Deductions

<div class="Section1">The treatment of a contribution of appreciated tangible personal property (i.e., property which, if sold, would generate long-term capital gain) depends on whether the use of the property is related or unrelated to the purpose or function of the (public or governmental) organization. If the property is related use property (e.g., a contribution of a painting to a museum), generally the full fair market value is deductible, up to 30 percent of the individual’s adjusted gross income; however, if the property is unrelated use property, the deduction is generally limited to the donor’s adjusted basis.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 170(e)(1)(B), 170(b)(1)(C); Treas. Reg. § 1.170A-4(b).<br /> <br /> </div>

<div class="Section1"><em>Editor&rsquo;s Note:</em> The 2021 year-end Consolidated Appropriations Act permanently reduced the medical expense deduction threshold from 10 percent to 7.5 percent.<div></div><div>A taxpayer who itemizes deductions can deduct unreimbursed expenses for &ldquo;medical care&rdquo; (the term &ldquo;medical care&rdquo; includes dental care) and expenses for <em>prescribed</em> drugs or insulin for himself, a spouse and dependents, to the extent that such expenses exceed 7.5 percent -of adjusted gross income. (On a joint return, the 7.5 percent floor amount is based on the combined adjusted gross income of both spouses.) The taxpayer first determines net unreimbursed expenses by subtracting all reimbursements received during the year from total expenses for medical care paid during the year. He or she must then subtract 7.5 percent of his adjusted gross income from net unreimbursed medical expenses; only the balance, if any, is deductible.<a href="#_ftn1" name="_ftnref1">¹</a> The deduction for medical expenses was not subject to the phaseout in itemized deductions for certain upper income taxpayers that applied before 2018. (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="731">731</a>.) However, the 2025 OBBB created a new limit on itemized deductions effective in 2026. That limit does not contain an exception or carveout for the medical expense deduction.&nbsp; <em>See</em> Q 732 for details.</div><div class="Section1"><br /> <br /> Though the 7.5 percent threshold was temporarily increased to 10 percent in 2013-2016, the 7.5 percent threshold continued to apply through 2016 if the taxpayer or the taxpayer&rsquo;s spouse turned age 65 before the end of the taxable year. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for examples of the types of expenses that can be deducted under the medical expense deduction.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect; 213.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A sole proprietor who purchases health insurance in his individual name has established a plan providing medical care coverage with respect to his trade or business, and therefore may deduct the medical care insurance costs for himself, his spouse, and dependents under IRC Section 162(l), but only to the extent the cost of the insurance does not exceed the earned income derived by the sole proprietor from the specific trade or business with respect to which the insurance was purchased.<br /> <br /> A self-employed individual may deduct the medical care insurance costs for himself and his spouse and dependents under a health insurance plan established for his trade or business up to the net earnings of the specific trade or business with respect to which the plan is established, but a self-employed individual may not add the net profits from all his trades and businesses for purposes of determining the deduction limit under IRC Section 162(l)(2)(A). However, if a self-employed individual has more than one trade or business, he may deduct the medical care insurance costs of the self-employed individual and his spouse and dependents under each specific health insurance plan established under each specific business up to the net earnings of that specific trade or business.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> In a legal memorandum, the IRS ruled that a self-employed individual may not deduct the costs of health insurance on Schedule C. The deduction under IRC section 162(l) must be claimed as an adjustment to gross income on the front of Form 1040.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. CCA 200524001.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. CCA 200623001.<br /> <br /> </div>

