Shorting Deductions

Dear Client – I know what you’re thinking. Since Gov. Romney didn’t claim all his charitable deductions so that he could hit his target tax rate, you’re thinking about not taking all your business (farm) deductions so that you can manipulate your income tax. I’m sorry to break the news to you but you can’t do that. Business deductions are not the same as charitable deductions.

If you spent the money on your business and have the documentation to prove it, you are required to take the expense off against your business income. I understand that you need to show a higher income for a bank loan or for Social Security but shorting your legitimate deductions is not a good idea. And don’t even think about manipulating your expenses for Earned Income Credit purposes. That is a good way to find yourself in deep trouble with the IRS. So don’t even try!

All taxpayers have to option to take their standard deduction (based on their filing status) or itemized deduction which includes their charitable deductions. Generally they will take the one that results in the least amount of tax. But it’s their choice. Not so with business income and deductions. The IRS expects a business to report all their income and take the ordinary and necessary expenses they paid.

Taking charitable deductions are a taxpayer decision. Correctly reporting your business income is the law.

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Comments

[Shirley Callahan, EA]

I am a tax instructor, and I would like to teach this theory. I understand the EIC thing, but not really the take all your deductions anyway for anybody with a business. Where do you think I might find this theory so I can present it to my students? It would be a good topic to teach in January just before tax season begins. Thanks. P. S. I have only recently found you, but I love what I see so far!

[John DeWitt]

K-1's show the gain or loss passed through, which is either taxed or is a deductible. However other distributions that are not taxable are common. The most common is the refi of an investment that generates cash (an apt. bldg., e.g.). That's not income and is not taxed to the LLC/S corp. The excess cash is distributed and is likewise not taxed. Those numbers are commonly huge. They are also commonly never recaptured but are passed in the estate at a stepped up basis (perhaps our biggest tax dodge) and never taxed. What distributions did Romney receive that were not taxable?

[Trish]

John, please re-read the post. Romney didn't claim all the charitable contributions he made so that his tax rate would be close to what he projected it to be. Never did I mention K-1 income.

[trishmc]

Please see my response to your comment.