Introduction . . . . . . . . . . . . . . . . . . 1 (2022)
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Publication 535
Contents
Business
Expenses
Introduction . . . . . . . . . . . . . . . . . . 1
Cat. No. 15065Z
Department
of the
Treasury
Internal
Revenue
Service
For use in preparing
2022 Returns
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 deductible. The general rules for deducting business 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 publication are to the Internal Revenue Code and regulation references are to the Income Tax Regulations under the Code.
Get forms and other information faster and easier at:
• IRS.gov (English)
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Feb 2, 2023
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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,
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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, instructions, and publications. Don’t send tax questions, tax returns, or payments to the above address.
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 Interactive 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 publications. 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 publications; call 800-829-3676 to order prior-year
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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 intended 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 organization 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 before 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 extended 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 before 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, Relief, and Economic Security (CARES) Act and
amended and extended by the Taxpayer Certainty 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 Internal 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 business could also claim the employee retention
credit for wages paid after September 30, 2021,
and before January 1, 2022. For more information, see chapter 2.
Credit for COBRA premium assistance payments is limited to periods of coverage beginning 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 termination of employment (assistance eligible individuals). This COBRA premium assistance is
available for periods of coverage beginning on
or after April 1, 2021, through periods of coverage beginning on or before September 30,
2021. For more information, see chapter 2.
Advance payment of COVID-19 credits extended. You may no longer request an advance payment of any credit on Form 7200, Advance Payment of Employer Credits Due to
COVID-19. For more information, see chapter 2.
Research and experimental costs. Beginning January 1, 2022, research and experimental expenditures, generally, have to be amortized 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 experimental costs paid or incurred in tax years beginning after 2021 must be capitalized and amortized 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 reinstated in 2023. P.L. 117-169, dated August 16,
2022, amended section 55 to impose a corporate 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 permanent. 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-MileageRates.
The following item highlights a change
regarding this publication.
Final revision. Pub. 535 will no longer be revised 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, Miscellaneous 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 insurance proceeds. See the Instructions for
Forms 1099-MISC and 1099-NEC for more information and additional reporting requirements.
Form 1099-NEC. File Form 1099-NEC, Nonemployee 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 information and additional reporting requirements.
Gig Economy Tax Center. The IRS Gig Economy 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 sharing, 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 taxpayers 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.
Photographs of missing children. The Internal Revenue Service is a proud partner with the
National Center for Missing & Exploited
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 slavery, and involves the use of force, fraud, or coercion 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 human trafficking, including forced labor, debt
bondage, involuntary servitude, “mail-order”
marriages, and sex trafficking. Trafficking in
persons can occur in both lawful and illicit industries 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 approach that addresses all aspects of human
trafficking. Online resources for recognizing and
reporting trafficking activities, and assisting victims include the Department of Homeland Security (DHS) Blue Campaign at DHS.gov/bluecampaign, the Department of State Office to
Monitor and Combat Trafficking in Persons at
State.gov/j/tip, and the National Human Trafficking 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 victimcentered approach to combating human trafficking, which places equal value on identifying
and stabilizing victims and on investigating and
prosecuting traffickers. Victims are crucial to investigations and prosecutions; each case and
every conviction changes lives. DHS understands how difficult it can be for victims to come
forward and work with law enforcement due to
their trauma. DHS is committed to helping victims feel stable, safe, and secure.
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 Financial Crimes Enforcement Network (FinCEN)
has issued a public advisory to financial institutions that contains red flag indicators for potential suspicious financial activity associated with
human trafficking. If warranted, financial institutions should file a Suspicious Activity Report
(FinCEN 112) with FinCEN to report these activities. For more information, go to Fincen.gov/
Sites/default/files/advisory/FIN-2014-A008.pdf.
925 Passive Activity and At-Risk Rules
925
936 Home Mortgage Interest
Deduction
936
946 How To Depreciate Property
946
Form (and Instructions)
Schedule A (Form 1040) Itemized
Deductions
Schedule A (Form 1040)
5213 Election To Postpone
Determination as To Whether the
Presumption Applies That an
Activity Is Engaged in for Profit
5213
See chapter 12 for information about getting
publications and forms.
What Can I Deduct?
To be deductible, a business expense must be
both ordinary and necessary. An ordinary expense is one that is common and accepted in
your industry. A necessary expense is one that
is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
1.
Deducting
Business
Expenses
Introduction
This chapter covers the general rules for deducting business expenses. Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the
business is operated to make a profit.
Cost of Goods Sold
If your business manufactures products or purchases 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 receipts 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.
Topics
This chapter discusses:
•
•
•
•
Even though an expense may be ordinary
and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. In some cases, you may not be allowed
to deduct the expense at all. Therefore, it is important to distinguish usual business expenses
from expenses that include the following.
• The expenses used to figure cost of goods
sold.
• Capital expenses.
• Personal expenses.
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
334
463 Travel, Gift, and Car Expenses
463
525 Taxable and Nontaxable Income
525
529 Miscellaneous Deductions
529
536 Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts
The following are types of expenses that go
into figuring cost of goods sold.
• The cost of products or raw materials, including freight.
• Storage.
• Direct labor (including contributions to pension or annuity plans) for workers who produce the products.