<div class="Section1">&ldquo;Income in respect of a decedent&rdquo; (IRD) refers to those amounts to which a decedent was entitled as gross income, but that were not includable in his taxable income for the year of his death.<a href="#_ftn1" name="_ftnref1">¹</a> It can include, for example: renewal commissions of a sales representative; payment for services rendered before death or under a deferred compensation agreement; and proceeds from sales on the installment method (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="667">667</a>). Generally, if stock is acquired in an S corporation from a decedent, the pro rata share of any income of the corporation that would have been IRD if that item had been acquired directly from the decedent is IRD.<a href="#_ftn2" name="_ftnref2">²</a><div></div><div>The IRS has determined that a distribution from a qualified plan of the balance as of the employee&rsquo;s death is IRD.<a href="#_ftn3" name="_ftnref3">³</a> The Service has also privately ruled that a distribution from a 403(b) tax sheltered annuity is IRD.<a href="#_ftn4" name="_ftnref4">⁴</a> The Service has also concluded that a death benefit paid to beneficiaries from a deferred variable annuity would be IRD to the extent that the death benefit exceeded the owner&rsquo;s investment in the contract.<a href="#_ftn5" name="_ftnref5">⁵</a> In addition, the Service has determined that distributions from a decedent&rsquo;s individual retirement account were IRD, including those parts of the distributions used to satisfy the decedent&rsquo;s estate tax obligation, since the individual retirement account was found to have automatically vested in the beneficiaries.<a href="#_ftn6" name="_ftnref6">⁶</a></div><div class="Section1"><br /> <br /> However, a rollover of funds from a decedent&rsquo;s IRA to a marital trust and then to the surviving spouse&rsquo;s IRA was not IRD, according to the Service, where the surviving spouse was the sole trustee and sole beneficiary of the trust.<a href="#_ftn7" name="_ftnref7">⁷</a> The Service also ruled that designation of a QTIP trust as the beneficiary of a decedent&rsquo;s account balance in a qualified profit sharing plan would not result in the acceleration of IRD at the time the assets from the plan passed into the trust. Consequently, the taxpayer would include the amounts of IRD in the plan in the taxpayer&rsquo;s gross income only when the taxpayer received a distribution (or distributions) from the trust.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> Gain realized upon the cancellation at death of a note payable to a decedent has been held to be IRD to the decedent&rsquo;s estate.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> The unreported increase in value reflected in the redemption value of savings bonds as of the date of a decedent&rsquo;s death constitutes income in respect of a decedent.<a href="#_ftn10" name="_ftnref10">¹⁰</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7688">7688</a>. If savings bonds on which the increases in value have not been reported are inherited, or the subject of a bequest, the reporting of such amounts may be delayed until the bonds are redeemed or disposed of by the legatee, or reach maturity, whichever is first.<a href="#_ftn11" name="_ftnref11">¹¹</a> However, to the extent savings bonds are distributed by an estate or trust to satisfy <em>pecuniary</em> obligations or legacies, the estate or trust is required to recognize the unreported incremental increase in the redemption price of Series E bonds as income in respect of a decedent.<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> The Service determined that in the case of a taxpayer who dies before a short sale of stock is closed, any income that may result from the closing of the short sale is not IRD, and the basis of any stock held on the date of the taxpayer&rsquo;s death will be stepped up.<a href="#_ftn13" name="_ftnref13">¹³</a> The Service also privately ruled that in the case of a sales contract entered into before the decedent&rsquo;s death, where an economically material contingency existed at the time of the decedent&rsquo;s death that might have disrupted the sale of the real property, any gain realized from the sale of the real property after the decedent&rsquo;s death did not constitute IRD.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> The Court of Appeals for the 10th Circuit has held that an alimony arrearage paid to the estate of a former spouse was IRD and thus, taxable to the recipient beneficiaries as ordinary income.<a href="#_ftn15" name="_ftnref15">¹⁵</a><br /> <br /> The Tax Court determined that because a signed withdrawal request from the decedent constituted an effective exercise of the decedent&rsquo;s right to a lump-sum distribution during his lifetime, the lump-sum distribution from TIAA-CREF was therefore income to the decedent and properly includable in the decedent&rsquo;s income. Accordingly, the court held, the lump sum payment received by the decedent&rsquo;s son was not a death benefits payment and, thus, was not includable in the son&rsquo;s gross income as IRD.<a href="#_ftn16" name="_ftnref16">¹⁶</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;IRC &sect; 691(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;IRC &sect; 1367(b).