Chapter 9 Employee Expenses and Deferred Compensation

Learning Objectives Determine the proper classification and deductibility of travel and transportation expenses Determine the proper deductible amount for entertainment expenses under the 50% disallowance rule Identify deductible moving expenses and determine the amount and year of deductibility

Learning Objectives Describe the requirements for deducting education expenses Determine whether the expenses of an office in the home meet requirements for deductibility and apply the gross income limitations Discuss the tax treatment requirements for various deferred compensation arrangements

Classification Of Employee Expenses Nature of employment relationship Limitations on Unreimbursed employee expenses

Nature Of Employment Relationship Significant tax consequences flow from the characterization of a taxpayer as an employee Vs. Self-employed (independent contractor)

Limitations On Unreimbursed Employees Unreimbursed employee expenses are classified as miscellaneous itemized deductions. Total of miscellaneous itemized deductions are reduced by 2% of AGI before any tax benefit realized If total miscellaneous itemized deductions do not exceed 2% of AGI or if total allowable itemized deductions do not exceed standard deduction, Unreimbursed employee expenses may provide no tax benefit; also may affect high-income taxpayers who have 3% scale down of itemized deductions

Travel Expenses Deductibility of travel expenses Definition of travel expenses 50% disallowance of business meals General qualification requirements Business versus pleasure Foreign travel Additional limitations

Nature Of Expenditure Travel expenses for self-employed individuals and fully reimbursed employee travel expenses are deducted for AGI Unreimbursed employee travel expenses (whether insufficient or no reimbursement occurs) are deducted as a miscellaneous itemized deduction subject to the 2% nondeductible floor

Definition Of Travel Expenses Includes transportation, meals, and lodging related to a trade, business, or employee status incurred while away from the taxpayer’s tax home Deductible amount of travel expenses may be reduced if actual expenses are lavish or extravagant

Transportation Expenses Definition and classification Treatment of automobile expenses Reimbursed expenses Reporting considerations Requirement to allocate expenses Reimbursement of automobile expenses

Definition and Classification Commuting costs are generally nondeductible personal expenses Commuting costs between multiple jobs for the same taxpayer will be deductible Transportation costs from employee’s regular work site to temporary one are deductible Commuting costs between home and a temporary work site are deductible if taxpayer has regular place of business

Entertainment Expenses Partial disallowance for meal & entertainment expenses (50%) Classification of expenses Business meals Entertainment facilities & club dues Business gifts Limitations on entertainment tickets

Reimbursed Employee Business Expenses Substantiation – the employee must make an adequate accounting of expenses to his employer Return excess reimbursement Accountable Plan Non-Accountable Plan Per Diem Allowances for Meals and Lodging

Moving Expenses Must meet certain distance requirements and certain employment duration requirements in order to be deductible New job at least 50 miles farther from taxpayer’s old residence New employee must be employed full-time at new location for 39 weeks out of year following the move Self-employed must remain employed for double the employee standard

Education Expenses Tax credits – HOPE and Lifetime Learning Exclusion of Scholarships Educational assistance for employees Student Loan Interest Deduction for higher education expenses - $4,000 for 2005 Qualified state tuition programs Coverdell Education IRA

Education Expenses Classification of education expenses General requirements for a deduction

Office In Home Expenses General requirement for a deduction Deduction and limitations

Deferred Compensation Qualified pension and profit- sharing plans Qualification requirements for a qualified plan Tax treatment to employees and employers Non qualified plans Employee stock options Plans for Self-employed individuals

Individual Retirement Accounts (IRAs) Traditional IRA Fully deductible IRA contributions (lesser of $4,000 or earned income) are available only to two groups of taxpayers Taxpayers who are not active participants in a qualified employer retirement plan Taxpayers who are active, but their AGI is $50,000 or less (single) or $70,000 or less (married filing jointly)

Traditional IRA Partial deductions are available to active participants with AGI less than $60,000 (single) or $80,000 (married/filing jointly) deduction is phased out ratably over the $10,000 AGI range A working spouse may deduct up to $4,000 for themselves and $4,000 for the non-working spouse

Roth IRA Referred to as “Back Loaded IRA” Nondeductible Maximum contribution is $4,000 –If qualify for both Traditional and Roth maximum contribution for both is $4,000 Subject to AGI phase-out limitations –$95,000 & $110,000 for Single –$150,000 & $160,000 for MFJ

Roth IRA Special ordering rules for withdrawals Rollover funds from an existing deductible IRA into Roth IRA –Not subject to 10% penalty –If the rollover was made before January 1, 1999, amounts included in gross income would be spread over 4 years

Roth IRA Roth IRAs must be established by the due date of the tax return Contributions are never deductible Contributions are subject to special modified AGI Limitations Contributions can be made after the owner has reached age 70 1/2 No distributions are required at any age Withdrawals from Roth are not taxable if withdrawals are qualified withdrawals.

Education IRA Coverdell Education savings Account Nondeductible contribution Maximum contribution = $2,000 year until the age of 18 Elementary, Secondary and higher education expenses Distributions are excluded from gross income if they do not exceed qualified education expenses

STET Savings Accounts Medicare Act of 2003 established STET Savings Accounts (TSETSAs) for taxable years beginning after December 31, 2003 –The purpose is to enable eligible individuals to accumulate funds on a tax free basis to pay qualified medical expenses currently or in the future.

Simplified Employee Pensions Immediate deductions for employer Annual deduction for each participant is limited to the lesser of 25% of the participant compensation (up to ceiling of $210,000) Treated as being made on last day of year if made by the due date of return Employer contributions must be nondiscriminatory Distributions from SEP are subject to taxation based on IRA rules A self-employed person may establish a SEP rather than a H.R. 10 Plan

Simple Retirement Plans Savings incentive match plan for employees For employers with < 100 employees who received at least $5,000 in compensation Elective contributions up to $10,000 per year and requires employer to make matching contributions

Tax Planning Considerations Employees may want to negotiate tax protection from employer in situations where moving reimbursements will exceed deductible moving expenses Traditional vs. Roth IRA Rollover from Traditional to Roth –Considerations include marginal tax rate, age of taxpayer and payment of taxes from rollover from post-tax funds

Compliance And Procedural Considerations Travel and entertainment expenses may be disallowed if the taxpayer does not maintain adequate records Employee business expenses are reported on Form 2106

Compliance And Procedural Considerations Moving expenses reported on Form 3903 Home office expenses reported on Form 8829 Reports for qualified retirement plans are required to be filed with the IRS and, sometimes, with the Dept. of Labor.