9-1 ©2008 Prentice Hall, Inc.

9-2 ©2008 Prentice Hall, Inc. EMPLOYEE EXPENSES & DEFERRED COMPENSATION (1 of 2)  Classification and limitations of employee expenses  Travel expenses  Transportation expenses  Entertainment expenses  Reimbursed employee business expenses

9-3 ©2008 Prentice Hall, Inc. EMPLOYEE EXPENSES & DEFERRED COMPENSATION (2 of 2)  Moving expenses  Education expenses  Office in home expenses  Deferred compensation  Tax planning considerations  Compliance and procedural considerations

9-4 ©2008 Prentice Hall, Inc. Classification and Limitations of Employee Expenses (1 of 3)  Nature of employment relationship  Employer has right to control end result of work and means accomplished  If employee, employer pays ½ FICA and Medicare  If self-employed, taxpayer pays all FICA and Medicare

9-5 ©2008 Prentice Hall, Inc. Classification and Limitations of Employee Expenses (2 of 3)  Limitations on unreimbursed employee expenses  2% of AGI floor applies to  Unreimbursed employee business expenses  Investment expenses other than interest  Tax return preparation fees and other deductions

9-6 ©2008 Prentice Hall, Inc. Classification and Limitations of Employee Expenses (3 of 3)  Limitations (continued)  If total misc itemized deductions ≤ 2% of AGI or if total allowable itemized deductions do not exceed std deduction  Unreimbursed employee expenses provide no tax benefit  Reduced benefit for high-income taxpayers from 3% scale down of itemized deductions

9-7 ©2008 Prentice Hall, Inc. Travel Expenses  Deductibility of travel expenses  Definition of travel expenses  General qualification requirements  Business vs. pleasure  Foreign travel  Additional limitations on travel expenses

9-8 ©2008 Prentice Hall, Inc. Deductibility of Travel Expenses  Depends on nature of expenditure and if employee reimbursed  Taxpayers engaged in ToB or production of rents or royalties  Travel expenses deductible for AGI  Employee  Deduction for AGI if reimbursed  2% misc deduction if not reimbursed

9-9 ©2008 Prentice Hall, Inc. Definition of Travel Expenses  Includes  Transportation, meals, & lodging related to a ToB, or employee status incurred while away from taxpayer’s tax home  Requires overnight stay  Deductible amount of travel expenses may be reduced if actual expenses lavish or extravagant

9-10 ©2008 Prentice Hall, Inc. General Qualification Requirements (1 of 2)  Away-from-tax-home requirement  Tax home is work location  Assignment must be temporary  Assignment not temporary if  Assignment indefinite OR  Expected to last > 12 months

9-11 ©2008 Prentice Hall, Inc. General Qualification Requirements (2 of 2)  Overnight requirement  Must be reasonable for taxpayer to be away overnight  Short rest stops on long day-trip not considered overnight

9-12 ©2008 Prentice Hall, Inc. Business vs. Pleasure  Travel to and from destination  If trip primarily personal, no deduction  If trip primarily business, all travel to and from destination deductible  Other travel-related expenses  Allocated to business and personal activities

9-13 ©2008 Prentice Hall, Inc. Foreign Travel  Generally disallowed  Allowed only if taxpayer shows activity directly related to business, AND  Reasonable for meeting to be held outside north America

9-14 ©2008 Prentice Hall, Inc. Additional Limitations on Travel Expenses  Travel expenses disallowed actual travel is for education  E.g., French student traveling through France  Luxury water travel limited  Travel to conventions, seminars not deductible if activity for production of income

9-15 ©2008 Prentice Hall, Inc. Transportation Expenses  Definition and classification  Treatment of automobile expenses  Reimbursement of automobile expenses  Excess expenses over reimbursement deductible as 2% misc itemized deductions

9-16 ©2008 Prentice Hall, Inc. Definition and Classification (1 of 2)  Commuting costs generally nondeductible personal expenses  Commuting costs between multiple jobs for same taxpayer deductible  Transportation costs from employee’s regular work site to temporary one deductible

9-17 ©2008 Prentice Hall, Inc. Definition and Classification (2 of 2)  Commuting costs between home and temporary work site deductible if taxpayer has regular place of business

9-18 ©2008 Prentice Hall, Inc. Treatment of Automobile Expenses  Standard mileage rate $0.485/mile  Cannot use std rate if use ≥ 2 vehicles  Does not include parking and tolls  Actual expenses  Includes gas, oil, maintenance and repairs, insurance, and depreciation  Based on ratio of business miles to total miles driven

9-19 ©2008 Prentice Hall, Inc. Entertainment Expenses  50% disallowance for meal and entertainment expenses  Classification of expenses  Business meals  Entertainment facilities and club dues  Business gifts  Limitations on entertainment tickets

