Unlike bagels, the deductions discussed in TC Memo. 2017-246 (Lender Management, LLC) have only two flavors: one the taxpayer prefers and one the IRS prefers.
The taxpayer manages investments for heirs of a family fortune built on frozen bagels. During tax years 2010 through 2012, the taxpayer claimed deductions for business expenses including salaries and wages, repairs and maintenance, rent, taxes and licenses, depreciation, retirement plans, employee benefit programs, and guaranteed payments to partners. Total claimed business expense deductions during 2010, 2011, and 2012 were $1,141,548, $1,115,893, and $1,184,620, respectively.
The taxpayer prefers the flavor of internal revenue code section 162. Under section 162, ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are generally subtracted in full from gross income to arrive at adjusted gross income.
The IRS says the taxpayer’s investment management activities are not a business. Instead, the IRS says the taxpayer can deduct the expenses under internal revenue code section 212. Section 212 provides for the deduction of the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income. The intention of section 212 is to allow deductions regarding certain income-or profit-oriented activities, notwithstanding the absence of a “trade or business.”
While the two code sections sound similar, and both originated from section 23(a) of the Revenue Act of 1932, certain limitations apply to deductions claimed under section 212 that do not apply to deductions under section 162.
Editorial Note: In this case (TC Memo. 2017-246, Lender Management, LLC), the tax court decided the taxpayer carried on operations in a continuous and businesslike manner for the purpose of earning a profit, and provided valuable services to clients for compensation. The court said the taxpayer was carrying on a trade or business for the purpose of section 162, and could claim the deductions as business expenses.
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Expenses deducted under section 162(a) generally are subtracted in full from gross income to arrive at adjusted gross income.
Expenses deducted under section 212 ordinarily are subtracted from adjusted gross income to arrive at taxable income and are subject to certain floor limitations on miscellaneous itemized deductions (section 67(a)).
A deduction under section 212 may also be limited by application of the alternative minimum tax (section 56(b)).
Additionally, under section 172, net operating losses may carry over from the year in which they were incurred to another year only if the losses were the result of operating a trade or business within the meaning of section 162(a).
The conference agreement suspends all miscellaneous itemized deductions that are subject to the 2% floor under present law. Under the provision, taxpayers may not claim (certain) items as itemized deductions for the taxable years to which the suspension applies. The provision does not apply for taxable years beginning after December 31, 2025.
Effective date −The provision is effective for taxable years beginning after December 31, 2017.
See Repeal of Certain Miscellaneous Itemized Deductions Subject to the Two-Percent Floor (sections 1307 and 1312 of the House bill, section 11045 of the Senate amendment, and sections 62, 67, and 212 of the internal revenue code).