Negative AGI and percentages for various deductions.

Discussion in 'Tax' started by D. Stussy, Aug 26, 2011.

  1. D. Stussy

    D. Stussy Guest

    From what I read in the IRC, it simply says that: "There shall be allowed
    as an expense the amount ... which exceeds X% of AGI." (paraphrase). This
    type of language is present in sections 67 (misc-2%), 165 (personal
    casualty loss - 10%), and 213 (medical expense - 7.5%). All three sections
    allow for an artificial number which is the difference between the
    respective percentage of AGI and the amount of the expense(s) incurred (for
    casualty, less an amount per incident). This isn't much of a problem when
    AGI is a positive number, but what about when it's negative?

    A response I got from the IRS suggested that when AGI is negative, the
    medical and miscellaneous percentages become zero, but surprisingly enough,
    not the casualty loss figure. However, I cannot find any authority for
    treating AGI as if it were zero for percentage purposes. There's nothing
    in the code nor the regulations, and I have not found any revenue ruling,
    procedure, or court case that says such.

    Does anyone know of any authority where a negative AGI is treated as zero
    for percentage-floor purposes of other deductions?

    If there is no authority for such, then is there any reason why the
    statutory formulae should be disregarded?
     
    D. Stussy, Aug 26, 2011
    #1
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  2. D. Stussy

    Alan Guest

    The IRS response is nonsensical.

    When AGI goes negative, an individual's itemized deductions become
    worthless for purposes of computing taxable income unless there is an
    NOL. The medical and misc. itemized deductions are not allowed for an
    NOL, so it doesn't matter what you use for the % floor limitation. The
    actual calculation would create an amount equal to the full expense
    whether you used the negative number or zero. The full expense would
    generate no tax benefit. Casualty & theft losses are not handled the
    same way. They are allowed for purposes of computing an NOL. Therefore,
    the amount of loss can create a tax benefit when AGI is negative. I am
    "not aware" of any guidance anywhere that says when you compute your
    casualty/theft loss, you use any number other than the amount identified
    as AGI and the amount of 10% that is in the statute. That would make the
    casualty/theft loss fully allowable (except for the incident deduction)
    for computing an NOL.
     
    Alan, Aug 26, 2011
    #2
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  3. D. Stussy

    D. Stussy Guest

    I agree that itemized deductions are pointless for the end tax result where
    there is no NOL, but it clearly does have an effect when an NOL is present.
    The medical deduction, as a non-business expense, does reduce net
    non-business income (if not already brought to zero) that can offset an
    NOL. As for Misc-2% expenses, some are business (i.e. EBE) and some
    aren't, but they also have an effect.

    Even the IRC does not treat the medical deduction as the expense. It is an
    artificial number - the difference between the expense and the AGI
    percentage. Therefore, when AGI is negative, why shouldn't its respective
    percentage also be negative? Same with the misc-2% category. However,
    where is there a limit that the artificial number resulting from the
    formula cannot exceed the amount of the expense? The code says simply (for
    all three deductions):

    D = E - %AGI.

    I'm looking for the authority that says that such can only be used when AGI
    that the IRS claims exists (and even if it exists, as the formulae are
    statutory, if the authority is not statutory, I see no valid reason to
    follow it).


    As I'm dealing with a NOL carryback year in a few months with IRS appeals
    over this matter, it does make a difference.
     
    D. Stussy, Aug 27, 2011
    #3
  4. D. Stussy

    Alan Guest

    I think your use of the word "percentage" has confused me. In fact, I am
    not sure exactly what the IRS is telling to you. All that being said, I
    am not aware of any statutory rule, IRS guidance or court decision that
    alters the basic formula. Your deduction equals the amount of expense
    that exceeds the limitation calculated by multiplying AGI by the
    applicable percentage. If AGI is negative, then the limit is negative
    and your excess will be greater than your actual expense. The law limits
    your deduction to the actual. In the worst case scenario, someone may
    argue that you can't use a negative limit and therefore you must use AGI
    of zero for the calculation. The end result is the same, you get to use
    the entire amount of expense.

