IRS Releases Publication 535 (2022), Business Expenses

Department

of the

Treasury

Internal

Revenue

Service

Feb 2, 2023

Publication 535

Cat. No. 15065Z

Business

Expenses

For use in preparing

2022 Returns


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Contents

Introduction. . . . . . . . . . . . . . . . . . 1

What's New for 2022 . . . . . . . . . . . . . 2

What's New for 2023 . . . . . . . . . . . . . 2

Reminders . . . . . . . . . . . . . . . . . . . 2

Chapter 1. Deducting

Business Expenses. . . . . . . . . . 3

Chapter 2. Employees' Pay. . . . . . . . 8

Chapter 3. Rent Expense. . . . . . . . 11

Chapter 4. Interest. . . . . . . . . . . . 13

Chapter 5. Taxes. . . . . . . . . . . . . 18

Chapter 6. Insurance . . . . . . . . . . . 21

Chapter 7. Costs You Can Deduct

or Capitalize . . . . . . . . . . . . . . 25

Chapter 8. Amortization. . . . . . . . . 29

Chapter 9. Depletion. . . . . . . . . . . 36

Chapter 10. Business Bad Debts . . . . 41

Chapter 11. Other Expenses. . . . . . 43

Chapter 12. How To Get Tax Help. . . 50

The Taxpayer Advocate Service

(TAS) Is Here To Help You. . . . . 54

Index. . . . . . . . . . . . . . . . . . . . . 56

Introduction

This publication discusses common business expenses and explains what is and is not de-ductible. The general rules for deducting busi-ness expenses are discussed in the opening chapter. The chapters that follow cover specific expenses and list other publications and forms you may need.

Note. Section references within this publica-tion are to the Internal Revenue Code and regu-lation references are to the Income Tax Regula-tions under the Code.

Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions.

You can send us comments through IRS.gov/FormComments. Or you can write to the Internal Revenue Service, Tax Forms and Publications, 1111 Constitution Ave. NW, IR-6526, Washington, DC 20224.

Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments and suggestions as we revise our tax forms, instruc-tions, and publications. Don’t send tax ques-tions, tax returns, or payments to the above ad-dress.

Getting answers to your tax questions.

If you have a tax question not answered by this

publication or the How To Get Tax Help section at the end of this publication, go to the IRS In-teractive Tax Assistant page at IRS.gov/ Help/ITA where you can find topics by using the search feature or viewing the categories listed.

Getting tax forms, instructions, and pub-lications. Go to IRS.gov/Forms to download current and prior-year forms, instructions, and publications.

Ordering tax forms, instructions, and publications. Go to IRS.gov/OrderForms to order current forms, instructions, and publica-tions; call 800-829-3676 to order prior-year forms and instructions. The IRS will process your order for forms and publications as soon as possible. Don’t resubmit requests you've al-ready sent us. You can get forms and publica-tions faster online.

Future Developments

For the latest information about developments related to Pub. 535, such as legislation enacted after it was published, go to IRS.gov/Pub535.

What's New for 2022

The following items highlight some changes in the tax law for 2022.

Form 1099-K reporting transition period. The transition period described in Notice 2023-10 delays the reporting of transactions in excess of $600 to transactions that occur after calendar year 2022. The transition period is in-tended to facilitate an orderly transition for TPSO tax compliance, as well as individual payee compliance with income tax reporting. A participating payee, in the case of a third-party network transaction, is any person who accepts payment from a third-party settlement organiza-tion for a business transaction.

The COVID-19 related credit for qualified sick and family leave wages is limited to leave taken after March 31, 2020, and be-fore October 1, 2021. Generally, the credit for qualified sick and family leave wages, as enacted under the Families First Coronavirus Response Act (FFCRA) and amended and ex-tended by the COVID-related Tax Relief Act of 2020, for leave taken after March 31, 2020, and before April 1, 2021, and the credit for qualified sick and family leave wages under sections 3131, 3132, and 3133 of the Internal Revenue Code, as enacted under the American Rescue Plan Act of 2021 (the ARP), for leave taken after March 31, 2021, and before October 1, 2021, have expired. However, employers that pay qualified sick and family leave wages in 2022 for leave taken after March 31, 2020, and be-fore October 1, 2021, are eligible to claim a credit for qualified sick and family leave wages in 2022. For more information, see chapter 2.

The COVID-19 related employee retention credit has expired. The employee retention credit enacted under the Coronavirus Aid, Re-lief, and Economic Security (CARES) Act and amended and extended by the Taxpayer Cer-tainty and Disaster Tax Relief Act of 2020 was limited to qualified wages paid after March 12,

Page 2

2020, and before July 1, 2021. The employee retention credit under section 3134 of the Inter-nal Revenue Code, as enacted by the ARP and amended by the Infrastructure Investment and Jobs Act, was limited to wages paid after June 30, 2021, and before October 1, 2021, unless the employer was a recovery startup business. An employer that was a recovery startup busi-ness could also claim the employee retention credit for wages paid after September 30, 2021, and before January 1, 2022. For more informa-tion, see chapter 2.

Credit for COBRA premium assistance pay-ments is limited to periods of coverage be-ginning on or after April 1, 2021, through periods of coverage beginning on or before September 30, 2021. Section 9501 of the ARP provides for COBRA premium assistance in the form of a full reduction in the premium otherwise payable by certain individuals and their families who elect COBRA continuation coverage due to a loss of coverage as the result of a reduction in hours or an involuntary termi-nation of employment (assistance eligible indi-viduals). This COBRA premium assistance is available for periods of coverage beginning on or after April 1, 2021, through periods of cover-age beginning on or before September 30, 2021. For more information, see chapter 2.

Advance payment of COVID-19 credits ex-tended. You may no longer request an ad-vance payment of any credit on Form 7200, Ad-vance Payment of Employer Credits Due to COVID-19. For more information, see chap-ter 2.

Research and experimental costs. Begin-ning January 1, 2022, research and experimen-tal expenditures, generally, have to be amor-tized over a 5-year period. A business cannot elect to deduct their total research expenses in the current year. For more information, see chapter 7.

Amortization of research and experimental expenditures. Specified research or experi-mental costs paid or incurred in tax years begin-ning after 2021 must be capitalized and amor-tized ratably over a 5-year period (15-year period for any expenditures related to foreign research). For more information, see chapter 8.

Corporate alternative minimum tax reinsta-ted in 2023. P.L. 117-169, dated August 16, 2022, amended section 55 to impose a corpo-rate alternative minimum tax. The amendment applies to tax years beginning after 2022. For more information, see chapter 9.

Excise tax on Black Lung Benefits now per-manent. P.L. 117-169 also amended section 4121 to eliminate the reduction in tax on coal from mines located in the United States sold by the producer. The amendment applies to sales in calendar quarters beginning after August 17, 2022. For more information, see chapter 9.

Standard mileage rate. For tax year 2022, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is:

58.5 cents per mile from January 1, 2022, through June 30, 2022; and

62.5 cents per mile from July 1, 2022, through December 31, 2022.

For more information, see chapter 11.

What's New for 2023

The following item highlights a change in the tax law for 2023.

Most current standard mileage rate. For the most current standard mileage rates, go to IRS.gov/Tax-Professionals/Standard-Mileage-Rates.

The following item highlights a change regarding this publication.

Final revision. Pub. 535 will no longer be re-vised and published. The 2022 edition will be the final revision available.

Reminders

The following reminders and other items may help you file your tax return.

IRS e-file (Electronic Filing)

You can file your tax returns electronically using an IRS e -file option. The benefits of IRS e-file include faster refunds, increased accuracy, and acknowledgment of IRS receipt of your return. You can use one of the following IRS e-file options.

Use an authorized IRS e-file provider.
Use a personal computer.
Visit a Volunteer Income Tax Assistance (VITA) or Tax Counseling for the Elderly (TCE) site.

For details on these fast filing methods, see your income tax package.

Form 1099-MISC. File Form 1099-MISC, Mis-cellaneous Income, for each person to whom you have paid during the year in the course of your trade or business at least $600 in rents, prizes and awards, other income payments, medical and health care payments, and crop in-surance proceeds. See the Instructions for Forms 1099-MISC and 1099-NEC for more in-formation and additional reporting require-ments.

Form 1099-NEC. File Form 1099-NEC, Non-employee Compensation, for each person to whom you have paid during the year in the course of your trade or business at least $600 in services (including parts and materials), who is not your employee. See the Instructions for Forms 1099-MISC and 1099-NEC for more in-formation and additional reporting require-ments.

Gig Economy Tax Center. The IRS Gig Econ-omy Tax Center on IRS.gov can help people in this growing area meet their tax obligations through more streamlined information.

The gig economy is also known as the shar-ing, on-demand, or access economy. It usually includes businesses that operate an app or website to connect people to provide services to customers. While there are many types of gig economy businesses, ride-sharing and home rentals are two of the most popular.

Publication 535 (2022)

The Gig Economy Tax Center streamlines various resources, making it easier for taxpay-ers to find information about the tax implications for the companies that provide the services and the individuals who perform them. It offers tips and resources on a variety of topics including:

• Filing requirements;

•Making quarterly estimated income tax payments;

• Paying self-employment taxes;

•Paying FICA, Medicare, and Additional Medicare taxes;

• Deductible business expenses; and

•Special rules for reporting vacation home rentals.

For more information, go to the Gig Economy Tax Center at IRS.gov/Gig.

To report suspected human trafficking, call the DHS domestic 24-hour toll-free number at

866-DHS-2-ICE (866-347-2423) or 802-872-6199 (non-toll-free international). For help from the NHTRC, call the National Human Trafficking Hotline toll free at 888-373-7888 or text HELP or INFO to BeFree (233733).

The U.S. Department of the Treasury’s Fi-nancial Crimes Enforcement Network (FinCEN) has issued a public advisory to financial institu-tions that contains red flag indicators for poten-tial suspicious financial activity associated with human trafficking. If warranted, financial institu-tions should file a Suspicious Activity Report (FinCEN 112) with FinCEN to report these ac-tivities. For more information, go to Fincen.gov/ Sites/default/files/advisory/FIN-2014-A008.pdf.

925 Passive Activity and At-Risk Rules

936 Home Mortgage Interest

Deduction

946 How To Depreciate Property

Form (and Instructions)

Schedule A (Form 1040) Itemized

Deductions

5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit

See chapter 12 for information about getting publications and forms.

Photographs of missing children. The Inter-

nal Revenue Service is a proud partner with the

NationalCenterforMissing&Exploited

What Can I Deduct?

Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1 -800-THE-LOST (1-800-843-5678) (24 hours a day, 7 days a week) if you recognize a child.

Preventing slavery and human trafficking. Human trafficking is a form of modern-day slav-ery, and involves the use of force, fraud, or co-ercion to exploit human beings for some type of labor or commercial sex purpose. The United States is a source, transit, and destination country for men, women, and children, both U.S. citizens and foreign nationals, who are subjected to the injustices of slavery and hu-man trafficking, including forced labor, debt bondage, involuntary servitude, “mail-order” marriages, and sex trafficking. Trafficking in persons can occur in both lawful and illicit in-dustries or markets, including in hotel services, hospitality, agriculture, manufacturing, janitorial services, construction, health and elder care, domestic service, brothels, massage parlors, and street prostitution, among others.

The President’s Interagency Task Force to Monitor and Combat Trafficking in Persons (PITF) brings together federal departments and agencies to ensure a whole-of-government ap-proach that addresses all aspects of human trafficking. Online resources for recognizing and reporting trafficking activities, and assisting vic-tims include the Department of Homeland Se-curity (DHS) Blue Campaign at DHS.gov/blue-campaign, the Department of State Office to Monitor and Combat Trafficking in Persons at State.gov/j/tip, and the National Human Traf-ficking Resource Center (NHTRC) at humantraffickinghotline.org. DHS is responsible for investigating human trafficking, arresting traffickers, and protecting victims. DHS also provides immigration relief to non-U.S. citizen victims of human trafficking. DHS uses a victim-centered approach to combating human traf-ficking, which places equal value on identifying and stabilizing victims and on investigating and prosecuting traffickers. Victims are crucial to in-vestigations and prosecutions; each case and every conviction changes lives. DHS under-stands how difficult it can be for victims to come forward and work with law enforcement due to their trauma. DHS is committed to helping vic-tims feel stable, safe, and secure.

1.

Deducting

Business

Expenses

Introduction

This chapter covers the general rules for de-ducting business expenses. Business expen-ses are the costs of carrying on a trade or busi-ness, and they are usually deductible if the business is operated to make a profit.

Topics

This chapter discusses:

What you can deduct
How much you can deduct
When you can deduct
Not-for-profit activities

Useful Items

You may want to see:

Publication

			334	Tax Guide for Small Business



			463	Travel, Gift, and Car Expenses


			525	Taxable and Nontaxable Income


			529	Miscellaneous Deductions


			536	Net Operating Losses (NOLs) for

				Individuals, Estates, and Trusts
			538	Accounting Periods and Methods


			542	Corporations


			547	Casualties, Disasters, and Thefts


			583	Starting a Business and Keeping

				Records
			587	Business Use of Your Home

To be deductible, a business expense must be both ordinary and necessary. An ordinary ex-pense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or busi-ness. An expense does not have to be indis-pensable to be considered necessary.

Even though an expense may be ordinary and necessary, you may not be allowed to de-duct the expense in the year you paid or incur-red it. In some cases, you may not be allowed to deduct the expense at all. Therefore, it is im-portant to distinguish usual business expenses from expenses that include the following.

The expenses used to figure cost of goods sold.

Capital expenses.
Personal expenses.

Cost of Goods Sold

If your business manufactures products or pur-chases them for resale, you must generally value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your business expenses may be included in figuring cost of goods sold. Cost of goods sold is deducted from your gross re-ceipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense.

The following are types of expenses that go into figuring cost of goods sold.

The cost of products or raw materials, in-cluding freight.

Storage.
Direct labor (including contributions to pen-sion or annuity plans) for workers who pro-duce the products.
Factory overhead.

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repack-aging, handling, and administrative costs.

This rule does not apply to small business taxpayers. You qualify as a small business tax-payer if you (a) have average annual gross

Chapter 1Deducting Business ExpensesPage 3

receipts of $27 million or less for the 3 prior tax years, and (b) are not a tax shelter (as defined in section 448(d)(3)). If your business has not been in existence for all of the 3-tax-year period used in figuring average gross receipts, base your average on the period it has existed, and if your business has a predecessor entity, include the gross receipts of the predecessor entity from the 3-tax-year period when figuring aver-age gross receipts. If your business (or prede-cessor entity) had short tax years for any of the 3-tax-year period, annualize your business’ gross receipts for the short tax years that are part of the 3-tax-year period. See Pub. 538 for more information.

For more information, see the following sources.

Cost of goods sold—chapter 6 of Pub. 334.

Inventories—Pub. 538.
Uniform capitalization rules—Pub. 538 and section 263A and the related regulations.

Capital Expenses

You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called “capital expen-ses.” Capital expenses are considered assets in your business. In general, you capitalize three types of costs.

Business startup costs (see Tip below).
Business assets.
Improvements.

You can elect to deduct or amortize TIP certain business startup costs. See

chapters 7 and 8.

Cost recovery. Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. These recovery methods allow you to deduct part of your cost each year. In this way, you are able to recover your capital expense. See Amortization (chapter 8) and Depletion (chapter 9) in this publication. A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduc-tion. A greater portion of these costs can be de-ducted if the property is qualified disaster assis-tance property. See Pub. 946 for details.

Going Into Business

The costs of getting started in business, before you actually begin business operations, are capital expenses. These costs may include ex-penses for advertising, travel, or wages for training employees.

If you go into business. When you go into business, treat all costs you had to get your business started as capital expenses.

Usually, you recover costs for a particular asset through depreciation. Generally, you can-not recover other costs until you sell the busi-ness or otherwise go out of business. However, you can choose to amortize certain costs for setting up your business. See Starting a Busi-ness in chapter 8 for more information on busi-ness startup costs.

If your attempt to go into business is un-successful. If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories.

1. The costs you had before making a deci-sion to acquire or begin a specific busi-ness. These costs are personal and non-deductible. They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility.

2. The costs you had in your attempt to ac-quire or begin a specific business. These costs are capital expenses and you can deduct them as a capital loss.

If you are a corporation and your attempt to go into a new trade or business is not success-ful, you may be able to deduct all investigatory costs as a loss.

The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. You can-not take a deduction for these costs. You will re-cover the costs of these assets when you dis-pose of them.

Business Assets

There are many different kinds of business as-sets, for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. You must fully capitalize the cost of these as-sets, including freight and installation charges.

Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. See Regulations section 1.263A-2 for information on these rules.

De Minimis Safe Harbor for Tangible Property

Although you must generally capitalize costs to acquire or produce real or tangible personal property used in your trade or business, such as buildings, equipment, or furniture, you can elect to use a de minimis safe harbor to deduct the costs of some tangible property. Under the de minimis safe harbor for tangible property, you can deduct de minimis amounts paid to ac-quire or produce certain tangible business prop-erty if these amounts are deducted by you for fi-nancial accounting purposes or in keeping your books and records. See the following for the re-quirements for the de minimis safe harbor.

You have an applicable financial statement. If you elect the de minimis safe harbor for the tax year, you can deduct amounts paid to ac-quire or produce certain tangible business prop-erty if:

You have a trade or business or are a cor-poration, partnership, or S corporation that has an applicable financial statement;

You have, at the beginning of the tax year, written accounting procedures treating as an expense for nontax purposes:

– Amounts paid for property costing less than a certain dollar amount, or

– Amounts paid for property with an economic useful life of 12 months or less;

You treat the amount paid during the tax year for which you make the election as an expense on your applicable financial state-ments in accordance with your written ac-counting procedures;

The amount paid for the property does not exceed $5,000 per invoice (or per item substantiated by invoice); and
The uniform capitalization rules do not ap-ply to the amount.

You do not have an applicable financial statement. If you elect the de minimis safe harbor for the tax year, you can deduct amounts paid to acquire or produce certain tangible busi-ness property if:

You have a trade or business, partnership, or S corporation that does not have an ap-plicable financial statement;

You have, at the beginning of the tax year, accounting procedures treating as an ex-pense for nontax purposes:

– Amounts paid for property costing less than a certain dollar amount, or

– Amounts paid for property with an economic useful life of 12 months or less;

You treat the amounts paid for the property as an expense on your books and records in accordance with your accounting proce-dures;

The amount paid for the property does not exceed $2,500 per invoice (or per item substantiated by invoice); and
The uniform capitalization rules do not ap-ply to the amounts.

How to make the de minimis safe harbor election. To elect the de minimis safe harbor for the tax year, attach a statement to the tax-payer’s timely filed original tax return (including extensions) for the tax year when qualifying amounts were paid. The statement must be ti-tled “Section 1.263(a)-1(f) de minimis safe har-bor election” and must include your name, ad-dress, taxpayer identification number (TIN), and a statement that you are making the de minimis safe harbor election under section 1.263(a) -1(f). In the case of a consolidated group filing a con-solidated income tax return, the election is made for each member of the consolidated group.

In the case of a consolidated group filing a consolidated income tax return, the election is made for each member of the consolidated group. In the case of an S corporation or a part-nership, the election is made by the S corpora-tion or the partnership and not by the share-holders or partners. The election applies only for the tax year for which it is made.

Example. In 2022, you do not have an ap-plicable financial statement and you purchase five laptop computers for use in your trade or business. You paid $2,000 each for a total cost of $10,000 and these amounts are substanti-ated in an invoice. You had an accounting pro-cedure in place at the beginning of 2022 to ex-pense the cost of tangible property if the property costs $2,000 or less. You treat each computer as an expense on your books and

Page 4Chapter 1Deducting Business Expenses

records for 2022 in accordance with this policy. If you elect the de minimis safe harbor in your tax returns for your 2022 tax year, you can de-duct the cost of each $2,000 computer.

Improvements

Generally, you must capitalize the costs of mak-ing improvements to a business asset if the im-provements result in a betterment to the unit of property, restore the unit of property, or adapt the unit of property to a new or different use.

Some examples of improvements include rewiring or replumbing of a building, replacing an entire roof, increasing the production output of your equipment, putting an addition on your building, strengthening the foundation of a building so you can use it for a new purpose, or replacing a major component or substantial structural part of a machine.

However, you may currently deduct the costs of repairs or maintenance that do not im-prove a unit of property. This generally includes the costs of routine repairs and maintenance to your property that result from your use of the property and that keep your property in an ordi-nary, efficient operating condition. For example, deductible repairs include costs such as paint-ing exteriors or interiors of business buildings, repairing broken windowpanes, replacing worn-out minor parts, sealing cracks and leaks, and changing oil or other fluids to maintain busi-ness equipment.

Routine maintenance safe harbor. If you determine that your cost was for an improve-ment to a building or equipment, you can de-duct your cost under the routine maintenance safe harbor. Under the routine maintenance safe harbor, you can deduct the costs of an im-provement that meets all of the following crite-ria.

It is paid for recurring activities performed on tangible property.

It arises from the use of the property in your trade or business.

It keeps your property in an ordinary, effi-cient operating condition.

You reasonably expect, at the time the property is placed in service, to perform this activity:

– For buildings and building systems, more than once during the 10-year pe-riod after you place the building in service; or

– For other property, more than once during the class life of the particular type of property. For class lives, see Revenue Procedure 88-57, 1987-2 C.B. 674.

Costs incurred during an improvement. You must capitalize both the direct and indirect costs of an improvement. Indirect costs include repairs and other expenses that directly benefit or are incurred by reason of your improvement. For example, if you improve the electrical sys-tem in your building, you must also capitalize the costs of repairing the holes that you made in walls to install the new wiring. This rule applies even if this work, performed by itself, would oth-

erwise be treated as currently deductible repair costs.

Election to capitalize repair and mainte-nance costs. You can elect to capitalize and depreciate certain amounts paid for repair and maintenance of tangible property, even if they do not improve your property. To qualify for this election, you must treat these amounts as capi-tal expenditures on your books and records used in figuring your income. If you make this election, you must apply it to all repair and maintenance costs of tangible property that you treat as capital expenditures on your books and records for this tax year. To make the election to treat repairs and maintenance as capital ex-penditures, attach a statement titled “Section 1.263(a)-3(n) Election” to your timely filed origi-nal tax return (including extensions) and include your name and address, TIN, and a statement that you elect to capitalize repair and mainte-nance costs under section 1.263(a)-3(n). You must treat these amounts as improvements to your tangible property and begin to depreciate these amounts when the improvement is placed in service.

Capital Versus Deductible Expenses

To help you distinguish between capital and de-ductible expenses, different examples are given below.

Motor vehicles. You usually capitalize the cost of a motor vehicle you use in your busi-ness. You can recover its cost through annual deductions for depreciation.

There are dollar limits on the depreciation you can claim each year on passenger automo-biles used in your business. See Pub. 463 for more information.

Generally, repairs you make to your busi-ness vehicle are currently deductible. However, amounts you pay to improve your business ve-hicle are generally capital expenditures and are recovered through depreciation.

Roads and driveways. The cost of building a private road on your business property and the cost of replacing a gravel driveway with a con-crete one are capital expenses you may be able to depreciate. The cost of maintaining a private road on your business property is a deductible expense.

Tools. Unless the uniform capitalization rules apply, amounts spent for tools used in your business are deductible expenses if the tools have a life expectancy of less than 1 year or they cost $200 or less per item or invoice.

Machinery parts. Unless the uniform capitali-zation rules apply, the cost of replacing short-lived parts of a machine to keep it in good working condition, but not to improve the ma-chine, is a deductible expense.

Heating equipment. The cost of changing from one heating system to another is a capital expense.

Deduction for qualified business income. For tax years beginning after 2017, you may be entitled to take a deduction of up to 20% of your qualified business income from your qualified trade or business, plus 20% of the aggregate amount of qualified real estate investment trust (REIT) and qualified publicly traded partnership income. The deduction is subject to various lim-itations, such as limitations based on the type of your trade or business, your taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unad-justed basis of qualified property held by your trade or business. You will claim this deduction on Form 1040 or 1040-SR, not on Schedule C. Unlike other deductions, this deduction can be taken in addition to the standard or itemized de-ductions. For more information, see the Instruc-tions for Form 1040.

Personal Versus Business Expenses

Generally, you cannot deduct personal, living, or family expenses. However, if you have an ex-pense for something that is used partly for busi-ness and partly for personal purposes, divide the total cost between the business and per-sonal parts. You can deduct the business part.

For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can generally deduct 70% of the interest as a business expense. The re-maining 30% is personal interest and is gener-ally not deductible. See chapter 4 for informa-tion on deducting interest and the allocation rules.

Business use of your home. If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depre-ciation.

To qualify to claim expenses for the busi-ness use of your home, you must meet both of the following tests.

1. The business part of your home must be used exclusively and regularly for your trade or business.

2. The business part of your home must be:

a. Your principal place of business;

b. A place where you meet or deal with patients, clients, or customers in the normal course of your trade or busi-ness; or

c. A separate structure (not attached to your home) used in connection with your trade or business.

You generally do not have to meet the ex-clusive use test for the part of your home that you regularly use either for the storage of inven-tory or product samples, or as a daycare facility.

Your home office qualifies as your principal place of business if you meet the following re-quirements.

You use the office exclusively and regu-larly for administrative or management ac-tivities of your trade or business.

Chapter 1Deducting Business ExpensesPage 5

You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

If you have more than one business loca-tion, determine your principal place of business based on the following factors.

The relative importance of the activities performed at each location.

If the relative importance factor does not determine your principal place of business, consider the time spent at each location.

Optional safe harbor method. Individual taxpayers can use the optional safe harbor method to determine the amount of deductible expenses attributable to certain business use of a residence during the tax year. This method is an alternative to the calculation, allocation, and substantiation of actual expenses.

The deduction under the optional method is limited to $1,500 per year based on $5 per square foot for up to 300 square feet. Under this method, you claim your allowable mortgage in-terest, real estate taxes, and casualty losses on the home as itemized deductions on Sched-ule A (Form 1040). You are not required to allo-cate these deductions between personal and business use, as is required under the regular method. If you use the optional method, you cannot depreciate the portion of your home used in a trade or business.

Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. All of the requirements discussed earlier under Business use of your home still apply.

For more information on the deduction for business use of your home, including the op-tional safe harbor method, see Pub. 587.

If you were entitled to deduct deprecia-

tion on the part of your home used for CAUTION business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997.

Business use of your car. If you use your car exclusively in your business, you can deduct car expenses. If you use your car for both busi-ness and personal purposes, you must divide your expenses based on actual mileage. Gen-erally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible.

You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. For 2022, the standard mileage rate is 58.5 cents per mile before July 1, 2022, and 62.5 cents per mile on or after July 1, 2022. To find the standard mileage rate for 2023, go to IRS.gov/Tax-Professionals/ Standard-Mileage-Rates.

If you are self-employed, you can also de-duct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate.

For more information on car expenses and the rules for using the standard mileage rate, see Pub. 463.

How Much Can I Deduct?

Generally, you can deduct the full amount of a business expense if it meets the criteria of ordi-nary and necessary and it is not a capital ex-pense.

Recovery of amount deducted (tax benefit rule). If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. If you have a re-covery in a later year, include the recovered amount in income in that year. However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income.

For more information on recoveries and the tax benefit rule, see Pub. 525.

Payments in kind. If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor.

Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. If these costs are included in the cost of goods sold, do not de-duct them again as a business expense.

Limits on losses. If your deductions for an in-vestment or business activity are more than the income it brings in, you have a loss. There may be limits on how much of the loss you can de-duct.

Not-for-profit limits. If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. For more information, see Not-for-Profit Activities, later.

At-risk limits. Generally, a deductible loss from a trade or business or other income-pro-ducing activity is limited to the investment you have “at risk” in the activity. You are at risk in any activity for the following.

1. The money and adjusted basis of property you contribute to the activity.

2. Amounts you borrow for use in the activity if:

a. You are personally liable for repay-ment, or

b. You pledge property (other than prop-erty used in the activity) as security for the loan.

For more information, see Pub. 925.

Passive activities. Generally, you are in a passive activity if you have a trade or business activity in which you do not materially partici-pate, or a rental activity. In general, deductions for losses from passive activities only offset in-come from passive activities. You cannot use any excess deductions to offset other income.

In addition, passive activity credits can only off-set the tax on net passive income. Any excess loss or credits are carried over to later years. Suspended passive losses are fully deductible in the year you completely dispose of the activ-ity. For more information, see Pub. 925.

Net operating loss (NOL). If your deduc-tions are more than your income for the year, you may have an NOL. You can use an NOL to lower your taxes in other years. See Pub. 536 for more information.

See Pub. 542 for information about NOLs of corporations.

When Can I

Deduct an Expense?

When you can deduct an expense depends on your accounting method. An accounting method is a set of rules used to determine when and how income and expenses are reported. The two basic methods are the cash method and the accrual method. Whichever method you choose must clearly reflect income.

For more information on accounting meth-ods, see Pub. 538.

Cash method. Under the cash method of ac-counting, you generally deduct business expen-ses in the tax year you pay them.

Accrual method. Under the accrual method of accounting, you generally deduct business expenses when both of the following apply.

1. The all-events test has been met. The test is met when:

a. All events have occurred that fix the fact of liability, and

b. The liability can be determined with reasonable accuracy.

2. Economic performance has occurred.

Economic performance. You generally cannot deduct or capitalize a business expense until economic performance occurs. If your ex-pense is for property or services provided to you, or for your use of property, economic per-formance occurs as the property or services are provided, or the property is used. If your ex-pense is for property or services you provide to others, economic performance occurs as you provide the property or services.

Example. Your tax year is the calendar year. In December 2022, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. You paid it by check in January 2023. If you use the ac-crual method of accounting, deduct the $600 on your tax return for 2022 because all events have occurred to “fix” the fact of liability (in this case, the work was completed), the liability can be determined, and economic performance oc-curred in that year.

If you use the cash method of accounting, deduct the expense on your 2023 tax return.

Prepayment. You generally cannot deduct ex-penses in advance, even if you pay them in ad-vance. This applies to prepaid interest, prepaid

Page 6Chapter 1Deducting Business Expenses

insurance premiums, and any other prepaid ex-pense that creates an intangible asset. If you pay an amount that creates an intangible asset, then you must capitalize the amounts paid and begin to amortize the payment over the appro-priate period.

However, you do not have to capitalize amounts for creating an intangible asset if the right or benefit created does not extend beyond the earlier of 12 months after the date that you first receive the right or benefit or the end of the tax year following the year in which you made the advance payment. If you are a cash method taxpayer and your advance payment qualifies for this exception, then you can generally de-duct the amount when paid. If you are an ac-crual method taxpayer, you cannot deduct the amount until the all-events test has been met and economic performance has occurred.

Example 1. In 2022, you sign a 10-year lease and immediately pay your rent for the first 3 years. Even though you paid the rent for 2022, 2023, and 2024, you can only deduct the rent for 2022 on your 2022 tax return. You can deduct the rent for 2023 and 2024 on your tax returns for those years.

Example 2. You are a cash method calen-dar year taxpayer. On December 1, 2022, you sign a 12-month lease, effective beginning Jan-uary 1, 2023, and immediately pay your rent for the entire 12-month period that begins on Janu-ary 1, 2023. The right or benefit attributable to the payment neither extends more than 12 months beyond January 1, 2023 (the first day that you are entitled to use the property) nor be-yond the tax year ending December 31, 2023 (the year following the year in which you made the advance payment). Therefore, your prepay-ment does not have to be capitalized, and you can deduct the entire payment in the year you pay it.

Contested liability. Under the cash method, you can deduct a contested liability only in the year you pay the liability. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. posses-sion income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. However, to take the deduction in the year of payment or transfer, you must meet cer-tain conditions. See Regulations section 1.461-2.

Related person. Under the accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the ex-pense before you can deduct it. Your deduction is allowed when the amount is includible in in-come by the related cash method payee. For more information, see Related Persons in Pub. 538.

Not-for-Profit Activities

If you do not carry on your business or invest-ment activity to make a profit, you cannot use a loss from the activity to offset other income. Ac-tivities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit.

The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

In determining whether you are carrying on an activity for profit, several factors are taken into account. No one factor alone is decisive. Among the factors to consider are whether:

You carry on the activity in a businesslike manner,

The time and effort you put into the activity indicate you intend to make it profitable,
You depend on the income for your liveli-hood,

Your losses are due to circumstances be-yond your control (or are normal in the startup phase of your type of business),

You change your methods of operation in an attempt to improve profitability,

You (or your advisors) have the knowledge needed to carry on the activity as a suc-cessful business,
You were successful in making a profit in similar activities in the past,

The activity makes a profit in some years, and

You can expect to make a future profit from the appreciation of the assets used in the activity.

Presumption of profit. An activity is pre-sumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they pro-duced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year within this period. You have a profit when the gross income from an activity exceeds the de-ductions.

If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death.

If your business or investment activity passes this 3- (or 2-) years -of-profit test, the IRS will presume it is carried on for profit. This means the limits discussed here will not apply. You can take all your business deductions from the activity, even for the years that you have a loss. You can rely on this presumption unless the IRS later shows it to be invalid.

Using the presumption later. If you are start-ing an activity and do not have 3 (or 2) years showing a profit, you can elect to have the pre-sumption made after you have the 5 (or 7) years of experience allowed by the test.

You can elect to do this by filing Form 5213. Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity.

The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. Accordingly, it will not restrict your deductions. Rather, you will gain time to earn a profit in the required number of years. If you show 3 (or 2) years of profit at the end of this period, your de-ductions are not limited under these rules. If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period.

Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the tax return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.

You must file Form 5213 within 3 years TIP after the due date of your tax return (determined without extensions) for the year in which you first carried on the activity, or,

if earlier, within 60 days after receiving written notice from the IRS proposing to disallow de-ductions attributable to the activity.

Gross Income

Gross income from a not-for-profit activity in-cludes the total of all gains from the sale, ex-change, or other disposition of property, and all other gross receipts derived from the activity. Gross income from the activity also includes capital gains and rents received for the use of property that is held in connection with the ac-tivity.

You can determine gross income from any not-for-profit activity by subtracting the cost of goods sold from your gross receipts. However, if you determine gross income by subtracting cost of goods sold from gross receipts, you must do so consistently, and in a manner that follows generally accepted methods of account-ing.

Limit on Deductions

You can no longer claim any miscella-

neous itemized deductions. Miscella-CAUTION neous itemized deductions are those deductions that would have been subject to the 2%-of-adjusted-gross-income limitation. You can still claim certain expenses as itemized de-ductions on Schedule A (Form 1040).

Deductions you can take for personal as well as for business activities are allowed in full. For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses, may also be deduc-ted. Deduct them on the appropriate lines of Schedule A (Form 1040).

For the limits that apply to home mortgage interest, see Pub. 936.

Generally, you can deduct a casualty loss on property you own for personal use only to the extent each casualty loss is more than $100, and the total of all casualty losses ex-ceeds 10% of your adjusted gross income (AGI). See Pub. 547 for more information on casualty losses.

Chapter 1Deducting Business ExpensesPage 7

Disaster tax relief. For personal casualty losses resulting from federally declared disas-ters that occurred before 2018, you may be en-titled to disaster tax relief. As a result, you may be required to figure your casualty loss differ-ently. For tax years beginning after 2017, casu-alty and theft losses are allowed only to the ex-tent it is attributable to a federally declared disaster. For more information, see Pub. 976, Disaster Relief.

Partnerships and S corporations. If a part-nership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. They are re-flected in the individual shareholder's or part-ner's distributive shares.

More than one activity. If you have several undertakings, each may be a separate activity or several undertakings may be combined. The following are the most significant facts and cir-cumstances in making this determination.

The degree of organizational and eco-nomic interrelationship of various under-takings.
The business purpose that is (or might be) served by carrying on the various under-takings separately or together in a busi-ness or investment setting.

The similarity of the undertakings.

The IRS will generally accept your charac-terization if it is supported by facts and circum-stances.

If you are carrying on two or more dif-TIP ferent activities, keep the deductions and income from each one separate.

Figure separately whether each is a not-for-profit activity. Then figure the limit on de-ductions and losses separately for each activity that is not for profit.

2.

Employees' Pay

What's New

The COVID-19 related credit for qualified sick and family leave wages is limited to leave taken after March 31, 2020, and be-fore October 1, 2021. Generally, the credit for qualified sick and family leave wages, as enacted under the Families First Coronavirus Response Act (FFCRA) and amended and ex-tended by the COVID-related Tax Relief Act of 2020, for leave taken after March 31, 2020, and before April 1, 2021, and the credit for qualified sick and family leave wages under sections 3131, 3132, and 3133 of the Internal Revenue Code, as enacted under the American Rescue Plan Act of 2021 (the ARP), for leave taken after March 31, 2021, and before October 1, 2021, have expired. However, employers that pay

Page 8Chapter 2Employees' Pay

qualified sick and family leave wages in 2022 for leave taken after March 31, 2020, and be-fore October 1, 2021, are eligible to claim a credit for qualified sick and family leave wages in 2022. For more information about the credit for qualified sick and family leave wages, go to IRS.gov/PLC.

The COVID-19 related employee retention credit has expired. The employee retention credit enacted under the Coronavirus Aid, Re-lief, and Economic Security (CARES) Act and amended and extended by the Taxpayer Cer-tainty and Disaster Tax Relief Act of 2020 was limited to qualified wages paid after March 12, 2020, and before July 1, 2021. The employee retention credit under section 3134 of the Inter-nal Revenue Code, as enacted by the ARP and amended by the Infrastructure Investment and Jobs Act, was limited to wages paid after June 30, 2021, and before October 1, 2021, unless the employer was a recovery startup business. An employer that was a recovery startup busi-ness could also claim the employee retention credit for wages paid after September 30, 2021, and before January 1, 2022.

Credit for COBRA premium assistance pay-ments is limited to periods of coverage be-ginning on or after April 1, 2021, through periods of coverage beginning on or before September 30, 2021. Section 9501 of the ARP provides for COBRA premium assistance in the form of a full reduction in the premium otherwise payable by certain individuals and their families who elect COBRA continuation coverage due to a loss of coverage as the result of a reduction in hours or an involuntary termi-nation of employment (assistance eligible indi-viduals). This COBRA premium assistance is available for periods of coverage beginning on or after April 1, 2021, through periods of cover-age beginning on or before September 30, 2021. A premium payee is entitled to the CO-BRA premium assistance credit at the time an eligible individual elects coverage. Therefore, due to the COBRA notice and election period requirements (generally, employers have 60 days to provide notice and assistance eligible individuals have 60 days to elect coverage), some employers may be eligible to claim the COBRA premium assistance credit on employ-ment tax returns for the first quarter of 2022.

