1. Income Tax Chapter 9 Employee Expenses and Deferred Compensation
Accounting 421
Income Tax
Chapter 9
Employee Expenses and Deferred Compensation
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2. Employee v Independent Contractor What is at stake?
income tax and FICA withholding
treatment of expenses, Schedule C or A
employee fringe benefit participation and discrimination
civil rights - discrimination protection - race, ethnicity, religion, gender, disability and age
IRA, retirement plan deduction
family leave allowance
workers’ compensation
unemployment compensation
workplace safety protections
other
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3. Employee v Independent Contractor
Who controls the performance of the work?
Employees are supervised and controlled in the way they perform work
Independent contractors perform the work without supervision or control - only the end product is considered
The employer and employee may not elect independent contractor status - they must live it by reference to the above rule
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4. Employee v. Independent Contractor The 20 factor test
Instructions
training
integration
who performs services
hiring, firing, etc
continuing relationship
full time
set hours
Order or sequence of work
reports
pay by the hour, week or by the job
furnish tools
profit or loss possible
investment
hold out to public
right to quit
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5. Employee Expenses Substantiation of expenses
the general rule regarding substantiation is that the taxpayer must prove the correctness of items on a tax return when asked by the IRS. Estimates per Cohan.
Sec 274 creates an important exception to the general rule in the case of travel, transportation, and entertainment expenses
these expenses must be substantiated as a condition of taking the expense
sustantiation requires contemporaneous record keeping and corroborated with receipts for items over $75
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6. Employee Expenses Travel away from home overnight on business
deductible as business travel are transportation, lodging, meals, entertainment, taxis, laundry and incidental expenses. Meals and entertainment expenses need not be consumed with business associates to be deductible
meals and entertainment must be reduced by 50%
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7. Employee Expenses Travel
spouse and dependents travel only if they are employed by the company
travel as education is not deductible
travel for education for investment activity only is not deductible
special rules apply for foreign conventions and luxury water travel (cruise ships)
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8. Employee Expenses Travel temporary v indefinite term
must expect to gone less than one year
must actually be gone less than one year
or, tax home shifts to place of work - or if taxpayer moves about constantly, taxpayer’s tax home may be wherever the taxpayer is at any point in time
special importance to construction, trucking and consulting industries
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9. Employee Expenses Transportation
airfare, train, bus, taxi, auto expenses
no deduction for commuting expenses - commuting is personal
home to workplace
between workplaces (2 jobs) or between customers’ offices etc. is business transportation
auto expenses
actual or mileage allowance - $
substantiation may be with use of a sample
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10. Employee Expenses Meals and Entertainment must meet either the
directly related to business test, or
the associated with business meeting test
rigorous substantiation - all elements of the expense, who, what, when, how much, and business purpose
special rules for entertainment facility (yachts, hunting lodge, etc.) and skyboxs - basically all these expenses are not deductible
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11. Employee Expenses Business gifts Other business expense
$25 per donee ceiling amount
Other business expense
dues and subscriptions
union dues
uniform costs - see eligibility rules
investment expenses
tax preparation fees
safe deposit box rental expenses
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12. Employee Expenses Reimbursed v unreimbursed
for agi v from agi as miscellaneous itemized deduction subject to 2% floor
accountable plan v nonaccountable plan
accountable plan - no tax withholding, no income, no deduction
nonaccountable plan - withholding of income tax and FICA, deductions from agi
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13. Employee Business Expense Reimbursements
Accountable Plans
Business purpose for the expense
Meet the substantiation requirement through accounting to employer
Requirement to repay employer for any advance or reimbursement of amounts in excess of the amount substantiated
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14. Employee Expenses Accountable plans
substantiate all elements of the expenses to employer
who, what, when, how much and business purpose with the use of adequate contemporaneous records - a diary or log of expenses made close in time to the date of the expenditure
corroborate the records with documentary evidence including receipts for all items over $75 and for lodging
per diem arrangements provide some relief from the burden of the substantiation rules. But, even per diem plans require proof of travel (away from home overnight) and business purpose of travel
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15. Employee Expenses Moving expenses Business related move
distance test: 50 miles, measured from the old house to the old workplace, and then old house to new workplace
time test: 39/52 or 78/104 for self-employed
this test is waived if the next move is employment related
deductible moving expenses are the costs of moving family and possessions to new home, the cost of lodging in route - but not meals. Moving mileage is $. /mile
deduction is for agi
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16. Employee Expenses Education expenses
generally education expenses are personal
expenses to maintain or improve required skills
expenses to meet requirements imposed by law or by the employer for retention of employment, rank, or compensation rate
a self-employed person may deduct on Schedule C
an employee on Schedule A as Misc Itemized subject to 2%
Note don’t confuse these rules with the gross income exclusion rules for education assistance plans and reimbursements of education expenses
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17. Employee Expenses Office in the home
principal place of business, regular place for meeting customers, patients, clients etc. or a separate structure
Soliman (USSupCt)
managerial function, no other office available
salespersons, inventory and product sample storage, garage space for company car - square foot allocation
exclusive office, allocate square footage
depreciation is ordinary gain on sale
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18. Employee Expenses
Generally, employee business expenses are reported on Form 2106
no reporting if expenses are reimbursed under an accountable plan
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19. Deferred Compensation
Qualified and nonqualified retirement plans
qualified under IRC Sections 401 to 415
immediate deduction for contribution by employer
no current recognition of income on the economic benefit attributable to the employer’s contribution
exclusion from income of amounts contributed by employee under a CODA
earnings not currently taxed
taxation is at time of distribution - sometimes at favorable rates
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20. Deferred Compensation
Qualified retirement plans
Profit sharing plans
ESOPs
IRAs and SEPs Pension plans
defined benefit plan
defined contribution plan
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21. Deferred Compensation
Pension and Profit Sharing plans
nondiscrimination requirement
coverage test in eligibility and participation
for the exclusive benefit of the employees
rules for eligibility - over age 18
participation hours of service/yr
vesting - 3 year cliff vesting or 5-6 yr graduated
funding - minimum funding standards for defined benefit plans
distributions - lump sum or, if annuities are allowed, then one of the annuity options must be joint life with spouse
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22. Deferred Compensation
Pension plans
defined benefit
the promise made is defined by reference to the benefit that will be paid
ex. 1% of average high three years compensation for each year of service. Ed worked for 30 years with company and had an average high three years compensation of $90,000. Annual benefit will be $27,000 usually paid monthly
subject to maximum benefit limits ($160,000)
Note: who takes investment risk?
