1. ©2003 South-Western College Publishing, Cincinnati, Ohio CHAPTER 4 Self-Employed and Employee Expenses Self-Employed and Employee Expenses

2. © 2003 South-Western College PublishingTransparency 4-2 Objective Understand the difference between deductions for AGI and deductions from AGI

3. © 2003 South-Western College PublishingTransparency 4-3 For versus From Deductions rDeductions for are those taken to arrive at adjusted gross income (AGI) <Self-employment expenses <Trade or business expenses, including some rental or royalty expenses rDeduction from are itemized deductions subtracted from AGI <Generally personal expenses, or <Expenses incurred by employees

4. © 2003 South-Western College PublishingTransparency 4-4 Deduct For AGI Deciding Classification of Business Expenses YesNo Schedule C or Schedule F (if farm) Deduct From AGI Next Slide Are expenses from Self-Employment?

5. © 2003 South-Western College PublishingTransparency 4-5 Are Expenses Reimbursed by employer? No If necessary for performance of job then itemize deduction on Schedule A (subject to 2% AGI) Yes Does firm have accountable plan? Did employee substantiate & return excess? Reimbursement included in gross wages. Deduction only allowed on Schedule A as miscellaneous itemized subject to 2% AGI Deciding Classification of Business Expenses NoYes Previous Slide No tax effect NoYes

6. © 2003 South-Western College PublishingTransparency 4-6 Objective Know the requirements for deducting travel and transportation expenses

7. © 2003 South-Western College PublishingTransparency 4-7 Travel Expenses rTo be deductible, travel expenses must result from <A business reason (needs to be documented) <Overnight travel away from taxpayer’s tax home (defined as primary place of business) rMeals and entertainment expenses are only 50% deductible

8. © 2003 South-Western College PublishingTransparency 4-8 Travel Expenses (continued) rIf primarily business trip in US: <Travel costs are deductible <Expenses must be split between business and personal reason rIf primarily business trip outside US: <Travel expenses are allocated between personal and business (based on number of days) <Meals & entertainment (only 50% deductible) must be before or after a business discussion and luxury items are not deductible rIf primarily pleasure trip (in or outside US): <Travel costs are not deductible <Other costs directly related to business are deductible

9. © 2003 South-Western College PublishingTransparency 4-9 Travel Expenses (continued) rEmployees under nonaccountable plan must track actual expenses rEmployees under accountable plan may either track actual expenses or use per diem method r(3 methods of calculating per diem) ÊFederal rate method (dependent on area) has a standard base rate of $85/day ÙIRS publishes per diem rates for each geographical area in US ÙCan access current rates at www.irs.gov ËHigh-low method (a few “high” areas ($204/day) and the rest are low areas $125/day) ÙEasier to use if employees travel extensively ÙIf employer uses high-low to reimburse employee, must continue throughout the year

10. © 2003 South-Western College PublishingTransparency 4-10 Travel Expenses (continued) ÌMeals and Incidental Expenses (M&IE) Method ÙAllows a per diem plus actual lodging ÙEither hi-low M&IE rates ($42 and $34) or federal rate method (standard base rate is $30) ÙIf taxpayer is self employed and elects a per diem method, must choose this one!

11. © 2003 South-Western College PublishingTransparency 4-11 Transportation rTaxpayer doesn’t have to be away from tax home to get transportation deduction <Commuting is never deductible, except if: Ùtraveling between home and temporary work and have regular place of business Ùtaxpayer’s principal place of business is home - then transportation is deductible Ùworking two jobs - cost of going from one job to another

12. © 2003 South-Western College PublishingTransparency 4-12 rMay take standard ($.365/mile) mileage rate plus parking/tolls (car loan interest and property taxes determined separately) or actual <To use standard per mile deduction, taxpayer must Ùown or lease car Ùnot rent out Ùnot own fleet Ùnot have depreciation other than straight line Ùnot have taken Section 179 depreciation on auto <Interest portion of car payment is only deductible if self employed Transportation (continued)

13. © 2003 South-Western College PublishingTransparency 4-13 Transportation (continued) rActual expense is calculated by receipts as multiplied by business use percent and includes: <gas, oil, repair, and maintenance <depreciation <plus property taxes and interest on car ONLY if self-employed <business-related parking/tolls FULLY deductible ÙNot multiplied by business use percentage rIf choose actual expense - cannot change to standard rIf choose standard - may change to actual, but must use straight line depreciation rReporting <If taxpayer is self-employed, vehicle expenses reported on Schedule C (and can take auto interest) <If an employee, report on 2106 which carries to Schedule A