Advance payment of COVID-19 credits ended. Although you may pay qualified sick and family leave wages in 2022 for leave taken after March 31, 2020, and before October 1, 2021, or provide COBRA premium assistance payments in 2022, you may no longer request an advance payment of any credit on Form 7200, Advance Payment of Employer Credits Due to COVID-19.

Introduction

You can generally deduct the amount you pay your employees for the services they perform. The pay may be in cash, property, or services. It may include wages, salaries, bonuses, commis-sions, or other noncash compensation such as vacation allowances and fringe benefits. For in-formation about deducting employment taxes, see chapter 5.

You may be able to claim employment TIP credits, such as the credits listed be-low, if you meet certain requirements.

You must reduce your deduction for employee wages by the amount of employment credits that you claim. For more information about these credits, see the instructions for the form on which the credit is claimed.

Work opportunity credit (Form 5884).
Empowerment zone employment credit (Form 8844).

Credit for employer differential wage pay-ments (Form 8932).

Employer credit for paid family and medi-cal leave (Form 8994).

Topics

This chapter discusses:

Tests for deducting pay
Kinds of pay

Useful Items

You may want to see:

Publication

15Employer's Tax Guide

15-A Employer's Supplemental Tax Guide

15-B Employer's Tax Guide to Fringe

Benefits

Form (and Instructions) 1099-NEC Nonemployee Compensation W-2 Wage and Tax Statement

See chapter 12 for information about getting publications and forms.

Tests for Deducting Pay

To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. These and other requirements that apply to all business expen-ses are explained in chapter 1.

In addition, the pay must meet both of the following tests.

Test 1. It must be reasonable.
Test 2. It must be for services performed.

The form or method of figuring the pay doesn't affect its deductibility. For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible.

Test 1—Reasonableness

You must be able to prove that the pay is rea-sonable. Whether the pay is reasonable de-pends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. If the pay is excessive, the excess pay is disallowed as a deduction.

Factors to consider. Determine the reasona-bleness of pay by the facts and circumstances.

Generally, reasonable pay is the amount that a similar business would pay for the same or simi-lar services.

To determine if pay is reasonable, also con-sider the following items and any other pertinent facts.

The duties performed by the employee.
The volume of business handled.
The character and amount of responsibil-ity.

The complexities of your business.
The amount of time required.
The cost of living in the locality.
The ability and achievements of the indi-vidual employee performing the service.
The pay compared with the gross and net income of the business, as well as with dis-tributions to shareholders if the business is a corporation.

Your policy regarding pay for all your em-ployees.

The history of pay for each employee.

Compensation in excess of $1 million. Pub-licly held corporations can't deduct compensa-tion to a “covered employee” to the extent that the compensation for the tax year exceeds $1 million. For more information, including the defi-nition of a “covered employee,” see the Instruc-tions for Form 1125-E and Regulations section 1.162-33.

Test 2—For Services Performed

You must be able to prove the payment was made for services actually performed.

Employee-shareholder salaries. If a corpo-ration pays an employee who is also a share-holder a salary that is unreasonably high con-sidering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-share-holder. The excessive part of the salary wouldn't be allowed as a salary deduction by the corporation. For more information on corpo-rate distributions to shareholders, see Pub. 542.

Kinds of Pay

Some of the ways you may provide pay to your employees in addition to regular wages or salar-ies are discussed next. For specialized and de-tailed information on employees' pay and the employment tax treatment of employees' pay, see Pubs. 15, 15-A, and 15-B.

Awards

You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. If you give property to an em-ployee as an employee achievement award, your deduction may be limited.

Achievement awards. An achievement award is an item of tangible personal property that meets all the following requirements.

It is given to an employee for length of service or safety achievement.

It is awarded as part of a meaningful pre-sentation.

It is awarded under conditions and circum-stances that don't create a significant likeli-hood of disguised pay.

Tangible personal property. An award isn't an item of tangible personal property if it is an award of cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than ar-rangements granting only the right to select and receive tangible personal property from a limi-ted assortment of items preselected or preap-proved by you). Also, tangible personal prop-erty doesn't include vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

Length-of-service award. An award will qualify as a length-of-service award only if ei-ther of the following applies.

The employee receives the award after their first 5 years of employment.

The employee didn't receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years.

Safety achievement award. An award for safety achievement will qualify as an achieve-ment award unless one of the following applies.

1. It is given to a manager, administrator, clerical employee, or other professional employee.

2. During the tax year, more than 10% of your employees, excluding those listed in

(1), have already received a safety ach-ievement award (other than one of very small value).

Deduction limit. Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following.

$400 for awards that aren't qualified plan awards.

$1,600 for all awards, whether or not quali-fied plan awards.

A qualified plan award is an achievement award given as part of an established written plan or program that doesn't favor highly com-pensated employees as to eligibility or benefits.

A highly compensated employee is an em-ployee who meets either of the following tests.

1. The employee was a 5% owner at any time during the year or the preceding year.

2. The employee received more than $130,000 in pay for the preceding year.

You can choose to ignore test (2) if the em-ployee wasn't also in the top 20% of employees when ranked by pay for the preceding year.

An award isn't a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. To figure this average cost, ig-nore awards of nominal value.

Deduct achievement awards, up to the max-imum amounts listed earlier, as a nonwage business expense on your return or business schedule.

You may not owe employment taxes on TIP the value of some achievement awards you provide to an employee. See Pub.

15-B.

Bonuses

You can generally deduct a bonus paid to an employee if you intended the bonus as addi-tional pay for services, not as a gift, and the services were performed. However, the total bonuses, salaries, and other pay must be rea-sonable for the services performed. If the bonus is paid in property, see Property, later.

Gifts of nominal value. If, to promote em-ployee goodwill, you distribute merchandise of nominal value or other de minimis items to your employees at holidays, you can deduct the cost of these items as a nonwage business ex-pense. See Pub. 15-B for additional information on de minimis fringe benefits. If you provide food to your employees, your business deduc-tion may be limited; see Meals and lodging, later.

Education Expenses

If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assis-tance program. Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. For information on educational assistance programs, see Educational Assis-tance in section 2 of Pub. 15-B.

Section 2206 of the CARES Act ex-TIP pands the definition of educational as-sistance to include certain employer payments of student loans paid after March 27, 2020. The exclusion applies to the payment by an employer, whether paid to the employee or to a lender, of principal or interest on any quali-fied education loan incurred by the employee for the education of the employee. Qualified ed-ucation loans are defined in chapter 10 of Pub.

970. This exclusion expires January 1, 2026, unless extended by future legislation.

Fringe Benefits

A fringe benefit is a form of pay for the perform-ance of services. You can generally deduct the cost of fringe benefits.

You may be able to exclude all or part of the value of some fringe benefits from your employ-ees' pay. You also may not owe employment taxes on the value of the fringe benefits. See Table 2-1 in Pub. 15-B for details.

Generally, no deduction is allowed for activi-ties generally considered entertainment, amusement, or recreation, or for a facility used in connection with such activity. However, you may deduct these expenses if the goods, serv-ices, or facilities are treated as compensation to the recipient and reported on Form W-2 for an employee or on Form 1099-NEC for an inde-pendent contractor. If the recipient is an officer, director, beneficial owner (directly or indirectly), or other “specified individual” (as defined in

Chapter 2Employees' PayPage 9

section 274(e)(2)(B) and Regulations section 1.274-9(b)), special rules apply. See section 274(e)(2) and Regulations sections 1.274-9 and 1.274-10.

Certain fringe benefits are discussed next. See Pub. 15-B for more details on these and other fringe benefits.

Meals and lodging. Generally, you can de-duct 50% of certain meal expenses and 100% of certain lodging expenses provided to your employees. If the amounts are deductible, de-duct the cost in whatever category the expense falls.

Deduction limit on meals. You can gen-erally deduct only 50% of the cost of furnishing meals to your employees. However, you can deduct the full cost of certain meals; see sec-tion 274(n)(2) and Regulations section 1.274-12(c) for more information. For example, you can deduct the full cost of the following meals.

Meals whose value you include in an em-ployee's wages.

Meals you furnish to your employees as part of the expense of providing recrea-tional or social activities, such as holiday parties or annual picnics, when made pri-marily for the benefit of your employees other than employees who are officers, shareholders or other owners who own a 10% or greater interest in your business, or other highly compensated employees.

Meals you furnish to your employees at the work site when you operate a restaurant or catering service.
Meals you’re required by federal law to fur-nish to crew members of certain commer-cial vessels (or would be required to fur-nish if the vessels were operated at sea). This doesn't include meals you furnish on vessels primarily providing luxury water transportation.

Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. This includes meals you furnish at a sup-port camp that is near and integral to an oil or gas drilling rig located in Alaska.

P.L. 115-97, Tax Cuts and Jobs Act,

changed the rules for the deduction of CAUTION food or beverage expenses that are ex-cludable from employee income as a de mini-mis fringe benefit. For amounts incurred or paid after 2017, the 50% limit on deductions for food or beverage expenses also applies to food or beverage expenses excludable from employee income as a de minimis fringe benefit. While your business deduction may be limited, the rules that allow you to exclude certain de mini-mis meals and meals on your business prem-ises from your employee's wages still apply. See Meals in section 2 of Pub. 15-B.

Food and beverage expense incurred to-gether with entertainment expenses. P.L. 115-97 changed the rules for the deduction of business entertainment expenses. For amounts incurred or paid after 2017, no business deduc-tion is allowed for any item generally consid-ered to be entertainment, amusement, or recre-ation. As discussed earlier, you can deduct 50% of the cost of business meals. If food and

Page 10Chapter 2Employees' Pay

beverages are provided during or at an enter-tainment activity, and the food and beverages are purchased separately from the entertain-ment, or the cost of the food and beverages is stated separately from the cost of the entertain-ment on one or more bills, invoices, or receipts, you may continue to deduct 50% of the busi-ness meal expenses. The amount charged for food or beverages on a bill, invoice, or receipt must reflect the venue's usual selling cost for those items if they were to be purchased sepa-rately from the entertainment or must approxi-mate the reasonable value of those items. If you purchase food and beverages together with en-tertainment expenses and the cost of the food and beverages isn't stated separately on the in-voice, the cost of the food and beverages is also an entertainment expense and none of the expenses are deductible. For more information, including details about additional requirements that must be met for a business meal to be de-ductible, see Regulations sections 1.274-11 and 1.274-12(a).

Section 210 of the Taxpayer Certainty TIP and Disaster Tax Relief Act of 2020 provides for the temporary allowance of a 100% business meal deduction for food or

beverages provided by a restaurant and paid or incurred after December 31, 2020, and before January 1, 2023. For more information, see No-tice 2021-25, 2021-17 I.R.B. 1118, available at IRS.gov/irb/2021-17_IRB#NOT-2021-25; and Notice 2021-63, 2021-49 I.R.B. 835, available at IRS.gov/irb/2021-49_IRB#NOT-2021-63.

Transportation (commuting) benefits. If you provide your employees with qualified transportation benefits, such as transportation in a commuter highway vehicle, transit passes, or qualified parking, you may no longer deduct these amounts. P.L. 115-97 provides that no deduction is allowed for qualified transportation benefits (whether provided directly by you, through a bona fide reimbursement arrange-ment, or through a compensation reduction agreement) incurred or paid after 2017. Also, no deduction is allowed for any expense incur-red for providing any transportation, or any pay-ment or reimbursement to your employee, in connection with travel between your employee's residence and place of employment, except as necessary for ensuring the safety of your em-ployee or for qualified bicycle commuting reim-bursements as described in section 132(f)(5)

(F). While you may no longer deduct payments for qualified transportation benefits, the fringe benefit exclusion rules still apply and the pay-ments, except for qualified bicycle commuting reimbursements, may be excluded from your employee's wages. Although the value of a qualified transportation fringe benefit is relevant in determining the fringe benefit exclusion and whether the section 274(e)(2) exception for ex-penses treated as compensation applies, the deduction that is disallowed relates to the ex-pense of providing a qualified transportation fringe, not its value. For more information, see Regulations sections 1.274-13 and 1.274-14. See Pub. 15-B for more information about quali-fied transportation benefits.

Employee benefit programs. Employee ben-efit programs include the following.

Accident and health plans.
Adoption assistance.
Cafeteria plans.
Dependent care assistance.
Education assistance.
Life insurance coverage.
Welfare benefit funds.

You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. For example, if you provide dependent care by operating a dependent care facility for your employees, de-duct your costs in whatever categories they fall (utilities, salaries, etc.).

Life insurance coverage. You can't de-duct the cost of life insurance coverage for you, an employee, or any person with a financial in-terest in your business if you’re directly or indi-rectly the beneficiary of the policy. See Regula-tions section 1.264-1 for more information.

Welfare benefit funds. A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent con-tractors, or their beneficiaries. Welfare benefits are any benefits other than deferred compensa-tion or transfers of restricted property.

Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. If your contributions to the fund are more than its qualified cost, carry the ex-cess over to the next tax year.

Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund.

The cost you would’ve been able to deduct using the cash method of accounting if you had paid for the benefits directly.

The contributions added to a reserve ac-count that are needed to fund claims incur-red but not paid as of the end of the year. These claims can be for supplemental un-employment benefits, severance pay, or disability, medical, or life insurance bene-fits.

For more information, see sections 419(c) and 419A and the related regulations.

Loans or Advances

You can generally deduct as wages an advance you make to an employee for services to be performed if you don't expect the employee to repay the advance. However, if the employee performs no services, treat the amount you ad-vanced as a loan; if the employee doesn't repay the loan, treat it as income to the employee.

Below-market interest rate loans. On cer-tain loans you make to an employee or share-holder, you’re treated as having received inter-est income and as having paid compensation or dividends equal to that interest. See Be-low-Market Loans in chapter 4.

Property

If you transfer property (including your compa-ny's stock) to an employee as payment for serv-ices, you can generally deduct it as wages. The amount you can deduct is the property's fair market value (FMV) on the date of the transfer less any amount the employee paid for the property.

You can claim the deduction only for the tax year in which your employee includes the prop-erty's value in their income. Your employee is deemed to have included the value in their in-come if you report it on their Form W-2 in a timely manner.

You treat the deductible amount as received in exchange for the property, and you must rec-ognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Your gain or loss is the difference between the FMV of the property and its adjusted basis on the date of transfer.

These rules also apply to property transfer-red to an independent contractor for services, generally reported on Form 1099-NEC.

Restricted property. If the property you transfer for services is subject to restrictions that affect its value, you generally can't deduct it and don't report gain or loss until it is substan-tially vested in the recipient. However, if the re-cipient pays for the property, you must report any gain at the time of the transfer up to the amount paid.

“Substantially vested” means the property isn't subject to a substantial risk of forfeiture. This means that the recipient isn't likely to have to give up their rights in the property in the fu-ture.

Reimbursements for

Business Expenses

You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. However, your de-duction may be limited.

If you make the payment under an account-able plan, deduct it in the category of the ex-pense paid. For example, if you pay an em-ployee for travel expenses incurred on your behalf, deduct this payment as a travel ex-pense. If you make the payment under a nonac-countable plan, deduct it as wages and include it on the employee's Form W-2.

See Reimbursement of Travel and Non-En-tertainment Related Meals in chapter 11 for more information about deducting reimburse-ments and an explanation of accountable and nonaccountable plans.

Sick and Vacation Pay

Sick pay. You can deduct amounts you pay to your employees for sickness and injury, includ-ing lump-sum amounts, as wages. However, your deduction is limited to amounts not com-pensated by insurance or other means.

Vacation pay. Vacation pay is an employee benefit. It includes amounts paid for unused va-

cation leave. You can deduct vacation pay only in the tax year in which the employee actually receives it. This rule applies regardless of whether you use the cash or accrual method of accounting.

3.

Rent Expense

Introduction

This chapter discusses the tax treatment of rent or lease payments you make for property you use in your business but do not own. It also dis-cusses how to treat other kinds of payments you make that are related to your use of this property. These include payments you make for taxes on the property.

Topics

This chapter discusses:

The definition of rent
Taxes on leased property
The cost of getting a lease
Improvements by the lessee
Capitalizing rent expenses

Useful Items

You may want to see:

Publication

538 Accounting Periods and Methods

544 Sales and Other Dispositions of Assets

946 How To Depreciate Property

See chapter 12 for information about getting publications and forms.

Rent

Rent is any amount you pay for the use of prop-erty you do not own. In general, you can deduct rent as an expense only if the rent is for prop-erty you use in your trade or business. If you have or will receive equity in or title to the prop-erty, the rent is not deductible.

Unreasonable rent. You can’t take a rental deduction for unreasonable rent. Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Rent isn’t unreasonable just because it is figured as a percentage of gross sales. For examples of related persons, see Related per-sons in chapter 2 of Pub. 544.

Rent on your home. If you rent your home and use part of it as your place of business, you

may be able to deduct the rent you pay for that part. You must meet the requirements for busi-ness use of your home. For more information, see Business use of your home in chapter 1.

Rent paid in advance. Generally, rent paid for use of property in your trade or business is de-ductible in the year paid or incurred. If you are an accrual method taxpayer and pay rent in ad-vance, you can deduct only the amount of rent that applies to your use of rented property dur-ing the tax year. You can deduct the rest of the rent payment only over the period to which it applies. If you are a cash method taxpayer, you may deduct the entire amount of rent you paid in advance in the year of payment if the pay-ment applies to the right to use property that does not extend beyond the earlier of 12 months after the first date you have the right to use the property or the end of the tax year fol-lowing the year in which you paid the advance rent. If your payment applies to the right to use property beyond this period, then you must cap-italize the rent payment and deduct it over the period to which it applies.

Example 1. You are an accrual method calendar year taxpayer and you lease a building at a monthly rental rate of $1,000 beginning July 1, 2022. On June 30, 2022, you pay ad-vance rent of $12,000 for the last 6 months of 2022 and the first 6 months of 2023. You can deduct only $6,000 for 2022, for the right to use property in 2022. You deduct the other $6,000 in 2023.

Example 2. Assume the same facts as Ex-ample 1, except you are a cash method calen-dar year taxpayer. You may deduct the entire $12,000 payment for 2022. The payment ap-plies to your right to use the property that does not extend beyond 12 months after the date you received this right. If you deduct the $12,000 in 2022, you should not deduct any part of this payment in 2023.

Example 3. You are either a cash or ac-crual calendar year taxpayer. Last January, you leased property for 3 years for $6,000 per year. You pay the full $18,000 (3 x $6,000) during the first year of the lease. Because this amount is a prepaid expense that must be capitalized, you can deduct only $6,000 per year, the amount al-locable to your use of the property in each year.

Canceling a lease. You can generally deduct as rent an amount you pay to cancel a business lease.

Lease or purchase. There may be instances in which you must determine whether your pay-ments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales con-tract. Payments made under a conditional sales contract are not deductible as rent expense.

Conditional sales contract. Whether an agreement is a conditional sales contract de-pends on the intent of the parties. Determine in-tent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies. However, in general, an agreement may be

Chapter 3Rent ExpensePage 11

considered a conditional sales contract rather than a lease if any of the following is true.

The agreement applies part of each pay-ment toward an equity interest you will re-ceive.
You get title to the property after you make a stated amount of required payments.
The amount you must pay to use the prop-erty for a short time is a large part of the amount you would pay to get title to the property.

You pay much more than the current fair rental value of the property.

You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the op-tion. Determine this value when you make the agreement.

You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agree-ment.

The agreement designates part of the pay-ments as interest, or that part is easy to recognize as interest.

Leveraged leases. Leveraged lease trans-actions may not be considered leases. Lever-aged leases generally involve three parties: a lessor, a lessee, and a lender to the lessor. Usually, the lease term covers a large part of the useful life of the leased property, and the lessee's payments to the lessor are enough to cover the lessor's payments to the lender.

If you plan to take part in what appears to be a leveraged lease, you may want to get an ad-vance ruling.

Revenue Procedure 2001-28 contains the guidelines the IRS will use to determine if a leveraged lease is a lease for federal in-come tax purposes.

Revenue Procedure 2001-29 provides the information required to be furnished in a request for an advance ruling on a lever-aged lease transaction.

These two revenue procedures can be found in I.R.B. 2001-19, which is available at IRS.gov/pub/irs-irbs/irb01-19.pdf.

For advance ruling purposes only, the IRS will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction to be a valid lease if all the fac-tors in the revenue procedure are met, including the following.

The lessor must maintain a minimum un-conditional “at risk” equity investment in the property (at least 20% of the cost of the property) during the entire lease term.

The lessee may not have a contractual right to buy the property from the lessor at less than FMV when the right is exercised.

The lessee may not invest in the property, except as provided by Revenue Procedure 2001-28.
The lessee may not lend any money to the lessor to buy the property or guarantee the loan used by the lessor to buy the prop-erty.

The lessor must show that it expects to re-ceive a profit apart from the tax deduc-tions, allowances, credits, and other tax at-tributes.

Page 12Chapter 3Rent Expense

The IRS may charge you a user fee for issu-ing a tax ruling. For more information, see Rev-enue Procedure 2022-1, available at IRS.gov/irb/2022-01_IRB#REV-PROC-2022-1.

Leveraged leases of limited-use prop-erty. The IRS won’t issue advance rulings on leveraged leases of so-called limited-use prop-erty. Limited-use property is property not ex-pected to be either useful to or usable by a les-sor at the end of the lease term except for continued leasing or transfer to a lessee. See Revenue Procedure 2001-28 for examples of limited-use property and property that isn’t limi-ted-use property.

Leases over $250,000. Special rules are pro-vided for certain leases of tangible property. The rules apply if the lease calls for total pay-ments of more than $250,000 and any of the fol-lowing apply.

Rents increase during the lease.
Rents decrease during the lease.
Rents are deferred (rent is payable after the end of the calendar year following the calendar year in which the use occurs and the rent is allocated).

Rents are prepaid (rent is payable before the end of the calendar year preceding the calendar year in which the use occurs and the rent is allocated).

These rules do not apply if your lease specifies equal amounts of rent for each month in the lease term and all rent payments are due in the calendar year to which the rent relates (or in the preceding or following calendar year).

Generally, if the special rules apply, you must use an accrual method of accounting (and time value of money principles) for your rental expenses, regardless of your overall method of accounting. In addition, in certain cases in which the IRS has determined that a lease was designed to achieve tax avoidance, you must take rent and stated or imputed interest into ac-count under a constant rental accrual method in which the rent is treated as accruing ratably over the entire lease term. For details, see sec-tion 467.

Taxes on Leased Property

If you lease business property, you can deduct as additional rent any taxes you have to pay to or for the lessor. When you can deduct these taxes as additional rent depends on your ac-counting method.

Cash method. If you use the cash method of accounting, you can deduct the taxes as addi-tional rent only for the tax year in which you pay them.

Accrual method. If you use an accrual method of accounting, you can deduct the taxes as additional rent for the tax year in which you can determine all the following.

That you have a liability for taxes on the leased property.

How much the liability is.
That economic performance occurred.

The liability and amount of taxes are deter-mined by state or local law and the lease agree-ment. Economic performance occurs as you use the property.

Example 1. Oak Corporation is a calendar year taxpayer that uses an accrual method of accounting. Oak leases land for use in its busi-ness. Under state law, owners of real property become liable (incur a lien on the property) for real estate taxes for the year on January 1 of that year. However, they don’t have to pay these taxes until July 1 of the next year (18 months later) when tax bills are issued. Under the terms of the lease, Oak becomes liable for the real estate taxes in the later year when the tax bills are issued. If the lease ends before the tax bill for a year is issued, Oak isn’t liable for the taxes for that year.

Oak cannot deduct the real estate taxes as rent until the tax bill is issued. This is when Oak's liability under the lease becomes fixed.

Example 2. The facts are the same as in Example 1, except that, according to the terms of the lease, Oak becomes liable for the real es-tate taxes when the owner of the property be-comes liable for them. As a result, Oak will de-duct the real estate taxes as rent on its tax return for the earlier year. This is the year in which Oak's liability under the lease becomes fixed.

Cost of Getting a Lease

You may either enter into a new lease with the lessor of the property or get an existing lease from another lessee. Very often when you get an existing lease from another lessee, you must pay the previous lessee money to get the lease, besides having to pay the rent on the lease.

If you get an existing lease on property or equipment for your business, you must gener-ally amortize any amount you pay to get that lease over the remaining term of the lease. For example, if you pay $10,000 to get a lease and there are 10 years remaining on the lease with no option to renew, you can deduct $1,000 each year.

The cost of getting an existing lease of tan-gible property is not subject to the amortization rules for section 197 intangibles discussed in chapter 8.

Option to renew. The term of the lease for amortization includes all renewal options plus any other period for which you and the lessor reasonably expect the lease to be renewed. However, this applies only if less than 75% of the cost of getting the lease is for the term re-maining on the purchase date (not including any period for which you may choose to renew, extend, or continue the lease). Allocate the lease cost to the original term and any option term based on the facts and circumstances. In some cases, it may be appropriate to make the allocation using a present value calculation. For more information, see Regulations section 1.178-1(b)(5).

Example 1. You paid $10,000 to get a lease with 20 years remaining on it and two op-tions to renew for 5 years each. Of this cost, you paid $7,000 for the original lease and $3,000 for the renewal options. Because $7,000 is less than 75% of the total $10,000 cost of the lease (or $7,500), you must amortize the $10,000 over 30 years. That is the remain-ing life of your present lease plus the periods for renewal.

Example 2. The facts are the same as in Example 1, except that you paid $8,000 for the original lease and $2,000 for the renewal op-tions. You can amortize the entire $10,000 over the 20-year remaining life of the original lease. The $8,000 cost of getting the original lease was not less than 75% of the total cost of the lease (or $7,500).

Cost of a modification agreement. You may have to pay an additional “rent” amount over part of the lease period to change certain provi-sions in your lease. You must capitalize these payments and amortize them over the remain-ing period of the lease. You can’t deduct the payments as additional rent, even if they are described as rent in the agreement.

Example. You are a calendar year tax-payer and sign a 20-year lease to rent part of a building starting on January 1. However, before you occupy it, you decide that you really need less space. The lessor agrees to reduce your rent from $7,000 to $6,000 per year and to re-lease the excess space from the original lease. In exchange, you agree to pay an additional rent amount of $3,000, payable in 60 monthly installments of $50 each.

You must capitalize the $3,000 and amortize it over the 20-year term of the lease. Your amor-tization deduction each year will be $150 ($3,000 ÷ 20). You can’t deduct the $600 (12 × $50) that you will pay during each of the first 5 years as rent.

Commissions, bonuses, and fees. Commis-sions, bonuses, fees, and other amounts you pay to get a lease on property you use in your business are capital costs. You must amortize these costs over the term of the lease.

Loss on merchandise and fixtures. If you sell at a loss merchandise and fixtures that you bought solely to get a lease, the loss is a cost of getting the lease. You must capitalize the loss and amortize it over the remaining term of the lease.

Improvements by Lessee

If you add buildings or make other permanent improvements to leased property, depreciate the cost of the improvements using the modified accelerated cost recovery system (MACRS). Depreciate the property over its appropriate re-covery period. You can’t amortize the cost over the remaining term of the lease.

If you don’t keep the improvements when you end the lease, figure your gain or loss

based on your adjusted basis in the improve-ments at that time.

For more information, see the discussion of MACRS in chapter 4 of Pub. 946.

Assignment of a lease. If a long-term lessee who makes permanent improvements to land later assigns all lease rights to you for money and you pay the rent required by the lease, the amount you pay for the assignment is a capital investment. If the rental value of the leased land increased since the lease began, part of your capital investment is for that increase in the rental value. The rest is for your investment in the permanent improvements.

The part that is for the increased rental value of the land is a cost of getting a lease, and you amortize it over the remaining term of the lease. You can depreciate the part that is for your in-vestment in the improvements over the recov-ery period of the property as discussed earlier, without regard to the lease term.

Capitalizing Rent Expenses

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indi-rect costs for certain production or resale activi-ties. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You re-cover the costs through depreciation, amortiza-tion, or cost of goods sold when you use, sell, or otherwise dispose of the property.

Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land.

Uniform capitalization rules. You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.

1. Produce real property or tangible personal property.

2. Acquire property for resale. However, this rule does not apply to personal property if your average annual gross receipts are $27 million or less.

Effective for tax years beginning after 2017, if you are a small business taxpayer (see Cost of Goods Sold in chapter 1), you are not re-quired to capitalize costs under section 263A. See section 263A(i).

Producing property. You produce prop-erty if you construct, build, install, manufacture, develop, improve, create, raise, or grow the property. Property produced for you under a contract is treated as produced by you to the extent you make payments or otherwise incur costs in connection with the property.

Example 1. You rent construction equip-ment to build a storage facility. If you are sub-ject to the uniform capitalization rules, you must capitalize as part of the cost of the building the rent you paid for the equipment. You recover your cost by claiming a deduction for depreciation on the building.

Example 2. You rent space in a facility to conduct your business of manufacturing tools. If you are subject to the uniform capitalization rules, you must include the rent you paid to oc-cupy the facility in the cost of the tools you pro-duce.

More information. For exceptions and more information on these rules, see Uniform Capital-ization Rules in Pub. 538 and the regulations under section 263A.

4.

Interest

Introduction

This chapter discusses the tax treatment of business interest expense. Business interest expense is an amount charged for the use of money you borrowed for business activities.

Topics

This chapter discusses:

Allocation of interest
Interest expense limitation
Interest you can deduct
Interest you cannot deduct
Capitalization of interest
When to deduct interest
Below-market loans

Useful Items

You may want to see:

Publication

537 Installment Sales

550 Investment Income and Expenses

936 Home Mortgage Interest Deduction

Form (and Instructions)

Schedule A (Form 1040) Itemized

Deductions

Schedule E (Form 1040) Supplemental Income and Loss

Schedule K-1 (Form 1065) Partner's

Share of Income,

Deductions, Credits, etc.

Schedule K-1 (Form 1120-S) Shareholder's Share of Income, Deductions, Credits, etc.

1098 Mortgage Interest Statement

3115 Application for Change in Accounting Method

4952 Investment Interest Expense Deduction

8582 Passive Activity Loss Limitations Chapter 4 Interest Page 13

8990 Limitation on Business Interest Expense Under Section 163(j)

See chapter 12 for information about getting publications and forms.

Allocation of Interest

The rules for deducting interest vary, depending on whether the loan proceeds are used for busi-ness, personal, or investment activities. If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds.

Allocate your interest expense to the follow-ing categories.

Nonpassive trade or business activity inter-est.

Passive trade or business activity interest.
Investment interest.
Portfolio interest.
Personal interest.

In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disburse-ments to specific uses.

The easiest way to trace disburse-TIP ments to specific uses is to keep the proceeds of a particular loan separate

from any other funds.

Secured loan. The allocation of loan proceeds and the related interest is generally not affected by the use of property that secures the loan.

Example. Marge and Jeff secure a loan with property used in their business. They use the loan proceeds to buy an automobile for per-sonal use. Jeff and Marge must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is se-cured by business property.

P.L. 115-97, section 11043, limited the

deduction for mortgage interest paid on CAUTION home equity loans and line of credit. For more information, see Pub. 936.

Allocation period. The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates.

The date the loan is repaid.
The date the loan is reallocated to another use.

Proceeds not disbursed to borrower. Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. This applies whether you pay for property, services, or any-thing else by incurring a loan, or you take prop-erty subject to a debt.

Proceeds deposited in borrower's account. Treat loan proceeds deposited in an account as property held for investment. It does not matter whether the account pays interest. Any interest you pay on the loan is investment interest ex-pense. If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds.

Page 14Chapter 4Interest

Example. Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immedi-ately uses the proceeds to open a checking ac-count. No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. On Septem-ber 4, Celina uses an additional $40,000 from the account for personal purposes.

Under the interest allocation rules, the entire $100,000 loan is treated as property held for in-vestment for the period from January 4 through April 1. From April 2 through September 3, Cel-ina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. From September 4 through December 31, she must treat $40,000 of the loan as used for personal purpo-ses, $20,000 as used in the passive activity, and $40,000 as property held for investment.

Order of funds spent. Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts.

Any unborrowed amounts held in the same account.

Any amounts deposited after these loan proceeds.

Example. On January 9, Olena opened a checking account, depositing $500 of the pro-ceeds of Loan A and $1,000 of unborrowed funds. The following table shows the transac-tions in her account during the tax year.

Date		Transaction

January 9	$500 proceeds of Loan A and
	$1,000 unborrowed funds
	deposited
January 14	$500 proceeds of Loan B
	deposited
February 19	$800 used for personal purposes
February 27	$700 used for passive activity
June 19	$1,000 proceeds of Loan C
	deposited
November 20	$800 used for an investment
December 18	$600 used for personal purposes

Olena treats the $800 used for personal pur-poses as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. She treats the $800 used for an investment as made entirely from the proceeds of Loan C. She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds.

For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment.

Payments from checking accounts. Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. You can treat checks written on the same day as written in any order.

Amounts paid within 30 days. If you re-ceive loan proceeds in cash or if the loan pro-ceeds are deposited in an account, you can treat any payment (up to the amount of the pro-ceeds) made from any account you own, or from cash, as made from those proceeds. This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account.

If the loan proceeds are deposited in an ac-count, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated earlier under Order of funds spent.

If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment.

Example. Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Giovanni deposits $1,500 in an account on Au-gust 8 and on August 18 writes a check on the account for a passive activity expense. Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Regardless of these other trans-actions, Giovanni can treat $1,000 of the de-posit he made on August 8 as being paid on Au-gust 4 from the loan proceeds. In addition, Giovanni can treat the passive activity expense he paid on August 18 as made from the $1,000 loan proceeds treated as deposited in the ac-count.

Optional method for determining date of reallocation. You can use the following method to determine the date loan proceeds are reallocated to another use. You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates.

The first day of that month.
The date the loan proceeds are deposited in the account.

However, you can use this optional method only if you treat all payments from the account dur-ing the same calendar month in the same way.

Interest on a segregated account. If you have an account that contains only loan pro-ceeds and interest earned on the account, you can treat any payment from that account as be-ing made first from the interest. When the inter-est earned is used up, any remaining payments are from loan proceeds.

Example. You borrowed $20,000 and used the proceeds of this loan to open a new savings account. When the account had earned interest of $867, you withdrew $20,000 for personal pur-poses. You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). All the interest charged on the loan from the time it was depos-ited in the account until the time of the with-drawal is investment interest expense. The in-terest charged on the part of the proceeds used for personal purposes ($19,133) from the time

you withdrew it until you either repay it or reallo-cate it to another use is personal interest ex-pense. The interest charged on the loan pro-ceeds you left in the account ($867) continues to be investment interest expense until you ei-ther repay it or reallocate it to another use.

Loan repayment. When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order.

1. Personal use.

2. Investments and passive activities (other than those included in (3)).

3. Passive activities in connection with a rental real estate activity in which you ac-tively participate.

4. Former passive activities.

5. Trade or business use and expenses for certain low-income housing projects.

Line of credit (continuous borrowings). The following rules apply if you have a line of credit or similar arrangement.

1. Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan.

2. Treat borrowed funds or parts of borrowed funds on which interest accrues at differ-ent fixed or variable rates as different loans. Treat these loans as repaid in the order shown on the loan agreement.

Loan refinancing. Allocate the replacement loan to the same uses to which the repaid loan was allocated. Make this allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan.

Debt-financed distribution. A debt -financed distribution occurs when a partnership or S cor-poration borrows funds and allocates those funds to distributions made to partners or shareholders. The manner in which you report the interest expense associated with the distrib-uted debt proceeds depends on your use of those proceeds.

How to report. If the proceeds were used in a nonpassive trade or business activity, re-port the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (i). If the proceeds were used in a passive activity, follow the In-structions for Form 8582 to determine the amount of interest expense that can be repor-ted on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partner-ship in column (a) and the amount in column

(g). If the proceeds were used in an investment activity, enter the interest on Form 4952. If the proceeds are used for personal purposes, the interest is generally not deductible.

Interest Expense Limitation

You must generally limit business interest ex-pense you pay or accrue during the tax year, unless an exception to the limitation is met.

The business interest expense deduction al-lowed for a tax year is generally limited to the sum of:

1. Business interest income,

2. 30% of the adjustable taxable income, and

3. Floor plan financing interest.

If the section 163(j) limitation applies, gener-ally the amount of any business interest ex-pense that is not allowed as a deduction under section 163(j) for the tax year is carried forward to the following year as a disallowed business interest expense carryforward. See the Instruc-tions for Form 8990, Limitation on Business In-terest Expense Under Section 163(j), for more information.

Interest You Can Deduct

Your trade or business interest expense may be limited. See the Instructions for Form 8990 for more information. Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. It does not matter what type of property secures the loan. You can deduct interest on a debt only if you meet all the following requirements.

You are legally liable for that debt.
Both you and the lender intend that the debt be repaid.

You and the lender have a true debtor– creditor relationship.

Partial liability. If you are liable for part of a business debt, only your share of the total inter-est paid or accrued is included in your interest limitation calculation.

Example. You and your sibling borrow money. You are liable for 50% of the note. You use your half of the loan in your business, and you make one-half of the loan payments. Your business interest is half of the total interest pay-ments. However, the current year interest ex-pense deduction may be limited.

Mortgage. Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as ex-plained later under Capitalization of Interest.

Statement. If you paid $600 or more of mortgage interest (including certain points) dur-ing the year on any one mortgage, you will gen-erally receive a Form 1098 or a similar state-ment. You will receive the statement if you pay interest to a person (including a financial institu-tion or a cooperative housing corporation) in the course of that person's trade or business. A governmental unit is a person for purposes of furnishing the statement.

If you receive a refund of interest you over-paid in an earlier year, this amount will be repor-ted in box 4 of Form 1098. You cannot deduct this amount. For information on how to report this refund, see Refunds of interest, later, in this chapter.

Expenses paid to obtain a mortgage. Certain expenses you pay to obtain a mortgage cannot be deducted as interest. These expen-ses, which include mortgage commissions, ab-stract fees, and recording fees, are capital ex-penses. If the property mortgaged is business or income-producing property, you can amor-tize the costs over the life of the mortgage.

Prepayment penalty. If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as inter-est.

Interest on employment tax deficiency. In-terest charged on employment taxes assessed on your business is deductible.

Original issue discount (OID). OID is a form of interest. A loan (mortgage or other debt) gen-erally has OID when its proceeds are less than its principal amount. The OID is the difference between the stated redemption price at maturity and the issue price of the loan.

A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated inter-est. Qualified stated interest is stated interest that is unconditionally payable in cash or prop-erty (other than another loan of the issuer) at least annually over the term of the loan at a sin-gle fixed rate.

