 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at deductions and losses and specifically we're going to be looking at timing of expense recognition and this allowed deductions. Now this session will, I always have fun in the classroom when we cover this session and you will see why. This this topic is covered in an income tax course on the CPA exam regulation as well as the enrolled agent exam. As always I would like to remind you to please connect with me especially only then I'm very active on LinkedIn I post my lectures as well as other news related topics. If you're a Facebook user like my Facebook page and you can connect with me on a personal level if you are not subscribed to my YouTube please subscribe to my YouTube like my videos share them so other people will benefit. I do have a Twitter account not that active and also you can access some of my lectures on my website. Time of expense recognition. Now we're going to keep for this course because it's an individual income tax course we're going to keep it simple. What I mean by simple we're going to be using the cash basis. What does that mean? It means if we're using the cash basis we're going to be deducting expenses when we pay them. Now that's not always the case but generally speaking generally speaking that's the case. Now we're going to later on look at more specific especially when we get to the corporate income tax portion of the course. However when we talk about depreciation depreciation is a non-cash expense and don't worry we're going to cover depreciation in detail. So that's all I'm going to talk about in regards to timing of expense recognition because we're assuming here we're using the cash basis. Now the next topic we're going to look at is non-deductible possibilities. So what are those? Those are deductions that they are not allowed or they are allowed but some students find them pretty interesting. Let's put it that way. First, illegal payments. Well illegal payments guess what? Are they necessary? No they're not necessary. Are they in the ordinary course of business? I don't think so. So illegal payment are not necessary therefore I don't have to say it not deductible. Okay. What about legal fees? There should be legal fees. Legal fees. Legal fees when are they deductible? If they are business expense so basically you are defending yourself or income producing. So basically those legal fees are to protect your business. Under those circumstances they are deductible. What about illegal business activities? Okay. What if you are conducting an illegal business activity? Well guess what? Operating expenses are deductible. Operating expenses are deductible. Although the business is illegal okay. You might be a bookie. You might be having poker machines or whatever your illegal businesses but they are they are the operating expenses are deductible. Now if you are making illegal payment to police officers as bribes, kickbacks to politicians those are not deductible. Although you are running an illegal business it's okay to up to it's not okay but I'm saying it's allowable by the IRS and Congress to deduct your operating expenses but if you are bribing the cops you cannot put that down on the books as an expense. Okay. What about if you're a drug dealer? This is an illegal business on its own. So if you're a drug dealer, if you have operating expenses I'm sorry you cannot deduct operating expenses. So drug dealer specifically you cannot operate. That's interesting. Just think about what type of operating expenses you would have. Okay but you cannot deduct them. However IRS allows you to deduct your cost of goods sold. So your cost of goods sold whatever product you bought believe it or not it's deductible. Okay the product that you bought because you invested the money but you know vehicle expense you know operate transportation expense guns anything like that to operate your business that's not that's not deductible or for example employee having employees or contractors that's not going to be deductible as a drug dealer. Political contributions obviously that's non-deductible and the reason is if they allow them the assumption is you will have rich people or people with financial power controlling the politician that again you know make your own judgment about our political system but generally not generally speaking political contribution they are not deductible. Okay they don't want to encourage you. Okay now let's take a look at an example just so we can kind of go over these additional examples just to make sure we cover as much as possible on our basis. Let's take a look at the first question and the question read Finn incurred and paid the following expenses during 2018 $50 for tickets for running red light while he was commuting to work. You might be saying I need I need to get to work well was that necessary? No and also you're commuting it's not even part of your business most probably therefore I'm sorry not deductible. Okay 100 ticket for parking and handicap parking space well that's not really nice but that's that's illegal and you should not be parking there therefore it's not deductible. Okay now $200 to an attorney to represent you in a traffic court as to two tickets above so now you'd hire an attorney can you deduct this that's a legal fees now you cannot deduct this it's not it's not the business expense. Now $500 to an attorney to draft an agreement with a tenant for one year lease on an apartment then Finn owns now you own an apartment and what you did you are going to you asked a lawyer to draft a lease for you I used to have rental properties to have a standard lease so it's easy to buy standard lease but yes this is a business expense therefore it is deductible it is deductible you paid a thousand dollar to an attorney to negotiate a reduction in the child support payment so you paid $1,000 to an attorney but now to reduce your child support payment if you know if we know from chapter four or five I don't know which one four or five don't we talked about income exclusion child support is not taxable therefore this is strictly personal item therefore it's not deductible you cannot use it okay. $2,500 to an attorney to negotiate a reduction in his and his qualified alimony payment to a former spouse here well for one thing this is going to go away because we're no longer having alimony payment actually this we shouldn't even cover this because going forward you don't have to worry about this but this is debatable because alimony used to be taxable and deductible so they use it was it was a great area but you could have you could have but again we don't have to worry about this because alimony payment are no longer deductible no longer taxable so we can't forget about this but this area is kind of used to be a gray area gray area let's take a look at this Travore a friend of yours from high school works as a server as at the ST cafe he asked you to help him prepare his federal income tax return when you inquire about why his bank deposits substantially exceed his step income he can he told you he can fight to you that he is a bookie on the side that's interesting Travore then provide you with the following documented income expenses for the year now let me tell you this uh from you know generally speaking you don't associate yourself with unethical people especially as an accountant you don't want to subject your ethics to anything you don't want to compromise your ethics and I will tell you right now if you fight if you face this type of situation in the real world walk away whether it's a friend relative especially a relative because I do have my own experience with a relative I happen to be the accountant of a relative who happens to be convicted in the 80s but for a bank crime bank crime bank it's a part of the savings and loan he then he did not really steal a bank with a gun he steal a bank you know in a different way part of the savings and loan and I thought that was in the 80s I was like I was a kid but I thought well you know he's a relative not very close relative but distant relative he's like why not I you know but I was always suspicious then something happened and you know I can't say what happened but the point is is stay away from unethical people that's that's the moral of the story okay that's the moral of the story so let's go back here will these items affect Travore's adjusted gross income okay ignore the impact of self-employment taxes we will ignore the impact okay tip income can we include the tip income can we include the tip income and the answer is of course the tip income gambling income from his bookie on the side guess what it's also included so we do include the income okay gambling expenses pay out to winners well guess what this is part of business basically operating the business remember if you're operating a business although it's illegal as long as it's not drug drug dealer he's not a drug dealer it's just a gambler I'm not sure which one is worse but that's your call pay out to winners 29 000 I'll take this back so 29 000 that's deductible those are taxable employee compensation yes that's also operating expenses that's deductible okay a bribe to police officer who's aware of Travore's bookie activity and then that's why you don't want to get involved with this because there we go now you're having police officers involved where they are being bribed and you're aware of it so you might find yourself in the newspaper testifying one day of not saying something because you know you you know as an accountant especially as a bookkeeper you have no confidentiality privilege if you're tax preparer you have absolutely no confidentiality privilege between you and the client so that's why you ought to be very careful you're not an auditor here you are just a tax preparer so knowing about this especially knowing the police officer's name or anything like this you're going to be in trouble down the road so simply put what's going to happen we're going to include all this 68 000 and if you decide to complete Travore's return minus 37 000 and what's going to happen Travore will find someone to complete his taxes don't worry he'll pay enough money to do it um that's that for this session if you have any questions any comments if you are studying for your CPA exam study hard 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