducted.
If you timely filed your return for the year
without making the election, you can still make
the election by filing an amended return within 6
months of the due date of the return (excluding
extensions). Clearly indicate the election on
your amended return and write “Filed pursuant
to section 301.9100-2.” File the amended return
at the same address you filed the original re-
turn. The election applies when figuring taxable
income for the current tax year and all subse-
quent years.
For additional information on reforestation
costs, see chapter 8.
Recapture. This deduction may have to be re-
captured as ordinary income under section
1245 when you sell or otherwise dispose of the
property that would have received an addition
to basis if you had not elected to deduct the ex-
penditure. For more information on recapturing
the deduction, see Depreciation Recapture in
Pub. 544.
Retired Asset Removal
Costs
If you retire and remove a depreciable asset in
connection with the installation or production of
a replacement asset, you can deduct the costs
of removing the retired asset. However, if you
replace a component (part) of a depreciable as-
set, capitalize the removal costs if the replace-
ment is an improvement and deduct the costs if
the replacement is a repair.
Barrier Removal Costs
The cost of an improvement to a business asset
is normally a capital expense. However, you
can elect to deduct the costs of making a facility
or public transportation vehicle more accessible
to and usable by those who are disabled or eld-
erly. You must own or lease the facility or vehi-
cle for use in connection with your trade or busi-
ness.
A facility is all or any part of buildings, struc-
tures, equipment, roads, walks, parking lots, or
similar real or personal property. A public trans-
portation vehicle is a vehicle, such as a bus or
railroad car, that provides transportation service
to the public (including service for your custom-
ers, even if you are not in the business of pro-
viding transportation services).
You cannot deduct any costs that you paid
or incurred to completely renovate or build a fa-
cility or public transportation vehicle or to re-
place depreciable property in the normal course
of business.
Deduction limit. The most you can deduct as
a cost of removing barriers to the disabled and
the elderly for any tax year is $15,000. How-
ever, you can add any costs over this limit to the
basis of the property and depreciate these ex-
cess costs.
Partners and partnerships. The $15,000 limit
applies to a partnership and also to each part-
ner in the partnership. A partner can allocate
the $15,000 limit in any manner among the part-
ner's individually incurred costs and the part-
ner's distributive share of partnership costs. If
the partner cannot deduct the entire share of
partnership costs, the partnership can add any
costs not deducted to the basis of the improved
property.
A partnership must be able to show that any
amount added to basis was not deducted by
the partner and that it was over a partner's
$15,000 limit (as determined by the partner). If
the partnership cannot show this, it is presumed
that the partner was able to deduct the distribu-
tive share of the partnership's costs in full.
Example. Emilio Azul's distributive share of
ABC partnership's deductible expenses for the
removal of architectural barriers was $14,000.
Emilio had $12,000 of similar expenses in his
sole proprietorship. He elected to deduct
$7,000 of them. Emilio allocated the remaining
$8,000 of the $15,000 limit to his share of
ABC's expenses. Emilio can add the excess
$5,000 of his own expenses to the basis of the
property used in his business. Also, if ABC can
show that Emilio could not deduct $6,000
($14,000 – $8,000) of his share of the partner-
ship's expenses because of how Emilio applied
the limit, ABC can add $6,000 to the basis of its
property.
Qualification standards. You can deduct
your costs as a current expense only if the bar-
rier removal meets the guidelines and require-
ments issued by the Architectural and Trans-
portation Barriers Compliance Board under the
Americans with Disabilities Act (ADA) of 1990.
You can view the Americans with Disabilities
Act at ADA.gov/pubs/ada.htm.
The following is a list of some architectural
barrier removal costs that can be deducted.
• Ground and floor surfaces.
• Walks.
• Parking lots.
• Ramps.
• Entrances.
• Doors and doorways.
• Stairs.
• Floors.
• Toilet rooms.
• Water fountains.
• Public telephones.
• Elevators.
• Controls.
• Signage.
• Alarms.
• Protruding objects.
• Symbols of accessibility.
You can find the ADA guidelines and require-
ments for architectural barrier removal at
USDOJ.gov/crt/ada/reg3a.html.
The costs for removal of transportation barri-
ers from rail facilities, buses, and rapid and light
rail vehicles are deductible. You can find the
guidelines and requirements for transportation
barrier removal at FTA.dot.gov.
Also, you can access the ADA website at
ADA.gov for additional information.
Other barrier removals. To be deductible,
expenses of removing any barrier not covered
by the above standards must meet all three of
the following tests.
1. The removed barrier must be a substantial
barrier to access or use of a facility or pub-
lic transportation vehicle by persons who
have a disability or are elderly.
2. The removed barrier must have been a
barrier for at least one major group of per-
sons who have a disability or are elderly
(such as people who are blind, deaf, or
wheelchair users).
3. The barrier must be removed without cre-
ating any new barrier that significantly im-
pairs access to or use of the facility or ve-
hicle by a major group of persons who
have a disability or are elderly.
How to make the election. If you elect to de-
duct your costs for removing barriers to the dis-
abled or the elderly, claim the deduction on
your income tax return (partnership return for
partnerships) for the tax year the expenses
were paid or incurred. Identify the deduction as
a separate item. The election applies to all the
qualifying costs you have during the year, up to
the $15,000 limit. If you make this election, you
must maintain adequate records to support your
deduction.
For your election to be valid, you generally
must file your return by its due date, including
extensions. However, if you timely filed your re-
turn for the year without making the election,
you can still make the election by filing an
amended return within 6 months of the due date
of the return (excluding extensions). Clearly in-
dicate the election on your amended return and
write “Filed pursuant to section 301.9100-2.”
File the amended return at the same address
Chapter 7 Costs You Can Deduct or Capitalize Page 27
you filed the original return. Your election is ir-
revocable after the due date, including exten-
sions, of your return.
Disabled access credit. If you make your
business accessible to persons with disabilities
and your business is an eligible small business,
you may be able to claim the disabled access
credit. If you choose to claim the credit, you
must reduce the amount you deduct or capital-
ize by the amount of the credit.
For more information, see Form 8826.
Film and Television
Production Costs
Film and television production costs are gener-
ally capital expenses. However, you can elect
to deduct certain costs of qualified film, televi-
sion, and live theatrical productions that begin
before January 1, 2018. For more information,
see section 181 and the related regulations.
Certain qualified film, television, or live the-
atrical productions acquired and placed in serv-
ice after September 27, 2017, may be eligible
for the special depreciation allowance under
section 168(k). For more information, see Pub.
946, How to Depreciate Property.
Repair and Maintenance
Costs
Generally, you can deduct amounts paid for re-
pairs and maintenance to tangible property if
the amounts paid are not otherwise required to
be capitalized. However, you may elect to capi-
talize amounts paid for repair and maintenance
consistent with the treatment on your books and
records. If you make this election, it applies to
all amounts paid for repair and maintenance to
tangible property that you treat as capital ex-
penditures on your books and records for the
tax year.
How to make the election. To make the elec-
tion to treat repairs and maintenance as capital
expenditures, attach a statement titled “Section
1.263(a)-3(n) Election” to your timely filed return
(including extensions). For more information on
what to include in the statement, see Regula-
tions section 1.263(a)-3(n). If you timely filed
your return without making the election, you can
still make the election by filing an amended re-
turn within 6 months of the due date of the re-
turn (excluding extensions). Attach the state-
ment to the amended return and write “Filed
pursuant to section 301.9100-2” on the state-
ment. File the amended return at the same ad-
dress you filed the original return.
8.
Amortization
Introduction
Amortization is a method of recovering (deduct-
ing) certain capital costs over a fixed period of
time. It is similar to the straight line method of
depreciation.
The various amortizable costs covered in
this chapter are included in the list below. How-
ever, this chapter doesn't discuss amortization
of bond premium. For information on that topic,
see chapter 3 of Pub. 550, Investment Income
and Expenses.
Topics
This chapter discusses:
• Deducting amortization
• Amortizing costs of starting a business
• Amortizing costs of getting a lease
• Amortizing costs of section 197 intangibles
• Amortizing reforestation costs
• Amortizing costs of geological and
geophysical costs
• Amortizing costs of pollution control
facilities
• Amortizing costs of research and
experimentation
• Amortizing costs of certain tax preferences
Useful Items
You may want to see:
Publication
544 Sales and Other Dispositions of
Assets
550 Investment Income and Expenses
946 How To Depreciate Property
Form (and Instructions)
3115 Application for Change in
Accounting Method
4562 Depreciation and Amortization
6251 Alternative Minimum
Tax—Individuals
See chapter 13 for information about getting
publications and forms.
How To Deduct
Amortization
To deduct amortization that begins during the
current tax year, complete Part VI of Form 4562
and attach it to your income tax return.
To report amortization from previous years,
in addition to amortization that begins in the cur-
rent year, list on Form 4562 each item sepa-
rately. For example, in 2017, you began to
3115
4562
6251
amortize a lease. In 2018, you began to amor-
tize a second lease. Report amortization from
the new lease on line 42 of your 2018 Form
4562. Report amortization from the 2017 lease
on line 43 of your 2018 Form 4562.
If you don't have any new amortizable ex-
penses for the current year, you aren't required
to complete Form 4562 (unless you are claim-
ing depreciation). Report the current year's de-
duction for amortization that began in a prior
year directly on the “Other deduction” or “Other
expense line” of your return.
Starting a Business
When you start a business, treat all eligible
costs you incur before you begin operating the
business as capital expenditures which are part
of your basis in the business. Generally, you re-
cover costs for particular assets through depre-
ciation deductions. However, you generally
can't recover other costs until you sell the busi-
ness or otherwise go out of business. For a dis-
cussion on how to treat these costs, see If your
attempt to go into business is unsuccessful un-
der Capital Expenses in chapter 1.
For costs paid or incurred after September
8, 2008, you can deduct a limited amount of
start-up and organizational costs. The costs
that aren't deducted currently can be amortized
ratably over a 180-month period. The amortiza-
tion period starts with the month you begin op-
erating your active trade or business. You aren't
required to attach a statement to make this
election. You can choose to forgo this election
by affirmatively electing to capitalize your
start-up costs on your income tax return filed by
the due date (including extensions) for the tax
year in which the active trade or business be-
gins. Once made, the election to either amortize
or capitalize start-up costs is irrevocable and
applies to all start-up costs that are related to
your trade or business. See Regulations sec-
tions 1.195-1, 1.248-1, and 1.709-1.
For costs paid or incurred after October 22,
2004, and before September 9, 2008, you can
elect to deduct a limited amount of business
start-up and organizational costs in the year
your active trade or business begins. Any costs
not deducted can be amortized ratably over a
180-month period, beginning with the month
you begin business. If the election is made, you
must attach any statement required by Regula-
tions sections 1.195-1(b), 1.248-1(c), and
1.709-1(c), as in effect before September 9,
2008.
Note. You can apply the provisions of Reg-
ulations sections 1.195-1, 1.248-1, and 1.709-1
to all business start-up and organizational costs
paid or incurred after October 22, 2004, provi-
ded the period of limitations on assessment
hasn't expired for the year of the election. Oth-
erwise, for business start-up and organizational
costs paid or incurred after October 22, 2004,
and before September 9, 2008, the provisions
under Regulations sections 1.195-1(b),
1.248-1(c), and 1.709-1(c), as in effect before
September 9, 2008, will apply.
For costs paid or incurred before October
23, 2004, you can elect to amortize business
Page 28 Chapter 8 Amortization
start-up and organizational costs over an amor-
tization period of 60 months or more. See How
To Make the Election, later.
The cost must qualify as one of the follow-
ing.
• A business start-up cost.
• An organizational cost for a corporation.
• An organizational cost for a partnership.
Business Start-Up Costs
Start-up costs are amounts paid or incurred for
(a) creating an active trade or business, or (b)
investigating the creation or acquisition of an
active trade or business. Start-up costs include
amounts paid or incurred in connection with an
existing activity engaged in for profit, and for the
production of income in anticipation of the activ-
ity becoming an active trade or business.
Qualifying costs. A start-up cost is amortiza-
ble if it meets both of the following tests.
• It is a cost you could deduct if you paid or
incurred it to operate an existing active
trade or business (in the same field as the
one you entered into).
• It is a cost you pay or incur before the day
your active trade or business begins.
Start-up costs include amounts paid for the
following.
• An analysis or survey of potential markets,
products, labor supply, transportation fa-
cilities, etc.
• Advertisements for the opening of the busi-
ness.
• Salaries and wages for employees who are
being trained and their instructors.
• Travel and other necessary costs for se-
curing prospective distributors, suppliers,
or customers.
• Salaries and fees for executives and con-
sultants, or for similar professional serv-
ices.
Nonqualifying costs. Start-up costs Don't in-
clude deductible interest, taxes, or research
and experimental costs. See Research and Ex-
perimental Costs, later.
Purchasing an active trade or business.
Amortizable start-up costs for purchasing an ac-
tive trade or business include only investigative
costs incurred in the course of a general search
for or preliminary investigation of the business.
These are costs that help you decide whether
to purchase a business. Costs you incur in an
attempt to purchase a specific business are
capital expenses that you can't amortize.
Example. On June 1, you hired an account-
ing firm and a law firm to assist you in the po-
tential purchase of XYZ, Inc. They researched
XYZ's industry and analyzed the financial pro-
jections of XYZ, Inc. In September, the law firm
prepared and submitted a letter of intent to
XYZ, Inc. The letter stated that a binding com-
mitment would result only after a purchase
agreement was signed. The law firm and ac-
counting firm continued to provide services in-
cluding a review of XYZ's books and records
and the preparation of a purchase agreement.
On October 22, you signed a purchase agree-
ment with XYZ, Inc.
All amounts paid or incurred to investigate
the business before October 22 are amortizable
investigative costs. Amounts paid on or after
that date relate to the attempt to purchase the
business and therefore must be capitalized.
Disposition of business. If you completely
dispose of your business before the end of the
amortization period, you can deduct any re-
maining deferred start-up costs. However, you
can deduct these deferred start-up costs only to
the extent they qualify as a loss from a busi-
ness.
Costs of Organizing a
Corporation
Amounts paid to organize a corporation are the
direct costs of creating the corporation.
Qualifying costs. To qualify as an organiza-
tional cost, it must be:
• For the creation of the corporation,
• Chargeable to a capital account (see chap-
ter 1),
• Amortized over the life of the corporation if
the corporation had a fixed life, and
• Incurred before the end of the first tax year
in which the corporation is in business.
A corporation using the cash method of ac-
counting can amortize organizational costs in-
curred within the first tax year, even if it doesn't
pay them in that year.
Examples of organizational costs include
the following.
• The cost of temporary directors.
• The cost of organizational meetings.
• State incorporation fees.
• The cost of legal services.
Nonqualifying costs. The following items are
capital expenses that can't be amortized.
• Costs for issuing and selling stock or se-
curities, such as commissions, professio-
nal fees, and printing costs.
• Costs associated with the transfer of as-
sets to the corporation.
Costs of Organizing a
Partnership
The costs to organize a partnership are the di-
rect costs of creating the partnership.
Qualifying costs. A partnership can amortize
an organizational cost only if it meets all the fol-
lowing tests.
• It is for the creation of the partnership and
not for starting or operating the partnership
trade or business.
• It is chargeable to a capital account (see
chapter 1).
• It could be amortized over the life of the
partnership if the partnership had a fixed
life.
• It is incurred by the due date of the partner-
ship return (excluding extensions) for the
first tax year in which the partnership is in
business. However, if the partnership uses
the cash method of accounting and pays
the cost after the end of its first tax year,
see Cash method partnership under How
To Amortize, later.
• It is for a type of item normally expected to
benefit the partnership throughout its entire
life.
Organizational costs include the following
fees.
• Legal fees for services incident to the or-
ganization of the partnership, such as ne-
gotiation and preparation of the partner-
ship agreement.
• Accounting fees for services incident to the
organization of the partnership.
• Filing fees.
Nonqualifying costs. The following costs
can't be amortized.
• The cost of acquiring assets for the part-
nership or transferring assets to the part-
nership.
• The cost of admitting or removing partners,
other than at the time the partnership is
first organized.
• The cost of making a contract concerning
the operation of the partnership trade or
business including a contract between a
partner and the partnership.
• The costs for issuing and marketing inter-
ests in the partnership such as brokerage,
registration, and legal fees and printing
costs. These “syndication fees” are capital
expenses that can't be depreciated or
amortized.
Liquidation of partnership. If a partnership is
liquidated before the end of the amortization pe-
riod, the unamortized amount of qualifying or-
ganizational costs can be deducted in the part-
nership's final tax year. However, these costs
can be deducted only to the extent they qualify
as a loss from a business.
How To Amortize
Deduct start-up and organizational costs in
equal amounts over the applicable amortization
period (discussed earlier under Business
Start-Up Costs). You can choose an amortiza-
tion period for start-up costs that is different
from the period you choose for organizational
costs, as long as both aren't less than the appli-
cable amortization period. Once you choose an
amortization period, you can't change it.
To figure your deduction, divide your total
start-up or organizational costs by the months in
the amortization period. The result is the
amount you can deduct for each month.
Cash method partnership. A partnership us-
ing the cash method of accounting can deduct
an organizational cost only if it has been paid by
the end of the tax year. However, any cost the
partnership could have deducted as an organi-
zational cost in an earlier tax year (if it had been
paid that year) can be deducted in the tax year
of payment.
How To Make the Election
To elect to amortize start-up or organizational
costs, you must complete and attach Form
4562 to your return for the first tax year you are
in business. You also may be required to attach
Chapter 8 Amortization Page 29
Organizational costs election statement (descri-
bed later) to your return.
For start-up or organizational costs paid or
incurred after September 8, 2008, an accompa-
nying statement isn't required. Generally, for
start-up or organizational costs paid or incurred
before September 9, 2008, and after October
22, 2004, unless you choose to apply Regula-
tions sections 1.195-1, 1.248-1, and 1.709-1,
you also must attach an accompanying state-
ment to elect to amortize the costs.
If you have both start-up and organizational
costs, attach a separate statement (if required)
to your return for each type of cost. See Starting
a Business, earlier, for more information.
Generally, you must file the return by the
due date (including any extensions). However,
if you timely filed your return for the year without
making the election, you can still make the elec-
tion by filing an amended return within 6 months
of the due date of the return (excluding exten-
sions). For more information, see the instruc-
tions for Part VI of Form 4562.
You can choose to forgo the election to am-
ortize by affirmatively electing to capitalize your
start-up or organizational costs on your income
tax return filed by the due date (including exten-
sions) for the tax year in which the active trade
or business begins.
Note. The election to either amortize or
capitalize start-up or organizational costs is ir-
revocable and applies to all start-up and organi-
zational costs that are related to the trade or
business.
If your business is organized as a corpora-
tion or partnership, only the corporation or part-
nership can elect to amortize its start-up or or-
ganizational costs. A shareholder or partner
can't make this election. You, as a shareholder
or partner, can't amortize any costs you incur in
setting up your corporation or partnership. Only
the corporation or partnership can amortize
these costs.
However, you, as an individual, can elect to
amortize costs you incur to investigate an inter-
est in an existing partnership. These costs qual-
ify as business start-up costs if you acquire the
partnership interest.
Start-up costs election statement. If you
elect to amortize your start-up costs, attach a
separate statement (if required) that contains
the following information.
• A description of the business to which the
start-up costs relate.
• A description of each start-up cost incur-
red.
• The month your active business began (or
was acquired).
• The number of months in your amortization
period (which is generally 180 months).
Filing the statement early. You can elect
to amortize your start-up costs by filing the
statement with a return for any tax year before
the year your active business begins. If you file
the statement early, the election becomes ef-
fective in the month of the tax year your active
business begins.
Revised statement. You can file a revised
statement to include any start-up costs not in-
cluded in your original statement. However, you
can't include on the revised statement any cost
you previously treated on your return as a cost
other than a start-up cost. You can file the re-
vised statement with a return filed after the re-
turn on which you elected to amortize your
start-up costs.
Organizational costs election statement. If
you elect to amortize your corporation's or part-
nership's organizational costs, attach a sepa-
rate statement (if required) that contains the fol-
lowing information.
• A description of each cost.
• The amount of each cost.
• The date each cost was incurred.
• The month your corporation or partnership
began active business (or acquired the
business).
• The number of months in your amortization
period (which is generally 180 months).
Partnerships. The statement prepared for
a cash basis partnership also must indicate the
amount paid before the end of the year for each
cost.
You don't need to separately list any part-
nership organizational cost that is less than
$10. Instead, you can list the total amount of
these costs with the dates the first and last
costs were incurred.
After a partnership makes the election to
amortize organizational costs, it can later file an
amended return to include additional organiza-
tional costs not included in the partnership's
original return and statement.
Getting a Lease
If you get a lease for business property, you
may recover the cost of acquiring the lease by
amortizing it over the term of the lease. The
term of the lease for amortization purposes gen-
erally includes all renewal options (and any
other period for which you and the lessor rea-
sonably expect the lease to be renewed). How-
ever, renewal periods aren't included if 75% or
more of the cost of acquiring the lease is for the
term of the lease remaining on the acquisition
date (not including any period for which you
may choose to renew, extend, or continue the
lease).
For more information on the costs of getting
a lease, see Cost of Getting a Lease in
chapter 3.
How to amortize. Enter your deduction in Part
VI of Form 4562 if you are deducting amortiza-
tion that begins during the current year, or on
the appropriate line of your tax return if you
aren't otherwise required to file Form 4562.
Section 197 Intangibles
Generally, you may amortize the capitalized
costs of “section 197 intangibles” (see Section
197 Intangibles Defined, later) ratably over a
15-year period. You must amortize these costs
if you hold the section 197 intangibles in con-
nection with your trade or business or in an ac-
tivity engaged in for the production of income.
You may not be able to amortize sec-
tion 197 intangibles acquired in a trans-
action that didn't result in a significant
change in ownership or use. See Anti-Churning
Rules, later.
Your amortization deduction each year is
the applicable part of the intangible's adjusted
basis (for purposes of determining gain), fig-
ured by amortizing it ratably over 15 years (180
months). The 15-year period begins with the
later of:
• The month the intangible is acquired, or
• The month the trade or business or activity
engaged in for the production of income
begins.
You can't deduct amortization for the month you
dispose of the intangible.
If you pay or incur an amount that increases
the basis of an amortizable section 197 intangi-
ble after the 15-year period begins, amortize it
over the remainder of the 15-year period begin-
ning with the month the basis increase occurs.
You aren't allowed any other depreciation or
amortization deduction for an amortizable sec-
tion 197 intangible.
Tax-exempt use property subject to a lease.
The amortization period for any section 197 in-
tangible leased under a lease agreement en-
tered into after March 12, 2004, to a tax-exempt
organization, governmental unit, or foreign per-
son or entity (other than a partnership), shall not
be less than 125% of the lease term.
Cost attributable to other property. The
rules for section 197 intangibles don't apply to
any amount that is included in determining the
cost of property that isn't a section 197 intangi-
ble. For example, if the cost of computer soft-
ware isn't separately stated from the cost of
hardware or other tangible property and you
consistently treat it as part of the cost of the
hardware or other tangible property, these rules
don't apply. Similarly, none of the cost of acquir-
ing real property held for the production of
rental income is considered the cost of good-
will, going concern value, or any other section
197 intangible.
Section 197 Intangibles
Defined
The following assets are section 197 intangibles
and must be amortized over 180 months.
1. Goodwill.
2. Going concern value.
3. Workforce in place.
4. Business books and records, operating
systems, or any other information base, in-
cluding lists or other information concern-
ing current or prospective customers.
5. A patent, copyright, formula, process, de-
sign, pattern, know-how, format, or similar
item.CAUTION
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Page 30 Chapter 8 Amortization
6. A customer-based intangible.
7. A supplier-based intangible.
8. Any item similar to items 3 through 7.
9. A license, permit, or other right granted by
a governmental unit or agency (including
issuances and renewals).
10. A covenant not to compete entered into in
connection with the acquisition of an inter-
est in a trade or business.
11. Any franchise, trademark, or trade name.
12. A contract for the use of, or a term interest
in, any item in this list.
You can't amortize any of the intangi-
bles listed in items 1 through 8 that you
created rather than acquired unless
you created them in acquiring assets that make
up a trade or business or a substantial part of a
trade or business.
Goodwill. This is the value of a trade or busi-
ness based on expected continued customer
patronage due to its name, reputation, or any
other factor.
Going concern value. This is the additional
value of a trade or business that attaches to
property because the property is an integral
part of an ongoing business activity. It includes
value based on the ability of a business to con-
tinue to function and generate income even
though there is a change in ownership (but
doesn't include any other section 197 intangi-
ble). It also includes value based on the imme-
diate use or availability of an acquired trade or
business, such as the use of earnings during
any period in which the business wouldn't other-
wise be available or operational.
Workforce in place, etc. This includes the
composition of a workforce (for example, its ex-
perience, education, or training). It also includes
the terms and conditions of employment,
whether contractual or otherwise, and any other
value placed on employees or any of their at-
tributes.
For example, you must amortize the part of
the purchase price of a business that is for the
existence of a highly skilled workforce. Also,
you must amortize the cost of acquiring an ex-
isting employment contract or relationship with
employees or consultants.
Business books and records, etc. This in-
cludes the intangible value of technical man-
uals, training manuals or programs, data files,
and accounting or inventory control systems. It
also includes the cost of customer lists, sub-
scription lists, insurance expirations, patient or
client files, and lists of newspaper, magazine,
radio, and television advertisers.
Patents, copyrights, etc. This includes pack-
age design, computer software, and any inter-
est in a film, sound recording, videotape, book,
or other similar property, except as discussed
later under Assets That aren't Section 197 In-
tangibles.
Customer-based intangible. This is the com-
position of market, market share, and any otherCAUTION
!
value resulting from the future provision of
goods or services because of relationships with
customers in the ordinary course of business.
For example, you must amortize the part of the
purchase price of a business that is for the exis-
tence of the following intangibles.
• A customer base.
• A circulation base.
• An undeveloped market or market growth.
• Insurance in force.
• A mortgage servicing contract.
• An investment management contract.
• Any other relationship with customers in-
volving the future provision of goods or
services.
Accounts receivable or other similar rights to
income for goods or services provided to cus-
tomers before the acquisition of a trade or busi-
ness aren't section 197 intangibles.
Supplier-based intangible. A supplier-based
intangible is the value resulting from the future
acquisitions (through contract or other relation-
ships with suppliers in the ordinary course of
business) of goods or services that you will sell
or use. The amount you pay or incur for sup-
plier-based intangibles includes, for example,
any portion of the purchase price of an acquired
trade or business that is attributable to the exis-
tence of a favorable relationship with persons
providing distribution services (such as a favor-
able shelf or display space or a retail outlet), or
the existence of favorable supply contracts.
Don't include any amount required to be paid
for the goods or services to honor the terms of
the agreement or other relationship. Also, see
Assets That aren't Section 197 Intangibles,
later.
Government-granted license, permit, etc.
This is any right granted by a governmental unit
or an agency or instrumentality of a governmen-
tal unit. For example, you must amortize the
capitalized costs of acquiring (including issuing
or renewing) a liquor license, a taxicab medal-
lion or license, or a television or radio broad-
casting license.
Covenant not to compete. Section 197 intan-
gibles include a covenant not to compete (or
similar arrangement) entered into in connection
with the acquisition of an interest in a trade or
business, or a substantial portion of a trade or
business. An interest in a trade or business in-
cludes an interest in a partnership or a corpora-
tion engaged in a trade or business.
An arrangement that requires the former
owner to perform services (or to provide prop-
erty or the use of property) isn't similar to a cov-
enant not to compete to the extent the amount
paid under the arrangement represents reason-
able compensation for those services or for that
property or its use.
Franchise, trademark, or trade name. A
franchise, trademark, or trade name is a section
197 intangible. You must amortize its purchase
or renewal costs, other than certain contingent
payments that you can deduct currently. For in-
formation on currently deductible contingent
payments, see chapter 11.
Professional sports franchise. A fran-
chise engaged in professional sports and any
intangible assets acquired in connection with
acquiring the franchise (including player con-
tracts) is a section 197 intangible amortizable
over a 15-year period.
Contract for the use of, or a term interest in,
a section 197 intangible. Section 197 intangi-
bles include any right under a license, contract,
or other arrangement providing for the use of
any section 197 intangible. It also includes any
term interest in any section 197 intangible,
whether the interest is outright or in trust.
Assets That aren't Section
197 Intangibles
The following assets aren't section 197 intangi-
bles.
1. Any interest in a corporation, partnership,
trust, or estate.
2. Any interest under an existing futures con-
tract, foreign currency contract, notional
principal contract, interest rate swap, or
similar financial contract.
3. Any interest in land.
4. Most computer software. (See Computer
software, later.)
5. Any of the following assets not acquired in
connection with the acquisition of a trade
or business or a substantial part of a trade
or business.
a. An interest in a film, sound recording,
video tape, book, or similar property.
b. A right to receive tangible property or
services under a contract or from a
governmental agency.
c. An interest in a patent or copyright.
d. Certain rights that have a fixed dura-
tion or amount. (See Rights of fixed
duration or amount, later.)