You generally deduct OID over the term of the loan. Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis.

De minimis OID. The OID is de minimis if it is less than one-fourth of 1% (0.0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan).

If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year.

On a constant-yield basis over the term of the loan.

On a straight-line basis over the term of the loan.

In proportion to stated interest payments.
In its entirety at maturity of the loan.

You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued.

Example. On January 1, 2022, you took out a $100,000 discounted loan and received $98,500 in proceeds. The loan will mature on January 1, 2032 (a 10-year term), and the $100,000 principal is payable on that date. In-terest of $10,000 is payable on January 1 of each year, beginning January 1, 2023. The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × 0.0025 × 10). You choose to deduct the OID on a straight-line

Chapter 4InterestPage 15

basis over the term of the loan. Beginning in 2022, you can deduct $150 each year for 10 years.

Constant-yield method. If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. You figure your deduction for the first year using the following steps.

1. Determine the issue price of the loan. Generally, this equals the proceeds of the loan. If you paid points on the loan (as dis-cussed later), the issue price is generally the difference between the proceeds and the points.

2. Multiply the result in (1) by the yield to ma-turity.

3. Subtract any qualified stated interest pay-ments from the result in (2). This is the OID you can deduct in the first year.

To figure your deduction in any subsequent year, follow the steps above, except determine the adjusted issue price in step 1. To get the adjusted issue price, add to the issue price any OID previously deducted. Then follow steps 2 and 3 above.

The yield to maturity is generally shown in the literature you receive from your lender. If you do not have this information, consult your lender or tax advisor. In general, the yield to maturity is the discount rate that, when used in figuring the present value of all principal and in-terest payments, produces an amount equal to the principal amount of the loan.

Example. The facts are the same as in the previous example, except that you deduct the OID on a constant-yield basis over the term of the loan. The yield to maturity on your loan is 10.2467%, compounded annually. For 2022, you can deduct $93 [($98,500 × 0.102467) − $10,000]. For 2023, you can deduct $103 [($98,593 × 0.102467) − $10,000].

Loan or mortgage ends. If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event.

If you refinance with the original lender,

you generally cannot deduct the re-CAUTION maining OID in the year in which the re-financing occurs, but you may be able to deduct it over the term of the new mortgage or loan. See Interest paid with funds borrowed from original lender under Interest You Cannot De-duct, later.

Points. The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges, discount points, or pre-mium charges. If any of these charges (points) are solely for the use of money, they are inter-est.

Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. However, you can choose to fully de-duct points in the year paid if you meet certain

Page 16Chapter 4Interest

tests. For exceptions to the general rule, see Pub. 936.

The points reduce the issue price of the loan and result in OID, deductible as explained in the preceding discussion.

Partial payments on a nontax debt. If you make partial payments on a debt (other than a debt owed to the IRS), the payments are ap-plied, in general, first to interest and any re-mainder to principal. You can deduct only the interest. This rule does not apply when it can be inferred that the borrower and lender under-stood that a different allocation of the payments would be made.

Installment purchase. If you make an install-ment purchase of business property, the con-tract between you and the seller generally pro-vides for the payment of interest. If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be re-characterized as interest (unstated interest). The amount recharacterized as interest reduces your basis in the property and increases your interest expense. For more information on in-stallment sales and unstated interest, see Pub. 537.

Interest You Cannot Deduct

Certain interest payments cannot be deducted. In addition, certain other expenses that may seem to be interest, but are not, cannot be de-ducted as interest.

You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest.

Interest paid with funds borrowed from original lender. If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. You can deduct the interest expense once you start making payments on the new loan.

When you make a payment on the new loan, you first apply the payment to interest and then to the principal. All amounts you apply to the in-terest on the first loan are deductible, along with any interest you pay on the second loan, sub-ject to any limits that apply.

Capitalized interest. You cannot currently de-duct interest you are required to capitalize un-der the uniform capitalization rules. See Capi-talization of Interest, later. In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Add this interest to the basis of the property.

Commitment fees or standby charges. Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. You may be able to deduct them as business expenses.

If the funds are for inventory or certain prop-erty used in your business, the fees are indirect costs and you must generally capitalize them under the uniform capitalization rules. See Cap-italization of Interest, later.

Interest on income tax. Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Treat this interest as a business deduction only in figuring a net operat-ing loss deduction.

Penalties. Penalties on underpaid deficien-cies and underpaid estimated tax are not inter-est. You cannot deduct them. Generally, you cannot deduct any fines or penalties.

Interest on loans with respect to life insur-ance policies. You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person.

If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. However, the deduction for any month cannot be more than the interest fig-ured using Moody's Composite Yield on Seas-oned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Aver-age—Monthly Average Corporates) (Moody's rate) for that month.

Who is a key person? A “key person” is an officer or 20% owner. However, the number of individuals you can treat as key persons is limited to the greater of the following.

Five individuals.
The lesser of 5% of the total officers and employees of the company or 20 individu-als.

Exceptions for pre-June 1997 contracts. You can generally deduct the interest if the con-tract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially inter-ested in your business. If the contract was pur-chased before June 21, 1986, you can gener-ally deduct the interest no matter who is covered by the contract.

Interest allocated to unborrowed policy cash value. Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life in-surance, annuity, or endowment contracts. This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. For more in-formation, see section 264(f).

Capitalization of Interest

Under the uniform capitalization rules, you must generally capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. The property must be produced by you for use in your trade or business or for sale to customers. You can-not capitalize interest related to property that you acquire in any other manner.

Interest you paid or incurred during the pro-duction period must be capitalized if the prop-erty produced is designated property. Designa-ted property is any of the following.

Real property.
Tangible personal property with a class life of 20 years or more.

Tangible personal property with an estima-ted production period of more than 2 years.
Tangible personal property with an estima-ted production period of more than 1 year if the estimated cost of production is more than $1 million.

Property you produce. You produce property if you construct, build, install, manufacture, de-velop, improve, create, raise, or grow it. Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property.

Carrying charges. Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more infor-mation, see chapter 7.

Capitalized interest. Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the property. If the property is inventory, recover capitalized interest through cost of goods sold. If the prop-erty is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method.

Partnerships and S corporations. The inter-est capitalization rules are applied first at the partnership or S corporation level. The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corpora-tion has insufficient debt to support the produc-tion or construction costs.

If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the part-nership or S corporation. You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation.

Additional information. The procedures for applying the uniform capitalization rules are be-yond the scope of this publication. For more in-formation, see Regulations sections 1.263A-8 through 1.263A-15 and Notice 88-99, which is in Cumulative Bulletin 1988-2.

When To Deduct Interest

If the uniform capitalization rules, discussed un-der Capitalization of Interest, earlier, and the business interest expense deduction limitation rules discussed under Interest Expense Limita-tion, earlier, do not apply, deduct interest as fol-lows.

Cash method. Under the cash method, you can generally deduct only the interest you ac-tually paid during the tax year. You cannot de-duct a promissory note you gave as payment because it is a promise to pay and not an actual payment.

Prepaid interest. You generally cannot de-duct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.

Discounted loan. If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Refunds of interest. If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. If you receive the re-fund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax.

Accrual method. Under an accrual method, you can deduct only interest that has accrued during the tax year.

Prepaid interest. You generally cannot de-duct any interest paid before the year it is due. Interest paid in advance can be deducted only in the tax year in which it is due.

Discounted loan. If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier.

Tax deficiency. If you contest a federal in-come tax deficiency, interest does not accrue until the tax year the final determination of liabil-ity is made. If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you.

However, if you contest but pay the pro-posed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid.

Related person. If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. The relation-ship is determined as of the end of the tax year for which the interest would otherwise be de-ductible. See section 267 for more information.

Below-Market Loans

If you receive a below-market gift or demand loan and use the proceeds in your trade or busi-ness, you may be able to deduct the forgone in-terest. See Treatment of gift and demand loans, later, in this discussion.

A “below-market loan” is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate (AFR). A gift or demand loan that is a be-low-market loan is generally considered an

arm's-length transaction in which you, the bor-rower, are considered as having received both of the following.

A loan in exchange for a note that requires the payment of interest at the AFR.
An additional payment in an amount equal to the forgone interest.

The additional payment is treated as a gift, divi-dend, contribution to capital, payment of com-pensation, or other payment, depending on the substance of the transaction.

Forgone interest. For any period, forgone in-terest is:

1. The interest that would be payable for that period if interest accrued on the loan at the AFR and was payable annually on De-cember 31, minus

2. Any interest actually payable on the loan for the period.

AFRs are published by the IRS each TIP month in the Internal Revenue Bulletin (I.R.B.), which is available on the IRS website at IRS.gov/IRB. You can also contact

an IRS office to get these rates.

Loans subject to the rules. The rules for be-low-market loans apply to the following.

1. Gift loans (below-market loans where the forgone interest is in the nature of a gift).

2. Compensation-related loans (below-mar-ket loans between an employer and an employee or between an independent contractor and a person for whom the con-tractor provides services).

3. Corporation-shareholder loans.

4. Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest ar-rangement).

5. Loans to qualified continuing care facilities under a continuing care contract (made af-ter October 11, 1985).

Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstand-ing after June 6, 1984, and to term loans (loans that are not demand loans) made after that date.

Treatment of gift and demand loans. If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc.) equal to the forgone interest on the loan. You are then trea-ted as transferring this amount back to the lender as interest. These transfers are consid-ered to occur annually, generally on December

31. If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. The lender must report it as interest income.

Limit on forgone interest for gift loans of $100,000 or less. For gift loans between indi-viduals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. This limit applies if the outstanding loans between the

Chapter 4InterestPage 17

lender and borrower total $100,000 or less. If the borrower's net investment income is $1,000 or less, it is treated as zero. This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement.

Treatment of term loans. If you receive a be-low-market term loan other than a gift or de-mand loan, you are treated as receiving an ad-ditional cash payment (as a dividend, etc.) on the date the loan is made. This payment is equal to the loan amount minus the present value, at the AFR, of all payments due under the loan. The same amount is treated as OID on the loan. See Original issue discount (OID) un-der Interest You Can Deduct, earlier.

Exceptions for loans of $10,000 or less. The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. This exception applies only to the follow-ing.

1. Gift loans between individuals if the loan is not directly used to buy or carry in-come-producing assets.

2. Compensation-related loans or corpora-tion-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement.

This exception does not apply to a term loan described in (2) above that was previously sub-ject to the below-market loan rules. Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less.

Exceptions for loans without significant tax effect. The following loans are specifically ex-empted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liabil-ity of the borrower or the lender.

1. Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices.

2. Loans subsidized by a federal, state, or municipal government that are made avail-able under a program of general applica-tion to the public.

3. Certain employee-relocation loans.

4. Certain loans to or from a foreign person, unless the interest income would be effec-tively connected with the conduct of a U.S. trade or business and not exempt from U.S. tax under an income tax treaty.

5. Any other loan if the taxpayer can show that the interest arrangement has no sig-nificant effect on the federal tax liability of the lender or the borrower. Whether an in-terest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Consider all the following factors.

a. Whether items of income and deduc-tion generated by the loan offset each other.

Page 18Chapter 5Taxes

b. The amount of the items.

c. The cost of complying with the be-low-market loan provisions if they were to apply.

d. Any reasons, other than taxes, for structuring the transaction as a be-low-market loan.

Exception for loans to qualified continuing care facilities. The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year.

A qualified continuing care facility is one or more facilities (excluding nursing homes) meet-ing the requirements listed below.

1. Designed to provide services under con-tinuing care contracts (defined below).

2. Includes an independent living unit, and either an assisted living or nursing facility, or both.

3. Substantially all of the independent living unit residents are covered by continuing care contracts.

A “continuing care contract” is a written con-tract between an individual and a qualified con-tinuing care facility that includes all of the fol-lowing conditions.

1. The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives.

2. The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individu-al's spouse in an:

a. Independent living unit (which has ad-ditional available facilities outside the unit for the provision of meals and other personal care), and

b. Assisted living or nursing facility avail-able in the continuing care facility.

3. The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care fa-cility, as required for the health of the indi-vidual or the individual's spouse.

For more information, see section 7872(h).

Sale or exchange of property. Different rules generally apply to a loan connected with the sale or exchange of property. If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. See Unstated Interest and Original Issue Discount (OID) in Pub. 537.

More information. For more information on below-market loans, see section 7872 and Reg-ulations section 1.7872-5.

5.

Taxes

Introduction

You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.

You cannot deduct federal income

taxes, estate and gift taxes, or state in-CAUTION heritance, legacy, and succession taxes.

Topics

This chapter discusses:

When to deduct taxes
Real estate taxes
Income taxes
Employment taxes
Other taxes

Useful Items

You may want to see:

Publication

15(Circular E), Employer's Tax Guide

334 Tax Guide for Small Business

510 Excise Taxes

538 Accounting Periods and Methods

551 Basis of Assets

Form (and Instructions)

1040 or 1040-SR U.S. Individual Income Tax Return

Schedule A (Form 1040) Itemized

Deductions

Schedule SE (Form 1040)

Self-Employment Tax

3115 Application for Change in Accounting Method

8959 Additional Medicare Tax

See chapter 12 for information about getting publications and forms.

When To Deduct Taxes

Generally, you can only deduct taxes in the year you pay them. This applies whether you use the cash method or an accrual method of accounting.

Under an accrual method, you can deduct a tax before you pay it if you meet the exception for recurring items discussed under Economic Performance in Pub. 538. You can also elect to ratably accrue real estate taxes as discussed later under Real Estate Taxes. See also Foreign income taxes, discussed later.

Limitation on acceleration of accrual of taxes. A taxing jurisdiction can require the use of a date for accruing taxes that is earlier than the date it originally required. However, if you use an accrual method, and can deduct the tax before you pay it, use the original accrual date for the year of change and all future years to de-termine when you can deduct the tax.

Example. Your state imposes a tax on per-sonal property used in a trade or business con-ducted in the state. This tax is assessed and becomes a lien as of July 1 (accrual date). In 2022, the state changed the assessment and lien dates from July 1, 2023, to December 31, 2022, for property tax year 2023. Use the origi-nal accrual date (July 1, 2023) to determine when you can deduct the tax. You must also use the July 1 accrual date for all future years to determine when you can deduct the tax.

Uniform capitalization rules. Uniform capital-ization rules apply to certain taxpayers who pro-duce real property or tangible personal property for use in a trade or business or for sale to cus-tomers. They also apply to certain taxpayers who acquire property for resale. Under these rules, you either include certain costs in inven-tory or capitalize certain expenses related to the property, such as taxes. For more information, see chapter 1.

Carrying charges. Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. You can elect to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. For more information, see chapter 7.

Refunds of taxes. If you receive a refund for any taxes you deducted in an earlier year, in-clude the refund in income to the extent the de-duction reduced your federal income tax in the earlier year. For more information, see Recov-ery of amount deducted (tax benefit rule) in chapter 1.

You must include in income any inter-TIP est you receive on tax refunds.

Real Estate Taxes

Deductible real estate taxes are any state or lo-cal taxes, including taxes imposed by U.S. pos-sessions, on real estate levied for the general public welfare. The taxing authority must base the taxes on the assessed value of the real es-tate and charge them uniformly against all prop-erty under its jurisdiction. Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property. See Taxes for local benefits, later.

Real estate taxes imposed by a foreign country are not deductible unless paid or ac-crued in connection with the conduct of a trade or business or for the production of income. For individual tax filers, the amount of deductible state and local real estate taxes may be subject to a $10,000 limitation. See State and local in-come taxes, later.

If you use an accrual method, you generally cannot accrue real estate taxes until you pay them to the government authority. However, you can elect to ratably accrue the taxes during the year. See Electing to ratably accrue, later.

Taxes for local benefits. Generally, you can-not deduct taxes charged for local benefits and improvements that tend to increase the value of your property. These include assessments for streets, sidewalks, water mains, sewer lines, and public parking facilities. You should in-crease the basis of your property by the amount of the assessment.

You can deduct taxes for these local bene-fits only if the taxes are for maintenance, re-pairs, or interest charges related to those bene-fits. If part of the tax is for maintenance, repairs, or interest, you must be able to show how much of the tax is for these expenses to claim a de-duction for that part of the tax.

Example. To improve downtown commer-cial business, Waterfront City converted a downtown business area street into an en-closed pedestrian mall. The city assessed the full cost of construction, financed with 10-year bonds, against the affected properties. The city is paying the principal and interest with the an-nual payments made by the property owners.

The assessments for construction costs are not deductible as taxes or as business expen-ses, but are depreciable capital expenses. The part of the payments used to pay the interest charges on the bonds is deductible as taxes.

Charges for services. Water bills, sewerage, and other service charges assessed against your business property are not real estate taxes, but are deductible as business expen-ses.

Purchase or sale of real estate. If real estate is sold, the real estate taxes must be allocated between the buyer and the seller.

The buyer and seller must allocate the real estate taxes according to the number of days in the real property tax year (the period to which the tax imposed relates) that each owned the property. Treat the seller as paying the taxes up to but not including the date of sale. Treat the buyer as paying the taxes beginning with the date of sale. You can usually find this informa-tion on the settlement statement you received at closing.

If you (the seller) use an accrual method and have not elected to ratably accrue real estate taxes, you are considered to have accrued your part of the tax on the date you sell the property.

Example. Lynn and Curt are calendar year accrual method taxpayers who own real estate in Olmo County. They have not elected to rata-bly accrue property taxes. November 30 of each year is the assessment and lien date for the current real property tax year, which is the calendar year. They sold the property on June 30, 2022. Under their accounting method, they would not be able to claim a deduction for the taxes because the sale occurred before No-vember 30. They are treated as having accrued their part of the tax, 181/365 (January 1–June 29), on June 30, and they can deduct it for 2022.

Electing to ratably accrue. If you use an ac-crual method, you can elect to accrue real es-tate tax related to a definite period ratably over that period.

Example. Lea and Joey are calendar year taxpayers who use an accrual method. Their real estate taxes for the real property tax year, July 1, 2022, to June 30, 2023, are $1,200. July 1 is the assessment and lien date.

If the Lea and Joey elect to ratably accrue the taxes, $600 will accrue in 2022 ($1,200 × 6/12, July 1–December 31) and the balance will accrue in 2023.

Separate elections. You can elect to rata-bly accrue the taxes for each separate trade or business and for nonbusiness activities if you account for them separately. Once you elect to ratably accrue real estate taxes, you must use that method unless you get permission from the IRS to change your accounting method. See Form 3115, later.

Making the election. If you elect to ratably accrue the taxes for the first year in which you incur real estate taxes, attach a statement to your income tax return for that year. The state-ment should show all the following items.

The trades or businesses to which the election applies and the accounting method or methods used.
The period to which the taxes relate.
The calculation of the real estate tax de-duction for that first year.

Generally, you must file your return by the due date (including extensions). However, if you timely filed your return for the year without electing to ratably accrue, you can still make the election by filing an amended return within 6 months after the due date of the return (exclud-ing extensions). Attach the statement to the amended return and write “Filed pursuant to section 301.9100-2” on the statement. File the amended return at the same address where you filed the original return.

Form 3115. If you elect to ratably accrue real estate taxes for a year after the first year in which you incur real estate taxes, or if you want to revoke your election to ratably accrue real estate taxes, file Form 3115. For more informa-tion, including applicable time frames for filing, see the Instructions for Form 3115.

Income Taxes

This section discusses federal, state, local, and foreign income taxes.

Federal income taxes. You cannot deduct federal income taxes.

State and local income taxes. A corporation or partnership can deduct state and local in-come taxes imposed on the corporation or part-nership as business expenses.

An individual can deduct state and local in-come taxes only as an itemized deduction on Schedule A (Form 1040), subject to limitations. The deduction is limited to $10,000 as a total of the following taxes.

Chapter 5TaxesPage 19

1. State and local income taxes or general sales taxes. See the Schedule A (Form 1040) instructions.

2. State and local real estate taxes. See the Schedule A (Form 1040) instructions. See also Real Estate Taxes, earlier.

3. State and local personal property taxes.

However, an individual can deduct a state tax on gross income (as distinguished from net income) directly attributable to a trade or busi-ness as a business expense.

Accrual of contested income taxes. If you use an accrual method, and you contest a state or local income tax liability, you must ac-crue and deduct any contested amount in the tax year in which the liability is finally deter-mined.

If additional state or local income taxes for a prior year are assessed in a later year, you can deduct the taxes in the year in which they were originally imposed (the prior year) if the tax lia-bility is not contested. You cannot deduct them in the year in which the liability is finally deter-mined.

The filing of an income tax return is not TIP considered a contest and, in the ab-sence of an overt act of protest, you can deduct the tax in the prior year. Also, you

can deduct any additional taxes in the prior year if you do not show some affirmative evidence of denial of the liability.

However, if you consistently deduct addi-tional assessments in the year they are paid or finally determined (including those for which there was no contest), you must continue to do so. You cannot take a deduction in the earlier year unless you receive permission to change your method of accounting. For more informa-tion on accounting methods, see When Can I Deduct an Expense in chapter 1.

If you contest a state or local tax liability, and you transfer money or other property as a provi-sional payment of the contested tax liability, you can accrue and deduct the amount of the con-tested tax liability for which you made the provi-sional payment in the year in which you made the payment, even though the liability is not de-termined until a later year.

If any portion of the contested amount which was deducted in the year the provisional pay-ment was made is later refunded when the con-test is settled, you must include such portion in your gross income in the year the refund is re-ceived.

Notwithstanding the exception that allows accrual and deduction of contested state or lo-cal income tax liability upon payment, current accrual and deduction is not allowed for in-come, war profits, and excess profits taxes im-posed by a foreign country or possession of the United States.

Foreign income taxes. Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession, subject to limitations. How-ever, an individual cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. For information on these exclusions,

Page 20Chapter 5Taxes

see Pub. 54. For information on the foreign tax credit, see Pub. 514.

Accrual of foreign income taxes. If you use an accrual method and choose to take a deduction (rather than a credit) for foreign in-come taxes, you can deduct the taxes in the year in which the fact of the liability becomes fixed and the amount of the liability can be de-termined with reasonable accuracy. Generally, this is the year with or within which the tax year that applies for foreign tax purposes ends or, in the case of a contested tax, the year in which the contest is resolved. Different rules may ap-ply to determine when a foreign income tax is considered to accrue for purposes of the for-eign tax credit. For more information on the for-eign tax credit, see Pub. 514.

Employment Taxes

If you have employees, you must withhold vari-ous taxes from your employees' pay. Most em-ployers must withhold their employees' share of social security, Medicare taxes, and Additional Medicare Tax (if applicable), along with state and federal income taxes. You may also need to pay certain employment taxes from your own funds. These include your share of social secur-ity and Medicare taxes as an employer, along with unemployment taxes.

Your deduction for wages paid is not re-duced by the social security and Medicare taxes, Additional Medicare Tax, and income taxes you withhold from your employees. You can deduct the employment taxes you must pay from your own funds as taxes.

Example. You pay your employee $18,000 a year. However, after you withhold various taxes, your employee receives $14,500. You also pay an additional $1,500 in employment taxes. You should deduct the full $18,000 as wages. You can deduct the $1,500 you pay from your own funds as taxes.

Additional Medicare Tax. You must withhold a 0.9% Additional Medicare Tax from wages you pay to an employee in excess of $200,000 in a calendar year. The Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax.

For more information on the Additional Med-icare Tax, see Form 8959 and its instructions.

For more information on employment TIP taxes, see Pub. 15 (Circular E).

Unemployment fund taxes. As an employer, you may have to make payments to a state un-employment compensation fund or to a state disability benefit fund. Deduct these payments as taxes.

Self-employment tax. You can deduct part of your self-employment tax as a business ex-pense in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect your net earnings from self-em-ployment or your self-employment tax.

To deduct the tax, enter on Schedule 1 (Form 1040), line 15, the amount shown on the

Deduction for one-half of self-employment tax line of Schedule SE (Form 1040).

For more information on self-employment tax, see Pub. 334.

Additional Medicare Tax. You may be re-quired to pay Additional Medicare Tax on self-employment income. See Form 8959 and the Instructions for Form 8959 for more informa-tion on the Additional Medicare Tax.

Other Taxes

The following are other taxes you can deduct if you incur them in the ordinary course of your trade or business.

Excise taxes. Generally, you can deduct as a business expense all excise taxes that are ordi-nary and necessary expenses of carrying on your trade or business. However, see Fuel taxes, later.

For more information on excise taxes, see Pub. 510.

Franchise taxes. You can deduct corporate franchise taxes as a business expense.

Fuel taxes. Generally, taxes on gasoline, die-sel fuel, and other motor fuels that you use in your business are included as part of the cost of the fuel. Do not deduct these taxes as a sepa-rate item.

You may be entitled to a credit or refund for federal excise tax you paid on fuels used for certain purposes. For more information, see Pub. 510.

Occupational taxes. You can deduct as a business expense an occupational tax charged at a flat rate by a locality for the privilege of working or conducting a business in the locality.

Personal property tax. You can deduct any tax imposed by a state or local government on personal property used in your trade or busi-ness.

Sales tax. Any sales tax you pay on a service for your business, or on the purchase or use of property in your business is treated as part of the cost of the service or property. If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. If the prop-erty is depreciable, add the sales tax to the ba-sis for depreciation. For more information on basis, see Pub. 551.

Do not deduct state and local sales

taxes imposed on the buyer that you CAUTION must collect and pay over to the state or local government. Also, do not include these taxes in gross receipts or sales.

6.

Insurance

Reminder

Premium tax credit. You may have to use the worksheets in Pub. 974 instead of the work-sheet in this chapter. Use the worksheets in Pub. 974 if the insurance plan established, or considered to be established, under your busi-ness was obtained through the Health Insur-ance Marketplace and you are claiming the pre-mium tax credit. See Pub. 974 for details.

Introduction

You can generally deduct the ordinary and nec-essary cost of insurance as a business expense if it is for your trade, business, or profession. However, you may have to capitalize certain in-surance costs under the uniform capitalization rules. For more information, see Capitalized Premiums, later.

Topics

This chapter discusses:

Deductible premiums
Nondeductible premiums
Capitalized premiums
When to deduct premiums

Useful Items

You may want to see:

Publication

15-B Employer's Tax Guide to Fringe Benefits

525 Taxable and Nontaxable Income

538 Accounting Periods and Methods

547 Casualties, Disasters, and Thefts

Form (and Instructions)

1040 U.S. Individual Income Tax Return

1040-NR U.S. Nonresident Alien Income

Tax Return

Schedule 1 (Form 1040) Additional

Income and Adjustments to Income

Schedule A (Form 1040) Itemized

Deductions

Schedule C (Form 1040) Profit or Loss From Business

Schedule F (Form 1040) Profit or Loss From Farming

Schedule SE (Form 1040)

Self-Employment Tax

Schedule K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc.

2555 Foreign Earned Income W-2 Wage and Tax Statement

See chapter 12 for information about getting publications and forms.

Deductible Premiums

You can generally deduct premiums you pay for the following kinds of insurance related to your trade or business.

1. Insurance that covers fire, storm, theft, ac-cident, or similar losses.

2. Credit insurance that covers losses from business bad debts.

3. Group hospitalization and medical insur-ance for employees, including long-term care insurance.

a. If a partnership pays accident and health insurance premiums for its partners, it can generally deduct them as guaranteed payments to partners.

b. If an S corporation pays accident and health insurance premiums for its more-than-2% shareholder-employ-ees, it can generally deduct them, but must also include them in the share-holder's wages subject to federal in-come tax withholding. See Pub.15-B.

4. Liability insurance.

5. Malpractice insurance that covers your personal liability for professional negli-gence resulting in injury or damage to pa-tients or clients.

6. Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault.

c. If a partnership pays workers' com-pensation premiums for its partners, it can generally deduct them as guaran-teed payments to partners.

d. If an S corporation pays workers' compensation premiums for its more-than-2% shareholder-employ-ees, it can generally deduct them, but must also include them in the share-holder's wages.

7. Contributions to a state unemployment in-surance fund are deductible as taxes if they are considered taxes under state law.

8. Overhead insurance that pays for busi-ness overhead expenses you have during long periods of disability caused by your injury or sickness.

9. Car and other vehicle insurance that cov-ers vehicles used in your business for lia-bility, damages, and other losses. If you operate a vehicle partly for personal use and partly for business use, deduct only the part of the insurance premium that ap-plies to the business use of the vehicle. If you use the standard mileage rate to fig-ure your car expenses, you can’t deduct any car insurance premiums.

10. Life insurance covering your officers and employees if you aren’t directly or indi-rectly a beneficiary under the contract.

11. Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause.

Self-Employed Health Insurance Deduction

You may be able to deduct the amount you paid for medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents. The health insur-ance can cover your child who was under age 27 at the end of 2022, even if the child wasn’t your dependent. A child includes your son, daughter, stepchild, adopted child, or foster child. A foster child is any child placed with you by an authorized placement agency or by judg-ment, decree, or other order of any court of competent jurisdiction.

One of the following statements must be true.

You were self-employed and had a net profit for the year reported on Schedule C (Form 1040) or Schedule F (Form 1040).

You were a partner with net earnings from self-employment for the year reported on Schedule K-1 (Form 1065), box 14, code A.

You used one of the optional methods to figure your net earnings from self-employ-ment on Schedule SE.
You received wages in 2022 from an S cor-poration in which you were a more-than-2% shareholder. Health insur-ance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2.

The insurance plan must be established, or considered to be established, as discussed in the following bullets, under your business.

For self-employed individuals filing a Schedule C (Form 1040) or Schedule F (Form 1040), a policy can be either in the name of the business or in the name of the individual.

For partners, a policy can be either in the name of the partnership or in the name of the partner. You can either pay the premi-ums yourself or the partnership can pay them and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in your gross in-come. However, if the policy is in your name and you pay the premiums yourself, the partnership must reimburse you and report the premium amounts on Sched-ule K-1 (Form 1065) as guaranteed pay-ments to be included in your gross income. Otherwise, the insurance plan won’t be considered to be established under your business.

For more-than-2% shareholders, a policy can be either in the name of the S corpora-tion or in the name of the shareholder. You can either pay the premiums yourself or the S corporation can pay them and report the premium amounts on Form W-2 as wa-ges to be included in your gross income. However, if the policy is in your name and

Chapter 6InsurancePage 21

you pay the premiums yourself, the S cor-poration must reimburse you and report the premium amounts in box 1 of Form W-2 as wages to be included in your gross income. Otherwise, the insurance plan won’t be considered to be established un-der your business.

Medicare premiums you voluntarily pay to obtain insurance in your name that is similar to qualifying private health insurance can be used to figure the deduction. Amounts paid for health insurance coverage from retirement plan distri-butions that were nontaxable because you are a retired public safety officer can’t be used to fig-ure the deduction.

You can claim the deduction for self-em-ployed health insurance on Schedule 1 (Form 1040), line 17.

Qualified long-term care insurance. You can include premiums paid on a qualified long-term care insurance contract when figuring your deduction. But, for each person covered,

you can include only the smaller of the following amounts.

1. The amount of premiums paid for that per-son.

2. The amount shown below. Use the per-son's age at the end of the tax year.

a. Age 40 or younger — $450

b. Age 41 to 50 — $850

c. Age 51 to 60 — $1,690

d. Age 61 to 70 — $4,510

e. Age 71 or older — $5,640

Qualified long-term care insurance con-tract. A qualified long -term care insurance contract is an insurance contract that only pro-vides coverage of qualified long-term care serv-ices. The contract must meet all the following requirements.

It must be guaranteed renewable.
It must provide that refunds, other than re-funds on the death of the insured or com-plete surrender or cancellation of the con-tract, and dividends under the contract

may be used only to reduce future premi-ums or increase future benefits.

It must not provide for a cash surrender value or other money that can be paid, as-signed, pledged, or borrowed.
It must generally not pay or reimburse ex-penses incurred for services or items that would be reimbursed under Medicare, ex-cept where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to ex-penses.

Qualified long-term care services. Quali-fied long-term care services are:

Necessary diagnostic, preventive, thera-peutic, curing, treating, mitigating, and re-habilitative services; and
Maintenance or personal care services.

The services must be required by a chronically ill individual and prescribed by a licensed health care practitioner.

Page 22Chapter 6Insurance

Worksheet 6-A. Self-Employed Health Insurance Deduction WorksheetKeep for Your Records

Caution. You may have to use the worksheets in Pub. 974 instead of this worksheet if the insurance plan established, or considered to be established, under your business was obtained through the Health Insurance Marketplace and you are claiming the premium tax credit. See Pub. 974 for details.

Note. Use a separate worksheet for each trade or business under which an insurance plan is established.

1.	Enter the total amount paid in 2022 for health insurance coverage established under your
	business (or the S corporation in which you were a more-than-2% shareholder) for 2022 for you,
	your spouse, and your dependents. Your insurance can also cover your child who was under age
	27 at the end of 2022, even if the child was not your dependent. But don’t include the following.
	•	Amounts for any month you were eligible to participate in a health plan subsidized by your
		employer or your spouse’s employer or the employer of either your dependent or your child
	•	who was under the age of 27 at the end of 2022.
		Any amounts paid from retirement plan distributions that were nontaxable because you are a
		retired public safety officer.	1.
	•	Any payments for qualified long-term care insurance (see line 2) . . . . . . . . . . . . . . . . . . . . . .
2.	For coverage under a qualified long-term care insurance contract, enter for each person covered
	the smaller of (a) or (b).
	a) Total payments made for that person during the year.
	b) The amount shown below. Use the person's age at the end of the tax year.
		$450— if that person is age 40 or younger
		$850— if age 41 to 50
		$1,690— if age 51 to 60
		$4,510— if age 61 to 70
		$5,640— if age 71 or older
		Note. The amount of long-term care premiums that can be included as a medical expense is
		limited by the person’s age. Don’t include payments for any month you were eligible to
		participate in a long-term care insurance plan subsidized by your employer or your spouse’s
		employer or the employer of either your dependent or your child who was under the age of
		27 at the end of 2022. If more than one person is covered, figure separately the amount to	2.
		enter for each person. Then enter the total of those amounts . . . . . . . . . . . . . . . . . . . . . . . . .
3.	. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Addlines1and2		3.
4.	Enter your net profit* and any other earned income** from the trade or business under which the
	insurance plan is established. Don’t include Conservation Reserve Program payments exempt		4.
	from self-employment tax. If the business is an S corporation, skip to line 11 . . . . . . . . . . . . . . . .
5.	Enter the total of all net profits* from Schedule C (Form 1040), line 31; Schedule F (Form 1040),
	line 34; or Schedule K -1 (Form 1065), box 14, code A, plus any other income allocable to the
	profitable businesses. Don’t include Conservation Reserve Program payments exempt from
	self-employment tax. See the Instructions for Schedule SE (Form 1040). Don’t include any net		5.
	losses shown on these schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.	. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Divideline4byline5		6.
7.	Multiply Schedule 1 (Form 1040), line 15, deductible part of self-employment tax, by the		7.
	percentage on line 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.	. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Subtractline7fromline4		8.
9.	Enter the amount, if any, from Schedule 1 (Form 1040), line 16, self-employed SEP, SIMPLE,
	and qualified plans, attributable to the same trade or business in which the insurance plan is		9.
	established . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.	. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Subtractline9fromline8		10.
11.	Enter your Medicare wages (box 5 of Form W-2) from an S corporation in which you are a		11.
	more-than-2% shareholder and in which the insurance plan is established . . . . . . . . . . . . . . . . . .
12.	Enter any amount from Form 2555, line 45, attributable to the amount entered on line 4 or 11		12.
	above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13.	. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Subtractline12fromline10or11,whicheverapplies		13.
14.	Self-employed health insurance deduction. Enter the smaller of line 3 or line 13 here and on
	Schedule 1 (Form 1040), line 17. Don’t include this amount when figuring any medical expense		14.
	deduction on Schedule A (Form 1040) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

If you used either optional method to figure your net earnings from self-employment from any business, don’t enter your net profit from the business. Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Part I, line 4b.
Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it doesn’t include capital gain income.

Chronically ill individual. A chronically ill individual is a person who has been certified as one of the following.

An individual who has been unable, due to loss of functional capacity for at least 90 days, to perform at least two activities of daily living without substantial assistance from another individual. Activities of daily living are eating, toileting, transferring

(general mobility), bathing, dressing, and continence.

An individual who requires substantial su-pervision to be protected from threats to health and safety due to severe cognitive impairment.

The certification must have been made by a li-censed health care practitioner within the previ-ous 12 months.

Benefits received. For information on ex-cluding benefits you receive from a long-term care contract from gross income, see Pub. 525.

Other coverage. You can’t take the deduction for any month you were eligible to participate in any employer (including your spouse's) subsi-dized health plan at any time during that month, even if you didn’t actually participate. In addi-tion, if you were eligible for any month or part of

Chapter 6InsurancePage 23

a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2022, don’t use amounts paid for coverage for that month to figure the deduction.

These rules are applied separately to plans that provide long-term care insurance and plans that don’t provide long-term care insurance. However, any medical insurance payments not deductible on Schedule 1 (Form 1040), line 17, can be included as medical expenses on Schedule A (Form 1040) if you itemize deduc-tions.

Effect on itemized deductions. Subtract the health insurance deduction from your medical insurance when figuring medical expenses on Schedule A (Form 1040) if you itemize deduc-tions.

Effect on self-employment tax. You can’t subtract the self-employed health insurance de-duction when figuring net earnings for your self-employment tax from the business under which the insurance plan is established, or con-sidered to be established, as discussed earlier. For more information, see Schedule SE (Form 1040).

How to figure the deduction. Generally, you can use the worksheet in the Form 1040 in-structions to figure your deduction. However, if any of the following apply, you must use Work-sheet 6-A in this chapter.

You had more than one source of income subject to self-employment tax.

You file Form 2555.
You are using amounts paid for qualified long-term care insurance to figure the de-duction.

More than one health plan and business. If you have more than one health plan during the year and each plan is established under a different business, you must use separate work-sheets (Worksheet 6-A) to figure each plan's net earnings limit. Include the premium you paid under each plan on line 1 or line 2 of that sepa-rate worksheet and your net profit (or wages) from that business on line 4 (or line 11). For a plan that provides long-term care insurance, the total of the amounts entered for each person on line 2 of all worksheets can’t be more than the appropriate limit shown on line 2 for that per-son.

Nondeductible Premiums

You can’t deduct premiums on the following kinds of insurance.

1. Self-insurance reserve funds. You can’t deduct amounts credited to a reserve set up for self-insurance. This applies even if you can’t get business insurance cover-age for certain business risks. However, your actual losses may be deductible. See Pub. 547.

