1. Chapter 5 Introduction to Business Expenses Howard Godfrey, Ph. D
Chapter 5 Introduction to Business Expenses Howard Godfrey, Ph.D., CPA UNC Charlotte Copyright © 2013 Dr. Howard Godfrey Edited August 10, 2013

2. Part 1. Introduction Part 2. Reporting Deductions, Conduits Part 3
Part 1. Introduction Part 2. Reporting Deductions, Conduits Part 3. Classification of Expenses – Profit motivated, Trade or business or Production of income, Rental, Personal, Mixed business and pleasure. Part 4. Tests for Deductibility –Ordinary, etc., Not personal, Not capital exp., Public policy, Not related to tax-exempt income, For taxpayer’s benefit Part 5. Limited Mixed-Use Expenses - Hobby, Vacation home, Home office Part 6. Timing – Cash basis, Accrual basis, Related party accrued expenses, Financial accounting and tax differences

10. Entity Reporting
Al and Beth partnership’s income of $37,000 in 2013 included the following:
Dividend income $ 1,000
Long‑term capital gain 4,000
They share profits and losses equally.
What amount of partnership income (excluding all separately reported items) should each partner report on his individual income tax return for 2013?
a. $16,000 b. $18,500 c. $ 15,000 d. Other

14. Code Sections
Sec deductions permitted only for those expenses and losses for which a deduction is authorized
Sec. 162(a) authorizes deductions for ordinary and necessary expenses, that are reasonable in amount, and incurred in actively carrying on a trade or business
Sec. 212 authorizes deductions for expenses related to production of income (investment-related expenses)

15. Rules for Deductions for AGI. [1 of 7]
A taxpayer reports income and can deduct reasonable expenses (and losses) for a trade or business operation.
A taxpayer reports income and can deduct reasonable expenses (and losses) for a transaction entered into for profit, even though it does not meet the definition of a trade or business operation.

16. Rules for Deductions for AGI. [2 of 7]
A trade or business operation often means providing goods or services to customers. (By comparison, an employee provides services to his or her employer.)
When you buy an asset hoping to sell it later at a profit (such as buying IBM stock) you are not in a trade or business, but this is a transaction entered into for profit.

17. Rules for Deductions for AGI. [3 of 7]
There is no good definition of a trade or business.
An typical investor is not in a trade or business. However, Wachovia Securities invests in stocks and sells stocks to its customers. It is a trade or business.
If you buy land and build an apartment building on it for resale, you may not be in a trade or business. If you repeat this 20 times, you are in a trade or business as a real estate developer.
When does your activity rise to the level that causes you to be in a trade or business? Who knows?

18. Rules for Deductions for AGI. [4 of 7]
Expenses (and losses) are deductible “For AGI” if they are for a trade or business operation (generally providing goods or services to customers, clients, etc.).
Expenses are deductible “For AGI” is they are for a transaction entered into for profit, and they involve property that generates rental income or royalty income.
Expenses for other transactions entered into for profit are deductible as Misc. Item. Deductions.

19. Rules for Deductions for AGI.[5 of 7]
A taxpayer can deduct reasonable expenses (and losses) for a trade or business operation. (Sec. 162)
A taxpayer can deduct reasonable expenses (and losses) for a transaction entered into for profit, even though it does not meet the definition of a trade or business operation. (Sec. 212)

20. Rules for Deductions for AGI. [6 of 7]
Renting property to tenants (for example under one-year contract or longer) is generally not a trade or business, unless you provide substantial services.
A golf course technically rents you the land for a few hours, but you are mainly paying for service.
A Marriott Hotel is a trade or business. They have many customers and they provide substantial services to their customers.

21. Rules for Deductions for AGI. [7 of 7]
An employee is in the trade or business of being an employee, but is subject to special limits on deductions.
Employee expenses are deductible from AGI (Misc. Deductions) except for reimbursed expenses. (If the reimbursement is included in income, there is an offsetting deduction for AGI. Usually, reimbursed expenses are not included in income, so there is no deduction.)

27. Investor Losses
An investor in the stock market deducts investment related expenses from AGI on Schedule A.
An investor in the stock market reports gains (and deducts losses) on the sale of stock on Schedule D, and the net gain or loss (subject to loss limits) flows from Schedule D to the front of Form 1040.
Capital losses from stock sales are deductible for AGI.

