1. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 6 Self-Employed Business Income “A fine is a tax for doing something wrong. A tax is a fine for doing something right.” -- Anonymous

2. LO #1- Income and Expenses of the Self- Employed Trade or Business – any activity that is engaged in for profit Self-employed income is reported on Schedule C 6-2

3. LO #1- Income and Expenses of the Self- Employed Gross receipts include –Direct sales to customers –Work performed as an independent contractor –Amounts reported to a “statutory employee” Independent contractors usually receive a Form 1099-MISC to report income 6-3

4. LO #1- Income and Expenses of the Self- Employed Cost of Goods Sold - reduction from sales to produce gross profit Accrual Method of Accounting – must be used if inventory is a material income- producing factor 6-4

5. LO # 2 Ordinary & Necessary Trade or Business Expenses To be deductible, expenses must be ordinary, necessary, and reasonable Ordinary – expenses must be customary or usual Necessary – expenses that are appropriate and helpful rather than essential Reasonable – expenses must be reasonable in amount and reasonable in relation to their purpose 6-5

6. LO # 2 Ordinary & Necessary Trade or Business Expenses Forbidden Expenses –Bribes, kickbacks, and other illegal payments –Lobbying and political expenses –Fines and penalty payments Not deductible even if ordinary, necessary, and reasonable 6-6

7. LO #3 Depreciation Components of Depreciation 1. Basis (usually the cost of the asset). 2. Depreciation Periods (Asset Class Lives). 3. Depreciation Convention (half-year, mid-quarter, mid-month). 4.Depreciation Method (200% or 150% Declining Balance or Straight-line). Reported on Schedule C, Schedule E, and Form 2106 6-7

8. LO #3 Depreciation Basis –Asset purchased; Basis = Cost –Personal to Business; Basis = Lesser of FMV or cost –Non-taxable Exchange; Basis = Cost less any deferred gain –Inherited; Basis = FMV at the date of death 6-8

9. LO #3 Depreciation Typical Depreciation Periods –3 yearsSpecialized Tools, Racehorses –5 yearsAutos, Trucks, Computers –7 yearsFurniture, Fixtures, Equipment –27.5 yearsResidential Real Property –39 yearsNonresidential Real Property 6-9

10. LO #3 Depreciation Depreciation Conventions –Half-year Convention –Mid-Quarter Convention –Mid-Month Convention Year of Disposal – convention is the same in the year of disposal. 6-10

11. LO #3 Depreciation Depreciation Methods –200% Declining Balance Switching to Straight-line –150% Declining Balance Switching to Straight-line –Straight-line 6-11

12. LO #3 Depreciation Maximum IRC Section 179 expense –2010$500,000 –2011$500,000 –2012$500,000 –2013$500,000 Property must be used in a trade or business. The 2012 Tax Act increased the amount to $500,000 for 2012 and 2013. Section 179 expense cannot create a NOL 6-12

13. LO #3 Depreciation 50% Bonus in 2013 MACRS < 20 year lives Fully Deductible/No limits other than Luxury Auto Limits Lessens Importance of Section 179 6-13

14. LO #3 Depreciation Listed property –Assets that have both a business and personal use component to them –Examples: autos, boats, computer equipment Section 179 is not allowed if listed property is used less than 50% for business Straight-line depreciation is required for listed property used less than 50% for business 6-14

15. LO #3 Depreciation Luxury Automobile Limitations –Autos less than 6,000 pounds –Light trucks or vans less than 6,000 lbs. have slightly higher limits AutoTruck –1 st year$11,160$11,360 –2 nd year $ 5,100$ 5,400 –3 rd year $ 3,050$ 3,550 –4 th and after$ 1,875$ 1,975 SUVs greater than 6,000 lbs – Section 179 is limited to $25,000 6-15

16. LO #3 Depreciation Leased Vehicles –“Lease inclusion amount”- the amount included in income when a leased vehicle is over the luxury auto levels –See Rev. Proc. 2013-21 for amounts The total business lease amount is deductible 6-16

17. LO #4 Transportation and Travel Ordinary and necessary travel expenses are deductible Transportation – expenses of getting from one workplace to another workplace within the taxpayer’s home area Travel – refers to business travel away from home that requires an overnight stay 6-17

18. LO #4 Transportation and Travel Deductible Local Transportation Cost –Getting from one workplace to another workplace –Visiting clients and customers –Business meeting away from the taxpayer’s regular workplace –Getting from home to a temporary workplace Transportation between a home office and temporary work location is deductible 6-18

19. LO #4 Transportation and Travel Automobile Expenses –Standard Mileage Rate - 56.5 cents per mile in 2013 –Actual Expenses - actual business auto costs are deducted Actual expenses usually gives a larger deduction but require more record keeping 6-19

20. LO #4 Transportation and Travel Travel Cost for Business Travel –Requires an overnight stay –Travel, meals, lodging and other incidental expenses are allowed –Should not last more than one year Limitations exist if the trip is partly personal or if there are lavish or extravagant expenditures 6-20

21. LO #4 Transportation and Travel Meals and Entertainment –Business meal costs are deductible but are limited to 50% –Must be directly related or associated with business –Standard meal per diem is $46 per day – can be higher in high cost areas Cannot be lavish or extravagant 6-21

22. LO #5 Business Use of Home and Business Bad Debts Business use of the home is deductible if the business use is: –Exclusive –Regular –For the taxpayer’s trade or business A specific area of the home must be used only for business Employees – use must be “for the convenience of the employer” 6-22

23. LO #5 Business Use of Your Home and Business Bad Debts Home office deductions are reported on Form 8829 Calculation determined by square footage used regularly and exclusively for business Direct business expenses are 100% deductible Indirect home expenses are deductible based on square footage 6-23

24. LO #5 Business Use of Your Home and Business Bad Debts Home office deduction limited to business income Order of deductions –Expenses deductible in any event (mortgage interest and real estate taxes) –Business use of insurance, utilities, and then depreciation 6-24

25. LO #5 Business Use of Your Home and Business Bad Debts Business Bad Debts –Business bad debts can be deducted as an ordinary expense if incurred in a business –Can be partially worthless or completely worthless Business Casualty Losses –Receive an ordinary loss –Not limited by the 10% AGI floor like personal casualty losses 6-25

26. LO #6 Hobby Loss Rules and Education Expenses Hobby Losses –Expenses allowed to the extent of hobby income –Nine factors to determine whether an activity is a hobby –Burden of proof lies with the taxpayer Order of expense deduction – mortgage interest and taxes, hobby expenses that do not reduce basis, then depreciation 6-26

27. LO #6 Hobby Loss Rules and Education Expenses Education Expenses – deductible if: –Maintains or improves skills of the taxpayer; or –Meets the express requirements of the law or regulation for a job Educational Expenses – not deductible if: –Cannot meet the minimum educational requirements for employment –Qualifies the taxpayer for a new trade or business 6-27

28. LO #7 Self-Employment Tax Consists of two parts: –Social Security 12.40% in 2013 –Medicare 2.90% –Total 13.30% Social security limited to first $113,700 of self-employment income in 2013 Medicare is not limited 6-28