2. Loss of earnings. You can’t deduct premi-ums for a policy that pays for lost earnings due to sickness or disability. However, see

Page 24Chapter 6Insurance

the discussion on overhead insurance, item (8), under Deductible Premiums, ear-lier.

3. Certain life insurance and annuities.

a. For contracts issued before June 9, 1997, you can’t deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a benefi-ciary of the policy. You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business.

b. For contracts issued after June 8, 1997, you generally can’t deduct the premiums on any life insurance policy, endowment contract, or annuity con-tract if you are directly or indirectly a beneficiary. The disallowance applies without regard to whom the policy covers.

c. Partners. If, as a partner in a partner-ship, you take out an insurance policy on your own life and name your part-ners as beneficiaries to induce them to retain their investments in the part-nership, you are considered a benefi-ciary. You can't deduct the insurance premiums.

4. Insurance to secure a loan. If you take out a policy on your life or on the life of an-other person with a financial interest in your business to get or protect a business loan, you can't deduct the premiums as a business expense. Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. In the event of death, the proceeds of the policy are generally not taxed as income even if they are used to liquidate the debt.

Capitalized Premiums

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indi-rect costs for certain production or resale activi-ties. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You re-cover the costs through depreciation, amortiza-tion, or cost of goods sold when you use, sell, or otherwise dispose of the property.

Indirect costs include premiums for insur-ance on your plant or facility, machinery, equip-ment, materials, property produced, or property acquired for resale.

Uniform capitalization rules. You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.

1. Produce real property or tangible personal property. For this purpose, tangible per-sonal property includes a film, sound re-cording, videotape, book, or similar prop-erty.

2. Acquire property for resale.

However, these rules don't apply to the follow-ing property.

1. Personal property you acquire for resale if your average annual gross receipts are $27 million or less for the 3 prior tax years.

2. Property you produce if you meet either of the following conditions.

a. Your indirect costs of producing the property are $200,000 or less.

b. You use the cash method of account-ing and don't account for inventories.

More information. For more information on these rules, see Uniform Capitalization Rules in Pub. 538 and the regulations under section 263A.

When To Deduct Premiums

You can usually deduct insurance premiums in the tax year to which they apply.

Cash method. If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. However, see Prepayment, later.

Accrual method. If you use an accrual method of accounting, you can't deduct insur-ance premiums before the tax year in which you incur a liability for them. In addition, you can't deduct insurance premiums before the tax year in which you actually pay them (unless the ex-ception for recurring items applies). For more information about the accrual method of ac-counting, see chapter 1. For information about the exception for recurring items, see Pub. 538.

Prepayment. You can't deduct expenses in advance, even if you pay them in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year.

Expenses such as insurance are generally allocable to a period of time. You can deduct in-surance expenses for the year to which they are allocable.

Example. In 2022, you signed a 3-year in-surance contract. Even though you paid the premiums for 2022, 2023, and 2024 when you signed the contract, you can only deduct the premium for 2022 on your 2022 tax return. You can deduct in 2023 and 2024 the premiums al-locable to those years.

Dividends received. If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the divi-dends are generally income. For more

information, see Recovery of amount deducted (tax benefit rule) in chapter 1 under How Much Can I Deduct.

7.

Costs You Can Deduct or Capitalize

What’s New

Research and experimental costs. Begin-ning January 1, 2022, research and experimen-tal expenditures, generally, have to be amor-tized over a 5-year period. A business cannot elect to deduct their total research expenses in the current year. See Research and Experimen-tal Costs in chapter 7 and chapter 8.

Introduction

This chapter discusses costs you can elect to deduct or capitalize.

You generally deduct a cost as a current business expense by subtracting it from your in-come in either the year you incur it or the year you pay it.

If you capitalize a cost, you may be able to recover it over a period of years through peri-odic deductions for amortization, depletion, or depreciation. When you capitalize a cost, you add it to the basis of property to which it relates.

A partnership, corporation, estate, or trust makes the election to deduct or capitalize the costs discussed in this chapter except for ex-ploration costs for mineral deposits. Each indi-vidual partner, shareholder, or beneficiary elects whether to deduct or capitalize explora-tion costs.

Individuals, estates, and trusts may be

subject to AMT if they deduct certain CAUTION research and experimental, intangible drilling, exploration, development, circulation, or business organizational costs.

For more information on the AMT, see the Instructions for Form 6251 and the Instructions for Schedule I (Form 1041).

Topics

This chapter discusses:

Carrying charges
Research and experimental costs
Intangible drilling costs
Exploration costs
Development costs
Circulation costs
Business startup and organizational costs
Reforestation costs

Retired asset removal costs
Barrier removal costs
Film and television production costs
Repair and maintenance costs

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions of Assets

Form (and Instructions)

Schedule C (Form 1040) Profit or Loss From Business

3468 Investment Credit

6765 Credit for Increasing Research Activities

8826 Disabled Access Credit

T (Timber) Forest Activities Schedule See chapter 12 for information about getting publications and forms.

Carrying Charges

Carrying charges include the taxes and interest you pay to carry or develop real property or to carry, transport, or install personal property. Certain carrying charges must be capitalized under the uniform capitalization rules. (For infor-mation on capitalization of interest, see chap-ter 4.) You can elect to capitalize carrying charges not subject to the uniform capitalization rules, but only if they are otherwise deductible.

You can elect to capitalize carrying charges separately for each project you have and for each type of carrying charge. Your election is good for only 1 year for unimproved and unpro-ductive real property. You must decide whether to capitalize carrying charges each year the property remains unimproved and unproduc-tive. For other real property, your election to capitalize carrying charges remains in effect un-til construction or development is completed. For personal property, your election is effective until the date you install or first use it, whichever is later.

How to make the election. To make the elec-tion to capitalize a carrying charge, attach a statement to your original tax return for the year the election is to be effective indicating which charges you are electing to capitalize. However, if you timely filed your return for the year without making the election, you can still make the elec-tion by filing an amended return within 6 months of the due date of the return (excluding exten-sions). Attach the statement to the amended re-turn and write “Filed pursuant to section 301.9100-2” on the statement. File the amen-ded return at the same address you filed the original return.

Research and Experimental Costs

Research or experimental expenditures paid or incurred in tax years beginning after December

31, 2021, must be charged to a separate speci-fied research or experimental capital account and amortized ratably over a 5-year period or a 15-year period for foreign research. The expen-ses cannot be deducted in full in the current year.

For information on amortizing these costs, see Research and Experimental Costs in chap-ter 8.

Research and experimental costs defined. Research or experimental expenditures, as used in section 174, are research and develop-ment costs, including costs incident to research in the experimental or laboratory sense, you in-cur in connection with your trade or business for activities intended to provide information that would eliminate uncertainty about the develop-ment or improvement of a product. Uncertainty exists if the information available to you does not establish how to develop or improve a prod-uct or the appropriate design of a product. Whether costs qualify as research and experi-mental expenditures depends on the nature of the activity to which the costs relate rather than on the nature of the product or improvement be-ing developed or the level of technological ad-vancement.

The costs of obtaining a patent, including at-torneys' fees paid or incurred in making and perfecting a patent application, are research and experimental expenditures. However, costs paid or incurred to obtain another's patent are not research and experimental expenditures.

The costs related to developing software are treated as research and experimental expendi-tures.

Product. The term “product” includes any of the following items.

Formula.
Invention.
Patent.
Pilot model.
Process.
Technique.
Property similar to the items listed above.

It also includes products used by you in your trade or business or held for sale, lease, or li-cense.

Costs not included. Research and experi-mental expenditures do not include expenses for any of the following activities.

Advertising or promotions.
Consumer surveys.
Efficiency surveys.
Land, including acquisition and improve-ment costs for land.

Acquisition and improvement costs of de-preciable property.

Exploration costs for the purpose of ascer-taining the existence, location, extent, or quality of any deposit of ore or other min-eral.

Management studies.
Quality control testing.
Research in connection with literary, his-torical, or similar projects.

The acquisition of another's patent, model, production, or process.

Research credit. If you pay or incur costs that may be treated as research or experimental

Chapter 7Costs You Can Deduct or CapitalizePage 25

costs, you may be able to take the research credit. For more information, see Form 6765 and its instructions.

Payroll tax credit. The payroll tax credit is an annual election made by a qualified small busi-ness specifying the amount of research credit, not to exceed $250,000, that may be used against the employer portion of social security liability. The credit is the smallest of the current year research credit, an elected amount not to exceed $250,000, or the general business credit carryforward for the tax year (before the application of the payroll tax credit election for the tax year). The election must be made on or before the due date of the originally filed return (including extensions). An election cannot be made for a tax year if an election was made for 5 or more preceding tax years. The election made by a partnership or S corporation is made at the entity level.

A qualified small business that elects to claim the payroll tax credit will claim the payroll tax credit against the employer's portion of so-cial security tax on its employment tax return for the first quarter that begins after it files the re-turn reflecting the payroll tax election. For more information, see the Instructions for Form 6765.

Intangible Drilling Costs

The costs of developing oil, gas, or geothermal wells are ordinarily capital expenditures. You can usually recover them through depreciation or depletion. However, you can elect to deduct intangible drilling costs (IDCs) as a current busi-ness expense. These are certain drilling and development costs for wells in the United States in which you hold an operating or work-ing interest. You can deduct only costs for drill-ing or preparing a well for the production of oil, gas, or geothermal steam or hot water.

You can elect to deduct only the costs of items with no salvage value. These include wa-ges, fuel, repairs, hauling, and supplies related to drilling wells and preparing them for produc-tion. Your cost for any drilling or development work done by contractors under any form of contract is also an IDC. However, see Amounts paid to contractor that must be capitalized, later.

You can also elect to deduct the cost of drill-ing exploratory bore holes to determine the lo-cation and delineation of offshore hydrocarbon deposits if the shaft is capable of conducting hydrocarbons to the surface on completion. It does not matter whether there is any intent to produce hydrocarbons.

If you do not elect to deduct your IDCs as a current business expense, you can elect to de-duct them over the 60-month period beginning with the month they were paid or incurred.

Amounts paid to contractor that must be capitalized. Amounts paid to a contractor must be capitalized if they are either:

Amounts properly allocable to the cost of depreciable property, or

Amounts paid only out of production or proceeds from production if these amounts are depletable income to the recipient.

How to make the election. You elect to de-duct IDCs as a current business expense by taking the deduction on your income tax return for the first tax year you have eligible costs. No formal statement is required. If you file Sched-ule C (Form 1040), enter these costs under “Other expenses.”

For oil and gas wells, your election is bind-ing for the year it is made and for all later years. For geothermal wells, your election can be re-voked by the filing of an amended return on which you do not take the deduction. You can file the amended return for the year up to the normal time of expiration for filing a claim for credit or refund, generally, within 3 years after the date you filed the original return or within 2 years after the date you paid the tax, whichever is later.

Energy credit for costs of geothermal wells. If you capitalize the drilling and development costs of geothermal wells that you place in serv-ice during the tax year, you may be able to claim a business energy credit. See the Instruc-tions for Form 3468 for more information.

Nonproductive well. If you capitalize your IDCs, you have another option if the well is non-productive. You can deduct the IDCs of the nonproductive well as an ordinary loss. You must indicate and clearly state your election on your tax return for the year the well is comple-ted. Once made, the election for oil and gas wells is binding for all later years. You can re-voke your election for a geothermal well by filing an amended return that does not claim the loss.

Costs incurred outside the United States. You cannot deduct as a current business ex-pense all the IDCs paid or incurred for an oil, gas, or geothermal well located outside the Uni-ted States. However, you can elect to include the costs in the adjusted basis of the well to fig-ure depletion or depreciation. If you do not make this election, you can deduct the costs over the 10-year period beginning with the tax year in which you paid or incurred them. These rules do not apply to a nonproductive well.

Exploration Costs

The costs of determining the existence, loca-tion, extent, or quality of any mineral deposit are ordinarily capital expenditures if the costs lead to the development of a mine. You recover these costs through depletion as the mineral is removed from the ground. However, you can elect to deduct domestic exploration costs paid or incurred before the beginning of the develop-ment stage of the mine (except those for oil and gas wells).

How to make the election. You elect to de-duct exploration costs by taking the deduction on your income tax return, or on an amended income tax return, for the first tax year for which you wish to deduct the costs paid or incurred during the tax year. Your return must ade-quately describe and identify each property or mine, and clearly state how much is being de-ducted for each one. The election applies to the tax year you make this election and all later tax years.

Partnerships and S corporations. Each partner, not the partnership, elects whether to capitalize or to deduct that partner's share of exploration costs. Each shareholder, not the S corporation, elects whether to capitalize or to deduct that shareholder's share of exploration costs.

Reduced corporate deductions for explora-tion costs. A corporation (other than an S cor-poration) can deduct only 70% of its domestic exploration costs. It must capitalize the remain-ing 30% of costs and amortize them over the 60-month period starting with the month the ex-ploration costs are paid or incurred. A corpora-tion may also elect to capitalize and amortize mining exploration costs over a 10-year period. For more information on this method of amorti-zation, see section 59(e).

The 30% that the corporation capitalizes cannot be added to its basis in the property to figure cost depletion. However, the amount amortized is treated as additional depreciation and is subject to recapture as ordinary income on a disposition of the property. See Section 1250 Property under Depreciation Recapture in chapter 3 of Pub. 544.

These rules also apply to the deduction of development costs by corporations. See Devel-opment Costs, later.

Recapture of exploration expenses. When your mine reaches the producing stage, you must recapture any exploration costs you elec-ted to deduct. Use either of the following meth-ods.

Method 1—Include the deducted costs in gross income for the tax year the mine rea-ches the producing stage. Your election must be clearly indicated on the return. In-crease your adjusted basis in the mine by the amount included in income. Generally, you must elect this recapture method by the due date (including extensions) of your return. However, if you timely filed your re-turn for the year without making the elec-tion, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding exten-sions). Make the election on your amended return and write “Filed pursuant to section 301.9100-2” on the form where you are in-cluding the income. File the amended re-turn at the same address you filed the origi-nal return.

Method 2—Do not claim any depletion de-duction for the tax year the mine reaches the producing stage and any later tax years until the depletion you would have deduc-ted equals the exploration costs you de-ducted.

You must also recapture deducted explora-tion costs if you receive a bonus or royalty from mine property before it reaches the producing stage. Do not claim any depletion deduction for the tax year you receive the bonus or royalty and any later tax years until the depletion you would have deducted equals the exploration costs you deducted.

Generally, if you dispose of the mine before you have fully recaptured the exploration costs you deducted, recapture the balance by treating all or part of your gain as ordinary income.

Page 26Chapter 7Costs You Can Deduct or Capitalize

Under these circumstances, you generally treat as ordinary income all of your gain if it is less than your adjusted exploration costs with re-spect to the mine. If your gain is more than your adjusted exploration costs, treat as ordinary in-come only a part of your gain, up to the amount of your adjusted exploration costs.

Foreign exploration costs. If you pay or incur exploration costs for a mine or other natural de-posit located outside the United States, you cannot deduct all the costs in the current year. You can elect to include the costs (other than for an oil, gas, or geothermal well) in the adjus-ted basis of the mineral property to figure cost depletion. (Cost depletion is discussed in chap-ter 9.) If you do not make this election, you must deduct the costs over the 10-year period begin-ning with the tax year in which you pay or incur them. These rules also apply to foreign devel-opment costs.

Development Costs

You can deduct costs paid or incurred during the tax year for developing a mine or any other natural deposit (other than an oil or gas well) lo-cated in the United States. These costs must be paid or incurred after the discovery of ores or minerals in commercially marketable quantities. Development costs also include depreciation on improvements used in the development of ores or minerals and costs incurred for you by a contractor. Development costs do not include the costs for the acquisition or improvement of depreciable property.

Instead of deducting development costs in the year paid or incurred, you can elect to treat the costs as deferred expenses and deduct them ratably as the units of produced ores or minerals benefited by the expenses are sold. This election applies each tax year to expenses paid or incurred in that year. Once made, the election is binding for the year and cannot be revoked for any reason.

How to make the election. The election to deduct development costs ratably as the ores or minerals are sold must be made for each mine or other natural deposit by a clear indica-tion on your return or by a statement filed with the IRS office where you file your return. Gener-ally, you must make the election by the due date of the return (including extensions). How-ever, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2.” File the amended return at the same address you filed the original re-turn.

Foreign development costs. The rules dis-cussed earlier for Foreign exploration costs ap-ply to foreign development costs.

Reduced corporate deductions for develop-ment costs. The rules discussed earlier for Reduced corporate deductions for exploration costs also apply to corporate deductions for de-velopment costs.

Circulation Costs

A publisher can deduct as a current business expense the costs of establishing, maintaining, or increasing the circulation of a newspaper, magazine, or other periodical. For example, a publisher can deduct the cost of hiring extra employees for a limited time to get new sub-scriptions through telephone calls. Circulation costs may be deducted even if they would nor-mally be capitalized.

This rule does not apply to the following costs that must be capitalized.

The purchase of land or depreciable prop-erty.

The acquisition of circulation through the purchase of any part of the business of an-other publisher of a newspaper, magazine, or other periodical, including the purchase of another publisher's list of subscribers.

Other treatment of circulation costs. If you do not want to deduct circulation costs as a cur-rent business expense, you can elect one of the following ways to recover these costs.

Capitalize all circulation costs that are properly chargeable to a capital account (see chapter 1).
Amortize circulation costs over the 3-year period beginning with the tax year they were paid or incurred.

How to make the election. You elect to capi-talize circulation costs by attaching a statement to your return for the first tax year the election applies. Your election is binding for the year it is made and for all later years, unless you get IRS approval to revoke it.

Business Startup and Organizational Costs

Business startup and organizational costs are generally capital expenditures. However, you can elect to deduct up to $5,000 of business startup and $5,000 of organizational costs paid or incurred after October 22, 2004. The $5,000 deduction is reduced by the amount your total startup or organizational costs exceed $50,000. Any remaining costs must be amortized. For in-formation about amortizing startup and organi-zational costs, see chapter 8.

Startup costs include any amounts paid or incurred in connection with creating an active trade or business or investigating the creation or acquisition of an active trade or business. Or-ganizational costs include the costs of creating a corporation or partnership.

How to make the election. You elect to de-duct the startup or organizational costs by claiming the deduction on your income tax re-turn (filed by the due date including extensions) for the tax year in which the active trade or busi-ness begins. For costs paid or incurred after September 8, 2008, you are not required to at-tach a statement to your return to elect to de-duct such costs. However, for startup or organi-zational costs paid or incurred before September 9, 2008, you may be required to at-

tach a statement to your return to elect to de-duct such costs. If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the re-turn (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2.”

File the amended return at the same ad-dress you filed the original return. The election applies when figuring taxable income for the current tax year and all subsequent years. Once made, the election is irrevocable. For more in-formation on startup and organizational costs, see chapter 8.

Reforestation Costs

Reforestation costs are generally capital expen-ditures. However, you can elect to deduct up to $10,000 ($5,000 if married filing separately; $0 for a trust) of qualifying reforestation costs paid or incurred after October 22, 2004, for each qualified timber property. The remaining costs can be amortized over an 84-month period. For information about amortizing reforestation costs, see chapter 8.

Qualifying reforestation costs are the direct costs of planting or seeding for forestation or re-forestation. Qualified timber property is property that contains trees in significant commercial quantities. See chapter 8 for more information on qualifying reforestation costs and qualified timber property.

If you elect to deduct qualified reforestation costs, create and maintain separate timber ac-counts for each qualified timber property and in-clude all reforestation costs and the dates each was applied. Do not include this qualified timber property in any account (for example, depletion block) for which depletion is allowed.

How to make the election. You elect to de-duct qualifying reforestation costs by claiming the deduction on your timely filed income tax re-turn (including extensions) for the tax year the expenses were paid or incurred. If Form T (Tim-ber) is required, complete Part IV of the form. If Form T (Timber) is not required, attach a state-ment containing the following information for each qualified timber property for which an election is being made.

The unique stand identification numbers.
The total number of acres reforested dur-ing the tax year.

The nature of the reforestation treatments.
The total amounts of qualified reforestation expenditures eligible to be amortized or deducted.

If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2.” File the amended return at the same address you filed the original re-turn. The election applies when figuring taxable income for the current tax year and all subse-quent years.

Chapter 7Costs You Can Deduct or CapitalizePage 27

For additional information on reforestation costs, see chapter 8.

Recapture. This deduction may have to be re-captured as ordinary income under section 1245 when you sell or otherwise dispose of the property that would have received an addition to basis if you had not elected to deduct the ex-penditure. For more information on recapturing the deduction, see Depreciation Recapture in Pub. 544.

Retired Asset Removal Costs

If you retire and remove a depreciable asset in connection with the installation or production of a replacement asset, you can deduct the costs of removing the retired asset. However, if you replace a component (part) of a depreciable as-set, capitalize the removal costs if the replace-ment is an improvement and deduct the costs if the replacement is a repair.

Barrier Removal Costs

The cost of an improvement to a business asset is normally a capital expense. However, you can elect to deduct the costs of making a facility or public transportation vehicle more accessible to and usable by those who are disabled or eld-erly. You must own or lease the facility or vehi-cle for use in connection with your trade or busi-ness.

A facility is all or any part of buildings, struc-tures, equipment, roads, walks, parking lots, or similar real or personal property. A public trans-portation vehicle is a vehicle, such as a bus or railroad car, that provides transportation service to the public (including service for your custom-ers, even if you are not in the business of pro-viding transportation services).

You cannot deduct any costs that you paid or incurred to completely renovate or build a fa-cility or public transportation vehicle or to re-place depreciable property in the normal course of business.

Deduction limit. The most you can deduct as a cost of removing barriers to the disabled and the elderly for any tax year is $15,000. How-ever, you can add any costs over this limit to the basis of the property and depreciate these ex-cess costs.

Partners and partnerships. The $15,000 limit applies to a partnership and also to each part-ner in the partnership. A partner can allocate the $15,000 limit in any manner among the part-ner's individually incurred costs and the part-ner's distributive share of partnership costs. If the partner cannot deduct the entire share of partnership costs, the partnership can add any costs not deducted to the basis of the improved property.

A partnership must be able to show that any amount added to basis was not deducted by the partner and that it was over a partner's $15,000 limit (as determined by the partner). If the partnership cannot show this, it is presumed

that the partner was able to deduct the distribu-tive share of the partnership's costs in full.

Example. Emilio Azul's distributive share of ABC partnership's deductible expenses for the removal of architectural barriers was $14,000. Emilio had $12,000 of similar expenses in his sole proprietorship. He elected to deduct $7,000 of them. Emilio allocated the remaining $8,000 of the $15,000 limit to his share of ABC's expenses. Emilio can add the excess $5,000 of his own expenses to the basis of the property used in his business. Also, if ABC can show that Emilio could not deduct $6,000 ($14,000 – $8,000) of his share of the partner-ship's expenses because of how Emilio applied the limit, ABC can add $6,000 to the basis of its property.

Qualification standards. You can deduct your costs as a current expense only if the bar-rier removal meets the guidelines and require-ments issued by the Architectural and Trans-portation Barriers Compliance Board under the Americans with Disabilities Act (ADA) of 1990. You can view the ADA at ADA.gov/pubs/ ada.htm.

The following is a list of some architectural barrier removal costs that can be deducted.

Ground and floor surfaces.
Walks.
Parking lots.
Ramps.
Entrances.
Doors and doorways.
Stairs.
Floors.
Toilet rooms.
Water fountains.
Public telephones.
Elevators.
Controls.
Signage.
Alarms.
Protruding objects.
Symbols of accessibility.

You can find the ADA guidelines and require-ments for architectural barrier removal at USDOJ.gov/crt/ada/reg3a.html.

The costs for removal of transportation barri-ers from rail facilities, buses, and rapid and light rail vehicles are deductible. You can find the guidelines and requirements for transportation barrier removal at transit.dot.gov.

Also, you can access the ADA website at ADA.gov for additional information.

Other barrier removals. To be deductible, expenses of removing any barrier not covered by the above standards must meet all three of the following tests.

1. The removed barrier must be a substantial barrier to access or use of a facility or pub-lic transportation vehicle by persons who have a disability or are elderly.

2. The removed barrier must have been a barrier for at least one major group of per-sons who have a disability or are elderly (such as people who are blind, deaf, or wheelchair users).

3. The barrier must be removed without cre-ating any new barrier that significantly im-pairs access to or use of the facility or ve-hicle by a major group of persons who have a disability or are elderly.

How to make the election. If you elect to de-duct your costs for removing barriers to the dis-abled or the elderly, claim the deduction on your income tax return (partnership return for partnerships) for the tax year the expenses were paid or incurred. Identify the deduction as a separate item. The election applies to all the qualifying costs you have during the year, up to the $15,000 limit. If you make this election, you must maintain adequate records to support your deduction.

For your election to be valid, you must gen-erally file your return by its due date, including extensions. However, if you timely filed your re-turn for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly in-dicate the election on your amended return and write “Filed pursuant to section 301.9100-2.” File the amended return at the same address you filed the original return. Your election is ir-revocable after the due date, including exten-sions, of your return.

Disabled access credit. If you make your business accessible to persons with disabilities and your business is an eligible small business, you may be able to claim the disabled access credit. If you choose to claim the credit, you must reduce the amount you deduct or capital-ize by the amount of the credit.

For more information, see Form 8826.

Film, Television, and Live Theatrical Production Costs

Film, television, and theatrical production costs are generally capital expenses. However, you can elect to deduct certain costs of a qualified film, television, or live theatrical production commencing before January 1, 2026 (after De-cember 31, 2015, and before January 1, 2026, for a live theatrical production), if the aggregate cost of the production doesn't exceed $15 mil-lion. There is a higher dollar limitation for pro-ductions in certain areas. The deduction is sub-ject to recapture under section 1245 if the election is voluntarily revoked or the production fails to meet the requirements for the deduction. For more information, see section 181 and the related regulations.

Certain qualified film, television, or live the-atrical productions acquired and placed in serv-ice after September 27, 2017, may be eligible for the special depreciation allowance under section 168(k). For more information, see Pub. 946, How To Depreciate Property.

Note. No other depreciation or amortization deduction is allowed for costs of qualified film or television production or any qualified live theat-rical production if an election is made to deduct such costs.

Page 28Chapter 7Costs You Can Deduct or Capitalize

Repair and Maintenance Costs

Generally, you can deduct amounts paid for re-pairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized. However, you may elect to capi-talize amounts paid for repair and maintenance consistent with the treatment on your books and records. If you make this election, it applies to all amounts paid for repair and maintenance to tangible property that you treat as capital ex-penditures on your books and records for the tax year.

How to make the election. To make the elec-tion to treat repairs and maintenance as capital expenditures, attach a statement titled “Section 1.263(a)-3(n) Election” to your timely filed return (including extensions). For more information on what to include in the statement, see Regula-tions section 1.263(a)-3(n). If you timely filed your return without making the election, you can still make the election by filing an amended re-turn within 6 months of the due date of the re-turn (excluding extensions). Attach the state-ment to the amended return and write “Filed pursuant to section 301.9100-2” on the state-ment. File the amended return at the same ad-dress you filed the original return.

8.

Amortization

What's New

Amortization of research and experimental expenditures. Specified research or experi-mental costs paid or incurred in tax years begin-ning after 2021 must be capitalized and amor-tized ratably over a 5-year period (15-year period for any expenditures related to foreign research). See Research and Experimental Costs, later.

Introduction

Amortization is a method of recovering (deduct-ing) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation.

The various amortizable costs covered in this chapter are included in the list below. How-ever, this chapter doesn't discuss amortization of bond premium. For information on that topic, see chapter 3 of Pub. 550, Investment Expen-ses.

Topics

This chapter discusses:

Deducting amortization
Amortizing costs of starting a business
Amortizing costs of getting a lease
Amortizing costs of section 197 intangibles
Amortizing reforestation costs
Amortizing costs of geological and geophysical costs

Amortizing costs of pollution control facilities

Amortizing costs of research and experimentation

Amortizing costs of certain tax preferences

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions of

Assets

550 Investment Income and Expenses

946 How To Depreciate Property

Form (and Instructions)

3115 Application for Change in Accounting Method

4562 Depreciation and Amortization

6251 Alternative Minimum Tax—Individuals

See chapter 12 for information about getting publications and forms.

How To Deduct Amortization

To deduct amortization that begins during the current tax year, complete Part VI of Form 4562 and attach it to your income tax return.

To report amortization from previous years, in addition to amortization that begins in the cur-rent year, list on Form 4562 each item sepa-rately. For example, in 2021, you began to am-ortize a lease. In 2022, you began to amortize a second lease. Report amortization from the new lease on line 42 of your 2022 Form 4562. Re-port amortization from the 2021 lease on line 43 of your 2022 Form 4562.

If you don't have any new amortizable ex-penses for the current year, you aren't required to complete Form 4562 (unless you are claim-ing depreciation). Report the current year's de-duction for amortization that began in a prior year directly on the “Other deduction” or “Other expense” line of your return.

Starting a Business

When you start a business, treat all eligible costs you incur before you begin operating the business as capital expenditures that are part of your basis in the business. Generally, you re-cover costs for particular assets through depre-ciation deductions. However, you generally

can't recover other costs until you sell the busi-ness or otherwise go out of business. For a dis-cussion on how to treat these costs, see If your attempt to go into business is unsuccessful un-der Capital Expenses in chapter 1.

For costs paid or incurred after September 8, 2008, you can deduct a limited amount of startup and organizational costs. The costs that aren't deducted currently can be amortized rat-ably over a 180-month period. The amortization period starts with the month you begin operat-ing your active trade or business. You aren't re-quired to attach a statement to make this elec-tion. You can choose to forgo this election by affirmatively electing to capitalize your startup costs on your income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. Once made, the election to either amortize or capital-ize startup costs is irrevocable and applies to all startup costs that are related to your trade or business. See Regulations sections 1.195-1, 1.248-1, and 1.709-1.

For costs paid or incurred after October 22, 2004, and before September 9, 2008, you can elect to deduct a limited amount of business startup and organizational costs in the year your active trade or business begins. Any costs not deducted can be amortized ratably over a 180-month period, beginning with the month you begin business. If the election is made, you must attach any statement required by Regula-tions sections 1.195-1(b), 1.248-1(c), and 1.709-1(c), as in effect before September 9, 2008.

Note. You can apply the provisions of Reg-ulations sections 1.195-1, 1.248-1, and 1.709-1 to all business startup and organizational costs paid or incurred after October 22, 2004, provi-ded the period of limitations on assessment hasn't expired for the year of the election. Oth-erwise, for business startup and organizational costs paid or incurred after October 22, 2004, and before September 9, 2008, the provisions under Regulations sections 1.195-1(b), 1.248-1(c), and 1.709-1(c), as in effect before September 9, 2008, will apply.

For costs paid or incurred before October 23, 2004, you can elect to amortize business startup and organizational costs over an amorti-zation period of 60 months or more. See How To Make the Election, later.

The cost must qualify as one of the follow-ing.

A business startup cost.
An organizational cost for a corporation.
An organizational cost for a partnership.

Business Startup Costs

Startup costs are amounts paid or incurred for

(a) creating an active trade or business, or (b) investigating the creation or acquisition of an active trade or business. Startup costs include amounts paid or incurred in connection with an existing activity engaged in for profit, and for the production of income in anticipation of the activ-ity becoming an active trade or business.

Chapter 8AmortizationPage 29

Qualifying costs. A startup cost is amortiza-ble if it meets both of the following tests.

It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into).

It is a cost you pay or incur before the day your active trade or business begins.

Startup costs include amounts paid for the following.

An analysis or survey of potential markets, products, labor supply, transportation fa-cilities, etc.
Advertisements for the opening of the busi-ness.

Salaries and wages for employees who are being trained and their instructors.

Travel and other necessary costs for se-curing prospective distributors, suppliers, or customers.
Salaries and fees for executives and con-sultants, or for similar professional serv-ices.

Nonqualifying costs. Startup costs don't in-clude deductible interest, taxes, or research and experimental costs. See Research and Ex-perimental Costs, later.

Purchasing an active trade or business. Amortizable startup costs for purchasing an ac-tive trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are costs that help you decide whether to purchase a business. Costs you incur in an attempt to purchase a specific business are capital expenses that you can't amortize.

Example. On June 1, you hired an ac-counting firm and a law firm to assist you in the potential purchase of XYZ, Inc. They re-searched XYZ's industry and analyzed the fi-nancial projections of XYZ, Inc. In September, the law firm prepared and submitted a letter of intent to XYZ, Inc. The letter stated that a bind-ing commitment would result only after a pur-chase agreement was signed. The law firm and accounting firm continued to provide services, including a review of XYZ's books and records and the preparation of a purchase agreement. On October 22, you signed a purchase agree-ment with XYZ, Inc.

All amounts paid or incurred to investigate the business before October 22 are amortizable investigative costs. Amounts paid on or after that date relate to the attempt to purchase the business and therefore must be capitalized.

Disposition of business. If you completely dispose of your business before the end of the amortization period, you can deduct any re-maining deferred startup costs. However, you can deduct these deferred startup costs only to the extent they qualify as a loss from a busi-ness.

Costs of Organizing a Corporation

Amounts paid to organize a corporation are the direct costs of creating the corporation.

Page 30Chapter 8Amortization

Qualifying costs. To qualify as an organiza-tional cost, it must be:

For the creation of the corporation,
Chargeable to a capital account (see chap-ter 1),

Amortized over the life of the corporation if the corporation had a fixed life, and

Incurred before the end of the first tax year in which the corporation is in business.

A corporation using the cash method of ac-counting can amortize organizational costs in-curred within the first tax year, even if it doesn't pay them in that year.

Examples of organizational costs include the following.

The cost of temporary directors.
The cost of organizational meetings.
State incorporation fees.
The cost of legal services.

Nonqualifying costs. The following items are capital expenses that can't be amortized.

Costs for issuing and selling stock or se-curities, such as commissions, professio-nal fees, and printing costs.
Costs associated with the transfer of as-sets to the corporation.

Costs of Organizing a Partnership

The costs to organize a partnership are the di-rect costs of creating the partnership.

Qualifying costs. A partnership can amortize an organizational cost only if it meets all the fol-lowing tests.

It is for the creation of the partnership and not for starting or operating the partnership trade or business.
It is chargeable to a capital account (see chapter 1).

It could be amortized over the life of the partnership if the partnership had a fixed life.
It is incurred by the due date of the partner-ship return (excluding extensions) for the first tax year in which the partnership is in business. However, if the partnership uses the cash method of accounting and pays the cost after the end of its first tax year, see Cash method partnership under How To Amortize, later.

It is for a type of item normally expected to benefit the partnership throughout its entire life.

Organizational costs include the following fees.

Legal fees for services incident to the or-ganization of the partnership, such as ne-gotiation and preparation of the partner-ship agreement.

Accounting fees for services incident to the organization of the partnership.

Filing fees.

Nonqualifying costs. The following costs can't be amortized.

The cost of acquiring assets for the part-nership or transferring assets to the part-nership.

The cost of admitting or removing partners, other than at the time the partnership is first organized.
The cost of making a contract concerning the operation of the partnership trade or business, including a contract between a partner and the partnership.

The costs for issuing and marketing inter-ests in the partnership such as brokerage, registration, and legal fees and printing costs. These “syndication fees” are capital expenses that can't be depreciated or amortized.

Liquidation of partnership. If a partnership is liquidated before the end of the amortization period, the unamortized amount of qualifying or-ganizational costs can be deducted in the part-nership's final tax year. However, these costs can be deducted only to the extent they qualify as a loss from a business.

How To Amortize

Deduct startup and organizational costs in equal amounts over the applicable amortization period (discussed earlier under Business Startup Costs). You can choose an amortization period for startup costs that is different from the period you choose for organizational costs, as long as both aren't less than the applicable am-ortization period. Once you choose an amorti-zation period, you can't change it.

To figure your deduction, divide your total startup or organizational costs by the months in the amortization period. The result is the amount you can deduct for each month.

Cash method partnership. A partnership us-ing the cash method of accounting can deduct an organizational cost only if it has been paid by the end of the tax year. However, any cost the partnership could have deducted as an organi-zational cost in an earlier tax year (if it had been paid that year) can be deducted in the tax year of payment.

How To Make the Election

To elect to amortize startup or organizational costs, you must complete and attach Form 4562 to your return for the first tax year you are in business. You may also be required to attach an organizational costs election statement (de-scribed later) to your return.

For startup or organizational costs paid or incurred after September 8, 2008, an accompa-nying statement isn't required. Generally, for startup or organizational costs paid or incurred before September 9, 2008, and after October 22, 2004, unless you choose to apply Regula-tions sections 1.195-1, 1.248-1, and 1.709-1, you must also attach an accompanying state-ment to elect to amortize the costs.

If you have both startup and organizational costs, attach a separate statement (if required) to your return for each type of cost. See Starting a Business, earlier, for more information.

Generally, you must file the return by the due date (including any extensions). However,

if you timely filed your return for the year without making the election, you can still make the elec-tion by filing an amended return within 6 months of the due date of the return (excluding exten-sions). For more information, see the instruc-tions for Part VI of Form 4562.

You can choose to forgo the election to am-ortize by affirmatively electing to capitalize your startup or organizational costs on your income tax return filed by the due date (including exten-sions) for the tax year in which the active trade or business begins.

Note. The election to either amortize or capitalize startup or organizational costs is ir-revocable and applies to all startup and organi-zational costs that are related to the trade or business.

If your business is organized as a corpora-tion or partnership, only the corporation or part-nership can elect to amortize its startup or or-ganizational costs. A shareholder or partner can't make this election. You, as a shareholder or partner, can't amortize any costs you incur in setting up your corporation or partnership. Only the corporation or partnership can amortize these costs.

However, you, as an individual, can elect to amortize costs you incur to investigate an inter-est in an existing partnership. These costs qual-ify as business startup costs if you acquire the partnership interest.

Startup costs election statement. If you elect to amortize your startup costs, attach a separate statement (if required) that contains the following information.

A description of the business to which the startup costs relate.

A description of each startup cost incurred.
The month your active business began (or was acquired).

The number of months in your amortization period (which is generally 180 months).

Filing the statement early. You can elect to amortize your startup costs by filing the state-ment with a return for any tax year before the year your active business begins. If you file the statement early, the election becomes effective in the month of the tax year your active busi-ness begins.

Revised statement. You can file a revised statement to include any startup costs not inclu-ded in your original statement. However, you can't include on the revised statement any cost you previously treated on your return as a cost other than a startup cost. You can file the re-vised statement with a return filed after the re-turn on which you elected to amortize your startup costs.

Organizational costs election statement. If you elect to amortize your corporation's or part-nership's organizational costs, attach a sepa-rate statement (if required) that contains the fol-lowing information.

