Gifting vs Inheriting
This post includes an overview of the differences between gifting property and inheriting property, touching on concepts of estate tax and property basis.
April 3rd, 2023
Last week we showed the first part of a presentation at a small business finance class at the University of Illinois. In addition to the topics discussed in the video blog last week, the students asked about deductions available to small businesses.
This presentation includes a high-level discussion of basic principles governing the deductibility of expenses. It also discusses some nuances of deducting interest and tracking these deductions so a small business owner can report them accurately on a tax return.
By John W. Richmann, EA, MBA
Tax Materials Specialist, U of I Tax School
Business expenses should be ordinary and necessary considering the type of business you are in. So, I have here a picture of what I think is a high-end Tesla. So probably a worth a couple hundred thousand. If you were a dog-walker, would a Tesla automobile like this be an ordinary and necessary expense? What if you were walking dogs for Hollywood celebrities? Would that change it at all? Probably not. But we must think about it a little bit. The provision for ordinary and necessary expenses is in the internal revenue code.
And as you might guess, what is ordinary and necessary for one business may not be for another one. So, for a landscaping business, would a truck be ordinary and necessary expense? What about for a financial planner? Probably not. But there would be other things for a financial planner that would be ordinary and necessary.
How about meals with customers? Are they ordinary and necessary? But what do you have to do with that? Do you think you can just write it on a piece of paper and the IRS is going to say it is okay?
There are lots of questions here, especially if the meal goes above $75. They are (the IRS) going to want to know some things. They are going to want to know where you had lunch and how much the lunch cost. There should be a receipt with it. You should have a note with whom you had lunch and what you talked about And of course where and when it took place. And those things are in the internal revenue code.
And that brings about the game. And I call it the documentation game. Because if you just tell the IRS you did something, if you’re questioned about it, do you think that’s going to fly? No. They’re going to want the evidence. And that evidence is something you take note of right away.
And that goes to the thought that the value of any business is in the systems. One of the systems must be keeping track of this information. And if you have a good system for collecting the information about the time you make an expense, it is going to help a lot.
Now here we have some people in a nice, neat office with a computer system. That is obviously a good implementation of a system. But frankly, it was not that long ago that offices had lots of paper files like that. And the costs with either could be ordinary and necessary. I want to leave you with the thought that one of the key systems for the success of your business is going to be how you keep track of expenses.
I wrote 523 up here for a very specific reason. 523 was the chart of accounts number that I used for office expense. So, for example in your landscaping business, if you bought a desk, you might put it under
523 because it’s an office expense. But if you do that a year after you make the expense, are you going to remember what it was? No. You need a system. You need something like this pipeline. So that it goes into a system and will come out on your tax return.
So what you really want is for a system to be present in your business so that the $2,000 office expense ends up here on line 18. Now if you wait a year to do that, you might still get it but it is far more unlikely.
And I will suggest to you that even thinking about how you might be doing this now will pay off for you five or 10 years from now. When you have a small business, think about it as a pipeline.
What about debt? Do you think interest on debt is a deductible expense? You do? I’m going to say it depends. Because generally interest on debt incurred by a small business is deductible. But there are times when it must be capitalized. And that might influence the chart of accounts that you use in your business. So that interest that is expensed is distinguished from interest that is capitalized.
For example, when you build a building, or you put a fence around a piece of property. So, one thing I’ll mention about this is that debt can really be difficult at times for small businesses.
Capitalized interest means you cannot deduct it because the asset isn’t built yet. You must pack the interest into the asset that’s being built. Think for a minute about an office building. It takes two years to build and who knows how many thousands of dollars. And what do you have in an office building? You have got steel. You’ve got wood You’ve got plumbing. But you have also got interest. So that interest that is used to finance the debt necessary for building the building is one of the components of the building.
It is not something that you can see. Like the structure of the building or the shingles on the roof or the plumbing. But it’s still an essential part of it. So, Congress says you don’t get to write that off. You must consider that as a part of the building. And then depreciate it. Or recover the cost of it over the 39 years if it’s a commercial building. Or 27 and a half years if it’s a residential rental property.
So that is one of the little tricks with interest. But it also illustrates why it depends on the nature of the business that is involved.
Disclaimer: The information referenced in Tax School’s blog is accurate at the date of publication. You may contact email@example.com if you have more up-to-date, supported information and we will create an addendum.
University of Illinois Tax School is not responsible for any errors or omissions, or for the results obtained from the use of this information. All information in this site is provided “as is”, with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information. This blog and the information contained herein does not constitute tax client advice.
Join 1,400 of your colleagues and get notified each time a new post is added.