6. An interest under either of the following.
a. An existing lease or sublease of tangi-
ble property.
b. A debt that was in existence when the
interest was acquired.
7. A right to service residential mortgages
unless the right is acquired in connection
with the acquisition of a trade or business
or a substantial part of a trade or business.
8. Certain transaction costs incurred by par-
ties to a corporate organization or reorgan-
ization in which any part of a gain or loss
isn't recognized.
Intangible property that isn't amortizable un-
der the rules for section 197 intangibles can be
depreciated if it meets certain requirements.
You generally must use the straight line method
over its useful life. For certain intangibles, the
depreciation period is specified in the law and
regulations. For example, the depreciation pe-
riod for computer software that isn't a section
197 intangible is generally 36 months.
For more information on depreciating intan-
gible property, see Intangible Property under
What Method Can You Use To Depreciate Your
Property? in chapter 1 of Pub. 946.
Chapter 8 Amortization Page 31
Computer software. Section 197 intangibles
don’t include the following types of computer
software.
1. Software that meets all the following re-
quirements.
a. It is, or has been, readily available for
purchase by the general public.
b. It is subject to a nonexclusive license.
c. It hasn't been substantially modified.
This requirement is considered met if
the cost of all modifications isn't more
than the greater of 25% of the price of
the publicly available unmodified soft-
ware or $2,000.
2. Software that isn't acquired in connection
with the acquisition of a trade or business
or a substantial part of a trade or business.
Computer software defined. Computer
software includes all programs designed to
cause a computer to perform a desired function.
It also includes any database or similar item that
is in the public domain and is incidental to the
operation of qualifying software.
Rights of fixed duration or amount. Section
197 intangibles don't include any right under a
contract or from a governmental agency if the
right is acquired in the ordinary course of a
trade or business (or in an activity engaged in
for the production of income) but not as part of a
purchase of a trade or business and either:
• Has a fixed life of less than 15 years; or
• Is of a fixed amount that, except for the
rules for section 197 intangibles, would be
recovered under a method similar to the
unit-of-production method of cost recov-
ery.
However, this doesn't apply to the following in-
tangibles.
• Goodwill.
• Going concern value.
• A covenant not to compete.
• A franchise, trademark, or trade name.
• A customer-related information base, cus-
tomer-based intangible, or similar item.
Safe Harbor for Creative
Property Costs
If you are engaged in the trade or business of
film production, you may be able to amortize the
creative property costs for properties not set for
production within 3 years of the first capitalized
transaction. You may amortize these costs rata-
bly over a 15-year period beginning on the first
day of the second half of the tax year in which
you properly write off the costs for financial ac-
counting purposes. If, during the 15-year pe-
riod, you dispose of the creative property rights,
you must continue to amortize the costs over
the remainder of the 15-year period.
Creative property costs include costs paid or
incurred to acquire and develop screenplays,
scripts, story outlines, motion picture production
rights to books and plays, and other similar
properties for purposes of potential future film
development, production, and exploitation.
Amortize these costs using the rules of Rev-
enue Procedure 2004-36. For more information,
see Revenue Procedure 2004-36, 2004-24
I.R.B. 1063, available at
IRS.gov/irb/2004-24_IRB#RP-2004-36.
A change in the treatment of creative
property costs is a change in method of
accounting.
Anti-Churning Rules
Anti-churning rules prevent you from amortizing
most section 197 intangibles if the transaction
in which you acquired them didn't result in a sig-
nificant change in ownership or use. These
rules apply to goodwill and going concern
value, and to any other section 197 intangible
that isn't otherwise depreciable or amortizable.
Under the anti-churning rules, you can't use
15-year amortization for the intangible if any of
the following conditions apply.
1. You or a related person (defined later)
held or used the intangible at any time
from July 25, 1991, through August 10,
1993.
2. You acquired the intangible from a person
who held it at any time during the period in
(1) and, as part of the transaction, the user
didn't change.
3. You granted the right to use the intangible
to a person (or a person related to that
person) who held or used it at any time
during the period in (1). This applies only if
the transaction in which you granted the
right and the transaction in which you ac-
quired the intangible are part of a series of
related transactions. See Related person,
later, for more information.
Exceptions. The anti-churning rules don't ap-
ply in the following situations.
• You acquired the intangible from a dece-
dent and its basis was stepped up to its
FMV.
• The intangible was amortizable as a sec-
tion 197 intangible by the seller or trans-
feror you acquired it from. This exception
doesn't apply if the transaction in which
you acquired the intangible and the trans-
action in which the seller or transferor ac-
quired it are part of a series of related
transactions.
• The gain-recognition exception, discussed
later, applies.
Related person. For purposes of the
anti-churning rules, the following are related
persons.
• An individual and his or her brothers, sis-
ters, half-brothers, half-sisters, spouse, an-
cestors (parents, grandparents, etc.), and
lineal descendants (children, grandchil-
dren, etc.).
• A corporation and an individual who owns,
directly or indirectly, more than 20% of the
value of the corporation's outstanding
stock.
• Two corporations that are members of the
same controlled group as defined in sec-
tion 1563(a), except that “more than 20%”
is substituted for “at least 80%” in that defi-
nition and the determination is made with-
out regard to subsections (a)(4) and (e)(3)CAUTION
!
(C) of section 1563. For an exception, see
section 1.197-2(h)(6)(iv) of the regulations.
• A trust fiduciary and a corporation if more
than 20% of the value of the corporation's
outstanding stock is owned, directly or in-
directly, by or for the trust or grantor of the
trust.
• The grantor and fiduciary, and the fiduciary
and beneficiary, of any trust.
• The fiduciaries of two different trusts, and
the fiduciaries and beneficiaries of two dif-
ferent trusts, if the same person is the
grantor of both trusts.
• The executor and beneficiary of an estate.
• A tax-exempt educational or charitable or-
ganization and a person who directly or in-
directly controls the organization (or whose
family members control it).
• A corporation and a partnership if the
same persons own more than 20% of the
value of the outstanding stock of the cor-
poration and more than 20% of the capital
or profits interest in the partnership.
• Two S corporations, and an S corporation
and a regular corporation, if the same per-
sons own more than 20% of the value of
the outstanding stock of each corporation.
• Two partnerships if the same persons own,
directly or indirectly, more than 20% of the
capital or profits interests in both partner-
ships.
• A partnership and a person who owns, di-
rectly or indirectly, more than 20% of the
capital or profits interests in the partner-
ship.
• Two persons who are engaged in trades or
businesses under common control (as de-
scribed in section 41(f)(1)).
When to determine relationship. Persons
are treated as related if the relationship existed
at the following time.
• In the case of a single transaction, immedi-
ately before or immediately after the trans-
action in which the intangible was ac-
quired.
• In the case of a series of related transac-
tions (or a series of transactions that com-
prise a qualified stock purchase under sec-
tion 338(d)(3)), immediately before the
earliest transaction or immediately after the
last transaction.
Ownership of stock. In determining
whether an individual directly or indirectly owns
any of the outstanding stock of a corporation,
the following rules apply.
Rule 1. Stock directly or indirectly owned
by or for a corporation, partnership, estate, or
trust is considered owned proportionately by or
for its shareholders, partners, or beneficiaries.
Rule 2. An individual is considered to own
the stock directly or indirectly owned by or for
his or her family. Family includes only brothers
and sisters, half-brothers and half-sisters,
spouse, ancestors, and lineal descendants.
Rule 3. An individual owning (other than by
applying Rule 2) any stock in a corporation is
considered to own the stock directly or indi-
rectly owned by or for his or her partner.
Page 32 Chapter 8 Amortization
Rule 4. For purposes of applying Rule 1, 2,
or 3, treat stock constructively owned by a per-
son under Rule 1 as actually owned by that per-
son. Don't treat stock constructively owned by
an individual under Rule 2 or 3 as owned by the
individual for reapplying Rule 2 or 3 to make an-
other person the constructive owner of the
stock.
Gain-recognition exception. This exception
to the anti-churning rules applies if the person
you acquired the intangible from (the transferor)
meets both of the following requirements.
• That person wouldn't be related to you (as
described under Related person, earlier) if
the 20% test for ownership of stock and
partnership interests were replaced by a
50% test.
• That person chose to recognize gain on
the disposition of the intangible and pay in-
come tax on the gain at the highest tax
rate. See chapter 2 in Pub. 544 for infor-
mation on making this choice.
If this exception applies, the anti-churning
rules apply only to the amount of your adjusted
basis in the intangible that is more than the gain
recognized by the transferor.
Notification. If the person you acquired the
intangible from chooses to recognize gain un-
der the rules for this exception, that person
must notify you in writing by the due date of the
return on which the choice is made.
Anti-abuse rule. You can't amortize any sec-
tion 197 intangible acquired in a transaction for
which the principal purpose was either of the
following.
• To avoid the requirement that the intangi-
ble be acquired after August 10, 1993.
• To avoid any of the anti-churning rules.
More information. For more information about
the anti-churning rules, including additional
rules for partnerships, see Regulations section
1.197-2(h).
Incorrect Amount of
Amortization Deducted
If you later discover that you deducted an incor-
rect amount for amortization for a section 197
intangible in any year, you may be able to make
a correction for that year by filing an amended
return. See Amended Return next. If you aren't
allowed to make the correction on an amended
return, you can change your accounting method
to claim the correct amortization. See Changing
Your Accounting Method, later.
Amended Return
If you deducted an incorrect amount for amorti-
zation, you can file an amended return to cor-
rect the following.
• A mathematical error made in any year.
• A posting error made in any year.
• An amortization deduction for a section
197 intangible for which you haven't adop-
ted a method of accounting.
When to file. If an amended return is allowed,
you must file it by the later of the following
dates.
• 3 years from the date you filed your original
return for the year in which you didn't de-
duct the correct amount. (A return filed
early is considered filed on the due date.)
• 2 years from the time you paid your tax for
that year.
Changing Your Accounting Method
Generally, you must get IRS approval to change
your method of accounting. File Form 3115 to
request a change to a permissible method of
accounting for amortization.
The following are examples of a change in
method of accounting for amortization.
• A change in the amortization method, pe-
riod of recovery, or convention of an amor-
tizable asset.
• A change in the accounting for amortizable
assets from a single asset account to a
multiple asset account (pooling), or vice
versa.
• A change in the accounting for amortizable
assets from one type of multiple asset ac-
count to a different type of multiple asset
account.
Changes in amortization that aren't a
change in method of accounting include the fol-
lowing.
• A change in figuring amortization in the tax
year in which your use of the asset
changes.
• An adjustment in the useful life of an amor-
tizable asset.
• Generally, the making of a late amortiza-
tion election or the revocation of a timely
valid amortization election.
• Any change in the placed-in-service date
of an amortizable asset.
See Regulations section 1.446-1(e)(2)(ii)(a)
for more information and examples.
Automatic approval. In some instances, you
may be able to get automatic approval from the
IRS to change your method of accounting for
amortization. For a list of automatic accounting
method changes, see the Instructions for Form
3115. Also, see the Instructions for Form 3115
for more information on getting approval, auto-
matic approval procedures, and a list of excep-
tions to the automatic approval process.
Disposition of Section 197
Intangibles
A section 197 intangible is treated as deprecia-
ble property used in your trade or business. If
you held the intangible for more than 1 year,
any gain on its disposition, up to the amount of
allowable amortization, is ordinary income (sec-
tion 1245 gain). If multiple section 197 intangi-
bles are disposed of in a single transaction or a
series of related transactions, treat all of the
section 197 intangibles as if they were a single
asset for purposes of determining the amount of
gain that is ordinary income. Any remaining
gain, or any loss, is a section 1231 gain or loss.
If you held the intangible 1 year or less, any
gain or loss on its disposition is an ordinary gain
or loss. For more information on ordinary or
capital gain or loss on business property, see
chapter 3 in Pub. 544.
Nondeductible loss. You can't deduct any
loss on the disposition or worthlessness of a
section 197 intangible that you acquired in the
same transaction (or series of related transac-
tions) as other section 197 intangibles you still
have. Instead, increase the adjusted basis of
each remaining amortizable section 197 intangi-
ble by a proportionate part of the nondeductible
loss. Figure the increase by multiplying the non-
deductible loss on the disposition of the intangi-
ble by the following fraction.
• The numerator is the adjusted basis of
each remaining intangible on the date of
the disposition.
• The denominator is the total adjusted
bases of all remaining amortizable section
197 intangibles on the date of the disposi-
tion.
Covenant not to compete. A covenant not to
compete, or similar arrangement, isn't consid-
ered disposed of or worthless before you dis-
pose of your entire interest in the trade or busi-
ness for which you entered into the covenant.
Nonrecognition transfers. If you acquire a
section 197 intangible in a nonrecognition trans-
fer, you are treated as the transferor with re-
spect to the part of your adjusted basis in the in-
tangible that isn't more than the transferor's
adjusted basis. You amortize this part of the ad-
justed basis over the intangible's remaining am-
ortization period in the hands of the transferor.
Nonrecognition transfers include transfers to a
corporation, partnership contributions and dis-
tributions, like-kind exchanges, and involuntary
conversions.
In a like-kind exchange or involuntary con-
version of a section 197 intangible, you must
continue to amortize the part of your adjusted
basis in the acquired intangible that isn't more
than your adjusted basis in the exchanged or
converted intangible over the remaining amorti-
zation period of the exchanged or converted in-
tangible. Amortize over a new 15-year period
the part of your adjusted basis in the acquired
intangible that is more than your adjusted basis
in the exchanged or converted intangible.
Example. You own a section 197 intangible
you have amortized for 4 full years. It has a re-
maining unamortized basis of $30,000. You ex-
change the asset plus $10,000 for a like-kind
section 197 intangible. The nonrecognition pro-
visions of like-kind exchanges apply. You amor-
tize $30,000 of the $40,000 adjusted basis of
the acquired intangible over the 11 years re-
maining in the original 15-year amortization pe-
riod for the transferred asset. You amortize the
other $10,000 of adjusted basis over a new
15-year period. For more information, see Reg-
ulations section 1.197-2(g).
Reforestation Costs
You can elect to deduct a limited amount of re-
forestation costs paid or incurred during the tax
Chapter 8 Amortization Page 33
year. See Reforestation Costs in chapter 7. You
can elect to amortize the qualifying costs that
aren't deducted currently over an 84-month pe-
riod. There is no limit on the amount of your am-
ortization deduction for reforestation costs paid
or incurred during the tax year.
The election to amortize reforestation costs
incurred by a partnership, S corporation, or es-
tate must be made by the partnership, corpora-
tion, or estate. A partner, shareholder, or bene-
ficiary can't make that election.
A partner's or shareholder's share of amor-
tizable costs is figured under the general rules
for allocating items of income, loss, deduction,
etc., of a partnership or S corporation. The am-
ortizable costs of an estate are divided between
the estate and the income beneficiary based on
the income of the estate allocable to each.
Qualifying costs. Reforestation costs are the
direct costs of planting or seeding for foresta-
tion or reforestation. Qualifying costs include
only those costs you must capitalize and in-
clude in the adjusted basis of the property.
They include costs for the following items.
• Site preparation.
• Seeds or seedlings.
• Labor.
• Tools.
• Depreciation on equipment used in plant-
ing and seeding.
Qualifying costs don't include costs for
which the government reimburses you under a
cost-sharing program, unless you include the
reimbursement in your income.
Qualified timber property. Qualified timber
property is property that contains trees in signif-
icant commercial quantities. It can be a woodlot
or other site that you own or lease. The property
qualifies only if it meets all of the following re-
quirements.
• It is located in the United States.
• It is held for the growing and cutting of tim-
ber you will either use in, or sell for use in,
the commercial production of timber prod-
ucts.
• It consists of at least one acre planted with
tree seedlings in the manner normally used
in forestation or reforestation.
Qualified timber property doesn't include
property on which you have planted shelter
belts or ornamental trees, such as Christmas
trees.
Amortization period. The 84-month amortiza-
tion period starts on the first day of the first
month of the second half of the tax year you in-
cur the costs (July 1 for a calendar year tax-
payer), regardless of the month you actually in-
cur the costs. You can claim amortization
deductions for no more than 6 months of the
first and last (eighth) tax years of the period.
Life tenant and remainderman. If one person
holds the property for life with the remainder go-
ing to another person, the life tenant is entitled
to the full amortization for qualifying reforesta-
tion costs incurred by the life tenant. Any re-
mainder interest in the property is ignored for
amortization purposes.
Recapture. If you dispose of qualified timber
property within 10 years after the tax year you
incur qualifying reforestation expenses, report
any gain as ordinary income up to the amortiza-
tion you took. See chapter 3 of Pub. 544 for
more information.
How to make the election. To elect to amor-
tize qualifying reforestation costs, complete Part
VI of Form 4562 and attach a statement that
contains the following information.
• A description of the costs and the dates
you incurred them.
• A description of the type of timber being
grown and the purpose for which it is
grown.
Attach a separate statement for each property
for which you amortize reforestation costs.
Generally, you must make the election on a
timely filed return (including extensions) for the
tax year in which you incurred the costs. How-
ever, if you timely filed your return for the year
without making the election, you can still make
the election by filing an amended return within 6
months of the due date of the return (excluding
extensions). Attach Form 4562 and the state-
ment to the amended return and write “Filed
pursuant to section 301.9100-2” on Form 4562.
File the amended return at the same address
you filed the original return.
Revoking the election. You must get IRS ap-
proval to revoke your election to amortize quali-
fying reforestation costs. Your application to re-
voke the election must include your name,
address, the years for which your election was
in effect, and your reason for revoking it. Please
provide your daytime telephone number (op-
tional), in case we need to contact you. You, or
your duly authorized representative, must sign
the application and file it at least 90 days before
the due date (without extensions) for filing your
income tax return for the first tax year for which
your election is to end.
Send the application to:
Internal Revenue Service
Associate Chief Counsel
Passthroughs and Special Industries
CC:PSI:6
1111 Constitution Ave. NW, IR-5300
Washington, DC 20224
Geological and
Geophysical Costs
You can amortize the cost of geological and ge-
ophysical expenses paid or incurred in connec-
tion with oil and gas exploration or development
within the United States. These costs can be
amortized ratably over a 24-month period be-
ginning on the mid-point of the tax year in which
the expenses were paid or incurred. For major
integrated oil companies (as defined in section
167(h)(5)), these costs must be amortized rata-
bly over a 5-year period for costs paid or incur-
red after May 17, 2006 (a 7-year period for
costs paid or incurred after December 19,
2007).
If you retire or abandon the property during
the amortization period, no amortization deduc-
tion is allowed in the year of retirement or aban-
donment.
Pollution Control
Facilities
You can elect to amortize the cost of a certified
pollution control facility over 60 months. How-
ever, see Atmospheric pollution control facili-
ties, later, for an exception. The cost of a pollu-
tion control facility that isn't eligible for
amortization can be depreciated under the reg-
ular rules for depreciation. Also, you can claim a
special depreciation allowance on a certified
pollution control facility that is qualified property
even if you elect to amortize its cost. You must
reduce its cost (amortizable basis) by the
amount of any special allowance you claim.
See chapter 3 of Pub. 946.
A certified pollution control facility is a new
identifiable treatment facility used in connection
with a plant or other property in operation be-
fore 1976 to reduce or control water or atmos-
pheric pollution or contamination. The facility
must do so by removing, changing, disposing,
storing, or preventing the creation or emission
of pollutants, contaminants, wastes, or heat.
The facility must be certified by state and fed-
eral certifying authorities.
The facility must not significantly increase
the output or capacity, extend the useful life, or
reduce the total operating costs of the plant or
other property. Also, it must not significantly
change the nature of the manufacturing or pro-
duction process or facility.
The federal certifying authority won't certify
your property to the extent it appears you will
recover (over the property's useful life) all or
part of its cost from the profit based on its oper-
ation (such as through sales of recovered
wastes). The federal certifying authority will de-
scribe the nature of the potential cost recovery.
You must then reduce the amortizable basis of
the facility by this potential recovery.
New identifiable treatment facility. A
new identifiable treatment facility is tangible de-
preciable property that is identifiable as a treat-
ment facility. It doesn't include a building and its
structural components unless the building is ex-
clusively a treatment facility.
Atmospheric pollution control facilities.
Certain atmospheric pollution control facilities
can be amortized over 84 months. To qualify,
the following must apply.
• The facility must be acquired and placed in
service after April 11, 2005. If acquired, the
original use must begin with you after April
11, 2005.
• The facility must be used in connection
with an electric generation plant or other
property placed in operation after Decem-
ber 31, 1975, that is primarily coal fired.
• If you construct, reconstruct, or erect the
facility, only the basis attributable to the
construction, reconstruction, or erection
completed after April 11, 2005, qualifies.
Page 34 Chapter 8 Amortization
Basis reduction for corporations. A corpora-
tion must reduce the amortizable basis of a pol-
lution control facility by 20% before figuring the
amortization deduction.
More information. For more information on
the amortization of pollution control facilities,
see sections 169 and 291(c) and the related
regulations.
Research and
Experimental Costs
You can elect to amortize your research and ex-
perimental costs, deduct them as current busi-
ness expenses, or write them off over a 10-year
period (see Optional write-off method below).
If you elect to amortize these costs, deduct
them in equal amounts over 60 months or more.
The amortization period begins the month you
first receive an economic benefit from the costs.
For a definition of “research and experimen-
tal costs” and information on deducting them as
current business expenses, see chapter 7.
Optional write-off method. Rather than am-
ortize these costs or deduct them as a current
expense, you have the option of deducting
(writing off) research and experimental costs
ratably over a 10-year period beginning with the
tax year in which you incurred the costs. For
more information, see Optional Write-Off of
Certain Tax Preferences, later, and section
59(e).
Costs you can amortize. You can amortize
costs chargeable to a capital account (see
chapter 1) if you meet both of the following re-
quirements.
• You paid or incurred the costs in your trade
or business.
• You aren't deducting the costs currently.
How to make the election. To elect to amor-
tize research and experimental costs, complete
Part VI of Form 4562 and attach it to your in-
come tax return. Generally, you must file the re-
turn by the due date (including extensions).
However, if you timely filed your return for the
year without making the election, you can still
make the election by filing an amended return
within 6 months of the due date of the return
(excluding extensions). Attach Form 4562 to
the amended return and write “Filed pursuant to
section 301.9100-2” on Form 4562. File the
amended return at the same address you filed
the original return.
Your election is binding for the year it is
made and for all later years unless you obtain
approval from the IRS to change to a different
method.
Optional Write-Off of
Certain Tax Preferences
You can elect to amortize certain tax preference
items over an optional period beginning in the
tax year in which you incurred the costs. If you
make this election, there is no AMT adjustment.
The applicable costs and the optional recovery
periods are as follows.
• Circulation costs—3 years.
• Intangible drilling and development
costs—60 months.
• Mining exploration and development
costs—10 years.
• Research and experimental costs—10
years.
How to make the election. To elect to amor-
tize qualifying costs over the optional recovery
period, complete Part VI of Form 4562 and at-
tach a statement containing the following infor-
mation to your return for the tax year in which
the election begins.
• Your name, address, and taxpayer identifi-
cation number.
• The type of cost and the specific amount of
the cost for which you are making the elec-
tion.
Generally, the election must be made on a
timely filed return (including extensions) for the
tax year in which you incurred the costs. How-
ever, if you timely filed your return for the year
without making the election, you can still make
the election by filing an amended return within 6
months of the due date of the return (excluding
extensions). Attach Form 4562 to the amended
return and write “Filed pursuant to section
301.9100-2” on Form 4562. File the amended
return at the same address you filed the original
return.
Revoking the election. You must obtain con-
sent from the IRS to revoke your election. Your
request to revoke the election must be submit-
ted to the IRS in the form of a letter ruling before
the end of the tax year in which the optional re-
covery period ends. The request must contain
all of the information necessary to demonstrate
the rare and unusual circumstances that would
justify granting revocation. If the request for rev-
ocation is approved, any unamortized costs are
deductible in the year the revocation is effec-
tive.
9.
Depletion
Introduction
Depletion is the using up of natural resources
by mining, drilling, quarrying stone, or cutting
timber. The depletion deduction allows an
owner or operator to account for the reduction
of a product's reserves.
There are two ways of figuring depletion:
cost depletion and percentage depletion. For
mineral property, you generally must use the
method that gives you the larger deduction. For
standing timber, you must use cost depletion.
Topics
This chapter discusses:
• Who can claim depletion
• Mineral property
• Timber
Useful Items
You may want to see:
Publication
544 Sales and Other Dispositions of
Assets
551 Basis of Assets
Form (and Instructions)
Schedule E (Form 1040) Supplemental
Income and Loss
Schedule K-1 (Form 1065) Partner's
Share of Income, Deductions,
Credits, etc.
Schedule K-1 (Form 1120S)
Shareholder's Share of Income,
Deductions, Credits, etc.
6198 At-Risk Limitations
8582 Passive Activity Loss Limitations
T (Timber) Forest Activities Schedule
See chapter 13 for information about getting
publications and forms.
Who Can Claim
Depletion?
If you have an economic interest in mineral
property or standing timber, you can take a de-
duction for depletion. More than one person
can have an economic interest in the same min-
eral deposit or timber. In the case of leased
property, the depletion deduction is divided be-
tween the lessor and the lessee.
You have an economic interest if both the
following apply.
• You have acquired by investment any in-
terest in mineral deposits or standing tim-
ber.
• You have a legal right to income from the
extraction of the mineral or cutting of the
timber to which you must look for a return
of your capital investment.
A contractual relationship that allows you an
economic or monetary advantage from prod-
ucts of the mineral deposit or standing timber is
not, in itself, an economic interest. A production
payment carved out of, or retained on the sale
of, mineral property is not an economic interest.
Individuals, estates, and trusts who
claim depletion deductions may be lia-
ble for the AMT. For tax years begin-
ning after 2017, the Tax Cuts and Jobs Act,
section 12001, repealed the corporate AMT.
Basis adjustment for depletion. You must
reduce the basis of your property by the deple-
tion allowed or allowable, whichever is greater.
Schedule E (Form 1040)
Schedule K-1 (Form 1065)
Schedule K-1 (Form 1120S)
6198
8582
T (Timber)CAUTION
!
Chapter 9 Depletion Page 35
Mineral Property
Mineral property includes oil and gas wells,
mines, and other natural deposits (including ge-
othermal deposits). For this purpose, the term
“property” means each separate interest you
own in each mineral deposit in each separate
tract or parcel of land. You can treat two or
more separate interests as one property or as
separate properties. See section 614 and the
related regulations for rules on how to treat sep-
arate mineral interests.
There are two ways of figuring depletion on
mineral property.
• Cost depletion.
• Percentage depletion.
Generally, you must use the method that gives
you the larger deduction. However, unless you
are an independent producer or royalty owner,
you generally cannot use percentage depletion
for oil and gas wells. See Oil and Gas Wells,
later.
Cost Depletion
To figure cost depletion, you must first deter-
mine the following.
• The property's basis for depletion.
• The total recoverable units of mineral in the
property's natural deposit.
• The number of units of mineral sold during
the tax year.
Basis for depletion. To figure the property's
basis for depletion, subtract all the following
from the property's adjusted basis.
1. Amounts recoverable through:
a. Depreciation deductions,
b. Deferred expenses (including defer-
red exploration and development
costs), and
c. Deductions other than depletion.
2. The residual value of land and improve-
ments at the end of operations.
3. The cost or value of land acquired for pur-
poses other than mineral production.
Adjusted basis. The adjusted basis of
your property is your original cost or other ba-
sis, plus certain additions and improvements,
and minus certain deductions such as depletion
allowed or allowable and casualty losses. Your
adjusted basis can never be less than zero. See
Pub. 551 for more information on adjusted ba-
sis.
Total recoverable units. The total recovera-
ble units is the sum of the following.
• The number of units of mineral remaining
at the end of the year (including units re-
covered but not sold).
• The number of units of mineral sold during
the tax year (determined under your
method of accounting, as explained next).
You must estimate or determine recoverable
units (tons, pounds, ounces, barrels, thousands
of cubic feet, or other measure) of mineral prod-
ucts using the current industry method and the
most accurate and reliable information you can
obtain. You must include ores and minerals that
are developed, in sight, blocked out, or as-
sured. You must also include probable or pro-
spective ores or minerals that are believed to
exist based on good evidence. But see Elective
safe harbor for owners of oil and gas property,
later.
Number of units sold. You determine the
number of units sold during the tax year based
on your method of accounting. Use the follow-
ing table to make this determination.
IF you
use ...
THEN the units sold during
the year are ...
the cash method
of accounting
the units sold for which you
receive payment during the tax
year (regardless of the year of
sale).
an accrual
method of
accounting
the units sold based on your
inventories and method of
accounting for inventory.
The number of units sold during the tax year
does not include any for which depletion deduc-
tions were allowed or allowable in earlier years.
Figuring the cost depletion deduction.
Once you have figured your property's basis for
depletion, the total recoverable units, and the
number of units sold during the tax year, you
can figure your cost depletion deduction by tak-
ing the following steps.