A description of each cost.
The amount of each cost.
The date each cost was incurred.

The month your corporation or partnership began active business (or acquired the business).
The number of months in your amortization period (which is generally 180 months).

Partnerships. The statement prepared for a cash basis partnership must also indicate the amount paid before the end of the year for each cost.

You don't need to separately list any part-nership organizational cost that is less than $10. Instead, you can list the total amount of these costs with the dates the first and last costs were incurred.

After a partnership makes the election to amortize organizational costs, it can later file an amended return to include additional organiza-tional costs not included in the partnership's original return and statement.

Getting a Lease

If you get a lease for business property, you may recover the cost of acquiring the lease by amortizing it over the term of the lease. The term of the lease for amortization purposes gen-erally includes all renewal options (and any other period for which you and the lessor rea-sonably expect the lease to be renewed). How-ever, renewal periods aren't included if 75% or more of the cost of acquiring the lease is for the term of the lease remaining on the acquisition date (not including any period for which you may choose to renew, extend, or continue the lease).

For more information on the costs of getting a lease, see Cost of Getting a Lease in chapter 3.

How to amortize. Enter your deduction in Part VI of Form 4562 if you are deducting amor-tization that begins during the current year, or on the appropriate line of your tax return if you aren't otherwise required to file Form 4562.

Section 197 Intangibles

Generally, you may amortize the capitalized costs of “section 197 intangibles” (see Section 197 Intangibles Defined, later) ratably over a 15-year period. You must amortize these costs if you hold the section 197 intangibles in con-nection with your trade or business or in an ac-tivity engaged in for the production of income.

You may not be able to amortize sec-

tion 197 intangibles acquired in a trans-CAUTION action that didn't result in a significant change in ownership or use. See Anti-Churning Rules, later.

Your amortization deduction each year is the applicable part of the intangible's adjusted basis (for purposes of determining gain), fig-ured by amortizing it ratably over 15 years (180 months). The 15-year period begins with the later of:

The month the intangible is acquired, or
The month the trade or business or activity engaged in for the production of income begins.

You can't deduct amortization for the month you dispose of the intangible.

If you pay or incur an amount that increases the basis of an amortizable section 197 intangi-ble after the 15-year period begins, amortize it over the remainder of the 15-year period begin-ning with the month the basis increase occurs.

You aren't allowed any other depreciation or amortization deduction for an amortizable sec-tion 197 intangible.

Tax -exempt use property subject to a lease. The amortization period for any section 197 in-tangible leased under a lease agreement en-tered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign per-son or entity (other than a partnership), shall not be less than 125% of the lease term.

Cost attributable to other property. The rules for section 197 intangibles don't apply to any amount that is included in determining the cost of property that isn't a section 197 intangi-ble. For example, if the cost of computer soft-ware isn't separately stated from the cost of hardware or other tangible property and you consistently treat it as part of the cost of the hardware or other tangible property, these rules don't apply. Similarly, none of the cost of acquir-ing real property held for the production of rental income is considered the cost of good-will, going concern value, or any other section 197 intangible.

Section 197 Intangibles Defined

The following assets are section 197 intangibles and must be amortized over 180 months.

1. Goodwill.

2. Going concern value.

3. Workforce in place.

4. Business books and records, operating systems, or any other information base, in-cluding lists or other information concern-ing current or prospective customers.

5. A patent, copyright, formula, process, de-sign, pattern, know-how, format, or similar item.

6. A customer-based intangible.

7. A supplier-based intangible.

8. Any item similar to items 3 through 7.

9. A license, permit, or other right granted by a governmental unit or agency (including issuances and renewals).

10. A covenant not to compete entered into in connection with the acquisition of an inter-est in a trade or business.

11. Any franchise, trademark, or trade name.

12. A contract for the use of, or a term interest in, any item in this list.

Chapter 8AmortizationPage 31

You can't amortize any of the intangi-

bles listed in items 1 through 8 that you CAUTION created rather than acquired unless you created them in acquiring assets that make up a trade or business or a substantial part of a trade or business.

Goodwill. This is the value of a trade or busi-ness based on expected continued customer patronage due to its name, reputation, or any other factor.

Accounts receivable or other similar rights to income for goods or services provided to cus-tomers before the acquisition of a trade or busi-ness aren't section 197 intangibles.

Supplier-based intangible. A supplier-based intangible is the value resulting from the future acquisitions (through contract or other relation-ships with suppliers in the ordinary course of business) of goods or services that you will sell or use. The amount you pay or incur for sup-plier-based intangibles includes, for example,

Assets That Aren't Section 197 Intangibles

The following assets aren't section 197 intangi-bles.

1.	Any interest in a corporation, partnership,
	trust, or estate.
2.	Any interest under an existing futures con-
	tract, foreign currency contract, notional
	principal contract, interest rate swap, or

Going concern value.				This is the additional	any portion of the purchase price of an acquired
value of a trade or business that attaches to					trade or business that is attributable to the exis-
property because the property is an integral					tence of a favorable relationship with persons
part of an ongoing business activity. It includes					providing distribution services (such as a favor-
value based on the ability of a business to con-					able shelf or display space or a retail outlet), or
tinue to function and generate income even					the existence of favorable supply contracts.
though there is a change in ownership (but					Don't include any amount required to be paid
doesn't include any other section 197 intangi-					for the goods or services to honor the terms of
ble). It also includes value based on the imme-					the agreement or other relationship. Also, see
diate use or availability of an acquired trade or					Assets That Aren't Section 197 Intangibles	,

business, such as the use of earnings during					later.
any period in which the business wouldn't other-					Government-granted license, permit, etc.
wise be available or operational.
					This is any right granted by a governmental unit
Workforce in place, etc. This includes the					or an agency or instrumentality of a governmen-
composition of a workforce (for example, its ex-					tal unit. For example, you must amortize the
perience, education, or training). It also includes					capitalized costs of acquiring (including issuing
the terms and conditions of employment,					or renewing) a liquor license, a taxicab medal-
whether contractual or otherwise, and any other					lion or license, or a television or radio broad-
value placed on employees or any of their at-					casting license.
tributes.					Covenant not to compete. Section 197 intan-
	For example, you must amortize the part of
					gibles include a covenant not to compete (or
the purchase price of a business that is for the
					similar arrangement) entered into in connection
existence		of a highly skilled workforce. Also,
					with the acquisition of an interest in a trade or
you must amortize the cost of acquiring an ex-
					business, or a substantial portion of a trade or
isting employment contract or relationship with
					business. An interest in a trade or business in-
employees or consultants.
					cludes an interest in a partnership or a corpora-
Business books and records, etc. This in-					tion engaged in a trade or business.
					An arrangement that requires the former
cludes the intangible value of technical man-
uals, training manuals or programs, data files,					owner to perform services (or to provide prop-
and accounting or inventory control systems. It					erty or the use of property) isn't similar to a cov-
also includes the cost of customer lists; sub-					enant not to compete to the extent the amount
scription lists; insurance expirations; patient or					paid under the arrangement represents reason-
client files; and lists of newspaper, magazine,					able compensation for those services or for that
radio, and television advertisers.					property or its use.
Patents, copyrights, etc. This includes pack-					Franchise, trademark, or trade name. A
age design, computer software, and any inter-					franchise, trademark, or trade name is a section
est in a film, sound recording, videotape, book,					197 intangible. You must amortize its purchase
or other similar property, except as discussed					or renewal costs, other than certain contingent
later under Assets That Aren't Section 197 In-					payments that you can deduct currently. For in-
tangibles.					formation on currently deductible contingent
					payments, see chapter 11.
Customer-based intangible. This is the

					*Professional sports franchise.* A fran-
composition of market, market share, and any					chise engaged in professional sports and any
other value resulting from the future provision of					intangible assets acquired in connection with
goods or services because of relationships with					acquiring the franchise (including player con-
customers in the ordinary course of business.					tracts) is a section 197 intangible amortizable
For example, you must amortize the part of the					over a 15-year period.
purchase price of a business that is for the exis-
tence of the following intangibles.					Contract for the use of, or a term interest in,
•	A customer base.				a section 197 intangible. Section 197 intan-
•	A circulation base.				gibles include any right under a license, con-
•	An undeveloped market or market growth.				tract, or other arrangement providing for the use
•	Insurance in force.				of any section 197 intangible. It also includes
•	A mortgage servicing contract.				any term interest in any section 197 intangible,
•	An investment management contract.				whether the interest is outright or in trust.
•	Any other relationship with customers in-
	volving the future provision of goods or
	services.
Page 32			Chapter 8	Amortization

	similar financial contract.
3. Any interest in land.
4. Most computer software. (See Computer
	software, later.)

5. Any of the following assets not acquired in
	connection with the acquisition of a trade
	or business or a substantial part of a trade
	or business.
	a. An interest in a film, sound recording,
		videotape, book, or similar property.
	b. A right to receive tangible property or
		services under a contract or from a
		governmental agency.
	c. An interest in a patent or copyright.
	d. Certain rights that have a fixed dura-
		tion or amount. (See Rights of fixed
		duration or amount,	later.)

6. An interest under either of the following.
	a. An existing lease or sublease of tangi-
		ble property.
	b. A debt that was in existence when the
		interest was acquired.
7. A right to service residential mortgages
	unless the right is acquired in connection
	with the acquisition of a trade or business
	or a substantial part of a trade or business.
8. Certain transaction costs incurred by par-
	ties to a corporate organization or reorgan-
	ization in which any part of a gain or loss
	isn't recognized.

Intangible property that isn't amortizable un-der the rules for section 197 intangibles can be depreciated if it meets certain requirements. You must generally use the straight line method over its useful life. For certain intangibles, the depreciation period is specified in the law and regulations. For example, the depreciation pe-riod for computer software that isn't a section 197 intangible is generally 36 months.

For more information on depreciating intan-gible property, see Intangible Property under What Method Can You Use To Depreciate Your Property? in chapter 1 of Pub. 946.

Computer software. Section 197 intangibles don’t include the following types of computer software.

1. Software that meets all the following re-quirements.

a. It is, or has been, readily available for purchase by the general public.

b. It is subject to a nonexclusive license.

c. It hasn't been substantially modified. This requirement is considered met if the cost of all modifications isn't more than the greater of 25% of the price of the publicly available unmodified soft-ware or $2,000.

2. Software that isn't acquired in connection with the acquisition of a trade or business or a substantial part of a trade or business.

Computer software defined. Computer software includes all programs designed to cause a computer to perform a desired function. It also includes any database or similar item that is in the public domain and is incidental to the operation of qualifying software.

Rights of fixed duration or amount. Section 197 intangibles don't include any right under a contract or from a governmental agency if the right is acquired in the ordinary course of a trade or business (or in an activity engaged in for the production of income) but not as part of a purchase of a trade or business and either:

Has a fixed life of less than 15 years; or
Is of a fixed amount that, except for the rules for section 197 intangibles, would be recovered under a method similar to the unit-of-production method of cost recov-ery.

However, this doesn't apply to the following in-tangibles.

Goodwill.
Going concern value.
A covenant not to compete.
A franchise, trademark, or trade name.
A customer-related information base, cus-tomer-based intangible, or similar item.

Safe Harbor for Creative Property Costs

If you are engaged in the trade or business of film production, you may be able to amortize the creative property costs for properties not set for production within 3 years of the first capitalized transaction. You may amortize these costs rata-bly over a 15-year period beginning on the first day of the second half of the tax year in which you properly write off the costs for financial ac-counting purposes. If, during the 15-year pe-riod, you dispose of the creative property rights, you must continue to amortize the costs over the remainder of the 15-year period.

Creative property costs include costs paid or incurred to acquire and develop screenplays, scripts, story outlines, motion picture production rights to books and plays, and other similar properties for purposes of potential future film development, production, and exploitation.

Amortize these costs using the rules of Rev-enue Procedure 2004-36. For more information, see Revenue Procedure 2004-36, 2004-24 I.R.B. 1063, available at IRS.gov/irb/ 2004-24_IRB#RP-2004-36.

A change in the treatment of creative

property costs is a change in method of CAUTION accounting.

Anti-Churning Rules

Anti-churning rules prevent you from amortizing most section 197 intangibles if the transaction in which you acquired them didn't result in a sig-nificant change in ownership or use. These rules apply to goodwill and going concern value, and to any other section 197 intangible that isn't otherwise depreciable or amortizable.

Under the anti-churning rules, you can't use 15-year amortization for the intangible if any of the following conditions apply.

1. You or a related person (defined later) held or used the intangible at any time from July 25, 1991, through August 10, 1993.

2. You acquired the intangible from a person who held it at any time during the period in

(1) and, as part of the transaction, the user didn't change.

3. You granted the right to use the intangible to a person (or a person related to that person) who held or used it at any time during the period in (1). This applies only if the transaction in which you granted the right and the transaction in which you ac-quired the intangible are part of a series of related transactions. See Related person, later, for more information.

Exceptions. The anti-churning rules don't ap-ply in the following situations.

You acquired the intangible from a dece-dent and its basis was stepped up to its fair market value.
The intangible was amortizable as a sec-tion 197 intangible by the seller or trans-feror you acquired it from. This exception doesn't apply if the transaction in which you acquired the intangible and the trans-action in which the seller or transferor ac-quired it are part of a series of related transactions.

The gain-recognition exception, discussed later, applies.

Related person. For purposes of the anti-churning rules, the following are related persons.

An individual and his or her brothers, sis-ters, half brothers, half sisters, spouse, an-cestors (parents, grandparents, etc.), and lineal descendants (children, grandchil-dren, etc.).

A corporation and an individual who owns, directly or indirectly, more than 20% of the value of the corporation's outstanding stock.

Two corporations that are members of the same controlled group as defined in sec-tion 1563(a), except that “more than 20%” is substituted for “at least 80%” in that defi-nition and the determination is made with-out regard to subsections (a)(4) and (e)(3)

(C) of section 1563. For an exception, see section 1.197-2(h)(6)(iv) of the regulations.

A trust fiduciary and a corporation if more than 20% of the value of the corporation's outstanding stock is owned, directly or in-directly, by or for the trust or grantor of the trust.

The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.

The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two dif-ferent trusts, if the same person is the grantor of both trusts.

The executor and beneficiary of an estate.
A tax-exempt educational or charitable or-ganization and a person who directly or in-directly controls the organization (or whose family members control it).

A corporation and a partnership if the same persons own more than 20% of the value of the outstanding stock of the cor-poration and more than 20% of the capital or profits interest in the partnership.
Two S corporations, and an S corporation and a regular corporation, if the same per-sons own more than 20% of the value of the outstanding stock of each corporation.

Two partnerships if the same persons own, directly or indirectly, more than 20% of the capital or profits interests in both partner-ships.

A partnership and a person who owns, di-rectly or indirectly, more than 20% of the capital or profits interests in the partner-ship.

Two persons who are engaged in trades or businesses under common control (as de-scribed in section 41(f)(1)).

When to determine relationship. Per-sons are treated as related if the relationship existed at the following time.

In the case of a single transaction, immedi-ately before or immediately after the trans-action in which the intangible was ac-quired.

In the case of a series of related transac-tions (or a series of transactions that com-prise a qualified stock purchase under sec-tion 338(d)(3)), immediately before the earliest transaction or immediately after the last transaction.

Ownership of stock. In determining whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.

Rule 1. Stock directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries.

Rule 2. An individual is considered to own the stock directly or indirectly owned by or for his or her family. Family includes only brothers and sisters, half brothers and half sisters, spouse, ancestors, and lineal descendants.

Rule 3. An individual owning (other than by applying Rule 2) any stock in a corporation is considered to own the stock directly or indi-rectly owned by or for their partner.

Rule 4. For purposes of applying Rule 1, 2, or 3, treat stock constructively owned by a per-son under Rule 1 as actually owned by that per-son. Don't treat stock constructively owned by an individual under Rule 2 or 3 as owned by the individual for reapplying Rule 2 or 3 to make an-other person the constructive owner of the stock.

Chapter 8AmortizationPage 33

Gain-recognition exception. This exception to the anti-churning rules applies if the person you acquired the intangible from (the transferor) meets both of the following requirements.

That person wouldn't be related to you (as described under Related person, earlier) if the 20% test for ownership of stock and partnership interests were replaced by a 50% test.

That person chose to recognize gain on the disposition of the intangible and pay in-come tax on the gain at the highest tax rate. See chapter 2 of Pub. 544 for infor-mation on making this choice.

If this exception applies, the anti-churning rules apply only to the amount of your adjusted basis in the intangible that is more than the gain recognized by the transferor.

Notification. If the person you acquired the intangible from chooses to recognize gain under the rules for this exception, that person must notify you in writing by the due date of the return on which the choice is made.

Anti-abuse rule. You can't amortize any sec-tion 197 intangible acquired in a transaction for which the principal purpose was either of the following.

To avoid the requirement that the intangi-ble be acquired after August 10, 1993.
To avoid any of the anti-churning rules.

More information. For more information about the anti-churning rules, including addi-tional rules for partnerships, see Regulations section 1.197-2(h).

Incorrect Amount of Amortization Deducted

If you later discover that you deducted an incor-rect amount for amortization for a section 197 intangible in any year, you may be able to make a correction for that year by filing an amended return. See Amended Return next. If you aren't allowed to make the correction on an amended return, you can change your accounting method to claim the correct amortization. See Changing Your Accounting Method, later.

Amended Return

If you deducted an incorrect amount for amorti-zation, you can file an amended return to cor-rect the following.

A mathematical error made in any year.
A posting error made in any year.
An amortization deduction for a section 197 intangible for which you haven't adop-ted a method of accounting.

When to file. If an amended return is allowed, you must file it by the later of the following dates.

3 years from the date you filed your original return for the year in which you didn't de-duct the correct amount. (A return filed early is considered filed on the due date.)

2 years from the time you paid your tax for that year.

Page 34Chapter 8Amortization

Changing Your Accounting Method

Generally, you must get IRS approval to change your method of accounting. File Form 3115 to request a change to a permissible method of accounting for amortization.

The following are examples of a change in method of accounting for amortization.

A change in the amortization method, pe-riod of recovery, or convention of an amor-tizable asset.
A change in the accounting for amortizable assets from a single asset account to a multiple asset account (pooling), or vice versa.

A change in the accounting for amortizable assets from one type of multiple asset ac-count to a different type of multiple asset account.

Changes in amortization that aren't a change in method of accounting include the fol-lowing.

A change in figuring amortization in the tax year in which your use of the asset changes.
An adjustment in the useful life of an amor-tizable asset.

Generally, the making of a late amortiza-tion election or the revocation of a timely valid amortization election.
Any change in the placed-in-service date of an amortizable asset.

See Regulations section 1.446-1(e)(2)(ii)(a) for more information and examples.

Automatic approval. In some instances, you may be able to get automatic approval from the IRS to change your method of accounting for amortization. For a list of automatic accounting method changes, see the Instructions for Form 3115. Also, see the Instructions for Form 3115 for more information on getting approval, auto-matic approval procedures, and a list of excep-tions to the automatic approval process.

Disposition of Section 197 Intangibles

A section 197 intangible is treated as deprecia-ble property used in your trade or business. If you held the intangible for more than 1 year, any gain on its disposition, up to the amount of allowable amortization, is ordinary income (sec-tion 1245 gain). If multiple section 197 intangi-bles are disposed of in a single transaction or a series of related transactions, treat all of the section 197 intangibles as if they were a single asset for purposes of determining the amount of gain that is ordinary income. Any remaining gain, or any loss, is a section 1231 gain or loss. If you held the intangible 1 year or less, any gain or loss on its disposition is an ordinary gain or loss. For more information on ordinary or capital gain or loss on business property, see chapter 3 of Pub. 544.

Nondeductible loss. You can't deduct any loss on the disposition or worthlessness of a section 197 intangible that you acquired in the same transaction (or series of related transac-

tions) as other section 197 intangibles you still have. Instead, increase the adjusted basis of each remaining amortizable section 197 intangi-ble by a proportionate part of the nondeductible loss. Figure the increase by multiplying the non-deductible loss on the disposition of the intangi-ble by the following fraction.

The numerator is the adjusted basis of each remaining intangible on the date of the disposition.
The denominator is the total adjusted basis of all remaining amortizable section 197 in-tangibles on the date of the disposition.

Covenant not to compete. A covenant not to compete, or similar arrangement, isn't consid-ered disposed of or worthless before you dis-pose of your entire interest in the trade or busi-ness for which you entered into the covenant.

Nonrecognition transfers. If you acquire a section 197 intangible in a nonrecognition trans-fer, you are treated as the transferor with re-spect to the part of your adjusted basis in the in-tangible that isn't more than the transferor's adjusted basis. You amortize this part of the ad-justed basis over the intangible's remaining am-ortization period in the hands of the transferor. Nonrecognition transfers include transfers to a corporation, partnership contributions and dis-tributions, like-kind exchanges, and involuntary conversions.

In a like-kind exchange or involuntary con-version of a section 197 intangible, you must continue to amortize the part of your adjusted basis in the acquired intangible that isn't more than your adjusted basis in the exchanged or converted intangible over the remaining amorti-zation period of the exchanged or converted in-tangible. Amortize over a new 15-year period the part of your adjusted basis in the acquired intangible that is more than your adjusted basis in the exchanged or converted intangible.

Example. You own a section 197 intangi-ble you have amortized for 4 full years. It has a remaining unamortized basis of $30,000. You exchange the asset plus $10,000 for a like-kind section 197 intangible. The nonrecognition pro-visions of like-kind exchanges apply. You amor-tize $30,000 of the $40,000 adjusted basis of the acquired intangible over the 11 years re-maining in the original 15-year amortization pe-riod for the transferred asset. You amortize the other $10,000 of adjusted basis over a new 15-year period. For more information, see Reg-ulations section 1.197-2(g).

Reforestation Costs

You can elect to deduct a limited amount of re-forestation costs paid or incurred during the tax year. See Reforestation Costs in chapter 7. You can elect to amortize the qualifying costs that aren't deducted currently over an 84-month pe-riod. There is no limit on the amount of your am-ortization deduction for reforestation costs paid or incurred during the tax year.

The election to amortize reforestation costs incurred by a partnership, S corporation, or es-tate must be made by the partnership, corpora-tion, or estate. A partner, shareholder, or beneficiary can't make that election.

A partner's or shareholder's share of amor-tizable costs is figured under the general rules for allocating items of income, loss, deduction, etc., of a partnership or S corporation. The am-ortizable costs of an estate are divided between the estate and the income beneficiary based on the income of the estate allocable to each.

Qualifying costs. Reforestation costs are the direct costs of planting or seeding for foresta-tion or reforestation. Qualifying costs include only those costs you must capitalize and in-clude in the adjusted basis of the property. They include costs for the following items.

Site preparation.
Seeds or seedlings.
Labor.
Tools.
Depreciation on equipment used in plant-ing and seeding.

Qualifying costs don't include costs for which the government reimburses you under a cost-sharing program, unless you include the reimbursement in your income.

Qualified timber property. Qualified timber property is property that contains trees in signif-icant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all of the following re-quirements.

It is located in the United States.
It is held for the growing and cutting of tim-ber you will use in, or sell for use in, the commercial production of timber products.

It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

Qualified timber property doesn't include property on which you have planted shelter belts or ornamental trees, such as Christmas trees.

Amortization period. The 84-month amorti-zation period starts on the first day of the first month of the second half of the tax year you in-cur the costs (July 1 for a calendar year tax-payer), regardless of the month you actually in-cur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

Life tenant and remainderman. If one per-son holds the property for life with the remain-der going to another person, the life tenant is entitled to the full amortization for qualifying re-forestation costs incurred by the life tenant. Any remainder interest in the property is ignored for amortization purposes.

Recapture. If you dispose of qualified timber property within 10 years after the tax year you incur qualifying reforestation expenses, report any gain as ordinary income up to the amortiza-tion you took. See chapter 3 of Pub. 544 for more information.

How to make the election. To elect to amor-tize qualifying reforestation costs, complete Part VI of Form 4562 and attach a statement that contains the following information.

A description of the costs and the dates you incurred them.

A description of the type of timber being grown and the purpose for which it is grown.

Attach a separate statement for each property for which you amortize reforestation costs.

Generally, you must make the election on a timely filed return (including extensions) for the tax year in which you incurred the costs. How-ever, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach Form 4562 and the state-ment to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

Revoking the election. You must get IRS ap-proval to revoke your election to amortize quali-fying reforestation costs. Your application to re-voke the election must include your name, address, the years for which your election was in effect, and your reason for revoking it. Pro-vide your daytime telephone number (optional), in case we need to contact you. You, or your duly authorized representative, must sign the application and file it at least 90 days before the due date (without extensions) for filing your in-come tax return for the first tax year for which your election is to end.

Send the application to:

Internal Revenue Service

Associate Chief Counsel

Passthroughs and Special Industries

CC:PSI:6

1111 Constitution Ave. NW, IR-5300

Washington, DC 20224

Geological and Geophysical Costs

You can amortize the cost of geological and ge-ophysical expenses paid or incurred in connec-tion with oil and gas exploration or development within the United States. These costs can be amortized ratably over a 24-month period be-ginning on the midpoint of the tax year in which the expenses were paid or incurred. For major integrated oil companies (as defined in section 167(h)(5)), these costs must be amortized rata-bly over a 7-year period for costs paid or incur-red after December 19, 2007 (a 5-year period for costs paid or incurred after May 17, 2006, and before December 20, 2007).

If you retire or abandon the property during the amortization period, no amortization deduc-tion is allowed in the year of retirement or aban-donment.

Pollution Control Facilities

You can elect to amortize the cost of a certified pollution control facility over 60 months. How-ever, see Atmospheric pollution control facili-ties, later, for an exception. The cost of a pollu-tion control facility that isn't eligible for amortization can be depreciated under the reg-ular rules for depreciation. Also, you can claim a special depreciation allowance on a certified pollution control facility that is qualified property even if you elect to amortize its cost. You must reduce its cost (amortizable basis) by the amount of any special allowance you claim. See chapter 3 of Pub. 946.

A certified pollution control facility is a new identifiable treatment facility used in connection with a plant or other property in operation be-fore 1976 to reduce or control water or atmos-pheric pollution or contamination. The facility must do so by removing, changing, disposing, storing, or preventing the creation or emission of pollutants, contaminants, wastes, or heat. The facility must be certified by state and fed-eral certifying authorities.

The facility must not significantly increase the output or capacity, extend the useful life, or reduce the total operating costs of the plant or other property. Also, it must not significantly change the nature of the manufacturing or pro-duction process or facility.

The federal certifying authority won't certify your property to the extent it appears you will recover (over the property's useful life) all or part of its cost from the profit based on its oper-ation (such as through sales of recovered wastes). The federal certifying authority will de-scribe the nature of the potential cost recovery. You must then reduce the amortizable basis of the facility by this potential recovery.

New identifiable treatment facility. A new identifiable treatment facility is tangible de-preciable property that is identifiable as a treat-ment facility. It doesn't include a building and its structural components unless the building is ex-clusively a treatment facility.

Atmospheric pollution control facilities. Certain atmospheric pollution control facilities can be amortized over 84 months. To qualify, the following must apply.

The facility must be acquired and placed in service after April 11, 2005. If acquired, the original use must begin with you after April 11, 2005.

The facility must be used in connection with an electric generation plant or other property placed in operation after Decem-ber 31, 1975, that is primarily coal fired.

If you construct, reconstruct, or erect the facility, only the basis attributable to the construction, reconstruction, or erection completed after April 11, 2005, qualifies.

Basis reduction for corporations. A corpo-ration must reduce the amortizable basis of a pollution control facility by 20% before figuring the amortization deduction.

Chapter 8AmortizationPage 35

More information. For more information on the amortization of pollution control facilities, see sections 169 and 291(c) and the related regulations.

Research and Experimental Costs

You must amortize specified research or experi-mental costs paid or incurred in tax years begin-ning after 2021.

You must amortize specified research or ex-perimental costs ratably over a 5-year period beginning with the midpoint of the tax year in which the expenditures were paid or incurred. Research or experimental expenditures attribut-able to foreign research conducted outside the United States, Puerto Rico, or any possession of the United States must be amortized ratably over a 15-year period beginning with the mid-point of the tax year in which the expenditures were paid or incurred. This includes any amounts paid or incurred in connection with the development of software which are not other-wise excluded expenditures under Internal Rev-enue Code section 174 and Treasury Regula-tions section 1.174-2. For a definition of “research and experimental costs,” see chap-ter 7.

How to make the election. To change to the required method of accounting for specified re-search or experimental expenditures in the first tax year beginning after December 31, 2021, at-tach the statement in lieu of Form 3115 as de-scribed in section 7.02(5) of Revenue Procedure 2023-11 to your income tax return. You must also complete Part VI of Form 4562 and attach it to your income tax return. Gener-ally, you must file the return by due date (includ-ing extensions). However, if you timely filed your return for the year without attaching the statement in lieu of Form 3115 or completed Part VI of Form 4562, you can make the elec-tion by filing an amended return within 6 months of the due date of the return (including exten-sions). Attach the required statement and com-pleted Form 4562 to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

Optional Write-off of Certain Tax Preferences

You can elect to amortize certain tax preference items over an optional period beginning in the tax year in which you incurred the costs. If you make this election, there is no alternative mini-mum tax adjustment. The applicable costs and the optional recovery periods are as follows.

Circulation costs—3 years.
Intangible drilling and development costs—60 months.

Mining exploration and development costs—10 years.

Research and experimental expenditures paid or incurred in tax years beginning be-fore January 1, 2022 (section 174(a) prior to amendment by section 13206(a) of P.L.

Page 36Chapter 9Depletion

115-97)—10 years. Amortization for these costs should be reported on line 43 of Form 4562.

How to make the election. To elect to amor-tize qualifying costs over the optional recovery period, complete Part VI of Form 4562 and at-tach a statement containing the following infor-mation to your return for the tax year in which the election begins.

Your name, address, and taxpayer identifi-cation number.

The type of cost and the specific amount of the cost for which you are making the elec-tion.

Generally, the election must be made on a timely filed return (including extensions) for the tax year in which you incurred the costs. How-ever, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach Form 4562 to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

Note. The amortization deduction and re-search and experimental expenditures under former section 174(b) or the dollar amount of re-search and experimental expenditures for which you elected to amortize over the 10-year period under section 59(e) must be reported on line 43 of Form 4562. Attach a statement that shows (a) a description of the costs, (b) the date amortization began, (c) the amortizable amount, (d) the applicable Code section, (e) the amortization period, (f) the accumulated amorti-zation, and (g) the amortization amount for this year.

Revoking the election. You must obtain con-sent from the IRS to revoke your section 59(e) election. Your request to revoke the election must be submitted to the IRS in the form of a letter ruling before the end of the tax year in which the optional recovery period ends. The request must contain all of the information nec-essary to demonstrate the rare and unusual cir-cumstances that would justify granting revoca-tion. If the request for revocation is approved, any unamortized costs are deductible in the year the revocation is effective.

9.

Depletion

What’s New

Corporate alternative minimum tax reinsta-ted in 2023. P.L. 117-169, August 16, 2022,

amended section 55 to impose a corporate al-ternative minimum tax. The amendment applies to tax years beginning after 2022.

Excise tax to fund Black Lung Benefits. P.L. 117-169 also amended section 4121 to elimi-nate the reduction in tax on coal from mines lo-cated in the United States sold by the producer. The amendment applies to sales in calendar quarters beginning after August 17, 2022.

Reminders

Domestic production activities deduction repealed. P.L. 115-97, December 22, 2017, repealed section 199, which provided a deduc-tion for income attributable to domestic produc-tion activities. The amendment applies to tax years beginning after 2017.

Qualified business income deduction enac-ted. P.L. 115-97 also added section 199A, which provides a deduction for qualified busi-ness income. The amendment applies to tax years beginning after 2017. Section 199A does not apply to tax years beginning after 2025.

Introduction

Depletion is the using up of natural resources extracted from a mineral property by mining, drilling, quarrying stone, or cutting timber. The depletion deduction allows an owner or opera-tor to account for the reduction of the mineral property’s value or basis as a result of the ex-traction of the natural resource.

There are two ways of figuring depletion: cost depletion and percentage depletion. For oil and gas wells, mines, other natural deposits (in-cluding geothermal deposits), and mineral property, you must generally use the method that gives you the larger deduction. For stand-ing timber, you must use cost depletion.

Topics

This chapter discusses:

Who can claim depletion
Mineral property
Timber

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions of

Assets

551 Basis of Assets

Form (and Instructions)

Schedule E (Form 1040) Supplemental Income and Loss

Schedule K-1 (Form 1065) Partner’s Share of Income, Deductions, Credits, etc.

Schedule K-1 (Form 1120-S) Shareholder's Share of Income, Deductions, Credits, etc.

6198 At-Risk Limitations

8582 Passive Activity Loss Limitations

T (Timber) Forest Activities Schedule

See chapter 12 for information about getting publications and forms.

Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber, you can take a de-duction for depletion. More than one person can have an economic interest in the same min-eral deposit or timber. In the case of leased property, the depletion deduction is divided be-tween the lessor and the lessee.

You have an economic interest if both the following apply.

You have acquired by investment any in-terest in mineral deposits or standing tim-ber.
You have a legal right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from prod-ucts of the mineral deposit or standing timber is not, in itself, an economic interest.

Depletion is an item of tax preference

under the Alternative Minimum Tax CAUTION (AMT). See section 57.

Basis adjustment for depletion. You must reduce the basis of your property by the deple-tion allowed or allowable, whichever is greater, but not below zero.

Mineral Property

Mineral property includes oil and gas wells, mines, and other natural deposits (including ge-othermal deposits). For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 and the related regulations for rules on how to treat sep-arate mineral interests.

There are two ways of figuring depletion on mineral property.

Cost depletion.
Percentage depletion.

Generally, you must use the method that gives you the larger deduction. However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells. See Oil and Gas Wells, later.

Cost Depletion

To figure cost depletion, you must first deter-mine the following.

The property's basis for depletion.
The total recoverable units of mineral in the property's natural deposit.

The number of units of mineral sold during the tax year.

Basis for depletion. To figure the property's basis for depletion, subtract all the following from the property's adjusted basis.

1. Amounts recoverable through:

a. Depreciation deductions,

b. Deferred expenses (including defer-red exploration and development costs), and

c. Deductions other than depletion.

2. The residual value of land and improve-ments at the end of operations.

3. The cost or value of land acquired for pur-poses other than mineral production.

Adjusted basis. The adjusted basis of your property is your original cost or other ba-sis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Your adjusted basis can never be less than zero. See Pub. 551 for more information on adjusted ba-sis.

Total recoverable units. The total recovera-ble units is the sum of the following.

The number of units of mineral remaining at the end of the year (including units re-covered but not sold).
The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next).

You must estimate or determine recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral prod-ucts using the current industry method and the most accurate and reliable information you can obtain. You must include ores and minerals that are developed, in sight, blocked out, or as-sured. You must also include probable or pro-spective ores or minerals that are believed to exist based on good evidence. But see Elective safe harbor for owners of oil and gas property, later.

Number of units sold during the tax year. You determine the number of units sold during the tax year based on your method of account-ing. Use the following table to make this deter-mination.

IF you	THEN the units sold during
use ...	the tax year are ...
the cash method	the units sold for which you
of accounting	receive payment during the tax
	year (regardless of the year of
	sale).
an accrual	the units sold based on your
method of	inventories and method of
accounting	accounting for inventory.

The number of units sold during the tax year does not include any for which depletion deduc-tions were allowed or allowable in earlier years.

Figuring the cost depletion deduction. Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you

can figure your cost depletion deduction by tak-ing the following steps.

Step	Action	Result
1	Divide your property's	Depletion unit.
	basis for depletion by
	total recoverable units.
2	Multiply the depletion	Cost depletion
	unit by units sold	deduction.
	during the tax year.

You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed.

Elective safe harbor for owners of oil and gas property. Instead of using the method de-scribed earlier to determine the total recovera-ble units, you can use an elective safe harbor to determine the property’s recoverable reserves for purposes of figuring cost depletion. If you choose the elective safe harbor, the total recov-erable units equal 105% of a property's proved reserves (both developed and undeveloped). For details, see Revenue Procedure 2004-19 on page 563 of I.R.B. 2004-10, available at IRS.gov/irb/2004-10_IRB#RP-2004-19.

To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. The election, if made, is effective for the tax year in which it is made and all later years. It cannot be revoked for the tax year in which it is elected, but it may be revoked in a later year. Once revoked, it cannot be re-elected for the next 5 years.

Percentage Depletion

To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year.

The rates to be used and other rules for oil and gas wells are discussed later under Inde-pendent Producers and Royalty Owners and under Natural Gas Wells. Rates and other rules for percentage depletion of other specific miner-als are found later under Mines and Geothermal Deposits.

Gross income. When figuring percentage de-pletion, subtract from your gross income from the property the following amounts.

Any rents or royalties you paid or incurred for the property.

The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year.

A bonus payment includes amounts you paid as a lessee to satisfy a production payment re-tained by the lessor.

Use the following fraction to figure the part of the bonus you must subtract.

No. of units sold in the tax year	×	Bonus

Recoverable units from the property		Payments

For oil and gas wells and geothermal depos-its, more information about the definition of

Chapter 9DepletionPage 37

gross income from the property is under Oil and Gas Wells, later. For other property, more infor-mation about the definition of gross income from the property is under Mines and Geother-mal Deposits, later.

Taxable income limit. The percentage deple-tion deduction generally cannot be more than 50% (100% for oil and gas property) of your tax-able income from the property figured without the depletion deduction, and any deduction un-der section 199A.

Taxable income from the property means gross income from the property minus all allow-able deductions (except any deduction for de-pletion or qualified business income) attributa-ble to mining processes, including limited mining transportation. These deductible items include, but are not limited to, the following.

Operating expenses.
Certain selling expenses.
Administrative and financial overhead.
Depreciation.
Intangible drilling and development costs.
Exploration and development expendi-tures.

Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit.
Losses sustained.

The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.

Do not deduct any net operating loss (NOL) deduction from the gross income from the property.
Corporations do not deduct charitable con-tributions from the gross income from the property.
If, during the year, you dispose of an item of section 1245 property that was used in connection with mineral property, reduce any allowable deduction for mining expen-ses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See Regulations section 1.613-5(b)(1) for information on how to fig-ure the ordinary gain allocable to the prop-erty.

Oil and Gas Wells

You cannot claim percentage depletion for an oil or gas well unless at least one of the follow-ing applies.

You are either an independent producer or a royalty owner.

The well produces one of the following: regulated natural gas, natural gas sold un-der a fixed contract, or natural gas from ge-opressured brine.