29. Kelley. Interest Deduction
When Kelley couldn’t make payments on a business loan, her brother Mike made three monthly payments of $700 each, a total of $2,100 ($1,950 for interest expense and $150 for principal) for Kelley’s loan. Kelley makes the other nine monthly payments herself ($5,850 for interest expense and $450 for principal).
a. What is Mike’s deduction for interest expense?
b. What is Kelley’s deduction for interest expense?
c. What could they have done to preserve the tax deductions? Explain.

30. Kelley. Interest Deduction
a. Mike cannot deduct anything because it is not his loan.
b. Kelly can only deduct the $5,850 interest expense for the nine monthly payments that she made.
c. Mike should have given (or loaned) the money to Kelly and let Kelly make the loan payments. hat way, Kelly could take a deduction for the $7,800 interest paid that year.

31. Reasonable in amount (not excessive)
Expense Requirements.
Business expense: deductible if it is
Ordinary and necessary (considered an appropriate expense by a prudent business person)
Reasonable in amount (not excessive)

32. Disallowed Deductions.
Unless provided for otherwise in the Code, a deduction will be disallowed if it is
A personal Expense
A capital expenditure But see-Start-up costs.
Contrary to public policy (fines, penalties)
Lobbying or political expenditure
Related to tax-exempt income
The obligation of another taxpayer
Accrued to related party (no deduction until related party recognizes income).

33. Costs of Starting a Business.
Sec. 162 allows deductions for “carrying on” a business. Expenses incurred prior to the commencement of operations do not qualify as “carrying on” a business but may be deductible as one of the following:
Business investigation expenses
Start-up expenses
Organization costs

34. Business Investigation.
Investigation expenses incurred while preparing to enter business include travel, market surveys, and feasibility studies
If the taxpayer is in a similar existing business - deduction allowed as a current expense
If taxpayer is not in a similar existing business
If new business acquired - expenses are part of start-up expenses. See next slide
If new business not acquired - no deduction

35. Start-up Expenses.
Start-up expenses are incurred after the decision to proceed with the new business, but before beginning actual operations (employee training and advertising)
If the business is related to the taxpayer’s existing business, start-up costs are considered continuing costs and are deductible currently

36. Start-up Expenses. Textbook page 5-19.
If the new business is not related to an existing business
Can deduct up to $5,000 (combined business investigation and start-up expenses) in the tax year in which the business begins
$5,000 amount is reduced by amount cumulative investigation and start-up expenses exceeds $50,000
Remainder of investigation and start-up expenses amortized over a 15-year period

37. Organization Costs.
Defined as costs related to the formation of a corporation or partnership (fees paid to the state for incorporation, legal fees, and accounting fees) and incurred before end of first year
Can deduct up to $5,000 in the year business begins
$5,000 deduction is reduced by amount organizational costs exceeds $50,000
Remaining organizational costs amortized over 15 years (180 months)

38. Organization Expenses-1
Costs of issuing or selling stock and transferring assets to the corporation reduce the amount of capital raised and are not deductible

39. Organization Expenses-2
Which of the following costs are
amortizable organizational expenditures?
a. Professional fees to issue the corporate stock.
b. Printing costs to issue the corporate stock.
c. Legal fees for drafting the corporate charter.
d. Commissions paid by the corporation to an underwriter CPA Nov. 1994

45. Diane. Business Investigation Expenses
Diane owns and manages a successful clothing store in Dallas. Before graduation of her brother, Cameron, they investigated the possibility of opening another store in Atlanta for Cameron to manage.

46. Diane. Business Investigation Expenses
Diane and Cameron each paid $1,600 in travel costs while looking for sites for the store. Each paid $300 in legal fees for a lawyer to compile a list of zoning regulations and other relevant city ordinances.
They decide that it is not feasible to open a new store at the present time.
Can Diane and Cameron deduct their business investigation expenses? Explain.

47. Diane. Business Investigation Expenses
Diane can deduct $1,900 ($1,600 + $300) in the current year as business investigation expenses.
Diane can deduct this amount because she is already in the clothing business and expenses for potential expansion are ordinary business expenses whether or not a new store is opened.

48. Diane. Business Investigation Expenses
Her brother, however, is not permitted any deduction for the $1,900 that he expended.
Cameron could only capitalize and amortize the expenses if the new store was opened.

