Disallowing Deductions Paid with Excluded Income

12 Pages Posted: 6 Feb 2013 Last revised: 1 Mar 2013

See all articles by Joseph M. Dodge

Joseph M. Dodge

Florida State University - College of Law

Date Written: February 5, 2013

Abstract

The idea advanced herein, as a thought experiment, is the possibility of expanding (by legislation) – or possibly interpreting (by Treasury regulation) – section 265(a)(1) to disallow deductions deemed to have paid out of tax-exempt (i.e., excluded) income. Although section 265(a)(1) already disallows deductions to obtain tax-exempt income (hereinafter referred to as “forward disallowance”), the Treasury has not seriously attempted to systematically disallow deductions paid with tax-exempt income (hereinafter referred to as “backward disallowance”). The reason for this Treasury inattention is undoubtedly a realization that a tracing rule (that would disallow deductions actually paid with tax-exempt income) would, in most cases, be easily avoidable (because cash is fungible) and only serve to unfairly lay a trap for the unsophisticated. This conundrum could be finessed, however, by disallowing that percentage of otherwise-allowable deductions as excluded income bears to total (included and excluded) income – an approach that respects the fungibility of cash.

Suggested Citation

Dodge, Joseph M., Disallowing Deductions Paid with Excluded Income (February 5, 2013). 32 Virginia Tax Review, 2013, FSU College of Law, Public Law Research Paper No. 623, Available at SSRN: https://ssrn.com/abstract=2212328 or http://dx.doi.org/10.2139/ssrn.2212328

Joseph M. Dodge (Contact Author)

Florida State University - College of Law ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States
850-644-4590 (Phone)

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