    If the IRS is saying, that when AGI goes negative, your deductions are
    disallowed, that is nonsensical.
     
    Alan, Aug 27, 2011
    #4
  5. D. Stussy

    Seth Guest

    I think that's what he's asking for: a reference to which law limits
    the deduction to the actual, since the Internal Revenue Code gives a
    formula that exceeds the actual.

    Seth
     
    Seth, Aug 27, 2011
    #5
  6. D. Stussy

    Alan Guest

    Well... if that's what he wants.... The actual code sections that allow
    the deductions for the items in question limit the amount to actuals.

    E.g., the section on medical (213) says you can deduct "the expenses
    paid during the taxable year, not compensated for by insurance or
    otherwise"; the section for losses (165) says you can deduct "any loss
    sustained during the taxable year and not compensated for by insurance
    or otherwise". The other sections of the code that flow to the 2%
    limited miscellaneous items have similar wording. E.g., the section on
    expenses for production of income (212) says you can deduct "all the
    ordinary and necessary expenses paid or incurred during the taxable
    year." The section on business expenses (162) uses the words "all the
    ordinary and necessary expenses paid or incurred during the taxable year
    in carrying on any trade or business..."


    And finally.... Section 461 and its Regulation, the general rule....
    Under the cash receipts and disbursements method of accounting, amounts
    representing allowable deductions shall, as a general rule, be taken
    into account for the taxable year in which paid.
     
    Alan, Aug 27, 2011
    #6
  7. D. Stussy

    D. Stussy Guest

    You said a key point: "The law limits your deduction to the actual." I
    don't see that in statute at all since the deduction is defined only as a
    difference (between two values). That's the problem. In most other
    sections, I agree that the deduction is the amount of the expense
    (occasionally with an adjsutment or two), but these three sections which
    have a percentage of AGI as the amount to compare with the expense to
    arrive at the deduction don't seem to have that boundary.

    What you identify above as the worst case scenario is what the IRS
    asserted. However, I cannot find authority for that position, nor is such
    consistent with the statutory formulae given in the code. That's why I
    asked the question.
     
    D. Stussy, Aug 28, 2011
    #7
  8. D. Stussy

    D. Stussy Guest

    Those sections all say that one may deduct the appropriate expense to the
    extent it exceeds the relevant percentage of AGI. It does not say to treat
    the that percentage as if AGI were zero when AGI is negative. The
    deduction is the difference between the expense and the floor, and when AGI
    is negative, the statutory formula indicates that the deduction is
    mathematically larger than the expense -- WITHOUT EXCEPTION.

    Except where AGI is naturally exactly zero, the deduction allowed will not
    equal the expense.

    Where is the wording that limits the artificial number computed as the
    deduction to the expense? Nowhere! That's why I asked the question.
    This issue is accounting method independent.
     
    D. Stussy, Aug 28, 2011
    #8
  9. D. Stussy

    Alan Guest

    Reread the sections and decisions on distortion of income based on
    accounting.

    Here's the one on Medical:

    (a) Allowance of deduction
    There shall be allowed as a deduction the expenses paid during the
    taxable year, not compensated for by insurance or otherwise, for medical
    care of the taxpayer, his spouse, or a dependent (as defined in section
    152, determined without regard to subsections (b)(1), (b)(2), and
    (d)(1)(B) thereof), to the extent that such expenses exceed 7.5 percent
    of adjusted gross income.

    Note that it says you can deduct what you "PAID" "to the extent" that it
    exceeds the limit. It doesn't say you can deduct the amount that exceeds
    the floor.

    Come on.... do you really believe that you would ever be allowed to
    deduct $1000 in medical expenses when you only paid $750?
     
    Alan, Aug 28, 2011
    #9
  10. D. Stussy

    D. Stussy Guest

    That's EXACTLY what the code itself literally says. If the floor is
    $-250.00 because the AGI is $-3,333.33, the expense paid does in fact
    exceed the floor by $1,000, and the deduction is the difference between the
    floor and the expense (when the floor is less than the expense). There is
    no limit on where the floor may be -- it is always 0.075 x AGI.

