Chapter 6 Business Expenses Howard Godfrey, Ph. D Chapter 6 Business Expenses Howard Godfrey, Ph.D., CPA Professor of Accounting UNC Charlotte Copyright © 2014, Dr. Howard Godfrey Edited September 18, 2014

Business Expenses Part 1. Introduction Part 2 Business Expenses Part 1. Introduction Part 2. Business Expenses, Meals and Entertainment, Auto,Travel, Gifts, Education expense Part 3. Compensation, Bad debts, Qualified production activity expenses, Insurance, Taxes, Legal fees. Part 4. Deductions for AGI- Reimbursed exp. [accountable plans] Deductions of self employed persons, IRAs, [also Roth] Coverdale, Higher education expenses, Student loan expenses, Moving Expenses

Meals & Entertainment. The deduction for business meals and entertainment expenses is limited to 50% of the qualified expenses The 50% limit is imposed on whoever (employer or employee) ultimately pays the expense

Transportation Expenses. Certain transportation expenses incurred when the taxpayer is not away from home are deductible and include the cost of transportation from one work location to another transportation between home and a temporary work location if the taxpayer has a regular place of business any meal costs are not deductible, however

Transportation Expenses The prorated business portion of actual auto expenses or a standard mileage rate (56¢ for 2014) plus related parking and tolls can be deducted Commuting expenses (between home and regular place of business) are a personal nondeductible expense

Documentation Expenses related to Meals, Entertainment, Automobile Usage, Travel, and Business Gifts are deductible subject to limitations and strict documentation requirements Amount Time and place Date and description Business purpose Business relationship of other person(s)

Travel Away From Home Travel expenses incurred for temporary travel away from home on business are deductible. Qualifying expenses include lodging, 50% of meals, transportation to destination and back, and incidental expenses Away from home refers to person’s tax home; that is, the location of principal place of employment regardless of where the family residence is maintained

Temporary Assignments Temporary is defined as one year or less Employment away from home in a single location that is realistically expected to last (and does in fact last) for one year or less, will be treated as temporary Assignment for more than one year shifts tax home to the new location (no deduction for travel and living costs)

Over 50% of the activity requiring travel must have a business purpose Combining Business with Pleasure Travel Over 50% of the activity requiring travel must have a business purpose Personal activity costs on a business trip are not deductible Incidental business expenses on a personal trip are deductible Travel for general educational purposes or for investment related meetings is not deductible

Combining Business with Pleasure Travel For U.S. travel, if the trip is primarily for business, all transportation costs to and from destination are deductible If primary purpose is pleasure, no deduction for transportation Primary purpose is determined by the number of days on business versus personal days

Combining Business with Pleasure Travel Meals & lodging are deductible only for days on which business is conducted If a taxpayer remains in a temporary location to reduce costs as a result of reduced airfare for Saturday night stays or for business conducted on both Friday and Monday the costs for additional days are deductible if they are less than the cost of returning home when business is completed

Travel Expenses- Martha Martha lives with her husband in Los Angeles but works in San Diego. During the week she stays in a hotel in San Diego and eats in restaurants. On weekends she flies home to Los Angeles. During the year, Martha spent $5,000 for the hotel, and $2,000 for meals while in San Diego. Her airfare for travel between San Diego and Los Angeles was $2,500. What is Martha’s deduction for travel expenses?

Travel Expenses-Martha Martha cannot deduct any travel expenses. Her tax home is in San Diego. Her travel to Los Angeles is purely personal and her expenses are nondeductible.

Transportation Expense-John John is a high school teacher. He travels three days per week to a school in the next county to work with gifted children in an after-school program that does not end until 6:30 P.M. He normally eats dinner before driving home. If he drives 75 miles each way on 90 days to the gifted program, his meal expense is $900, and he maintains adequate records, how much may John deduct?

Transportation Expense-John $6,885 (90 days x 150 miles x 51¢). John is allowed to deduct his mileage only. He has no deduction for meals as he is not “traveling away from home.”

Business Gifts. Randy gave one of his best customers a $150 bottle of wine. How much can he deduct for this business gift?

Business Gifts – Slide 2 The deduction for business gifts is limited annually to $25 per donee.