Step Action Result
1 Divide your property's
basis for depletion by
total recoverable units.
Rate per unit.
2 Multiply the rate per
unit by units sold
during the tax year.
Cost depletion
deduction.
You must keep accounts for the depletion of
each property and adjust these accounts each
year for units sold and depletion claimed.
Elective safe harbor for owners of oil and
gas property. Instead of using the method de-
scribed earlier to determine the total recovera-
ble units, you can use an elective safe harbor. If
you choose the elective safe harbor, the total
recoverable units equal 105% of a property's
proven reserves (both developed and undevel-
oped). For details, see Revenue Procedure
2004-19 on page 563 of I.R.B. 2004-10, availa-
ble at IRS.gov/irb/2004-10_IRB/RP-2004-19.
To make the election, attach a statement to
your timely filed (including extensions) original
return for the first tax year for which the safe
harbor is elected. The statement must indicate
that you are electing the safe harbor provided
by Revenue Procedure 2004-19. The election, if
made, is effective for the tax year in which it is
made and all later years. It cannot be revoked
for the tax year in which it is elected, but may be
revoked in a later year. Once revoked, it cannot
be re-elected for the next 5 years.
Percentage Depletion
To figure percentage depletion, you multiply a
certain percentage, specified for each mineral,
by your gross income from the property during
the tax year.
The rates to be used and other rules for oil
and gas wells are discussed later under Inde-
pendent Producers and Royalty Owners and
under Natural Gas Wells. Rates and other rules
for percentage depletion of other specific miner-
als are found later under Mines and Geothermal
Deposits.
Gross income. When figuring percentage de-
pletion, subtract from your gross income from
the property the following amounts.
• Any rents or royalties you paid or incurred
for the property.
• The part of any bonus you paid for a lease
on the property allocable to the product
sold (or that otherwise gives rise to gross
income) for the tax year.
A bonus payment includes amounts you paid as
a lessee to satisfy a production payment re-
tained by the lessor.
Use the following fraction to figure the part
of the bonus you must subtract.
No. of units sold in the tax year
Recoverable units from the property × Bonus
Payments
For oil and gas wells and geothermal depos-
its, more information about the definition of
gross income from the property is under Oil and
Gas Wells, later. For other property, more infor-
mation about the definition of gross income
from the property is under Mines and Geother-
mal Deposits, later.
Taxable income limit. The percentage deple-
tion deduction generally cannot be more than
50% (100% for oil and gas property) of your tax-
able income from the property figured without
the depletion deduction and the domestic pro-
duction activities deduction.
Taxable income from the property means
gross income from the property minus all allow-
able deductions (except any deduction for de-
pletion or domestic production activities) attrib-
utable to mining processes, including mining
transportation. These deductible items include,
but are not limited to, the following.
• Operating expenses.
• Certain selling expenses.
• Administrative and financial overhead.
• Depreciation.
• Intangible drilling and development costs.
• Exploration and development expendi-
tures.
• Deductible taxes (see chapter 5), but not
taxes that you capitalize or take as a credit.
• Losses sustained.
The following rules apply when figuring your
taxable income from the property for purposes
of the taxable income limit.
• Do not deduct any NOL deduction from the
gross income from the property.
• Corporations do not deduct charitable con-
tributions from the gross income from the
property.
• If, during the year, you dispose of an item
of section 1245 property that was used in
connection with mineral property, reduce
any allowable deduction for mining expen-
ses by the part of any gain you must report
as ordinary income that is allocable to the
Page 36 Chapter 9 Depletion
mineral property. See section 1.613-5(b)
(1) of the regulations for information on
how to figure the ordinary gain allocable to
the property.
Oil and Gas Wells
You cannot claim percentage depletion for an
oil or gas well unless at least one of the follow-
ing applies.
• You are either an independent producer or
a royalty owner.
• The well produces natural gas that is either
sold under a fixed contract or produced
from geopressured brine.
If you are an independent producer or roy-
alty owner, see Independent Producers and
Royalty Owners next.
For information on the depletion deduction
for wells that produce natural gas that is either
sold under a fixed contract or produced from
geopressured brine, see Natural Gas Wells,
later.
Independent Producers and
Royalty Owners
If you are an independent producer or royalty
owner, you figure percentage depletion using a
rate of 15% of the gross income from the prop-
erty based on your average daily production of
domestic crude oil or domestic natural gas up to
your depletable oil or natural gas quantity. How-
ever, certain refiners, as explained next, and
certain retailers and transferees of proven oil
and gas properties, as explained next, cannot
claim percentage depletion. For information on
figuring the deduction, see Figuring percentage
depletion, later.
Refiners who cannot claim percentage de-
pletion. You cannot claim percentage deple-
tion if you or a related person refines crude oil
and you and the related person refined more
than 75,000 barrels on any day during the tax
year based on average (rather than actual) daily
refinery runs for the tax year. The average daily
refinery run is figured by dividing total refinery
runs for the tax year by the total number of days
in the tax year.
Related person. You and another person
are related persons if either of you holds a sig-
nificant ownership interest in the other person
or if a third person holds a significant ownership
interest in both of you.
For example, a corporation, partnership, es-
tate, or trust and anyone who holds a significant
ownership interest in it are related persons. A
partnership and a trust are related persons if
one person holds a significant ownership inter-
est in each of them.
For purposes of the related person rules,
significant ownership interest means direct or
indirect ownership of 5% or more in any one of
the following.
• The value of the outstanding stock of a
corporation.
• The interest in the profits or capital of a
partnership.
• The beneficial interests in an estate or
trust.
Any interest owned by or for a corporation,
partnership, trust, or estate is considered to be
owned directly both by itself and proportionately
by its shareholders, partners, or beneficiaries.
Retailers who cannot claim percentage de-
pletion. You cannot claim percentage deple-
tion if both the following apply.
1. You sell oil or natural gas or their by-prod-
ucts directly or through a related person in
any of the following situations.
a. Through a retail outlet operated by
you or a related person.
b. To any person who is required under
an agreement with you or a related
person to use a trademark, trade
name, or service mark or name
owned by you or a related person in
marketing or distributing oil, natural
gas, or their by-products.
c. To any person given authority under
an agreement with you or a related
person to occupy any retail outlet
owned, leased, or controlled by you or
a related person.
2. The combined gross receipts from sales
(not counting resales) of oil, natural gas, or
their by-products by all retail outlets taken
into account in (1) are more than $5 million
for the tax year.
For the purpose of determining if this rule
applies, do not count the following.
• Bulk sales (sales in very large quantities)
of oil or natural gas to commercial or indus-
trial users.
• Bulk sales of aviation fuels to the Depart-
ment of Defense.
• Sales of oil or natural gas or their by-prod-
ucts outside the United States if none of
your domestic production or that of a rela-
ted person is exported during the tax year
or the prior tax year.
Related person. To determine if you and
another person are related persons, see Rela-
ted person under Refiners who cannot claim
percentage depletion, earlier.
Sales through a related person. You are
considered to be selling through a related per-
son if any sale by the related person produces
gross income from which you may benefit be-
cause of your direct or indirect ownership inter-
est in the person.
You are not considered to be selling
through a related person who is a retailer if all
the following apply.
• You do not have a significant ownership in-
terest in the retailer.
• You sell your production to persons who
are not related to either you or the retailer.
• The retailer does not buy oil or natural gas
from your customers or persons related to
your customers.
• There are no arrangements for the retailer
to acquire oil or natural gas you produced
for resale or made available for purchase
by the retailer.
• Neither you nor the retailer knows of or
controls the final disposition of the oil or
natural gas you sold or the original source
of the petroleum products the retailer ac-
quired for resale.
Transferees who cannot claim percentage
depletion. You cannot claim percentage de-
pletion if you received your interest in a proven
oil or gas property by transfer after 1974 and
before October 12, 1990. For a definition of the
term “transfer,” see section 1.613A-7(n) of the
regulations. For a definition of the term “interest
in proven oil or gas property,” see section
1.613A-7(p) of the regulations.
Figuring percentage depletion. Generally,
as an independent producer or royalty owner,
you figure your percentage depletion by figuring
your average daily production of domestic oil or
gas and comparing it to your depletable oil or
gas quantity. If your average daily production
does not exceed your depletable oil or gas
quantity, you figure your percentage depletion
by multiplying the gross income from the oil or
gas property (as defined under Gross income
from the property, later) by 15% (0.15). If your
average daily production of domestic oil or gas
exceeds your depletable oil or gas quantity, you
must make an allocation as explained later un-
der Average daily production.
In addition, there is a limit on the percentage
depletion deduction. See Taxable income limit,
later.
Average daily production. Figure your aver-
age daily production by dividing your total do-
mestic production of oil or gas for the tax year
by the number of days in your tax year.
Partial interest. If you have a partial inter-
est in the production from a property, figure
your share of the production by multiplying total
production from the property by your percent-
age of interest in the revenues from the prop-
erty.
You have a partial interest in the production
from a property if you have a net profits interest
in the property. To figure the share of produc-
tion for your net profits interest, you must first
determine your percentage participation (as
measured by the net profits) in the gross reve-
nue from the property. To figure this percent-
age, you divide the income you receive for your
net profits interest by the gross revenue from
the property. Then multiply the total production
from the property by your percentage participa-
tion to figure your share of the production.
Example. Javier Robles owns oil property
in which Pablo Olmos owns a 20% net profits
interest. During the year, the property produced
10,000 barrels of oil, which Javier sold for
$200,000. Javier had expenses of $90,000 at-
tributable to the property. The property gener-
ated a net profit of $110,000 ($200,000 −
$90,000). Pablo received income of $22,000
($110,000 × 20% (0.20)) for his net profits inter-
est.
Pablo determined his percentage participa-
tion to be 11% by dividing $22,000 (the income
he received) by $200,000 (the gross revenue
from the property). Pablo determined his share
Chapter 9 Depletion Page 37
of the oil production to be 1,100 barrels (10,000
barrels × 11% (0.11)).
Depletable oil or natural gas quantity. Gen-
erally, your depletable oil quantity is 1,000 bar-
rels. Your depletable natural gas quantity is
6,000 cubic feet multiplied by the number of
barrels of your depletable oil quantity that you
choose to apply. If you claim depletion on both
oil and natural gas, you must reduce your de-
pletable oil quantity (1,000 barrels) by the num-
ber of barrels you use to figure your depletable
natural gas quantity.
Example. You have both oil and natural
gas production. To figure your depletable natu-
ral gas quantity, you choose to apply 360 bar-
rels of your 1,000-barrel depletable oil quantity.
Your depletable natural gas quantity is 2.16 mil-
lion cubic feet of gas (360 × 6,000). You must
reduce your depletable oil quantity to 640 bar-
rels (1,000 – 360).
If you have production from marginal wells,
see section 613A(c)(6) to figure your depletable
oil or natural gas quantity. Also, see Notice
2012-50, available at IRS.gov/irb/
2012-31_IRB#NOT-2012-50.
Business entities and family members.
You must allocate the depletable oil or gas
quantity among the following related persons in
proportion to each entity's or family member's
production of domestic oil or gas for the year.
• Corporations, trusts, and estates if 50% or
more of the beneficial interest is owned by
the same or related persons (considering
only persons that own at least 5% of the
beneficial interest).
• You and your spouse and minor children.
A related person is anyone mentioned in the re-
lated persons discussion under Nondeductible
loss in chapter 2 of Pub. 544, except that for
purposes of this allocation, item (1) in that dis-
cussion includes only an individual, his or her
spouse, and minor children.
Controlled group of corporations. Mem-
bers of the same controlled group of corpora-
tions are treated as one taxpayer when figuring
the depletable oil or natural gas quantity. They
share the depletable quantity. A controlled
group of corporations is defined in section
1563(a), except that, for this purpose, the stock
ownership requirement in that definition is
“more than 50%” rather than “at least 80%.”
Gross income from the property. For purpo-
ses of percentage depletion, gross income from
the property (in the case of oil and gas wells) is
the amount you receive from the sale of the oil
or gas in the immediate vicinity of the well. If
you do not sell the oil or gas on the property but
manufacture or convert it into a refined product
before sale, or transport it before sale, the gross
income from the property is the representative
market or field price (RMFP) of the oil or gas
before conversion or transportation.
If you sold gas after you removed it from the
premises for a price that is lower than the
RMFP, determine gross income from the prop-
erty for percentage depletion purposes without
regard to the RMFP.
Gross income from the property does not in-
clude lease bonuses, advance royalties, or
other amounts payable without regard to pro-
duction from the property.
Average daily production exceeds depleta-
ble quantities. If your average daily produc-
tion for the year is more than your depletable oil
or natural gas quantity, figure your allowance for
depletion for each domestic oil or natural gas
property as follows.
1. Figure your average daily production of oil
or natural gas for the year.
2. Figure your depletable oil or natural gas
quantity for the year.
3. Figure depletion for all oil or natural gas
produced from the property using a per-
centage depletion rate of 15% (0.15).
4. Multiply the result figured in (3) by a frac-
tion, the numerator of which is the result
figured in (2) and the denominator of
which is the result figured in (1). This is
your depletion allowance for that property
for the year.
Taxable income limit. If you are an independ-
ent producer or royalty owner of oil and gas,
your deduction for percentage depletion is limi-
ted to the smaller of the following.
• 100% of your taxable income from the
property figured without the deduction for
depletion and the deduction for domestic
production activities under section 199.
For a definition of taxable income from the
property, see Taxable income limit, earlier,
under Mineral Property.
• 65% of your taxable income from all sour-
ces, figured without the depletion allow-
ance, the deduction for domestic produc-
tion activities, any NOL carryback, and any
capital loss carryback.
You can carry over to the following year any
amount you cannot deduct because of the
65%-of-taxable-income limit. Add it to your de-
pletion allowance (before applying any limits)
for the following year.
Partnerships and S Corporations
Generally, each partner or S corporation share-
holder, and not the partnership or S corpora-
tion, figures the depletion allowance separately.
Each partner or shareholder must decide
whether to use cost or percentage depletion. If
a partner or shareholder uses percentage de-
pletion, he or she must apply the 65%-of-taxa-
ble-income limit using his or her taxable income
from all sources.
Partner's or shareholder's adjusted basis.
The partnership or S corporation must allocate
to each partner or shareholder his or her share
of the adjusted basis of each oil or gas property
held by the partnership or S corporation. The
partnership or S corporation makes the alloca-
tion as of the date it acquires the oil or gas
property.
Each partner's share of the adjusted basis of
the oil or gas property generally is figured ac-
cording to that partner's interest in partnership
capital. However, in some cases, it is figured
according to the partner's interest in partnership
income.
The partnership or S corporation adjusts the
partner's or shareholder's share of the adjusted
basis of the oil and gas property for any capital
expenditures made for the property and for any
change in partnership or S corporation inter-
ests.
Recordkeeping. Each partner or
shareholder must separately keep re-
cords of his or her share of the adjus-
ted basis in each oil and gas property of the
partnership or S corporation. The partner or
shareholder must reduce his or her adjusted
basis by the depletion allowed or allowable on
the property each year. The partner or share-
holder must use that reduced adjusted basis to
figure cost depletion or his or her gain or loss if
the partnership or S corporation disposes of the
property.
Reporting the deduction. Information that
you, as a partner or shareholder, use to figure
your depletion deduction on oil and gas proper-
ties is reported by the partnership or S corpora-
tion on Schedule K-1 (Form 1065) or on Sched-
ule K-1 (Form 1120S). Deduct oil and gas
depletion for your partnership or S corporation
interest on Schedule E (Form 1040). The deple-
tion deducted on Schedule E is included in fig-
uring income or loss from rental real estate or
royalty properties. The Instructions for Sched-
ule E (Form 1040) explain where to report this
income or loss and whether you need to file ei-
ther of the following forms.
• Form 6198.
• Form 8582.
Natural Gas Wells
You can use percentage depletion for a well
that produces natural gas that is either:
• Sold under a fixed contract, or
• Produced from geopressured brine.
Natural gas sold under a fixed contract.
Natural gas sold under a fixed contract qualifies
for a percentage depletion rate of 22%. This is
domestic natural gas sold by the producer un-
der a contract that does not provide for a price
increase to reflect any increase in the seller's
tax liability because of the repeal of percentage
depletion for gas. The contract must have been
in effect from February 1, 1975, until the date of
sale of the gas. Price increases after February
1, 1975, are presumed to take the increase in
tax liability into account unless demonstrated
otherwise by clear and convincing evidence.
Natural gas from geopressured brine.
Qualified natural gas from geopressured brine
is eligible for a percentage depletion rate of
10%. This is natural gas that is both the follow-
ing.
• Produced from a well you began to drill af-
ter September 1978 and before 1984.
• Determined in accordance with section
503 of the Natural Gas Policy Act of 1978
to be produced from geopressured brine.RECORDS
Page 38 Chapter 9 Depletion
Mines and Geothermal
Deposits
Certain mines, wells, and other natural depos-
its, including geothermal deposits, qualify for
percentage depletion.
Mines and other natural deposits. For a nat-
ural deposit, the percentage of your gross in-
come from the property that you can deduct as
depletion depends on the type of deposit.
The following is a list of the percentage de-
pletion rates for the more common minerals.
DEPOSITS RATE
Sulphur, uranium, and, if from deposits in
the United States, asbestos, lead ore,
zinc ore, nickel ore, and mica . . . . . . . . 22%
Gold, silver, copper, iron ore, and certain
oil shale, if from deposits in the United
States . . . . . . . . . . . . . . . . . . . . . . . 15%
Borax, granite, limestone, marble,
mollusk shells, potash, slate, soapstone,
and carbon dioxide produced from a
well . . . . . . . . . . . . . . . . . . . . . . . . . . 14%
Coal, lignite, and sodium chloride . . . . . 10%
Clay and shale used or sold for use in
making sewer pipe or bricks or used or
sold for use as sintered or burned
lightweight aggregates . . . . . . . . . . . . 7.5%
Clay used or sold for use in making
drainage and roofing tile, flower pots,
and kindred products, and gravel, sand,
and stone (other than stone used or sold
for use by a mine owner or operator as
dimension or ornamental stone) . . . . . . 5%
You can find a complete list of minerals and
their percentage depletion rates in section
613(b).
Corporate deduction for iron ore and
coal. The percentage depletion deduction of a
corporation for iron ore and coal (including lig-
nite) is reduced by 20% (0.20) of:
• The percentage depletion deduction for
the tax year (figured without this reduc-
tion), minus
• The adjusted basis of the property at the
close of the tax year (figured without the
depletion deduction for the tax year).
Gross income from the property. For prop-
erty other than a geothermal deposit or an oil or
gas well, gross income from the property
means the gross income from mining. Mining
includes all the following.
• Extracting ores or minerals from the
ground.
• Applying certain treatment processes de-
scribed later.
• Transporting ores or minerals (generally,
not more than 50 miles) from the point of
extraction to the plants or mills in which the
treatment processes are applied.
Excise tax. Gross income from mining in-
cludes the separately stated excise tax re-
ceived by a mine operator from the sale of coal
to compensate the operator for the excise tax
the mine operator must pay to finance black
lung benefits.
Extraction. Extracting ores or minerals
from the ground includes extraction by mine
owners or operators of ores or minerals from
the waste or residue of prior mining. This does
not apply to extraction from waste or residue of
prior mining by the purchaser of the waste or
residue or the purchaser of the rights to extract
ores or minerals from the waste or residue.
Treatment processes. The processes in-
cluded as mining depend on the ore or mineral
mined. To qualify as mining, the treatment pro-
cesses must be applied by the mine owner or
operator. For a listing of treatment processes
considered as mining, see section 613(c)(4)
and the related regulations.
Transportation of more than 50 miles. If
the IRS finds that the ore or mineral must be
transported more than 50 miles to plants or
mills to be treated because of physical and
other requirements, the additional authorized
transportation is considered mining and inclu-
ded in the calculation of gross income from min-
ing.
If you wish to include transportation of
more than 50 miles in the calculation of
gross income from mining, request an
advance ruling from the IRS. Include in the re-
quest the facts about the physical and other re-
quirements that prevented the construction and
operation of the plant within 50 miles of the
point of extraction. For more information about
requesting an advance ruling, see Revenue
Procedure 2018-1, available at IRS.gov/irb/
2018-01_IRB#RP-2018-1.
Disposal of coal or iron ore. You cannot take
a depletion deduction for coal (including lignite)
or iron ore mined in the United States if both the
following apply.
• You disposed of it after holding it for more
than 1 year.
• You disposed of it under a contract under
which you retain an economic interest in
the coal or iron ore.
Treat any gain on the disposition as a capital
gain.
Disposal to related person. This rule
does not apply if you dispose of the coal or iron
ore to one of the following persons.
• A related person (as listed in chapter 2 of
Pub. 544).
• A person owned or controlled by the same
interests that own or control you.
Geothermal deposits. Geothermal deposits
located in the United States or its possessions
qualify for a percentage depletion rate of 15%.
A geothermal deposit is a geothermal reservoir
of natural heat stored in rocks or in a watery liq-
uid or vapor. For percentage depletion purpo-
ses, a geothermal deposit is not considered a
gas well.
Figure gross income from the property for a
geothermal steam well in the same way as for
oil and gas wells. See Gross income from the
property, earlier, under Oil and Gas Wells. Per-
centage depletion on a geothermal deposit can-
not be more than 50% of your taxable income
from the property.
Lessor's Gross Income
In the case of leased property, the depletion de-
duction is divided between the lessor and the
lessee.
A lessor's gross income from the property
that qualifies for percentage depletion usually is
the total of the royalties received from the lease.
Bonuses and advanced royalties. Bonuses
and advanced royalties are payments a lessee
makes before production to a lessor for the
grant of rights in a lease or for minerals, gas, or
oil to be extracted from leased property. If you
are the lessor, your income from bonuses and
advanced royalties received is subject to an al-
lowance for depletion, as explained in the next
two paragraphs.
Figuring cost depletion. To figure cost
depletion on a bonus, multiply your adjusted ba-
sis in the property by a fraction, the numerator
of which is the bonus and the denominator of
which is the total bonus and royalties expected
to be received. To figure cost depletion on ad-
vanced royalties, use the calculation explained
earlier under Cost Depletion, treating the num-
ber of units for which the advanced royalty is re-
ceived as the number of units sold.
Figuring percentage depletion. In the
case of mines, wells, and other natural deposits
other than gas, oil, or geothermal property, you
may use the percentage rates discussed earlier
under Mines and Geothermal Deposits. Any bo-
nus or advanced royalty payments are gener-
ally part of the gross income from the property
to which the rates are applied in making the cal-
culation. However, for oil, gas, or geothermal
property, gross income does not include lease
bonuses, advanced royalties, or other amounts
payable without regard to production from the
property.
Ending the lease. If you receive a bonus
on a lease that ends or is abandoned before
you derive any income from mineral extraction,
include in income the depletion deduction you
took. Do this for the year the lease ends or is
abandoned. Also, increase your adjusted basis
in the property to restore the depletion deduc-
tion you previously subtracted.
For advanced royalties, include in income
the depletion claimed on minerals for which the
advanced royalties were paid if the minerals
were not produced before the lease ended. In-
clude this amount in income for the year the
lease ends. Increase your adjusted basis in the
property by the amount you include in income.
Delay rentals. These are payments for defer-
ring development of the property. Since delay
rentals are ordinary rent, they are ordinary in-
come that is not subject to depletion. These
rentals can be avoided by either abandoning
the lease, beginning development operations,
or obtaining production.
Timber
You can figure timber depletion only by the cost
method. Percentage depletion does not apply
to timber. Base your depletion on your cost or
Chapter 9 Depletion Page 39
other basis in the timber. Your cost does not in-
clude the cost of land or any amounts recovera-
ble through depreciation.
Depletion takes place when you cut stand-
ing timber. You can figure your depletion de-
duction when the quantity of cut timber is first
accurately measured in the process of exploita-
tion.
Figuring cost depletion. To figure your cost
depletion allowance, you multiply the number of
timber units cut by your depletion unit.
Timber units. When you acquire timber
property, you must make an estimate of the
quantity of marketable timber that exists on the
property. You measure the timber using board
feet, log scale, cords, or other units. If you later
determine that you have more or less units of
timber, you must adjust the original estimate.
The term “timber property” means your eco-
nomic interest in standing timber in each tract or
block representing a separate timber account.
Depletion unit. You figure your depletion
unit each year by taking the following steps.
1. Determine your cost or adjusted basis of
the timber on hand at the beginning of the
year. Adjusted basis is defined under Cost
Depletion in the discussion on Mineral
Property, earlier.
2. Add to the amount determined in (1) the
cost of any timber units acquired during
the year and any additions to capital.
3. Figure the number of timber units to take
into account by adding the number of tim-
ber units acquired during the year to the
number of timber units on hand in the ac-
count at the beginning of the year and
then adding (or subtracting) any correction
to the estimate of the number of timber
units remaining in the account.
4. Divide the result of (2) by the result of (3).
This is your depletion unit.
Example. You bought a timber tract for
$160,000 and the land was worth as much as
the timber. Your basis for the timber is $80,000.
Based on an estimated 1 million board feet
(1,000 MBF) of standing timber, you figure your
depletion unit to be $80 per MBF ($80,000 ÷
1,000). If you cut 500 MBF of timber, your de-
pletion allowance would be $40,000 (500 MBF
× $80).
When to claim depletion. Claim your deple-
tion allowance as a deduction in the year of sale
or other disposition of the products cut from the
timber, unless you choose to treat the cutting of
timber as a sale or exchange (explained below).
Include allowable depletion for timber products
not sold during the tax year the timber is cut as
a cost item in the closing inventory of timber
products for the year. The inventory is your ba-
sis for determining gain or loss in the tax year
you sell the timber products.
Example. The facts are the same as in the
previous example, except that you sold only
half of the timber products in the cutting year.
You would deduct $20,000 of the $40,000 de-
pletion that year. You would add the remaining
$20,000 depletion to your closing inventory of
timber products.
Electing to treat the cutting of timber as a
sale or exchange. You can elect, under cer-
tain circumstances, to treat the cutting of timber
held for more than 1 year as a sale or ex-
change. You must make the election on your in-
come tax return for the tax year to which it ap-
plies. If you make this election, subtract the
adjusted basis for depletion from the FMV of
the timber on the first day of the tax year in
which you cut it to figure the gain or loss on the
cutting. You generally report the gain as
long-term capital gain. The FMV then becomes
your basis for figuring your ordinary gain or loss
on the sale or other disposition of the products
cut from the timber. For more information, see
Timber in chapter 2 of Pub. 544.
You may revoke an election to treat the cut-
ting of timber as a sale or exchange without the
IRS's consent. The prior election (and revoca-
tion) is disregarded for purposes of making a
subsequent election. See Form T (Timber) for
more information.
Form T (Timber). Complete and attach Form
T (Timber) to your income tax return if you claim
a deduction for timber depletion, choose to treat
the cutting of timber as a sale or exchange, or
make an outright sale of timber.
10.
Business Bad
Debts
Introduction
You have a bad debt if you cannot collect
money owed to you. A bad debt is either a busi-
ness bad debt or a nonbusiness bad debt. This
chapter discusses only business bad debts.
Generally, a business bad debt is one that
comes from operating your trade or business.
You can deduct business bad debts on Sched-
ule C (Form 1040) or your applicable business
income tax return.
All other bad debts are nonbusiness bad
debts and are deductible only as short-term
capital losses. For more information on nonbus-
iness bad debts, see Pub. 550.
Topics
This chapter discusses:
• Definition of business bad debt
• When a debt becomes worthless
• How to claim a business bad debt
• Recovery of a bad debt
Useful Items
You may want to see:
Publication
525 Taxable and Nontaxable Income
536 Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts
544 Sales and Other Dispositions of
Assets
550 Investment Income and Expenses
556 Examination of Returns, Appeal
Rights, and Claims for Refund
Form (and Instructions)
Schedule C (Form 1040) Profit or Loss
From Business
1040X Amended U.S. Individual Income
Tax Return
1045 Application for Tentative Refund
1065 U.S. Return of Partnership Income
1065X Amended Return or Administrative
Adjustment Request (AAR)
1120S U.S. Income Tax Return for an S
Corporation
1120X Amended U.S. Corporation
Income Tax Return
1139 Corporation Application for
Tentative Refund
3115 Application for Change in
Accounting Method
See chapter 13 for information about getting
publications and forms.
Definition of Business
Bad Debt
A business bad debt is a loss from the worth-
lessness of a debt that was either:
• Created or acquired in your trade or busi-
ness, or
• Closely related to your trade or business
when it became partly or totally worthless.
A debt is closely related to your trade or
business if your primary motive for incurring the
debt is business related. Bad debts of a corpo-
ration (other than an S corporation) are always
business bad debts.
Credit sales. Business bad debts are mainly
the result of credit sales to customers. Goods
that have been sold, but not yet paid for, and
services that have been performed, but not yet
paid for, are recorded in your books as either
accounts receivable or notes receivable. After a
reasonable period of time, if you have tried to
collect the amount due, but are unable to do so,
the uncollectible part becomes a business bad
debt.
