Lecture 01: Deductions from Gross Income. [Income Taxation]

Sir Win - Accounting Lectures

15 Oct 202117:49

Summary

TLDRIn this accounting lecture, the focus is on deductions allowed by tax codes to calculate taxable income. Deductions are only permissible with legislative authorization and are crucial for individuals and corporations in trade or business. The lecture distinguishes between substantiated deductions and those disallowed, emphasizing the importance of legislative grace. It also explores the differences between exclusions, which are income-based, and deductions, which are expense-based. The discussion further delves into the classification of expenditures as either capital or revenue, with capital expenditures benefiting multiple accounting periods and revenue expenditures impacting a single period.

Takeaways

📚 Deductions are amounts allowed by the tax code to reduce gross income to taxable income for tax liability calculation.
🏢 Deductions are only available to individuals and corporations engaged in trade or business, and individuals exercising a profession.
🚫 Not all expenses are deductible; deductions are a matter of legislative grace and must be authorized by law.
❌ Wrong deductions are not allowed, emphasizing the importance of substantiation and verification of expenses.
🔍 Deductions are categorized and can vary based on the taxpayer's residence, citizenship, and source of income.
💡 Deductions are distinct from exclusions, which are not outflows of economic resources but rather adjustments to income.
🏭 Capital expenditures are large, non-recurring costs that benefit more than one accounting period and are not immediately expensed.
💼 Revenue expenditures are costs that benefit only one accounting period and are recorded as expenses in the period they are incurred.
📊 The taxation formula differentiates between exclusions, which reduce taxable income, and deductions, which are reductions from gross income.
⏳ The timing of deductions and exclusions can impact the taxpayer's overall tax liability, with some being more favorable depending on the situation.

Q & A

What are the conditions for a taxpayer to claim deductions under the tax code?
-A taxpayer can claim deductions if there is a law authorizing such deductions, as per section 24, 25(a), 26(a), 26(c), and 28(a) of the tax code.
Who are typically allowed to claim deductions for trade or business activities?
-Individuals and corporations engaged in trade or business, and individuals exercising their professions are typically allowed to claim deductions.
What is the significance of the term 'legislative grace' in the context of tax deductions?
-The term 'legislative grace' signifies that a taxpayer can only deduct an item or amount from gross income if there is a specific law that allows it, and without such law, no deduction can be claimed regardless of the expense's nature.
What are the two classic deductions that are not allowed according to the script?
-The two classic deductions that are not allowed are those that are not substantiated and those that depend on the taxpayer's residence, citizenship, and source of income.
What does it mean for a deduction to be 'substantiated'?
-A deduction is 'substantiated' when there is verifiable evidence that the expense actually occurred, allowing it to be claimed as a deduction.
How does the script differentiate between exclusions and deductions?
-Exclusions are considered part of the income taxation formula and are inherently income, while deductions are outflows of economic resources.
What is the difference between capital expenditures and revenue expenditures as per the script?
-Capital expenditures are non-recurring and large monetary amounts that typically benefit more than one accounting period, whereas revenue expenditures are recorded and typically benefit just one accounting period.
Why are capital expenditures not considered as expenses for tax purposes?
-Capital expenditures are not considered as expenses for tax purposes because they are meant to benefit more than one accounting period, unlike revenue expenditures which are for one period.
What is the script's stance on the necessity of having a law to authorize deductions?
-The script emphasizes that deductions can only be claimed if there is a law authorizing them, highlighting the importance of legislative grace in tax deduction allowances.
How does the script suggest comparing exclusions and deductions for tax purposes?
-The script suggests comparing exclusions and deductions by understanding that exclusions are part of the income taxation formula and inherently relate to income, while deductions are expenses that reduce taxable income.

Outlines

00:00

📚 Introduction to Deductions in Accounting

The paragraph introduces the topic of deductions in accounting, specifically focusing on the tax code's allowance for certain amounts to be deducted from gross income to determine taxable income. It mentions the relevant sections of the tax code, including 24(8), 25(a), 26(a), 26(c), and 28(a). The speaker emphasizes that deductions are a matter of legislative grace, meaning that taxpayers can only deduct items or amounts if there is a law authorizing it. The paragraph also touches on the idea that deductions are not allowed for expenses that are not substantiated or verified, and that the deductibility of an expense can depend on the taxpayer's residence, citizenship, and source of income.

06:17

🔍 Classification of Deductions and Their Criteria

This paragraph delves into the classification of deductions, distinguishing between itemized deductions and those that are not allowed. The speaker highlights the importance of substantiating deductions, meaning that expenses must be verifiable to be claimed as deductions. The paragraph also discusses how deductions are influenced by the taxpayer's residence and citizenship status, as well as the source of their income. The speaker mentions that deductions are subject to certain rules and regulations, which are crucial for taxpayers to understand and adhere to.

12:37

💼 Understanding Exclusions, Capital vs. Revenue Expenditures

The final paragraph shifts focus to the concepts of exclusions and the distinction between capital expenditures and revenue expenditures. Exclusions are described as a form of income that is not subject to taxation, contrasting with deductions which are outflows of economic resources. The speaker explains that capital expenditures are large, non-recurring amounts that benefit more than one accounting period and are not considered expenses for tax purposes. In contrast, revenue expenditures are costs that benefit only one accounting period and are typically deductible. The paragraph aims to clarify these financial concepts for a better understanding of tax implications.