If you are an independent producer or roy-alty owner, see Independent Producers and Royalty Owners next.

For information on the depletion deduction for wells that produce regulated natural gas, natural gas sold under a fixed contract, or natu-ral gas from geopressured brine, see Natural Gas Wells, later.

Page 38Chapter 9Depletion

Independent Producers and Royalty Owners

If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the prop-erty based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. How-ever, an independent producer or royalty owner that also acts as a retailer or refiner may be ex-cluded from claiming percentage depletion. For information on figuring the deduction, see Figur-ing percentage depletion, later.

Refiners who cannot claim percentage de-pletion. You cannot claim percentage deple-tion if you or a related person refines crude oil and you and the related person refined more than 75,000 barrels on any day during the tax year based on average (rather than actual) daily refinery runs for the tax year. The average daily refinery run is figured by dividing total refinery runs for the tax year by the total number of days in the tax year.

Related person. You and another person are related persons if either of you holds a sig-nificant ownership interest in the other person or if a third person holds a significant ownership interest in both of you.

For example, a corporation, partnership, es-tate, or trust and anyone who holds a significant ownership interest in it are related persons. A partnership and a trust are related persons if one person holds a significant ownership inter-est in each of them.

For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more in any one of the following.

The value of the outstanding stock of a corporation.

The interest in the profits or capital of a partnership.

The beneficial interests in an estate or trust.

Any interest owned by or for a corporation, partnership, trust, or estate is considered to be owned directly both by itself and proportionately by its shareholders, partners, or beneficiaries.

Retailers who cannot claim percentage de-pletion. You cannot claim percentage deple-tion if both the following apply.

1. You sell oil or natural gas or their byprod-ucts directly or through a related person in any of the following situations.

a. Through a retail outlet operated by you or a related person.

b. To any person who is required under an agreement with you or a related person to use a trademark, trade name, or service mark or name owned by you or a related person in marketing or distributing oil, natural gas, or their byproducts.

c. To any person given authority under an agreement with you or a related

person to occupy any retail outlet owned, leased, or controlled by you or a related person.

2. The combined gross receipts from sales (not counting resales) of oil, natural gas, or their byproducts by all retail outlets taken into account in (1) are more than $5 million for the tax year.

For the purpose of determining if this rule applies, do not count the following.

Bulk sales (sales in very large quantities) of oil or natural gas to commercial or indus-trial users.
Bulk sales of aviation fuels to the Depart-ment of Defense.

Sales of oil or natural gas or their byprod-ucts outside the United States if none of your domestic production or that of a rela-ted person is exported during the tax year or the prior tax year.

Related person. To determine if you and another person are related persons, see Rela-ted person under Refiners who cannot claim percentage depletion, earlier.

Sales through a related person. You are considered to be selling oil or natural gas (or a product derived therefrom) through a related person if any sale by the related person produ-ces gross income from which you may benefit because of your direct or indirect ownership in-terest in the related person.

You are not considered to be selling oil or natural gas (or a product derived therefrom) through a related person who is a retailer if all of the following apply.

You do not own a significant ownership in-terest in the retailer.

You sell your production to persons who are not related to either you or the retailer.
The retailer does not buy oil or natural gas from your customers or persons related to your customers.
There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase by the retailer.

Neither you nor the retailer knows of, or controls, the final disposition of the oil or natural gas you sold or the original source of the petroleum products the retailer ac-quired for resale.

Transferees who cannot claim percentage depletion. You cannot claim percentage de-pletion if you received your interest in a proven oil or gas property by transfer after 1974 and before October 12, 1990. For a definition of the term “transfer,” see Regulations section 1.613A-7(n). For a definition of the term “inter-est in proven oil or gas property,” see Regula-tions section 1.613A-7(p).

Figuring percentage depletion. Generally, as an independent producer or royalty owner, you figure your percentage depletion by figuring your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (as defined under Gross income

from the property, later) by 15% (0.15). If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later un-der Average daily production.

In addition, there is a limit on the percentage depletion deduction. See Taxable income limit, later.

Average daily production. Figure your aver-age daily production by dividing your total do-mestic production of oil or gas for the tax year by the number of days in your tax year.

Partial interest. If you have a partial inter-est in the production from a property, figure your share of the production by multiplying total production from the property by your percent-age participation in the revenues from the prop-erty.

You have a partial interest in the production from a property if you have a net profits interest in the property. To figure the share of produc-tion for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross reve-nue from the property. To figure this percent-age, you divide the income you receive for your net profits interest by the gross revenue from the property. Then multiply the total production from the property by your percentage participa-tion to figure your share of the production.

Example. Riley owns oil property in which Finley owns a 20% net profits interest. During the year, the property produced 10,000 barrels of oil, which Riley sold for $200,000. Riley had expenses of $90,000 attributable to the prop-erty. The property generated a net profit of $110,000 ($200,000 − $90,000). Finley re-ceived income of $22,000 ($110,000 × 20% (0.20)) as Finley’s net profits interest.

The percentage participation that Finley de-termined was 11%, figured by dividing $22,000 (income received) by $200,000 (the gross reve-nue from the property). Finley’s share of the oil production was determined to be 1,100 barrels (10,000 barrels × 11% (0.11)).

Depletable oil or natural gas quantity. Gen-erally, your depletable oil quantity is 1,000 bar-rels. Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. If you claim depletion on both oil and natural gas, you must reduce your de-pletable oil quantity (1,000 barrels) by the num-ber of barrels you use to figure your depletable natural gas quantity.

Example. You have both oil and natural gas production. To figure your depletable natu-ral gas quantity, you choose to apply 360 bar-rels of your 1,000-barrel depletable oil quantity. Your depletable natural gas quantity is 2.16 mil-lion cubic feet of gas (360 × 6,000). You must reduce your depletable oil quantity to 640 bar-rels (1,000 – 360).

If you have production from marginal wells, see section 613A(c)(6) to figure your depletable oil or natural gas quantity. See also Notice 2022-24, available at IRS.gov/irb/2022-21_IRB.

Business entities and family members.

You must allocate the depletable oil or gas

quantity among the following related persons in proportion to each business entity's or family member's production of domestic oil or gas for the year.

Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering only persons that own at least 5% of the beneficial interest).

You and your spouse and minor children.

A related person is anyone mentioned in the re-lated persons discussion under Nondeductible loss in chapter 2 of Pub. 544, except that for purposes of this allocation, item (1) in that dis-cussion includes only an individual, spouse, and their minor children.

Controlled group of corporations. Mem-bers of the same controlled group of corpora-tions are treated as one taxpayer when figuring the depletable oil or natural gas quantity. They share the depletable quantity. A controlled group of corporations is defined in section 1563(a), except that, for this purpose, the stock ownership requirement is “more than 50%” rather than “at least 80%,” as described in sec-tion 1563(a).

Gross income from the property. For purpo-ses of percentage depletion, gross income from the property (in the case of oil and gas wells) is the amount you receive from the sale of the oil or gas in the immediate vicinity of the well. If you do not sell the oil or gas on the property but manufacture or convert it into a refined product before sale, or transport it before sale, the gross income from the property is the representative market or field price (RMFP) of the oil or gas before conversion or transportation.

However, if you sold gas after you transpor-ted it from the premises for a price that is lower than the RMFP, determine gross income from the property for percentage depletion purposes without regard to the RMFP.

Gross income from the property does not in-clude lease bonuses, advance royalties, or other amounts payable without regard to pro-duction from the property.

Average daily production exceeds depleta-ble quantities. If your average daily produc-tion for the year is more than your depletable oil or natural gas quantity, figure your allowance for depletion for each domestic oil or natural gas property as follows.

1. Figure your average daily production of oil or natural gas for the year.

2. Figure your depletable oil or natural gas quantity for the year.

3. Figure depletion for all oil or natural gas produced from the property using a per-centage depletion rate of 15% (0.15).

4. Multiply the result figured in (3) by a frac-tion, the numerator of which is the result figured in (2) and the denominator of which is the result figured in (1). This is your depletion allowance for that property for the year.

Taxable income limit. If you are an independ-ent producer or royalty owner of oil and gas,

your deduction for percentage depletion is limi-ted to the smaller of the following.

100% of your taxable income from the property figured without the deduction for depletion and the deduction for qualified business income under section 199A. For a definition of taxable income from the property, see Taxable income limit, earlier, under Mineral Property.

65% of your taxable income for the year figured without the deduction for depletion, the deduction for qualified business in-come under section 199A, any net operat-ing loss carryback to the tax year under section 172, any capital loss carryback to the tax year under section 1212, and in the case of a trust, any distribution to its bene-ficiary (with certain exceptions).

You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Add it to your de-pletion allowance (before applying any limits) for the following year.

Partnerships and S Corporations

Generally, each partner or S corporation share-holder, and not the partnership or S corpora-tion, figures the depletion allowance separately. Each partner or shareholder must decide whether to use cost or percentage depletion. A partner or shareholder using percentage deple-tion must apply the 65% -of-taxable-income limit using its taxable income from all sources.

Partner's or shareholder's adjusted basis. The partnership or S corporation must allocate to each partner or shareholder its share of the adjusted basis of each oil or gas property held by the partnership or S corporation. The part-nership or S corporation makes the allocation as of the date it acquires the oil or gas property.

Each partner's share of the adjusted basis of the oil or gas property is generally figured ac-cording to that partner's interest in partnership capital. However, in some cases, it is figured according to the partner's interest in partnership income.

The partnership or S corporation adjusts the partner's or shareholder's share of the adjusted basis of the oil and gas property for any capital expenditures made for the property and for any change in partnership or S corporation inter-ests.

Recordkeeping.Eachpartneror

shareholder must separately keep re-RECORDS cords of its share of the adjusted basis in each oil and gas property of the partnership or S corporation. The partner or shareholder must reduce its applicable adjusted basis by the depletion allowed or allowable on the prop-erty each year. The partner or shareholder must use that reduced adjusted basis to figure cost depletion, or its gain or loss, if the partnership or S corporation disposes of the property.

Reporting the deduction. Information that you, as a partner or shareholder, use to figure your depletion deduction on oil and gas proper-ties is reported by the partnership or S corpora-tion on Schedule K-1 (Form 1065) or on Sched-ule K-1 (Form 1120-S). Deduct oil and gas

Chapter 9DepletionPage 39

depletion for your partnership or S corporation interest on Schedule E (Form 1040). The deple-tion deducted on Schedule E is included in fig-uring income or loss from rental real estate or royalty properties. The Instructions for Sched-ule E (Form 1040) explain where to report this income or loss and whether you need to file ei-ther of the following forms.

Form 6198.
Form 8582.

Natural Gas Wells

You can use percentage depletion for a well that produces natural gas that is either:

Regulated natural gas,
Sold under a fixed contract, or
Produced from geopressured brine.

Regulated natural gas. Regulated natural gas qualifies for a percentage depletion rate of 22%. Regulated natural gas is domestic natural gas produced and sold by the producer before July 1, 1976, and is regulated by the Federal Power Commission. The price for regulated gas can-not be adjusted to reflect any increase in the seller’s tax liability because of the repeal of per-centage depletion for gas. Price increases after February 1, 1975, are presumed to take the in-crease in tax liability into account unless dem-onstrated otherwise by clear and convincing evidence.

Natural gas sold under a fixed contract. Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. Natural gas sold under a fixed contract is domestic nat-ural gas sold by the producer under a contract that does not provide for a price increase to re-flect any increase in the seller's tax liability be-cause of the repeal of percentage depletion for gas. The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Price increases after February 1, 1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing evidence.

Natural gas from geopressured brine. Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. This is natural gas that meets both of the following conditions.

Produced from a well you began to drill af-ter September 1978 and before 1984.

Determined in accordance with section 503 of the Natural Gas Policy Act of 1978 to be produced from geopressured brine.

Mines and Geothermal Deposits

Certain mines, oil and gas wells, and other nat-ural deposits, including geothermal deposits, qualify for percentage depletion.

Mines, oil and gas wells, and other natural deposits. The percentage of your gross in-come from the property that you can deduct as depletion depends on the type of deposit.

See section 613(b) for the percentage de-pletion rates.

Page 40Chapter 9Depletion

Corporate deduction for iron ore and coal. The percentage depletion deduction of a corporation for iron ore and coal (including lig-nite) is reduced by 20% (0.20) of:

The percentage depletion deduction for the tax year (figured without this reduc-tion), minus
The adjusted basis of the property at the close of the tax year (figured without the depletion deduction for the tax year).

Gross income from the property. For prop-erty other than a geothermal deposit or an oil or gas well, gross income from the property means the gross income from mining. Mining includes all of the following.

Extracting ores or minerals from the ground.

Applying certain treatment processes de-scribed below.

Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which the treatment processes are applied.

Excise tax. Gross income from mining in-cludes the separately stated excise tax re-ceived by a mine operator from the sale of coal to compensate the operator for the excise tax the mine operator must pay to finance the bene-fits provided under the Black Lung Benefits Revenue Act of 1977.

Extraction. Extracting ores or minerals from the ground includes extraction by mine owners or operators of ores or minerals from the waste or residue of prior mining. This does not apply to extraction from waste or residue of prior mining by the purchaser of the waste or residue or the purchaser of the rights to extract ores or minerals from the waste or residue.

Treatment processes. The processes in-cluded as mining depend on the ore or mineral mined. To qualify as mining, the treatment pro-cesses must be applied by the mine owner or operator. For a listing of treatment processes considered as mining, see section 613(c)(4) and the related regulations.

Transportation of more than 50 miles. If ore or mineral must be transported more than 50 miles to plants or mills to be treated because of physical and other requirements, the addi-tional authorized transportation may be consid-ered mining and included in the calculation of gross income from mining if authorized by the IRS.

If you wish to include transportation of more than 50 miles in the calculation of gross income from mining, request an

advance ruling from the IRS. Include in the re-quest the facts about the physical and other re-quirements that prevented the construction and operation of the plant (in which mining pro-cesses are applied) within 50 miles of the point of extraction. For more information about re-questing an advance ruling, see Rev. Proc. 2022-1, available at IRS.gov/irb/2022-01_IRB, modified by Rev. Proc. 2022-10, available at IRS.gov/irb/2022-06_IRB, AND superseded by Rev. Proc. 2023-1, available at IRS.gov/irb/ 2023-01_IRB.

Disposal of coal or iron ore. You cannot take a percentage depletion deduction for coal (in-cluding lignite) or iron ore mined in the United States if both of the following apply.

You disposed of it after holding it for more than 1 year.

You disposed of it under a contract under which you retain an economic interest in the coal or iron ore.

Treat any gain on the disposition as a capital gain.

Disposal to related person. This rule does not apply if you dispose of the coal or iron ore to one of the following persons.

A related person (as listed in chapter 2 of Pub. 544).

A person owned or controlled by the same interests that own or control you.

Geothermal deposits. Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%. A geothermal deposit is a geothermal reservoir of natural heat stored in rocks or in a watery liq-uid or vapor (whether or not under pressure). For percentage depletion purposes, a geother-mal deposit is not considered a gas well.

Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. See Gross income from the property , earlier, under Oil and Gas Wells. Per-centage depletion on a geothermal deposit can-not be more than 50% of your taxable income from the property.

Lessor's Gross Income

In the case of leased property, the depletion de-duction is divided between the lessor and the lessee.

A lessor's gross income from the property that qualifies for percentage depletion is usually the total of the royalties received from the lease.

Bonuses and advanced royalties. Bonuses and advanced royalties are payments a lessee makes before production to a lessor for the grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. If you are the lessor, your income from bonuses and advanced royalties received is subject to an al-lowance for depletion, as explained in the next two paragraphs.

Figuring cost depletion. To figure cost depletion on a bonus, multiply your adjusted ba-sis in the property by a fraction, the numerator of which is the bonus and the denominator of which is the total bonus and royalties expected to be received. To figure cost depletion on ad-vanced royalties, use the calculation explained earlier under Cost Depletion, treating the num-ber of units for which the advanced royalty is re-ceived as the number of units sold.

Figuring percentage depletion. In the case of mines, wells, and other natural deposits other than gas, oil, or geothermal property, you may use the percentage rates discussed earlier under Mines and Geothermal Deposits. Any bo-nus or advanced royalty payments are gener-ally part of the gross income from the property to which the rates are applied in making the

calculation. However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts payable without regard to production from the property.

Ending the lease. If you receive a bonus on a lease that ends or is abandoned before you derive any income from mineral extraction or the cutting of timber, include in income the depletion deduction you took on the bonus. Do this for the year the lease ends or is aban-doned. Also, increase your adjusted basis in the property to restore the depletion deduction you previously subtracted.

For advanced royalties, include in income the depletion claimed on minerals or timber for which the advanced royalties were paid, if the minerals were not produced or timber not cut before the lease ended. Include this amount in income for the year the lease ends. Increase your adjusted basis in the property by the amount you include in income.

Delay rentals. These are payments for defer-ring development of the property. Since delay rentals are ordinary rent, they are ordinary in-come to the payee that is not subject to deple-tion. These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining production.

Timber

You can figure timber depletion only by the cost method. Percentage depletion does not apply to timber. Base your depletion on your cost or other basis in the timber. Your cost does not in-clude the cost of land or any amounts recovera-ble through depreciation.

Depletion takes place when you cut stand-ing timber. You can figure your depletion de-duction when the quantity of cut timber is first accurately measured in the process of exploita-tion.

Figuring cost depletion. To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit.

Timber units. When you acquire timber property, you must make an estimate of the quantity of marketable timber reasonably known, or on good evidence believed to exist on the property. You measure the timber using feet board measure (FBM), log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

The term “timber property” means your eco-nomic interest in standing timber in each tract or block representing a separate timber account.

Depletion unit. You figure your depletion unit each year by taking the following steps.

1. Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property, earlier.

2. Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.

3. Figure the number of timber units to take into account by adding the number of tim-ber units acquired during the year to the number of timber units on hand in the ac-count at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.

4. Divide the result of (2) by the result of (3). This is your depletion unit.

Example. You bought a timber tract for $160,000 and the land was worth as much as the timber. Your basis for the timber is $80,000. Based on an estimated 1 million feet board measure (FBM) or 1,000 “thousand board feet” (MFBM) of standing timber, you figure your de-pletion unit to be $80 per MFBM ($80,000 ÷ 1,000). If you cut 500 MFBM of timber, your de-pletion allowance would be $40,000 (500 MFBM × $80).

When to claim depletion. Claim your deple-tion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. The inventory is your ba-sis for determining gain or loss in the tax year you sell the timber products.

Example. The facts are the same as in the previous example, except that you sold only half of the timber products in the cutting year. You would deduct $20,000 of the $40,000 de-pletion that year. You would add the remaining $20,000 depletion to your closing inventory of timber products.

Electing to treat the cutting of timber as a sale or exchange. You can elect, under cer-tain circumstances, to treat the cutting of timber held for more than 1 year as a sale or ex-change. You must make the election on your in-come tax return for the tax year to which it ap-plies. The election can’t be made on an amended return. If you make this election, sub-tract the adjusted basis for depletion from the fair market value (FMV) of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. You generally re-port the gain as long-term capital gain. The FMV then becomes your basis for figuring your ordinary gain or loss on the sale or other dispo-sition of the products cut from the timber. For more information, see Timber in chapter 2 of Pub. 544.

You may revoke an election to treat the cut-ting of timber as a sale or exchange, without the IRS's consent, by the due date (including exten-sions) for the return. The prior election (and rev-ocation) is disregarded for purposes of making a subsequent election. See Form T (Timber, Forest Activities Schedule) for more informa-tion.

Form T (Timber, Forest Activities Sched-ule). Complete and attach Form T (Timber, Forest Activities Schedule) to your income tax return if you claim a deduction for timber deple-tion, choose to treat the cutting of timber as a

sale or exchange, or make an outright sale of timber.

10.

Business Bad Debts

Introduction

You have a bad debt if you cannot collect money owed to you. A bad debt is either a busi-ness bad debt or a nonbusiness bad debt. This chapter discusses only business bad debts.

Generally, a business bad debt is one that comes from operating your trade or business. You can deduct business bad debts on Sched-ule C (Form 1040) or your applicable business income tax return.

All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. For more information on nonbus-iness bad debts, see Pub. 550.

Topics

This chapter discusses:

Definition of business bad debt
When a debt becomes worthless
How to claim a business bad debt
Recovery of a bad debt

Useful Items

You may want to see:

Publication

525 Taxable and Nontaxable Income

536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts

544 Sales and Other Dispositions of Assets

550 Investment Income and Expenses

556 Examination of Returns, Appeal Rights, and Claims for Refund

Form (and Instructions)

Schedule C (Form 1040) Profit or Loss From Business

1040-X Amended U.S. Individual Income

		Tax Return
	1045	Application for Tentative Refund


	1065	U.S. Return of Partnership Income


	1065-X Amended Return or

		Administrative Adjustment Request
		(AAR)
	1120-S U.S. Income Tax Return for an S

		Corporation
Chapter 10		Business Bad Debts	Page 41

1120-X Amended U.S. Corporation Income Tax Return

1139 Corporation Application for Tentative Refund

3115 Application for Change in Accounting Method

See chapter 12 for information about getting publications and forms.

Definition of Business Bad Debt

A business bad debt is a loss from the worth-lessness of a debt that was either:

Created or acquired in your trade or busi-ness, or

Closely related to your trade or business when it became partly or totally worthless.

A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Bad debts of a corpo-ration (other than an S corporation) are always business bad debts.

Credit sales. Business bad debts are mainly the result of credit sales to customers. Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part of the receivables be-comes a business bad debt.

Accounts or notes receivable valued at fair market value (FMV) when received are deducti-ble only at that value, even though the FMV may be less than the face value. If you pur-chased an account receivable for less than its face value, and the receivable subsequently be-comes worthless, the most you’re allowed to deduct is the amount you paid to acquire it.

You can claim a business bad debt de-

duction only if the amount owed to you CAUTION was previously included in gross in-come. This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest.

Accrual method. If you use an accrual method of accounting, you generally report in-come as you earn it. You can only claim a bad debt deduction for an uncollectible receivable if you have previously included the uncollectible amount in income.

If you qualify, you can use the nonac-crual-experience method of accounting, dis-cussed later. Under this method, you don’t have to accrue income that, based on your experi-ence, you don’t expect to collect.

Cash method. If you use the cash method of accounting, you generally report income when you receive payment. You can’t claim a bad debt deduction for amounts owed to you because you never included those amounts in income. For example, a cash basis architect can’t claim a bad debt deduction if a client fails to pay the bill because the architect's fee was never included in income.

Page 42Chapter 10Business Bad Debts

Debts from a former business. If you sell your business but retain its receivables, these debts are business debts because they arose out of your trade or business. If any of these re-ceivables subsequently become worthless, the loss is still a business bad debt.

Debt acquired from a decedent. The character of a loss from debts of a business ac-quired from a decedent is determined in the same way as debts acquired on the purchase of a business. The executor of the decedent's es-tate treats any loss from the debts as a busi-ness bad debt if the debts were closely related to the decedent's trade or business when they became worthless. Otherwise, a loss from these debts becomes a nonbusiness bad debt for the decedent's estate.

Liquidation. If you liquidate your business and some of the accounts receivable that you retain become worthless, they’re treated as business bad debts.

Types of Business Bad Debts

Business bad debts may result from the follow-ing.

Loans to clients and suppliers. If you loan money to a client, supplier, employee, or distrib-utor for a business reason and you’re unable to collect the loan after attempting to do so, you have a business bad debt.

Debts owed by political parties. If a political party (or other organization that accepts contri-butions or spends money to influence elections) owes you money and the debt becomes worth-less, you can claim a bad debt deduction only if all of the following requirements are met.

1. You use an accrual method of accounting.

2. The debt arose from the sale of goods or services in the ordinary course of your trade or business.

3. More than 30% of your receivables ac-crued in the year of the sale were from sales to political parties.

4. You made substantial and continuing ef-forts to collect on the debt.

Loan or capital contribution. You cannot claim a bad debt deduction for a loan you made to a corporation if, based on the facts and cir-cumstances, the loan is actually a contribution to capital.

Debts of an insolvent partner. If your busi-ness partnership breaks up and one of your for-mer partners becomes insolvent, you may have to pay more than your pro rata share of the part-nership's debts. If you pay any part of the insol-vent partner's share of the debts, you can claim a bad debt deduction for the amount you paid that is attributable to the insolvent partner's share.

Business loan guarantee. If you guarantee a debt that subsequently becomes worthless, the

debt can qualify as a business bad debt if all of the following requirements are met.

You made the guarantee in the course of your trade or business.

You have a legal duty to pay the debt.
You made the guarantee before the debt became worthless. You meet this require-ment if you reasonably expected you wouldn’t have to pay the debt without full reimbursement from the borrower.
You received reasonable consideration for making the guarantee. You meet this re-quirement if you made the guarantee ac-cording to normal business practice or for a good faith business purpose.

Example. Jane Zayne owns the Zayne Dress Company. She guaranteed payment of a $20,000 note for Elegant Fashions, a dress out-let. Elegant Fashions is one of Zayne's largest clients. Elegant Fashions later defaulted on the loan. As a result, Ms. Zayne paid the remaining balance of the loan in full to the bank.

She can claim a business bad debt deduc-tion only for the amount she paid because her guarantee was made in the course of her trade or business for a good faith business purpose. She was motivated by the desire to retain one of her better clients and keep a sales outlet.

Deductible in the year paid. If you make a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have rights against the borrower.

Rights against a borrower. When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. The debt is then owed to you. If you have this right, or some other right to demand payment from the borrower, you can’t claim a bad debt deduction until these rights become partly or totally worthless.

Joint debtor. If two or more debtors jointly owe you money, your inability to collect from one doesn’t enable you to deduct a proportion-ate amount as a bad debt.

Sale of mortgaged property. If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt is a bad debt.

When a Debt Becomes Worthless

A debt becomes worthless when there is no longer any chance the amount owed will be paid. This may occur on the date the debt is due or prior to that date.

To demonstrate worthlessness, you must only show that you have taken reasonable steps to collect the debt but were unable to do so. It isn’t necessary to go to court if you can show that a judgment from the court would be uncollectible. Bankruptcy of your debtor is gen-erally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt.

Property received for debt. If you receive property in partial settlement of a debt, reduce the debt by the property's FMV, which becomes the property's basis. You can deduct the re-maining debt as a bad debt if and when it be-comes worthless.

If you later sell the property for more than its basis, any gain on the sale is due to the appre-ciation of the property. It isn’t a recovery of a bad debt. For information on the sale of an as-set, see Pub. 544.

How To Claim a Business Bad Debt

There are two methods to claim a business bad debt.

The specific charge-off method.
The nonaccrual-experience method.

Generally, you must use the specific charge-off method. However, you may use the nonac-crual-experience method if you meet the re-quirements discussed later under Nonac-crual-Experience Method.

Specific Charge-off Method

If you use the specific charge-off method, you can deduct specific business bad debts that be-come either partly or totally worthless during the tax year. However, with respect to partly worth-less bad debts, your deduction is limited to the amount you charged off on your books during the year.

Partly worthless debts. You can deduct spe-cific bad debts that become partly uncollectible during the tax year. Your tax deduction is limi-ted to the amount you charge off on your books during the year. You don’t have to charge off and deduct your partly worthless debts annu-ally. You can delay the charge-off until a later year. However, you can’t deduct any part of a debt after the year it becomes totally worthless.

Significantly modified debt. An excep-tion to the charge-off rule exists for debt that has been significantly modified and on which the holder recognized gain. For more informa-tion, see Regulations section 1.166-3(a)(3).

Deduction disallowed. Generally, you can claim a partial bad debt deduction only in the year you make the charge-off on your books. If, under audit, the IRS doesn’t allow your deduction and the debt becomes partly worthless in a later tax year, you can deduct the amount you charged off in that year plus the disallowed amount charged off in the earlier year. The charge-off in the earlier year, unless reversed on your books, fulfills the charge-off requirement for the later year.

Totally worthless debts. If a debt becomes totally worthless in the current tax year, you can deduct the entire amount minus any amount de-ducted in an earlier tax year when the debt was only partly worthless.

You don’t have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. However, you may want to do so. If you don’t and the IRS later

rules the debt is only partly worthless, you will not be allowed a deduction for the debt in that tax year because a deduction of a partly worth-less bad debt is limited to the amount actually charged off. See Partly worthless debts, earlier.

Filing a claim for refund. If you didn’t deduct a bad debt on your original return for the year it became worthless, you can file a claim for a credit or refund. If the bad debt was totally worthless, you must file the claim by the later of the following dates.

7 years from the date your original return was due (not including extensions).
2 years from the date you paid the tax.

If the claim is for a partly worthless bad debt, you must file the claim by the later of the follow-ing dates.

3 years from the date you filed your original return.

2 years from the date you paid the tax.

You may have longer to file the claim if you were unable to manage your financial affairs due to a physical or mental impairment. Such an impairment requires proof of existence.

For details and more information about filing a claim, see Pub. 556. Use one of the following forms to file a claim. For more information, see the instructions for the applicable form.

Table 10-1. Forms Used To File a

Claim

IF you filed as	THEN file...
a...
sole proprietor	Form 1040-X.
or farmer

corporation	Form 1120-X.
S corporation	Form 1120-S and check
	box H(4).
partnership	Form 1065-X if filing on
	paper or
	Form 1065 and check box
	G(5) if filing electronically.

Nonaccrual-Experience Method

Generally, a person using accrual accounting isn’t required to accrue a service-provided re-ceivable that experience shows won't be collec-ted if:

The service provided is health, law, engi-neering, architecture, accounting, actuarial science, performing arts, or consulting; or

The person's average annual gross re-ceipts for all previous 3‐tax‐year periods don’t exceed $27 million.

See section 448 for details and exceptions.

Recovery of a Bad Debt

If you claim a deduction for a bad debt on your income tax return and later recover (collect) all or part of it, you may have to include all or part of the recovery in gross income. The amount you include is limited to the amount you actually deducted. However, you can exclude the

amount deducted that did not reduce your tax. Report the recovery as “Other income” on the appropriate business form or schedule.

See Recoveries in Pub. 525 for more infor-mation.

NOL carryover. If a bad debt deduction in-creases an NOL carryover that has not expired before the beginning of the tax year in which the recovery takes place, you treat the deduction as having reduced your tax. A bad debt deduction that contributes to an NOL helps lower taxes in the year to which you carry the NOL. For more information about NOLs for individuals, see Pub. 536. Also, see the Instructions for Form 1045, and the Instructions for Form 1139.

11.

Other Expenses

What's New

Standard mileage rate. For tax year 2022, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for busi-ness use is:

58.5 cents per mile from January 1, 2022, through June 30, 2022; and

62.5 cents per mile from July 1, 2022, through December 31, 2022.

For more information, see Car and truck ex-penses under Miscellaneous Expenses, later.

Reminders

No miscellaneous itemized deductions al-lowed. You can no longer claim any miscella-neous itemized deductions, including the de-duction for repayments (claim of right). Miscellaneous itemized deductions are those deductions that would have been subject to the 2%-of-adjusted-gross-income limitation.

Qualified business income deduction. For tax years beginning after 2017, individual tax-payers and some trusts and estates may be en-titled to a deduction of up to 20% of their quali-fied business income (QBI) from a trade or business, including income from a pass-through entity, but not from a C corporation, plus 20% of qualified real estate investment trust (REIT) div-idends and qualified publicly traded partnership (PTP) income. The deduction is subject to mul-tiple limitations, such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid in the trade or busi-ness, and the unadjusted basis immediately af-ter acquisition (UBIA) of qualified property held by the trade or business. The deduction can be taken in addition to the standard or itemized de-ductions. See the Instructions for Form 8995 and the Instructions for Form 8995-A for more information.

Chapter 11Other ExpensesPage 43

Travel, meals, and entertainment. In gen-eral, entertainment expenses are no longer de-ductible. For more information on travel and non-entertainment-related meals, including de-ductibility, see Pub. 463.

Certain payments made in sexual harass-ment or sexual abuse cases. For amounts paid or incurred after December 22, 2017, new section 162(q) provides that no deduction is al-lowed under section 162 for any settlement or payment related to sexual harassment or sexual abuse if it is subject to a nondisclosure agree-ment. In addition, attorney’s fees related to such a settlement or payment aren’t allowed as a de-duction.

Introduction

This chapter covers business expenses that may not have been explained to you, as a busi-ness owner, in previous chapters of this publi-cation.

Topics

This chapter discusses:

Travel and non-entertainment-related meals

Bribes and kickbacks
Charitable contributions
Education expenses
Lobbying expenses
Penalties and fines
Repayments (claim of right)
Other miscellaneous expenses

Useful Items

You may want to see:

Publication

15-B Employer's Tax Guide to Fringe

	Benefits
463	Travel, Gift, and Car Expenses
526	Charitable Contributions
529	Miscellaneous Deductions
544	Sales and Other Dispositions of
	Assets
946	How To Depreciate Property
970	Tax Benefits for Education

Form (and Instructions)

Schedule A (Form 1040) Itemized

Deductions

Schedule C (Form 1040) Profit or Loss

		From Business
	Schedule F (Form 1040) Profit or Loss

		From Farming
	1099-MISC Miscellaneous Information


	1120	U.S. Corporation Income Tax

		Return
	4562	Depreciation and Amortization


	8949	Sales and Other Dispositions of

		Capital Assets
Page 44		Chapter 11 Other Expenses

8995 Qualified Business Income Deduction Simplified Computation

8995-A Qualified Business Income Deduction

W-2 Wage and Tax Statement

See chapter 12 for information about getting publications and forms.

Reimbursement of

Travel and

Non-Entertainment-Relat

ed Meals

The following discussion explains how to han-dle any reimbursements or allowances you may provide to your employees under a reimburse-ment or allowance arrangement for travel and non-entertainment-related meals expenses. If you are self-employed and report your income and expenses on Schedule C (Form 1040), see Pub. 463.

To be deductible for tax purposes, expen-ses incurred for travel and non-entertain-ment-related meals must be ordinary and nec-essary expenses incurred while carrying on your trade or business. For more information on travel and non-entertainment-related meals, in-cluding deductibility, see Pub. 463.

Reimbursements

A “reimbursement or allowance arrangement” provides for payment of advances, reimburse-ments, and allowances for travel and non-enter-tainment-related meals expenses incurred by your employees during the ordinary course of business. If the expenses are substantiated, you can deduct the allowable amount on your tax return. Because of differences between ac-counting methods and tax law, the amount you can deduct for tax purposes may not be the same as the amount you deduct on your busi-ness books and records. For example, you can deduct 100% of the cost of meals on your busi-ness books and records. However, only 50% of these costs are allowed by law as a tax deduc-tion.

How you deduct a business expense under a reimbursement or allowance arrangement de-pends on whether you have:

An accountable plan, or
A nonaccountable plan.

If you reimburse these expenses under an ac-countable plan, deduct them as travel and non-entertainment-related meals expenses.

If you reimburse these expenses under a nonaccountable plan, report the reimburse-ments as wages on Form W-2, and deduct them as wages on the appropriate line of your tax return. If you make a single payment to your employees and it includes both wages and an expense reimbursement, you must specify the amount of the reimbursement and report it ac-cordingly. See Table 11-1.

Accountable Plans

An accountable plan requires your employees to meet all of the following requirements. Each employee must:

1. Have paid or incurred deductible expen-ses while performing services as your em-ployee,

2. Adequately account to you for these ex-penses within a reasonable period of time, and

3. Return any excess reimbursement or al-lowance within a reasonable period of time.

An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements are also met.

The advance is reasonably calculated not to exceed the amount of anticipated ex-penses.
You make the advance within a reasonable period of time of your employee paying or incurring the expense.

If any expenses reimbursed under this ar-rangement aren’t substantiated, or an excess reimbursement isn’t returned within a reasona-ble period of time by an employee, you can’t treat these expenses as reimbursed under an accountable plan. Instead, treat the reimbursed expenses as paid under a nonaccountable plan, discussed later.

Adequate accounting. Your employees must adequately account to you for their travel and non-entertainment-related meals expenses. They must give you documentary evidence of their travel, mileage, and other employee busi-ness expenses. This evidence should include items such as receipts, along with either a statement of expenses, an account book, a day planner, or similar record in which the employee entered each expense at or near the time the expense was incurred.

Excess reimbursement or allowance. An excess reimbursement or allowance is any amount you pay to an employee that is more than the business-related expenses for which the employee adequately accounted. The em-ployee must return any excess reimbursement or other expense allowance to you within a rea-sonable period of time.

Reasonable period of time. A reasonable period of time depends on the facts and circum-stances. Generally, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time.

1. You give an advance within 30 days of the time the employee pays or incurs the ex-pense.

2. Your employees adequately account for their expenses within 60 days after the ex-penses were paid or incurred.

3. Your employees return any excess reim-bursement within 120 days after the ex-penses were paid or incurred.

58.5 cents per mile for January 1, 2022, through June 30, 2022; and

4. You give a periodic statement (at least quarterly) to your employees that asks them to either return or adequately ac-count for outstanding advances and they comply within 120 days of the date of the statement.

How to deduct. You can claim a deduction for travel and non-entertainment-related meals ex-penses if you reimburse your employees for these expenses under an accountable plan. Generally, the amount you can deduct for non-entertainment-related meals is subject to a 50% limit, discussed later. If you are a sole pro-prietor, or are filing as a single member limited liability company, deduct the travel reimburse-ment on line 24a and the deductible part of the non-entertainment-related meals reimburse-ment on line 24b of Schedule C (Form 1040).

If you are filing an income tax return for a corporation, include the reimbursement on the Other deductions line of Form 1120. If you are filing any other business income tax return, such as a partnership or S corporation return, deduct the reimbursement on the appropriate

Table 11-1. Reporting Reimbursements

IF the type of reimbursement (or other expense	THEN the employer reports on Form W-2
allowance) arrangement is under
An accountable plan with:
Actual expense reimbursement:	No amount.
Adequate accounting made and excess returned
Actual expense reimbursement:	The excess amount as wages in box 1.
Adequate accounting and return of excess both required
but excess not returned
Per diem or mileage allowance up to the federal rate:	No amount.
Adequate accounting made and excess returned
Per diem or mileage allowance up to the federal rate:	The excess amount as wages in box 1. The amount up to
Adequate accounting and return of excess both required	the federal rate is reported only in box 12—it isn’t
but excess not returned	reported in box 1.
Per diem or mileage allowance exceeds the federal rate:	The excess amount as wages in box 1. The amount up to
Adequate accounting made up to the federal rate only and	the federal rate is reported only in box 12—it isn’t
excess not returned	reported in box 1.
A nonaccountable plan with:
Either adequate accounting or return of excess, or both, not	The entire amount as wages in box 1.
required by plan
No reimbursement plan	The entire amount as wages in box 1.

line of the return as provided in the instructions for that return.

