Post on 27-Dec-2015
Chapter 6Chapter 6
Business ExpensesBusiness Expenses
©2006 South-Western©2006 South-Western©2006 South-Western©2006 South-Western
Kevin MurphyKevin MurphyMark HigginsMark Higgins
Kevin MurphyKevin MurphyMark HigginsMark Higgins
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All deductions are a matter of Legislative Grace
All deductions are a matter of Legislative Grace
Just because GAAP allows a deduction, don’t assume tax law will too!
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Business ExpensesBusiness Expenses
All expenses must first meet the basic tests for deductibility - Have a business purposeBe ordinary, necessary, and reasonableBe allowed under the Legislative Grace
Concept
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Business ExpensesSubstantiation Requirements
Business ExpensesSubstantiation Requirements
Expenses related to Meals, Entertainment, Automobile Usage, Travel, and Business Gifts are deductible subject to limitations and strict documentation requirementsAmountTime and placeDate and descriptionBusiness purposeBusiness relationship of other person(s)
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Meals and EntertainmentMeals and Entertainment
Meals and entertainment expenses must be directly related to or associated with the active conduct of a business activity.
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Meals and EntertainmentDirectly Related Test
Meals and EntertainmentDirectly Related Test
The “directly related to” test is met ifThere is more than a general expectation
of business benefitA bona fide business activity takes place
during the meal or entertainmentThe principal reason for the meal or
entertainment is businessThe expenses are related to the taxpayer
and people involved in the business activity
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Meals and EntertainmentAssociated With Test
Meals and EntertainmentAssociated With Test
The “associated with” test is met ifThere is a clear business purpose for the
meal or entertainmentThe meal or entertainment directly
precedes or directly follows a substantial business discussion
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Meals and EntertainmentCosts
Meals and EntertainmentCosts
Meal costs include food, beverage, tax, and tips
Entertainment costs include expenses for clubs, theaters, and sporting eventsOnly the face amount of a ticket is allowedClub dues do not qualify
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Meals and EntertainmentCost Limitations
Meals and EntertainmentCost Limitations
Only 50% of the allowable costs may be deducted
Exceptions to the 50% limitationReimbursed expensesExpenses that are taxable income to a
non-employee recipient (awards, prizes)Expenses for recreational or social
activities which benefit employees
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Auto ExpensesGeneral Requirements
Auto ExpensesGeneral Requirements
The cost of using an automobile for business is deductibleUse of the automobile must be for travel
Out of town From home to a temporary workplace From the regular to a temporary workplace From the workplace to a second job
The cost of commuting is never deductible.
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Auto ExpensesAuto Expenses
Auto expenses may be computed under one of two methods:Actual CostStandard Mileage Rate
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Auto ExpensesActual Cost Method
Auto ExpensesActual Cost Method
The actual cost of using the automobile may be deductedThe business percentage of depreciation,
gas and oil, repairs, insurance, interest, license fees, etc. is deductible
Deduction amount is often larger than the standard rate
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Auto ExpensesStandard Mileage Rate
Method
Auto ExpensesStandard Mileage Rate
MethodThe administrative convenience concept
allows a deduction based on the number of business miles driven during the yearRate is $0.405 per mile Tolls, parking, interest and property taxes may be
added
Standard rate method is not allowed if multiple cars are used
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Travel ExpensesTravel Expenses
Travel expenses incurred while on business away from the tax home overnight are deductibleTax home is the principal area in which
business is conductedOvernight means longer than a regular
workday
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Travel ExpensesLimitations
Travel ExpensesLimitations
Over 50% of the activity requiring travel must have a business purposePersonal activity costs on a business trip
are not deductibleIncidental business expenses on a
personal trip are deductibleTravel for general educational purposes or
for investment related meetings is not deductible
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Business GiftsBusiness Gifts
The cost of a gift given to a business customer may not be fully deductibleThere is an overall limitation of $25 per
person, per yearGifts are not subject to the 50%
entertainment limitsDelivery, gift wrap, engraving, etc., do not
count toward the $25
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Education ExpensesEducation Expenses
Costs of education are deductible ifRequired by law (or employer) to maintain
employment, orMaintains or improves current job skills
Costs of education are not deductible ifNecessary to meet minimum job requirements, orQualifies taxpayer for new trade or business
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Unreimbursed allowable costs are deductible as miscellaneous itemized deduction
Employee may exclude up to $5,250 of reimbursed expenses from a qualified plan
Education ExpensesEducation Expenses
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Compensation of EmployeesCompensation of Employees
Wages, salaries, bonuses and other compensation paid to employees is deductible if two basic tests are met:Employees must perform actual servicePayment must be reasonable in amount
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Compensation of EmployeesReasonable Compensation
Compensation of EmployeesReasonable Compensation
Some factors considered when determining if compensation is reasonable areDuties, responsibilities and pay history of the
employeeVolume and complexity of the businessTime required to do the workAbility and accomplishments of the employeeCompany pay policy
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Compensation of EmployeesReasonable Compensation
Compensation of EmployeesReasonable Compensation
Payments to a related party may be examined closely forLack of a business purposeAn arms-length transaction Reality of compensation in a closely-held
business
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Compensation of EmployeesReasonable Compensation
Compensation of EmployeesReasonable Compensation
Size of deduction for salary paid to a covered employee is limited CEO and the four highest paid officers are covered
employees$1,000,000 limit on compensation deduction per
employeeSome amounts are exempt from the limit
commissions and performance based payments pension plan contributions fringe benefits
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Bad DebtsBad Debts
Business bad debts are deductible only under the accrual method
Nonbusiness (investment) bad debts are deductible if the debt is bona fideReport as a short-term capital lossNo deduction is allowed if the debt is voluntarily forgiven
Bad debts are generally deductible under the capital recovery concept.