• Factory overhead.
536
538 Accounting Periods and Methods
538
542 Corporations
542
547 Casualties, Disasters, and Thefts
547
583 Starting a Business and Keeping
Records
583
587 Business Use of Your Home
587
Chapter 1
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, repackaging, handling, and administrative costs.
This rule does not apply to small business
taxpayers. You qualify as a small business taxpayer if you (a) have average annual gross
Deducting Business Expenses
Page 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 average gross receipts. If your business (or predecessor 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 expenses.” 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 deduction. A greater portion of these costs can be deducted if the property is qualified disaster assistance 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 expenses 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 cannot recover other costs until you sell the business or otherwise go out of business. However,
you can choose to amortize certain costs for
setting up your business. See Starting a Business in chapter 8 for more information on business startup costs.
Page 4
Chapter 1
If your attempt to go into business is unsuccessful. 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 decision to acquire or begin a specific business. These costs are personal and nondeductible. 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 acquire 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 successful, 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 cannot take a deduction for these costs. You will recover the costs of these assets when you dispose of them.
Business Assets
There are many different kinds of business assets, for example, land, buildings, machinery,
furniture, trucks, patents, and franchise rights.
You must fully capitalize the cost of these assets, 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 acquire or produce certain tangible business property if these amounts are deducted by you for financial accounting purposes or in keeping your
books and records. See the following for the requirements 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 acquire or produce certain tangible business property if:
• You have a trade or business or are a corporation, 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:
Deducting Business Expenses
– 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 statements in accordance with your written accounting 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 apply 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 business property if:
• You have a trade or business, partnership,
or S corporation that does not have an applicable financial statement;
• You have, at the beginning of the tax year,
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 amounts paid for the property
as an expense on your books and records
in accordance with your accounting procedures;
• 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 apply 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 taxpayer’s timely filed original tax return (including
extensions) for the tax year when qualifying
amounts were paid. The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and must include your name, address, 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 consolidated 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 partnership, the election is made by the S corporation or the partnership and not by the shareholders or partners. The election applies only
for the tax year for which it is made.
Example. In 2022, you do not have an applicable 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 substantiated in an invoice. You had an accounting procedure in place at the beginning of 2022 to expense the cost of tangible property if the
property costs $2,000 or less. You treat each
computer as an expense on your books and
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 deduct the cost of each $2,000 computer.
Improvements
Generally, you must capitalize the costs of making improvements to a business asset if the improvements 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 improve 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 ordinary, efficient operating condition. For example,
deductible repairs include costs such as painting 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 business equipment.
Routine maintenance safe harbor. If you
determine that your cost was for an improvement to a building or equipment, you can deduct your cost under the routine maintenance
safe harbor. Under the routine maintenance
safe harbor, you can deduct the costs of an improvement that meets all of the following criteria.
• 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, efficient 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 period 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 system 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 maintenance 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 capital 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 expenditures, attach a statement titled “Section
1.263(a)-3(n) Election” to your timely filed original tax return (including extensions) and include
your name and address, TIN, and a statement
that you elect to capitalize repair and maintenance 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 deductible expenses, different examples are given
below.
Motor vehicles. You usually capitalize the
cost of a motor vehicle you use in your business. You can recover its cost through annual
deductions for depreciation.
There are dollar limits on the depreciation
you can claim each year on passenger automobiles used in your business. See Pub. 463 for
more information.
Generally, repairs you make to your business vehicle are currently deductible. However,
amounts you pay to improve your business vehicle 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 concrete 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 capitalization rules apply, the cost of replacing
short-lived parts of a machine to keep it in good
working condition, but not to improve the machine, is a deductible expense.
Heating equipment. The cost of changing
from one heating system to another is a capital
expense.
Chapter 1
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 limitations, 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 unadjusted 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 deductions. For more information, see the Instructions for Form 1040.
Personal Versus Business
Expenses
Generally, you cannot deduct personal, living,
or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide
the total cost between the business and personal 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 remaining 30% is personal interest and is generally not deductible. See chapter 4 for information 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 depreciation.
To qualify to claim expenses for the business 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 business; 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 exclusive use test for the part of your home that
you regularly use either for the storage of inventory or product samples, or as a daycare facility.
Your home office qualifies as your principal
place of business if you meet the following requirements.
• You use the office exclusively and regularly for administrative or management activities of your trade or business.
Deducting Business Expenses
Page 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 location, 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 interest, real estate taxes, and casualty losses on
the home as itemized deductions on Schedule A (Form 1040). You are not required to allocate 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 optional safe harbor method, see Pub. 587.
If you were entitled to deduct depreciation 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 business and personal purposes, you must divide
your expenses based on actual mileage. Generally, 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 deduct 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.
Page 6
Chapter 1
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 ordinary and necessary and it is not a capital expense.
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 recovery 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 deduct them again as a business expense.
Limits on losses. If your deductions for an investment 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 deduct.
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-producing 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 repayment, or
b. You pledge property (other than property 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 participate, or a rental activity. In general, deductions
for losses from passive activities only offset income from passive activities. You cannot use
any excess deductions to offset other income.
Deducting Business Expenses
In addition, passive activity credits can only offset 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 activity. For more information, see Pub. 925.