Accounts or notes receivable valued at FMV
when received are deductible only at that value,
even though the FMV may be less than the face
value. If you purchased an account receivable
for less than its face value, and the receivable
Schedule C (Form 1040)
1040X
1045
1065
1065X
1120S
1120X
1139
3115
Page 40 Chapter 10 Business Bad Debts
subsequently becomes worthless, the most
you’re allowed to deduct is the amount you paid
to acquire it.
You can claim a business bad debt de-
duction only if the amount owed to you
was previously included in gross in-
come. This applies to amounts owed to you
from all sources of taxable income, including
sales, services, rents, and interest.
Accrual method. If you use an accrual
method of accounting, you generally report in-
come as you earn it. You can only claim a bad
debt deduction for an uncollectible receivable if
you have previously included the uncollectible
amount in income.
If you qualify, you can use the nonac-
crual-experience method of accounting dis-
cussed later. Under this method, you don’t have
to accrue income that, based on your experi-
ence, you don’t expect to collect.
Cash method. If you use the cash method
of accounting, you generally report income
when you receive payment. You can’t claim a
bad debt deduction for amounts owed to you
because you never included those amounts in
income. For example, a cash basis architect
can’t claim a bad debt deduction if a client fails
to pay the bill because the architect's fee was
never included in income.
Debts from a former business. If you sell
your business but retain its receivables, these
debts are business debts because they arose
out of your trade or business. If any of these re-
ceivables subsequently become worthless, the
loss is still a business bad debt.
Debt acquired from a decedent. The
character of a loss from debts of a business ac-
quired from a decedent is determined in the
same way as debts acquired on the purchase of
a business. The executor of the decedent's es-
tate treats any loss from the debts as a busi-
ness bad debt if the debts were closely related
to the decedent's trade or business when they
became worthless. Otherwise, a loss from
these debts becomes a nonbusiness bad debt
for the decedent's estate.
Liquidation. If you liquidate your business
and some of the accounts receivable that you
retain become worthless, they’re treated as
business bad debts.
Types of Business Bad
Debts
Business bad debts may result from the follow-
ing.
Loans to clients and suppliers. If you loan
money to a client, supplier, employee, or distrib-
utor for a business reason and you’re unable to
collect the loan after attempting to do so, you
have a business bad debt.
Debts owed by political parties. If a political
party (or other organization that accepts contri-
butions or spends money to influence elections)
owes you money and the debt becomes worth-
less, you can claim a bad debt deduction only if
all of the following requirements are met.CAUTION
!
1. You use an accrual method of accounting.
2. The debt arose from the sale of goods or
services in the ordinary course of your
trade or business.
3. More than 30% of your receivables ac-
crued in the year of the sale were from
sales to political parties.
4. You made substantial and continuing ef-
forts to collect on the debt.
Loan or capital contribution. You cannot
claim a bad debt deduction for a loan you made
to a corporation if, based on the facts and cir-
cumstances, the loan is actually a contribution
to capital.
Debts of an insolvent partner. If your busi-
ness partnership breaks up and one of your for-
mer partners becomes insolvent, you may have
to pay more than your pro rata share of the part-
nership's debts. If you pay any part of the insol-
vent partner's share of the debts, you can claim
a bad debt deduction for the amount you paid
that is attributable to the insolvent partner's
share.
Business loan guarantee. If you guarantee a
debt that subsequently becomes worthless, the
debt can qualify as a business bad debt if all the
following requirements are met.
• You made the guarantee in the course of
your trade or business.
• You have a legal duty to pay the debt.
• You made the guarantee before the debt
became worthless. You meet this require-
ment if you reasonably expected you
wouldn’t have to pay the debt without full
reimbursement from the borrower.
• You received reasonable consideration for
making the guarantee. You meet this re-
quirement if you made the guarantee ac-
cording to normal business practice or for
a good faith business purpose.
Example. Jane Zayne owns the Zayne
Dress Company. She guaranteed payment of a
$20,000 note for Elegant Fashions, a dress out-
let. Elegant Fashions is one of Zayne's largest
clients. Elegant Fashions later defaulted on the
loan. As a result, Ms. Zayne paid the remaining
balance of the loan in full to the bank.
She can claim a business bad debt deduc-
tion only for the amount she paid because her
guarantee was made in the course of her trade
or business for a good faith business purpose.
She was motivated by the desire to retain one
of her better clients and keep a sales outlet.
Deductible in the year paid. If you make a
payment on a loan you guaranteed, you can de-
duct it in the year paid, unless you have rights
against the borrower.
Rights against a borrower. When you
make payment on a loan you guaranteed, you
may have the right to take the place of the
lender. The debt is then owed to you. If you
have this right, or some other right to demand
payment from the borrower, you can’t claim a
bad debt deduction until these rights become
partly or totally worthless.
Joint debtor. If two or more debtors jointly
owe you money, your inability to collect from
one doesn’t enable you to deduct a proportion-
ate amount as a bad debt.
Sale of mortgaged property. If mortgaged or
pledged property is sold for less than the debt,
the unpaid, uncollectible balance of the debt is
a bad debt.
When a Debt Becomes
Worthless
A debt becomes worthless when there is no
longer any chance the amount owed will be
paid. This may occur on the date the debt is
due or prior to that date.
To demonstrate worthlessness, you must
only show that you have taken reasonable
steps to collect the debt but were unable to do
so. It isn’t necessary to go to court if you can
show that a judgment from the court would be
uncollectible. Bankruptcy of your debtor is gen-
erally good evidence of the worthlessness of at
least a part of an unsecured and unpreferred
debt.
Property received for debt. If you receive
property in partial settlement of a debt, reduce
the debt by the property's FMV, which becomes
the property's basis. You can deduct the re-
maining debt as a bad debt if and when it be-
comes worthless.
If you later sell the property for more than its
basis, any gain on the sale is due to the appre-
ciation of the property. It isn’t a recovery of a
bad debt. For information on the sale of an as-
set, see Pub. 544.
How To Claim a
Business Bad Debt
There are two methods to claim a business bad
debt.
• The specific charge-off method.
• The nonaccrual-experience method.
Generally, you must use the specific charge-off
method. However, you may use the nonac-
crual-experience method if you meet the re-
quirements discussed later under Nonac-
crual-Experience Method.
Specific Charge-off Method
If you use the specific charge-off method, you
can deduct specific business bad debts that be-
come either partly or totally worthless during the
tax year. However, with respect to partly worth-
less bad debts, your deduction is limited to the
amount you charged off on your books during
the year.
Partly worthless debts. You can deduct spe-
cific bad debts that become partly uncollectible
during the tax year. Your tax deduction is limi-
ted to the amount you charge off on your books
during the year. You don’t have to charge off
and deduct your partly worthless debts annu-
ally. You can delay the charge-off until a later
year. However, you can’t deduct any part of a
debt after the year it becomes totally worthless.
Chapter 10 Business Bad Debts Page 41
Significantly modified debt. An exception
to the charge-off rule exists for debt that has
been significantly modified and on which the
holder recognized gain. For more information,
see Regulations section 1.166-3(a)(3).
Deduction disallowed. Generally, you can
claim a partial bad debt deduction only in the
year you make the charge-off on your books. If,
under audit, the IRS doesn’t allow your deduc-
tion and the debt becomes partly worthless in a
later tax year, you can deduct the amount you
charged off in that year plus the disallowed
amount charged off in the earlier year. The
charge-off in the earlier year, unless reversed
on your books, fulfills the charge-off require-
ment for the later year.
Totally worthless debts. If a debt becomes
totally worthless in the current tax year, you can
deduct the entire amount minus any amount de-
ducted in an earlier tax year when the debt was
only partly worthless.
You don’t have to make an actual charge-off
on your books to claim a bad debt deduction for
a totally worthless debt. However, you may
want to do so. If you don’t and the IRS later
rules the debt is only partly worthless, you’ll not
be allowed a deduction for the debt in that tax
year because a deduction of a partly worthless
bad debt is limited to the amount actually
charged off. See Partly worthless debts, earlier.
Filing a claim for refund. If you didn’t deduct
a bad debt on your original return for the year it
became worthless, you can file a claim for a
credit or refund. If the bad debt was totally
worthless, you must file the claim by the later of
the following dates.
• 7 years from the date your original return
was due (not including extensions).
• 2 years from the date you paid the tax.
If the claim is for a partly worthless bad debt,
you must file the claim by the later of the follow-
ing dates.
• 3 years from the date you filed your original
return.
• 2 years from the date you paid the tax.
You may have longer to file the claim if you
were unable to manage your financial affairs
due to a physical or mental impairment. Such
an impairment requires proof of existence.
For details and more information about filing
a claim, see Pub. 556. Use one of the following
forms to file a claim. For more information, see
the instructions for the applicable form.
Table 10-1. Forms Used To File a
Claim
IF you filed as
a...
THEN file...
sole proprietor
or farmer Form 1040X.
corporation Form 1120X.
S corporation Form 1120S and check
box H(4).
partnership Form 1065X if filing on
paper or
Form 1065 and check box
G(5) if filing electronically.
Nonaccrual-Experience
Method
Generally, a person using accrual accounting
isn’t required to accrue a service-provided re-
ceivable that experience shows won't be collec-
ted if:
• The service provided is health, law, engi-
neering, architecture, accounting, actuarial
science, performing arts, or consulting; or
• The person's average annual gross re-
ceipts for all previous 3-tax-year periods
don't exceed $25 million.
See section 448 for details and exceptions.
Recovery of a Bad Debt
If you claim a deduction for a bad debt on your
income tax return and later recover (collect) all
or part of it, you may have to include all or part
of the recovery in gross income. The amount
you include is limited to the amount you actually
deducted. However, you can exclude the
amount deducted that did not reduce your tax.
Report the recovery as “Other income” on the
appropriate business form or schedule.
See Recoveries in Pub. 525 for more infor-
mation.
NOL carryover. If a bad debt deduction in-
creases an NOL carryover that has not expired
before the beginning of the tax year in which the
recovery takes place, you treat the deduction as
having reduced your tax. A bad debt deduction
that contributes to an NOL helps lower taxes in
the year to which you carry the NOL. For more
information about NOLs for individuals, see
Pub. 536. Also, see the Instructions for Form
1045, and the Instructions for Form 1139.
11.
Other Expenses
What's New
Standard mileage rate. Beginning in 2018,
the standard mileage rate for the cost of operat-
ing your car, van, pickup, or panel truck for
business use is 54.5 cents per mile. For more
information, see Car and truck expenses under
Miscellaneous Expenses, later.
No miscellaneous itemized deductions al-
lowed. You can no longer claim any miscella-
neous itemized deductions, including the de-
duction for repayments (claim of right).
Miscellaneous itemized deductions are those
deductions that would have been subject to the
2%-of-adjusted-gross-income limitation.
Qualified business income deduction. For
tax years beginning after 2017, individual tax-
payers and some trusts and estates may be en-
titled to a deduction of up to 20% of their Quali-
fied Business Income (QBI) from a trade or
business, including income from a pass-through
entity, but not from a C corporation, plus 20% of
qualified real estate investment trust (REIT) div-
idends and qualified publicly traded partnership
(PTP) income. The deduction is subject to mul-
tiple limitations, such as the type of trade or
business, the taxpayer’s taxable income, the
amount of W-2 wages paid in the trade or busi-
ness, and the unadjusted basis immediately af-
ter acquisition (UBIA) of qualified property held
by the trade or business. The deduction can be
taken in addition to the standard or itemized de-
ductions. See chapter 12 of this publication for
more information.
Travel, meals, and entertainment. In gen-
eral, entertainment expenses are no longer de-
ductible. For more information on travel and
non-entertainment related meals including de-
ductibility, see Pub. 463.
Certain payments made in sexual harass-
ment or sexual abuse cases. For amounts
paid or incurred after December 22, 2017, new
section 162(q) provides that no deduction is al-
lowed under section 162 for any settlement or
payment related to sexual harassment or sexual
abuse if it is subject to a nondisclosure agree-
ment. In addition, attorney’s fees related to such
a settlement or payment are not allowed as a
deduction.
Introduction
This chapter covers business expenses that
may not have been explained to you, as a busi-
ness owner, in previous chapters of this publi-
cation.
Topics
This chapter discusses:
• Travel and non-entertainment related
meals
Page 42 Chapter 11 Other Expenses
• Bribes and kickbacks
• Charitable contributions
• Education expenses
• Lobbying expenses
• Penalties and fines
• Repayments (claim of right)
• Other miscellaneous expenses
Useful Items
You may want to see:
Publication
15-B Employer's Tax Guide to Fringe
Benefits
463 Travel, Gift, and Car Expenses
526 Charitable Contributions
529 Miscellaneous Deductions
544 Sales and Other Dispositions of
Assets
946 How To Depreciate Property
970 Tax Benefits for Education
Form (and Instructions)
Schedule A (Form 1040) Itemized
Deductions
Schedule C (Form 1040) Profit or Loss
From Business
Schedule C-EZ (Form 1040) Net Profit
From Business
Schedule F (Form 1040) Profit or Loss
From Farming
1099-MISC Miscellaneous Income
1120 U.S. Corporation Income Tax
Return
4562 Depreciation and Amortization
8949 Sales and Other Dispositions of
Capital Assets
W-2 Wage and Tax Statement
See chapter 13 for information about getting
publications and forms.
Reimbursement of
Travel and
Non-Entertainment
Related Meals
The following discussion explains how to han-
dle any reimbursements or allowances you may
provide to your employees under a reimburse-
ment or allowance arrangement for travel and
non-entertainment related meals expenses. If
you are self-employed and report your income
and expenses on Schedule C (Form 1040) or
Schedule C-EZ (Form 1040), see Pub. 463.
To be deductible for tax purposes, expen-
ses incurred for travel and non-entertainment
related meals must be ordinary and necessary
expenses incurred while carrying on your trade
or business. Generally, you also must show that
non-entertainment related meals expenses are
15-B
Schedule A (Form 1040)
Schedule C (Form 1040)
Schedule C-EZ (Form 1040)
Schedule F (Form 1040)
1099-MISC
1120
4562
8949
W-2
directly related to, or associated with, the con-
duct of your trade or business. For more infor-
mation on travel and non-entertainment related
meals, including deductibility, see Pub. 463.
Reimbursements
A “reimbursement or allowance arrangement”
provides for payment of advances, reimburse-
ments, and allowances for travel and non-enter-
tainment related meals expenses incurred by
your employees during the ordinary course of
business. If the expenses are substantiated,
you can deduct the allowable amount on your
tax return. Because of differences between ac-
counting methods and tax law, the amount you
can deduct for tax purposes may not be the
same as the amount you deduct on your busi-
ness books and records. For example, you can
deduct 100% of the cost of meals on your busi-
ness books and records. However, only 50% of
these costs are allowed by law as a tax deduc-
tion.
How you deduct a business expense under
a reimbursement or allowance arrangement de-
pends on whether you have:
• An accountable plan, or
• A nonaccountable plan.
If you reimburse these expenses under an ac-
countable plan, deduct them as travel and
non-entertainment related meals expenses.
If you reimburse these expenses under a
nonaccountable plan, report the reimburse-
ments as wages on Form W-2, and deduct
them as wages on the appropriate line of your
tax return. If you make a single payment to your
employees and it includes both wages and an
expense reimbursement, you must specify the
amount of the reimbursement and report it ac-
cordingly. See Table 11-1.
Accountable Plans
An accountable plan requires your employees
to meet all of the following requirements. Each
employee must:
1. Have paid or incurred deductible expen-
ses while performing services as your em-
ployee,
2. Adequately account to you for these ex-
penses within a reasonable period of time,
and
3. Return any excess reimbursement or al-
lowance within a reasonable period of
time.
An arrangement under which you advance
money to employees is treated as meeting (3)
above only if the following requirements are
also met.
• The advance is reasonably calculated not
to exceed the amount of anticipated ex-
penses.
• You make the advance within a reasonable
period of time of your employee paying or
incurring the expense.
If any expenses reimbursed under this ar-
rangement aren’t substantiated, or an excess
reimbursement isn’t returned within a reasona-
ble period of time by an employee, you cannot
treat these expenses as reimbursed under an
accountable plan. Instead, treat the reimbursed
expenses as paid under a nonaccountable
plan, discussed later.
Adequate accounting. Your employees must
adequately account to you for their travel and
non-entertainment related meals expenses.
They must give you documentary evidence of
their travel, mileage, and other employee busi-
ness expenses. This evidence should include
items such as receipts, along with either a
statement of expenses, an account book, a
day-planner, or similar record in which the em-
ployee entered each expense at or near the
time the expense was incurred.
Excess reimbursement or allowance. An
excess reimbursement or allowance is any
amount you pay to an employee that is more
than the business-related expenses for which
the employee adequately accounted. The em-
ployee must return any excess reimbursement
Table 11-1. Reporting Reimbursements
IF the type of reimbursement (or other expense
allowance) arrangement is under THEN the employer reports on Form W-2
An accountable plan with:
Actual expense reimbursement:
Adequate accounting made and excess returned
No amount.
Actual expense reimbursement:
Adequate accounting and return of excess both required
but excess not returned
The excess amount as wages in box 1.
Per diem or mileage allowance up to the federal rate:
Adequate accounting made and excess returned
No amount.
Per diem or mileage allowance up to the federal rate:
Adequate accounting and return of excess both required
but excess not returned
The excess amount as wages in box 1. The amount up to
the federal rate is reported only in box 12—it is not
reported in box 1.
Per diem or mileage allowance exceeds the federal rate:
Adequate accounting made up to the federal rate only and
excess not returned
The excess amount as wages in box 1. The amount up to
the federal rate is reported only in box 12—it is not
reported in box 1.
A nonaccountable plan with:
Either adequate accounting or return of excess, or both, not
required by plan
The entire amount as wages in box 1.
No reimbursement plan The entire amount as wages in box 1.
Chapter 11 Other Expenses Page 43
or other expense allowance to you within a rea-
sonable period of time.
Reasonable period of time. A reasonable pe-
riod of time depends on the facts and circum-
stances. Generally, actions that take place
within the times specified in the following list will
be treated as taking place within a reasonable
period of time.
1. You give an advance within 30 days of the
time the employee pays or incurs the ex-
pense.
2. Your employees adequately account for
their expenses within 60 days after the ex-
penses were paid or incurred.
3. Your employees return any excess reim-
bursement within 120 days after the ex-
penses were paid or incurred.
4. You give a periodic statement (at least
quarterly) to your employees that asks
them to either return or adequately ac-
count for outstanding advances and they
comply within 120 days of the date of the
statement.
How to deduct. You can claim a deduction for
travel and non-entertainment related meals ex-
penses if you reimburse your employees for
these expenses under an accountable plan.
Generally, the amount you can deduct for
non-entertainment related meals is subject to a
50% limit, discussed later. If you are a sole pro-
prietor, or are filing as a single member limited
liability company, deduct the travel reimburse-
ment on line 24a and the deductible part of the
non-entertainment related meals reimburse-
ment on line 24b, Schedule C (Form 1040), or
line 2, Schedule C-EZ (Form 1040).
If you are filing an income tax return for a
corporation, include the reimbursement on the
Other deductions line of Form 1120. If you are
filing any other business income tax return,
such as a partnership or S corporation return,
deduct the reimbursement on the appropriate
line of the return as provided in the instructions
for that return.
Per Diem and Car Allowances
You can reimburse your employees under an
accountable plan based on travel days, miles,
or some other fixed allowance. In these cases,
your employee is considered to have accounted
to you for the amount of the expense that
doesn’t exceed the rates established by the
federal government. Your employee must ac-
tually substantiate to you the other elements of
the expense, such as time, place, and business
purpose.
Federal rate. The federal rate can be figured
using any one of the following methods.
1. For car expenses:
a. The standard mileage rate.
b. A fixed and variable rate (FAVR).
2. For per diem amounts:
a. The regular federal per diem rate.
b. The standard meal allowance.
c. The high-low rate.
Car allowance. Your employee is considered
to have accounted to you for car expenses that
do not exceed the standard mileage rate. Be-
ginning in 2018, the standard business mileage
rate is 54.5 cents per mile.
You can choose to reimburse your employ-
ees using an FAVR allowance. This is an allow-
ance that includes a combination of payments
covering fixed and variable costs, such as a
cents-per-mile rate to cover your employees'
variable operating costs (such as gas, oil, etc.)
plus a flat amount to cover your employees'
fixed costs (such as depreciation, insurance,
etc.). For information on using an FAVR allow-
ance, see Revenue Procedure 2010-51, availa-
ble at IRS.gov/irb/2010-51_IRB#RP-2010-51,
and Notice 2018-03, available at IRS.gov/irb/
2018-02_IRB#NOT-2018-03.
Per diem allowance. If your employee ac-
tually substantiates to you the other elements
(discussed earlier) of the expenses reimbursed
using the per diem allowance, how you report
and deduct the allowance depends on whether
the allowance is for lodging and meal expenses
or for meal expenses only and whether the al-
lowance is more than the federal rate.
Regular federal per diem rate. The regu-
lar federal per diem rate is the highest amount
the federal government will pay to its employ-
ees while away from home on travel. It has the
following two components.
1. Lodging expense.
2. Meal and incidental expense (M&IE).
The rates are different for different locations.
See GSA.gov/perdiem for the per diem rates in
the continental United States.
Standard meal allowance. The federal
rate for M&IE is the standard meal allowance.
You can pay only an M&IE allowance to em-
ployees who travel away from home if:
• You pay the employee for actual expenses
for lodging based on receipts submitted to
you,
• You provide for the lodging,
• You pay for the actual expense of the lodg-
ing directly to the provider,
• You don’t have a reasonable belief that
lodging expenses were incurred by the
employee, or
• The allowance is figured on a basis similar
to that used in figuring the employee's wa-
ges (that is, number of hours worked or
miles traveled).
Per diem rates online. You can access
per diem rates at GSA.gov/perdiem.
High-low method. This is a simplified
method of figuring the federal per diem rate for
travel within the continental United States. It
eliminates the need to keep a current list of the
per diem rate for each city.
Under the high-low method, the per diem
amount for travel during January through Sep-
tember of 2018 is $284 ($68 for M&IE) for cer-
tain high-cost locations. All other areas have a
per diem amount of $191 ($57 for M&IE). The
high-cost localities eligible for the higher per
diem amount under the high-low method are lis-
ted in Notice 2018-77, available at IRS.gov/irb/
2018-42_IRB#NOT-2018-77.
Effective October 1, 2018, the per diem rate
for high-cost locations increased to $287 ($71
for M&IE). The rate for all other locations in-
creased to $195 ($60 for M&IE). For October,
November, and December 2018, you can either
continue to use the rates described in the pre-
ceding paragraph or change to the new rates.
However, you must use the same rate for all
employees reimbursed under the high-low
method.
For more information about the high-low
method, see Notice 2018-77, available at
IRS.gov/irb/2018-42_IRB#NOT-2018-77. See
GSA.gov/perdiem for the current per diem rates
for all locations.
Reporting per diem and car allowances.
The following discussion explains how to report
per diem and car allowances. The manner in
which you report them depends on how the al-
lowance compares to the federal rate. See Ta-
ble 11-1.
Allowance less than or equal to the fed-
eral rate. If your allowance for the employee is
less than or equal to the appropriate federal
rate, that allowance isn’t included as part of the
employee's pay in box 1 of the employee's
Form W-2. Deduct the allowance as travel ex-
penses (including meals that may be subject to
the 50% limit, discussed later). See How to de-
duct under Accountable Plans, earlier.
Allowance more than the federal rate. If
your employee's allowance is more than the ap-
propriate federal rate, you must report the al-
lowance as two separate items.
Include the allowance amount up to the fed-
eral rate in box 12 (code L) of the employee's
Form W-2. Deduct it as travel expenses (as ex-
plained above). This part of the allowance is
treated as reimbursed under an accountable
plan.
Include the amount that is more than the
federal rate in box 1 (and in boxes 3 and 5 if
they apply) of the employee's Form W-2. De-
duct it as wages subject to income tax withhold-
ing, social security, Medicare, and federal un-
employment taxes. This part of the allowance is
treated as reimbursed under a nonaccountable
plan as explained later under Nonaccountable
Plans.
Meals and Entertainment
Under an accountable plan, you can generally
deduct only 50% of any otherwise deductible
business-related meal and entertainment ex-
penses you reimburse your employees. The de-
duction limit applies even if you reimburse them
for 100% of the expenses.
Application of the 50% limit. The 50% de-
duction limit applies to reimbursements you
make to your employees for expenses they in-
cur for meals while traveling away from home
on business and for entertaining business cus-
tomers at your place of business, a restaurant,
or another location. It applies to expenses in-
curred at a business convention or reception,
business meeting, or business luncheon at a
club. The deduction limit may also apply to
meals you furnish on your premises to your em-
ployees.
Page 44 Chapter 11 Other Expenses
Related expenses. Taxes and tips relating
to a meal or entertainment activity you reim-
burse to your employee under an accountable
plan are included in the amount subject to the
50% limit. Reimbursements you make for ex-
penses, such as cover charges for admission to
a nightclub, rent paid for a room to hold a dinner
or cocktail party, or the amount you pay for
parking at a sports arena, are all subject to the
50% limit. However, the cost of transportation to
and from an otherwise allowable business meal
or a business-related entertainment activity isn’t
subject to the 50% limit.
Amount subject to 50% limit. If you provide
your employees with a per diem allowance only
for meal and incidental expenses, the amount
treated as an expense for food and beverages
is the lesser of the following.
• The per diem allowance.
• The federal rate for M&IE.
If you provide your employees with a per
diem allowance that covers lodging, meals, and
incidental expenses, you must treat an amount
equal to the federal M&IE rate for the area of
travel as an expense for food and beverages. If
the per diem allowance you provide is less than
the federal per diem rate for the area of travel,
you can treat 40% of the per diem allowance as
the amount for food and beverages.
Meal expenses when subject to “hours of
service” limits. You can deduct 80% of the
cost of reimbursed meals your employees con-
sume while away from their tax home on busi-
ness during, or incident to, any period subject to
the Department of Transportation's “hours of
service” limits.
See Pub. 463 for a detailed discussion of in-
dividuals subject to the Department of Trans-
portation's “hours of service” limits.
De minimis (minimal) fringe benefit. The
50% limit doesn’t apply to an expense for food
or beverage that is excluded from the gross in-
come of an employee because it is a de minimis
fringe benefit. See Pub.15-B for additional infor-
mation on de minimis fringe benefits.
Company cafeteria or executive dining
room. The cost of food and beverages you
provide primarily to your employees on your
business premises is deductible. This includes
the cost of maintaining the facilities for provid-
ing the food and beverages. These expenses
are subject to the 50% limit unless they qualify
as a de minimis fringe benefit, as just dis-
cussed, or unless they are compensation to
your employees (explained later).
Employee activities. The expense of provid-
ing recreational, social, or similar activities (in-
cluding the use of a facility) for your employees
is deductible and isn’t subject to the 50% limit.
The benefit must be primarily for your employ-
ees who aren’t highly compensated.
For this purpose, a highly compensated em-
ployee is an employee who meets either of the
following requirements.
1. Owned a 5% or more interest in the busi-
ness during the year or the preceding
year. An employee is treated as owning
any interest owned by his or her brother,
sister, spouse, ancestors, and lineal de-
scendants.
2. Received more than $80,000 in pay for the
preceding year. You can choose to in-
clude only employees who were also in
the top 20% of employees when ranked by
pay for the preceding year.
For example, the expenses for food, bever-
ages, and entertainment for a company-wide
picnic aren’t subject to the 50% limit.
Meals or entertainment treated as compen-
sation. The 50% limit doesn’t apply to either of
the following.
1. Expenses for meals or entertainment that
you treat as:
a. Compensation to an employee who
was the recipient of the meals or en-
tertainment, and
b. Wages subject to withholding of fed-
eral income tax.
2. Expenses for meals or entertainment if:
a. A recipient of the meals or entertain-
ment who isn’t your employee has to
include the expenses in gross income
as compensation for services or as a
prize or award; and
b. You include that amount on a Form
1099-MISC issued to the recipient, if a
Form 1099-MISC is required.
Sales of meals or entertainment. You can
deduct the cost of meals or entertainment (in-
cluding the use of facilities) you sell to the pub-
lic. For example, if you run a nightclub, your ex-
pense for the entertainment you furnish to your
customers, such as a floor show, is a business
expense that is fully deductible. The 50% limit
doesn’t apply to this expense.
Providing meals or entertainment to gen-
eral public to promote goodwill. You can
deduct the cost of providing meals, entertain-
ment, or recreational facilities to the general
public as a means of advertising or promoting
goodwill in the community. The 50% limit
doesn’t apply to this expense.
Director, stockholder, or employee meet-
ings. You can deduct entertainment expenses
directly related to business meetings of your
employees, partners, stockholders, agents, or
directors. You can provide some minor social
activities, but the main purpose of the meeting
must be your company's business. These ex-
penses are subject to the 50% limit.