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;Rev. Rul. 69-297, 1969-1 CB 131; Rev. Rul. 75-125, 1975-1 CB 254.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;Let. Rul. 9031046.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;Let. Rul. 200041018.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp;&nbsp;Let. Rul. 9132021. <em><em>See</em></em> Rev. Rul. 92-47, 1992-1 CB 198. <em><em>See also</em></em> Let. Rul. 200336020.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp;&nbsp;Let. Rul. 200023030.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp;&nbsp;Let. Rul. 200702007.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp;&nbsp;<em>Estate of Frane v. Commissioner</em>, 998 F.2d 567 (8th Cir. 1993).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;Rev. Rul. 64-104, 1964-1 CB 223.<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;Let. Ruls. 9845026, 9507008, 9024016.<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;Let. Rul. 9507008.<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;Let. Rul. 9436017. <em><em>See</em></em> IRC &sect; 1014.<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;Let. Rul. 200744001.<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp;<em>Kitch v. Commissioner</em>, 103 F. 3d 104, 97-1 USTC &para;&nbsp;50,124 (10th Cir. 1996).<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp; <em>Eberly v. Commissioner,</em> TC Summary Op. 2006-45.<br /> <br /> </div></div><br />

<div class="Section1">No charitable deduction is allowed for a contribution of cash, check, or other monetary gift unless the donor maintains either a bank record or a written communication from the donee showing the name of the organization and the date and the amount of the contribution.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> Charitable contributions of $250 or more (whether in cash or property) must be substantiated by a contemporaneous written acknowledgment of the contribution supplied by the charitable organization. (An organization can provide the acknowledgement electronically, such as via an e-mail addressed to the donor.)<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In prior years, substantiation was not required if certain information was reported on a return filed by the charitable organization (this exception was repealed by the 2017 TJCA for tax years beginning after December 31, 2016).<a href="#_ftn3" name="_ftnref3">³</a> Special rules apply to the substantiation and disclosure of quid pro quo contributions and contributions made by payroll deduction.<a href="#_ftn4" name="_ftnref4">⁴</a> A qualified appraisal is generally required for contributions of nonreadily valued property for which a deduction of more than $5,000 is claimed.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> No charitable deduction is allowed for a contribution of clothing or a household item unless the property is in good or used condition. Regulations may deny a deduction for a contribution of clothing or a household item which has minimal monetary value. These rules do not apply to a contribution of a single item if a deduction of more than $500 is claimed and a qualified appraisal is included with the return. Household items include furniture, furnishings, electronics, linens, appliances, and similar items; but not food, art, jewelry, and collections.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> Special rules apply to certain types of gifts, including charitable donations of patents and intellectual property, and for donations of used motor vehicles, boats, and airplanes.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 170(f)(17).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRS Pub. 1771 (March 2016), p. 5.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 170(f)(8) (repealed by Pub. Law. No. 115-97).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. §§ 1.170A-13(f), 1.6115-1.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 170(f)(11).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 170(f)(16).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. IRC §§ 170(e)(1)(B), 170(f)(11), 170(f)(12), 170(m); Notice 2005-44, 2005-25 IRB 1287.<br /> <br /> </div>