Net operating loss (NOL). If your deductions 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 methods, see Pub. 538.
Cash method. Under the cash method of accounting, you generally deduct business expenses 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 expense is for property or services provided to
you, or for your use of property, economic performance occurs as the property or services are
provided, or the property is used. If your expense 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 accrual 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 occurred in that year.
If you use the cash method of accounting,
deduct the expense on your 2023 tax return.
Prepayment. You generally cannot deduct expenses in advance, even if you pay them in advance. This applies to prepaid interest, prepaid
insurance premiums, and any other prepaid expense 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 appropriate 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 deduct the amount when paid. If you are an accrual 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 calendar year taxpayer. On December 1, 2022, you
sign a 12-month lease, effective beginning January 1, 2023, and immediately pay your rent for
the entire 12-month period that begins on January 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 beyond the tax year ending December 31, 2023
(the year following the year in which you made
the advance payment). Therefore, your prepayment 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. possession 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 certain 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 expense before you can deduct it. Your deduction
is allowed when the amount is includible in income 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 investment activity to make a profit, you cannot use a
loss from the activity to offset other income. Activities 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 livelihood,
• Your losses are due to circumstances beyond 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 successful 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 presumed 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 produced 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 deductions.
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 starting an activity and do not have 3 (or 2) years
showing a profit, you can elect to have the presumption 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.
Chapter 1
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 deductions 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 deductions attributable to the activity.
Gross Income
Gross income from a not-for-profit activity includes the total of all gains from the sale, exchange, 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 activity.
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 accounting.
Limit on Deductions
You can no longer claim any miscellaneous itemized deductions. MiscellaCAUTION 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 deductions 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 deducted. 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 exceeds 10% of your adjusted gross income
(AGI). See Pub. 547 for more information on
casualty losses.
Deducting Business Expenses
Page 7
Disaster tax relief. For personal casualty
losses resulting from federally declared disasters that occurred before 2018, you may be entitled to disaster tax relief. As a result, you may
be required to figure your casualty loss differently. For tax years beginning after 2017, casualty and theft losses are allowed only to the extent it is attributable to a federally declared
disaster. For more information, see Pub. 976,
Disaster Relief.
Partnerships and S corporations. If a partnership or S corporation carries on a
not-for-profit activity, these limits apply at the
partnership or S corporation level. They are reflected in the individual shareholder's or partner'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 circumstances in making this determination.
• The degree of organizational and economic interrelationship of various undertakings.
• The business purpose that is (or might be)
served by carrying on the various undertakings separately or together in a business or investment setting.
• The similarity of the undertakings.
The IRS will generally accept your characterization if it is supported by facts and circumstances.
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 deductions 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 before 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 extended 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 8
Chapter 2
Employees' Pay
qualified sick and family leave wages in 2022
for leave taken after March 31, 2020, and before 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, Relief, and Economic Security (CARES) Act and
amended and extended by the Taxpayer Certainty 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 Internal 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 business could also claim the employee retention
credit for wages paid after September 30, 2021,
and before January 1, 2022.
Credit for COBRA premium assistance payments is limited to periods of coverage beginning 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 termination of employment (assistance eligible individuals). This COBRA premium assistance is
available for periods of coverage beginning on
or after April 1, 2021, through periods of coverage beginning on or before September 30,
2021. A premium payee is entitled to the COBRA 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 employment 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, commissions, or other noncash compensation such as
vacation allowances and fringe benefits. For information 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 payments (Form 8932).
• Employer credit for paid family and medical leave (Form 8994).
Topics
This chapter discusses:
• Tests for deducting pay
• Kinds of pay
Useful Items
You may want to see:
Publication
15
15
Employer's Tax Guide
15-A Employer's Supplemental Tax Guide
15-A
15-B Employer's Tax Guide to Fringe
Benefits
15-B
Form (and Instructions)
1099-NEC Nonemployee Compensation
1099-NEC
W-2 Wage and Tax Statement
W-2
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 expenses 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 reasonable. Whether the pay is reasonable depends 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 reasonableness of pay by the facts and circumstances.
Generally, reasonable pay is the amount that a
similar business would pay for the same or similar services.
To determine if pay is reasonable, also consider the following items and any other pertinent
facts.
• The duties performed by the employee.
• The volume of business handled.
• The character and amount of responsibility.
• The complexities of your business.
• The amount of time required.
• The cost of living in the locality.
• The ability and achievements of the individual employee performing the service.
• The pay compared with the gross and net
income of the business, as well as with distributions to shareholders if the business is
a corporation.
• Your policy regarding pay for all your employees.
• The history of pay for each employee.
Compensation in excess of $1 million. Publicly held corporations can't deduct compensation to a “covered employee” to the extent that
the compensation for the tax year exceeds $1
million. For more information, including the definition of a “covered employee,” see the Instructions 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 corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the
excessive part of the salary may be treated as a
constructive dividend to the employee-shareholder. The excessive part of the salary
wouldn't be allowed as a salary deduction by
the corporation. For more information on corporate 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 salaries are discussed next. For specialized and detailed 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 employee 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 circumstances that don't create a significant likelihood 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 arrangements granting only the right to select and
receive tangible personal property from a limited assortment of items preselected or preapproved by you). Also, tangible personal property 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 either 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 achievement 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 achievement 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 qualified 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 compensated employees as to eligibility or benefits.
