Negative AGI and percentages for various deductions.


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?
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On 8/26/11 8:47 AM, D. Stussy wrote:

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.
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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.
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On 8/26/11 6:50 PM, D. Stussy wrote:

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.
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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
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On 8/27/11 1:34 PM, Seth wrote:

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.
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wrote:

limits
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.
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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.
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On 8/28/11 9:20 AM, D. Stussy wrote:

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?
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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.
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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." ------------ That is, the second "max" function above should have been a "min" function.
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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
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wrote:

I think if you go through Form 1045 Schedule B, you will find that to be the case. See especially lines 13-18.
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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.
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