<div class="Section1"><br /> <br /> <em>Editor&rsquo;s Note:</em> The 2017 tax reform legislation increased the 50 percent AGI limit on contributions to public charities and certain private foundations to 60 percent for tax years beginning after 2017 and before 2026. The 2025 OBBB made the change permanent.<br /> <p class="QU" style="margin-top: 15.0pt;">If an individual makes a charitable contribution to a 60 percent-type charity (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="740">740</a>) of property that, if sold, would have resulted in long-term capital gain (other than certain tangible personal property, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="742">742</a>), he is generally entitled to deduct the full fair market value of the property, but the deduction will be limited to 30 percent of adjusted gross income.<a href="#_ftn1" name="_ftnref1">¹</a></p><br /> <br /> <div class="Section1"><br /> <br /> <em>Long-term capital gain property.</em> &ldquo;Long-term capital gain&rdquo; means &ldquo;gain from the sale or exchange of a capital asset held for more than one year, if and to the extent such gain is taken into account in computing gross income.&rdquo;<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Any portion of a gift of long-term capital gain property to a 60 percent-type organization that is disallowed as a result of the adjusted gross income limitation may be carried over for five years, retaining its character as a 30 percent type deduction (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="740">740</a>).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A taxpayer may elect in any year to have gifts of long-term capital gain property be subject to a 50 (or 60) percent of adjusted gross income limit; if he does so, the gift is valued at the donor&rsquo;s adjusted basis. Once made, such an election applies to all contributions of capital gain property during the taxable year (except unrelated use gifts of appreciated tangible personal property, as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="742">742</a>) and is generally irrevocable for that year.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> The deduction for any charitable contribution of property is reduced by the amount of gain that would <em>not</em> be long-term capital gain if the property were sold at its fair market value at the time of the contribution.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect; 170(b)(1)(C).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;IRC &sect; 1222(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;IRC &sect; 170(b)(1)(C)(ii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;IRC &sect; 170(b)(1)(C)(iii); <em>Woodbury v. Commissioner</em>, TC Memo 1988-272, <em>aff&rsquo;d</em>, 90-1 USTC &para; 50,199 (10th Cir. 1990).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;IRC &sect; 170(e)(1)(A).<br /> <br /> </div></div><br />

<div class="Section1"><em>Editor&rsquo;s Note:</em> The 2017 tax reform legislation increased the 50 percent AGI limit on contributions to public charities and certain private foundations to 60 percent for tax years beginning after 2017 and before 2026. The 2025 OBBB made this change permanent.<div class="Section1"><br /> <br /> Most private foundations are family foundations subject to restricted contribution limits. Certain other private foundations (i.e., conduit foundations and private <em>operating</em> foundations), which operate much like public charities, are treated as 50 (or 60) percent-type organizations (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="740">740</a>).<a href="#_ftn1" name="_ftnref1">¹</a> The term &ldquo;private foundations&rdquo; as used under this heading refers to standard private (e.g., family) foundations.<br /> <br /> The amount of the deduction for a contribution of appreciated property (tangible or intangible) contributed <em>to</em> or <em>for the use of</em> private foundations generally is limited to the donor&rsquo;s adjusted basis; however, certain gifts of <em>qualified appreciated stock</em> made to a private foundation are deductible at their full fair market value.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <em>Qualified appreciated stock</em> is generally publicly traded stock which, if sold on the date of contribution at its fair market value, would result in a long-term capital gain.<a href="#_ftn3" name="_ftnref3">³</a> Such a contribution will not constitute qualified appreciated stock to the extent that it exceeds 10 percent of the value of all outstanding stock of the corporation; family attribution rules apply in reaching the 10 percent level.<a href="#_ftn4" name="_ftnref4">⁴</a> The Service has determined that shares in a mutual fund can constitute qualified appreciated stock.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect;&sect; 170(b)(1)(E), 170(b)(1)(A)(vii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;IRC &sect; 170(e)(5).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;IRC &sect; 170(e)(5).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;IRC &sect; 170(e)(5)(C).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;Let. Rul. 199925029. <em><em>See also</em></em> Let. Rul. 200322005 (ADRs are qualified appreciated stock).<br /> <br /> </div></div><br />