Trade association meetings. You can deduct
expenses directly related to and necessary for
attending business meetings or conventions of
certain tax-exempt organizations. These organi-
zations include business leagues, chambers of
commerce, real estate boards, and trade and
professional associations.
Nonaccountable Plans
A nonaccountable plan is an arrangement that
doesn’t meet the requirements for an accounta-
ble plan. All amounts paid, or treated as paid,
under a nonaccountable plan are reported as
wages on Form W-2. The payments are subject
to income tax withholding, social security, Medi-
care, and federal unemployment taxes. You can
deduct the reimbursement as compensation or
wages only to the extent it meets the deductibil-
ity tests for employees' pay in chapter 2. Deduct
the allowable amount as compensation or wa-
ges on the appropriate line of your income tax
return, as provided in its instructions.
Miscellaneous Expenses
In addition to travel, meal, and entertainment
expenses, there are other expenses you can
deduct.
Advertising expenses. You generally can de-
duct reasonable advertising expenses that are
directly related to your business activities. Gen-
erally, you can’t deduct amounts paid to influ-
ence legislation (for example, lobbying). For
more information, see Lobbying expenses,
later.
You can usually deduct as a business ex-
pense the cost of institutional or goodwill adver-
tising to keep your name before the public if it
relates to business you reasonably expect to
gain in the future. For example, the cost of ad-
vertising that encourages people to contribute
to the Red Cross, to buy U.S. Savings Bonds,
or to participate in similar causes is usually de-
ductible.
Anticipated liabilities. Anticipated liabilities or
reserves for anticipated liabilities aren’t deducti-
ble. For example, assume you sold 1-year TV
service contracts this year totaling $50,000.
From experience, you know you will have ex-
penses of about $15,000 in the coming year for
these contracts. You can’t deduct any of the
$15,000 this year by charging expenses to a re-
serve or liability account. You can deduct your
expenses only when you actually pay or accrue
them, depending on your accounting method.
Bribes and kickbacks. Engaging in the pay-
ment of bribes or kickbacks is a serious criminal
matter. Such activity could result in criminal
prosecution. Any payments that appear to have
been made, either directly or indirectly, to an of-
ficial or employee of any government or an
agency or instrumentality of any government
aren’t deductible for tax purposes and are in vi-
olation of the law.
Payments paid directly or indirectly to a per-
son in violation of any federal or state law (but
only if that state law is generally enforced, de-
fined below) that provides for a criminal penalty
or for the loss of a license or privilege to engage
in a trade or business aren’t allowed as a de-
duction for tax purposes.
Meaning of “generally enforced.” A state
law is considered generally enforced unless it is
never enforced or enforced only for infamous
persons or persons whose violations are extra-
ordinarily flagrant. For example, a state law is
generally enforced unless proper reporting of a
violation of the law results in enforcement only
under unusual circumstances.
Chapter 11 Other Expenses Page 45
Kickbacks. A kickback is a payment for re-
ferring a client, patient, or customer. The com-
mon kickback situation occurs when money or
property is given to someone as payment for in-
fluencing a third party to purchase from, use the
services of, or otherwise deal with the person
who pays the kickback. In many cases, the per-
son whose business is being sought or enjoyed
by the person who pays the kickback isn’t
aware of the payment.
For example, the Yard Corporation is in the
business of repairing ships. It returns 10% of
the repair bills as kickbacks to the captains and
chief officers of the vessels it repairs. Although
this practice is considered an ordinary and nec-
essary expense of getting business, it is clearly
a violation of a state law that is generally en-
forced. These expenditures aren’t deductible
for tax purposes, whether or not the owners of
the shipyard are subsequently prosecuted.
Form 1099-MISC. It doesn’t matter
whether any kickbacks paid during the tax year
are deductible on your income tax return in re-
gards to information reporting. See Form
1099-MISC for more information.
Car and truck expenses. The costs of operat-
ing a car, truck, or other vehicle in your busi-
ness are deductible. For more information on
how to figure your deduction, see Pub. 463.
Charitable contributions. Cash payments to
an organization, charitable or otherwise, may
be deductible as business expenses if the pay-
ments aren’t charitable contributions or gifts
and are directly related to your business. If the
payments are charitable contributions or gifts,
you can’t deduct them as business expenses.
However, corporations (other than S corpora-
tions) can deduct charitable contributions on
their income tax returns, subject to limitations.
See the Instructions for Form 1120 for more in-
formation. Sole proprietors, partners in a part-
nership, or shareholders in an S corporation
may be able to deduct charitable contributions
made by their business on Schedule A (Form
1040).
Example. You paid $15 to a local church
for a half-page ad in a program for a concert it is
sponsoring. The purpose of the ad was to en-
courage readers to buy your products. Your
payment isn’t a charitable contribution. You can
deduct it as an advertising expense.
Example. You made a $100,000 donation
to a committee organized by the local Chamber
of Commerce to bring a convention to your city,
intended to increase business activity, including
yours. Your payment isn’t a charitable contribu-
tion. You can deduct it as a business expense.
See Pub. 526 for a discussion of donated in-
ventory, including capital gain property.
Club dues and membership fees. Generally,
you can’t deduct amounts paid or incurred for
membership in any club organized for business,
pleasure, recreation, or any other social pur-
pose. This includes country clubs, golf and ath-
letic clubs, hotel clubs, sporting clubs, airline
clubs, and clubs operated to provide meals un-
der circumstances generally considered to be
conducive to business discussions.
Exception. The following organizations
aren’t treated as clubs organized for business,
pleasure, recreation, or other social purpose
unless one of the main purposes is to conduct
entertainment activities for members or their
guests or to provide members or their guests
with access to entertainment facilities.
• Boards of trade.
• Business leagues.
• Chambers of commerce.
• Civic or public service organizations.
• Professional organizations such as bar as-
sociations and medical associations.
• Real estate boards.
• Trade associations.
Credit card convenience fees. Credit card
companies charge a fee to businesses who ac-
cept their cards. This fee when paid or incurred
by the business can be deducted as a business
expense.
Damages recovered. Special rules apply to
compensation you receive for damages sus-
tained as a result of patent infringement, breach
of contract or fiduciary duty, or antitrust viola-
tions. You must include this compensation in
your income. However, you may be able to take
a special deduction. The deduction applies only
to amounts recovered for actual economic in-
jury, not any additional amount. The deduction
is the smaller of the following.
• The amount you received or accrued for
damages in the tax year reduced by the
amount you paid or incurred in the year to
recover that amount.
• Your losses from the injury you haven’t de-
ducted.
Demolition expenses or losses. Amounts
paid or incurred to demolish a structure aren’t
deductible. These amounts are added to the
basis of the land where the demolished struc-
ture was located. Any loss for the remaining un-
depreciated basis of a demolished structure
wouldn’t be recognized until the property is dis-
posed of.
Education expenses. Ordinary and neces-
sary expenses paid for the cost of the education
and training of your employees are deductible.
See Education Expenses in chapter 2.
You can also deduct the cost of your own
education (including certain related travel) rela-
ted to your trade or business. You must be able
to show the education maintains or improves
skills required in your trade or business, or that
it is required by law or regulations, for keeping
your license to practice, status, or job. For ex-
ample, an attorney can deduct the cost of at-
tending Continuing Legal Education (CLE)
classes that are required by the state bar asso-
ciation to maintain his or her license to practice
law.
Education expenses you incur to meet the
minimum requirements of your present trade or
business, or those that qualify you for a new
trade or business, aren’t deductible. This is true
even if the education maintains or improves
skills presently required in your business. For
more information on education expenses, see
Pub. 970.
Franchise, trademark, trade name. If you
buy a franchise, trademark, or trade name, you
can deduct the amount you pay or incur as a
business expense only if your payments are
part of a series of payments that are:
1. Contingent on productivity, use, or dispo-
sition of the item;
2. Payable at least annually for the entire
term of the transfer agreement; and
3. Substantially equal in amount (or payable
under a fixed formula).
When determining the term of the transfer
agreement, include all renewal options and any
other period for which you and the transferor
reasonably expect the agreement to be re-
newed.
A franchise includes an agreement that
gives one of the parties to the agreement the
right to distribute, sell, or provide goods, serv-
ices, or facilities within a specified area.
Impairment-related expenses. If you are dis-
abled, you can deduct expenses necessary for
you to be able to work (impairment-related ex-
penses) as a business expense, rather than as
a medical expense.
You are disabled if you have either of the fol-
lowing.
• A physical or mental disability (for exam-
ple, blindness or deafness) that function-
ally limits your being employed.
• A physical or mental impairment that sub-
stantially limits one or more of your major
life activities.
The expense qualifies as a business ex-
pense if all the following apply.
• Your work clearly requires the expense for
you to satisfactorily perform that work.
• The goods or services purchased are
clearly not needed or used, other than inci-
dentally, in your personal activities.
• Their treatment isn’t specifically provided
for under other tax law provisions.
Example. You are blind. You must use a
reader to do your work, both at and away from
your place of work. The reader's services are
only for your work. You can deduct your expen-
ses for the reader as a business expense.
Internet-related expenses. Generally, you
can deduct Internet-related expenses including
domain registration fees and webmaster con-
sulting costs. If you are starting a business, you
may have to amortize these expenses as
start-up costs. For more information about am-
ortizing start-up and organizational costs, see
chapter 8.
Interview expense allowances. Reimburse-
ments you make to job candidates for transpor-
tation or other expenses related to interviews
for possible employment aren’t wages. You can
deduct the reimbursements as a business ex-
pense. However, expenses for food, bever-
ages, and entertainment are subject to the 50%
limit discussed earlier under Meals and Enter-
tainment.
Legal and professional fees. Fees charged
by accountants and attorneys that are ordinary
Page 46 Chapter 11 Other Expenses
and necessary expenses directly related to op-
erating your business are deductible as busi-
ness expenses. However, usually legal fees
you pay to acquire business assets aren’t de-
ductible. These costs are added to the basis of
the property.
Fees that include payments for work of a
personal nature (such as drafting a will, or dam-
ages arising from a personal injury) aren’t al-
lowed as a business deduction on Schedule C
(Form 1040) or Schedule C-EZ (Form 1040). If
the invoice includes both business and per-
sonal charges, figure the business portion as
follows: multiply the total amount of the bill by a
fraction, the numerator of which is the amount
attributable to business matters, the denomina-
tor of which is the total amount paid. The result
is the portion of the invoice attributable to busi-
ness expenses. The portion attributable to per-
sonal matters is the difference between the total
amount and the business portion (figured
above).
Legal fees relating to doing or keeping your
job, such as those you paid to defend yourself
against criminal charges arising out of your
trade or business, may be deductible on Sched-
ule A (Form 1040), if you itemize deductions.
For more information, see Pub. 529.
Certain payments made in sexual har-
assment or sexual abuse cases. For
amounts paid or incurred after December 22,
2017, new section 162(q) provides that no de-
duction is allowed under section 162 for any
settlement or payment related to sexual harass-
ment or sexual abuse if it is subject to a nondi-
sclosure agreement. In addition, attorney’s fees
related to such a settlement or payment are not
allowed as a deduction.
Tax preparation fees. The cost of hiring a
tax professional, such as a Certified Public Ac-
countant (CPA), to prepare that part of your tax
return relating to your business as a sole pro-
prietor is deductible on Schedule C (Form
1040) or Schedule C-EZ (Form 1040). Deduct
expenses of preparing tax schedules relating to
rentals or royalties (Schedule E), or farm in-
come and expenses (Schedule F) on the appro-
priate schedule. Expenses for completing the
remainder of the return are miscellaneous de-
ductions and are no longer deductible.
You can also claim a business deduction for
amounts paid or incurred in resolving asserted
tax deficiencies for your business operated as a
sole proprietor.
Licenses and regulatory fees. Licenses and
regulatory fees for your trade or business paid
annually to state or local governments generally
are deductible. Some licenses and fees may
have to be amortized. See chapter 8 for more
information.
Lobbying expenses. Generally, lobbying ex-
penses aren’t deductible. Lobbying expenses
include amounts paid or incurred for any of the
following activities.
• Influencing legislation.
• Participating in or intervening in any politi-
cal campaign for, or against, any candidate
for public office.
• Attempting to influence the general public,
or segments of the public, about elections,
legislative matters, or referendums.
• Communicating directly with covered ex-
ecutive branch officials (defined later) in
any attempt to influence the official actions
or positions of those officials.
• Researching, preparing, planning, or coor-
dinating any of the preceding activities.
Your expenses for influencing legislation
and communicating directly with a covered ex-
ecutive branch official include a portion of your
labor costs and general and administrative
costs of your business. For information on mak-
ing this allocation, see section 1.162-28 of the
regulations.
You can’t claim a charitable or business ex-
pense deduction for amounts paid to an organi-
zation if both of the following apply.
• The organization conducts lobbying activi-
ties on matters of direct financial interest to
your business.
• A principal purpose of your contribution is
to avoid the rules discussed earlier that
prohibit a business deduction for lobbying
expenses.
If a tax-exempt organization, other than a
section 501(c)(3) organization, provides you
with a notice on the part of dues that is allocable
to nondeductible lobbying and political expen-
ses, you can’t deduct that part of the dues.
Covered executive branch official. For
purposes of this discussion, a covered execu-
tive branch official is any of the following.
1. The President.
2. The Vice President.
3. Any officer or employee of the White
House Office of the Executive Office of the
President and the two most senior level of-
ficers of each of the other agencies in the
Executive Office.
4. Any individual who:
a. Is serving in a position in Level I of the
Executive Schedule under section
5312 of title 5, United States Code;
b. Has been designated by the Presi-
dent as having Cabinet-level status;
or
c. Is an immediate deputy of an individ-
ual listed in item (a) or (b).
Exceptions to denial of deduction. The
general denial of the deduction doesn’t apply to
the following.
• Any in-house expenses for influencing leg-
islation and communicating directly with a
covered executive branch official if those
expenses for the tax year don’t exceed
$2,000 (excluding overhead expenses).
• Expenses incurred by taxpayers engaged
in the trade or business of lobbying (pro-
fessional lobbyists) on behalf of another
person (but does apply to payments by the
other person to the lobbyist for lobbying
activities).
Moving machinery. Generally, the cost of
moving machinery from one city to another is a
deductible expense. So is the cost of moving
machinery from one plant to another, or from
one part of your plant to another. You can de-
duct the cost of installing the machinery in the
new location. However, you must capitalize the
costs of installing or moving newly purchased
machinery.
Outplacement services. The costs of out-
placement services you provide to your employ-
ees to help them find new employment, such as
career counseling, résumé assistance, skills as-
sessment, etc., are deductible.
The costs of outplacement services may
cover more than one deduction category. For
example, deduct as a utilities expense the cost
of telephone calls made under this service and
deduct as a rental expense the cost of renting
machinery and equipment for this service.
For information on whether the value of out-
placement services is includible in your employ-
ees' income, see Pub. 15-B.
Penalties and fines. Penalties paid for late
performance or nonperformance of a contract
are generally deductible. For instance, you own
and operate a construction company. Under a
contract, you are to finish construction of a
building by a certain date. Due to construction
delays, the building isn’t completed and ready
for occupancy on the date stipulated in the con-
tract. You are now required to pay an additional
amount for each day that completion is delayed
beyond the completion date stipulated in the
contract. These additional costs are deductible
business expenses.
On the other hand, generally, no deduction
is allowed for penalties and fines paid to a gov-
ernment or specified nongovernmental entity for
the violation of any law except the following.
• Amounts that constitute restitution.
• Amounts paid to come into compliance
with the law.
• Amounts paid or incurred as the result of
certain court orders in which no govern-
ment or specified nongovernmental
agency is a party.
• Amounts paid or incurred for taxes due.
On or after December 22, 2017, no deduc-
tion is allowed for the restitution amount or
amount paid to come into compliance with the
law unless the amounts are specifically identi-
fied in the settlement agreement or court order.
Also, any amount paid or incurred as reim-
bursement to a government for the costs of any
investigation or litigation are not eligible for the
exceptions and are nondeductible.
See section 162(f), as amended by P.L.
115-97, section 13306.
Examples of nondeductible penalties and
fines include the following.
• Amounts paid because of a conviction for
a crime or after a plea of guilty or no con-
test in a criminal proceeding.
• Amounts paid as a penalty imposed by
federal, state, or local law in a civil action,
including certain additions to tax and addi-
tional amounts and assessable penalties
imposed by the Internal Revenue Code.
• Amounts paid in settlement of actual or
possible liability for a fine or penalty,
whether civil or criminal.
• Amounts forfeited as collateral posted for a
proceeding that could result in a fine or
penalty.
• Fines paid for violating city housing codes.
• Fines paid by truckers for violating state
maximum highway weight laws.
Chapter 11 Other Expenses Page 47
• Fines paid for violating air quality laws.
• Civil penalties paid for violating federal
laws regarding mining safety standards
and discharges into navigable waters.
A fine or penalty doesn’t include any of the
following.
• Legal fees and related expenses to defend
yourself in a prosecution or civil action for a
violation of the law imposing the fine or civil
penalty.
• Court costs or stenographic and printing
charges.
• Compensatory damages paid to a govern-
ment.
Political contributions. Contributions or gifts
paid to political parties or candidates aren’t de-
ductible. In addition, expenses paid or incurred
to take part in any political campaign of a candi-
date for public office aren’t deductible.
Indirect political contributions. You can’t
deduct indirect political contributions and costs
of taking part in political activities as business
expenses. Examples of nondeductible expen-
ses include the following.
• Advertising in a convention program of a
political party, or in any other publication if
any of the proceeds from the publication
are for, or intended for, the use of a politi-
cal party or candidate.
• Admission to a dinner or program (includ-
ing, but not limited to, galas, dances, film
presentations, parties, and sporting
events) if any of the proceeds from the
function are for, or intended for, the use of
a political party or candidate.
• Admission to an inaugural ball, gala, pa-
rade, concert, or similar event if identified
with a political party or candidate.
Repairs. The cost of repairing or improving
property used in your trade or business is either
a deductible or capital expense. Routine main-
tenance that keeps your property in a normal ef-
ficient operating condition, but that doesn’t ma-
terially increase the value or substantially
prolong the useful life of the property, is deduc-
tible in the year that it is incurred. Otherwise,
the cost must be capitalized and depreciated.
See Form 4562 and its instructions for how to
figure and claim the depreciation deduction.
The cost of repairs includes the costs of la-
bor, supplies, and certain other items. The
value of your own labor isn’t deductible. Exam-
ples of repairs include:
• Reconditioning floors (but not replace-
ment),
• Repainting the interior and exterior walls of
a building,
• Cleaning and repairing roofs and gutters,
and
• Fixing plumbing leaks (but not replacement
of fixtures).
Repayments. If you had to repay an amount
you included in your income in an earlier year,
you may be able to deduct the amount repaid
for the year in which you repaid it. Or, if the
amount you repaid is more than $3,000, you
may be able to take a credit against your tax for
the year in which you repaid it. In most cases,
you can claim a deduction or credit only if the
repayment qualifies as an expense or loss in-
curred in your trade or business or in a for-profit
transaction.
Type of deduction. The type of deduction
you are allowed in the year of repayment de-
pends on the type of income you included in the
earlier year. For instance, if you repay an
amount you previously reported as a capital
gain, deduct the repayment as a capital loss as
explained in the Instructions for Schedule D
(Form 1040). If you reported it as self-employ-
ment income, deduct it as a business expense
on Schedule C (Form 1040) or Schedule C-EZ
(Form 1040) or Schedule F (Form 1040).
If you reported the amount as wages, unem-
ployment compensation, or other nonbusiness
ordinary income, you may be able to deduct it
as an other itemized deduction if the amount re-
paid is over $3,000.
Beginning in 2018, due to the suspen-
sion of miscellaneous itemized deduc-
tions subject to the 2% floor under sec-
tion 67(a), your are not able to deduct the
repayment as an itemized deduction if it is
$3,000 or less.
Repayment—$3,000 or less. If the
amount you repaid was $3,000 or less, deduct it
from your income in the year you repaid it.
Repayment—Over $3,000. If the amount
you repaid was more than $3,000, you can de-
duct the repayment as an other itemized deduc-
tion on Schedule A (Form 1040), line 16, if you
included the income under a “claim of right.”
This means that at the time you included the in-
come, it appeared that you had an unrestricted
right to it. However, you can choose to take a
credit for the year of repayment. Figure your tax
under both methods and use the method that
results in less tax.
Method 1. Figure your tax for 2018 claim-
ing a deduction for the repaid amount.
Method 2. Figure your tax for 2018 claim-
ing a credit for the repaid amount. Follow these
steps.
1. Figure your tax for 2018 without deducting
the repaid amount.
2. Refigure your tax from the earlier year
without including in income the amount
you repaid in 2018.
3. Subtract the tax in (2) from the tax shown
on your return for the earlier year. This is
the amount of your credit.
4. Subtract the answer in (3) from the tax for
2018 figured without the deduction (step
1).
If Method 1 results in less tax, deduct the
amount repaid as discussed earlier under Type
of deduction.
If Method 2 results in less tax, claim the
credit on Schedule 5 (Form 1040), line 74, and
write “I.R.C. 1341” next to line 74.
Example. For 2017, you filed a return and
reported your income on the cash method. In
2018, you repaid $5,000 included in your 2017
gross income under a claim of right. Your filing
status in 2018 and 2017 is single. Your income
and tax for both years are as follows:CAUTION
!
2017
With Income
2017
Without
Income
Taxable
Income $15,000 $10,000
Tax $ 1,788 $ 1,038
2018
Without
Deduction
2018
With Deduction
Taxable
Income $49,950 $44,950
Tax $6,934 $5,834
Your tax under Method 1 is $5,834. Your tax un-
der Method 2 is $6,184, figured as follows:
Tax previously determined for
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 1,788
Less: Tax as refigured . . . . . . . . . . . − 1,038
Decrease in 2017 tax $750
Regular tax liability for 2018 . . . . . . . $6,934
Less: Decrease in 2017 tax . . . . . . . − 750
Refigured tax for 2018 $ 6,184
Because you pay less tax under Method 1, you
should take a deduction for the repayment in
2018.
Repayment does not apply. This discus-
sion doesn’t apply to the following.
• Deductions for bad debts.
• Deductions from sales to customers, such
as returns and allowances, and similar
items.
• Deductions for legal and other expenses of
contesting the repayment.
Year of deduction (or credit). If you use
the cash method of accounting, you can take
the deduction (or credit, if applicable) for the tax
year in which you actually make the repayment.
If you use any other accounting method, you
can deduct the repayment or claim a credit for it
only for the tax year in which it is a proper de-
duction under your accounting method. For ex-
ample, if you use the accrual method, you are
entitled to the deduction or credit in the tax year
in which the obligation for the repayment ac-
crues.
Supplies and materials. Unless you have de-
ducted the cost in any earlier year, you gener-
ally can deduct the cost of materials and sup-
plies actually consumed and used during the
tax year.
If you keep incidental materials and supplies
on hand, you can deduct the cost of the inci-
dental materials and supplies you bought during
the tax year if all the following requirements are
met.
• You don’t keep a record of when they are
used.
• You don’t take an inventory of the amount
on hand at the beginning and end of the
tax year.
• This method doesn’t distort your income.
You can also deduct the cost of books, pro-
fessional instruments, equipment, etc., if you
normally use them within a year. However, if the
usefulness of these items extends substantially
Page 48 Chapter 11 Other Expenses
beyond the year they are placed in service, you
generally must recover their costs through de-
preciation. For more information regarding de-
preciation, see Pub. 946.
Utilities. Business expenses for heat, lights,
power, telephone service, and water and sew-
erage are deductible. However, any part due to
personal use isn’t deductible.
Telephone. You can’t deduct the cost of
basic local telephone service (including any
taxes) for the first telephone line you have in
your home, even if you have an office in your
home. However, charges for business long-dis-
tance phone calls on that line, as well as the
cost of a second line into your home used ex-
clusively for business, are deductible business
expenses.
12.
Qualified
Business
Income
Deduction
Introduction
This chapter covers the rules for determining
the qualified business income (QBI) deduction.
For tax years beginning after 2017, individ-
ual taxpayers and certain trusts and estates
may be entitled to a deduction of up to 20% of
their QBI from a trade or business, including in-
come from a pass-through entity, but not from a
C corporation, plus 20% of qualified real estate
investment trust (REIT) dividends and qualified
publicly traded partnership (PTP) income. The
deduction is subject to multiple limitations, de-
pending on the taxpayer’s taxable income, and
may include the type of trade or business, the
amount of W-2 wages paid by the trade or busi-
ness, and the unadjusted basis immediately af-
ter acquisition (UBIA) of qualified property held
by the trade or business. The deduction can be
taken in addition to the standard or itemized de-
ductions. For more information, see section
199A, the Regulations section 1.199A, Rev.
Proc. 2019–11, and Notice 2019–07.
Topics
This chapter discusses:
• Taxpayers who may take a QBI deduction
• How to figure the deduction
• Coordination with other Code sections
• Special rules
Useful Items
You may want to see:
Form (and Instructions)
Form 1040 U.S. Individual Income Tax
Return
Schedule K-1 (Form 1065) Partner’s
Share of Income, Deductions,
Credits, etc.
Schedule K-1 (Form 1120S)
Shareholder’s Share of Income,
Deductions, Credits, etc.
Form 1041 U.S. Income Tax Return for
Estates and Trusts
Schedule K-1 (Form 1041) Beneficiary’s
Share of Income, Deductions,
Credits, etc.
See chapter 13 for information about getting
publications and forms.
Taxpayers Who May
Take a Qualified
Business Income
Deduction
Individuals, estates, and trusts may take a QBI
deduction.
S corporations and partnerships. S corpo-
rations and partnerships are not eligible for the
deduction. Instead, S corporations and partner-
ships must pass through the necessary infor-
mation to their shareholders or partners so they
may figure their deduction.
S corporations and partnerships must report
each shareholder’s or partner’s share of the fol-
lowing items for each qualified trade or busi-
ness (or aggregated trade or business) on
Schedule K-1, so the shareholder or partner
may figure their deduction.
• Section 199A QBI.
• Section 199A W-2 wages.
• Section 199A UBIA.
• Section 199A Qualified REIT dividends.
• Section 199A Qualified PTP income.
• QBI allocable to qualified payments re-
ceived from a specified cooperative.
• Passed-through domestic production activ-
ities deduction (DPAD) under section
199A(g) from a specified cooperative.
• Whether each trade or business is a speci-
fied service trade or business.
• Disclosure of information for aggregated
trades or businesses.
For more information, see the Instructions
for Form 1120S, U.S. Income Tax Return for an
S Corporations, and Form 1065, U.S. Return of
Partnership Income.
Estates and trusts. To the extent that a gran-
tor or another person is treated as owning all or
part of a trust or estate, the owner will compute
its QBI with respect to the owned portion of the
trust as if that QBI had been received directly by
the owner. Generally, in the case of a non-gran-
tor trust or estate, the trust or estate may either
deduct or pass through information to their ben-
Form 1040
Schedule K-1 (Form 1065)
Schedule K-1 (Form 1120S)
Form 1041
Schedule K-1 (Form 1041)
eficiaries so that the beneficiaries may figure
their deduction. In determining the QBI deduc-
tion or the amount that must be passed through
to beneficiaries, the estate or trust allocates QBI
items based on the relative proportion of the es-
tate's or trust's distributable net income (DNI)
for the tax year that is distributed or required to
be distributed to the beneficiary or retained by
the estate or trust. If the estate or trust has no
DNI for the tax year, QBI, W-2 wages, and UBIA
are allocated entirely to the estate or trust.
Although estates and trusts may compute
their own QBI deduction, they must reduce the
amounts reported as QBI, W-2 wages, and
UBIA to reflect the portion of those amounts
that were allocated to beneficiaries.
For more information, see the Instructions
for Form 1041, U.S. Income Tax Return for Es-
tates and Trusts.
Agricultural and horticultural cooperatives.
See the Instructions for Form 1120C, U.S. In-
come Tax Return for Cooperative Associations,
for rules applicable to agricultural and horticul-
tural cooperatives.
How To Figure the
Deduction
General Computation. In general, the amount
of your QBI deduction equals your QBI Compo-
nent plus your qualified REIT/PTP Component.
However, the deduction is limited to the lesser
of this amount or 20% of your taxable income
minus your net capital gain.
Use one of two worksheets to help you fig-
ure your QBI deduction.
1. Use the Qualified Business Income De-
duction—Simplified Worksheet in the In-
structions for Form 1040 if:
a. You have QBI, qualified REIT divi-
dends, or qualified PTP income (de-
fined later);
b. Your 2018 taxable income before QBI
deduction isn’t more than $157,500
($315,000 if married filing jointly); and
c. You aren’t a patron in a specified agri-
cultural or horticultural cooperative.
2. Use Worksheet 12-A and its instructions in
this Pub. 535 if:
a. You have QBI, qualified REIT divi-
dends, or qualified PTP income, and
b. Your 2018 taxable income before QBI
deduction is more than $157,500
($315,000 if married filing jointly); or
c. You’re a patron in a specified agricul-
tural or horticultural cooperative.