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InsuranceInsurance
Fire, theft, casualty or liabilityGroup medical, term-life and worker’s
compensationPerformance and fidelity bondsBusiness interruption
Insurance premiums paid to protect a business from the following losses are deductible.
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TaxesTaxes
Exceptions:Sales taxes related to long-lived assets must be
capitalizedProperty taxes related to real estate bought or
sold during the year must be allocated between buyer and seller
Assessments for local benefits are added to the property’s basis
Most business related taxes are deductible unless paid to the federal government.
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Legal FeesLegal Fees
Legal fees are deductible if they were paid to defend business income, reputation, or goodwillIf fees are related to property ownership,
they are capitalized with the cost of the property
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Individual DeductionsFor Adjusted Gross Income
Individual DeductionsFor Adjusted Gross Income
Expenses paid by individuals for a business purpose, orspecifically allowed by Congress to create
equity in tax treatment
are allowed as deductions for AGI.
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Accountable PlanAccountable Plan
Reimbursements = expenses nothing is reported
Reimbursements < expenses reimbursement is reported as income expenses = reimbursement income are deducted for AGI excess expenses are deducted from AGI
Reimbursements > expenses and excess is not returned excess reimbursement is reported as income
Employees are required to make an adequate accounting of their expenses.
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Nonaccountable PlanNonaccountable Plan
Employees are not required to make an adequate accounting of their expenses.
All reimbursements are included in incomeAll expenses are deducted from AGI
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Deductions for Self-Employed TaxpayersDeductions for Self-Employed Taxpayers
To provide self-employed taxpayers equity with the tax treatment of employees, they are allowed to deduct:
The cost of health insurance premiums paid for themselves
50% of the amount of self-employment tax paid
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Retirement Plan Contribution Deductions
Retirement Plan Contribution Deductions
Taxpayers who do not have access to an employer sponsored pension plan are allowed several options:Keogh or H.R.10 plans (for self-employed
taxpayers only)Individual Retirement Accounts (for all
taxpayers)
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Individual Retirement Accounts
Contributions
Individual Retirement Accounts
ContributionsAll taxpayers may contribute a
maximum of $4,000 of their earned income to a Deductible or a Roth IRA.Special “Catch-up” rule allows up to $4,500
if 50 or older
A married couple may contribute $8,000 in total ($9,000 if over 50), but not more than $4,000 ($4,500) to any one account.
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Three Major IRA TypesThree Major IRA Types
ConventionalRothEducational
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1. Conventional IRA1. Conventional IRA
Contributions limited to lesser of $4,000 ($4,500 if > 50) or amount of earned income Fully deductible if not covered by an
employer’s plan Not linked to spouse’s coverage
If covered, maximum deduction equals:
(Maximum contribution) X [1 - {(AGI - phase-out) / $10,000}]
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Conventional IRA: Phase-out AmountsConventional IRA: Phase-out Amounts
Tax Year Married Single
2005 $70,000 $50,000 2006 $75,000 $50,000 2007 $80,000 $50,000
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Conventional IRA - ExampleConventional IRA - Example
Single taxpayer with AGI = $58,000 contributes $4,000 to an IRA. How much is deductible if the t/p is covered by a qualified plan?
$4,000 X [ 1 - ($58,000 - $50,000)/10,000]
= $4,000 X [ 1 - 0.80]
= $4,000 X 0.20
= $600 maximum deduction
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2. Roth IRA2. Roth IRA
Contributions are not deductibleEarnings distributions are tax-free if
IRA has existed for 5 years, andTaxpayer is >59 1/2 years oldNo age limit to begin distributions
Contributions are phased-out like Conventional IRAMarried, between $150,000 to $160,000Others, between $95,000 to $110,000
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3. Educational IRA3. Educational IRA
Set up as a trust for the benefit of any person under age 18
$2,000 nondeductible contribution per student per yearPhased-out for AGI greater than
Married, from $190,000 Others, from $95,000
Max. contribution X [1 - {(AGI - phase-out) / 15,000}]
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3. Educational IRA Continued3. Educational IRA Continued
Tax-free growth in the IRANo tax at time of withdrawal if used for
qualified expensesTuition and fees of student
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Higher Education Expense Deduction
Higher Education Expense Deduction
May deduct up to $4,000 of qualifying higher education expenseQualifying = tuition and feesMust have AGI < $65,000 if single
($130,000 for MFJ)Cannot claim in addition to HOPE or
Lifetime Learning Credits
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Educational Loan InterestEducational Loan Interest
May deduct up to $2,500 for interest paid on education loansTaken as a “for” deductionOnly for payments made during first 60
months of the loanDeduction phased-out when AGI exceeds
Married, from $105,000; Others, from $50,000
Deduction = Amt. Paid X [1 - {(AGI - phase-out) / 15,000}]
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Moving ExpensesMoving Expenses
Moving expenses are deductible if they meet two tests.
1. Distance test
Old house
Old jobx + 51 miles
x m
iles
New job
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Moving ExpensesTime Test
Moving ExpensesTime Test
2. Time TestEmployee taxpayers must be employed in
the new area for 39 weeks of the 12 months after moving
Self-employed taxpayers must be employed in the new area for 78 weeks of the 24 months after moving
Waived for death, disability, or required transfer
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Moving ExpensesQualifying Expenses
Moving ExpensesQualifying Expenses
Only two types of expenses are deductible:Costs of moving household goods and
personal items to the new locationTransportation and lodging costs of moving
the taxpayer and family to the new location Mileage is allowed at $0.15 per mile None of the cost of meals is deductible
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Moving ExpensesReimbursementsMoving ExpensesReimbursements
Any reimbursement of moving expenses received from an employer is included as income