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CHAPTER ACCT 6 SPRING 2012
BUSINESS EXPENSES
I.
Primary Business Expenses
A.
Meals and Entertainment
1.
The entertainment must either be directly related or associated with the business.
a.
Directly related means that there must be active business discussion or take
place in a business setting.
1.
b.
Examples 1-2, page 3.
Associated with means that the entertainment precedes or follows a bona fide
business discussion, and there is a clear business purpose.
1.
Example 3, page 3.
2.
Out-of town meal expenses are deductible if they qualify as travel expenses (part C
below).
3.
Cost of meals includes amounts spent for food, beverage, tax and tips.
4.
Cost of entertainment includes amounts spent at night clubs, theater, sporting events,
golf courses, and other recreational events.
a.
The amount for sporting tickets are limited to the face value of the tickets;
therefore, box seats may not be fully deductible.
1.
b.
The costs paid for other people are deductible if their presence serves a clear
business purpose.
1.
5.
Examples 4-5, pages 4.
Example 6, page 4.
In general, no deduction is allowed for the cost for the use of entertainment facilities.
a.
b.
6.
Club membership dues are not deductible.
Dues to professional & service organizations are deductible.
Deductions related to reciprocal entertaining are not allowed.
a.
7.
Example 7, page 5.
Generally, only 50% of the costs of meal and entertainment expenses are deductible.
Exceptions include the following:
a.
Employee picnics and Christmas parties.
1.
b.
Example 8, page 5.
Employee expenses when reimbursed by employer.
8.
Documentation requirements.
a.
b.
c.
d.
B.
Receipt.
Time and place.
Business purpose.
Individuals entertained and their business relationship.
Automobile Expenses (See Figure 6.1, page 6)
1.
Must be incurred in connection with the performance of services as an employee or
as a self-employed individual.
a.
For example, commuting is not deductible.
2.
There are two methods for calculating the auto expenses standard mileage rate and
business percentage of actual costs.
3.
Question How does one compute the business miles and business percentage?
a.
Maintenance of logs is highly recommended.
b.
Distance from home to primary business location is commuting miles, not
business miles.
c.
If an employee has more than one job, he/she may deduct transportation
expense from one job to another. If the employee goes home before going to
an additional job, the mileage is limited to the distance between the two job
sites.
d.
If traveling to a temporary work location, the business miles equal:
1.
The total miles traveled if the temporary location is outside the
taxpayer's principal job location;
2.
The total miles traveled if the temporary location is within the taxpayer's
principal job location and the taxpayer has at least one regular place of
business other than the home;
3.
The total miles traveled if the temporary location is within the taxpayer's
principal job location and the taxpayer's home; if the home is his/her
principal place of business;
4.
Zero, if the taxpayer's home is not his/her principal place of business and
there are no other regular places of business.
e.
f.
4.
Business percentage equals business miles/total miles.
Examples 9-10, page 6.
The standard mileage rate for 2011 is:
51 cents per business mile from 1/1 - 6/30
55 cents per business mile from 1/7 - 12/31
(for 2010, it was 50 cents per business mile).
a.
Business tolls and parking are deducted separately on Form 2106 [line 2].
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b.
c.
Auto interest may be deductible on Schedule A if debt qualifies as home equity
debt [if sole proprietor, business percentage of interest is deductible on
Schedule C].
d.
Basis is reduced by 22 cents per business mile in 2011 (23 cents in 2010).
e.
5.
Personal property taxes also related to the auto are deductible as an itemized
deduction on Schedule A [or as a business deduction on Schedule C if sole
proprietor].
Example 11, page 7.
The second option is to sum the actual auto costs during the year and multiply it by
the business percentage.
a.
b.
Business parking and tolls are fully deducted.
c.
Interest and personal property taxes are not included in part 5a. Instead, they
are deducted as provided in 4b. and 4c. above.
d.
C.
Auto costs include gas, oil, repairs, license, sales taxes, insurance, and
depreciation.
Example 12, page 7.
Travel Expenses
1.
The usual costs claimed include: meals (50%), lodging, and transportation costs
while "away from home".