Per Diem and Car Allowances

You can reimburse your employees under an accountable plan based on travel days, miles, or some other fixed allowance. In these cases, your employee is considered to have accounted to you for the amount of the expense that doesn’t exceed the rates established by the federal government. Your employee must ac-tually substantiate to you the other elements of the expense, such as time, place, and business purpose.

Federal rate. The federal rate can be figured using any one of the following methods.

1. For car expenses:

a. The standard mileage rate.

b. A fixed and variable rate (FAVR).

2. For per diem amounts:

c. The regular federal per diem rate.

d. The standard meal allowance.

e. The high-low rate.

Car allowance. Your employee is considered to have accounted to you for car expenses that don’t exceed the standard mileage rate. For tax year 2022, the standard business mileage rate is:_•

62.5 cents per mile for July 1, 2022, through December 31, 2022.

To find the standard mileage rate for 2023, go to IRS.gov/Tax-Professionals/Standard-Mileage-Rates.

You can choose to reimburse your employ-ees using an FAVR allowance. This is an allow-ance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your employees' variable operating costs (such as gas, oil, etc.) plus a flat amount to cover your employees'

fixed costs (such as depreciation, insurance, etc.). For information on using an FAVR allow-ance, see Revenue Procedure 2019-46, availa-ble at IRS.gov/irb/2019-49_IRB#RP-2019-46, and Notice 2022-03, available at IRS.gov/irb/ 2022-02_IRB.

Per diem allowance. If your employee ac-tually substantiates to you the other elements (discussed earlier) of the expenses reimbursed using the per diem allowance, how you report and deduct the allowance depends on whether the allowance is for lodging and meal expenses or for meal expenses only and whether the al-lowance is more than the federal rate.

Regular federal per diem rate. The regu-lar federal per diem rate is the highest amount the federal government will pay to its employ-ees while away from home on travel. It has the following two components.

1. Lodging expense.

2. Meal and incidental expenses (M&IE).

The rates are different for different locations. See GSA.gov/perdiem for the per diem rates in the continental United States.

Standard meal allowance. The federal rate for M&IE is the standard meal allowance. You can pay only an M&IE allowance to em-ployees who travel away from home if:

You pay the employee for actual expenses for lodging based on receipts submitted to you,
You provide for the lodging,
You pay for the actual expense of the lodg-ing directly to the provider,

You don’t have a reasonable belief that lodging expenses were incurred by the employee, or
The allowance is figured on a basis similar to that used in figuring the employee's wa-ges (that is, number of hours worked or miles traveled).

Per diem rates online. You can access per diem rates at GSA.gov/perdiem.

High-low method. This is a simplified method of figuring the federal per diem rate for travel within the continental United States. It eliminates the need to keep a current list of the per diem rate for each city.

Under the high-low method, the per diem amount for travel during January through Sep-tember of 2022 is $296 ($74 for M&IE) for cer-tain high-cost locations. All other areas have a per diem amount of $202 ($64 for M&IE). The high-cost localities eligible for the higher per diem amount under the high-low method are lis-ted in Notice 2021-52, available at IRS.gov/irb/ 2021-38_IRB#NOT-2021-52.

Effective October 1, 2023, the per diem rate for high-cost locations will increase to $297 ($74 for M&IE). The rate for all other locations will increase to $204 ($64 for M&IE). For Octo-ber, November, and December 2023, you can either continue to use the rates described in the preceding paragraph or change to the new rates. However, you must use the same rate for all employees reimbursed under the high-low method.

For more information about the high-low method, see Notice 2022-44, available at IRS.gov/irb/2022-41_IRB#NOT-2022-44. See GSA.gov/perdiem for the current per diem rates for all locations.

Reporting per diem and car allowances. The following discussion explains how to report per diem and car allowances. The manner in which you report them depends on how the al-lowance compares to the federal rate. See Ta-ble 11-1.

Allowance less than or equal to the fed-eral rate. If your allowance for the employee is less than or equal to the appropriate federal rate, that allowance isn’t included as part of the employee's pay in box 1 of the employee's Form W-2. Deduct the allowance as travel ex-penses (including meals that may be subject to the 50% limit, discussed later). See How to de-duct under Accountable Plans, earlier.

Chapter 11Other ExpensesPage 45

Allowance more than the federal rate. If your employee's allowance is more than the ap-propriate federal rate, you must report the al-lowance as two separate items.

Include the allowance amount up to the fed-eral rate in box 12 (code L) of the employee's Form W-2. Deduct it as travel expenses (ex-plained above). This part of the allowance is treated as reimbursed under an accountable plan.

Include the amount that is more than the federal rate in box 1 (and in boxes 3 and 5 if they apply) of the employee's Form W-2. De-duct it as wages subject to income tax withhold-ing, social security, Medicare, and federal un-employment taxes. This part of the allowance is treated as reimbursed under a nonaccountable plan (explained later) under Nonaccountable Plans.

Meals

Under an accountable plan, you can generally deduct only 50% of any otherwise deductible business-related meal expenses you reimburse your employees. The deduction limit applies even if you reimburse them for 100% of the ex-penses.

Application of the 50% limit. The 50% de-duction limit applies to reimbursements you make to your employees for expenses they in-cur for meals while traveling away from home on business and meals for business customers at your place of business, a restaurant, or an-other location. It applies to expenses incurred at a business convention or reception, business meeting, or business luncheon at a club. The deduction limit may also apply to meals you fur-nish on your premises to your employees.

Section 210 of the Taxpayer Certainty TIP and Disaster Tax Relief Act of 2020 provides for the temporary allowance of a 100% business meal deduction for food or

beverages provided by a restaurant and paid or incurred after December 31, 2020, and before January 1, 2023.

Related expenses. Taxes and tips relat-ing to a meal you reimburse to your employee under an accountable plan are included in the amount subject to the 50% limit. However, the cost of transportation to and from an otherwise allowable business meal isn’t subject to the 50% limit.

Amount subject to 50% limit. If you provide your employees with a per diem allowance only for meal and incidental expenses, the amount treated as an expense for food and beverages is the lesser of the following.

The per diem allowance.
The federal rate for M&IE.

If you provide your employees with a per diem allowance that covers lodging, meals, and incidental expenses, you must treat an amount equal to the federal M&IE rate for the area of travel as an expense for food and beverages. If the per diem allowance you provide is less than the federal per diem rate for the area of travel, you can treat 40% of the per diem allowance as the amount for food and beverages.

Page 46Chapter 11Other Expenses

Meal expenses when subject to “hours of service” limits. You can deduct 80% of the cost of reimbursed meals your employees con-sume while away from their tax home on busi-ness during, or incident to, any period subject to the Department of Transportation's “hours of service” limits.

See Pub. 463 for a detailed discussion of in-dividuals subject to the Department of Trans-portation's “hours of service” limits.

De minimis (minimal) fringe benefit. P.L. 115-97, Tax Cuts and Jobs Act, changed the rules for the deduction of food or beverage ex-penses that are excludable from employee in-come as a de minimis fringe benefit. For amounts incurred or paid after 2017, the 50% limit on deductions for food or beverage expen-ses also applies to food or beverage expenses excludable from employee income as a de mini-mis fringe benefit. While your business deduc-tion may be limited, the rules that allow you to exclude certain de minimis meals and meals on your business premises from your employee's wages still apply. See Meals in section 2 of Pub. 15-B.

Company cafeteria or executive dining room. The cost of food and beverages you provide primarily to your employees on your business premises is deductible. This includes the cost of maintaining the facilities for provid-ing the food and beverages. These expenses are subject to the 50% limit unless they are compensation to your employees (explained later).

Employee activities. The expense of provid-ing recreational, social, or similar activities (in-cluding the use of a facility) for your employees is deductible and isn’t subject to the 50% limit. The benefit must be primarily for your employ-ees who aren’t highly compensated.

For this purpose, a highly compensated em-ployee is an employee who meets either of the following requirements.

1. Owned a 5%-or-more interest in the busi-ness during the year or the preceding year. An employee is treated as owning any interest owned by their sibling, spouse, ancestors, and lineal descend-ants.

2. Received more than $130,000 in pay for the preceding year. You can choose to in-clude only employees who were also in the top 20% of employees when ranked by pay for the preceding year.

For example, the expenses for food, bever-ages, and entertainment for a company-wide picnic aren’t subject to the 50% or 100% limit.

Meals or entertainment treated as compen-sation. The 50% limit doesn’t apply to either of the following.

1. Expenses for meals or entertainment that you treat as:

a. Compensation to an employee who was the recipient of the meals or en-tertainment, and

b. Wages subject to withholding of fed-eral income tax.

2. Expenses for meals or entertainment if:

a. A recipient of the meals or entertain-ment who isn’t your employee has to include the expenses in gross income as compensation for services or as a prize or award; and

b. You include that amount on a Form 1099-MISC issued to the recipient, if a Form 1099-MISC is required.

Sales of meals or entertainment. You can deduct the cost of meals or entertainment (in-cluding the use of facilities) you sell to the pub-lic. For example, if you run a nightclub, your ex-pense for the entertainment you furnish to your customers, such as a floor show, is a business expense that is fully deductible. The 100% limit doesn’t apply to this expense.

Providing meals or entertainment to gen-eral public to promote goodwill. You can deduct the cost of providing meals, entertain-ment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. The 50% or 100% limit doesn’t apply to this expense.

Director, stockholder, or employee meet-ings. You can deduct entertainment expenses directly related to business meetings of your employees, partners, stockholders, agents, or directors. You can provide some minor social activities, but the main purpose of the meeting must be your company's business. These ex-penses are subject to the 100% limit.

Trade association meetings. You can de-duct expenses directly related to, and neces-sary for, attending business meetings or con-ventions of certain tax-exempt organizations. These organizations include business leagues, chambers of commerce, real estate boards, and trade and professional associations.

Nonaccountable Plans

A nonaccountable plan is an arrangement that doesn’t meet the requirements for an accounta-ble plan. All amounts paid, or treated as paid, under a nonaccountable plan are reported as wages on Form W-2. The payments are subject to income tax withholding, social security, Medi-care, and federal unemployment taxes. You can deduct the reimbursement as compensation or wages only to the extent it meets the deductibil-ity tests for employees' pay in chapter 2. Deduct the allowable amount as compensation or wa-ges on the appropriate line of your income tax return, as provided in its instructions.

Miscellaneous Expenses

In addition to travel, meal, and certain entertain-ment expenses, there are other expenses you can deduct.

Advertising expenses. You can generally de-duct reasonable advertising expenses that are directly related to your business activities. Gen-erally, you can’t deduct amounts paid to influ-ence legislation (for example, lobbying). For

more information, see Lobbying expenses, later.

You can usually deduct as a business ex-pense the cost of institutional or goodwill adver-tising to keep your name before the public if it relates to business you reasonably expect to gain in the future. For example, the cost of ad-vertising that encourages people to contribute to the Red Cross, to buy U.S. savings bonds, or to participate in similar causes is usually deduc-tible.

Anticipated liabilities. Anticipated liabilities or reserves for anticipated liabilities aren’t deducti-ble. For example, assume you sold 1-year TV service contracts this year totaling $50,000. From experience, you know you will have ex-penses of about $15,000 in the coming year for these contracts. You can’t deduct any of the $15,000 this year by charging expenses to a re-serve or liability account. You can deduct your expenses only when you actually pay or accrue them, depending on your accounting method.

Bribes and kickbacks. Engaging in the pay-ment of bribes or kickbacks is a serious criminal matter. Such activity could result in criminal prosecution. Any payments that appear to have been made, either directly or indirectly, to an of-ficial or employee of any government or an agency or instrumentality of any government aren’t deductible for tax purposes and are in vi-olation of the law.

Payments paid directly or indirectly to a per-son in violation of any federal or state law (but only if that state law is generally enforced, de-fined below) that provides for a criminal penalty or for the loss of a license or privilege to engage in a trade or business aren’t allowed as a de-duction for tax purposes.

Meaning of “generally enforced.” A state law is considered generally enforced unless it is never enforced or enforced only for infamous persons or persons whose violations are extra-ordinarily flagrant. For example, a state law is generally enforced unless proper reporting of a violation of the law results in enforcement only under unusual circumstances.

Kickbacks. A kickback is a payment for re-ferring a client, patient, or customer. The com-mon kickback situation occurs when money or property is given to someone as payment for in-fluencing a third party to purchase from, use the services of, or otherwise deal with the person who pays the kickback. In many cases, the per-son whose business is being sought or enjoyed by the person who pays the kickback isn’t aware of the payment.

For example, the Yard Corporation is in the business of repairing ships. It returns 10% of the repair bills as kickbacks to the captains and chief officers of the vessels it repairs. Although this practice is considered an ordinary and nec-essary expense of getting business, it is clearly a violation of a state law that is generally en-forced. These expenditures aren’t deductible for tax purposes, whether or not the owners of the shipyard are subsequently prosecuted.

Form 1099-MISC. It doesn’t matter whether any kickbacks paid during the tax year

are deductible on your income tax return in re-gards to information reporting. See Form 1099-MISC for more information.

Car and truck expenses. The costs of operat-ing a car, truck, or other vehicle in your busi-ness may be deductible. For more information on how to figure your deduction, see Pub. 463.

Charitable contributions. Cash payments to an organization, charitable or otherwise, may be deductible as business expenses if the pay-ments aren’t charitable contributions or gifts and are directly related to your business. If the payments are charitable contributions or gifts, you can’t deduct them as business expenses. However, corporations (other than S corpora-tions) can deduct charitable contributions on their income tax returns, subject to limitations. See the Instructions for Form 1120 for more in-formation. Sole proprietors, partners in a part-nership, or shareholders in an S corporation may be able to deduct charitable contributions made by their businesses on Schedule A (Form 1040).

Example. You paid $15 to a local church for a half-page ad in a program for a concert it is sponsoring. The purpose of the ad was to en-courage readers to buy your products. Your payment isn’t a charitable contribution. You can deduct it as an advertising expense.

Example. You made a $100,000 donation to a committee organized by the local Chamber of Commerce to bring a convention to your city, intended to increase business activity, including yours. Your payment isn’t a charitable contribu-tion. You can deduct it as a business expense.

See Pub. 526 for a discussion of donated in-ventory, including capital gain property.

Club dues and membership fees. Generally, you can’t deduct amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or any other social pur-pose. This includes country clubs, golf and ath-letic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals un-der circumstances generally considered to be conducive to business discussions.

Exception. The following organizations aren’t treated as clubs organized for business, pleasure, recreation, or other social purpose unless one of the main purposes is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities.

Boards of trade.
Business leagues.
Chambers of commerce.
Civic or public service organizations.
Professional organizations such as bar as-sociations and medical associations.

Real estate boards.
Trade associations.

Credit card convenience fees. Credit card companies charge a fee to businesses who ac-cept their cards. This fee when paid or incurred by the business can be deducted as a business expense.

Damages recovered. Special rules apply to compensation you receive for damages sus-tained as a result of patent infringement, breach of contract or fiduciary duty, or antitrust viola-tions. You must include this compensation in your income. However, you may be able to take a special deduction. The deduction applies only to amounts recovered for actual economic in-jury, not any additional amount. The deduction is the smaller of the following.

The amount you received or accrued for damages in the tax year reduced by the amount you paid or incurred in the year to recover that amount.

Your losses from the injury you haven’t de-ducted.

Demolition expenses or losses. Amounts paid or incurred to demolish a structure aren’t deductible. These amounts are added to the basis of the land where the demolished struc-ture was located. Any loss for the remaining un-depreciated basis of a demolished structure wouldn’t be recognized until the property is dis-posed of.

Education expenses. Ordinary and neces-sary expenses paid for the cost of the education and training of your employees are deductible. See Education Expenses in chapter 2.

You can also deduct the cost of your own education (including certain related travel) rela-ted to your trade or business. You must be able to show the education maintains or improves skills required in your trade or business, or that it is required by law or regulations, for keeping your license to practice, status, or job. For ex-ample, an attorney can deduct the cost of at-tending Continuing Legal Education (CLE) classes that are required by the state bar asso-ciation to maintain their license to practice law.

Education expenses you incur to meet the minimum requirements of your present trade or business, or those that qualify you for a new trade or business, aren’t deductible. This is true even if the education maintains or improves skills presently required in your business. For more information on education expenses, see Pub. 970.

Franchise, trademark, trade name. If you buy a franchise, trademark, or trade name, you can deduct the amount you pay or incur as a business expense only if your payments are part of a series of payments that are:

1. Contingent on productivity, use, or dispo-sition of the item;

2. Payable at least annually for the entire term of the transfer agreement; and

3. Substantially equal in amount (or payable under a fixed formula).

When determining the term of the transfer agreement, include all renewal options and any other period for which you and the transferor reasonably expect the agreement to be re-newed.

A franchise includes an agreement that gives one of the parties to the agreement the right to distribute, sell, or provide goods, serv-ices, or facilities within a specified area.

Chapter 11Other ExpensesPage 47

Impairment-related expenses. If you are dis-abled, you can deduct expenses necessary for you to be able to work (impairment-related ex-penses) as a business expense, rather than as a medical expense.

You are disabled if you have either of the fol-lowing.

A physical or mental disability (for exam-ple, blindness or deafness) that function-ally limits your being employed.
A physical or mental impairment that sub-stantially limits one or more of your major life activities.

The expense qualifies as a business ex-pense if all the following apply.

Your work clearly requires the expense for you to satisfactorily perform that work.

The goods or services purchased are clearly not needed or used, other than inci-dentally, in your personal activities.
Their treatment isn’t specifically provided for under other tax law provisions.

Example. You are blind. You must use a reader to do your work, both at and away from your place of work. The reader's services are only for your work. You can deduct your expen-ses for the reader as a business expense.

Internet-related expenses. Generally, you can deduct Internet-related expenses including domain registration fees and webmaster con-sulting costs. If you are starting a business, you may have to amortize these expenses as startup costs. For more information about amor-tizing startup and organizational costs, see chapter 8.

Interview expense allowances. Reimburse-ments you make to job candidates for transpor-tation or other expenses related to interviews for possible employment aren’t wages. You can deduct the reimbursements as a business ex-pense. However, expenses for food and bever-ages are subject to the 50% limit discussed ear-lier under Meals.

Legal and professional fees. Fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to op-erating your business are deductible as busi-ness expenses. However, legal fees you pay to acquire business assets usually aren’t deducti-ble. These costs are added to the basis of the property.

Fees that include payments for work of a personal nature (such as drafting a will or dam-ages arising from a personal injury) aren’t al-lowed as a business deduction on Schedule C (Form 1040). If the invoice includes both busi-ness and personal charges, figure the business portion as follows: multiply the total amount of the bill by a fraction, the numerator of which is the amount attributable to business matters, and the denominator of which is the total amount paid. The result is the portion of the in-voice attributable to business expenses. The portion attributable to personal matters is the difference between the total amount and the business portion (figured above).

Legal fees related to doing or keeping your job, such as those you paid to defend yourself against criminal charges arising out of your

Page 48Chapter 11Other Expenses

trade or business, may be deductible on Sched-ule A (Form 1040) if you itemize deductions. For more information, see Pub. 529.

Certain payments made in sexual har-assment or sexual abuse cases. For amounts paid or incurred after December 22, 2017, new section 162(q) provides that no de-duction is allowed under section 162 for any settlement or payment related to sexual harass-ment or sexual abuse if it is subject to a nondi-sclosure agreement. In addition, attorney’s fees related to such a settlement or payment aren’t allowed as a deduction.

Tax preparation fees. The cost of hiring a tax professional, such as a certified public ac-countant (CPA), to prepare that part of your tax return relating to your business as a sole pro-prietor is deductible on Schedule C (Form 1040). You can deduct the expenses of prepar-ing tax schedules relating to rental properties on Schedule E or farm income and expenses on Schedule F. Expenses for completing the re-mainder of the return are miscellaneous deduc-tions and are no longer deductible.

You can also claim a business deduction for amounts paid or incurred in resolving asserted tax deficiencies for your business operated as a sole proprietor.

Licenses and regulatory fees. Licenses and regulatory fees for your trade or business paid annually to state or local governments are gen-erally deductible. Some licenses and fees may have to be amortized. See chapter 8 for more information.

Lobbying expenses. Generally, lobbying ex-penses aren’t deductible. Lobbying expenses include amounts paid or incurred for any of the following activities.

Influencing legislation.
Participating in or intervening in any politi-cal campaign for, or against, any candidate for public office.
Attempting to influence the general public, or segments of the public, about elections, legislative matters, or referendums.

Communicating directly with covered ex-ecutive branch officials (defined later) in any attempt to influence the official actions or positions of those officials.

Researching, preparing, planning, or coor-dinating any of the preceding activities.

Your expenses for influencing legislation and communicating directly with a covered ex-ecutive branch official include a portion of your labor costs and general and administrative costs of your business. For information on mak-ing this allocation, see section 1.162-28 of the regulations.

You can’t claim a charitable or business ex-pense deduction for amounts paid to an organi-zation if both of the following apply.

The organization conducts lobbying activi-ties on matters of direct financial interest to your business.
A principal purpose of your contribution is to avoid the rules discussed earlier that prohibit a business deduction for lobbying expenses.

If a tax-exempt organization, other than a section 501(c)(3) organization, provides you

with a notice on the part of dues that is allocable to nondeductible lobbying and political expen-ses, you can’t deduct that part of the dues.

Covered executive branch official. For purposes of this discussion, a “covered execu-tive branch official” is any of the following.

1. The President.

2. The Vice President.

3. Any officer or employee of the White House Office of the Executive Office of the President and the two most senior level of-ficers of each of the other agencies in the Executive Office.

4. Any individual who:

a. Is serving in a position in Level I of the Executive Schedule under section 5312 of title 5, United States Code;

b. Has been designated by the Presi-dent as having Cabinet-level status; or

c. Is an immediate deputy of an individ-ual listed in item (a) or (b).

Exceptions to denial of deduction. The general denial of the deduction doesn’t apply to the following.

Any in-house expenses for influencing leg-islation and communicating directly with a covered executive branch official if those expenses for the tax year don’t exceed $2,000 (excluding overhead expenses).

Expenses incurred by taxpayers engaged in the trade or business of lobbying (pro-fessional lobbyists) on behalf of another person (but does apply to payments by the other person to the lobbyist for lobbying activities).

Moving machinery. Generally, the cost of moving machinery from one city to another is a deductible expense. So is the cost of moving machinery from one plant to another, or from one part of your plant to another. You can de-duct the cost of installing the machinery in the new location. However, you must capitalize the costs of installing or moving newly purchased machinery.

Outplacement services. The costs of out-placement services you provide to your employ-ees to help them find new employment, such as career counseling, resume assistance, skills as-sessment, etc., are deductible.

The costs of outplacement services may cover more than one deduction category. For example, deduct as a utilities expense the cost of telephone calls made under this service and deduct as a rental expense the cost of renting machinery and equipment for this service.

For information on whether the value of out-placement services is includible in your employ-ees' income, see Pub. 15-B.

Penalties and fines. Penalties paid for late performance or nonperformance of a contract are generally deductible. For instance, you own and operate a construction company. Under a contract, you are to finish construction of a building by a certain date. Due to construction delays, the building isn’t completed and ready

for occupancy on the date stipulated in the con-tract. You are now required to pay an additional amount for each day that completion is delayed beyond the completion date stipulated in the contract. These additional costs are deductible business expenses.

On the other hand, generally, no deduction is allowed for penalties and fines paid to a gov-ernment or specified nongovernmental entity for the violation of any law except the following.

Amounts that constitute restitution.
Amounts paid to come into compliance with the law.

Amounts paid or incurred as the result of certain court orders in which no govern-ment or specified nongovernmental agency is a party.

Amounts paid or incurred for taxes due.

On or after December 22, 2017, no deduc-tion is allowed for the restitution amount or amount paid to come into compliance with the law unless the amounts are specifically identi-fied in the settlement agreement or court order. Also, any amount paid or incurred as reim-bursement to a government for the costs of any investigation or litigation aren’t eligible for the exceptions and are nondeductible.

See section 162(f), as amended by P.L.

115-97, section 13306.

Examples of nondeductible penalties and fines include the following.

Amounts paid because of a conviction for a crime or after a plea of guilty or no con-test in a criminal proceeding.
Amounts paid as a penalty imposed by federal, state, or local law in a civil action, including certain additions to tax and addi-tional amounts and assessable penalties imposed by the Internal Revenue Code.
Amounts paid in settlement of actual or possible liability for a fine or penalty, whether civil or criminal.
Amounts forfeited as collateral posted for a proceeding that could result in a fine or penalty.
Fines paid for violating city housing codes.
Fines paid by truckers for violating state maximum highway weight laws.

Fines paid for violating air quality laws.
Civil penalties paid for violating federal laws regarding mining safety standards and discharges into navigable waters.

A fine or penalty doesn’t include any of the following.

Legal fees and related expenses to defend yourself in a prosecution or civil action for a violation of the law imposing the fine or civil penalty.

Court costs or stenographic and printing charges.

Compensatory damages paid to a govern-ment.

Political contributions. Contributions or gifts paid to political parties or candidates aren’t de-ductible. In addition, expenses paid or incurred to take part in any political campaign of a candi-date for public office aren’t deductible.

Indirect political contributions. You can’t deduct indirect political contributions and

costs of taking part in political activities as busi-ness expenses. Examples of nondeductible ex-penses include the following.

Advertising in a convention program of a political party, or in any other publication if any of the proceeds from the publication are for, or intended for, the use of a politi-cal party or candidate.

Admission to a dinner or program (includ-ing, but not limited to, galas, dances, film presentations, parties, and sporting events) if any of the proceeds from the function are for, or intended for, the use of a political party or candidate.

Admission to an inaugural ball, gala, pa-rade, concert, or similar event if identified with a political party or candidate.

Repairs. The cost of repairing or improving property used in your trade or business is either a deductible or capital expense. Routine main-tenance that keeps your property in a normal ef-ficient operating condition, but that doesn’t ma-terially increase the value or substantially prolong the useful life of the property, is deduc-tible in the year that it is incurred. Otherwise, the cost must be capitalized and depreciated. See Form 4562 and its instructions for how to figure and claim the depreciation deduction.

The cost of repairs includes the costs of la-bor, supplies, and certain other items. The value of your own labor isn’t deductible. Exam-ples of repairs include:

Reconditioning floors (but not replace-ment),

Repainting the interior and exterior walls of a building,

Cleaning and repairing roofs and gutters, and

Fixing plumbing leaks (but not replacement of fixtures).

Repayments. If you had to repay an amount you included in your income in an earlier year, you may be able to deduct the amount repaid for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. In most cases, you can claim a deduction or credit only if the repayment qualifies as an expense or loss in-curred in your trade or business or in a for-profit transaction.

Type of deduction. The type of deduction you are allowed in the year of repayment de-pends on the type of income you included in the earlier year. For instance, if you repay an amount you previously reported as a capital gain, deduct the repayment as a capital loss as explained in the Instructions for Schedule D (Form 1040). If you reported it as self -employ-ment income, deduct it as a business expense on Schedule C (Form 1040), or a farm expense on Schedule F (Form 1040).

If you reported the amount as wages, unem-ployment compensation, or other nonbusiness ordinary income, you may be able to deduct it as an other itemized deduction if the amount re-paid is over $3,000.

Beginning in 2018, due to the suspen-

sion of miscellaneous itemized deduc-CAUTION tions subject to the 2% floor under sec-tion 67(a), you aren’t able to deduct the repayment as an itemized deduction if it is $3,000 or less.

Repayment—$3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it.

Repayment—Over $3,000. If the amount you repaid was more than $3,000, you can de-duct the repayment as an other itemized deduc-tion on Schedule A (Form 1040), line 16, if you included the income under a “claim of right.” This means that at the time you included the in-come, it appeared that you had an unrestricted right to it. However, you can choose to take a credit for the year of repayment. Figure your tax under both methods and use the method that results in less tax.

Method 1. Figure your tax for 2022 claim-ing a deduction for the repaid amount.

Method 2. Figure your tax for 2022 claim-ing a credit for the repaid amount. Follow these steps.

1. Figure your tax for 2022 without deducting the repaid amount.

2. Refigure your tax from the earlier year without including in income the amount you repaid in 2022.

3. Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the amount of your credit.

4. Subtract the answer in (3) from the tax for 2022 figured without the deduction (step 1).

If Method 1 results in less tax, deduct the amount repaid as discussed earlier under Type of deduction.

If Method 2 results in less tax, claim the credit on Schedule 3 (Form 1040), line 13z, and write “I.R.C. 1341” next to line 13z.

Example. For 2021, you filed a return and reported your income on the cash method. In 2022, you repaid $5,000 included in your 2021 gross income under a claim of right. Your filing status in 2022 and 2021 is single. Your income and tax for both years are as follows:

	2022		2022
		Without	With Deduction
Taxable		Deduction
	$49,950		$44,950
Income
Tax	$6,606		$5,506

Your tax under Method 1 is $5,506. Your tax un-der Method 2 is $6,006, figured as follows:

Chapter 11Other ExpensesPage 49

Tax previously determined for

2021 ........................... $1,604 Less: Tax as refigured . . . . . . . . . . . − 1,004

. . . . . . . . . . . .Decreasein2021tax	$600
Regular tax liability for 2022
.......	$6,606
Less: Decrease in 2021 tax . . . . . . .	− 600
. . . . . . .Refiguredtaxfor2022	$6,006

Because you pay less tax under Method 1, you should take a deduction for the repayment in 2022.

Repayment does not apply. This discus-sion doesn’t apply to the following.

Deductions for bad debts.
Deductions from sales to customers, such as returns and allowances, and similar items.
Deductions for legal and other expenses of contesting the repayment.

Year of deduction (or credit). If you use the cash method of accounting, you can take the deduction (or credit, if applicable) for the tax year in which you actually make the repayment. If you use any other accounting method, you can deduct the repayment or claim a credit for it only for the tax year in which it is a proper de-duction under your accounting method. For ex-ample, if you use the accrual method, you are entitled to the deduction or credit in the tax year in which the obligation for the repayment ac-crues.

Supplies and materials. Unless you have de-ducted the cost in any earlier year, you can gen-erally deduct the cost of materials and supplies actually consumed and used during the tax year.

If you keep incidental materials and supplies on hand, you can deduct the cost of the inci-dental materials and supplies you bought during the tax year if all the following requirements are met.

You don’t keep a record of when they are used.

You don’t take an inventory of the amount on hand at the beginning and end of the tax year.
This method doesn’t distort your income.

You can also deduct the cost of books, pro-fessional instruments, equipment, etc., if you normally use them within a year. However, if the usefulness of these items extends substantially beyond the year they are placed in service, you must generally recover their costs through de-preciation. For more information regarding de-preciation, see Pub. 946.

Utilities. Business expenses for heat, lights, power, telephone service, and water and sew-erage are deductible. However, any part due to personal use isn’t deductible.

Telephone. You can’t deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home. However, charges for business long-dis-tance phone calls on that line, as well as the cost of a second line into your home used ex-clusively for business, are deductible business expenses.

12.

How To Get Tax Help

If you have questions about a tax issue; need help preparing your tax return; or want to down-load free publications, forms, or instructions, go to IRS.gov to find resources that can help you right away.

TTY/TDD and Federal Relay Service. People who are deaf, hard of hearing, or have a speech disability and who have access to TTY/TDD equipment can call toll free 800-829-4059 to ask tax questions or to order forms and publica-tions. Deaf or hard of hearing customers may call any of our toll-free numbers using their choice of relay service.

Coronavirus. Go to IRS.gov/Coronavirus for links to information on the impact of the corona-virus, as well as tax relief available for individu-als and families, small and large businesses, and tax-exempt organizations.

Preparing and filing your tax return. After receiving all your wage and earning statements (Forms W-2, W-2G, 1099-R, 1099-MISC, 1099-NEC, etc.); unemployment compensation statements (by mail or in a digital format) or other government payment statements (Form 1099-G); and interest, dividend, and retirement statements from banks and investment firms (Forms 1099), you have several options to choose from to prepare and file your tax return. You can prepare the tax return yourself, see if you qualify for free tax preparation, or hire a tax professional to prepare your return.

Free options for tax preparation. Go to IRS.gov to see your options for preparing and filing your return online or in your local commun-ity, if you qualify, which include the following.

Free File. This program lets you prepare and file your federal individual income tax return for free using brand-name tax-prep-aration-and-filing software or Free File filla-ble forms. However, state tax preparation may not be available through Free File. Go to IRS.gov/FreeFile to see if you qualify for free online federal tax preparation, e-filing, and direct deposit or payment options.

VITA. The Volunteer Income Tax Assis-tance (VITA) program offers free tax help to people with low-to-moderate incomes, persons with disabilities, and limited-Eng-lish-speaking taxpayers who need help preparing their own tax returns. Go to IRS.gov/VITA, download the free IRS2Go app, or call 800-906-9887 for information on free tax return preparation.

TCE. The Tax Counseling for the Elderly (TCE) program offers free tax help for all taxpayers, particularly those who are 60 years of age and older. TCE volunteers specialize in answering questions about pensions and retirement-related issues

unique to seniors. Go to IRS.gov/TCE, download the free IRS2Go app, or call 888-227-7669 for information on free tax return preparation.

MilTax. Members of the U.S. Armed Forces and qualified veterans may use Mil-Tax, a free tax service offered by the De-partment of Defense through Military One-Source. For more information, go to MilitaryOneSource (MilitaryOneSource.mil/ MilTax).

Also, the IRS offers Free Fillable Forms, which can be completed online and then filed electronically regardless of income.

Employers can register to use Business Services Online. The Social Security Adminis-tration (SSA) offers online service at SSA.gov/ Employer for fast, free, and secure online W-2 filing options to certified public accountants (CPAs), accountants, enrolled agents, and indi-viduals who process Forms W-2, Wage and Tax Statement, and Forms W-2c, Corrected Wage and Tax Statement.

Tax reform. Tax reform legislation affects indi-viduals, businesses, and tax-exempt and gov-ernment entities. Go to IRS.gov/TaxReform for information and updates on how this legislation affects your taxes.

A–Z index for business. Find it fast! Know what you're looking for and want to find it fast? Select business topics using our A–Z listing, or by business type such as sole proprietor, cor-poration, etc. We also provide links to major business subjects, such as Business Expenses, which provide a gateway to all related informa-tion on those subjects.

Small Business Forms and Publications. You can download forms and publications for small businesses and self-employed in-dividuals.

Employer ID Numbers (EINs). Find out about EINs or apply for one online.
e-File Form 940, 941, 944, or 945 for Small Businesses. Learn your options for e-filing Form 940, 941, 944, or 945 for small busi-nesses.

Employment Taxes. Federal income tax, social security and Medicare taxes, FUTA tax, self-employment tax, and more.

Independent Contractor (Self-Employed) or Employee. It is critical that you, the em-ployer, correctly determine whether the in-dividuals providing services are employees or independent contractors.

Self-Employed Individuals Tax Center. The basics on self-employment, filing require-ments, and reporting responsibilities for in-dependent contractors.

Information Return Filing Requirements. If you made or received a payment as a small business or self-employed individual, you are most likely required to file an infor-mation return with the IRS.

IRS Video Portal. Videos, webinars, and audio presentations for small businesses, individuals, and tax pros.
Small Business Events. Workshops and webinars on a variety of topics for small businesses.
Online Tools & Educational Products. Choose from a variety of products,

Page 50Chapter 12How To Get Tax Help

including the Tax Calendar desktop tool, to help you learn about business taxes on your own time, and at your own pace.

Subscribe to e-News. A free electronic mail service keeping you up to date on tax topics.

Requirements for filing. If you made or re-ceived a payment during the calendar year as a small business or self-employed individual, you are most likely required to file an information re-turn with the IRS. For more information, see Am I Required To File a Form 1099 or Other Information Return? on IRS.gov.

Getting answers to your tax ques-tions. On IRS.gov, you can get up-to-date information on current

events and changes in tax law.

IRS.gov/Help: A variety of tools to help you get answers to some of the most common tax questions.
IRS.gov/ITA: The Interactive Tax Assistant, a tool that will ask you questions and, based on you input, provide answers on a number of tax law topics.

IRS.gov/Forms: Find forms, instructions, and publications. You will find details on the most recent tax changes and interac-tive links to help you find answers to your questions.

You may also be able to access tax law in-formation in your electronic filing software.

IRS social media. Go to IRS.gov/SocialMedia to see the various social media tools the IRS uses to share the latest information on tax changes, scam alerts, initiatives, products, and services. At the IRS, privacy and security are our highest priority. We use these tools to share public information with you. Don’t post your so-cial security number (SSN) or other confidential information on social media sites. Always pro-tect your identity when using any social net-working site.

The following IRS YouTube channels pro-vide short, informative videos on various tax-re-lated topics in English, Spanish, and ASL.

Watching IRS videos. The IRS Video portal (IRSVideos.gov) contains video and audio pre-sentations for individuals, small businesses, and tax professionals.

Online tax information in other languages. You can find information on IRS.gov/ MyLanguage if English isn't your native lan-guage.

Free Over-the-Phone Interpreter (OPI) Serv-ice. The IRS is committed to serving our multi-lingual customers by offering OPI services. The OPI Service is a federally funded program and is available at Taxpayer Assistance Centers (TACs), other IRS offices, and every VITA/TCE return site. The OPI Service is accessible in more than 350 languages.

Accessibility Helpline available for taxpay-ers with disabilities. Taxpayers who need in-

formation about accessibility services can call 833-690-0598. The Accessibility Helpline can answer questions related to current and future accessibility products and services available in alternative media formats (for example, braille, large print, audio, etc.). The Accessibility Help-line does not have access to your IRS account. For help with tax law, refunds, or account-rela-ted issues, go to IRS.gov/LetUsHelp.

Note. Form 9000, Alternative Media Prefer-ence, or Form 9000(SP) allows you to elect to receive certain types of written correspondence in the following formats.

Standard Print.
Large Print.
Braille.
Audio (MP3).
Plain Text File (TXT).
Braille Ready File (BRF).

Disasters. Go to Disaster Assistance and Emergency Relief for Individuals and Businesses to review the available disaster tax relief.

Getting tax forms and publications. Go to IRS.gov/Forms to view, download, or print all of the forms, instructions, and publications you may need. Or, you can go to IRS.gov/ OrderForms to place an order and have them mailed to you within 10 business days.

Getting tax publications and instructions in eBook format. You can also download and view popular tax publications and instructions (including the Instructions for Form 1040) on mobile devices as eBooks at IRS.gov/eBooks.

