Deductions in Revenue Code Sections 170-174

The Internal Revenue Code (IRC) is the body of law governing federal taxation in the United States. This article provides an overview of deductions found in IRC Sections 170 through 174. These sections cover a range of topics, including charitable contributions, net operating losses for businesses, and research and experimental expenditures. The rules also address more specialized situations involving amortizable bond premiums.

Charitable Contribution Deductions

Under IRC Section 170, a charitable contribution is a donation of money or property to a qualified organization without receiving a substantial benefit in return. A qualified organization must be a nonprofit operated for purposes such as religious, charitable, scientific, literary, or educational reasons. No part of the organization’s net earnings can benefit a private shareholder or individual.

The deduction for contributions is limited by a taxpayer’s adjusted gross income (AGI). For individuals, cash contributions to public charities are limited to 60% of AGI, while property contributions are limited to 50%, 30%, or 20% of AGI, depending on the specifics. For corporations, total charitable deductions are capped at 10% of taxable income.

Cash contributions are valued at their face amount, while non-cash contributions require determining the property’s fair market value. The deduction for ordinary income property, like inventory, is limited to its cost basis. The deduction for capital gain property, such as stocks held for more than a year, is its fair market value, subject to AGI limits.

For any single contribution of $250 or more, a taxpayer must obtain a written acknowledgment from the organization before filing their tax return. This document must state the contribution amount, describe any property given, and note whether any goods or services were provided in exchange.

For non-cash contributions over $500, taxpayers must file Form 8283 with their tax return. If the value of an item or group of similar items exceeds $5,000, a qualified appraisal is also required.

Net Operating Loss Deductions

A Net Operating Loss (NOL) under IRC Section 172 occurs when a taxpayer’s allowable deductions exceed their taxable income for the year. This is common for businesses but can also apply to individuals with business losses, estates, and trusts. An NOL can be used to offset taxable income in other years.

For NOLs generated in tax years after December 31, 2017, the loss can be carried forward indefinitely to future tax years. There is no time limit on using these losses to offset future profits.

A limitation applies to these carryforwards. The NOL deduction in any subsequent year is limited to 80% of that year’s taxable income, calculated before the NOL deduction is taken. This means a business cannot use an NOL to completely eliminate its tax liability in a profitable year, as the deduction is capped at 80% of taxable income.

The CARES Act of 2020 temporarily allowed NOLs from 2018, 2019, and 2020 to be carried back five years. However, these carryback provisions are no longer available for most taxpayers, making the indefinite carryforward rule the standard.

Research and Experimental Expenditures

IRC Section 174 governs the tax treatment of research and experimental (R&E) expenditures. A significant change now requires businesses to handle these costs differently. For tax years beginning after December 31, 2021, companies can no longer immediately deduct R&E expenses. Instead, businesses must capitalize these costs and amortize them, deducting them incrementally over a specified period.

The amortization period depends on where the research is conducted. For R&E expenditures from research within the United States, costs must be amortized over a five-year period. For costs from research conducted outside the United States, a fifteen-year amortization period is required.

The definition of R&E expenditures is broad, including costs for discovering information to eliminate uncertainty about developing or improving a product. This includes salaries for researchers, materials used in experiments, and costs for developing software. The mandatory amortization applies across all industries, affecting technology companies, manufacturers, and any business that invests in improving its products or processes.

Amortizable Bond Premium

IRC Section 171 addresses amortizable bond premium, which occurs when a taxpayer buys a bond for a price higher than its face value. This premium is paid when the bond’s stated interest rate is higher than prevailing market rates at the time of purchase.

Bondholders can elect to amortize this premium over the life of the bond. This election allows the taxpayer to deduct a portion of the premium each year, which reduces their taxable interest income from the bond. Once made, the election applies to all taxable bonds the taxpayer owns.