QBI Component. Your QBI Component is
generally 20% of your QBI from your trades or
businesses. However, if your taxable income
(before the QBI deduction) exceeds the thresh-
old your QBI for each of your trades or busi-
nesses may be partially or fully reduced to the
greater of 50% of wages from the qualified
trade or business, or 25% of wages plus 2.5%
of the unadjusted basis on acquisition of
Chapter 12 Qualified Business Income Deduction Page 49
qualified property from the qualified trade or
business. The partial or full reduction to QBI is
determined by your taxable income. If your tax-
able income (before the QBI deduction) is:
• At or below the threshold, you don’t need
to reduce your QBI,
• Above the threshold but below the phase
in range, the reduction is phased-in,
• Above the threshold and phase in range,
the full reduction applies.
In addition, if you are a patron of an agricul-
tural or horticultural cooperative you must re-
duce your cooperative QBI by the lesser of:
• 9% of the QBI allocable to qualified pay-
ments, or
• 50% of W-2 wages from the trade or busi-
ness allocable to the qualified payments.
Determining your qualified trades or busi-
nesses. Your qualified trades and businesses
include your section 162 trades or businesses,
other than trades or businesses conducted
through a C corporation, W-2 wages earned as
an employee, and specified service trades or
businesses.
In general, to be engaged in a trade or busi-
ness, you must be involved in the activity with
continuity and regularity and your primary pur-
pose for engaging in the activity must be for in-
come or profit. If you own an interest in a
pass-through entity, the trade or business de-
termination is made at that entity's level.
The ownership and rental of real property
may constitute a trade or business. Notice
2019-07 provides a safe harbor under which
rental real estate enterprise will be treated as a
trade or business for purposes of the QBI de-
duction. For more information, on the safe har-
bor see Notice 2019-07. Rental real estate that
does not meet the requirements of the safe har-
bor may still be treated as a trade or business
for purposes of the QBI deduction if it is a sec-
tion 162 trade or business.
In addition, the rental or licensing of property
to a commonly controlled trade or business op-
erated by an individual or a pass-through entity
is considered a trade or business under section
199A.
Services performed as an employee exclu-
ded from qualified trades or businesses.
The trade or business of performing services as
an employee is not a trade or business for pur-
poses of section 199A. Therefore, any amounts
reported in box 1 of Form W-2, other than
amounts reported in box 1 where the “Statutory
Employee” box in box 13 is checked, are not
QBI. If you were previously an employee of a
business and continue to provide substantially
the same services to that business after you are
no longer treated as an employee, there is a
presumption that you are providing services as
an employee for purposes of section 199A for
the 3-year period after ceasing to be an em-
ployee. You may have to rebut this presumption
upon notice from the IRS by providing records
such as contracts or partnership agreements
that corroborate your status as a non-em-
ployee. For more information on whether you
are an employee or an independent contractor,
see Pub. 15-A, Employer’s Supplemental Tax
Guide, and Pub. 1779, Independent Contractor
or Employee.
Specified service trade or business exclu-
ded from your qualified trades or busi-
nesses. Specified service trades or busi-
nesses generally are excluded from the
definition of qualified trade or business income
if the taxpayer's taxable income exceeds the
threshold. Therefore, no QBI, W-2 wages, or
UBIA of the qualified property from the specified
trade or business are taken into account in fig-
uring your QBI deduction. If the specified serv-
ice trade or business is conducted by your
pass-through entity, the same limitation applies
to the pass-through items regardless of whether
you are a passive owner or materially partici-
pate in the business.
Exception 1: If your taxable income before
the QBI deduction isn’t more than $157,500
($315,000 if married filing jointly), your specified
service trade or business is a qualified trade or
business, and thus may generate income eligi-
ble for the QBI deduction.
Exception 2: If your taxable income before
the QBI deduction is more than $157,500 but
not $207,500 ($315,000 and $415,000 if mar-
ried filing jointly), an applicable percentage of
your specified service trade or business is trea-
ted as a qualified trade or business. For more
information on the applicable percentage and
this exception, see the instructions for Sched-
ule A in this publication.
A specified service trade or business is any
trade or business providing services in the
fields of:
• Health, including physicians, nurses, den-
tists, veterinarians, physical therapists,
psychologists, and other similar healthcare
professionals. However, it excludes serv-
ices not directly related to a medical serv-
ices field, such as the operation of health
clubs or spas; payment processing; or the
research, testing, manufacture, and sale of
pharmaceuticals or medical devices;
• Law, including lawyers, paralegals, legal
arbitrators, mediators, and similar profes-
sionals. However, it excludes services that
do not require skills unique to the field of
law such as services by printers, delivery
services, or stenography services;
• Accounting, including accountants, enrol-
led agents, return preparers, financial audi-
tors, and similar professionals;
• Actuarial science, including actuaries, and
similar professionals;
• Performing arts, including actors, directors,
singers, musicians, entertainers, and simi-
lar professionals. However, it excludes
services that don’t require skills unique to
the creation of performing arts, such as the
maintenance and operation of equipment
or facilities for use in the performing arts or
the provision of services by persons who
broadcast video or audio of performing arts
to the public;
• Consulting, including providing advice and
counsel with the intention of influencing
decisions made by a government or gov-
ernmental agency and all attempts to influ-
ence legislators and other government offi-
cials on behalf of a client by lobbyists, and
other similar professionals. However, it ex-
cludes the performance of services other
than advice or counsel, such as sales,
training or educational courses. It also ex-
cludes embedded or ancillary services that
are otherwise not SSTBs, if there is no
separate payment for the services;
• Athletics, including athletes, coaches, and
managers in sports such as baseball, bas-
ketball, football, soccer, hockey, martial
arts, boxing, bowling, tennis, golf, snow-
boarding, track and field, billiards, racing,
and other athletic performance. However,
it excludes services that do not require
skills unique to athletic competition, such
as the maintenance and operation of
equipment or facilities for use in athletic
events or the provision of services by per-
sons who broadcast video or audio of ath-
letic events to the public;
• Financial services, including managing
wealth, advising clients with respect to fi-
nances, developing retirement plans, de-
veloping wealth transition plans, the provi-
sion of advisory and other similar services
regarding valuations, mergers, acquisi-
tions, dispositions, restructuring (including
in title 11 or similar cases), and raising fi-
nancial capital by underwriting, or acting
as a client’s agent in the issuance of secur-
ities, and similar services. This includes
services provided by financial advisors, in-
vestment bankers, wealth planners, retire-
ment advisors, and other similar professio-
nals. However, it excludes taking deposits
or making loans, but does include arrange
lending transactions between a lender and
borrower;
• Brokerage services, including services in
which a person arranges transactions be-
tween a buyer and a seller with respect to
securities for a commission or fee includ-
ing services provided by stock brokers and
other similar professionals. However, it ex-
cludes services provided by real estate
agents and brokers, or insurance agents
and brokers;
• Investing and investment management, in
which a fee is received for providing invest-
ing, asset management, or investment
management services, including providing
advice with respect to buying and selling
investments. However, it excludes the
service of directly managing real property;
• Trading, including the trade or business of
trading in securities (as defined in section
475(c)(2)), commodities (as defined in
section 475(e)(2)), or partnership interests;
• Dealing in securities, including dealing in
securities (as defined in section 475(c)(2)),
commodities (as defined in section 475(e)
(2)), or partnership interests;
• Any trade or business where the principal
asset is the reputation or skill of one or
more of its employees, as demonstrated
by:
– Receiving fees, compensation, or
other income for endorsing products
or services;
– Licensing or receiving fees, com-
pensation or other income for the use
of an individual’s image, likeness,
name, signature, voice, trademark, or
any other symbols associated with the
individual’s identity; or
– Receiving fees, compensation, or
other income for appearing at an
event or on radio, television, or an-
other media format.
Page 50 Chapter 12 Qualified Business Income Deduction
De minimis rule 1—If your gross receipts
from a trade or business are $25 million or less
and less than 10% of the gross receipts are
from the performance of services in a specified
service field, then your trade or business is not
considered specified service trade or business,
and thus may generate income eligible for the
QBI deduction for the tax year.
De minimis rule 2—If your gross receipts
from a trade or business are more than $25 mil-
lion and less than 5% of the gross receipts are
from the performance of services, then your
trade or business is not considered a specified
service trade or business, and thus may gener-
ate income eligible for the QBI deduction for the
tax year.
Service or peoperty provided to an
SSTB—If your trade or business provides serv-
ices or property to an SSTB and there is 50% or
more common ownership of the trades or busi-
nesses, that portion of the services or property
provided to the SSTB is treated as a separate
SSTB.
Determining your qualified business in-
come. Your QBI includes items of income,
gain, deduction, and loss from any trades or
businesses (or aggregated trade or business)
that are effectively connected with the conduct
of a trade or business within the United State.
This includes income from partnerships (other
than PTPs), S corporations, sole proprietor-
ships, and certain trusts that are included or al-
lowed in determining your taxable income for
the year. It also includes other deductions at-
tributable to the trade or business including, but
not limited to, deductible tax on self-employ-
ment income, self-employed health insurance,
and contributions to qualified retirement plans.
Note. Your QBI doesn’t include any losses
or deductions disallowed under the basis,
at-risk, passive loss, or section 461(l) limita-
tions, as they aren’t included or allowed in de-
termining your taxable income for the year. In-
stead, these losses and deductions are taken
into account in the tax year they are included in
determining your taxable income. Loss and de-
duction items that were generated prior to 2018,
that are included in income during the year, are
not included in QBI.
QBI doesn’t include any of the following.
• Items that aren’t properly includible in in-
come.
• Investment items such as capital gains or
losses, or dividends.
• Interest income, other than interest income
properly allocable to a trade or business
(interest income attributable to an invest-
ment of working capital, reserves, or simi-
lar accounts is not properly allocable to a
trade or business).
• W-2 income. See Services performed as
an employee excluded from qualified
trades or businesses., earlier.
• Income that isn’t effectively connected with
the conduct of business within the United
States. (For more information, go to
IRS.gov and type in the key word “effec-
tively connected income.”)
• Commodities transaction or foreign cur-
rency gains or losses described in section
954(c)(1)(C) or (D).
• Income, loss, or deductions from notional
principal contracts under section 954(c)(1)
(F).
• Annuities (unless received in connection
with the trade or business).
• Amounts received as reasonable compen-
sation from an S corporation.
• Amounts received as guaranteed pay-
ments.
• Payments received by a partner for serv-
ices under section 707(a).
• Qualified REIT dividends.
• Qualified PTP income.
W-2 wages. W-2 wages generally include
amounts paid to employees for the perform-
ance of services, plus elective deferrals (for ex-
ample, contributions to 401(k) plans), deferred
compensation, and Roth IRA contributions.
Amounts paid to statutory employees when the
“Statutory Employee” box in box 13 is checked
are not W-2 wages.
If you conduct more than one trade or busi-
ness, the W-2 wages must be allocated among
the various trades or businesses (or aggregated
trades or businesses) to the business that gen-
erated the wage. In addition, only the W-2 wa-
ges properly allocable to QBI are includible.
W-2 wages are properly allocable to QBI if the
associated wage expense is taken into account
in computing QBI.
Before allocating W-2 wages among various
trades or businesses (or aggregated trades or
businesses) and/or allocating W-2 wages to
QBI, first determine the total amount of W-2 wa-
ges. There are three methods to figure your
W-2 wages.
• Unmodified box method.
• Modified box 1 method.
• Tracking wages method.
Unmodified box method. Under the un-
modified box method, W-2 wages are the
smaller of:
1. The sum of the amounts reported in box 1
of the relevant Forms W-2, or
2. The sum of the amounts reported in box 5
of the relevant Forms W-2.
Modified box 1 method. Under the modi-
fied box 1 method, W-2 wages are figured as
follows.
1. Add the amounts reported in box 1 of the
relevant Forms W-2.
2. Add all the amounts described below that
have been included in box 1 of the rele-
vant Forms W-2.
a. Amounts not considered wages for
federal income tax withholding purpo-
ses.
b. Supplemental unemployment com-
pensation benefits within the meaning
of Rev. Rul. 90-72.
c. Sick pay or annuity payments.
3. Subtract (2) from (1).
4. Add together any amounts reported in
box 12 of the relevant Forms W-2 that are
properly coded D, E, F, G, or S.
5. Add (3) and (4).
Tracking wages method. Under the
tracking wages method, W-2 wages are figured
as follows.
1. Add the amounts that are wages for fed-
eral income tax withholding purposes and
that are also reported in box 1 of the rele-
vant Forms W-2.
2. Add together any amounts reported in
box 12 of the relevant Forms W-2 that are
properly coded D, E, F, G, or S.
3. Add (1) and (2).
To figure your W-2 wages using one of the
three methods above, generally use the sum of
the amounts you properly report for each em-
ployee on Form W-2, Wage and Tax Statement,
for the calendar year ending with or within your
tax year. However, don't use any amounts re-
ported on a Form W-2 filed with the Social Se-
curity Administration more than 60 days after its
due date (including extensions).
Short tax year. If you have a short tax year,
you generally will use the sum of the amounts
you properly report for each employee on Form
W-2 for the calendar year ending with or within
that short tax year. However, if you have a short
tax year that doesn't include a calendar year
ending within that short tax year, then wages
you properly report on Form W-2 that you paid
during the short tax year are treated as W-2 wa-
ges for that short tax year.
Acquisition or disposition of a trade or
business. If you acquired or disposed of a
trade or business that causes you and another
employer to pay W-2 wages to employees of
the acquired or disposed of trade or business
during the calendar year, then the W-2 wages
for the calendar year of the acquisition or dispo-
sition are allocated between each employer
based on the period that the employees of the
acquired or disposed of trade or business were
employed by each employer. If you have a short
tax year that doesn’t include a calendar year
ending within your short tax year, see Short tax
year, earlier.
Non-duplication rule. Amounts that are trea-
ted as W-2 wages for a tax year under any
method can't be treated as W-2 wages for any
other tax year. Also, an amount can't be treated
as W-2 wages by more than one taxpayer.
Unadjusted basis immediately after acquis-
ition. For purposes of determining your UBIA
for all qualified property, the unadjusted basis
immediately after acquisition means the basis
on the placed-in-service date. Qualified prop-
erty includes all tangible property subject to de-
preciation under section 167 that is held and
used by the trade or business (or aggregated
trade or business) during and at the close of the
tax year, for which the depreciable period hasn’t
ended. The depreciable period ends on the
later of 10 years after the property is
placed-in-service or the last day of the full year
for the applicable recovery period under section
168. Additional first-year depreciation, such as
bonus depreciation, doesn’t affect the applica-
ble recovery period.
Improvements to property are treated as a
separate qualified property.
Chapter 12 Qualified Business Income Deduction Page 51
For like-kind exchange and involuntary con-
version property, the depreciable period ends
on the same date as the relinquished property.
The UBIA is the same as the UBIA of the quali-
fied property exchanged, decreased by excess
boot or increased by the amount of money paid
or the fair market value of property received that
is not of a like-kind or similar service/use. And
the depreciable period of any excess basis of
the replacement property is determined using
the date on which the replacement property is
first placed in service.
Generally, property received in a non-recog-
nition transaction (for example, section 332,
351, 361, 721, or 731) retains the same unad-
justed basis and placed-in-service date as that
of the transferor. However, for the portion of the
transferee’s unadjusted basis that exceeds the
transferor’s unadjusted basis, the portion is
treated as a separate qualified property placed
in service on the date of the transfer.
Property acquired within 60 days of the year
end that is disposed within 120 days without be-
ing used by the trade or business for at least 45
days generally isn’t qualified property.
REIT / PTP Component. Your qualified
REIT/PTP component equals 20% of your quali-
fied REIT dividends and qualified PTP income
or loss (including your share of REIT dividends
and PTP income or loss from relevant
pass-through entities (RPEs)).
Determining your qualified REIT dividends
and qualified PTP income/(loss). Qualified
REIT dividends include any dividend you re-
ceived from a real estate investment trust held
for more than 45 days and for which the pay-
ment is not obligated to someone else and that
isn’t a capital gain dividend under section
857(b)(3) and isn’t a qualified dividend under
section 1(h)(11). Plus your qualified REIT divi-
dends received from a regulated investment
company (RIC).
Qualified PTP income/(loss) includes your
share of qualified items of income, gain, deduc-
tion, and loss from a PTP. It also may include
gain or loss recognized on the disposition of
your partnership interest that isn’t treated as a
capital gain or loss. It doesn’t include any loss
or deduction disallowed in determining your tax-
able income for the year. Note: PTP income
generated by an SSTB may be limited to the
applicable percentage if your taxable income is
within the phase in-range or completely exclu-
ded from qualified PTP income if your taxable
income is above the phase-in range. See
Schedule A.
Taxable Income Limitation. Your total quali-
fied business income deduction is limited to
20% of taxable income, calculated before the
QBI deduction, less net capital gain.
Worksheet 12-A Specific
Instructions
Be aware that you may need to fill out Sched-
ule A, B, C, and/or D, as applicable, prior to
starting Part I of the worksheet.
Schedule A—Specified Service Trades or Businesses (SSTB) Keep for Your Records
Caution. Complete Schedule A only if your trade or business is a specified service trade or business and your taxable income is
more than $157,500 but not $207,500 ($315,000 and $415,000 if married filing jointly). If your taxable income isn’t more than
$157,500 ($315,000 if married filing jointly), and you aren’t a patron of agricultural or horticultural cooperative, don’t use this
worksheet; instead, use the Qualified Business Income Deduction—Simplified Worksheet in the Instructions for Form 1040.
Otherwise, complete Schedule D before beginning Part I. If your taxable income is more than $207,500 ($415,000 if married filing
jointly), your specified service business doesn’t qualify for the deduction.
Part I—Non-Publiclly Traded Partnership
SSTB 1 SSTB 2 SSTB 3
1a. Trade or business name: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1b. Taxpayer identification number . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Qualified business income from the trade or business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Allocable share of W-2 wages from the trade or business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4. Allocable share of the unadjusted basis of all qualified property . . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Taxable income before qualified business income deduction . . . . . . . . . . . . . . . . . .
6. Threshold. Enter $157,500 ($315,000 if married filing jointly) . . . . . . . . . . . . . . . . . .
7. Subtract line 6 from line 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8. Phase-in range. Enter $50,000 ($100,000 if married filing jointly) . . . . . . . . . . . . . . .
9. Divide line 7 by line 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10. Applicable percentage. Subtract line 9 from 100% . . . . . . . . . . . . . . . . . . . . . . . . . . .
11. Applicable percentage of qualified business income. Multiply line 2 by line 10. Enter this amount
on Schedule C or Part II, line 2, for the corresponding trade or business, as appropriate . . . . . . .
12. Applicable percentage of W-2 wages. Multiply line 3 by line 10. Enter this amount on Part II,
line 4, for the corresponding trade or business, as appropriate . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13. Applicable percentage of the unadjusted basis of qualified property. Multiply line 4 by line 10.
Enter this amount on Part II, line 7, for the corresponding trade or business, as
appropriate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part II—Publiclly Traded Partnership
PTP
SSTB 1
PTP
SSTB 2
PTP
SSTB 3
14. Trade or business name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15. Taxpayer identification number . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Page 52 Chapter 12 Qualified Business Income Deduction
16. Qualified PTP income or loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17. Taxable income before qualified business income deduction . . . . . . . . . . . . . . . . . .
18. Threshold. Enter $157,500 ($315,000 if married filing jointly) . . . . . . . . . . . . . . . . . .
19. Subtract line 18 from line 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20. Phase-in range. Enter $50,000 ($100,000 if married filing jointly) . . . . . . . . . . . . . . .
21. Divide line 19 by line 20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22. Applicable percentage. Subtract line 21 from 100% . . . . . . . . . . . . . . . . . . . . . . . . .
23. Applicable percentage of qualified PTP income or loss. Multiply line 16 by line 22. Enter this
amount on Part IV, line 28 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Schedule A—Specified
Service Trades or
Businesses (SSTB)
Fill out Schedule A if your trade or business is a
specified service trade or business and your
taxable income is more than $157,500 but not
$207,500 ($315,000 and $415,000 if married fil-
ing jointly). If your taxable income is $157,500
or less ($315,000 if married filing jointly), skip
Schedule A. If your taxable income is $207,500
or greater ($415,000 if married filing jointly),
your specified services business does not qual-
ify for the QBI deduction.
For more information on specified service
trades or businesses, see Specified service
trade or business excluded from your qualified
trades or businesses, earlier.
Line 2. Qualified business income from the
trade or business. Enter your QBI for each
specified service trade or business.
Line 3. Allocable share of W-2 wages from
trade or business. Enter your W-2 wages
from each specified service trade or business.
Line 4. Allocable share of the unadjusted
basis immediately after acquisition. Enter
your share of the UBIA of qualified property for
each specified service trade or business.
Line 5. Taxable income before qualified
business income deduction. Enter your tax-
able income figured without regard to the QBI
deduction. (Form 1040, line 7, Adjusted gross
income, minus Form 1040, line 8, Standard de-
duction or itemized deductions).
Line 6. Threshold. Enter the threshold
amount, $157,500 ($315,000 if married filing
jointly).
Line 8. Phase-in range. Enter the phase-in
range, $50,000 ($100,000 if married filing
jointly).
Schedule B—Aggregation of Business Operations Keep for Your Records
Aggregation:
1. Provide a description of the trade or business and an explanation of the factors met that allow the aggregation in accordance
with Regulations section 1.199A-4. In addition, if you hold a direct or indirect interest in a relevant pass-through entity (RPE)
that aggregates multiple trades or businesses you must attach a copy of the RPE's aggregations.
2. Has this trade or business aggregation changed from the prior year? This includes changes in the aggregation due to a trade
or business being formed, acquired, disposed, or ceasing operations. If yes, explain.
3.
(a) Name of trade or business
(b) Taxpayer
identification number
(c) Qualified
business income/
(loss) (d) W-2 wages
(e) Unadjusted basis
immediately after
acquisition
4. Totals. Total columns (c), (d),and (e). Enter the total
amounts on Schedule C or Parts II and IV of Worksheet
12-A, as appropriate. See instructions . . . . . . . . . . . . . . . . . .
Note. If you have more than one aggregated group, attach additional Schedules B. Name the additional aggregations 2, 3, 4, and
so forth.
Chapter 12 Qualified Business Income Deduction Page 53
Schedule B—Aggregation of
Business Operations
An individual or pass-through entity may be en-
gaged in more than one trade or business.
Each trade or business is a separate trade or
business for purposes of applying the W-2
wage limitation or the UBIA limitation, dis-
cussed earlier. However, you may choose to
aggregate multiple trades or businesses into a
single trade or business for purposes of apply-
ing the limitations if you met the following re-
quirements.
1. You or a group of persons directly or indi-
rectly own 50% or more of each trade or
business for a majority of the tax year, in-
cluding the last day of the tax year, and all
trades or businesses use the same tax
year end,
2. None of the trades or business are a
specified service trade or business, and
3. The trades or business meet at least two
of the following factors.
a. They provide products, property, or
services that are the same or that are
customarily offered together.
b. They share facilities or share signifi-
cant centralized business elements
such as personnel, accounting, legal,
manufacturing, purchasing, human re-
sources, or information technology re-
sources.
c. They are operated in coordination
with, or reliance upon, one or more of
the businesses in the aggregated
group.
If a RPE aggregates multiple trades or busi-
nesses, you must attach the RPE’s aggrega-
tions to your Schedule B. You may not subtract
from the trades or businesses aggregated by
the RPE, but you may add additional trades or
businesses to the aggregation, assuming the
rules above are met. If you choose to aggregate
multiple trades or businesses, fill out Sched-
ule B before starting Part I in Worksheet 12-A.
Your aggregations must be reported consis-
tently for all subsequent years, unless there is a
significant change in facts and circumstances
that disqualify the aggregation. Schedule B
must be completed each year to show your
trade or business aggregations, and must in-
clude any aggregation of a RPE in which you
hold a direct or indirect interest. Failure to dis-
close such aggregations may cause them to be
disaggregate.
Note. You must combine the QBI, W-2 wa-
ges, and UBIA of qualified property for all ag-
gregated trades or businesses, for purposes of
applying the W-2 wage and UBIA limitations.
Line 3(c). Current year qualified business
income/(loss). Enter your QBI for each sepa-
rate trade or business.
Line 3(d). W-2 wages. Enter your W-2 wages
from the trade or business.
Line 3(e). Unadjusted basis immediately af-
ter acquisition. Enter your UBIA of qualified
property from the trade or business.
Line 4. Totals. If any of your trades or busi-
nesses have a net loss for the current year or
you have a qualified business net loss carryfor-
ward from prior years, you must complete
Schedule C before starting Part I.
If none of your trades or businesses have a
net loss in the current year and you don’t have a
qualified business loss carryforward from prior
years, enter the total amounts on the appropri-
ate lines of Parts II and IV of Worksheet 12-A.
Schedule C—Loss Netting and Carryforward Keep for Your Records
Trade, business, or
aggregation name
Taxpayer identification
number
(a) Qualified business
income/(loss)
(b) Reduction for loss
netting
(c) Adjusted qualified
business income
(combine (a) and (b);
if zero or less,
enter -0-)
1.
2. Qualified business net loss carryforward from prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Total trade or business losses. Combine the negative amounts on lines 1, column (a), and 2, for all
trades and businesses. Enter as a negative number . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4. Total trade or business income. Add the positive amounts on line 1, column (a), for all trades and
businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Losses netted with income of other trades or businesses. Enter as a negative number, the smaller of
the absolute value of line 3 or line 4. Allocate this amount to each trade or business on line 1, column
(b). See instructions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6. Qualified business net loss carryforward. Subtract line 5 from line 3. If greater than zero,
enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Schedule C—Loss Netting
and Carryforward
If any of your trades or businesses have a net
loss for the current year or you have a qualified
business net loss carryforward from prior years,
you must complete Schedule C before starting
Part I.
Schedule C offsets your trade or business
net losses against net income from your other
trades or businesses. The net loss must be ap-
portioned among all your trades or businesses
with net income in proportion to their net in-
come.
Note. The line items for this schedule are
computed out of order: first figure line 1, column
(a), and line 2; then skip to lines 3 through 5;
and come back to line 1, columns (b) and (c).
Line 1, column (a). Qualified business in-
come or (loss) from the trade or business.
Enter each trade’s or business’s income or loss.
If you aggregated multiple trades or busi-
nesses into a single business on Schedule B,
enter the aggregation group name, that is
Aggregation 1, 2, 3, etc., instead of entering the
business name and TIN along with the aggrega-
ted trade’s or business’s total income or loss.
Line 2. Qualified business net loss carryfor-
ward from prior years. Enter your qualified
business net loss carryforward from prior years,
if any. This is the amount reported in the prior
year on line 6.
Line 1, column (b). Reduction for loss net-
ting. Apportion the amount from line 5 among
all your trades or businesses with net income in
proportion to their net income.
Page 54 Chapter 12 Qualified Business Income Deduction
Line 1, column (c). Adjusted qualified busi-
ness income. Subtract line 1, column (b) from
column (a); if zero or less, enter -0-. Enter this
amount on the corresponding line on Part II.
Note. If the adjusted QBI from the trade or
business is zero or less after the reduction for
loss netting, then the amount reported for W-2
wages and UBIA of qualified property must be
zero for that trade or business, as the actual
amounts aren’t allowed in computing your quali-
fied business income limitations.
Line 6. Qualified business net loss carryfor-
ward. Subtract line 5 from line 3. If greater
than zero, enter -0-. The amount reported on
this line must be reported in the next tax year on
line 2, Qualified business net loss carryforward
from prior years.
Note. If you have an overall net loss for the
year, you don’t qualify for a QBI deduction in the
current year.
Worksheet 12-A. Qualified Business Income Deduction Worksheet Keep for Your Records
Part I: Trade, Business, or Aggregation Information
1. (a) Name (b) Check if
specified service
(c) Check if
Aggregated
(d) Taxpayer
identification
number
(e) Check if Patron
A.
B.
C.
Part II: Determine Your Qualified Business Income Component
A B C
2. Qualified business income from the trade, business, or aggregation (see
instructions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Multiply line 2 by 20% (0.20). If your taxable income is $157,500 or less
($315,000 if married filing jointly), skip lines 4 through 12 and enter line 3 on
line 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4. Allocable share of W-2 wages from the trade, business, or
aggregation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Multiply line 4 by 50% (0.50) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6. Multiply line 4 by 25% (0.25) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7. Allocable share of the unadjusted basis of all qualified property . . . . . . . . . . .
8. Multiply line 7 by 2.5% (0.025) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9. Add lines 6 and 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10. Enter the greater of line 5 or line 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11. W-2 wage and qualified property limitation. Enter the smaller of line 3 or
line 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12. Phased-in reduction. Enter amount from Part III, line 26, if any. See
instructions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13. Qualified business income deduction before patron reduction. Enter the
greater of line 11 or line 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14. Patron reduction. Enter the amount from Schedule D, line 6, if any . . . . . . . . .
