Deductions and Credits

• Author: Lionel S. Sobel
• Pages: 47-108

47

CHAPTER 3

Deductions and Credits

What Kinds of Expenses Are Deductible,

and Who May Deduct Them?

Trade or Business Expenses versus Hobby Expenses

Trade or Business Expenses versus Personal Expenses

Travel, Meals, and Lodging

Expenses of Seeking Employment

Union Dues

Home Office

Charitable Contributions

Substantiating Deductible

Where on the Income Tax Return Is a Particular

Expense Deducted?

Why Does It Matter “Where” on the Tax Return

an Expense Is Deducted?

When Is a Particular Expense Deductible?

Start-Up Expenses or Established Business Expenses?

Service Provider or Property Producer?

Service Provider Only

Property Producer

Credits

Chapter 2 was titled simply “Income,” but almost all of the sections

of the Code and Regulations that you read in that chapter used the

more precise term “gross income.” The United States does not impose

tax on “gross income,” however. It imposes tax on “taxable income.” 1

Gross income and taxable income are quite different; and taxable

income is always less than gross income, for every taxpayer.

1. I.R.C. §1.

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48 CHAPTER 3

The law gets us from gross income to taxable income by allow-

ing taxpayers to subtract certain expenses called “deductions.” Those

deductions are what this chapter is all about. If you like formulas,

here is the simple version:

Gross Income

2 Deductions

5 Taxable Income

A word about the accuracy of this simple version of the for-

mula: the Code actually divides “deductions” into two types: those

that tax lawyers call “above the line” deductions and those that tax

lawyers call “below the line” deductions. (Entertainment lawyers use

the phrases “above the line” and “below the line” to classify movie

production expenses. But there is no relationship—absolutely none—

between above- and below-the-line tax deductions and above- and

below-the-line movie production expenses. The phrases are the same,

but their meanings are as unrelated as apples and airplanes.)

By dividing deductions into two types, the Code creates three

kinds of income:

• gross income

• adjusted gross income

• taxable income

Later in this chapter, we’ll get to the consequences of having two

types of deductions and three kinds of income. For now, though, the

simple formula is enough.

If this chapter had a subtitle, it would be “What, Who, Where,

Why, and When?” because this chapter concerns these questions:

• What kinds of expenses are deductible?

• Who may deduct those types of expenses?

• Where on the income tax form is a particular expense

deducted?

• Why does it matter where on the tax form an expense is

deducted?

• When is a particular expense deductible?

Figure 3.1 is a roadmap to the topics covered in this chapter. It may

help you put each of the topics in context.

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Deductions and Credits 49

Figure 3.1

What Kinds of Expenses Are Deductible,

and Who May Deduct Them?

We begin with this very basic question: “What kinds of expenses are

deductible?” We do, because long ago the Supreme Court held that

Job search expenses

Form 2106 > Sch A > Form 1040 Line 40

Sch C > Form 1040 Line 12

1040 Line 40: below-the-line; 2% floor (hurdle)

1040 Line 12: above-the-line; no floor (hurdle)

Trade or business expenses vs. hobby expenses

Trade or business expenses vs. personal expenses

Travel, meals, and lodging expenses

Union dues

What expenses are deductible,

and who may deduct them?

Where on the tax return is a

particular expense deducted?

When is a particular

expense deductible?

Deductions

and Credits

Employees

Self-employed

Inventory

Equipment

Current expenses

Authors, photographers, artists

Credits

Why does “where” matter?

Home office expenses

Foreign Tax Credit - Chapter 11

Expenses

Exclusion vs. deduction of prizes

Deduction for self-created works

Ordinary expenses

Travel, entertainment, gifts, cars, computers

Substantiating expenses

Charitable contributions

Service provider

Current expenses

Equipment

Property producer

Job search expenses

Recording artists, filmmakers

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