2.
What is considered "away from home"?
a.
Home generally refers to the primary business location. If none, then it's the
tax home [one's principal residence]. If none of the above, two of the
following three conditions must be satisfied:
1.
2.
Living expenses are duplicated.
3.
3.
Some work is performed at designated home.
Family resides there or it is taxpayer's historical place of lodging.
Travel implies that it is temporary versus indefinite.
a.
Generally, away for < one year is considered temporary. For expected stays
greater than one year [even though actual stay is less than one year] travel
expenses are not allowed.
4.
In addition, the taxpayer's stay must be long enough such that it reasonably requires
a period of rest [generally overnight]. Therefore, traveling from Columbia to
Charlotte and back in one day will not qualify for travel deductions [only
transportation].
5.
If the travel includes personal travel, then expenses which may be allocable to the
personal portion [meals, lodging, and car costs] are not deductible.
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a.
b.
No costs allowed for family members unless they serve a business purpose.
c.
6.
Expenses which cannot be directly allocated [plane fare] are deductible in full
if the primary purpose of the trip was for business reasons.
Examples 13-15, page 8.
Travel costs for attending investment meetings are not deductible.
a.
D.
Examples 16-18, pages 9.
Business Gifts
1.
2.
Not subject to 50% limit.
3.
E.
Limited to $25 per donee per year.
Examples 19-20, page 9-10.
Substantiation Requirements
1.
In general, no documentation, no deduction.
2.
For travel, entertainment, and meals, the following must be documented:
a.
b.
c.
d.
3.
Receipts or a canceled check together with a bill are generally sufficient to document
an expense.
a.
F.
Business purpose.
Location.
People entertained [n/a for travel].
Amount.
No receipts are needed for expenditures less than $75.
Compensation
1.
Wages must be reasonable in amount.
2.
Closely held businesses are particularly scrutinized by the reasonableness
requirement.
a.
b.
3.
For corporations, unreasonable compensation to employee-owners will be
classified as dividends.
Payments to related parties also will be examined closely (i.e., payments to
children and deductible against business profits).
Factors examined to determine reasonable compensation include the following:
a.
b.
c.
d.
e.
f.
Duties performed.
Complexity of business.
Time required to perform duties.
Ability of the employee.
Relationship of compensation to income.
Consistency (particularly year-end bonuses).
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4.
Not quite the issue it was before dividend income was taxed at the shareholders
MTR.
5.
Maximum compensation deduction of chief executive and four highest paid officers
for publicly-held corporations is $1,000,000.
a.
6.
G.
Does not apply to stock-based compensation.
Example 24-25, page 12.
Business Bad Debts.
1.
Written off as ordinary losses.
2.
Deductible in year it is deemed uncollectible.
a.
Allowance method not allowed, must use specific write off.
b.
Portion of the debt can be written off.
3.
4.
No deduction for cash-basis taxpayer.
5.
H.
Typical examples of business debts are accounts receivable, loans to employees, and
loans to suppliers.
Examples 26, 28, and 29, page 12-13.
Nonbusiness Bad Debts.
1.
Defined by Code Section 166 as any debt other than
a.
b.
2.
A debt created or acquired in connection with a trade or business of the
taxpayer or
A debt the loss from the worthlessness of which is incurred in the taxpayer's
trade or business.
Written off as a short-term capital loss.
a.
Maximum net capital loss deduction per year is $3,000.
3.
Must be worthless before it can be written off. That is, partial worthlessness, as in
the case of A.2. above, can not be written off.
4.
Investment loans and personal loans [to friends and relatives] are the most common
examples of nonbusiness loans.
a.
b.
5.
Investing, no matter how extensive, is not deemed to be a trade or business.
Shareholder loans to his/her corporation are considered nonbusiness debt.
Example 27, page 12 and examples 32-34, page 14.
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II.
Other Business Expenses
A.
Qualified Production Activities Deduction
1.
For certain corporations, there is a deduction equal to a specified percentage times
the lesser of (1) the corporations taxable income or (2) the net income from the
qualified activity.
a.
2.
It really is an exclusion of income.