Meals & Entertainment Directly-related expenses - costs incurred when a significant business discussion takes place between the taxpayer and a customer in atmosphere conducive to the serious conduct of business. Associated-with expenses - deductible when directly preceded or followed by a substantial business discussion Deduction for entertainment tickets is limited to 50% of the tickets’ face value

Deductions Restriction No deduction allowed for the costs of owning and maintaining entertainment facilities such as hunting lodges and yachts No deduction allowed for membership dues and fees paid to social, athletic, or sporting clubs Deductions are allowed for dues to professional organizations, public service organizations, and trade associations Deduction for business gifts limited to $25 per donee per year

Entertainment Expenses - Jim Jim, a self-employed individual, takes an important customer to the hockey playoffs. Although the face value of a ticket is only $70, he pays a scalper $400 for each ticket. Assuming all other requirements are met, how much can Jim deduct for the two tickets?

$70. Entertainment Expenses-Jim Entertainment tickets are not only subject to the 50% limit, but the 50% limit applies to the face value of the tickets. Thus, Jim is allowed a deduction for only one-half of the face value of the tickets or $70 (50% x $140).

Unreasonable Salaries- MC Question A business owner takes a large salary from her very profitable corporation. If the IRS determines that the salary is unreasonably large and treats it as in substance a dividend, it will propose? a. Increase the gross income of owner b. Increase the gross income of corporation c. Decrease the expense of the corporation

Bad Debt Expense. Specific charge-off method must be used Investment and personal loans are considered nonbusiness (capital losses) Loan must be valid debt No bad debt deduction for cash basis taxpayers who have not previously included amount in income

Uncollectible Accounts-1 Maria earns $50,000 from consulting contracts during the year. She collects only $48,000 from her clients and expects the $2,000 will remain uncollectible. a. If Maria’s business is on the accrual basis, what is her gross income for the year and how much can she deduct for bad debt expense? b. If Maria’s business is on the cash basis, what is her gross income for the year and how much can she deduct for bad debt expense?

Uncollectible Accounts-2 a. Maria must recognize $50,000 of income during the current year. She will deduct the $2,000 as a bad debt in the year she determines it is uncollectible. b. Maria will recognize only $48,000 of income in the current year. She has no deduction for the $2,000 that she cannot collect because it was never recognized as income.

Insurance Expense Premiums for fire, casualty, and theft insurance for business property are deductible Payments into a self-insurance reserve are not deductible - only actual losses are deductible Premiums for life insurance when business is beneficiary are not deductible

Insurance- Melbourne Melbourne Corp. paid the $2,000 annual premium this year for a life insurance policy on its president, for which Melbourne Corp. is the beneficiary. Melbourne also pays $20,000 in annual premiums for group term life insurance for its employees as an employee benefit; the employees designate the beneficiaries. Additionally, Melbourne pays $16,000 in annual premiums for business fire, casualty, and theft insurance. How much can Melbourne deduct as business expenses?

Insurance- Melbourne-2 Melbourne can deduct $36,000 ($16,000 + $20,000) in insurance expense. The $2,000 premium for the president’s life insurance policy is not deductible because the insurance proceeds would be tax exempt if received by the corporation.

Taxes Deductible taxes include State, local, & foreign real property taxes State and local personal property taxes State, local, and foreign income taxes Employer’s payroll taxes Other federal, state, local, and foreign taxes incurred in a business or other income-producing activity Federal income taxes are not deductible

Taxes When real estate is sold, the seller is responsible for taxes through the day before the sale date Assessments for improvements must be added to basis of property Sales taxes are added to cost of business property or service

Legal Expenses Legal Fees deductible only if related to a trade or business Legal fees incurred to defend title to property are added to the asset’s basis Criminal defense fees are deductible only if the legal action has a direct relationship to a profit-seeking activity Personal legal expenses are not deductible

Deductions For AGI-1 Trade or business expenses Rent and Royalty expenses Reimbursed employee expenses Capital loss Alimony paid Retirement plan contributions including IRAs 50% of self-employment taxes Self-employed health insurance

Moving expenses Deductions For AGI-2 Educator expenses Student loan interest expense Tuition and fees deduction Health savings accounts Penalty on early withdrawals of savings Other deductions for AGI

Accountable Plan Employees are required to make an adequate accounting of their expenses. 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

Nonaccountable Plan Employees are not required to make an adequate accounting of their expenses. All reimbursements are included in income All expenses are deducted from AGI

Deductions 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

Self-Employment Taxes Self-employed individuals must pay both the employer’s and the employee’s share of FICA taxes for a combined rate of 15.3% 12.4 % (6.2% x 2) for Social Security on income up to $117,000 in 2014 2.9% (1.45% x 2) for Medicare – no income limit Deduction for employer portion iis simulated by multiplying net income from by 92.35% (100% - 7.65%) before calculating SE tax

Self-Employment Taxes Tax computed on Schedule SE Self-employed individuals are also allowed a deduction for AGI for the employer’s half of self-employment taxes Calculated by multiplying net income from self-employment by 92.35% (100% - 7.65%) before calculating SE tax There is no deduction for the employee’s half of the taxes

Self-Employment Tax Carrie owns a business that she operates as a sole proprietorship. The business had a net profit of $25,000. This is Carrie’s only earned income. a. How much must she pay for self-employment taxes? b. How much can she deduct on her tax return? c. If the business had a net loss of $10,000 (instead of a $25,000 profit), how much in self-employment taxes must Carrie pay?

