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Mark D
Mark D, Enrolled Agent
Category: Tax
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Experience:  MBA, EA, Specializing in Business and Individual Tax Returns and Issues
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Kitty Kat, Inc. runs a brothel (illegal under state law) and

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Kitty Kat, Inc. runs a brothel (illegal under state law) and has the following items of income and expense. What is the amount that it must include in taxable income from the operation?

Income

$200,000

Expenses:




Rent
8,000


Utilities
2,000


Bribes to police
10,000


Medical expense
5,000


Legal fees
20,000


Depreciation
14,000


Illegal kickbacks
15,000
Hello,

Ordinary and necessary expenses incurred in carrying on an illegal business are generally deductible unless they frustrate a sharply defined public policy. Hence, illegal payments such as bribes and discounts are not deductible but expenses like medical care or prostitutes, rent, and depreciation would be. Also, A taxpayer convicted of organized crime activities could deduct his legal defense fees because his illegal activities constituted his trade or business in the case J. DiFronzo v Commr.

  • 200K
  • (8K) Rent
  • (2K Utilities)
  • (14K) Depreciation
  • (20K) Legal
$156K would be the taxable income.

Please let me know if you have further questions.

Regards,

Mark D
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