The percentage is as follows:
a.
b.
3.
6% for 2007-2009.
9% after 2009.
The deduction is limited to 50% of the W-2 wages paid by the employer.
a.
After May 17, 2006, the W-2 wages must relate to the taxpayer's domestic
production gross receipts (not responsible).
4.
5.
Examples 35-36, pages 15.
6.
B.
The deduction is available to corporations engaged in the following activities: lease,
rental, license, sale or other disposition of (1) tangible property; (2) computer
software; and, (3) sound recordings which are manufactured, produced, grown, or
extracted in the U.S.
Not responsible for detailed analysis of qualified production property, receipts, and
definitions in pages 16-17 (including exhibits 6-1 and 6-2).
Insurance Expense
1.
Insurance to protect a taxpayers business from loss is deductible.
a.
b.
As noted in chapter 5, an exception exists under the cash basis for prepaid
items that are required to be paid advance and do not extend beyond the next
taxable year.
c.
2.
Generally, prepaid insurance must be allocated to the applicable period
regardless of whether the taxpayer reports on the cash or accrual basis.
Example 40, page 18 this example extends the prepaid expense for 3 years.
Generally, life insurance premiums are not deductible (this is an example of no
deduction for expenses related to tax free income).
a.
b.
C.
One exception deals with group-term life insurance premiums paid by the
employer for its employees.
Examples 41-42, page 18.
Taxes The following are deductible:
1.
Real estate taxes.
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2.
Personal property taxes.
3.
State, local, and foreign income taxes.
4.
Payroll taxes (share of FICA, share of medicare, and unemployment taxes.
5.
Sales taxes.
a. Capitalized if related to property acquisition.
6.
Excise taxes.
7.
Miscellaneous taxes.
a.
D.
See examples 43-47, pages 19.
Legal Fees.
1.
2.
III.
Must be business or related related to a profit-motivated activity.
Some legal fees must be capitalized if they relate to acquisition of property,
defending title, or establishing ownership of property.
3.
Examples 48-50, page 20
Above-the-line Deductions for Individuals (see exhibit 6-3, page 21 for a comprehensive list)
A.
Employee Business Expenses
1.
Reimbursed employee business expenses paid out of an accountable plan are trade
or business deductions deductible as an adjustment For AGI.
a.
Although technically these expenses are deductible, they are not deducted on
the return or reportable as gross income. Thus, reimbursed expenses are a
wash on the return.
2.
If not reimbursed from an accountable plan, the reimbursement is includible in
income (included in wages & compensation on an employee's W-2) and the
deduction is reported below the line as an itemized deduction (as a deduction From
AGI).
3.
Unreimbursed employee business expenses are deductible as an itemized deduction
(as a deduction From AGI).
a.
These expenses, along with other expenses are lumped into a miscellaneous
expense category and are deductible only to the extent they exceed 2% of AGI.
4.
5.
B.
An accountable plan requires strict documentation requirements and that the
employee pay back any unused advances (or treat the unused advance as
compensation).
Examples 53-54, page 23.
Health Insurance for Self-employed Taxpayers
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1.
2.
Purpose of this deduction is to partially equalize the tax treatment if the business
were incorporated.
3.
C.
Note this is not a deduction on Schedule C, which would be better since selfemployment tax is based on Schedule C income.
Example 57, pages 24.
Self-employment Tax
1.
One-half (representing the employers share) of self-employment tax is deductible as
a for AGI deduction and in computing the self employment tax.
2.
For 2011 the SE tax rate is 13.3% of the first $106,800 and 2.9% of remaining net
self-employment income.
a.
The general rate on the first $106,800 is 15.3%, but the 2011 rate is reduce by
2% which is equivalent to the 2% reduction allowed in 2011on the employee
portion of social security tax
1.
Operationally, the self-employment tax is calculated as follows:
Self-employment income X 92.35% (100% - 7.65%) X 15.3%
2.
3.
3.
D.
Multiplying the amount by 92.35% has the same effect as claiming a
deduction of the employers share of the tax from schedule C income.