49. Expenses of Illegal Business
Taxpayer sells drugs at local junior high school.
We know revenue from an illegal business is taxable.
May he deduct expenses such as “pay-offs” to police and school officials, etc.?
He cannot deduct certain expenses – when it would be against public policy to allow the deduction.
In many cases normal expenses such as auto expenses would be deductible.
But Congress added a code section prohibiting deduction of expenses by a dealer in illegal drugs.
Deductions are allowed for normal expenses of other types of illegal businesses.

51. ACTIVITIES NOT … FOR PROFIT 183(a) GENERAL RULE
ACTIVITIES NOT … FOR PROFIT 183(a) GENERAL RULE. --In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.

52. Hobby Expenses.
Activities that earn income and incur expenses but do not meet the requirements to be a business or investment are hobbies
Regulations list factors to consider in determining if activity is a hobby including:
Manner in which activity carried on
Expertise of taxpayer and/or consultants
Time and effort spend in activity
Actual profits earned in one or more years
Elements of pleasure or recreation

53. Hobby Expenses
If a profit is realized in 3 out of 5 years (2 out of 7 years for horses) then burden of proof shifts to IRS to prove activity is a hobby
Taxpayer can deduct expenses, even if a net loss results, by showing activity is run in a businesslike manner
If activity is a hobby, the deduction for expenses is limited to hobby income

54. Expenses deducted in this order:
Hobby Expenses
Expenses deducted in this order:
Otherwise allowable expenses (mortgage interest, taxes, and casualty losses)
Expenses that do not reduce the tax basis of the assets used in the hobby (advertising, insurance, utilities and maintenance)
Depreciation and amortization
Excess expenses are lost - no carryover

55. Sec. 183 Activities Not. For Profit -1 (b) Deductions Allowable
Sec. 183 Activities Not.. For Profit -1 (b) Deductions Allowable.-- In the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed-- (1) the deductions which would be allowable … without regard to whether or not such activity is engaged in for profit, and

56. Sec. 183 Activities Not … For Profit -2
(b) Deductions Allowable.--
(2) a deduction equal to the amount of the deductions which would be allowable … … only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1).

58. Teresa. Business vs. Hobby. 1 of 4.
Teresa is an accomplished actress. During the summer, she rented a vacant store to stage productions of four plays, using the local townspeople as actors and stagehands. She sold $24,000 of tickets to the various plays.
Her expenses included
$10,000 for copyright fees,
$3,000 store rental,
$8,000 for costume purchases and rentals, $2,000 for props and other supplies, and
$4,000 for all other miscellaneous expenses related to producing the series of plays.

59. Teresa. Business vs. Hobby. 2 of 4.
a. How does Teresa treat the revenue and expenses if the activity is deemed a business?
b. How does Teresa treat the revenue and expenses if the activity is considered a hobby?
c. What are some of the factors that should be considered in deciding if this constitutes a business or a hobby?

60. Teresa. Business vs. Hobby. 3 of 4.
a. If the activity is a business, Teresa may deduct all of the expenses from the revenue; she will report a loss of $3,000 ($24,000 - $10,000 - $3,000 - $8,000 - $2,000 - $4,000).
b. If the activity is a hobby, Teresa will be able to deduct expenses only to the extent of her income from the activity. So she can deduct only $24,000 of the expenses.

61. Teresa. Business vs. Hobby. 4 of 4.
c. Some factors that should be considered are:
Manner in which the taxpayer carries on the activity;
Expertise of the taxpayer and/of the taxpayer’s consultants;
Time & effort spent by taxpayer in the activity;
Taxpayer’s history of profits or losses for this activity;
Success of the taxpayer in similar activities;
Overall financial status of the taxpayer; and
Elements of pleasure or recreation that are part of the activity.