9-20 ©2008 Prentice Hall, Inc. Classification of Expenses  Criteria for deduction  Directly related expense  Benefit must be for other than goodwill and be in a clear business setting  Associated with expense  Must establish clear business purpose and activity must directly precede or follow bona fide business discussion  Need proper substantiation

9-21 ©2008 Prentice Hall, Inc. Business Meals  Business meals must meet “directly related to” or “associated with” tests  Cannot be lavish or extravagant for circumstances

9-22 ©2008 Prentice Hall, Inc. Entertainment Facilities and Club Dues  No deduction permitted costs related to maintenance of entertainment, amusement, or recreation facilities  No deduction for club dues

9-23 ©2008 Prentice Hall, Inc. Business Gifts  Generally annual ceiling of $25/donee  Exceptions include  Employee achievement awards < $400  Gift from employer to employee’s survivor

9-24 ©2008 Prentice Hall, Inc. Limitations on Entertainment Tickets  50% limitation applies to face value of ticket  Further restrictions on skyboxes

9-25 ©2008 Prentice Hall, Inc. Reimbursed Employee Business Expenses (1 of 2)  Substantiation  Employee must make adequate accounting of expenses to employer  Employee required to return excess reimbursement  Accountable Plan  Reimbursements and deductions not reported by employee if no excess deductions

9-26 ©2008 Prentice Hall, Inc. Reimbursed Employee Business Expenses (2 of 2)  Non-Accountable Plan  Reimbursement taxable  Deductions miscellaneous subject to 2% of AGI floor  Per Diem Allowances for Meals and Lodging  IRS has special tables  Substantiation less burdensome

9-27 ©2008 Prentice Hall, Inc. Moving Expenses Distance and Duration Requirements  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  78 weeks for self-employed individuals

9-28 ©2008 Prentice Hall, Inc. Moving Expenses Definition of Moving Expenses  For AGI deduction  Qualified expenses  Cost of moving household good and personal effects from old to new home  Includes storage if < 30 days  Cost of traveling from old to new home  Includes lodging, but not meals  $0.20/mile or actual expenses allowed for car

9-29 ©2008 Prentice Hall, Inc. Education Expenses (1 of 3)  Classification of education expenses  See Table I9-3  Deduction for higher ed expenses  $4,000 for AGI deduction in 2007  If AGI between $65K-$80K ($130K- $160K for MFJ), $2,000 deduction  No deduction if AGI > $80K ($160K for MFJ)

9-30 ©2008 Prentice Hall, Inc. Education Expenses (2 of 3)  General requirements for a deduction  Maintain or improve skills required for employment  Meet requirements imposed by law or by employer for retention of employment, rank, or compensation rate

9-31 ©2008 Prentice Hall, Inc. Education Expenses (3 of 3)  Nondeductible if  Meet minimum educational requirements for qualifications in taxpayer’s employment  Qualifies taxpayer for new trade or business

9-32 ©2008 Prentice Hall, Inc. Office in Home Expenses General Requirements  Must meet one of requirements and be used on exclusive and regular basis  Office used as principal place of business for any ToB  Includes doing administrative work if no other fixed location available  Place for meeting clients in normal course of business  Located in separate structure

9-33 ©2008 Prentice Hall, Inc. Office in Home Expenses Deduction and Limitations (1 of 2)  Categories of expenses  Expenses directly related to office  Expenses indirectly related to office  Expenses related to whole home  Prorate based on square footage or other method  Total expenses cannot create loss

9-34 ©2008 Prentice Hall, Inc. Office in Home Expenses Deduction and Limitations (2 of 2)  Order of expense deductions 1. Expenses not related to home office 2. Expenses directly related to home office 3. Pro-rata portion of indirect expenses  E.g, mortgage, interest, utilities, insurance  Disallowed expenses carried forward to future year

9-35 ©2008 Prentice Hall, Inc. Deferred Compensation (1 of 3)  Qualified pension and profit-sharing plans  Qualification requirements for a qualified plan  Tax treatment to employees and employers  Nonqualified plans

9-36 ©2008 Prentice Hall, Inc. Deferred Compensation (2 of 3)  Employee stock options  Plans for self-employed individuals  Traditional Individual Retirement Account (IRA)  Roth IRA  Coverdell education savings account

9-37 ©2008 Prentice Hall, Inc. Deferred Compensation (3 of 3)  Health savings accounts  Simplified plans

9-38 ©2008 Prentice Hall, Inc. Qualified Pension and Profit-Sharing Plans  Pension plans  Defined benefit  Defined contribution  Profit-sharing plans  Include 401(k) plans  Stock bonus plans  DC plan where investments invested in company stock