The 2% reduction in SE tax and the EE portion of social security tax has
been extended thru February 2012 with congress currently (02/16/2012)
haggling over an additional extension.
Examples 58-59, page 25.
Deduction for Traditional IRAs.
1.
If neither spouse is a participant in an employers retirement plan, or a self-employed
retirement plan then each spouse can contribute up to $5,000 per year to an IRA.
a.
Deduction is limited to earned income.
1.
Where the taxpayer is not a participant and the spouse earns less than
$5,000, both spouses may contribute up to $5,000 per year as long as the
combined earned income exceeds $10,000.
b.
c.
2.
Individuals at least 50 years of age can make catch-up contributions of an
extra $1,000 per year.
See Table 6-2, page 30 and examples 60-63, pages 26.
If the taxpayer is a participant in an employer retirement plan, the maximum
deductible contribution is reduced as follows:
Reduction for unmarried taxpayers: [AGI Base Amount] / $10,000 X $5,000
a.
Base amount for 2011 is $56,000 ($56,000 for 2010) for unmarried taxpayers
(so complete phase-out occurs at $66,000 ($66,000 for 2010) AGI).
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b.
Base amount is zero for married-separate taxpayers so phase-out occurs at
$10,000 AGI.
Reduction for MFJ taxpayers (each): [AGI Base Amount] / $20,000 X $5,000
c.
Base amount for 2011 is $90,000 ($89,000 for 2010) for joint taxpayers (so
complete phase-out occurs at $110,000 ($109,000 for 2010) AGI).
3.
If only one of the spouses is an active participant, the deductibility of the active
participants contribution to an IRA will be limited under the above AGI phaseout
amounts. However, the deductible IRA contribution for the spouse who is not an
active participant is phased out over an AGI range of $169,000 - $179,000 ($167,000
- $177,000 for 2010).
4.
Example:
Assume for 2010 Bob and Joan (1) are married filing jointly, (2) each have wages in
excess of $5,000, and (3) have AGI (before IRA contributions) of $98,000.
a.
If neither is a participant in an employer retirement plan, each may contribute
and deduct up to $5,000 to an IRA.
b.
If both are participants in an employer plan, each may deduct $3,000 of IRA
contributions computed as follows:
$5,000 - ([$98,000 - $90,000]/$20,000 X $5,000) = $3,000
c.
If one is a participant, the nonparticipant may deduct $5,000 (because AGI is
less than $169,000) and the participant may deduct $3,000 (see calculation
above).
d.
Also see Examples 64-66, p. 27 and 11-13, page 7-8 (chapter 15).
5.
6.
A 6% penalty applies on excess contributions
7.
E.
If a taxpayers deductible IRA contribution is reduced below $5,000, he can make a
nondeductible contribution for the remaining amount. Taxpayers can also elect to
make completely nondeductible contributions (however, see Roth IRAs below).
Taxpayers have until 4/15 after year end to make a contribution.
Distributions from Traditional IRAs (not in chapter 6)
1.
Generally, distributions are included in the income of the recipient.
a.
If nondeductible contributions have been made, the taxpayer will have a basis in
the IRA.
b.
As a result, part of any distribution will be nontaxable (not responsible for
calculations).
2.
Withdrawals before age 59 are subject to a 10% tax penalty.
3.
Taxpayers may convert a traditional IRA to a Roth IRA (see part F for Roth IRAs)
a.
AGI was limited to less than $100,000 in 2010.
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1. Unlimited after 2010.
b.
c.
Major advantage is that future earnings will never be taxed if future distributions
are qualified.
d.
4.
In year of conversion, the IRA balance less nondeductible contributions is
included in taxpayers gross income.
Similar rules apply to distributions to employees from employer plans and to
distributions to self-employed persons from Keogh plans.
By April 1 following the year that the taxpayer reaches 70 , the taxpayer must begin
to withdraw the regular deductible IRA account balance over a specified distribution
period.
a.
F.
See table 15-2, page 15.11.
The Roth IRA (only a brief review in chapter 6)
1.
Contributions to a Roth IRA are NOT deductible. It is referred to as a back loaded
IRA
because the tax benefits come at the end (at distribution from the IRA).