62. Vacation Homes

64. Residential Rental Property
If rental of real estate is a business, all income is included and all expenses are deductible, even if it creates a loss (subject to passive loss rules)
Expenses include: advertising, cleaning, maintenance, utilities, insurance, taxes, interest, commissions for collection of rent, travel to collect rental income or to manage the property or maintain the property

65. Residential Rental Property
When property is converted from personal to rental property, expenses must be divided between rental and personal use
No depreciation or insurance deduction allowed for personal-use part of year
Mortgage interest and real estate taxes for personal-use can be deducted as itemized deductions

66. Rental of a Vacation Home
If the residence is rented for less than 15 days during the year a de minimis exception applies
No rental income is reported and
No deductions are allowed for expenses other than mortgage interest and property taxes as itemized deductions

67. Rental of a Vacation Home
If rental period is greater than 14 days and
If personal use does not exceed the greater of 14 days or 10% of the rental days
All rent is included in income
Expenses are allocated between rental and personal use
All expenses related to the rental use are deductible (even if this creates a loss)

68. Rental of a Vacation Home
If rental period is greater than 14 days but
Personal use exceeds the greater of 14 days or 10% of the rental days
Rental expenses limited to rental income (no loss)
Nondeductible rental expenses can be carried forward to the future years
Real estate taxes and mortgage interest for personal-use portion allowed as itemized deductions

70. Expenses … Business Use of Home, Rental of Vacation Homes, etc.
Sec. 280A Disallowance of Certain
Expenses … Business Use of Home,
Rental of Vacation Homes, etc.
(a) General Rule.-- Except as otherwise provided in this section, in the case of a taxpayer who is an individual or a S corporation, no deduction otherwise allowable … shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.

71. Sec. 280A Disallowance of Certain Expenses … Business Use of Home, Rental of Vacation Homes, etc. (b) Exceptions for Interest, Taxes, Casualty Losses, Etc.-- Subsection (a) shall not apply to any deduction allowable to the taxpayer without regard to its connection with his trade or business (or with his income-producing activity).

72. Sec. 280A Disallowance… (d) Use as Residence.--
(1) In General.--For purposes of this section, a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of--

73. (d) Use as Residence.-- Sec. 280A Disallowance…
(A) 14 days, or 10 percent of the number of days during such year for which such unit is rented at a fair rental. For purposes of subparagraph (B), a unit shall not be treated as rented at a fair rental for any day for which it is used for personal purposes.

74. Sec. 280A Disallowance… (g) Special Rule for Certain Rental Use.--
Notwithstanding any other provision of this section or section 183, if a dwelling unit is used … by the taxpayer as a residence and
… rented for less than 15 days during the taxable year, then--

75. Sec. 280A Disallowance… (g) Special Rule...-- …
(1) no deduction otherwise allowable … because of the rental use of such dwelling unit shall be allowed, and (2) the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under section 61.

76. (e) Expenses Attributable To Rental. -- (1) In General. --…where
(e) Expenses Attributable To Rental.-- (1) In General.--…where .. an individual or an S corp. uses a dwelling unit for personal purposes on any day .. (whether or not he is treated under this section as using such unit as a residence), the amount deductible.. with respect to expenses attributable to the rental of the unit (or portion thereof) .. shall not exceed an amount which bears the same relationship to such expenses as the number of days during each year that the unit (or portion thereof) is rented at a fair rental bears to the total number of days .. that the unit (or portion thereof) is used.

77. (e) Expenses Attributable To Rental
(e) Expenses Attributable To Rental.-- (2) Exception for Deductions Otherwise Allowable.--This subsection shall not apply with respect to deductions which would be allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was rented.

78. Sue rents her vacation home for 60 days and lives in the home for 30 days. Sue's gross Rental income is $5,000
Expenses for the entire year:
Real estate taxes $2,300
Mortgage interest expense $7,000
Utilities and maintenance $2,400
Depreciation $9,000
How much depreciation will Sue
deduct on her tax return?
a. $1, b. $6, c. $3, d. $1,400

83. Home Office Expenses

84. Home Office Expenses
Home office must be used exclusively on a regular basis and meet one of the following three tests to be deductible
the principal place of business for any business of taxpayer, or
2. a place for meeting with clients or customers in the normal course of business, or
3. located in a separate structure

85. Home Office Expenses
Principal place of business includes a place used for the administrative or management activities of the business if there is no other fixed location available
Employee must also show that the office is maintained for the convenience of the employer
Deductible expenses include portion of rent or mortgage interest, property taxes, insurance, utilities, repairs, depreciation but are limited to gross income from the business

86. Expenses are deducted in this order:
Home Office Expenses
Expenses are deducted in this order:
Expenses directly related to the business other than home office expenses (supplies)
The allocated portion of otherwise deductible itemized deductions (mortgage interest and property taxes)
3. Other home expenses including utilities, insurance, and maintenance
4. Depreciation
Excess expenses are carried forward