15. Qualified business income component. Subtract line 14 from line 13 . . . . . . .
16. Total qualified business income component. Add all amounts reported on
line 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part III: Phased-in Reduction
Caution. Complete Part III only if your taxable income is more than $157,500 but not $207,500 ($315,000 and $415,000 if married
filing jointly), and line 10 is less than line 3. Otherwise, skip Part III.
A B C
17. Enter amounts from line 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18. Enter the amount from line 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19. Subtract line 18 from line 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20. Taxable income before qualified business income
deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
21. Threshold. Enter $157,500 ($315,000 if married filing
jointly) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Chapter 12 Qualified Business Income Deduction Page 55
22. Subtract line 21 from line 20 . . . . . . . . . . . . . . . . . . . . . . . . . . .
23. Phase-in range. Enter $50,000 ($100,000 if married filing
jointly) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24. Phase-in percentage. Divide line 22 by line 23 . . . . . . . . . . . .
25. Total phase-in reduction. Multiply line 19 by line 24 . . . . . . . . . . . . . . . . . . . . . .
26. Qualified business income after phase-in reduction. Subtract line 25 from
line 17. Enter this amount on line 12 for the corresponding trade or
business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part IV: Determine Your Qualified Business Income Deduction
27. Total qualified business income component from all qualified trades, businesses, or
aggregations. Enter the amount from Part II, line 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27.
28. Qualified REIT dividends and qualified PTP income or (loss) (see instructions) . . . . . . . . . 28.
29. Qualified REIT dividends and qualified PTP loss carryforward from prior years. Enter as a
negative number . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29.
30. Total qualified REIT dividends and qualified PTP income. Add lines 28 and 29. If less than
zero, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.
31. REIT and PTP component. Multiply line 30 by 20% (0.20) . . . . . . . . . . . . . . . . . . . . . . . . . . . 31.
32. Qualified business income deduction before the income limitation. Add lines 27 and 31 . . . . . 32.
33. Taxable income before qualified business income deduction . . . . . . . . . . . . . . . . . . . . . . . . 33.
34. Net capital gain (see instructions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34.
35. Subtract line 34 from line 33. If zero or less, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35.
36. Income limitation. Multiply line 35 by 20% (0.20) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36.
37. Qualified business income deduction. Enter the smaller of line 32 or line 36 . . . . . . . . . . . . . . . 37.
38. Total qualified REIT dividend and qualified PTP loss carryforward. Add lines 28 and 29, if zero
or greater enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38.
39. DPAD under section 199A(g) allocated from an agricultural or horticultural cooperative. Don't
enter more than line 33 minus line 37. Enter this deduction on Form 1040, line 10. See the
instructions for Form 1040, line 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39.
Part I—Trade, Business, and
Aggregation Information
Before you beginning to fill out Part I, determine
if you need to complete Schedule A, B, C, or D
by answering the following questions.
1. Do you have a specified service trade or
business? If you answered yes, complete
Schedule A before starting Part I.
2. Are you choosing to aggregate multiple
trades or businesses into a single trade or
business? If you answered yes, complete
Schedule B before starting Part I.
3. Did any of your trades or businesses have
a net loss for the year or do you have a
qualified business net loss from prior
years? If you answered yes, complete
Schedule C before starting Part I.
Line 1. Enter the trade or business name and
check the appropriate boxes. If you aggregated
multiple trades or businesses into a single busi-
ness on Schedule B, enter the aggregation
group name, for example, Aggregation 1, 2, 3,
etc., instead of entering the business name and
leave line 1(d) blank. Enter on line 1(d), the em-
ployer identification number (EIN) that was is-
sued to you or your business on Form SS-4. If
you do not have an EIN, enter your social se-
curity number (SSN) or individual taxpayer
identification number (ITIN). If you are the sole
owner of an LLC that is not treated as a sepa-
rate entity for federal income tax purposes, en-
ter the EIN issued to the LLC. If you do not have
such an EIN, enter the owner's name and tax
identification number.
Part II—Determine Your
Qualified Business Income
Component
Line 2. Qualified business income from the
trade or business. Enter your QBI for each
trade or business. The amount reported on
line 2 can’t be less than zero. See the instruc-
tions for Schedule C.
Line 3. Multiple line 2 by 20% (0.20). If your
taxable income is $157,500 or less ($315,000 if
married filing jointly), skip lines 4 through 12
and enter line 3 on line 13.
Line 4. Allocable share of W-2 wages from
trade or business. Enter your W-2 wages
from the trade or business.
Note. if the QBI on line 2 for the trade or
business is zero, then the amount reported on
line 4 with respect to that trade or business
must also be zero.
Line 7. Allocable share of the unadjusted
basis immediately after acquisition. Enter
your share of the UBIA for all qualified property
for the trade or business.
Note. if the QBI on line 2 for the trade or
business is zero, then the amount reported on
line 7 with respect to that trade or business
must also be zero.
Line 14. Patron reduction. Patrons of agri-
cultural or horticultural cooperatives are re-
quired to reduce their QBI deduction by the
lesser of:
• 9% of QBI allocable to qualified payments
from a specified cooperative, or
• 50% of W-2 wages allocable to qualified
payments.
If you are a patron of an agricultural or horti-
cultural cooperative, fill out Schedule D, Special
Rules for Patrons of Agricultural or Horticultural
Cooperatives.
Page 56 Chapter 12 Qualified Business Income Deduction
Schedule D—Special Rules for Patrons of Agricultural or Horticultural
Cooperatives (Coop) Keep for Your Records
Caution. Complete Schedule D only if you're a patron of an agricultural or horticultural cooperative.
Coop 1 Coop 2 Coop 3
1a. Trade, business, or aggregation name: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1b. Taxpayer identification number . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Qualified business income allocable to qualified payments received from
cooperative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Multiply line 2 by 9% (0.09) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4. W-2 wages from trade or business allocable to the qualified payments . . . . . . .
5. Multiply line 4 by 50% (0.50) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6. Patron reduction. Enter the smaller of line 3 or line 5. Enter this amount on Part
II, line 14, for the corresponding trade or business . . . . . . . . . . . . . . . . . . . . . . . .
Schedule D—Special Rules
for Patrons of Agricultural or
Horticultural Cooperatives
(Coop)
A specified agricultural or horticultural coopera-
tive is a cooperative that markets or is engaged
in the manufacturing, production, growth, or ex-
traction of any agricultural or horticultural prod-
ucts to which Part I of Subchapter T applies.
See section 199A(g)(3).
Line 2. Qualified payments received from
cooperative. Enter your qualified business in-
come allocable to qualified payments received
from the cooperative. Qualified payments in-
clude patronage dividends and per-unit retains
allocations.
Line 4. W-2 wages from trade or business.
Enter your W-2 wages allocable to qualified
payments.
Part III—Phased-in
Reduction
Fill out Part III if your taxable income is more
than $157,500 but not $207,500 ($315,000 and
$415,000 if married filing jointly), and line 10 is
smaller than line 3. Otherwise, skip Part III.
Line 20. Taxable income before qualified
business income deduction. Enter your tax-
able income figured without regard to any de-
duction computed on this worksheet (Form
1040, line 7, Adjusted gross income, minus
Form 1040, line 8, Standard deduction or item-
ized deductions).
Line 21. Threshold. Enter the threshold
amount, $157,500 (315,000 if married filing
jointly).
Line 23. Phase-in range. Enter the phase-in
range, $50,000 ($100,000 if married filing
jointly).
Part IV—Determine Your
Qualified Business Income
Deduction
Line 28. Qualified REIT dividends and quali-
fied PTP income. Enter your qualified REIT
dividends and qualified PTP income. If the net
amount is a loss, enter as a negative number.
Any resulting loss isn’t netted against net
positive QBI; instead, the net loss is carried for-
ward to the next tax year and offsets future
qualified REIT dividends and qualified PTP in-
come.
Line 29. Qualified REIT dividends and quali-
fied PTP loss carryforward from prior
years. Enter your qualified PTP loss carryfor-
ward from prior years, if any. Enter as a nega-
tive number.
Line 30. Total qualified REIT dividends and
qualified PTP income. Add lines 28 and 29. If
zero or less, enter -0-. If the amount reported on
this line is less than zero, it must be reported in
the next tax year on the line for PTP loss carry-
forward from prior years.
Line 33. Taxable income before qualified
business income deduction. Enter your tax-
able income figured without regard to any de-
duction computed on this worksheet (Form
1040, line 7, Adjusted gross income, minus
Form 1040, line 8, Standard deduction or item-
ized deductions).
Line 34. Net capital gain. Enter your quali-
fied dividends from Form 1040, line 3a, plus
your net capital gain. If you’re not required to file
Schedule D (Form 1040), your net capital gain
is the gain reported on your Schedule 1 (Form
1040), line 13. If you file Schedule D (Form
1040), your net capital gain is the smaller of
Schedule D (Form 1040), line 15 or line 16, un-
less either line is zero or less, in which case
your net capital gain is zero.
Line 37. Qualified business income deduc-
tion. Enter this amount on Form 1040, line 9.
Line 38. Total qualified REIT dividends and
qualified PTP loss carryforward. Add lines
28 and 29; if zero or greater, enter -0-. This loss
must be carried over to the next tax year.
Line 39. DPAD allocated from an agricul-
tural or horticultural cooperative. Enter
your DPAD allocated from your agricultural or
horticultural cooperative, if any. The amount en-
tered on this line can’t be more than your taxa-
ble income less your qualified business income
deduction (line 33 less line 37). Include this de-
duction on Form 1040, line 10, and attach a
statement and name it “DPAD 199A(g)” to ex-
plain this adjustment that reduces taxable in-
come. See instructions for Form 1040, line 10.
Coordination With Other
Code Sections.
A net operating loss under section 172 gen-
erally is figured without the QBI deduction,
meaning the QBI deduction can’t create or in-
crease the net operating loss.
Alternative minimum tax. The QBI deduction
that is used to determine regular tax is also
used to determine alternative minimum taxable
income.
Net earnings from self-employment aren’t
reduced by the QBI deduction when computing
self-employment tax.
Net investment income isn’t reduced by the
QBI deduction when computing net investment
income tax.
Special Rules
Puerto Rico. For purposes of determining
QBI, the United States includes Puerto Rico for
taxpayers who have taxable income from sour-
ces within Puerto Rico that are subject to tax
under section 1. Further, W-2 wages are figured
by including W-2 wages paid for services per-
formed in Puerto Rico without regard to section
3401(a)(8).
Chapter 12 Qualified Business Income Deduction Page 57
13.
How To Get Tax
Help
If you have questions about a tax issue, need
help preparing your tax return, or want to down-
load free publications, forms, or instructions, go
to IRS.gov and find resources that can help you
right away.
People who are deaf, hard of hearing, or have a
speech disability and who have access to
TTY/TDD equipment can call toll free
800-829-4059 to ask tax questions or to order
forms and publications. Deaf or hard-of-hearing
individuals can contact the IRS through relay
services such as the Federal Relay Service,
available at GSA.gov/FedRelay.
Tax reform. Major tax reform legislation im-
pacting individuals, businesses, and tax-ex-
empt entities was enacted in the Tax Cuts and
Jobs Act on December 22, 2017. Go to
IRS.gov/TaxReform for information and up-
dates on how this legislation affects your taxes.
Tax reform provisions that affect busi-
nesses. Business owners can refer to IRS.gov/
Newsroom/Businesses for updates and resour-
ces on business-related changes resulting from
the Tax Cuts and Jobs Act 2017.
Small Business and Self-Employed (SB/SE)
tax center. SB/SE serves taxpayers who file
Form 1040, Schedules C, E, or F, or Form
2106, as well as small businesses with assets
under $10 million.
A–Z index for business. Find it fast! Know
what you're looking for and want to find it fast?
Select business topics using our A–Z listing, or
by business type such as sole proprietor, cor-
poration, etc. We also provide links to major
business subjects, such as Business Expenses,
which provide a gateway to all related informa-
tion on those subjects.
• Small Business Forms and Publications.
You can download forms and publications
for small business and self-employed indi-
viduals.
• Employer ID Numbers (EINs). Find out
about EINs or apply for one online.
• e-File Form 940, 941, 944, or 945 for Small
Businesses. Learn your options for e-filing
Form 940, 941, 944, or 945 for small busi-
nesses.
• Starting, Operating, or Closing a Business.
Important tax information related to the
various stages of owning a business.
• Employment Taxes. Federal income tax,
social security and Medicare taxes, FUTA,
self-employment tax, and more.
• Independent Contractor (Self-Employed)
or Employee. It is critical that you, the em-
ployer, correctly determine whether the in-
dividuals providing services are employees
or independent contractors.
• Self-Employed Individuals Tax Center. The
basics on self-employment, filing require-
ments, and reporting responsibilities for in-
dependent contractors.
• Information Return Filing Requirements. If
you made or received a payment as a
small business or self-employed individual,
you are most likely required to file an infor-
mation return with the IRS.
• IRS Video Portal. Video, webinars, and au-
dio presentations for small businesses, in-
dividuals, and tax pros.
• Small Business Events. Workshops and
webinars on a variety of topics for small
businesses.
• Online Tools & Educational Products.
Choose from a variety of products, includ-
ing the Tax Calendar desktop tool, to help
you learn about business taxes on your
own time, and at your own pace.
• Subscribe to e-News. A free electronic
mail service keeping you up to date on tax
topics.
Requirements for filing. If you made or re-
ceived a payment during the calendar year as a
small business or self-employed individual, you
are most likely required to file an information re-
turn with the IRS. For more information, see Am
I Required To File a Form 1099 or Other
Information Return? on IRS.gov.
Preparing and filing your tax return. Find
free options to prepare and file your return on
IRS.gov or in your local community if you qual-
ify.
The Volunteer Income Tax Assistance
(VITA) program offers free tax help to people
who generally make $55,000 or less, persons
with disabilities, the elderly, and limited-Eng-
lish-speaking taxpayers who need help prepar-
ing their own tax returns. The Tax Counseling
for the Elderly (TCE) program offers free tax
help for all taxpayers, particularly those who are
60 years of age and older. TCE volunteers spe-
cialize in answering questions about pensions
and retirement-related issues unique to seniors.
You can go to IRS.gov/Filing to see your op-
tions for preparing and filing your return, which
include the following.
• Free File. Go to IRS.gov/FreeFile. See if
you qualify to use brand-name software to
prepare and e-file your federal tax return
for free.
• VITA. Go to IRS.gov/VITA, download the
free IRS2Go app, or call 800-906-9887 to
find the nearest VITA location for free tax
preparation.
• TCE. Go to IRS.gov/TCE, download the
free IRS2Go app, or call 888-227-7669 to
find the nearest TCE location for free tax
preparation.
How to choose a tax return preparer. If you
choose to have someone prepare your tax re-
turn, choose that preparer wisely. A paid tax re-
turn preparer is primarily responsible for the
overall substantive accuracy of your tax return
and, by law, is required to sign the return and
include their preparer tax identification number
(PTIN) on it. Although the tax return preparer
signs the return, you are ultimately responsible
for the accuracy of every item reported on your
return. Anyone paid to prepare tax returns for
others should have a thorough understanding of
tax matters and is required to have a PTIN. You
may want to ask friends, co-workers, or your
employer for help in selecting a competent tax
return preparer.
For your convenience, the IRS provides an
online database for all Authorized IRS e-file
Providers that choose to be included in the da-
tabase. You can locate the closest Authorized
IRS e-file Providers in your area where you can
electronically file your tax return. For more infor-
mation on finding a tax return preparer who pro-
vides IRS e-file, see Authorized IRS e-file
Providers for Individuals on IRS.gov, or go to
IRS.gov/uac/Authorized-IRS-e-file-Providers-
for-Individuals. The inclusion in this database
does not constitute any endorsement by the
IRS of the e-file Providers listed in this database
or any of the products or services that they pro-
vide. You should always be sure to conduct
your own due diligence when selecting an e-file
Provider. In addition to the Authorized IRS e-file
Provider locator tool above, you can also find
professional help through the IRS Tax
Professional Partner page at IRS.gov/Tax-
Professionals/IRSTaxProAssociationPartners.
Choose a tax return preparer you will be
able to contact in case the IRS examines your
return and has questions regarding how your
return was prepared. You can designate your
paid tax return preparer or another third party to
speak to the IRS concerning the preparation of
your return, payment/refund issues, and mathe-
matical errors. The third party authorization
checkbox on Form 1040 gives the designated
party the authority to receive and inspect re-
turns and return information for 1 year from the
original due date of your return (without regard
to extensions). You can extend the authority to
receive and inspect returns and return informa-
tion to a third party using Form 8821, Tax
Information Authorization.
The following points will assist you when se-
lecting a tax return preparer.
• Check the preparer’s qualifications. All
paid tax return preparers are required to
have a PTIN.
• Check the preparer’s history. You can
check with the Better Business Bureau to
find out if a preparer has a questionable
history. Check for disciplinary actions and
the license status for credentialed prepar-
ers. For Certified Public Accountants
(CPAs), check with the State Board of Ac-
countancy. For attorneys, check with the
State Bar Association. For Enrolled Agents
(EAs), go to IRS.gov/Tax-Professionals/
Verify-the-Status-of-an-Enrolled-Agent and
follow the instructions for requesting EA
status verification.
• Ask about service fees. Avoid preparers
who base their fee on a percentage of your
refund or those who say they can get
larger refunds than others can. Always
make sure any refund due is sent directly
to you or deposited into your bank ac-
count. You should not have your refund
deposited into a preparer’s bank account.
• Ask to e-file your return. Make sure your
preparer offers IRS e-file. Any paid pre-
parer who prepares and files more than 10
returns generally must e-file their clients’
returns. The IRS has safely processed
more than 1.3 billion e-filed tax returns.
Page 58 Chapter 13 How To Get Tax Help
• Make sure the preparer is available.
You need to ensure that you can contact
the tax preparer after you file your return.
That’s true even after the April 15, 2019,
due date for individual returns. The due
date for partnerships and S corporations
using a calendar year is March 15, 2019.
You may need to contact the preparer if
questions come up about your tax return at
a later time.
• Provide tax records. A good preparer will
ask to see your records and receipts. They
ask you questions to report your total in-
come and the tax benefits you’re entitled to
claim. These may include tax deductions,
tax credits, and other items. Do not use a
preparer who is willing to e-file your return
using your last pay stub instead of your
Form W-2. This is against IRS e-file rules.
• Never sign a blank tax return. Do not
use a tax preparer who asks you to sign a
blank tax form.
• Review your return before signing. Be-
fore you sign your tax return, review it thor-
oughly. Ask questions if something is not
clear to you. Make sure you’re comfortable
with the information on the return before
you sign it.
• Preparer must sign returns and include
their PTIN. A paid preparer must sign re-
turns and include his or her PTIN as re-
quired by law. The preparer also must give
you a copy of the return.
• Report abusive tax preparers to the
IRS. You can report abusive tax preparers
and suspected tax fraud to the IRS. Use
Form 14157, Complaint: Tax Return
Preparer. If you suspect a return preparer
filed or changed the return without your
consent, you should also file Form 14157-
A, Return Preparer Fraud or Misconduct
Affidavit. You can download and print
these forms from IRS.gov. If you need a
paper form mailed to you, go to IRS.gov/
OrderForms to order online. For more in-
formation, go to How Do You Report
Suspected Tax Fraud Activity? on IRS.gov.
Getting answers to your tax law questions.
On IRS.gov, get answers to your tax questions
anytime, anywhere.
• Go to IRS.gov/Help or IRS.gov/LetUsHelp
for a variety of tools that will help you get
answers to the most common tax ques-
tions.
• Go to IRS.gov/ITA for the Interactive Tax
Assistant (ITA), a tool that will ask you
questions on a number of tax law topics
and provide answers. You can print the en-
tire interview and the final response for
your records.
• Go to IRS.gov/Pub17 to get Pub. 17, Your
Federal Income Tax for Individuals, which
features details on tax-saving opportuni-
ties, 2018 tax changes, and thousands of
interactive links to help you find answers to
your questions. View it online in HTML or
as a PDF or, better yet, download it to your
mobile device to enjoy eBook features.
• You may also be able to access tax law in-
formation in your electronic filing software.
• Go to IRS.gov and click on the Help & Re-
sources tab for more information.
Getting tax forms and publications. Go to
IRS.gov/Forms to view, download, or print all of
the forms and publications you may need. You
can also download and view popular tax publi-
cations and instructions (including the 1040 in-
structions) on mobile devices such as an eBook
at no charge. Or you can go to IRS.gov/
OrderForms to place an order.
Access your online account (individual tax-
payers only). Go to IRS.gov/Account to se-
curely access information about your federal tax
account.
• View the amount you owe, pay online, or
set up an online payment agreement.
• Access your tax records online.
• Review the past 18 months of your pay-
ment history.
• Go to IRS.gov/SecureAccess to review the
required identity authentication process.
Using direct deposit. The fastest way to re-
ceive a tax refund is to combine direct deposit
and IRS e-file. Direct deposit securely and elec-
tronically transfers your refund directly into your
financial account. Eight in 10 taxpayers use di-
rect deposit to receive their refunds. The IRS is-
sues more than 90% of refunds in less than 21
days.
Delayed refund for returns claiming certain
credits. Due to changes in the law, the IRS
can’t issue refunds for 2018 tax returns before
mid-February 2019 for returns that claim the
earned income credit (EIC) or the additional
child tax credit (ACTC). This applies to the en-
tire refund, not just the portion associated with
these credits.
Getting a transcript or copy of a return. Tax
transcripts are summaries of tax returns. IRS
transcripts are best and most often used to vali-
date past income and tax filing status for mort-
gage, student, and small business loan applica-
tions, and to help with tax preparation.
Taxpayers can also use transcripts to obtain
their prior-year adjusted gross income (AGI),
which they need in order to e-file their tax re-
turns. You can get a transcript by mail to view
your tax account transactions or line-by-line tax
return information for a specific tax year. The
method you used to file your return and whether
you have a refund or balance due affects your
current tax year transcript availability. Gener-
ally, these transcript types are available for the
current tax year and 3 prior years. The quickest
way to get a copy of your tax transcript is to go
to IRS.gov/Transcripts. Click on either "Get
Transcript Online" or "Get Transcript by Mail" to
order a copy of your transcript. If you need an
account transcript for an older tax year, a wage
and income transcript, or a verification of nonfil-
ing letter, you’ll need to complete Form 4506-T,
Request for Transcript of Tax Return, available
at IRS.gov/Forms-Pubs/About-Form-4506-T-
Request-for-Transcript-of-Tax-Return,
and send it to us as instructed on the form. If
you made estimated tax payments and/or ap-
plied your overpayment from a prior-year tax re-
turn to your current-year tax return, you can re-
quest a tax account transcript to confirm these
payments or credits a few weeks after the be-
ginning of the calendar year prior to filing your
current-year return. For the list of the various
types of transcripts available for you to order,
see Transcript Types and Ways to Order Them
at IRS.gov/Individuals/Tax-Return-Transcript-
Types-and-Ways-to-Order-Them. To order your
transcript, you can choose from one of the fol-
lowing convenient options.
• Request a return or account transcript us-
ing Get Transcript at IRS.gov/Individuals/
Get-Transcript.
• Download the free IRS2Go app to your
mobile device and use it to order tran-
scripts of your tax returns or tax account.
• Call the automated transcript toll-free line
at 800-908-9946 to receive your transcript
by mail.
• Go to Get Transcript at IRS.gov/
Individuals/Get-Transcript, and click on
“Get Transcript by Mail.” You will need
your social security number (SSN) or your
Individual Taxpayer Identification Number
(ITIN), date of birth, and address from your
latest tax return. Transcripts arrive in 5 to
10 calendar days at the address we have
on file for you.
• Mail Form 4506-T, Request for Transcript
of Tax Return, or Form 4506T-EZ, Short
Form Request for Individual Tax Return
Transcript (both available on IRS.gov).
The IRS never sends email requesting that
you obtain or access your transcripts. Report all
unsolicited email claiming to be from the IRS or
an IRS-related function to phishing@irs.gov.
A transcript isn’t a photocopy of your return.
If you need a photocopy of your original return,
complete and mail Form 4506, Request for
Copy of Tax Return, available at IRS.gov/Pub/
irs-pdf/F4506.pdf, along with the applicable fee.
Using online tools to help prepare your re-
turn. Go to IRS.gov/Tools for the following.
• The Earned Income Tax Credit Assistant
(IRS.gov/EIC) determines if you are eligi-
ble for the EIC.
• The Online EIN Application (IRS.gov/EIN)
helps you get an employer identification
number.
• The IRS Withholding Calculator (IRS.gov/
W4App) estimates the amount you should
have withheld from your paycheck for fed-
eral income tax purposes.
• The First Time Homebuyer Credit Account
Look-up (IRS.gov/HomeBuyer) tool pro-
vides information on your repayments and
account balance.
• The Sales Tax Deduction Calculator
(IRS.gov/SalesTax) figures the amount you
can claim if you itemize deductions on
Schedule A (Form 1040), choose not to
claim state and local income taxes, and
didn’t save your receipts showing the sales
tax you paid.
Where to file your tax return.
• There are many ways to file your return
electronically. It’s safe, quick, and easy.
See Preparing and filing your tax return,
earlier, for more information.
• See your tax return instructions to deter-
mine where to mail your completed paper
tax return.
Understanding and resolving tax-related
identity (ID) theft issues. The IRS doesn’t ini-
tiate contact with taxpayers by email or phone
Chapter 13 How To Get Tax Help Page 59
to request personal or financial information.
This includes any type of electronic communi-
cation, such as text messages and social media
channels.
For 2018, the IRS, the states, and the tax in-
dustry joined together to enact new safeguards
and take additional actions to combat tax-rela-
ted identity theft. Many of these safeguards will
be invisible to you, but invaluable to our fight
against these criminal syndicates. If you pre-
pare your own return with tax software, you will
see new log-on standards. Some states also
have taken additional steps. See your state
revenue agency’s web site for additional de-
tails.
The following is a list of resources available
to assist you in identifying and resolving ID theft
issues.
• Go to IRS.gov/IDProtection for information
and videos.
• If your SSN or ITIN has been lost or stolen
or you suspect you are a victim of tax-rela-
ted ID theft, visit IRS.gov/ID to learn what
steps you should take. Also, see Pub.
5027, Identity Theft Information for
Taxpayers, available at IRS.gov/Pub/irs-
pdf/P5027.pdf, for more information.
• To report ID theft, access the IRS ID Theft
Tool Kit at IRS.gov/uac/Taxpayer-Guide-
to-Identity-Theft. This page also provides a
list of helpful toll-free phone numbers and
links to other resources for reporting ID or
data theft.
• The IRS stops and flags suspicious or du-
plicate federal tax returns that falsely rep-
resent your identity, such as your name or
SSN. If the IRS suspects tax ID theft, the
agency will send a 5071C letter to your
home address. If you receive this letter,
verify your identity at IDVerify.IRS.gov or
call the toll-free number listed in the letter.
If you did not receive an IRS notice but be-
lieve you’ve been the victim of ID theft,
contact the IRS Identity Protection Special-
ized Unit at 800-908-4490 right away so
we can take steps to secure your tax ac-
count and match your SSN or ITIN.
• Also, fill out and submit the IRS Form
14039, Identity Theft Affidavit. Please write
legibly and follow the directions on the
back of the form that relate to your specific
circumstances.
• If you are a victim of state tax ID theft, con-
tact your state's taxation department or
comptroller's office about the next steps
you need to take.
• You should protect the information that you
keep, and properly dispose of what you no
longer need. And, of course, you should
create a plan to respond to security inci-
dents. As part of its long-standing efforts to
promote good data security practices, the
Federal Trade Commission (FTC) has un-
dertaken extensive efforts to educate busi-
nesses and has brought more than 50 law
enforcement actions related to data secur-
ity issues. For more information, see Pro-
tecting Personal Information: A Guide for
Business, available at FTC.gov/Tips-
advice/business-center/guidance/
protecting-personal-information-guide-
business, for practical tips on creating and
implementing a plan for safeguarding per-
sonal information used in your business.
Most recently, the FTC released Start with
Security: A Guide for Business, available
at FTC.gov/Tips-advice/business-center/
guidance/start-security-guide-business?
utm_source=govdelivery, which draws on
the lessons learned from the FTC's en-
forcement actions.
The FTC works for consumers to prevent
fraudulent, deceptive, and unfair business prac-
tices and to provide information to help spot,
stop, and avoid them. To file a complaint, for
example, to report someone falsely claiming to
be from the government, a business, or a family
member, visit the FTC’s online Complaint
Assistant or call 877-FTC-HELP
(877-382-4357). The FTC enters complaints
into Consumer Sentinel, a secure, online data-
base available to more than 2,000 civil and
criminal law enforcement agencies in the United
States and abroad. Complaints from consumers
help the FTC detect patterns of fraud and
abuse. The FTC’s website provides free infor-
mation on a variety of consumer topics, in Eng-
lish and in Spanish.