    The equation of the code section itself is:

    Where E <= 0, D = 0:
    Where E <= 0.075 x AGI, D = 0, and
    where E > 0.075 x AGI, D = E - 0.075 x AGI.

    That's it. There is no condition to treat AGI as equal to 0 when AGI is
    negative. The deduction is not the expense itself but an artificial number
    based on it. Where the floor and expense are equal, the expense does not
    exceed the floor, thus equality is assigned to the first part of the
    equation.

    Show me where it specifically says D <= E (i.e. where the deduction may not
    exceed the expense). I see no such language in the section itself.

    "There shall be allowed as a deduction the expenses paid during the taxable
    year, not compensated for by insurance or otherwise, for medical care of
    the taxpayer, his spouse, or a dependent (as defined in section 152,
    determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B)
    thereof), ..."

    => E > 0. (expenses must exist; i.e. not zero), and

    "... to the extent that such expenses exceed 7.5 percent of adjusted gross
    income."

    => E > 0.075 x AGI.
    Then D = E - 0.075 x AGI.


    In the computer language C, this would be written as a single, one line
    equation:

    D = ( E > max( 0, 0.075 * AGI))? (E - 0.075 * AGI) : 0;

    There simply is nothing that says that AGI must be non-negative, and the
    IRC in section 61 as well as 62 do not forbid a negative AGI. In fact,
    since gross income includes capital losses, and section 62 are all
    subtractions from gross income (section 61) to arrive at AGI, if the value
    of the sum of those subtractions exceed gross income (including when GI
    itself is negative), AGI will be negative without question.


    A paraphrase of the section (formula part): Where there exists a
    qualifying expense, the deduction is the amount that the expense exceeds
    the appropriate percentage of AGI. It simply does not say that [the
    absolute value of] the deduction may not exceed [the absolute value] of the
    expense anywhere.

    However, the IRS says the deduction is limited to the expense. Where's the
    authority for that outcome?

    That would be the same as:

    D = ( E > max( 0, 0.075 * AGI))? max(E, E - 0.075 * AGI) : 0;

    Which is an identical outcome to declaring AGI equal to zero when otherwise
    negative.
     
    D. Stussy, Aug 29, 2011
    #10
  11. D. Stussy

    D. Stussy Guest

    The last part of my reply this message is attached to should read:

    "However, the IRS says the deduction is limited to the expense. Where's
    the
    authority for that outcome?

    "That would be the same as:

    D = ( E > max( 0, 0.075 * AGI))? min(E, E - 0.075 * AGI) : 0;

    "Which is an identical outcome to declaring AGI equal to zero when
    otherwise
    negative."
     
    D. Stussy, Aug 29, 2011
    #11
  12. I think if you go through Form 1045 Schedule B, you will find that to be the case. See especially lines 13-18.
     
    Ron Rosenfeld, Aug 29, 2011
    #12
  13. D. Stussy

    Seth Guest

    It says you may deduct *the expenses paid* *to the extent that they
    exceed the floor*. That is (in a particular example), you may deduct
    the $1000 paid to the extent that it exceeds $-250. "To the extent
    that" is the phrase that implies "the lesser of".

    Seth
     
    Seth, Aug 29, 2011
    #13
  14. D. Stussy

    og954

    Joined:
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    This is exactly as a I understand the section to mean just by reading it.
     
    og954, Aug 30, 2011
    #14
  15. D. Stussy

    D. Stussy Guest

    The examination that this question resulted from was just closed with the
    taxpayer's claim ALLOWED IN FULL, which includes negative percentages for
    the respective AGI-based floors. This does mean that the allowed
    deductions did exceed the expenses of each respective category. Today, the
    taxpayer received a check for full payment of the claim (plus statutory
    interest).

    I guess the IRS didn't want to litigate the issue.
     
    D. Stussy, Sep 20, 2011
    #15
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