<div class="Section1">Generally, IRD must be included in the gross income of the recipient; however, a deduction is normally permitted for estate and generation-skipping transfer taxes paid on the income. The amount of the total deduction is determined by computing the federal estate tax (or generation-skipping transfer tax) with the net IRD included and then recomputing the tax with the net IRD excluded. The difference in the two results is the amount of the income tax deduction. However, if two or more persons receive IRD of the same decedent, each recipient is entitled to only a proportional share of the income tax deduction. Similarly, if the IRD is received over more than one taxable year, only a proportional part of the deduction is allowable each year. Where the income would have been ordinary income in the hands of the decedent, the deduction is an itemized deduction.<a href="#_ftn1" name="_ftnref1">¹</a> The recipient does not receive a stepped up basis (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="692">692</a>).<a href="#_ftn2" name="_ftnref2">²</a> A beneficiary was allowed to claim a deduction for IRD attributable to annuity payments that had been received even though the estate tax had not yet been paid.<a href="#_ftn3" name="_ftnref3">³</a><div class="Section1"><br /> <br /> In technical advice, the IRS stated that the value of a decedent&rsquo;s IRA should not be discounted for estate tax purposes to reflect income taxes that will be payable by the beneficiaries upon receipt of distributions from the IRAs or for lack of marketability. The Service reasoned that the deduction is a statutory remedy for the adverse income tax impact and makes any valuation discount inappropriate if the deduction applies.<a href="#_ftn4" name="_ftnref4">⁴</a> Courts have likewise denied discounts for lack of marketability.<a href="#_ftn5" name="_ftnref5">⁵</a> The Service also determined that a deduction claimed on a decedent&rsquo;s estate tax return &ndash; which represented income taxes paid by the estate on the estate&rsquo;s income tax return, which in turn were triggered by the amount distributed to the estate from the decedent&rsquo;s IRAs &ndash; was not allowable as a deduction under IRC Section 2053. According to the Service, even if the estate had not claimed the IRD deduction, the income taxes paid on the distributions from the IRAs would still not be deductible under IRC Section 2053 because any additional benefit beyond what Congress had intended would be unwarranted.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> The Service has ruled that if the owner-annuitant of a deferred annuity contract dies <em>before</em> the annuity starting date, and the beneficiary receives a death benefit under the annuity contract, the amount received by the beneficiary in a lump sum in excess of the owner-annuitant&rsquo;s investment in the contract is includible in the beneficiary&rsquo;s gross income as IRD. If the death benefit is instead received in the form of a series of periodic payments, the amounts received are likewise includible in the beneficiary&rsquo;s gross income in an amount determined under IRC Section 72 as IRD.<a href="#_ftn7" name="_ftnref7">⁷</a> See, e.g., Let. Rul. 200537019 (where the Service ruled that the amount equal to the excess of the contract&rsquo;s value over the decedent&rsquo;s basis, which would be received by the estate as the named beneficiary of the contract upon surrender of the contract, would constitute IRD includible by the estate in its gross income; however, the estate would be entitled to a deduction for the amounts of IRD paid to charities in the taxable year, or for the remaining amounts of IRD that would be set aside for charitable purposes).<br /> <br /> In <em>Estate of Kahn</em>,<a href="#_ftn8" name="_ftnref8">⁸</a> the Tax Court held that in computing the gross estate value, the value of the assets held in the IRAs is not reduced by the anticipated income tax liability following the distribution of IRAs, in part because IRC Section 691(c) addresses the potential double tax issue. The Tax Court further held that a discount for lack of marketability is not warranted because the assets in the IRAs are publicly traded securities. Payment of the tax upon distribution is not a prerequisite to making the assets in the IRA marketable; consequently there is no basis for the discount. In technical advice the Service has also determined that a discount for lack of marketability is not available to an estate where the deduction for IRD is available to mitigate the potential income tax liability triggered by the IRD assets.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect; 691(c); Rev. Rul. 78-203, 1978-1 CB 199.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;IRC &sect; 1014(c).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;FSA 200011023.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;TAM 200247001; <em><em>see also</em></em> TAM 200303010.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;<em>Estate of Smith v. U.S.</em>, 300 F. Supp. 2d 474 (S.D. TX 2004), <em>appeal docketed</em>, No. 04-20194 (5th Cir. 2004); <em>Estate of Robinson v. Commissioner</em>, 69 TC 222 (1977).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;Let. Rul. 200444021.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;Rev. Rul. 2005-30, 2005-20 IRB 1015.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;125 TC 227 (2005).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;TAM 200247001; <em><em>see also</em></em> TAM 200303010.<br /> <br /> </div></div><br />