87. Maureen. Home Office Expenses
Maureen operates a cosmetic sales business from her home. She uses 400 of 1,600 square feet of the home as an office.
Her income before her home office deduction is $2,300.
How much of the following unapportioned expenses for the home are deductible?
If any of the expenses are not deductible currently, how are they treated for tax purposes?
Mortgage interest $5,000
Property taxes 1,400
Utilities 1,200
Repairs and maintenance
Depreciation for the entire house 6,000

88. Maureen. Home Office Expenses
Deductible expenses for home office are limited to the business income ($2,300) and she must account for expenses in the following order:
Mortgage interest & property taxes [($5,000 + $1,400) x (400/1600)] $1,600
Utilities & repairs [($1,200 + $600) x 400/1600] 450
Depreciation ($6,000 x 400/1600 = $1,500) limited to $250 ($2,300 - $1,600 - $450 = $250). 250
The nondeductible portion of the depreciation ($1,250) will be carried forward to future years and subject to similar limitations.

89. Section 280A
(c) Exceptions for Certain Business or Rental Use; Limitation on Deductions for Such Use.--
(1) Certain Business Use.--Subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit which is exclusively used on a regular basis--
(A) the principal place of business for any trade or business of the taxpayer,
(B) as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or business, or
(C) in the case of a separate structure which is not attached to the dwelling unit, in connection with the taxpayer's trade or business. In the case of an employee, the preceding sentence shall apply only if the exclusive use referred to in the preceding sentence is for the convenience of his employer.

90. Section 280A
(c) Exceptions for Certain Business or Rental Use; Limitation on Deductions for Such Use.--
For purposes of subparagraph (A), the term "principal place of business" includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business.

92. Cash Method
When an expense is paid by providing services, the expense can be deducted but the value of the services provided is also income
Assets with useful lives extending substantially beyond the end of the year must be capitalized with their cost recovered through depreciation, amortization, or depletion
When considering whether to make an early payment of year-end expenses, the tax rates for both years and the time value of money should be considered

93. Use of Cash Method
Businesses that sell merchandise to their customers must use the accrual method to account for purchases and sales of inventory
Cash method can be used for other than inventory and cost of goods sold
Large corporations with average annual gross receipts of more than $5 million cannot use the cash method for tax reporting
All personal service corporations can use the cash method

94. Prepaid Expenses
Prepaid expenses must be capitalized as assets and their costs prorated if their lives exceed one year and the items will not be consumed by the close of the following year
But see one-year rule.
Prepaid interest must generally be prorated over the life of the loan
OID is a form of prepaid interest and must be amortized over term of loan

95. Bender. Prepaid Rent
On October 1, Bender (calendar-year, cash-basis taxpayer) signs a lease with Realco to rent office space for 36 months. Bender obtains favorable monthly payments of $600 by agreeing to prepay the rent for the entire 36-month period.
a. If Bender pays the entire $21,600 on October 1, how much can it deduct in the current year?
b. Assume the same facts above except that the lease requires Bender to make three annual payments of $7,200 each on October 1 of each year for the next 12 months rent. On October 1 of the current year, Bender pays $7,200 for the first 12-month rental period. How much can Bender Company deduct in the current year?

96. Bender. Prepaid Rent
a. Bender can only deduct $1,800 (3 x $600) rent for the three months remaining in the current year, because the rent payment is for a period extending beyond the end of the succeeding year.
b. Bender can deduct the $7,200 in each year that it is paid. The contract calls for the advance payments and each payment does not extend beyond the end of the year following the year it is paid.

97. Simon Corp. Prepaid Expenses
On December 15, Simon Corporation (a cash-basis calendar-year corporation) paid $5,000 for five months of supplies and $9,000 for an insurance policy covering its office building for the next three calendar years.
How much can Simon deduct this year for these expenses?

98. Simon can only deduct the $5,000 paid for supplies.
Simon Corp. Prepaid Expenses
Simon can only deduct the $5,000 paid for supplies.
The insurance payment must be capitalized and written off one-third in each of the years it covers as if Simon was an accrual-basis taxpayer.