Consumer complaints regarding interna-
tional scams can be reported online through
Econsumer.gov. These are also entered into
Consumer Sentinel, the complaint database
maintained by the FTC, and are made available
to enforcers and regulators in countries with
participating agencies. Those agencies may
use the complaints to investigate cross-border
issues, uncover new scams, pursue regulatory
or enforcement actions, and spot consumer
trends.
Recognizing and reporting tax scams. The
Dirty Dozen is compiled annually by the IRS
and lists a variety of common scams taxpayers
may encounter any time during the year. Many
of these con games peak during filing season
as people prepare their tax returns or hire
someone to do so. Aggressive and threatening
phone calls by criminals impersonating IRS
agents remain near the top of the annual Dirty
Dozen list of tax scams for the 2018 filing sea-
son.
Scammers are able to alter caller identifica-
tion (caller ID) numbers to make it look like the
IRS is calling. They use fake names and bogus
IRS identification or badge numbers. They often
leave “urgent” callback requests. They prey on
the most vulnerable people, such as the elderly,
newly arrived immigrants, and those whose first
language is not English. Scammers have been
known to impersonate agents of IRS Criminal
Investigation as well.
Be cautious when receiving suspicious calls
at home or at work from sources claiming to be
from the IRS, other agencies, or outside sour-
ces asking for money or credit card information,
or threatening to have you arrested for not pay-
ing. These callers may demand money or may
say you have a refund due and try to trick you
into sharing private information. These con ar-
tists can sound convincing when they call. They
may know a lot about you.
Here are five things the scammers often do
but the IRS will not do. Any one of these five
things is a tell-tale sign of a scam.
The IRS will never do any of the follow-
ing.
• Call to demand immediate payment, nor
will the agency call about taxes owed with-
out first having mailed you a bill.
• Demand that you pay taxes without giving
you the opportunity to question or appeal
the amount they say you owe.
• Require you to use a specific payment
method for your taxes, such as a prepaid
debit card.
• Ask for credit or debit card numbers over
the phone.
• Threaten to bring in local police or other
law-enforcement groups to have you arres-
ted for not paying.
If you get a phone call from someone claim-
ing to be from the IRS and asking for money, do
not disclose your personal information. You
should make notes of all information regarding
the call and/or the caller, for example, any caller
ID information, then hang up immediately and
do the following.
• If you know you owe taxes or think you
might owe, call the IRS toll free at
800-829-1040. The IRS assistors can help
you with a payment issue.
• If you know you don’t owe taxes or have no
reason to believe that you do, report the in-
cident to the Treasury Inspector General
for Tax Administration (TIGTA) toll free at
800-366-4484 or at TIGTA.gov.
• If you’ve been targeted by this scam, also
contact the FTC and use their FTC
Complaint Assistant at FTC.gov. Please
add “IRS Telephone Scam” to the com-
ments of your complaint.
Remember, too, the IRS does not use
email, text messages, or any social media to
discuss your personal tax issue involving bills or
refunds. If you get a phone call from someone
claiming to be from the IRS regarding a refund
owed to you and asking you for your SSN and
bank account information, do not give them this
information. You should make notes of all infor-
mation regarding the call and/or the caller, for
example, any caller ID information, and report
this scam. For more information on reporting tax
scams, go to IRS.gov and type “scam” in the
search box. You can verify any potential re-
funds owed to you by contacting the IRS di-
rectly.
Additional information about tax scams is
available on IRS social media sites, including
YouTube, youtube.com/irsvideos, and Tumblr,
internalrevenueservice.tumblr.com, where peo-
ple can search “scam” to find all the scam-rela-
ted posts.
Checking on the status of a refund.
• Go to IRS.gov/Refunds.
• According to the Protecting Americans
from Tax Hikes (PATH) Act, the IRS can’t
issue refunds before mid-February 2019
for returns that properly claim the EIC or
the ACTC. This applies to the entire re-
fund, not just the portion associated with
these credits.
• Download the official IRS2Go app to your
mobile device to check your refund status.
• Call the automated refund hotline toll free
at 800-829-1954.
Page 60 Chapter 13 How To Get Tax Help
Making a tax payment. The IRS uses the lat-
est encryption technology to ensure your elec-
tronic payments are safe and secure. You can
make electronic payments online, by phone,
and from a mobile device using the IRS2Go
app. Paying electronically is quick, easy, and
faster than mailing in a check or money order.
Go to IRS.gov/Payments to make a payment
using any of the following options.
• IRS Direct Pay. Pay your individual tax bill
or estimated tax payment directly from
your checking or savings account at no
cost to you.
• Debit or credit card. Choose an approved
payment processor to make a secure tax
payment online, by phone, and by mobile
device. Your payment will be processed by
a payment processor who will charge a
processing fee. The fees vary by service
provider and may be tax deductible. No
part of the service fee goes to the IRS.
Note. You usually can’t cancel payments.
You can’t make Federal Tax Deposits. You
can't get an immediate release of a Fed-
eral Tax Lien.
• Electronic Funds Withdrawal. Offered only
when filing your federal taxes using tax
preparation software or through a tax pro-
fessional during e-filing.
• Electronic Federal Tax Payment System
(EFTPS®). EFTPS® is a system for pay-
ing federal taxes electronically online, or
by phone using the EFTPS® Voice Re-
sponse System. EFTPS® is offered free
by the U.S. Department of Treasury. You
can use EFTPS® to make all your federal
tax payments, including income, employ-
ment, estimated, and excise taxes. It is the
best option for businesses. Enrollment is
required. You can initiate your tax payment
from your home or office, 24/7. Businesses
and individuals can schedule payments up
to 365 days in advance. Scheduled pay-
ments can be changed or canceled up to 2
business days in advance of the scheduled
payment date.
• Check or money order. Mail your payment
to the address listed on the notice or in-
structions.
• Cash. If cash is your only option, you may
be able to pay your taxes at a participating
retail store.
What if I can’t pay now? Go to IRS.gov/
Payments for more information about your op-
tions.
• Apply for an online payment agreement
(IRS.gov/OPA) to meet your tax obligation
in monthly installments if you can’t pay
your taxes in full by the due date of the re-
turn. For individuals to qualify for a
long-term agreement, you must owe
$50,000 or less in combined tax, penalties,
and interest, and must have filed all re-
quired returns. You may also qualify for a
short-term agreement if your balance is un-
der $100,000. For a business to qualify,
you must owe $25,000 or less in combined
tax, penalties, and interest for the current
year or last year's liabilities, and must have
filed all required returns. Once you com-
plete the online process (in about 30 mi-
nutes), you will receive immediate notifica-
tion of whether your agreement has been
approved.
• Use the Offer in Compromise Pre-Qualifier
(IRS.gov/OIC) to see if you can settle your
tax debt for less than the full amount you
owe.
Note. If you are a sole proprietor or inde-
pendent contractor, apply for a payment agree-
ment as an individual.
Checking the status of an amended return.
Go to IRS.gov/WMAR, Where’s My Amended
Return, to track the status of Form 1040X
amended returns.
Note. It can take up to 3 weeks from the
date you mailed your amended return for it to
show up in our system and processing it can
take up to 16 weeks.
Filing past due tax returns. File all tax re-
turns that are due, regardless of whether or not
you can pay in full. File your past due return the
same way and to the same location where you
would file an on-time return. If you have re-
ceived a notice, make sure to send your past
due return to the location indicated on the no-
tice you received. If you have a past due return,
filing your past due return now can help you do
the following.
• Avoid interest and penalties. File your
past due return and pay now to limit inter-
est charges and late payment penalties.
• Claim a refund. You risk losing your re-
fund if you don't file your return. If you are
due a refund for withholding or estimated
taxes, you must file your return to claim it
within 3 years of the return due date. The
same rule applies to a right to claim tax
credits such as the EIC. We hold income
tax refunds in cases where our records
show that one or more income tax returns
are past due. We hold them until we get
the past due return or receive an accepta-
ble reason for not filing a past due return.
• Protect social security benefits. If you
are self-employed and do not file your fed-
eral income tax return, any self-employ-
ment income you earned will not be repor-
ted to the Social Security Administration
and you will not receive credits toward so-
cial security retirement or disability bene-
fits.
• Avoid issues obtaining loans. Loan ap-
provals may be delayed if you don't file
your return. Copies of filed tax returns must
be submitted to financial institutions, mort-
gage lenders/brokers, etc., whenever you
want to buy or refinance a home, get a loan
for a business, or apply for federal aid for
higher education.
For more information, go to Filing Past Due
Tax Returns on IRS.gov.
Substitute return. If you fail to file voluntarily,
we may file a substitute return for you, based on
income reported to the IRS. This return might
not give you credit for deductions and exemp-
tions you may be entitled to receive. We will
send you a Notice of Deficiency CP3219N
(90-day letter) proposing a tax assessment.
You will have 90 days to file your past due tax
return or file a petition in Tax Court. If you do
neither, we will proceed with our proposed as-
sessment. If you have received a Notice of Defi-
ciency CP3219N, you can't request an exten-
sion to file. Call us if you think you don't have to
file.
If any of the income listed is incorrect, you
may do the following.
• Contact us toll free at 866-681-4271 to let
us know.
• Contact the payer (source) of the income
to request a corrected Form W-2 or 1099.
• Attach the corrected forms when you send
us your completed tax returns.
If the IRS files a substitute return, it is still in
your best interest to file your own tax return to
take advantage of any exemptions, credits, and
deductions you are entitled to receive. The IRS
generally will adjust your account to reflect the
correct figures. If you filed a past due return and
have received a notice, you should send us a
copy of the past due return to the indicated ad-
dress. It takes approximately 6 weeks for us to
process an accurately completed past due tax
return.
Understanding an IRS notice or letter. Go to
IRS.gov/Notices to find additional information
about responding to an IRS notice or letter. We
will send you a notice or letter if any of the fol-
lowing apply.
• You have a balance due.
• You are due a larger or smaller refund.
• We have a question about your tax return.
• We need to verify your identity.
• We need additional information.
• We changed your return.
• We are notifying you of delays in process-
ing your return.
When you receive correspondence from us,
read the entire notice or letter carefully. Typi-
cally, we only need a response if you don’t
agree with the information, we need additional
information, or you have a balance due. If we
changed your tax return, compare the informa-
tion we provided in the notice or letter with the
information in your original return. If we receive
a return that we suspect is ID theft, we will ask
you to verify your identity using the web ad-
dress provided in the letter.
If we ask for a response within a specific
timeframe, you must respond on time to mini-
mize additional interest and penalty charges or
to preserve your appeal rights if you don’t
agree. Pay as much as you can, even if you
can’t pay the full amount you owe. You can pay
online or apply for an Online Payment Agree-
ment or Offer in Compromise. See What if I
can’t pay now? above or visit our payments
page, IRS.gov/Payments, for more information.
We provide our contact phone number on
the top right-hand corner of our correspond-
ence. Be sure you have your tax return and any
related documentation available when you call.
You can also write to us at the address in the
correspondence to explain why you disagree. If
you write, allow at least 30 days for our re-
sponse. Keep a copy of all correspondence
with your tax records.
Collection and enforcement actions. The
return we prepare for you (our proposed as-
sessment) will lead to a tax bill, which, if unpaid,
will trigger the collection process. This can
Chapter 13 How To Get Tax Help Page 61
include such actions as a levy on your wages or
bank account or the filing of a notice of federal
tax lien. If you repeatedly do not file, you could
be subject to additional enforcement measures,
such as additional penalties and/or criminal
prosecution.
Contacting your local IRS office. Keep in
mind, many questions can be resolved on
IRS.gov without visiting an IRS Tax Assistance
Center (TAC). Go to IRS.gov/LetUsHelp for the
topics people ask about most. If you still need
help, IRS TACs provide tax help when a tax is-
sue can’t be handled online or by phone. All
TACs now provide service by appointment so
you’ll know in advance that you can get the
service you need without long wait times. Be-
fore you visit, go to IRS.gov/TACLocator to find
the nearest TAC, and check hours, available
services, and appointment options. Or, on the
IRS2Go app, under the Stay Connected tab,
choose the Contact Us option and click on “Lo-
cal Offices.”
Watching IRS videos. The IRS Video Portal,
IRSVideos.gov, contains video and audio pre-
sentations on topics of interest to individuals,
small businesses, and tax professionals.
Getting tax information in other languages.
For taxpayers whose native language is not
English, we have information on IRS.gov in the
following languages.
• Spanish (IRS.gov/Spanish).
• Chinese (IRS.gov/Chinese).
• Vietnamese (IRS.gov/Vietnamese).
• Korean (IRS.gov/Korean).
• Russian (IRS.gov/Russian).
The IRS TACs provide over-the-phone inter-
preter service in over 170 languages, and the
service is available free to taxpayers.
The Taxpayer Advocate
Service Is Here To Help
You
What is the Taxpayer
Advocate Service?
The Taxpayer Advocate Service (TAS) is an in-
dependent organization within the IRS that
helps taxpayers and protects taxpayer rights.
Their job is to ensure that every taxpayer is
treated fairly and that you know and understand
your rights under the Taxpayer Bill of Rights.
The Taxpayer Bill of Rights groups the existing
rights in the tax code into 10 fundamental rights,
and makes them clear, understandable, and ac-
cessible. See How Can You Learn About Your
Taxpayer Rights, later.
What Can the TAS Do For You?
They can help you resolve problems that you
can’t resolve with the IRS, and their service is
free. If you qualify for their assistance, you will
be assigned to one advocate who will work with
you throughout the process and will do every-
thing possible to resolve your issue. The TAS
can help you if:
• Your problem is causing financial difficulty
for you, your family, or your business;
• You face (or your business is facing) an
immediate threat of adverse action; or
• You’ve tried repeatedly to contact the IRS
but no one has responded, or the IRS
hasn’t responded by the date promised.
How Can You Reach the TAS?
The TAS has offices in every state, the District
of Columbia, and Puerto Rico. Your local advo-
cate’s number is in your local directory and at
TaxpayerAdvocate.IRS.gov. You can also call
them toll free at 877-777-4778.
How Can You Learn About Your
Taxpayer Rights?
The Taxpayer Bill of Rights describes 10 basic
rights that all taxpayers have when dealing with
the IRS. The TAS Tax Toolkit at
TaxpayerAdvocate.IRS.gov/Contact-Us can
help you understand what these rights mean to
you and how they apply. These are your rights.
Know them. Use them.
The IRS released the Taxpayer Bill of Rights
following extensive discussions with the TAS.
You can find a list of your rights and the IRS’s
obligations to protect them in Pub. 1, Your
Rights as a Taxpayer. It includes the following.
1. The Right To Be Informed. Taxpayers
have the right to know what they need to
do to comply with the tax laws. They are
entitled to clear explanations of the laws
and IRS procedures in all tax forms, in-
structions, publications, notices, and cor-
respondence. They have the right to be in-
formed of IRS decisions about their tax
accounts and to receive clear explana-
tions of the outcomes.
2. The Right to Quality Service. Taxpayers
have the right to receive prompt, courte-
ous, and professional assistance in their
dealings with the IRS, to be spoken to in a
way they can easily understand, to receive
clear and easily understandable communi-
cations from the IRS, and to speak to a su-
pervisor about inadequate service.
3. The Right To Pay No More Than the
Correct Amount of Tax. Taxpayers have
the right to pay only the amount of tax le-
gally due, including interest and penalties,
and to have the IRS apply all tax payments
properly.
4. The Right To Challenge the IRS’s Posi-
tion and Be Heard. Taxpayers have the
right to raise objections and provide addi-
tional documentation in response to formal
IRS actions or proposed actions, to expect
that the IRS will consider their timely ob-
jections and documentation promptly and
fairly, and to receive a response if the IRS
does not agree with their position.
5. The Right To Appeal an IRS Decision
in an Independent Forum. Taxpayers
are entitled to a fair and impartial adminis-
trative appeal of most IRS decisions, in-
cluding many penalties, and have the right
to receive a written response regarding
the Office of Appeals’ decision. Taxpayers
generally have the right to take their cases
to court.
6. The Right to Finality. Taxpayers have
the right to know the maximum amount of
time they have to challenge the IRS’s posi-
tion as well as the maximum amount of
time the IRS has to audit a particular tax
year or collect a tax debt. Taxpayers have
the right to know when the IRS has fin-
ished an audit.
7. The Right to Privacy. Taxpayers have
the right to expect that any IRS inquiry, ex-
amination, or enforcement action will com-
ply with the law and be no more intrusive
than necessary, and will respect all due
process rights, including search and seiz-
ure protections, and will provide, where
applicable, a collection due process hear-
ing.
8. The Right to Confidentiality. Taxpayers
have the right to expect that any informa-
tion they provide to the IRS will not be dis-
closed unless authorized by the taxpayer
or by law. Taxpayers have the right to ex-
pect appropriate action will be taken
against employees, return preparers, and
others who wrongfully use or disclose tax-
payer return information.
9. The Right To Retain Representation.
Taxpayers have the right to retain an au-
thorized representative of their choice to
represent them in their dealings with the
IRS. Taxpayers have the right to seek as-
sistance from a Low Income Taxpayer
Clinic if they cannot afford representation.
10. The Right to a Fair and Just Tax Sys-
tem. Taxpayers have the right to expect
the tax system to consider facts and cir-
cumstances that might affect their underly-
ing liabilities, ability to pay, or ability to pro-
vide information timely. Taxpayers have
the right to receive assistance from the
TAS if they are experiencing financial diffi-
culty or if the IRS has not resolved their tax
issues properly and timely through its nor-
mal channels.
The IRS is trying to increase the number of
Americans who know and understand their
rights under the tax law. To expand awareness,
the IRS is making Pub. 1 available in multiple
languages on IRS.gov. This important publica-
tion is available in the following languages.
• English, Your Rights as a Taxpayer, at
IRS.gov/Pub/irs-pdf/P1.pdf.
• Chinese, Chinese- Your Rights as a
Taxpayer (Pub 1), at IRS.gov/Chinese.
• Korean, Korean- Your Rights as a
Taxpayer (Pub 1), at IRS.gov/Korean.
• Russian, Ваши права в качестве
налогоплательщика (Публикацию № 1),
at IRS.gov/Russian.
• Spanish, Publicación 1SP, Derechos del
Contribuyente, at IRS.gov/Spanish.
• Vietnamese, Quyền Hạn của Người Đóng
Thuế, Your Rights as a Taxpayer (Pub 1),
at IRS.gov/Vietnamese.
Page 62 Chapter 13 How To Get Tax Help
The IRS will include Pub. 1 when sending noti-
ces to taxpayers on a range of issues, such as
an audit or collection matter. All IRS facilities
will publicly display the rights for taxpayers and
employees to see.
How Else Does the TAS Help
Taxpayers?
The TAS works to resolve large-scale problems
that affect many taxpayers. If you know of one
of these broad issues, please report it to them
at IRS.gov/SAMS.
The TAS also has a website, Tax Reform
Changes, which shows you how the new tax
law may change your future tax filings and helps
you plan for these changes. The information is
categorized by tax topic in the order of the IRS
Form 1040. Go to TaxChanges.us for more in-
formation.
Low Income Taxpayer
Clinics (LITCs)
LITCs are independent from the IRS and repre-
sent individuals whose income is below a cer-
tain level and need to resolve tax problems with
the IRS such as audits, appeals, and tax collec-
tion disputes. Some LITCs can provide informa-
tion about taxpayer rights and responsibilities in
different languages for individuals who speak
English as a second language. Services are of-
fered for free or a small fee. To find an LITC
near you, visit TaxpayerAdvocate.IRS.gov/
LITCmap or see Pub. 4134, Low Income
Taxpayer Clinic List.
Chapter 13 How To Get Tax Help Page 63
To help us develop a more useful index, please let us know if you have ideas for index entries.
See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.Index
A
Advertising 45
Amortization:
Anti-abuse rule 33
Anti-churning rules 32
Atmospheric pollution control
facilities 34
Corporate organization costs 29
Dispositions of section 197
intangibles 33
Experimental costs 35
Geological and geophysical
costs 34
How to deduct 28
Incorrect amount deducted 33
Partnership organization
costs 29
Pollution control facilities 34
Reforestation costs 33
Reforestation expenses 26
Related person 32
Research costs 35
Section 197 intangibles
defined 30
Starting a businesscosts 28
Start-up costs 29
Anticipated liabilities 45
Assistance (See Tax help)
At-risk limits 6
Attorney fees 46
Authorized IRS e-file
providers 58
Awards 8, 9
A-Z Index for Business 58
B
Bad debts:
Defined 40
How to treat 41
Recovery 42
Types of 41
When worthless 41
Bonuses:
Employee 9
Royalties 39
Bribes 45
Business:
Assets 4
Books and records 31
Meal expenses 44
Use of car 6, 46
Use of home 5
C
Campaign contribution 48
Capital expenses 3, 5
Capitalization of interest 16
Car allowance 44
Car and truck expenses 46
Carrying charges 24
Charitable contributions 46
Checking amended return
status 61
Choosing a tax return
preparer 58
Circulation costs, newspapers
and periodicals 26
Claim a refund 61
Club dues 46
Collection and enforcement
actions 61
Commitment fees 16
Compensation in excess of $1
million 8
Computer software 32
Constant-yield method, OID 15
Contested liability 7
Contributions:
Charitable 46
Political 48
Copyrights 31
Cost depletion 36
Cost of getting lease 12, 30
Cost of goods sold 3
Cost recovery 4
Covenant not to compete 31
Credit card convenience fees 46
D
Debt-financed distributions 14
Definitions:
Business bad debt 40
Necessary expense 3
Ordinary expense 3
Section 197 intangibles 30
De minimis OID 15
Demolition expenses 46
Depletion:
Mineral property 36
Oil and gas wells 37
Percentage table 39
Timber 39
Who can claim 35
Depreciation (See Cost recovery)
Development costs, miners 26
Direct Pay 61
Dirty Dozen 60
Disabled, improvements for 27
Drilling and development
costs 25
Dues, membership 46
E
Economic interest 35
Economic performance 6
Education expenses 9, 46
e-File Form 940, 941, or 944 for
Small Businesses 58
Elderly, improvements for 27
Electronic Federal Tax Payment
System (EFTPS®) 61
Employee benefit programs 10
Employer ID Numbers (EINs) 58
Employment taxes 19
Employment Taxes 58
Additional Medicare Tax 19
Self-employment tax:
Additional Medicare Tax 20
Unemployment fund 19
e-News 58
Entertainment 43
Entertainment expenses 9
Experimentation costs 24, 35
Exploration costs 25
F
Federal Relay Service 58
Fees:
Commitment 16
Legal and professional 46
Regulatory 47
Tax return preparation 47
Filing past due tax returns 61
Fines 47
Forgone 17
Forgone interest 17
Form:
3115 33
4562 28
5213 7
8826 28
T 40
Franchise 31, 46
Fringe benefits 9
G
Gas wells 38
Geological and geophysical
costs:
Development, oil and gas 34
Exploration, oil and gas 34
Geothermal wells 25, 39
Gifts, nominal value 9
Going into business 4, 28
Goodwill 31
Gross income, not-for-profit
activity 7
H
Health coverage tax credit
(HCTC) 23
Health plan 23
Heating equipment 5
Home, business use of 5
How to Figure the Deduction 49
I
Identity (ID) theft issues 59
Impairment-related expenses 46
Improvements 4
By lessee 12
For disabled and elderly 27
Income Taxes 19
Accrual of contested income
taxes 19
Federal income taxes 19
Foreign income taxes 19
State and local income taxes 19
Incorrect amount of amortization
deducted 33
Independent Contractor
(Self-Employed) or
Employee? 58
Information Return Filing
Requirements 58
Insurance 23
Capitalized premiums 23
Deductible premiums 20
Nondeductible premiums 23
Intangible drilling costs 25
Intangibles, amortization 30
Interest 17
Allocation of 13
Below-market 17
Business expense for 13
Capitalized 16
Carrying charge 24
Deductible 15
Life insurance policies 16
Limitation 14
Not deductible 16
Refunds of 16
When to deduct 16
Internet-related expenses 46
Interview expenses 46
IRS Tax Professional
Partners 58
IRS Video Portal 58
K
Key person 16
Kickbacks 45
L
Leases:
Canceling 11
Cost of getting 12, 30
Improvements by lessee 12
Leveraged 11
Mineral 39
Oil and gas 39
Sales distinguished 11
Taxes on 12
Legal and professional fees 46
Letter 5071C 60
Licenses 31, 47
Life insurance coverage 10
Limit on deductions 7
Line of credit 14
Loans:
Below-market 17
Discounted 16
Loans or advances 10
Lobbying expenses 47
Long-term care insurance 21
Losses 6, 7
At-risk limits 6
Net operating 6
Passive activities 6
Low Income Taxpayer Clinics
(LITCs) 63
M
Machinery parts 5
Making a tax payment 61
Meals 43
Meals and entertainment 44
Meals and lodging 9
Methods of accounting 6
Page 64 Publication 535 (2018)
Mining:
Depletion 39
Development costs 26
Exploration costs 25
More than one health plan and
business 23
Mortgage 15
Moving expenses, machinery 47
N
Natural gas 38
Nonqualifying intangibles 31
Not-for-profit activities 7
Not-for-profit activity, gross
income 7
Notice of Deficiency
CP3219N 61
O
Office in home 5
Oil and gas wells:
Depletion 37
Drilling costs 25
Partnerships 38
S corporations 38
Online payment agreement 61
Online Tools & Educational
Products 58
Optional safe harbor method 5
Optional write-off method:
Circulation costs 35
Experimental costs 35
Intangible drilling and
development costs 35
Mining exploration and
development costs 35
Research costs 35
Organizational costs 26
Organization costs:
Corporate 29
Partnership 29
Original issue discount 15
Other coverage 23
Other Taxes 20
Excise taxes 20
Franchise taxes 20
Fuel taxes 20
Occupational taxes 20
Personal property taxes 20
Sales taxes 20
Outplacement services 47
P
Passive activities 6
Payments in kind 6
Penalties 15
Deductible 47
Nondeductible 47
Prepayment 15
Percentage depletion 36
Per diem and car allowances 44
Political contributions 48
Pollution control facilities 34
Prepaid expense 6
Extends useful life 24
Interest 16, 17
Rent 11
Prepayment penalty 15
Presumption of profit 7
Publication 1, Your Rights as a
Taxpayer 62
Publications (See Tax help)
Q
Qualified Business Income
Deduction Worksheet 55
Qualified long-term care
insurance:
Benefits received 22
Chronically ill individual 22
Qualified long-term care
insurance contract 21
Qualified long-term care
services 21
R
Real EstateTaxes 18
Assessments Local 18
Charges for services 19
Electing to ratably accrue to a
definite period 19
Form 3115 19
Making the election to ratably
accrue the taxes 19
Purchase or sale of real
estate 19
Separate elections to ratably
accrue for each separate
trade or business and for
nonbusiness activities 19
Recapture:
Exploration expenses 25
Timber property 34
Recordkeeping 38
Recovery of amount deducted 6
Refiners who cannot claim
percentage depletion 37
Reforestation costs 26, 33
Regulatory fees 47
Reimbursements 43
Business expenses 10
Mileage 44
Nonaccountable plan 45
Per diem 44
Related persons:
Anti-churning rules 32
Coal or iron ore 39
Payments to 7, 17
Refiners 37
Unreasonable rent 11
Reminder:
Premium tax credit 20
Removal 27
Rent expense, capitalizing 13
Repairs 48
Repayments (claim of right) 48
Reporting abusive tax
preparers 59
Research costs 24, 35
S
Scammers 60
Section 179 expense
deduction (See Cost recovery)
Self-employed health insurance
deduction 21
Self-Employed Health Insurance
Deduction Worksheet 22
Self-Employed Individuals Tax
Center 58
Self-insurance, reserve for 23
Sick pay 10
Small Business and
Self-Employed (SB/SE) Tax
Center 58
Small Business Events 58
Small Business Forms and
Publications 58
Standard meal allowance 44
Standard mileage
rate (See Business use of your
car)
Standby charges 16
Starting, Operating, or Closing a
Business 58
Start-up costs 26, 29
Substitute return 61
Supplies and materials 48
T
Taxes 12, 18
Carrying charge 24
Leased property 12
When To Deduct Taxes 18
Tax help 58
Tax information in other
languages 62
Tax law questions 59
Taxpayer Advocate Service
(TAS) 62
Taxpayer Assistance Center
(TAC) locator 62
Taxpayer Bill of Rights 62
Tax preparation 58
Tax preparation fees 47
Tax scams 60
Telephone 49
Timber 33, 39
Tools 5
Trademark, trade name 31, 46
transcript or copy of a return 59
Transportation (commuting)
benefits 10
Travel 43
TTY/TDD information 58
U
Understanding an IRS notice or
letter 61
Unpaid expenses, related
person 17
Utilities 49
V
Vacation pay 10
W
Wages:
Property 10
Tests for deducting pay 8
Welfare benefit funds 10
When To Deduct Premiums 23
When To Deduct Taxes:
Carrying charges 18
Limit on accrual of taxes 18
Refunds of taxes 18
Uniform capitalization rules 18
Where to file 59
Publication 535 (2018) Page 65