<div class="Section1"><em>Editor’s Note:</em> The 50 percent limit discussed below was lifted for 2021 and 2022, so that business meal expenses were entirely tax deductible if they otherwise qualified for the deduction and the expense was incurred in a restaurant.</div><br /> <div class="Section1"><br /> <br /> Prior to 2018, expenses for business meals and entertainment were required to meet one of two tests, as defined in regulations, in order to be deductible. The meal had to be: (1) “directly related to” the active conduct of the trade or business, or (2) “associated with” the trade or business. Generally, the deduction for business meals and entertainment expenses was limited to 50 percent of allowable expenses.<a href="#_ftn1" name="_ftnref1">¹</a> The 50 percent otherwise allowed as a deduction was <em>then</em> subject to the 2 percent floor that applies to miscellaneous itemized deductions.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Under the 2017 TCJA, the deduction for all business-related entertainment expenses was repealed. However, the 50 percent deduction for food and beverage expenses was retained. It seems clear that food and beverages consumed while traveling for business continue to be deductible subject to the 50 percent limit. The 2025 OBBB generally extended the TCJA treatment but created an exception so that the 50 percent limit will not apply to meals provided to employees on certain fishing vessels and at certain fish processing facilities.<a href="#_ftn2" name="_ftnref2">³</a><br /> <br /> Costs associated with meals and beverages provided for the convenience of the employer (i.e., meals brought to the office when employees are working late or provided through an onsite dining facility) are deductible subject to the 50 percent limit, but only through 2025.<br /> <br /> The IRS has released a technical advice memorandum (TAM) that sheds light on the potential tax implications when employers provide employees with free meals in the office. Post-tax reform, meals provided “for the convenience of the employer” may receive favorable tax treatment. In the TAM, the IRS denied exclusion of the meals’ value from employee compensation. In the scenario presented, the employer provided free meals to all employees in snack areas, at their desks and in the cafeteria, justifying provision of these meals by citing need for a secure business environment for confidential discussions, employee protection, improvement of employee health and a shortened meal period policy. The IRS rejected these rationales, stating that the employer was required to show that the policies existed in practice, not just in form, and that they were enforced upon specific employees. In this case, the employer had no policies relating to employee discussion of confidential information and provided no factual support for its other claims. General goals of improving employee health were found to be insufficient. The IRS also considered the availability of meal delivery services a factor in denying the exclusion, but indicated that if the employees were provided meals because they had to remain on the premises to respond to emergencies, that would be a factor indicating that the exclusion should be granted.<br /> <br /> Post-tax reform, employees are permitted to exclude the cost of employer-provided meals furnished to employees on the premises and for the employer’s convenience. The IRS guidance clarifies that the previously applicable standard, which requires that the meals are deemed to be provided for the employer’s convenience only if they are necessary for employees to properly perform their duties, will continue to apply even post-reform. Employers who wish to provide meals under this “convenience of the employer” provision must be able to substantiate that they have policies in place reflecting the need, and must be able to show that those policies connect the employer’s stated needs and goals to the necessity of providing employee meals. Sufficient substantiation will depend on the facts and circumstances of each case.