A highly compensated employee is an employee 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 employee 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, ignore awards of nominal value.
Deduct achievement awards, up to the maximum 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
15-B.
you provide to an employee. See Pub.
Bonuses
You can generally deduct a bonus paid to an
employee if you intended the bonus as additional pay for services, not as a gift, and the
services were performed. However, the total
bonuses, salaries, and other pay must be reasonable for the services performed. If the bonus
is paid in property, see Property, later.
Gifts of nominal value. If, to promote employee 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 expense. See Pub. 15-B for additional information
on de minimis fringe benefits. If you provide
food to your employees, your business deduction 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 assistance program. Deduct them on the “Employee
benefit programs” or other appropriate line of
your tax return. For information on educational
assistance programs, see Educational Assistance 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 qualified education loan incurred by the employee
for the education of the employee. Qualified education 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 performance 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 employees' 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 activities 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, services, 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 independent contractor. If the recipient is an officer,
director, beneficial owner (directly or indirectly),
or other “specified individual” (as defined in
Chapter 2
Employees' Pay
Page 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 deduct 50% of certain meal expenses and 100%
of certain lodging expenses provided to your
employees. If the amounts are deductible, deduct the cost in whatever category the expense
falls.
Deduction limit on meals. You can generally deduct only 50% of the cost of furnishing
meals to your employees. However, you can
deduct the full cost of certain meals; see section 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 employee's wages.
• Meals you furnish to your employees as
part of the expense of providing recreational or social activities, such as holiday
parties or annual picnics, when made primarily 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 furnish to crew members of certain commercial vessels (or would be required to furnish 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 support 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 excludable from employee income as a de minimis 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 minimis meals and meals on your business premises from your employee's wages still apply.
See Meals in section 2 of Pub. 15-B.
!
Food and beverage expense incurred together 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 deduction is allowed for any item generally considered to be entertainment, amusement, or recreation. As discussed earlier, you can deduct
50% of the cost of business meals. If food and
Page 10
Chapter 2
Employees' Pay
beverages are provided during or at an entertainment activity, and the food and beverages
are purchased separately from the entertainment, or the cost of the food and beverages is
stated separately from the cost of the entertainment on one or more bills, invoices, or receipts,
you may continue to deduct 50% of the business 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 separately from the entertainment or must approximate the reasonable value of those items. If you
purchase food and beverages together with entertainment expenses and the cost of the food
and beverages isn't stated separately on the invoice, 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 deductible, 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 Notice 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 arrangement, or through a compensation reduction
agreement) incurred or paid after 2017. Also,
no deduction is allowed for any expense incurred for providing any transportation, or any payment 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 employee or for qualified bicycle commuting reimbursements 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 payments, 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 expenses treated as compensation applies, the
deduction that is disallowed relates to the expense 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 qualified transportation benefits.
Employee benefit programs. Employee benefit 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, deduct your costs in whatever categories they fall
(utilities, salaries, etc.).
Life insurance coverage. You can't deduct the cost of life insurance coverage for you,
an employee, or any person with a financial interest in your business if you’re directly or indirectly the beneficiary of the policy. See Regulations 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 contractors, or their beneficiaries. Welfare benefits
are any benefits other than deferred compensation 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 excess 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 account that are needed to fund claims incurred but not paid as of the end of the year.
These claims can be for supplemental unemployment benefits, severance pay, or
disability, medical, or life insurance benefits.
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 advanced as a loan; if the employee doesn't repay
the loan, treat it as income to the employee.
Below-market interest rate loans. On certain loans you make to an employee or shareholder, you’re treated as having received interest income and as having paid compensation or
dividends equal to that interest. See Below-Market Loans in chapter 4.
Property
If you transfer property (including your company's stock) to an employee as payment for services, 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 property's value in their income. Your employee is
deemed to have included the value in their income 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 recognize 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 transferred 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 substantially vested in the recipient. However, if the recipient 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 future.
Reimbursements for
Business Expenses
You can generally deduct the amount you pay
or reimburse employees for business expenses
incurred for your business. However, your deduction may be limited.
If you make the payment under an accountable plan, deduct it in the category of the expense paid. For example, if you pay an employee for travel expenses incurred on your
behalf, deduct this payment as a travel expense. If you make the payment under a nonaccountable plan, deduct it as wages and include
it on the employee's Form W-2.
See Reimbursement of Travel and Non-Entertainment Related Meals in chapter 11 for
more information about deducting reimbursements and an explanation of accountable and
nonaccountable plans.
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 discusses 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
538
544 Sales and Other Dispositions of
Assets
Rent paid in advance. Generally, rent paid for
use of property in your trade or business is deductible in the year paid or incurred. If you are
an accrual method taxpayer and pay rent in advance, you can deduct only the amount of rent
that applies to your use of rented property during 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 payment 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 following 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 capitalize 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 advance 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 Example 1, except you are a cash method calendar year taxpayer. You may deduct the entire
$12,000 payment for 2022. The payment applies 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.