George has net income from self-employment of $50,000 in 2014. Self-Employment Tax George has net income from self-employment of $50,000 in 2014. He has a salary of $100,000. What is his self-employment tax? What amount may he deduct?

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)

Individual Retirement Accounts Contributions All taxpayers may contribute a maximum of $5,500 of their earned income to a Deductible or a Roth IRA. Special “Catch-up” rule allows up to $6,500 if 50 or older (includes extra deduction of $1,000) A married couple may contribute $11,000 in total ($13,000 if over 50), but not more than $5,500 ($6,500) to any one account.

Three Major IRA Types Conventional Roth Coverdell Educational Savings Account

1. Conventional IRA Contributions limited to lesser of $5,500 ($6,500 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 – IRA percentage*] * (AGI - phase-out) / $10,000 ($20,000 MFJ)

Conventional IRA: Phase-out Amounts when both spouses are covered.

Joe is a single taxpayer, age 40. In 2014, he earned $39,000 Joe is a single taxpayer, age 40. In 2014, he earned $39,000. He is not covered by an employer retirement plan. What is Joe’s maximum deduction for 2014, for contributions made to a Roth IRA? a. $ 0 b. $600 c. $5,500 d. $4,500 e. None of these

Joe is a single taxpayer, age 40. In 2014, he earned $39,000 Joe is a single taxpayer, age 40. In 2014, he earned $39,000. He is not covered by an employer retirement plan. What is Joe’s maximum deduction for 2014, for contributions made to a Roth IRA? a. $ 0 b. $600 c. $5,500 d. $4,500 e. None of these

Vin and Mary are married and file jointly Vin and Mary are married and file jointly. In 2015, Vin earned $45,000 and Mary earned $55,000. Both are under age 40 and are covered by an employer retirement plan. What is the maximum total amount of IRA contributions they can deduct for 2014? a. $600 b. $8,000 c. $4,800 d. $2,500 e. None of these

2. Roth IRA-2013 Contributions are not deductible Earnings distributions are tax-free if IRA has existed for 5 years, and Taxpayer is >59 1/2 years old No age limit to begin distributions Contributions are phased-out like Conventional IRA in 2014 Married beginning at $181,000 Others beginning at $114,000

3. Coverdell Education Savings Account (CESA) Set up as a trust for the benefit of any person under age 18 $2,000 nondeductible contribution per student per year Phased-out for AGI greater than Married, from $190,000 Others, from $95,000 Max. contribution X [1 - {(AGI - phase-out) / 15,000}]

3. CESA Continued Tax-free growth in the IRA No tax at time of withdrawal if used for qualified expenses Tuition and fees of student

Higher Education Expense Deduction (through 2013) May deduct up to $4,000 of qualifying higher education expense Qualifying = tuition and fees Must have AGI < $65,000 if single ($130,000 for MFJ) Cannot claim in addition to HOPE or Lifetime Learning Credits (Chapter 8)

Moving Expenses Moving expenses are deductible if they meet two tests. 1. Distance test Old job New job x + 51 miles x miles Old house

Moving Expenses Time Test Employee 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

Moving Expenses Qualifying Expenses Only two types of expenses are deductible: Costs of moving household goods and personal items to the new location Transportation and lodging costs of moving the taxpayer and family to the new location Mileage allowed at $0.235 (2013) per mile None of the cost of meals is deductible

Moving Expenses Reimbursements Any reimbursement of moving expenses received from an employer is included as income

Student Loan Interest-1 Deduction allowed for interest paid on qualified student loans incurred and used for tuition, fees, room, board, books, and supplies.

Student Loan Interest-2 Deduction limit is $2,500 Limit is phased out for AGI of $60,000 - $75,000 ($120,000 - $150,000 for married persons filing jointly)

Student Loan Interest-2 Individuals claimed as dependents cannot take deduction on their own tax return. Expenses paid by tax-exempt scholarships or subject to education credits must be excluded from loan amounts and related interest.

Student Loan Interest Cecilia is married and files a joint return with her husband, Steve. They have AGI of $125,000. Cecilia paid $2,700 in student loan interest in 2014. What is her interest deduction?

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