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Chapter 5 Fall 11

Chapter 5 Fall 11 - ACCT 403 CHAPTER 5 FALL 2011...

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ACCT 403 CHAPTER 5 – FALL 2011 INTRODUCTION TO BUSINESS EXPENSES I. Introduction and Where to Report A. Justifications for Claiming Deductions 1. Capital Recovery Concept a. Income is not taxed until invested capital is “recovered.” b. Examples 1. Gain from the sale of stock (amount realized less basis). 2. Gross profit from sale of inventory (net sales price less cost of goods sold). 2. Ability to Pay Principle a. A tax should be based on the amount that the taxpayer can afford to pay tax. b. Examples 1. Two couples each earn the same income but one couple has no children and the other couple has three children (justification for dependent exemption deduction). 2. Two businesses each have sales of $1,000,000 but one company incurs $600,000 of expenses and the other company incurs $800,000 of expenses. 3. Example 1, page 5.4 is an example of both the capital recovery concept and ability to pay principle. 3. Business Purpose a. In order to claim a deduction against business income, the primary or dominant motive for the expenditure must be business related. 1. Example 3, page 5.4. b. The expense must be related to the taxpayer’s business, not someone else’s business. 1. Example 4, p, 5.5, 2 . Harold M. Jenkins court case. B. Where Deductions Are Reported 1. Deductions for AGI – Individuals a. Reductions in gross income 1.
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2 2. Schedule D for capital losses. 3. Schedule E for rental expenses. b. Reductions in AGI (between gross income and AGI) 1. Moving expenses. 2. Self-employed health insurance premiums. 3. Educator expenses. 2. Deductions from AGI – Individuals a. Unreimbursed employee business expenses. b. Investment-related expenses. 1. The above two items are deductible as miscellaneous itemized deductions subject to the 2% AGI threshold (only to extent the total exceeds 2% of AGI). c. Exhibit 5-1, page 5.6, also lists other personal deductions (already discussed in Chapter 8). However, the focus of this chapter is business expenses. d. Example 5, page 5.7 . C. Conduit Entity Reporting 1. Partnerships and S Corporations are considered conduits as they do not pay income tax but rather allocate their income to their owners who report their share of income on their tax returns. a. The character of the income (ordinary, capital gain, tax-exempt) is preserved. b. Similarly, any deduction or credit that has a potential to alter a taxpayer’s tax liability (for example if it were limited in some manner or had some other special tax treatment), must be separately stated. c. These items are discussed in more detail in Chapter 14. 2. An owner’s share of nonseparately-stated items (so called bottom line or ordinary business income) is reported on page 2 of Schedule E. 3.
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Chapter 5 Fall 11 - ACCT 403 CHAPTER 5 FALL 2011...

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