544
946 How To Depreciate Property
946
See chapter 12 for information about getting
publications and forms.
Rent
Rent is any amount you pay for the use of property you do not own. In general, you can deduct
rent as an expense only if the rent is for property you use in your trade or business. If you
have or will receive equity in or title to the property, the rent is not deductible.
Sick pay. You can deduct amounts you pay to
your employees for sickness and injury, including lump-sum amounts, as wages. However,
your deduction is limited to amounts not compensated by insurance or other means.
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 persons in chapter 2 of Pub. 544.
Vacation pay. Vacation pay is an employee
benefit. It includes amounts paid for unused va-
Rent on your home. If you rent your home
and use part of it as your place of business, you
Sick and Vacation Pay
may be able to deduct the rent you pay for that
part. You must meet the requirements for business use of your home. For more information,
see Business use of your home in chapter 1.
Example 3. You are either a cash or accrual 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 allocable 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 payments are for rent or for the purchase of the
property. You must first determine whether your
agreement is a lease or a conditional sales contract. Payments made under a conditional sales
contract are not deductible as rent expense.
Conditional sales contract. Whether an
agreement is a conditional sales contract depends on the intent of the parties. Determine intent 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 3
Rent Expense
Page 11
considered a conditional sales contract rather
than a lease if any of the following is true.
• The agreement applies part of each payment toward an equity interest you will receive.
• You get title to the property after you make
a stated amount of required payments.
• The amount you must pay to use the property 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 option. 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 agreement.
• The agreement designates part of the payments as interest, or that part is easy to
recognize as interest.
Leveraged leases. Leveraged lease transactions may not be considered leases. Leveraged 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 advance ruling.
• Revenue Procedure 2001-28 contains the
guidelines the IRS will use to determine if a
leveraged lease is a lease for federal income tax purposes.
• Revenue Procedure 2001-29 provides the
information required to be furnished in a
request for an advance ruling on a leveraged 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 factors in the revenue procedure are met, including
the following.
• The lessor must maintain a minimum unconditional “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 property.
• The lessor must show that it expects to receive a profit apart from the tax deductions, allowances, credits, and other tax attributes.
Page 12
Chapter 3
Rent Expense
The IRS may charge you a user fee for issuing a tax ruling. For more information, see Revenue Procedure 2022-1, available at
IRS.gov/irb/2022-01_IRB#REV-PROC-2022-1.
The liability and amount of taxes are determined by state or local law and the lease agreement. Economic performance occurs as you
use the property.
Leveraged leases of limited-use property. The IRS won’t issue advance rulings on
leveraged leases of so-called limited-use property. Limited-use property is property not expected to be either useful to or usable by a lessor 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 limited-use property.
Example 1. Oak Corporation is a calendar
year taxpayer that uses an accrual method of
accounting. Oak leases land for use in its business. 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.
Leases over $250,000. Special rules are provided for certain leases of tangible property.
The rules apply if the lease calls for total payments of more than $250,000 and any of the following 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 account under a constant rental accrual method in
which the rent is treated as accruing ratably
over the entire lease term. For details, see section 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 accounting method.
Cash method. If you use the cash method of
accounting, you can deduct the taxes as additional 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.
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 estate taxes when the owner of the property becomes liable for them. As a result, Oak will deduct 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 generally 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 tangible 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 remaining 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 options 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 remaining 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 options. 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 provisions in your lease. You must capitalize these
payments and amortize them over the remaining 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 taxpayer 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 release 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 amortization 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. Commissions, 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 recovery 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 improvements 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 investment in the improvements over the recovery 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 indirect costs for certain production or resale activities. Include these costs in the basis of property
you produce or acquire for resale, rather than
claiming them as a current deduction. You recover the costs through depreciation, amortization, 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.
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 occupy the facility in the cost of the tools you produce.
More information. For exceptions and more
information on these rules, see Uniform Capitalization 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
537
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 required to capitalize costs under section 263A.
See section 263A(i).
Producing property. You produce property 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 equipment to build a storage facility. If you are subject 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.
550 Investment Income and Expenses
550
936 Home Mortgage Interest Deduction
936
Form (and Instructions)
Schedule A (Form 1040) Itemized
Deductions
Schedule A (Form 1040)
Schedule E (Form 1040) Supplemental
Income and Loss
Schedule E (Form 1040)
Schedule K-1 (Form 1065) Partner's
Share of Income,
Deductions, Credits, etc.
Schedule K-1 (Form 1065)
Schedule K-1 (Form 1120-S)
Shareholder's Share of Income,
Deductions, Credits, etc.
Schedule K-1 (Form 1120-S)
1098 Mortgage Interest Statement
1098
3115 Application for Change in
Accounting Method
3115
4952 Investment Interest Expense
Deduction
4952
8582 Passive Activity Loss Limitations
8582
Chapter 4
Interest
Page 13
8990 Limitation on Business Interest
Expense Under Section 163(j)
8990
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 business, 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 following categories.
• Nonpassive trade or business activity interest.
• 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 disbursements 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. Celina, a calendar-year taxpayer,
borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. 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 September 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 investment for the period from January 4 through
April 1. From April 2 through September 3, Celina 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 purposes, $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 proceeds of Loan A and $1,000 of unborrowed
funds. The following table shows the transactions in her account during the tax year.