99. Substantiation.
All taxpayers must maintain records that substantiate their expense deductions
Stringent substantiation requirements for travel, entertainment, and gifts
Amount of expenditure
Time and place (or date & description of gift)
Business purpose of expenditure
Business relationship of person entertained or receiving a gift

100. Timing of Deductions Accrual method – expenses deductible when
“All events” have occurred that fix liability and
“Economic performance” occurs (property or services provided or used)
Cash basis taxpayer - expenses deductible when paid
Date check is mailed
Date charged on credit card

101. Accrual Accounting-1 REG §1. 446-1
Accrual Accounting-1 REG § methods of accounting …a liability is incurred, …, [when] all events have occurred that establish the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

102. Aloha. Timing of Expense Deduction
Aloha Airlines is required by law to have its aircraft engines tested and recertified after 5,000 flight hours. Molokai Maintenance performs the engine tests and recertification for $2,200 per aircraft. For financial accounting purposes, Aloha establishes a reserve account and accrues a maintenance expense of 44 cents per flight hour. When the maintenance is done, the amount paid for the maintenance is deducted from the reserve account. For tax purposes, when can the maintenance expense be deducted?

103. Aloha. Timing of Expense Deduction
Businesses are not permitted to use reserves for expenses for tax purposes.
Aloha can only deduct the repair expenses
in the year repairs are performed, if it is an accrual-basis taxpayer, or
when they are paid, if it is a cash-basis taxpayer.

104. Accrual Accounting-1 REG §1.446-1. ..methods of accounting
…a liability is incurred, …, [when] all events have occurred that establish the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

105. Accrual Accounting-1
Automobile manufacturer sells an auto to dealer for a wholesale price of $30,000.
Dealer sells it later that year for $40,000.
Manufacturer warrants the auto for five years and estimates that the warranty cost over five years will be $3,000 per auto.
Is the manufacturer permitted to recognize an expense in the year of sale and set up a “reserve” for future warranty costs (equal to $3,000 per auto sold this year)? See Reg earlier.

113. Liability for Warranties [1 of 4] MufCo sells mufflers with a 1-year guarantee. MufCo provides a free replacement of a defective muffler, and installs the muffler for a service charge of $10. In 2010, MufCo sold 100,000 mufflers at $50 each, and expects that 1% of the mufflers will be defective. Mufflers cost MufCo $20 each. The entry to record warranty expense for 2010 would include: a. credit product warranty expense for $20,000 b. debit estimated warranty liability for $20,000 c. debit product warranty expense for $30,000 d. credit estimated warranty liability for $20,000

117. Turtle Co. Slide 1 of 3
Turtle Co. bought equipment on Jan-1 year 1, for $50,000. Equipment had an estimated 5‑year service life & no expected salvage value. Turtle uses the 200% double‑declining depreciation method. Assume income tax rate is 30%. What is accumulated depreciation at the end of year 2?
a. $30, b. $32,000
c. $39, d. $42,000

122. Sales Company [Slide-3] In 2010, taxable income exceeded book net income because write-off of receivables on tax return was less than bad debts expense (Uncollectible Accounts Expense) in financial statements. In 2011, taxable income was less than book income. Cumulative difference at end of 2011 was $10,000.

123. Tax Accounting vs. Financial Acct

124. Tax vs. Financial Accounting
The goals of financial accounting are not the same as those for tax reporting
Financial accounting seeks to provide information that decision makers find useful.
Tax reporting seeks to collect revenue equitably.

125. Differences fall into two categories Temporary or timing differences
Tax vs. Financial Accounting
Differences fall into two categories
Temporary or timing differences
Permanent differences

131. Temporary Differences.
Arise when income is taxed either before or after it is accrued for accounting purposes
Example: prepaid rent generally is taxable when received from the tenant but it is included in financial accounting income only as it is earned
Are accounted for as either a deferred tax asset or deferred tax liability on financial statements

132. Permanent Differences.
Income that is not taxed but is reported for financial accounting purposes
Example: municipal bond interest generally is not taxed but is recorded as income in financial accounting records

134. (Ignore accrual of interest on loan.)
Next Slide.
A company normally has annual revenue of $200,000 & expenses of $130,000. (NI of $70,000)
In 2013, company sold some land for $100,000. Company had paid $80,000 for the land. Company will collect $60,000 in 2014 and $40,000 in 2015.
(Ignore accrual of interest on loan.)

145. End