MGMT 127A Lecture Notes - Lecture 11: Net Operating Loss, Macrs, Financial Accounting

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8 May 2016
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1. Lecture 11: section 5
Section 5: Business deductions
In EMBRACES- E (self employed) and B (business expenses)
General rules and exceptions
Section 162 says: in general, there shall be allowed as a deduction all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or business
oPaid vacation is counted as ordinary and necessary
oAll of the things that are obvious to think about for a company will usually be deductible
Business income and expenses are reported on schedule C, and the net income is then reported
on the form 1040
Limitations and restrictions (things that are not completely deductible)
oMeals and entertainment: 50%
oGifts: $25/recipient
oBad debt: direct write off (accrual only)
Financial accounting says we have to be conservative and not overstate assets
or understate liabilities so it requires us to have accounts of estimates for bad debts
and warranty liabilities
As taxpayers, we want to make taxable income as low as possible so if we were
allowed to make estimates of bad debts and warranties, we would estimate really
high
So an accrual based taxpayer has to use the direct write off method for taxes
You cannot write off a bad debt expense until you have officially determined
you will never get it (no accruing for it like in financial accounting)
If you are a cash basis taxpayer, you would never have to write it off because it
is never actually included in income (because you haven't received the money and you
don’t do A/R)
If you have inventory, you have to be an accrual based company
oWarranty costs- when incurred
Same as bad debts- you can only expense these when they are incurred/when
you actually pay them out
oDepreciation- MACRS
MACRS is modified accelerated cost recovery system
MACRS dictates our salvage value and method
For realty (land and anything attached):
For residential realty, life is 27.5 years straight line
For nonresidential realty, the life is 39 years straight line (note that in
financial accounting it is 40 years)
Personalty
oGoodwill- 15 years straight line (not self created)
In financial accounting, we don’t depreciate or amortize goodwill, but we do in
tax
oStart up costs-
5k expensed (dollar for dollar phase-out if you spend over $50k)
The remaining costs we capitalize and amortize over 180 months (15 years)
straight line
Not costs of issuing, printing, and selling stock
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Look to the right for a graph of how these costs work
So if you spend 51k on startup costs, you can expense 4k immediately and the
remaining 47k we capitalize and amortize over 15 years
So in that first year, you can deduct 4k + (
If you spend 60k on startup costs, you cannot deduct any of it right away- you
can get 4k this year for amortize costs though
oResearch and development: 3 options available that will determine how it is deducted
Can be expensed (deducted)
Normally we want to accelerate deductions so this option seems the
best except when you expect to see big income returns in the future
Deferred and amortized over a period of no less than 60 months (5 years)- this is
so you can defer it to when you start seeing a benefit
Choose this option when you expect a higher income in the future
because of this R&D so you want to have the deductions then
Written off ratably over an optional 10 year period
With financial accounting, we expense R&D right away because we don’t know
if we will get a benefit but the tax law gives you a choice
Business research
For an industry you are not currently in business for
Don’t go into that business: costs not deductible
Do go into that business: you can capitalize and amortize the
costs over 15 years
For an industry you are currently in business for:
Don’t go into that business: yes deductible
Do go into that business: yes deductible
oNet operating loss (NOL): 2 year carryback and 20 year carry forward
Note that this is completely unrelated to capital losses where you can only
deduct 3k in the current year and carry forward the loss indefinitely!
NOLs are operating losses of the company- like if you are running a company
and you randomly have a bad year and lose a lot of money
Your options:
Go back to year -2 and add losses there to bring net income to 0, then
to year -1 and on to future until the losses are all spent
Or you can forgo the option of the carryback and you only use the losses
going forward- once you do this, you cant decide to later go back and use the
carryback option
Example:
In year -2, you have net income of 50k
In year -1, you have net income of 200k
In current year, your business loses 150k
You go back to year -2 and file an amended return to bring net income
to 0
Then you go back to year -1 and file an amended return to bring net
income to 100k and get a refund on the taxes you paid on the total income of
that year
If your losses are actually 450k, then you would bring year -2 to 0, bring
year -1 to 0, and then go forward to bring as many net incomes to 0 as it takes
to use up all of the losses
Non deductible items:
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