Individual Income Taxes: Tax-Deductible Losses - Research Paper Example

Individual Income Taxes - Tax-Deductible Losses al Affiliation The main focus of this paper is tax-deductible losses in the US. Tax-deductible loss means that loss can’t be compensated through insurance and it must be sustained during the taxable year. According to the United States internal revenue code, there are certain losses that are considered for tax purposes. Under the current tax laws, a casualty loss deduction is allowed if the extent of the loss is not reimbursed by insurance. Tax-deductible losses are reasonable because they give evidence of closed and completed transactions. A tax deductible loss does not harm a taxpayer because this deduction is done incase his or her property suffers damaged or destruction. Casualty loss is not deductible if the damage or destruction is caused by accidental breaking like glassware, fire that was set willingly and finally a car accident is neglected or willingly act caused it. Keeping adequate records is one of the most important things a taxpayer can avoid a potential IRS audit doesn’t result in any assessment of additional tax, penalties and interests. This method helps you defend yourself against IRS audit. Keywords: IRS, audit, tax-deductible loss, casualty loss Manner in which tax-deductible losses originally became part of the U.S. Tax Code According to the United States internal revenue code, there are certain losses that are considered for tax purposes. This means that the loss can’t be compensated by Insurance and it must be sustained during the taxable year. If the losses are casualty or theft of personal, family, the loss must result from an event that is identifiable, and damaging or unusual nature. Losses incurred in a business or a profit-seeking activity are deductible whether if not they are due to casualty or theft (Pratt & Kulsurd, 2012). Under the current tax laws a casualty loss deduction is allowed if the extent of the loss is not reimbursed by insurance. This law was enacted because of the natural causes that frequently happen and the insurance companies are not fully equipped and able to pay for the massive damages caused. The tax-deductible losses have been modified for years, allowing losses under the tax code. In the 1880s deductions were allowed for losses related to fire and shipwrecks. In the 1990s it covered natural disasters and other casualties and theft. The federal government has responded in so much losses by offering aid to help cover by removing debris and rebuilding areas hit hardest Some people are covered by insurance but the insurance doesn’t cover the entire loss fully, if a tax payer doesn’t have insurance, he/she can be compensate by the federal income tax return for the casualty loss related to disaster. Individuals not connected with business losses are limited under the internal revenue code. The tax-deductible loses are reasonable because the loss must be an evidence that a closed and completed transaction, identifiable event happened. The amount of the loss allowed as a deduction shall not exceed the amount prescribed by the adjusted basis determining the loss for sale and other properties involved. Significant tax-deductible loss A significant tax-deductible loss is losses incurred because of a casualty, disaster or theft. The event that caused the loss must be identified, unexcepeted and unusual (Hoffman, Smith &Willis, 2008). The unusual and unexcepeted events are like car accidents, disaster-related demolitions, earthquakes, fires, floods, hurricanes and storms. Another significant tax-deductible include loss of property because of theft; according to IRS a theft is the act of taking or removing property with the intent to deprive the owner of it. This act is illegal under the state law and it must have been done with a criminal intention. Unfortunately disaster may happen or occur at any moment, hurricanes, volcanoes and river overflows. Congress has recognized that when such unusual events occur they may seriously impair the taxpayer’s ability to pay taxes. A tax deduction loss, doesn’t harm a taxpayer because this deduction is done incase his/her property suffers damaged or destruction. For this reason, taxpayers are allowed to deduct losses that may arise from casualty or theft. The deductible provides that an individual losses arising from casualty or theft are regardless in which the losses are incurred. A deduction is allowed only for casualties related to property owned by the taxpayers, no deduction is allowed for damages the taxpayers may be required to pay for the inflicting harm done. The tax deductions represent losses to the taxpayers for which the taxpayers get no benefits in return. Losses need to be deducted even in a tax because a loss diminishes the standard of living or the ability to pay of the taxpayer. A taxpayer can deduct personal casualty losses, to the aggregate losses during the taxable year. Personal casualty losses are losses of property not associated with trade or business entered into for a profit. A taxpayer has a claim on reimbursement of casualty loss, if the loss is not deducted until the taxable year in which the amount is reimbursed is ascertained (Bankman, Griffith & Pratt, 2008). A taxpayer may take casualty loss deduction for property damaged due to the taxpayers negligence. I recommend that congress enact on the reform tax system and provide a net tax reduction for individual and businesses. Tax relief and maintaining a strong economy are very important. This enactment will provide a sustaining economy recovery and making a tax system that is fairer and simpler. Simply returns by eliminating the deductions for sales, personal property and miscellaneous taxes and combining Example of a type of loss that is not deductible A casualty loss cannot be considered to be deductible, if the damage is caused by accidental breaking like glassware, fire that was set willingly and finally a car accident that has been caused by neglected or willingly act caused it. Myers& DeScherer stated that the Loss of property due to continuous deterioration is not deductible as casualty loss (2008). This is because the damage results from an operating cause or normal process, rather than from a sudden or unusual event. These are examples of progressive deterioration; weakening building due to normal weather conditions, water heater bursts and property losses caused by drought. This loss doesn’t qualify to be deductible because the damage has happened over many years before it caused total damage. This kind of loss shouldn’t be paid for, because the person is fully aware of the problem blows out of proportion he/she shouldn’t ask for payment because they can prevent it. If glassware breaks