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23. Deferred Compensation
Pension plans
defined contribution type - called a money purchase pension plan
the promise made is expressed as a percentage of the current compensation
ex. 10% of compensation. Jennifer’s compensation is $85,000. The company must contribute $8,500/year
promise can not exceed 25% of pay or $40,000
Note: who takes investment risk?
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24. Deferred Compensation
Profit sharing plans
defined contribution plans
limits are 15% of pay or $44,000
discretionary contributions
401(k) plans are defined contribution plans but have the additional feature that allows,or in some cases requires, the employee to contribute to the plan. The employee’s contribution is generally made on a before tax basis. The employer’s contribution is often defined with a reference to the amount contributed by the employee
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25. Deferred Compensation
SEPs and SIMPLEs
both are IRA type employer retirement plans that allow companies to make a contribution to an employee’s IRA. These are popular with small business because they are less expensive to setup and maintain. There is little IRS reporting with either of these plans.
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26. Deferred Compensation
Traditional IRA
$4,000, or earned income if less, is deductible for agi
individual may not be an active participant in an employer sponsored retirement plan
active participants may contribute if their agi is less than threshold amounts - $34k, $54k; phase out to $44k and $64K
otherwise contributions are nondeductible
special rules for married couples where one is active participant in employer plan
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27. Deferred Compensation
Traditional IRA
distributions are taxed as ordinary income
10% penalty for most early withdrawals - before age 59 1/2
distributions must begin by 4/1 of year after individual reaches age 70 1/2
penalty of 6% for excess contributions
penalty for late distributions
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28. Deferred Compensation
Roth IRA
nondeductible contributions
limit on contributions of $4,000/y
agi limitations on eligibility
$95K - $110k - unmarried
$150k - $160k - married
no taxation on distributions if -
5 yr. Holding period
distributions may not be made before age 59 1/2 unless due to a disability or to a beneficiary after individual’s death
up to $10k may be distributed to first time homebuyers
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29. Deferred Compensation
Rollover IRA
May be used by an employee to take a distribution from an employer’s plan and “roll it over” to her own IRA. The rollover maintains the primary tax benefit of deferred taxation. The rollover feature facilitates employee mobility.
Use “trustee to trustee” transfers in lieu of actual distribution and contribution rollovers
(60 day and tax withholding problems may be eliminated)
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30. Deferred Compensation
Nonqualified plans
Called deferred compensation plans and contemplate an agreement between the employer and employee to pay an amount of compensation in a future period
unfunded and nonforfeitable promise to pay an amount in the future
restricted and nontransferable fully or partially funded plan (often funded with company stock) - subject to a substantial risk of forfeiture
Issues are constructive receipt and economic benefit
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31. Deferred Compensation
Stock option plans
On January 2, 2005 Lindsey was granted an option to buy 8,000 shares of her company, XYZ Co, at $32/share. Under the option she may not exercise the option for at least two years, she will then have 10 years thereafter to do so. The stock is currently selling for $32/share
readily ascertainable market value for option
no readily ascertainable market value for option
strike price
grant date, date when restriction lifted, exercise date
taxation at exercise date
taxation at sale
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32. Deferred Compensation
Incentive Stock Options - requirements
option price equal or greater than current market price at date of grant
exercisable and exercised within 10 years of grant
nontransferable and exercisable only by employee
employee may not own more than 10% of the voting power of stock of employer company immediately before the grant
exercised limit of $100,000 in a year
employee must not sell stock for at least two years from grant date and one year from exercise date
employee must be employed at grant date and continue in employee to at least three months before exercise date
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33. Deferred Compensation
ISOs
tax implications
no tax on date of exercise
excess of fmv of stock over strike price is an AMT preference item
capital gain on sale
no employer deduction for compensation
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34. Deferred Compensation
Coverdell Education Savings Plans – Sec 530
Non deductible contributions - $2,000
elementary and secondary education as well as higher ed
may be used with Hope and Lifetime learning credits
Compare to Sec 529 College Savings Plans
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