Date
Example. Marge and Jeff secure a loan
with property used in their business. They use
the loan proceeds to buy an automobile for personal use. Jeff and Marge must allocate interest
expense on the loan to personal use (purchase
of the automobile) even though the loan is secured by business property.
January 9
Transaction
$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
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.
June 19
$1,000 proceeds of Loan C
deposited
November 20
$800 used for an investment
December 18
$600 used for personal purposes
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.
Olena treats the $800 used for personal purposes 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.
!
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 anything else by incurring a loan, or you take property 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 expense. If you withdraw the proceeds of the loan,
you must reallocate the loan based on the use
of the funds.
Page 14
Chapter 4
Interest
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 receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can
treat any payment (up to the amount of the proceeds) 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 account, 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 August 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 transactions, Giovanni can treat $1,000 of the deposit he made on August 8 as being paid on August 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 account.
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 during the same calendar month in the same way.
Interest on a segregated account. If you
have an account that contains only loan proceeds and interest earned on the account, you
can treat any payment from that account as being made first from the interest. When the interest 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 purposes. 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 deposited in the account until the time of the withdrawal is investment interest expense. The interest 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 reallocate it to another use is personal interest expense. The interest charged on the loan proceeds you left in the account ($867) continues
to be investment interest expense until you either 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 actively 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 different 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 corporation 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 distributed debt proceeds depends on your use of
those proceeds.
How to report. If the proceeds were used
in a nonpassive trade or business activity, report 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 Instructions for Form 8582 to determine the
amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter
“interest expense” and the name of the partnership 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 expense you pay or accrue during the tax year,
unless an exception to the limitation is met.
The business interest expense deduction allowed 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, generally the amount of any business interest expense 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 Instructions for Form 8990, Limitation on Business Interest 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 interest 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 payments. However, the current year interest expense 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 explained later under Capitalization of Interest.
Statement. If you paid $600 or more of
mortgage interest (including certain points) during the year on any one mortgage, you will generally receive a Form 1098 or a similar statement. You will receive the statement if you pay
interest to a person (including a financial institution 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 overpaid in an earlier year, this amount will be reported 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 expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. If the property mortgaged is business
or income-producing property, you can amortize 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 interest.
Interest on employment tax deficiency. Interest 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) generally 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 interest. Qualified stated interest is stated interest
that is unconditionally payable in cash or property (other than another loan of the issuer) at
least annually over the term of the loan at a single 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. Interest 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 4
Interest
Page 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 discussed later), the issue price is generally
the difference between the proceeds and
the points.
2. Multiply the result in (1) by the yield to maturity.
3. Subtract any qualified stated interest payments 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 interest 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 reCAUTION maining OID in the year in which the refinancing 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 Deduct, 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 premium charges. If any of these charges (points)
are solely for the use of money, they are interest.
Because points are prepaid interest, you
generally cannot deduct the full amount in the
year paid. However, you can choose to fully deduct points in the year paid if you meet certain
Page 16
Chapter 4
Interest
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 applied, in general, first to interest and any remainder to principal. You can deduct only the
interest. This rule does not apply when it can be
inferred that the borrower and lender understood that a different allocation of the payments
would be made.
Installment purchase. If you make an installment purchase of business property, the contract between you and the seller generally provides 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 recharacterized as interest (unstated interest).
The amount recharacterized as interest reduces
your basis in the property and increases your
interest expense. For more information on installment 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 deducted 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 interest on the first loan are deductible, along with
any interest you pay on the second loan, subject to any limits that apply.
Capitalized interest. You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. See Capitalization 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 property used in your business, the fees are indirect
costs and you must generally capitalize them
under the uniform capitalization rules. See Capitalization 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 operating loss deduction.
Penalties. Penalties on underpaid deficiencies and underpaid estimated tax are not interest. You cannot deduct them. Generally, you
cannot deduct any fines or penalties.
Interest on loans with respect to life insurance 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 figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as
Moody's Corporate Bond Yield Average—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 individuals.
Exceptions for pre-June 1997 contracts.
You can generally deduct the interest if the contract was issued before June 9, 1997, and the
covered individual is someone other than an
employee, officer, or someone financially interested in your business. If the contract was purchased before June 21, 1986, you can generally 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 insurance, 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 information, 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 cannot capitalize interest related to property that
you acquire in any other manner.
Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Designated 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 estimated production period of more than 2
years.
• Tangible personal property with an estimated 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, develop, 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 information, 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 property 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 interest 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 corporation has insufficient debt to support the production 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 partnership 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 beyond the scope of this publication. For more information, 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 under Capitalization of Interest, earlier, and the
business interest expense deduction limitation
rules discussed under Interest Expense Limitation, earlier, do not apply, deduct interest as follows.
Cash method. Under the cash method, you
can generally deduct only the interest you actually paid during the tax year. You cannot deduct a promissory note you gave as payment
because it is a promise to pay and not an actual
payment.