it shouldn’t be considered as a tax-deductible loss but planned damage. An alternative to loss deductions Payroll taxation: are deductions imposed by the federal Government (Fordney, French & Follins, 2008). These deductions include social security and Medicare taxes that are imposed on both the employer and employee. Many systems allow deductions for loss on sale, and exchange. The deduction may be limited to gains from the assets. In the US a loss is considered a capital loss and deduction of loss is limited to capital gain. Recent IRS audit activities related to loss deductions The possibility of being audited or hearing from the IRS increases depends on various factors, including income level, the kinds of deductions or losses claimed, the business youre engaged and whether you own foreign assets. As a result of the IRS audit, taxpayers owing rental estates should have additional tax compliance requirements. Prior to the 1986, a taxpayer should be deducted losses in full rental activities and trade regardless of his/her participation. This taxation will give rise to a number of tax shelters that will allow taxpayers to deduct non-economic losses against wages incomes. Because of the value deductions, people prefer to be business owner than an investor. It’s important to decide on which deductions you will entitled to, if you decide business and take business-only deductions, IRS will audit your returns and put you in the category of investor. This will deny one the business-only deduction in future and would be subjected to pay back taxes and interests on the business-only deduction applied (Fishman,2004 ). The reason why people own residential houses is to earn profits. If the main purpose owns a rental other than earning a profit the rental activity will be classified under not-for-profit activity. If the IRS considers one rental activity as a not-for-profit then your deductions will be severely limited. This means you will be able to deduct only your expenses from what the rental activity generates. One can’t carry over any deductions to use in the future when you earn income you will lose them forever. Fishman stated that if you have income and your activity is considered not-for-profit you must deduct your expenses in a way that is less beneficial than that of a regular landlord deductions (2004). This category expense deduction is miscellaneous itemized by IRS. This means that you must itemize the deductions rather than taking the standard deductions. The itemized deductions can be used to offset your income activities, but only for as long as the expenses plus your other miscellaneous itemized deductions. The frequent types of losses that would most likely trigger an IRS audit include: Real Estate Rental losses: If you’re a real estate professional, you may use the losses incurred from your real estate to offset other incomes. The IRS defines it as it applies to more than half of the personal services performed and worked for more than 750 hours in trade during the tax year conducted in a real property trade in which you materially participated. During the tax year in real property business in which you provided material support, you don’t qualify as a pro; your losses may be limited to offset any income. If the losses are carried forward until the property is sold to someone not related to you. Claiming the loss when you are not a pro will trigger an audit from IRS. Business loss: a loss on your tax return is a major cause of audit. It’s an uncommon procedure for new businesses to show losses in their first year with a high startup costs and early, slow business. Kamoroff stated that a warning applies to people who make losses after years of business and no result of profit calls for an IRS audit (2011). The owner of the business can rule out that the business is merely a hobby; the IRS then treats the income from a hobby as a taxable income, but not loss that is not deductible. A business can experience losses for several years without been challenged by the IRS. In the case an audit is conducted by IRS will allow the ongoing losses, if they are convinced it’s an operating areal business. Adequate record keeping is important things a taxpayer can avoid a potential IRS audit doesn’t result in any assessment of additional tax, penalties and interests. An IRS audit occurs when the tax returns to review the taxpayers records from which the information that is reported on tax returned. In the United States a client to challenge a loss deduction he/she should have a substantiate expenses and adequate records. This means they can easily defend their case without any difficulties. A taxpayer bears the burden to prove that IRS revenue agent methods during an audit are unfair and inaccurate (United States, congress, Senate, committee on finance, 1998). It’s important to maintain adequate records to support items like income, deduction losses and credits. In conclusion, tax-deductible loss means that the loss can’t be compensated by Insurance and it must be sustained during the taxable year. These losses are unusual and unexcepeted like loses caused by floods, tornadoes and hurricanes. The tax-deductible losses dont affect the taxpayer as it benefits them. A significant tax-deductible loss is losses incurred because of a casualty, disaster or theft. The event that caused the loss must be identified, unexcepeted and unusual. Loss of property due to progressive deterioration is not deductible as casualty loss. Payroll taxation could be a fairer alternative to loss deduction. Recent IRS audit is the real estate Rental losses, if you’re a real estate professional, you may use the losses incurred from your real estate to offset other incomes. Reference List Bankman, J., Griffith, T. & Pratt K. (2008). Federal Income Tax: Examples & Explanations. New York: Aspen Publishers. Fishman, S. (2004).   Every Landlords Tax Deduction Guide. (11th ed). California: Nolo trademark. Fordeny, M., French, L. & Follis, J. (2008). Administrative Medical Assisting. New York: Delmar Cengage Learning. Hoofman, W., Smith, J. & Willis, E.(2008). West Federal Taxation 2008: Individual Income Taxes, Professional Version. Mason: Thomson Higher Education. Kamoroff, B. (2011). Small Time Operator: How to Start Your Own Business, Keep Your Books, Pay your taxes and stay out of trouble. (12th ed). Maryland: Taylor Trade publishing. Myers, T. & DeScherer, D. (2008). Individual Tax Answer Book, Book 2009. Chicago: CCHGroup. Pratt, J. & Kulsrud, W. (2012). Individual Taxation 2013. New York: Cengage Learning. United States Congress, Senate and Committee on Finance. (1998). IRS Restructuring: Hearings before the Committee on Finance, United States Senate. Washington: US Government Printing Office. Read More