<a href="#_ftn3" name="_ftnref3">⁴</a><br /> <br /> The IRS has provided further guidance on the matter of whether food or beverages with a client before or after an event that is clearly categorized as “entertainment” continue to be deductible subject to the 50 percent limit, or whether they will be categorized as pure “entertainment” expenses. The 50 percent deduction for business meal expenses will continue in effect under the 2017 tax reform legislation under certain circumstances even if provided in connection with non-deductible entertainment expenses. In general, business owners may continue to deduct 50 percent of business meal expenses that are ordinary and necessary expenses, so long as the meal is not lavish or extravagant under the circumstances. The meal or beverages must also be provided to current or prospective business associates, and must be purchased separately from any entertainment activities that are taking place simultaneously. It is also permissible that the cost of the food and beverages be separately stated from the cost of the entertainment on a receipt.<a href="#_ftn4" name="_ftnref4">⁵</a><br /> <br /> In general (both pre- and post-reform), the taxpayer or his employee generally must be present for meal expenses to be deductible, and expenses that are lavish or extravagant may be disallowed. Substantiation is required for lodging expenses and, in the case of expenditures incurred on or after October 1, 1995, for most items of $75.00 or more.<a href="#_ftn5" name="_ftnref5">⁶</a> An employee must generally provide an “adequate accounting” of reimbursed expenses to his employer.<a href="#_ftn6" name="_ftnref6">⁷</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 274(n)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Temp. Treas. Reg. § 1.67-1T(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 274(n)(2)(C).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRS CCA 2018-004.<br /> <br /> <a href="#_ftnref4" name="_ftn4">5</a>. Notice 2018-76.<br /> <br /> <a href="#_ftnref5" name="_ftn5">6</a>. Treas. Reg. § 1.274-5(c)(2)(iii).<br /> <br /> <a href="#_ftnref6" name="_ftn6">7</a>. Treas. Reg. § 1.274-5(f)(4).<br /> <br /> </div>

<div class="Section1">Under prior law, business owners were typically permitted to deduct interest expenses incurred in carrying on a trade or business (subject to limitations).<a href="#_ftn1" name="_ftnref1">¹</a> The 2017 tax reform legislation generally limits the interest expense deduction to the sum of (1) business interest income, (2) 30 percent of the business’ adjusted taxable income and (3) floor plan financing interest (see below).<a href="#_ftn2" name="_ftnref2">²</a> Businesses with average annual gross receipts of $31 million or less (in 2025) for the three-taxable year period that ends with the previous tax year are exempt from this new limitation (i.e., businesses that meet the gross receipts test of IRC Section 448(c)).<a href="#_ftn3" name="_ftnref3">³</a></div><br /> <div></div><br /> <div>Generally, the limit applies at the taxpayer level, but in the case of a group of affiliated corporations that file a consolidated return, it applies at the consolidated tax return filing level.</div><br /> <div class="Section1"><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> The IRS has released guidance on how the 2017 tax reform legislation impacts the business interest deduction limitation for consolidated groups. The limitation will apply at the consolidated group level, meaning that the group’s overall adjusted taxable income for purposes of the limitation will be its consolidated taxable income, and inter-company obligations will be disregarded.<br /> <br /> <hr /><br /> <br /> Further, the IRS and Treasury have released proposed regulations governing the allocation of the limitation among group members, and the treatment of disallowed interest carryforwards where a member leaves or joins the group. When one subsidiary leaves the group, the consolidated group must determine the amount of interest carryforwards that were allocated to the subsidiary. The regulations will treat an affiliated group as a single taxpayer only if it files a consolidated return for Section 163(j) purposes.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> “Business interest” generally excludes investment interest. It includes any interest paid or accrued on indebtedness properly allocable to carrying on a trade or business.<br /> <br /> The final regulations released in 2020 specifically exclude commitment fees and debt issuance costs from the definition of interest. While partnership guaranteed payments and hedging gains or losses are not specifically included in the definition of business interest, examples in the regulations provide guidance on when such payments may be included. The final regulations retain substitute interest payments in the definition of interest because the payments generally are economically equivalent to interest. However, the final regulations provide that a substitute interest payment is treated as an interest expense to the payor only if the payment relates to a sale-repurchase or securities lending transaction that is not entered into by the payor in the payor’s ordinary course of business. Further, the rules provide that a substitute interest payment is treated as interest income to the recipient only if the payment relates to a sale-repurchase or securities lending transaction that is not entered into by the recipient in the recipient’s ordinary course of business.