Prepaid interest. You generally cannot deduct 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 refund 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 deduct 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 income tax deficiency, interest does not accrue
until the tax year the final determination of liability 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 proposed 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 relationship is determined as of the end of the tax year
for which the interest would otherwise be deductible. 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 business, you may be able to deduct the forgone interest. 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 below-market loan is generally considered an
arm's-length transaction in which you, the borrower, 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, dividend, contribution to capital, payment of compensation, or other payment, depending on the
substance of the transaction.
Forgone interest. For any period, forgone interest 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 December 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 below-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-market loans between an employer and an
employee or between an independent
contractor and a person for whom the contractor 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 arrangement).
5. Loans to qualified continuing care facilities
under a continuing care contract (made after 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) outstanding 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 treated as transferring this amount back to the
lender as interest. These transfers are considered 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 individuals, 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 4
Interest
Page 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 below-market term loan other than a gift or demand loan, you are treated as receiving an additional 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) under 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 following.
1. Gift loans between individuals if the loan is
not directly used to buy or carry income-producing assets.
2. Compensation-related loans or corporation-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 subject 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 exempted from the rules for below-market loans
because their interest arrangements do not
have a significant effect on the federal tax liability 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.
b. The amount of the items.
c. The cost of complying with the below-market loan provisions if they
were to apply.
5.
d. Any reasons, other than taxes, for
structuring the transaction as a below-market loan.
Taxes
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) meeting the requirements listed below.
1. Designed to provide services under continuing 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 contract between an individual and a qualified continuing care facility that includes all of the following 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 individual's spouse in an:
a. Independent living unit (which has additional available facilities outside the
unit for the provision of meals and
other personal care), and
b. Assisted living or nursing facility available in the continuing care facility.
2. Loans subsidized by a federal, state, or
municipal government that are made available under a program of general application to the public.
3. The individual or individual's spouse will
be provided with assisted living or nursing
care available in the continuing care facility, as required for the health of the individual or the individual's spouse.
3. Certain employee-relocation loans.
For more information, see section 7872(h).
4. Certain loans to or from a foreign person,
unless the interest income would be effectively 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 significant effect on the federal tax liability of
the lender or the borrower. Whether an interest 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 deduction generated by the loan offset each
other.
Page 18
Chapter 5
Taxes
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 Regulations section 1.7872-5.
Introduction
You can deduct various federal, state, local,
and foreign taxes directly attributable to your
trade or business as business expenses.
!
CAUTION
taxes.
You cannot deduct federal income
taxes, estate and gift taxes, or state inheritance, legacy, and succession
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
15
(Circular E), Employer's Tax Guide
334 Tax Guide for Small Business
334
510 Excise Taxes
510
538 Accounting Periods and Methods
538
551 Basis of Assets
551
Form (and Instructions)
1040 or 1040-SR U.S. Individual Income
Tax Return
1040 or 1040-SR
Schedule A (Form 1040) Itemized
Deductions
Schedule A (Form 1040)
Schedule SE (Form 1040)
Self-Employment Tax
Schedule SE (Form 1040)
3115 Application for Change in
Accounting Method
3115
8959 Additional Medicare Tax
8959
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 determine when you can deduct the tax.
Example. Your state imposes a tax on personal property used in a trade or business conducted 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 original 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 capitalization rules apply to certain taxpayers who produce real property or tangible personal property
for use in a trade or business or for sale to customers. They also apply to certain taxpayers
who acquire property for resale. Under these
rules, you either include certain costs in inventory 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, include the refund in income to the extent the deduction reduced your federal income tax in the
earlier year. For more information, see Recovery of amount deducted (tax benefit rule) in
chapter 1.
TIP
You must include in income any interest you receive on tax refunds.
Real Estate Taxes
Deductible real estate taxes are any state or local taxes, including taxes imposed by U.S. possessions, on real estate levied for the general
public welfare. The taxing authority must base
the taxes on the assessed value of the real estate and charge them uniformly against all property 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 accrued 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 income 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 cannot 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 increase the basis of your property by the amount
of the assessment.
You can deduct taxes for these local benefits only if the taxes are for maintenance, repairs, or interest charges related to those benefits. 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 deduction for that part of the tax.
Example. To improve downtown commercial business, Waterfront City converted a
downtown business area street into an enclosed 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 annual payments made by the property owners.
The assessments for construction costs are
not deductible as taxes or as business expenses, 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 expenses.
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 information 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 ratably 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 November 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 accrual method, you can elect to accrue real estate 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 ratably 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 statement 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 deduction 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 (excluding 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 information, 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 income taxes imposed on the corporation or partnership as business expenses.
An individual can deduct state and local income 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 5
Taxes
Page 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 business 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 accrue and deduct any contested amount in the
tax year in which the liability is finally determined.
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 liability is not contested. You cannot deduct them
in the year in which the liability is finally determined.
The filing of an income tax return is not
TIP considered a contest and, in the absence 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 additional 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 information 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 provisional payment of the contested tax liability, you
can accrue and deduct the amount of the contested tax liability for which you made the provisional payment in the year in which you made
the payment, even though the liability is not determined until a later year.
If any portion of the contested amount which
was deducted in the year the provisional payment was made is later refunded when the contest is settled, you must include such portion in
your gross income in the year the refund is received.