14. © 2003 South-Western College PublishingTransparency 4-14 Objective Understand when a Home Office deduction may be claimed and how deduction is computed

15. © 2003 South-Western College PublishingTransparency 4-15 Office in Home (OIH) rGenerally may not take a deduction for business use of a home rMay take home office deduction if <Home is used regularly and exclusively as the principal place of business ÙOr required for the “convenience of employer” <Office in home is used regularly and exclusively to manage business or meet with clients <Office is separate structure and used exclusively for business or storage of inventory (and home is taxpayer’s sole place of business)

16. © 2003 South-Western College PublishingTransparency 4-16 Home Office (continued) rCompute using Form 8829 <Allowable deduction carries to bottom of Schedule C if self employed <Allowable deduction carries to bottom of Schedule A if an employee business expense – but can only take if necessary for employer convenience when employer does not provide a regular office rTwo columns on 8829 for OIH expenses <Direct expenses Ùwork done directly on home office (for example new cabinetry) and <indirect expenses Ùapplicable to entire home and allocable to OIH (such as new furnace or lawn maintenance) <Allocation done on basis of square footage

17. © 2003 South-Western College PublishingTransparency 4-17 Home Office (continued) rOIH deduction cannot be used to create a Net Loss for the business (other than allocable portion of mortgage interest and taxes) rTherefore, OIH is deducted using a tier system: Gross income less:Interest/taxes allocable to OIH (balance to A) less:Other business deductions less*:Maintenance, depreciation, rent, utilities (only deductible if GI remaining) *These items cannot put taxpayer into a loss <Must carry forward excess to future years – “OIH Carry Forward”

18. © 2003 South-Western College PublishingTransparency 4-18 Objective Know the special requirements for claiming other common business expenses

19. © 2003 South-Western College PublishingTransparency 4-19 Entertainment rMay take a deduction for 50% of cost of entertainment connected with a business rEntertainment must be either directly related to, or associated with active conduct of business <“Directly related” costs are those related to an actual business meeting, such as a business lunch <“Associated with” costs serve a specific business purpose and must occur immediately before or after a business discussion rDeduction for the cost of entertainment facilities is severely limited <Club dues are not deductible

20. © 2003 South-Western College PublishingTransparency 4-20 Educational Expenses rDeductible if the education: <Maintains or improves existing skills, or <Is needed to meet requirements of taxpayer’s current employment rCost of courses and transportation, lodging and 50% meals (if travel is required to obtain education) <Self-employed educational expenses are reported on Schedule C <Employee on Schedule A

21. © 2003 South-Western College PublishingTransparency 4-21 Dues, Subscriptions and Publications rProfessionals may deduct the cost of dues, subscriptions and publications related to their profession rPrepaid amounts must be allocated over useful life if > one year

22. © 2003 South-Western College PublishingTransparency 4-22 Uniforms rUniforms and special clothes are deductible if: <Can’t be worn outside of work and <Are required by employer rProtective wear always deductible

23. © 2003 South-Western College PublishingTransparency 4-23 Business Gifts rMay deduct the cost of gifts up to $25 per donee per year <Husband and wife = 1 donee <No limitation for small business gifts (not cash) up to $4 each that have taxpayer’s name or company name on them rTangible personal property (not cash) up to $400 is allowable if given to employees for safety or length of service awards ($1,600 in conjunction with a “qualified” plan)

24. © 2003 South-Western College PublishingTransparency 4-24 Substantiation rTaxpayers must have written proof of expenses for entertainment (E) and gifts (G) <Amount (E & G) <Time and place (E) <Date and description (G) <Business purpose (E & G) <Business relationship (E & G)

25. © 2003 South-Western College PublishingTransparency 4-25 Objective Be able to complete a simple Form 2106 and Schedule C

26. © 2003 South-Western College PublishingTransparency 4-26 Schedule C vs. C-EZ rCan use C-EZ if: <Business expenses are $2,500 or less per year <Business does not carry inventory <Business uses cash method of accounting <Don’t need to file a Form 4562 for depreciation <Don’t have an office in home <Don’t have a net loss and have only one business <Don’t have employees

27. © 2003 South-Western College PublishingTransparency 4-27 The End