Mindmap

Keywords

💡Deductions

Deductions refer to the amounts that can be subtracted from gross income to calculate taxable income, as per the tax code. In the context of the video, deductions are essential for determining a taxpayer's income tax liability. The script mentions that deductions are allowed by specific sections of the tax code, indicating their legislative basis. For example, 'definition deductions are amounts, allowed by the tax code to be deducted, from gross income to arrive at a taxable income' illustrates the foundational role of deductions in tax computation.

💡Taxable Income

Taxable income is the portion of a person's or corporation's income that is subject to taxation after allowable deductions have been subtracted from the gross income. The video emphasizes that deductions directly influence the calculation of taxable income, which is central to understanding tax liabilities. The script states, 'to arrive at a taxable income for purposes of computing the income tax liability,' highlighting the significance of this concept.

💡Legislative Grace

Legislative grace in the context of the video refers to the discretionary power of the legislature to allow certain deductions. This concept is crucial as it underscores that taxpayers can only deduct items if the law specifically permits them to do so. The script mentions, 'conservative deductions are a matter of legislative grace,' which implies that the right to deduct is not automatic but is granted based on legal provisions.

💡Substantiated

Substantiated, in the video, means that an expense or deduction is verifiable and can be proven to have been incurred. This is important for tax purposes as it ensures that only legitimate expenses are deducted. The script states, 'when we say substantiated, i mean you can verify that there is really such expense,' emphasizing the need for evidence to support deductions.

💡Capital Expenditures

Capital expenditures are costs associated with acquiring or improving long-term assets, such as property or equipment, which benefit the business over multiple accounting periods. The video differentiates these from revenue expenditures, highlighting their long-term nature. The script explains, 'capital expenditures, they are non-recurring large monetary amount and typically benefit more than one accounting period,' indicating their significance in financial planning and accounting.

💡Revenue Expenditures

Revenue expenditures, as discussed in the video, are costs incurred for the day-to-day operations of a business that benefit only the current accounting period. These are contrasted with capital expenditures, which have a longer-term impact. The script mentions, 'revenue expenditures... typically benefit one accounting period,' which helps to clarify their role in the immediate financial activities of a business.

💡Itemized Deductions

Itemized deductions are specific expenses that taxpayers can list and deduct from their taxable income if they exceed the standard deduction. The video script refers to these as 'classic deductions not allowed,' suggesting that not all deductions are permissible and that taxpayers must adhere to specific guidelines when itemizing.

💡Tax Code

The tax code is the set of laws that govern taxation in a jurisdiction. In the video, the tax code is central to understanding what deductions are permissible. The script mentions various sections of the tax code, such as 'section 24 8 25 a 26 a point c and 28 a1,' which are the legal authorities for allowable deductions.

💡Taxpayer

A taxpayer is an individual or entity subject to taxes. The video discusses deductions and other tax-related concepts from the perspective of the taxpayer, emphasizing their responsibilities and rights within the tax system. The script uses the term in various contexts, such as 'a taxpayer can deduct an item or amounts from gross income,' highlighting the central role of the taxpayer in tax calculations.

💡Trade or Business

Trade or business, as mentioned in the video, refers to the activities in which individuals or corporations engage to earn income. The script specifies that deductions are typically allowed for those 'engaged in trade or business and individuals in the exercise of his or her profession,' which sets the context for who can claim certain deductions.

💡Exercise of Profession

The exercise of profession refers to the practice of a profession by an individual. The video script mentions this in relation to deductions, indicating that professionals, like those in trade or business, may be eligible for certain tax deductions. This term is used to specify a category of taxpayers who can claim deductions, as in 'individuals in the exercise of his or her profession.'

Highlights

Definition of deductions as amounts allowed by the tax code to be deducted from gross income to arrive at taxable income.

Deductions are allowed under specific sections of the tax code: 248, 25A, 26A, 26C, and 28A1.

Wrong deductions are clarified, emphasizing that only individuals and corporations engaged in trade or business can claim certain deductions.

Deductions are a matter of legislative grace, meaning they are only allowed if authorized by law.

The necessity for deductions to be substantiated, meaning they must be verifiable expenses.

The concept of substantiated deductions, which are only claimable if they can be proven to be real expenses.

The differentiation between exclusions and deductions, with exclusions being a part of the income taxation formula.

Exclusions are inherently income, while deductions are outflows of economic resources.

The comparison between capital expenditures and revenue expenditures, highlighting their impact on accounting periods.

Capital expenditures are non-recurring and typically benefit more than one accounting period.

Revenue expenditures are recorded and typically benefit only one accounting period.

The importance of understanding the residence, citizenship, and source of income of taxpayers for deductions.

The role of legislative grace in determining what expenses can be deducted from gross income.

The significance of itemized deductions and their relation to necessary and ordinary expenses.

The process of substantiating deductions to ensure they are legitimate claims.

The distinction between deductions and exclusions in the context of income taxation.

The criteria for capital expenditures, including their non-recurring nature and long-term benefits.

The nature of revenue expenditures as expenses that benefit only one accounting period.