2.
As in the case of the Traditional IRA, a contribution of up to $5,000 per spouse may be
made to a Roth IRA (limited to earned income).
3,
If contributions are made to both a Traditional and a Roth IRA, the combined
contribution is limited to $5,000 per taxpayer.
4.
The maximum contribution is phased out for single individuals with AGI between
$107,000 - $122,000 ($105,000 - $120,000 for 2010) and for joint filers with AGI
between $169,000 - $179,000 ($167,000 - $177,000 for 2010).
5.
Unlike deductible IRAs, contributions to a Roth IRA may continue after the taxpayer
has attained age 70 .
6.
The major attraction of this provision is that qualified distributions are not includible in
gross income nor subject to the 10% premature distribution penalty.
7.
In order for a distribution to qualify as a gross income exclusion, it must be made after
the five taxable-year period beginning with the first taxable year in which the taxpayer
makes a contribution to a Roth IRA, and it must be made for one of the following four
reasons:
a.
b.
It is made to a beneficiary after the death of the individual;
c.
The individual is disabled; or
d.
8.
The individual has attained age 59 ;
The individual uses distribution for first-time homebuyer expenses ($10,000
max).
For nonqualified Roth distributions, contributions (basis) are deemed to be distributed
before earnings.
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9.
G.
Examples 67-68, page 28.
Coverdell Education Savings Accounts
1.
Up to $2,000 per beneficiary per year can be contributed to a tax-exempt education
savings account.
2.
The contribution is phased out for contributors with AGI between $190,000-$220,000
for MFJ ($95,000-$110,000 for single).
a.
Not subject to adjustment for inflation.
3.
4.
Qualified education costs include tuition, fees, room and board, and related expenses
for higher education costs as well as qualified education expenses for elementary and
secondary education expenses.
5.
H.
Distributions by the beneficiary are excludible from income as long as the proceeds are
used for qualified education expenses.
Example 69, page 30.
Deduction for Higher Education Expenses
1.
Up to $4,000 of qualified tuition and related fees are deductible.
2.
The deduction is $2,000 rather than $4,000 if the AGI is between $130,000-$160,000
for MFJ and $65,000-$80,000 for single taxpayers.
a.
Not subject to adjustment for inflation.
3.
4.
I.
Cant double dip take a deduction as well as a tax credit or receive other tax benefits
from other education provisions.
Examples 70-71, page 31.
Deduction for Interest on Education Loans
1.
Up to $2,500 of interest expenses on qualified education loans is deductible.
2.
The deduction is phased out at AGIs between $120,000 - $150,000 (same for 2010) for
MFJ and $60,000-$75,000 (same for 20) for all other filing statuses.
a.
3.
J.
Not subject to adjustment for inflation.
Example 73, page 31.
Moving Expenses
1.
Two requirements must be satisfied the distance requirement and work requirement.
a.
Distance requirement The distance from taxpayer's former residence to the
new job location must be 50 miles greater than the distance from taxpayer's
former residence to former job location.
b.
Work requirement Taxpayer must work full-time in the new job location as
follows:
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1.
2.
c.
2.
Employed at least 39 weeks of the first 52 weeks.
Self-employed individuals must work at least 39 weeks of the first 52
weeks and 78 weeks of the first 104 weeks.
Deduction is taken in the year the expenses are incurred even though the work
test may not be completely satisfied until the next year.
Eligible Expenses Two categories of "Direct Moving Expenses".
a.
Moving household goods & personal effects.
b.
Traveling, including lodging en route.
1.
2.
3.
Each family member is entitled to one trip.
Auto expenses can be either actual out of pocket or mileage allowance at
19 cents per mile for 1/1 - 6/30
23.5 cents per mile for 7/1 - 12/31
(16 cents per mile for 2010).
No deduction is allowed for meals.
3.
No deduction allowed for indirect moving expenses such as expenses related to house
hunting trips, temporary living expenses at the new location and expenses related to the
sale, lease, or purchase of your personal residence.
4.
Examples 74-75, pages 31-32.
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