Note. IRS eBooks have been tested using Apple's iBooks for iPad. Our eBooks haven't been tested on other dedicated eBook readers, and eBook functionality may not operate as in-tended.

Access your online account (individual tax-payers only). Go to IRS.gov/Account to se-curely access information about your federal tax account.

View the amount you owe and a break-down by tax year.

See payment plan details or apply for a new payment plan.

Make a payment or view 5 years of pay-ment history and any pending or sched-uled payments.
Access your tax records, including key data from your most recent tax return and transcripts.
View digital copies of select notices from the IRS.

Approve or reject authorization requests from tax professionals.

View your address on file or manage your communication preferences.

Tax Pro Account. This tool lets your tax pro-fessional submit an authorization request to ac-cess your individual taxpayer IRS online account. For more information, go to IRS.gov/ TaxProAccount.

Using direct deposit. The fastest way to re-ceive a tax refund is to file electronically and

choose direct deposit, which securely and elec-tronically transfers your refund directly into your financial account. Direct deposit also avoids the possibility that your check could be lost, stolen, or returned undeliverable to the IRS. Eight in 10 taxpayers use direct deposit to receive their re-funds. If you don't have a bank account, go to IRS.gov/DirectDeposit for more information on where to find a bank or credit union that can open an account online.

Need someone to prepare your tax return? There are various types of tax return preparers, including enrolled agents, CPAs, attorneys, and many others who don't have professional cre-dentials. If you choose to have someone pre-pare your tax return, choose that preparer wisely. A paid tax preparer is:

Primarily responsible for the overall sub-stantive accuracy of your return,

Required to sign the return, and
Required to include their preparer tax iden-tification number (PTIN).

Although the tax preparer always signs the return, you're ultimately responsible for provid-ing all the information required for the preparer to accurately prepare your return. Anyone paid to prepare tax returns for others should have a thorough understanding of tax matters. For more information on how to choose a tax pre-parer, go to Tips for Choosing a Tax Preparer on IRS.gov.

For your convenience, the IRS provides an online database for all Authorized IRS e-file Providers that choose to be included in the da-tabase. You can locate the closest Authorized IRS e-file Providers in your area where you can electronically file your tax return. For more infor-mation on finding a tax return preparer who pro-vides IRS e -file, see Authorized IRS e-file Providers for Individuals on IRS.gov, or go to IRS.gov/uac/Authorized-IRS-e-file-Providers-for-Individuals. The inclusion in this database does not constitute any endorsement by the IRS of the e-file Providers listed in this database or any of the products or services that they pro-vide. You should always be sure to conduct your own due diligence when selecting an e-file Provider. In addition to the Authorized IRS e-file Provider locator tool above, you can also find professional help through the IRS Tax Professional Partner page at IRS.gov/Tax-Professionals/IRSTaxProAssociationPartners.

Choose a tax return preparer you will be able to contact in case the IRS examines your return and has questions regarding how your return was prepared. You can designate your paid tax return preparer or another third party to speak to the IRS concerning the preparation of your return, payment/refund issues, and mathe-matical errors. The third party authorization checkbox on Form 1040 or 1040-SR gives the designated party the authority to receive and in-spect returns and return information for 1 year from the original due date of your return (without regard to extensions). You can extend the au-thority to receive and inspect returns and return information to a third party using Form 8821, Tax Information Authorization.

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The following points will assist you when se-lecting a tax return preparer.

Check the preparer’s qualifications. All paid tax return preparers are required to have a PTIN.
Check the preparer’s history. You can check with the Better Business Bureau to find out if a preparer has a questionable history. Check for disciplinary actions and the license status for credentialed prepar-ers. For CPAs, check with the State Board of Accountancy. For attorneys, check with the State Bar Association. For Enrolled Agents (EAs), go to IRS.gov/Tax-Professionals/Verify-the-Status-of-an-Enrolled-Agent and follow the instructions for requesting EA status verification.
Ask about service fees. Avoid preparers who base their fee on a percentage of your refund or those who say they can get larger refunds than others can. Always make sure any refund due is sent directly to you or deposited into your bank ac-count. You should not have your refund deposited into a preparer’s bank account.

Ask to e-file your return. Make sure your preparer offers IRS e-file. Any paid pre-parer who prepares and files more than 10 returns must generally e-file their clients’ returns. The IRS has safely processed more than 1.3 billion e-filed tax returns.

Make sure the preparer is available. You need to ensure that you can contact the tax preparer after you file your return. That’s true even after the April 17, 2023, due date for individual returns. The due date for partnerships and S corporations using a calendar year is March 15, 2023. You may need to contact the preparer if questions come up about your tax return at a later time.

Provide tax records. A good preparer will ask to see your records and receipts. They ask you questions to report your total in-come and the tax benefits you’re entitled to claim. These may include tax deductions, tax credits, and other items. Do not use a preparer who is willing to e-file your return using your last pay stub instead of your Form W-2. This is against IRS e-file rules.

Never sign a blank tax return. Do not use a tax preparer who asks you to sign a blank tax form.
Review your return before signing. Be-fore you sign your tax return, review it thor-oughly. Ask questions if something is not clear to you. Make sure you’re comfortable with the information on the return before you sign it.

Preparer must sign returns and include their PTIN. A paid preparer must sign re-turns and include his or her PTIN as re-quired by law. The preparer must also give you a copy of the return.

Report abusive tax preparers to the IRS. You can report abusive tax preparers and suspected tax fraud to the IRS. Use Form 14157, Complaint: Tax Return Preparer. If you suspect a return preparer filed or changed the return without your consent, you should also file Form 14157-A, Return Preparer Fraud or Misconduct Affidavit. You can download and print these forms from IRS.gov. If you need a

paper form mailed to you, go to IRS.gov/ OrderForms to order online. For more in-formation, go to How Do You Report Suspected Tax Fraud Activity? on IRS.gov.

Using online tools to help prepare your re-turn. Go to IRS.gov/Tools for the following.

The Earned Income Tax Credit Assistant (IRS.gov/EITCAssistant) determines if you’re eligible for the earned income credit (EIC).

The Online EIN Application (IRS.gov/EIN) helps you get an employer identification number (EIN) at no cost.
The Tax Withholding Estimator (IRS.gov/ W4app) makes it easier for you to estimate the federal income tax you want your em-ployer to withhold from your paycheck. This is tax withholding. See how your with-holding affects your refund, take-home pay, or tax due.

The First-Time Homebuyer Credit Account Look-up (IRS.gov/HomeBuyer) tool pro-vides information on your repayments and account balance.

The Sales Tax Deduction Calculator

(IRS.gov/SalesTax) figures the amount you can claim if you itemize deductions on Schedule A (Form 1040).

Go to IRS.gov/Pub17 to get Pub. 17, Your Federal Income Tax for Individuals, which features details on tax-saving opportuni-ties, 2022 tax changes, and thousands of interactive links to help you find answers to your questions. View it online in HTML or as a PDF or, better yet, download it to your mobile device to enjoy eBook features.

You may also be able to access tax law in-formation in your electronic filing software.
Go to IRS.gov and click on the Help & Re-sources tab for more information.

Getting a transcript or copy of a return. Tax transcripts are summaries of tax returns. IRS transcripts are best and most often used to vali-date past income and tax filing status for mort-gage, student, and small business loan applica-tions, and to help with tax preparation. Taxpayers can also use transcripts to obtain their prior-year adjusted gross income (AGI), which they need in order to e-file their tax re-turns. You can get a transcript by mail to view your tax account transactions or line-by-line tax return information for a specific tax year. The method you used to file your return and whether you have a refund or balance due affects your current tax year transcript availability. Gener-ally, these transcript types are available for the current tax year and 3 prior years. The quickest way to get a copy of your tax transcript is to go to IRS.gov/Transcripts. Click on either "Get Transcript Online" or "Get Transcript by Mail" to order a free copy of your transcript. If you need an account transcript for an older tax year, a wage and income transcript, or a verification of nonfiling letter, you’ll need to complete Form 4506-T, Request for Transcript of Tax Return, available at IRS.gov/Forms-Pubs/About-Form-4506-T, and send it to us as instructed on the form. If you made estimated tax payments and/or applied your overpayment from a prior-year tax return to your current -year tax re-turn, you can request a tax account transcript to confirm these payments or credits a few weeks

after the beginning of the calendar year prior to filing your current-year return. For the list of the various types of transcripts available for you to order, see Transcript Types and Ways to Order Them at IRS.gov/Individuals/Tax-Return-Transcript-Types-and-Ways-to-Order-Them . To order your transcript, you can choose from one of the following convenient options.

Request a return or account transcript us-ing Get Transcript at IRS.gov/Individuals/ Get-Transcript.
Download the free IRS2Go app to your mobile device and use it to order tran-scripts of your tax returns or tax account.

Call the automated transcript toll-free line at 800-908-9946 to receive your transcript by mail.
Go to Get Transcript at IRS.gov/ Individuals/Get-Transcript, and click on “Get Transcript by Mail.” You will need your SSN or your individual taxpayer iden-tification number (ITIN), date of birth, and address from your latest tax return. Tran-scripts arrive in 5 to 10 calendar days at the address we have on file for you.

Mail Form 4506-T, Request for Transcript of Tax Return, or Form 4506T-EZ, Short Form Request for Individual Tax Return Transcript (both available on IRS.gov).

The IRS never sends email requesting that you obtain or access your transcripts. Report all unsolicited email claiming to be from the IRS or an IRS-related function to phishing@irs.gov.

A transcript isn’t a photocopy of your return. If you need a photocopy of your original return, complete and mail Form 4506, Request for Copy of Tax Return, available at IRS.gov/Pub/ irs-pdf/F4506.pdf, along with the applicable fee.

Reporting and resolving your tax-related identity theft issues.

Tax-related identity theft happens when someone steals your personal information to commit tax fraud. Your taxes can be af-fected if your SSN is used to file a fraudu-lent return or to claim a refund or credit.

The IRS doesn't initiate contact with tax-payers by email, text messages (including shortened links), telephone calls, or social media channels to request or verify per-sonal or financial information. This in-cludes requests for personal identification numbers (PINs), passwords, or similar in-formation for credit cards, banks, or other financial accounts.

Go to IRS.gov/IdentityTheft, the IRS Iden-tity Theft Central webpage, for information on identity theft and data security protec-tion for taxpayers, tax professionals, and businesses. If your SSN has been lost or stolen or you suspect you're a victim of tax-related identity theft, you can learn what steps you should take.

Get an Identity Protection PIN (IP PIN). IP PINs are six-digit numbers assigned to tax-payers to help prevent the misuse of their SSNs on fraudulent federal income tax re-turns. When you have an IP PIN, it pre-vents someone else from filing a tax return with your SSN. To learn more, go to IRS.gov/IPPIN.

The IRS stops and flags suspicious or du-plicate federal tax returns that falsely

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represent your identity, such as your name or SSN. If the IRS suspects tax ID theft, the agency will send a 5071C letter to your home address. If you receive this letter, verify your identity at IDVerify.IRS.gov or call the toll-free number listed in the letter. If you did not receive an IRS notice but be-lieve you’ve been the victim of ID theft, contact the IRS Identity Protection Special-ized Unit at 800-908-4490 right away so we can take steps to secure your tax ac-count and match your SSN or ITIN.

Also, fill out and submit the IRS Form 14039, Identity Theft Affidavit. Please write legibly and follow the directions on the back of the form that relate to your specific circumstances.

If you are a victim of state tax ID theft, con-tact your state's taxation department or comptroller's office about the next steps you need to take.

You should protect the information that you keep, and properly dispose of what you no longer need. And, of course, you should create a plan to respond to security inci-dents. As part of its long-standing efforts to promote good data security practices, the Federal Trade Commission (FTC) has un-dertaken extensive efforts to educate busi-nesses and has brought more than 50 law enforcement actions related to data secur-ity issues. For more information, see Pro-tecting Personal Information: A Guide for Business, available at FTC.gov/Tips-advice/business-center/guidance/ protecting-personal-information-guide-business, for practical tips on creating and implementing a plan for safeguarding per-sonal information used in your business. Most recently, the FTC released Start with Security: A Guide for Business, available at FTC.gov/Tips-advice/business-center/ guidance/start-security-guide-business? utm_source=govdelivery, which draws on the lessons learned from the FTC's en-forcement actions.

The IRS, the states, and the tax industry joined together to enact new safeguards and take additional actions to combat tax-related identity theft. Many of these safeguards will be invisible to you, but invaluable to our fight against these criminal syndicates. If you pre-pare your own return with tax software, you will see new log-on standards. Some states also have taken additional steps. See your state revenue agency’s web site for additional de-tails.

The FTC works for consumers to prevent fraudulent, deceptive, and unfair business prac-tices and to provide information to help spot, stop, and avoid them. To file a complaint, for example, to report someone falsely claiming to be from the government, a business, or a family member, visit the FTC’s online Report Fraud

Assistant or call 877-FTC-HELP (877-382-4357). The FTC enters complaints into Consumer Sentinel, a secure, online data-base available to more than 2,000 civil and criminal law enforcement agencies in the United States and abroad. Complaints from consumers help the FTC detect patterns of fraud and

abuse. The FTC’s website provides free infor-mation on a variety of consumer topics, in Eng-lish and in Spanish.

Consumer complaints regarding interna-tional scams can be reported online through Econsumer.gov. These are also entered into Consumer Sentinel, the complaint database maintained by the FTC, and are made available to enforcers and regulators in countries with participating agencies. Those agencies may use the complaints to investigate cross-border issues, uncover new scams, pursue regulatory or enforcement actions, and spot consumer trends.

Ways to check on the status of your refund.

Go to IRS.gov/Refunds.
Download the official IRS2Go app to your mobile device to check your refund status.
Call the automated refund hotline at 800-829-1954.

Note. The IRS can’t issue refunds before mid-February for returns that claimed the EIC or the additional child tax credit (ACTC). This ap-plies to the entire refund, not just the portion as-sociated with these credits.

Making a tax payment. Go to IRS.gov/ Payments for information on how to make a payment using any of the following options.

IRS Direct Pay: Pay your individual tax bill or estimated tax payment directly from your checking or savings account at no cost to you.

Debit or Credit Card: Choose an approved payment processor to pay online or by phone.
Electronic Funds Withdrawal: Schedule a payment when filing your federal taxes us-ing tax return preparation software or through a tax professional.

Electronic Federal Tax Payment System: Best option for businesses. Enrollment is required.
Check or Money Order: Mail your payment to the address listed on the notice or in-structions.
Cash: You may be able to pay your taxes with cash at a participating retail store.
Same-Day Wire: You may be able to do same-day wire from your financial institu-tion. Contact your financial institution for availability, cost, and time frames.

Note. The IRS uses the latest encryption technology to ensure that the electronic pay-ments you make online, by phone, or from a mobile device using the IRS2Go app are safe and secure. Paying electronically is quick, easy, and faster than mailing in a check or money or-der.

What if I can’t pay now? Go to IRS.gov/ Payments for more information about your op-tions.

Apply for an online payment agreement

(IRS.gov/OPA) to meet your tax obligation in monthly installments if you can’t pay your taxes in full today. Once you complete the online process, you will receive imme-diate notification of whether your agree-ment has been approved.

Use the Offer in Compromise Pre-Qualifier to see if you can settle your tax debt for less than the full amount you owe. For more information on the Offer in Compro-mise program, go to IRS.gov/OIC. If you are a sole proprietor or independent con-tractor, apply for a payment agreement as an individual.

Filing an amended return. Go to IRS.gov/ Form1040X for information and updates.

Checking the status of an amended return. Go to IRS.gov/WMAR to track the status of Form 1040-X amended returns.

Note. It can take up to 3 weeks from the date you filed your amended return for it to show up in our system, and processing it can take up to 16 weeks.

Filing past due tax returns. File all tax re-turns that are due, regardless of whether or not you can pay in full. File your past due return the same way and to the same location where you would file an on-time return. If you have re-ceived a notice, make sure to send your past due return to the location indicated on the no-tice you received. If you have a past due return, filing your past due return now can help you do the following.

Avoid interest and penalties. File your past due return and pay now to limit inter-est charges and late payment penalties.

Claim a refund. You risk losing your re-fund if you don't file your return. If you are due a refund for withholding or estimated taxes, you must file your return to claim it within 3 years of the return due date. The same rule applies to a right to claim tax credits such as the EIC. We hold income tax refunds in cases where our records show that one or more income tax returns are past due. We hold them until we get the past due return or receive an accepta-ble reason for not filing a past due return.
Protect social security benefits. If you are self-employed and do not file your fed-eral income tax return, any self-employ-ment income you earned will not be repor-ted to the SSA and you will not receive credits toward social security retirement or disability benefits.

Avoid issues obtaining loans. Loan ap-provals may be delayed if you don't file your return. Copies of filed tax returns must be submitted to financial institutions, mort-gage lenders/brokers, etc., whenever you want to buy or refinance a home, get a loan for a business, or apply for federal aid for higher education.

For more information, go to Filing Past Due Tax Returns on IRS.gov.

Substitute return. If you fail to file voluntarily, we may file a substitute return for you, based on income reported to the IRS. This return might not give you credit for deductions and exemp-tions you may be entitled to receive. We will send you a Notice of Deficiency CP3219N (90-day letter) proposing a tax assessment. You will have 90 days to file your past due tax return or file a petition in Tax Court. If you do neither, we will proceed with our proposed

Chapter 12How To Get Tax HelpPage 53

assessment. If you have received a Notice of Deficiency CP3219N, you can't request an ex-tension to file. Call us if you think you don't have to file.

If any of the income listed is incorrect, you may do the following.

Contact us toll free at 866-681-4271 to let us know.

Contact the payer (source) of the income to request a corrected Form W-2 or 1099.
Attach the corrected forms when you send us your completed tax returns.

If the IRS files a substitute return, it is still in your best interest to file your own tax return to take advantage of any exemptions, credits, and deductions you are entitled to receive. The IRS will generally adjust your account to reflect the correct figures. If you filed a past due return and have received a notice, you should send us a copy of the past due return to the address con-tained in the notice. It takes approximately 6 weeks for us to process an accurately comple-ted past due tax return.

Understanding an IRS notice or letter. Go to IRS.gov/Notices to find additional information about responding to an IRS notice or letter. We will send you a notice or letter if any of the fol-lowing apply.

You have a balance due.
You are due a larger or smaller refund.
We have a question about your tax return.
We need to verify your identity.
We need additional information.
We changed your return.
We are notifying you of delays in process-ing your return.

When you receive correspondence from us, read the entire notice or letter carefully. Typi-cally, we only need a response if you don’t agree with the information, we need additional information, or you have a balance due. If we changed your tax return, compare the informa-tion we provided in the notice or letter with the information in your original return. If we receive a return that we suspect is ID theft, we will ask you to verify your identity using the web ad-dress provided in the letter.

If we ask for a response within a specific time frame, you must respond on time to mini-mize additional interest and penalty charges or to preserve your appeal rights if you don’t agree. Pay as much as you can, even if you can’t pay the full amount you owe. You can pay online or apply for an OPA or OIC. See What if I can’t pay now, earlier, or visit our Payments page, IRS.gov/Payments, for more information.

We provide our contact phone number on the top right-hand corner of our correspond-ence. Be sure you have your tax return and any related documentation available when you call. You can also write to us at the address in the correspondence to explain why you disagree. If you write, allow at least 30 days for our re-sponse. Keep a copy of all correspondence with your tax records.

Note. You can use Schedule LEP (Form 1040), Request for Change in Language Prefer-ence, to state a preference to receive notices, letters, or other written communications from the IRS in an alternative language. The IRS's commitment to LEP taxpayers is part of a

multi-year timeline that is scheduled to begin providing translations in 2023. You will continue to receive communications, including notices and letters, in English until they are translated to your preferred language.

Collection and enforcement actions. The return we prepare for you (our proposed as-sessment) will lead to a tax bill, which, if unpaid, will trigger the collection process. This can in-clude such actions as a levy on your wages or bank account or the filing of a notice of federal tax lien. If you repeatedly do not file, you could be subject to additional enforcement measures, such as additional penalties and/or criminal prosecution.

Contacting your local IRS office. Keep in mind, many questions can be answered on IRS.gov without visiting an IRS TAC. Go to IRS.gov/LetUsHelp for the topics people ask about most. If you still need help, IRS TACs provide tax help when a tax issue can’t be han-dled online or by phone. All TACs now provide service by appointment, so you’ll know in ad-vance that you can get the service you need without long wait times. Before you visit, go to IRS.gov/TACLocator to find the nearest TAC and to check hours, available services, and ap-pointment options. Or, on the IRS2Go app, un-der the Stay Connected tab, choose the Con-tact Us option and click on “Local Offices.”

Recognizing and reporting tax scams. The Dirty Dozen is compiled annually by the IRS and lists a variety of common scams taxpayers may encounter any time during the year. Many of these con games peak during filing season as people prepare their tax returns or hire someone to do so. Aggressive and threatening phone calls by criminals impersonating IRS agents remain near the top of the annual Dirty Dozen list of tax scams for the filing season.

Scammers are able to alter caller identifica-tion (caller ID) numbers to make it look like the IRS is calling. They use fake names and bogus IRS identification or badge numbers. They often leave “urgent” callback requests. They prey on the most vulnerable people, such as the elderly, newly arrived immigrants, and those whose first language is not English. Scammers have been known to impersonate agents of IRS Criminal Investigation as well.

Be cautious when receiving suspicious calls at home or at work from sources claiming to be from the IRS, other agencies, or outside sour-ces asking for money or credit card information, or threatening to have you arrested for not pay-ing. These callers may demand money or may say you have a refund due and try to trick you into sharing private information. These con ar-tists can sound convincing when they call. They may know a lot about you.

Here are five things the scammers often do but the IRS will not do. Any one of these five things is a tell-tale sign of a scam.

The IRS will never do any of the follow-ing.

Call to demand immediate payment, nor will the agency call about taxes owed with-out first having mailed you a bill.
Demand that you pay taxes without giving you the opportunity to question or appeal the amount they say you owe.

Require you to use a specific payment method for your taxes, such as a prepaid debit card.
Ask for credit or debit card numbers over the phone.

Threaten to bring in local police or other law-enforcement groups to have you arres-ted for not paying.

If you get a phone call from someone claim-ing to be from the IRS and asking for money, do not disclose your personal information. You should make notes of all information regarding the call and/or the caller, for example, any caller ID information, then hang up immediately and do the following.

If you know you owe taxes or think you might owe, call the IRS toll free at

800-829-1040. The IRS assistors can help you with a payment issue.

If you know you don’t owe taxes or have no reason to believe that you do, report the in-cident to the Treasury Inspector General for Tax Administration (TIGTA) toll free at 800-366-4484 or at TIGTA.gov.

If you’ve been targeted by this scam, also contact the FTC and use their Report Fraud Assistant at FTC.gov. Please add “IRS Telephone Scam” to the comments of your complaint.

Remember, too, the IRS does not use email, text messages, or any social media to discuss your personal tax issue involving bills or refunds. If you get a phone call from someone claiming to be from the IRS regarding a refund owed to you and asking you for your SSN and bank account information, do not give them this information. You should make notes of all infor-mation regarding the call and/or the caller, for example, any caller ID information, and report this scam. For more information on reporting tax scams, go to IRS.gov and type “scam” in the search box. You can verify any potential re-funds owed to you by contacting the IRS di-rectly.

The Taxpayer Advocate Service (TAS) Is Here To Help You

What Is TAS?

TAS is an independent organization within the IRS that helps taxpayers and protects taxpayer rights. Their job is to ensure that every taxpayer is treated fairly and that you know and under-stand your rights under the Taxpayer Bill of Rights.

How Can You Learn About Your Taxpayer Rights?

The Taxpayer Bill of Rights describes 10 basic rights that all taxpayers have when dealing with the IRS. Go to TaxpayerAdvocate.IRS.gov to help you understand what these rights mean to you and how they apply. These are your rights. Know them. Use them.

Page 54Chapter 12How To Get Tax Help

You can find a list of your rights and the IRS’s obligations to protect them in Pub. 1, Your Rights as a Taxpayer. It includes the following.

1. The Right To Be Informed. Taxpayers have the right to know what they need to do to comply with the tax laws. They are entitled to clear explanations of the laws and IRS procedures in all tax forms, in-structions, publications, notices, and cor-respondence. They have the right to be in-formed of IRS decisions about their tax accounts and to receive clear explana-tions of the outcomes.

2. The Right to Quality Service. Taxpayers have the right to receive prompt, courte-ous, and professional assistance in their dealings with the IRS, to be spoken to in a way they can easily understand, to receive clear and easily understandable communi-cations from the IRS, and to speak to a su-pervisor about inadequate service.

3. The Right To Pay No More Than the Correct Amount of Tax. Taxpayers have the right to pay only the amount of tax le-gally due, including interest and penalties, and to have the IRS apply all tax payments properly.

4. The Right To Challenge the IRS’s Posi-tion and Be Heard. Taxpayers have the right to raise objections and provide addi-tional documentation in response to formal IRS actions or proposed actions, to expect that the IRS will consider their timely ob-jections and documentation promptly and fairly, and to receive a response if the IRS does not agree with their position.

5. The Right To Appeal an IRS Decision in an Independent Forum. Taxpayers are entitled to a fair and impartial adminis-trative appeal of most IRS decisions, in-cluding many penalties, and have the right to receive a written response regarding the Office of Appeals’ decision. Taxpayers generally have the right to take their cases to court.

6. The Right to Finality. Taxpayers have the right to know the maximum amount of time they have to challenge the IRS’s posi-tion as well as the maximum amount of time the IRS has to audit a particular tax year or collect a tax debt. Taxpayers have the right to know when the IRS has fin-ished an audit.

7. The Right to Privacy. Taxpayers have the right to expect that any IRS inquiry, ex-amination, or enforcement action will com-ply with the law and be no more intrusive

than necessary, and will respect all due process rights, including search and seiz-ure protections, and will provide, where applicable, a collection due process hear-ing.

8. The Right to Confidentiality. Taxpayers have the right to expect that any informa-tion they provide to the IRS will not be dis-closed unless authorized by the taxpayer or by law. Taxpayers have the right to ex-pect appropriate action will be taken against employees, return preparers, and others who wrongfully use or disclose taxpayer return information.

9. The Right To Retain Representation. Taxpayers have the right to retain an au-thorized representative of their choice to represent them in their dealings with the IRS. Taxpayers have the right to seek as-sistance from a Low Income Taxpayer Clinic if they cannot afford representation.

10. The Right to a Fair and Just Tax Sys-tem. Taxpayers have the right to expect the tax system to consider facts and cir-cumstances that might affect their underly-ing liabilities, ability to pay, or ability to pro-vide information timely. Taxpayers have the right to receive assistance from TAS if they are experiencing financial difficulty or if the IRS has not resolved their tax issues properly and timely through its normal channels.

The IRS is working to increase the number of Americans who know and understand their rights under the tax law. To expand awareness, the IRS makes Pub. 1 available in multiple lan-guages on IRS.gov. This important publication is available in the following languages.

English, Your Rights as a Taxpayer, at IRS.gov/Pub/irs-pdf/P1.pdf.

Chinese, Chinese- Your Rights as a Taxpayer (Pub 1), at IRS.gov/Chinese.
Korean, Korean- Your Rights as a Taxpayer (Pub 1), at IRS.gov/Korean.
Russian, Ваши права в качестве налогоплательщика (Публикацию № 1), at IRS.gov/Russian.
Spanish, Publicación 1SP, Derechos del Contribuyente, at IRS.gov/Spanish.

Vietnamese, Quyền Hạn của Người Đóng Thuế, Your Rights as a Taxpayer (Pub 1), at IRS.gov/Vietnamese.

The IRS will include Pub. 1 when sending noti-ces to taxpayers on a range of issues, such as an audit or collection matter. All IRS facilities will publicly display the rights for taxpayers and employees to see.

What Can TAS Do for You?

TAS can help you resolve problems that you can’t resolve with the IRS. And their service is free. If you qualify for their assistance, you will be assigned to one advocate who will work with you throughout the process and will do every-thing possible to resolve your issue. TAS can help you if:

Your problem is causing financial difficulty for you, your family, or your business;
You face (or your business is facing) an immediate threat of adverse action; or
You’ve tried repeatedly to contact the IRS but no one has responded, or the IRS hasn’t responded by the date promised.

How Can You Reach TAS?

TAS has offices in every state, the District of Columbia, and Puerto Rico. Your local advo-cate’s number is in your local directory and at TaxpayerAdvocate.IRS.gov/Contact-Us. You can also call them at 877-777-4778.

How Else Does TAS Help Taxpayers?

TAS works to resolve large-scale problems that affect many taxpayers. If you know of one of these broad issues, report it to them at IRS.gov/ SAMS.

TAS for Tax Professionals

TAS can provide a variety of information for tax professionals, including tax law updates and guidance, TAS programs, and ways to let TAS know about systemic problems you’ve seen in your practice.

Low Income Taxpayer Clinics (LITCs)

LITCs are independent from the IRS. LITCs represent individuals whose income is below a certain level and need to resolve tax problems with the IRS, such as audits, appeals, and tax collection disputes. In addition, LITCs can pro-vide information about taxpayer rights and re-sponsibilities in different languages for individu-als who speak English as a second language. Services are offered for free or a small fee for eligible taxpayers. To find an LITC near you, go to TaxpayerAdvocate.IRS.gov/about-us/Low-Income-Taxpayer-Clinics-LITC or see IRS Pub. 4134, Low Income Taxpayer Clinic List.

Chapter 12How To Get Tax HelpPage 55

	To help us develop a more useful index, please let us know if you have ideas for index entries.

Index
	See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

A

A-Z Index for Business 50 Advertising 46 Amortization:

Anti-abuse rule 34

Anti-churning rules 33

Atmospheric pollution control

facilities 35

Corporate organization costs 30 Dispositions of section 197

intangibles 34 Experimental costs 36 Geological and geophysical

costs 35

How to deduct 29

Incorrect amount deducted 34 Partnership organization

costs 30

Pollution control facilities 35

Claim a refund 53

Club dues 47

Collection and enforcement actions 54

Commitment fees 16

Compensation in excess of $1 million 9

Computer software 32 Constant-yield method, OID 16 Contested liability 7 Contributions:

Charitable 47

Political 49

Copyrights 32 Cost depletion 37

Cost of getting lease 12, 31

Cost of goods sold 3

Cost recovery 4

Covenant not to compete 32

Credit card convenience fees 47

F

Federal Relay Service 50

Fees:

Commitment 16

Legal and professional 48 Regulatory 48

Tax return preparation 48

Filing past due tax returns 53 Fines 48

Forgone interest 17

Form:

3115 34

4562 29

5213 7

8826 28, 29

41 Franchise 32, 47 Fringe benefits 9

Capitalized 16

Carrying charge 25

Deductible 15

Forgone 17

Life insurance policies 16 Limitation 15

Not deductible 16

Refunds of 17

When to deduct 17

Internet-related expenses 48

Interview expenses 48

IRS social media 51

IRS Tax Professional Partners 51

IRS Video Portal 50

K

Key person 16

Kickbacks 47

Reforestation costs 34

Reforestation expenses 27

Related person 33

Research costs 36

Section 197 intangibles

defined 31

Starting a businesscosts 29 Startup costs 29

Anticipated liabilities 47

Assistance (See Tax help)

At-risk limits 6

Attorney fees 48

Authorized IRS e-file providers 51

Awards 9

B

Bad debts:

Defined 42

How to treat 43

Recovery 43

Types of 42

When worthless 42

Bonuses:

Employee 9

Royalties 40

Bribes 47

Business:

Assets 4

Books and records 32

Meal expenses 46

Use of car 6, 47

Use of home 5

Business Services Online 50

C

Campaign contribution 49

Capital expenses 4, 5

Capitalization of interest 16

Car allowance 45

Car and truck expenses 47

Carrying charges 25

Charitable contributions 47

Checking amended return status 53

Choosing a tax return preparer 51

Circulation costs, newspapers and periodicals 27

Page 56

D

De minimis OID 15 Debt-financed distribution 15 Definitions:

Business bad debt 42

Necessary expense 3

Ordinary expense 3

Section 197 intangibles 31

Demolition expenses 47

Depletion:

Mineral property 37

Oil and gas wells 38

Timber 41

Who can claim 37

Depreciation (See Cost recovery)

Development costs, miners 27

Direct Pay 53

Dirty Dozen 54

Disabled, improvements for 28

Drilling and development costs 26

Dues, membership 47

E

e-File Form 940, 941, or 944 for Small Businesses 50

e-News 51

Economic interest 37

Economic performance 6

Education expenses 9, 47

Elderly, improvements for 28

Electronic Federal Tax Payment System (EFTPS®) 53

Employee benefit programs 10 Employer ID Numbers (EINs) 50 Employment taxes 20 Employment Taxes 50

Additional Medicare Tax 20

Self-employment tax:

Additional Medicare Tax 20 Unemployment fund 20

Entertainment 46 Entertainment expenses 10 Experimentation costs 25, 36 Exploration costs 26

G

Gas wells 40

Geological and geophysical costs:

Development, oil and gas 35 Exploration, oil and gas 35

Geothermal wells 26, 40 Gifts, nominal value 9 Going into business 4, 29 Goodwill 32

Gross income, not-for-profit activity 7

H

Health plan 24

Heating equipment 5

Home, business use of 5

I

Identity theft 52

Identity theft issues 52

Impairment-related expenses 48

Improvements 5

By lessee 13

For disabled and elderly 28 Income Taxes 19

Accrual of contested income taxes 20

Federal income taxes 19

Foreign income taxes 20

State and local income taxes 19

Incorrect amount of amortization deducted 34

Independent Contractor (Self-Employed) or Employee? 50

Information Return Filing

Requirements 50

Insurance 24

Capitalized premiums 24

Deductible premiums 21

Nondeductible premiums 24

Intangible drilling costs 26 Intangibles, amortization 31 Interest:

Allocation of 14 Below-market 17 Business expense for 13

L

Leases:

Canceling 11

Cost of getting 12, 31 Improvements by lessee 13 Leveraged 12 Mineral 40

Oil and gas 40

Sales distinguished 11 Taxes on 12

Legal and professional fees 48 Letter 5071C 53 Licenses 32, 48

Life insurance coverage 10

Limit on deductions 7

Line of credit 15

Loans:

Below-market 17

Discounted 17

Loans or advances 10 Lobbying expenses 48 Long-term care insurance 22 Losses 6, 7

At-risk limits 6

Net operating 6

Passive activities 6

Low Income Taxpayer Clinics (LITCs) 55

M

Machinery parts 5 Making a tax payment 53 Meals 44

Meals and entertainment 46 Meals and lodging 10 Methods of accounting 6 Mining:

Depletion 40 Development costs 27 Exploration costs 26

More than one health plan and business 24

Mortgage 15

Moving expenses, machinery 48

N

Natural gas 40

Publication 535 (2022)

Nonqualifying intangibles 32 Not-for-profit activities 7

Not-for-profit activity, gross income 7

Notice of Deficiency

CP3219N 53

O

Office in home 5

Oil and gas wells:

Depletion 38

Drilling costs 26

Partnerships 39

S corporations 39

Online payment agreement 53

Online Tools & Educational Products 50

Optional safe harbor method 6

Optional write-off method:

Circulation costs 36

Experimental costs 36

Intangible drilling and

Prepayment 15

Per diem and car allowances 45

Percentage depletion 37

Political contributions 49

Pollution control facilities 35

Prepaid expense 6

Extends useful life 24 Interest 17 Rent 11

Prepayment penalty 15

Presumption of profit 7

Publication 1, Your Rights as a Taxpayer 54, 55

Publications (See Tax help)

Q

Qualified long-term care insurance:

Benefits received 23

Chronically ill individual 23

Qualified long-term care

insurance contract 22

Regulatory fees 48 Reimbursements 44

Business expenses 11

Mileage 45

Nonaccountable plan 46

Per diem 45

Related persons:

Anti-churning rules 33

Coal or iron ore 40

Payments to 7, 17

Refiners 38

Unreasonable rent 11

Reminder:

Premium tax credit 21 Removal 28

Rent expense, capitalizing 13 Repairs 49

Repayments (claim of right) 49

Reporting abusive tax preparers 52

Research costs 25, 36

Tax information in other languages 51

Tax preparation 50

Tax preparation fees 48

Tax questions 51

Tax scams 54

Taxes 12, 18

Carrying charge 25

Leased property 12

When To Deduct Taxes 18

Taxpayer Advocate Service (TAS) 54

Taxpayer Assistance Center (TAC) locator 54

Telephone 50

Timber 34, 41

Tools 5

Trademark, trade name 32, 47 transcript or copy of a return 52 Transportation (commuting)

benefits 10

Travel 44

development costs 36 Mining exploration and

development costs 36 Research costs 36

Organization costs: Corporate 30 Partnership 30

Organizational costs 27 Original issue discount 15 Other coverage 23 Other Taxes 20

Excise taxes 20

Franchise taxes 20

Fuel taxes 20

Occupational taxes 20

Personal property taxes 20

Sales taxes 20

Outplacement services 48

P

Passive activities 6

Payments in kind 6

Penalties 15

Deductible 48

Nondeductible 48

Qualified long-term care services 22

R

Real Estate Taxes 19 Assessments Local 19 Charges for services 19 Electing to ratably accrue to a

definite period 19

Form 3115 19

Making the election to ratably accrue the taxes 19

Purchase or sale of real estate 19

Separate elections to ratably accrue for each separate trade or business and for nonbusiness activities 19

Recapture:

Exploration expenses 26 Timber property 35

Recordkeeping 39

Recovery of amount deducted 6

Refiners who cannot claim percentage depletion 38

Reforestation costs 27, 34

S

U

Scammers 54

Understanding an IRS notice or

Section 179 expense deduction

letter 54

(See Cost recovery)

Unpaid expenses, related

Self-employed health insurance

person 17

deduction

21

Utilities

50

Self-Employed

Health Insurance

Deduction Worksheet 23

V

Self-Employed Individuals

Tax

Center

50

Vacation pay 11

Self-insurance, reserve for 24

Sick pay 11

50

W

Small Business Events

Wages:

Small Business Forms and

Publications 50

Property 11

Standard meal

Tests for

allowance 45

deducting pay 8

Standard mileage rate

45

Welfare benefit funds 10

Standby charges 16

When To Deduct Premiums

24

startup costs

27

When To Deduct Taxes:

Startup costs

29

53

Carrying charges 19

Substitute return

Limitation on acceleration of

Supplies and materials

50

accrual of taxes

19

Refunds of taxes 19

T

rules

19

Uniform capitalization

Tax help 50

Publication 535 (2022)Page 57

With Income

Without

Income