<br /> <br /> “Business interest income” means the amount of interest that is included in the taxpayer’s gross income for the tax year that is properly allocable to carrying on a trade or business.<br /> <br /> “Adjusted taxable income” means taxable income computed without regard to (1) items of income, gain, deduction or loss not allocable to carrying on a trade or business, (2) business interest or business interest income, (3) any net operating loss deduction (NOL), (4) the deduction for pass-through income under Section 199A and (5) for years before 2022, any deduction for depreciation, amortization or depletion.<a href="#_ftn5" name="_ftnref5">⁵</a> For the purpose of the business interest deduction, adjusted taxable income is computed without regard for the deductions that are allowed for depreciation, amortization or depletion for tax years beginning after December 31, 2017 and before January 1, 2022. The 2025 OBBB restored the original definition of ATI for tax years beginning after 2024.<br /> <br /> <strong>___________________________________________________________________</strong><br /> <br /> <strong>Planning Point:</strong> The EBITDA-type calculation restored by the OBBB is generally considered more favorable because it tends to result in a higher calculation of ATI, thus increasing the permitted business interest deduction.<br /> <br /> __________________________________________________________________________<br /> <br /> “Floor plan financing interest” is interest paid or accrued on floor plan financing indebtedness, which is indebtedness incurred to finance the purchase of motor vehicles held for sale or lease to retail customers (and secured by the inventory that is acquired).<a href="#_ftn6" name="_ftnref6">⁶</a> For tax years beginning in 2025 and beyond, the definition of “motor vehicle” for floor plan financing purposes in the business interest context was modified to include any trailer or camper which is designed to provide temporary living quarters for recreational, camping, or seasonal use and is designed to be towed by, or affixed to, a motor vehicle.<a href="#_ftn6" name="_ftnref6">⁷</a><br /> <br /> As a result of these rules, business interest income and floor plan financing interest are fully deductible, with the limitation applying to 30 percent of the business’ adjusted taxable income.<br /> <br /> Unused interest expense deductions may be carried forward indefinitely.<a href="#_ftn7" name="_ftnref7">⁸</a> The IRS has released regulations stating that the disallowance and carryfoward of a business interest deduction in the C corporation context will not affect whether (or when) the business interest expense reduces the C corporation’s earnings and profits.<a href="#_ftn8" name="_ftnref8">⁹</a> This means that corporations need not wait until the year in which the deduction is allowed to reduce earnings and profits.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> The IRS has released guidance clarifying that taxpayers with disqualified business interest that was disallowed for the last tax year beginning before January 1, 2018 may carry the interest forward as business interest to the first tax year beginning after December 31, 2017. When this interest is carried forward (i.e., to 2018 and beyond), it will be treated as any other business interest that is incurred in a year beginning after December 31, 2017. This means that the carried forward interest will be subject to the same limitations that apply to interest expenses actually incurred after the new rules became effective in 2018. Because the new law does not contain a provision providing for excess limitation carryforwards under previously applicable “super affiliation rules”, these amounts may not be carried forward to tax years beginning after December 31, 2017.<a href="#_ftn9" name="_ftnref9">^{1<a href="#_ftn8" name="_ftnref8">0</a>}</a><br /> <br /> <hr /><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 163(j).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 163(j)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC §§ 163(j)(2), 448(c), Rev. Proc. 2023-34.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Notice 2018-28.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 163(j)(8).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 163(j)(9).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 163(j)(9)(C).<br /> <br /> <a href="#_ftnref7" name="_ftn7">8</a>. IRC § 163(j)(2).<br /> <br /> <a href="#_ftnref8" name="_ftn8">9</a>. Notice 2018-28.<br /> <br /> <a href="#_ftnref9" name="_ftn9">1</a>0. Notice 2018-28.<br /> <br /> </div>