9-39 ©2008 Prentice Hall, Inc. Qualification Requirements for a Qualified Plan  Must be for employees’ exclusive benefit  Does not discriminate in favor or highly compensated employees  >5% owners or comp >$100K  Contributions proportionate to comp  Coverage requirements  Vesting requirement

9-40 ©2008 Prentice Hall, Inc. Tax Treatment to Employees and Employers  Employer contributions immediately deductible  Employee contributions may come from pre-tax or after-tax earnings  Benefits generally taxed to employees if contributions from pre-tax earnings  Use exclusion ratio if contributions from after-tax earnings

9-41 ©2008 Prentice Hall, Inc. Nonqualified Plans  Often used to provide incentives or supplementary retirement to execs  No nondiscrimination or vesting rules  Employer does not receive deduction until benefits available to employee  Unfunded compensation plans

9-42 ©2008 Prentice Hall, Inc. Employee Stock Options Incentive Stock Options (ISOs)  No tax to employee on exercise date  LTCG treatment when employee sells stock  (amount realized – exercise price)  Employer receives no deduction

9-43 ©2008 Prentice Hall, Inc. Employee Stock Options Nonqualified Stock Options (NSOs)  Nonqualified stock options (NSOs)  Employee recognizes compensation income on exercise date  (FMV – exercise price)  Employer receives deduction on exercise date

9-44 ©2008 Prentice Hall, Inc. Traditional IRA (1 of 2)  Fully deductible IRA contributions  Lesser of $4,000 or earned income  $5,000 if over age 50  Available only for following taxpayers  Taxpayers who are not active participants in a qualified employer retirement plan  Taxpayers who are active, but AGI ≤ $52K (or ≤ $83K for MFJ)  Spouse active participant, but AGI ≤ $156K

9-45 ©2008 Prentice Hall, Inc. Traditional IRA (2 of 2)  Phase out for active participants  AGI $52K - $62K  $83K - $93K for MFJ  $156K - $166K for MFJ if spouse active  Deduction for non-working spouse  $4,000 or $5,000 if ≥ age 50  All distributions taxable  Unless some contributions nondeductible

9-46 ©2008 Prentice Hall, Inc. Roth IRA (1 of 2)  Nondeductible  Max contribution $4,000  If qualify for both Traditional and Roth maximum contribution for both is $4,000  Max contribution $5,000 if ≥ age 50

9-47 ©2008 Prentice Hall, Inc. Roth IRA (2 of 2)  Contribution phase-out AGI limitations  $99,000 - $114,000 for Single  $156,000 - $166,000 for MFJ  Qualified distributions nontaxable

9-48 ©2008 Prentice Hall, Inc. Coverdell Education Savings Account  Nondeductible contribution  Maximum contribution $2,000/year until beneficiary reaches age of 18  Elementary, secondary & higher ed exp  Distributions excluded from gross income if ≤ qualified ed expenses  May be used in same year as Hope & Lifetime learning credits

9-49 ©2008 Prentice Hall, Inc. Health Savings Accounts  Purpose to enable eligible individuals to accumulate funds on tax free basis to pay qualified medical expenses currently or in the future  No employer-provided insurance  Must use high-deductible policy

9-50 ©2008 Prentice Hall, Inc. Simplified Plans  Simplified employee pensions  Reduced administrative complexity  Simple retirement plans  Savings incentive match plan for employees  For employers with < 100 employees who received at least $5,000 in compensation

9-51 ©2008 Prentice Hall, Inc. Tax Planning Considerations (1 of 2)  Moving expenses only deductible if  Employee must secure full-time work before incurring moving expenses, or  Self-employeds must carry on ToB prior to incurring moving expenses  Excess reimbursements are taxable compensation

9-52 ©2008 Prentice Hall, Inc. Tax Planning Considerations (2 of 2)  Rollover from Traditional to Roth IRA  Considerations include marginal tax rate, age of taxpayer and payment of taxes from rollover from post-tax funds  Rollover included in gross income  $100K AGI limit removed after 2009

9-53 ©2008 Prentice Hall, Inc. Compliance and Procedural Considerations (1 of 2)  Travel and entertainment expenses may be disallowed if taxpayer does not maintain adequate records  Employee business expenses reported on Form 2106  Moving expenses reported on Form 3903

9-54 ©2008 Prentice Hall, Inc. Compliance and Procedural Considerations (2 of 2)  Home office expenses reported on Form 8829  Reports for qualified retirement plans required to be filed with IRS and, sometimes, with Dept. of Labor

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 9-55 ©2008 Prentice Hall, Inc.