Business Taxation and Income, Deductions, and Credits
Gross Income and Exclusions
Start with the broad definition of gross income and then carve out exclusions: life insurance proceeds, gifts, certain municipal bond interest, and qualified fringe benefits. The trap is treating a reimbursement or a loan proceeds receipt as income, or excluding an item that is merely tax-deferred rather than excluded.
Ordinary and Necessary Deductions
Deductions require a business purpose and ordinary and necessary status. Know the limits: 50 percent of business meals, no deduction for fines and penalties, capitalization versus repair distinctions, and the capitalization and amortization rules for intangible assets. The recurring trap is deducting a capital expenditure currently or applying the meals limit to a fully deductible event.
Credits and Business Incentives
Business credits reduce tax dollar for dollar and generally are nonrefundable, subject to carryback and carryforward rules. Research credit, work opportunity credit, and the general business credit limitation each appear. The trap is confusing a deduction with a credit or forgetting that credits are limited to tax liability with specified ordering.
Depreciation and Cost Recovery
Know the modified accelerated cost recovery system classes, the half-year and mid-quarter conventions, section 179 expensing limits, and bonus depreciation. The trap is applying the half-year convention when more than 40 percent of property was placed in service in the fourth quarter, which forces mid-quarter.
Worked Example
A business buys $50,000 of five-year property in the second quarter and no other property. Because the mid-quarter test is not triggered, the half-year convention applies, yielding first-year MACRS depreciation of $10,000 at the 20 percent rate before any section 179 or bonus election.