Chapter
6
Taxable Income from
Business Operations
Taxable Income
Taxable income = gross income less allowable deductions
Gross income:
 Sale of tangible goods → gross profit (sales – cost of goods sold)
 Sale of services → all charges, fees, commissions, bonuses, etc.
 Compensation for allowing use of property → gross rents, royalties, etc.
Other sources of income → increases in net worth arising from trade
or business activities are recognized as income:
 Receipt of property other than cash in satisfaction of obligation for services
or goods sold or exchanged
 Generally, income recognized is equal to value of property received
 Forgiveness of indebtedness is recognized as income to extent it
increases borrower’s net worth (i.e., to extent such forgiveness increases
solvency)
 Many forms of “disguised” exchanges generate income as well—e.g.:
 Discounted purchases,
 below-market interest rate loans, etc.
Gross Income vs. Net Income
“Gross” income is distinguished from “net” income in that the
latter is what is left after deduction of expenses
Deductions are allowed for all “ordinary and necessary
expenses … in carrying on any trade or business.”
Ordinary expense → “normal, usual or customary”
 “May be infrequent to an individual taxpayer, but not in the life of the
group, the community, of which he is a part”
 For example, payment in settlement of defamation charges filed
against a newspaper
Necessary → “appropriate and helpful for the development of the
[taxpayer's] business”
 Generally speaking, illegal payments will not be considered ordinary,
and therefore will not be deductible
 Expenses are also denied if they are against public policy (e.g., fines &
penalties)