Notwithstanding the exception that allows
accrual and deduction of contested state or local income tax liability upon payment, current
accrual and deduction is not allowed for income, war profits, and excess profits taxes imposed 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. However, 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 20
Chapter 5
Taxes
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 income 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 determined 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 apply to determine when a foreign income tax is
considered to accrue for purposes of the foreign tax credit. For more information on the foreign tax credit, see Pub. 514.
Employment Taxes
If you have employees, you must withhold various taxes from your employees' pay. Most employers 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 security and Medicare taxes as an employer, along
with unemployment taxes.
Your deduction for wages paid is not reduced 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 Medicare 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 unemployment 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 expense in figuring your adjusted gross income.
This deduction only affects your income tax. It
does not affect your net earnings from self-employment 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 required to pay Additional Medicare Tax on
self-employment income. See Form 8959 and
the Instructions for Form 8959 for more information 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 ordinary 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, diesel 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 separate 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 business.
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 property is depreciable, add the sales tax to the basis 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.
!
2555 Foreign Earned Income
2555
6.
W-2 Wage and Tax Statement
W-2
See chapter 12 for information about getting
publications and forms.
Insurance
Deductible Premiums
Reminder
Premium tax credit. You may have to use the
worksheets in Pub. 974 instead of the worksheet in this chapter. Use the worksheets in
Pub. 974 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.
Introduction
You can generally deduct the ordinary and necessary cost of insurance as a business expense
if it is for your trade, business, or profession.
However, you may have to capitalize certain insurance costs under the uniform capitalization
rules. For more information, see Capitalized
Premiums, later.
Topics
This chapter discusses:
•
•
•
•
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, accident, or similar losses.
2. Credit insurance that covers losses from
business bad debts.
3. Group hospitalization and medical insurance 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-employees, it can generally deduct them, but
must also include them in the shareholder's wages subject to federal income tax withholding. See Pub.15-B.
4. Liability insurance.
5. Malpractice insurance that covers your
personal liability for professional negligence resulting in injury or damage to patients or clients.
Deductible premiums
Nondeductible premiums
Capitalized premiums
When to deduct premiums
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.
Useful Items
You may want to see:
Publication
15-B Employer's Tax Guide to Fringe
Benefits
15-B
525 Taxable and Nontaxable Income
525
538 Accounting Periods and Methods
538
547 Casualties, Disasters, and Thefts
547
Form (and Instructions)
1040 U.S. Individual Income Tax Return
1040
1040-NR U.S. Nonresident Alien Income
Tax Return
1040-NR
Schedule 1 (Form 1040) Additional
Income and Adjustments to Income
a. If a partnership pays workers' compensation premiums for its partners, it
can generally deduct them as guaranteed payments to partners.
b. If an S corporation pays workers'
compensation premiums for its
more-than-2% shareholder-employees, it can generally deduct them, but
must also include them in the shareholder's wages.
7. Contributions to a state unemployment insurance fund are deductible as taxes if
they are considered taxes under state law.
Schedule 1 (Form 1040)
Schedule A (Form 1040) Itemized
Deductions
Schedule A (Form 1040)
Schedule C (Form 1040) Profit or Loss
From Business
Schedule C (Form 1040)
Schedule F (Form 1040) Profit or Loss
From Farming
Schedule F (Form 1040)
Schedule SE (Form 1040)
Self-Employment Tax
Schedule SE (Form 1040)
Schedule K-1 (Form 1065) Partner's
Share of Income, Deductions,
Credits, etc.
Schedule K-1 (Form 1065)
8. Overhead insurance that pays for business overhead expenses you have during
long periods of disability caused by your
injury or sickness.
9. Car and other vehicle insurance that covers vehicles used in your business for liability, 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 applies to the business use of the vehicle. If
you use the standard mileage rate to figure 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 indirectly 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 insurance 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 judgment, 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-employment on Schedule SE.
• You received wages in 2022 from an S corporation in which you were a
more-than-2% shareholder. Health insurance 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 premiums 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 income. 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 Schedule K-1 (Form 1065) as guaranteed payments 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 corporation 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 wages to be included in your gross income.
However, if the policy is in your name and
Chapter 6
Insurance
Page 21
you pay the premiums yourself, the S corporation 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 under 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 distributions that were nontaxable because you are a
retired public safety officer can’t be used to figure the deduction.
You can claim the deduction for self-employed 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,
Page 22
Chapter 6
Insurance
you can include only the smaller of the following
amounts.
1. The amount of premiums paid for that person.
2. The amount shown below. Use the person'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 contract. A qualified long-term care insurance
contract is an insurance contract that only provides coverage of qualified long-term care services. The contract must meet all the following
requirements.
• It must be guaranteed renewable.
• It must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract
may be used only to reduce future premiums or increase future benefits.
• It must not provide for a cash surrender
value or other money that can be paid, assigned, pledged, or borrowed.
• It must generally not pay or reimburse expenses incurred for services or items that
would be reimbursed under Medicare, except where Medicare is a secondary payer
or the contract makes per diem or other
periodic payments without regard to expenses.
Qualified long-term care services. Qualified long-term care services are:
• Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services; and
• Maintenance or personal care services.
The services must be required by a chronically
ill individual and prescribed by a licensed
This text is long and has been trimmed here. Open the source document for the complete record.
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