1. Taxation of Business Entities C17-1 Chapter 17 Individuals as Employees and Proprietors Individuals as Employees and Proprietors Copyright ©2010 Cengage Learning Taxation of Business Entities

2. C17-2 Employee vs. Self-Employed (slide 1 of 2) Business expenses for self-employed persons are deductible for AGI –Reported on Schedule C Business expenses for employees are generally deductible from AGI subject to 2% of AGI floor –Reported on Form 2106 (Employee Business Expenses) and Schedule A (Itemized Deductions) Business expenses for self-employed persons are deductible for AGI –Reported on Schedule C Business expenses for employees are generally deductible from AGI subject to 2% of AGI floor –Reported on Form 2106 (Employee Business Expenses) and Schedule A (Itemized Deductions)

3. Taxation of Business Entities C17-3 Employee vs. Self-Employed (slide 2 of 2) Person is classified as an employee if: –Subject to will and control of another with respect to what shall be done and how it shall be done –Another furnishes tools or the place of work –Income based on time spent rather than task performed Person is classified as an employee if: –Subject to will and control of another with respect to what shall be done and how it shall be done –Another furnishes tools or the place of work –Income based on time spent rather than task performed

4. Taxation of Business Entities C17-4 Advantages of Qualified Fringe Benefits Cost of qualified fringe benefits is deductible by employer Value of qualified fringe benefits is excluded from employee’s gross income Cost of qualified fringe benefits is deductible by employer Value of qualified fringe benefits is excluded from employee’s gross income

5. Taxation of Business Entities C17-5 Employer-Sponsored Accident and Health Plans Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function

6. Taxation of Business Entities C17-6 Long-Term Care Insurance (slide 1 of 2) Employer paid insurance premiums for employee’s long- term care are excludible subject to annual limits as follows: Insured’s Age before Close of Tax Year 2008 2009 40 or less $ 310$ 320 41 to 50 580 600 51 to 60 1,150 1,190 61 to 70 3,080 3,180 More than 70 3,850 3,980 Employer paid insurance premiums for employee’s long- term care are excludible subject to annual limits as follows: Insured’s Age before Close of Tax Year 2008 2009 40 or less $ 310$ 320 41 to 50 580 600 51 to 60 1,150 1,190 61 to 70 3,080 3,180 More than 70 3,850 3,980

7. Taxation of Business Entities C17-7 Long-Term Care Insurance (slide 2 of 2) Exclusion of benefits received from policy is limited to the greater of: $280 in 2009 for each day patient receives long-term care (indexed amount for 2008 is $270) The actual cost of the care –Reduced by any amounts received from other third parties (e.g., damages received) Exclusion of benefits received from policy is limited to the greater of: $280 in 2009 for each day patient receives long-term care (indexed amount for 2008 is $270) The actual cost of the care –Reduced by any amounts received from other third parties (e.g., damages received)

8. Taxation of Business Entities C17-8 Meals and Lodging Not taxable to employee if: –Furnished by employer On employer’s business premises For convenience of employer –In the case of lodging, employee is required to accept lodging as a condition of employment Not taxable to employee if: –Furnished by employer On employer’s business premises For convenience of employer –In the case of lodging, employee is required to accept lodging as a condition of employment

9. Taxation of Business Entities C17-9 Group Term Life Insurance Premiums on the first $50,000 of group term life insurance are excluded from gross income –If plan discriminates in favor of certain key employees (e.g., officers), they are not eligible for the exclusion Key employees must include in gross income the greater of –Actual premiums paid by the employer, or –The amount calculated from the IRS tables Premiums on the first $50,000 of group term life insurance are excluded from gross income –If plan discriminates in favor of certain key employees (e.g., officers), they are not eligible for the exclusion Key employees must include in gross income the greater of –Actual premiums paid by the employer, or –The amount calculated from the IRS tables

10. Taxation of Business Entities C17-10 Other Fringe Benefits (slide 1 of 3) Dependent care –Up to $5,000 of care costs paid for by employer can be excluded Athletic facilities –Value of use of athletic facilities located on employer premises can be excluded Dependent care –Up to $5,000 of care costs paid for by employer can be excluded Athletic facilities –Value of use of athletic facilities located on employer premises can be excluded

11. Taxation of Business Entities C17-11 Other Fringe Benefits (slide 2 of 3) Educational assistance programs –Employer-provided educational assistance for undergraduate and graduate education is excludible Exclusion limited to $5,250 per year Includes tuition, fees, books, and supplies Educational assistance programs –Employer-provided educational assistance for undergraduate and graduate education is excludible Exclusion limited to $5,250 per year Includes tuition, fees, books, and supplies

12. Taxation of Business Entities C17-12 Other Fringe Benefits (slide 3 of 3) Adoption assistance programs –Employee adoption expenses paid or reimbursed by employer are excludible Exclusion limited to $12,150 Exclusion phases-out as AGI increases from $182,180 to $222,180 Adoption assistance programs –Employee adoption expenses paid or reimbursed by employer are excludible Exclusion limited to $12,150 Exclusion phases-out as AGI increases from $182,180 to $222,180

13. Taxation of Business Entities C17-13 Cafeteria Plans Allows employees to choose between cash and certain nontaxable benefits –If cash is chosen, the amount received is taxable –If a nontaxable benefit is chosen, the benefit remains nontaxable Provide tremendous flexibility in tailoring the employee pay package to fit individual needs Allows employees to choose between cash and certain nontaxable benefits –If cash is chosen, the amount received is taxable –If a nontaxable benefit is chosen, the benefit remains nontaxable Provide tremendous flexibility in tailoring the employee pay package to fit individual needs

14. Taxation of Business Entities C17-14 Flexible Spending Plans Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income –Called a use or lose plan since reduction in pay cannot be recovered if covered expenses are less than expected Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income –Called a use or lose plan since reduction in pay cannot be recovered if covered expenses are less than expected

15. Taxation of Business Entities C17-15 Classes of Nontaxable Employee Benefits No-additional-cost services Qualified employee discounts Working condition fringes De minimis fringes Qualified transportation fringes Qualified moving expense reimbursements Qualified retirement planning services No-additional-cost services Qualified employee discounts Working condition fringes De minimis fringes Qualified transportation fringes Qualified moving expense reimbursements Qualified retirement planning services

16. Taxation of Business Entities C17-16 No Additional Cost Services Are nontaxable if: –Employee receives services (not property) –Employer incurs no substantial additional cost in providing the services –Services offered are within line of business in which employee works –Benefit is offered on nondiscriminatory basis Are nontaxable if: –Employee receives services (not property) –Employer incurs no substantial additional cost in providing the services –Services offered are within line of business in which employee works –Benefit is offered on nondiscriminatory basis

17. Taxation of Business Entities C17-17 Qualified Employee Discounts Are nontaxable if: –Discount is not on realty or investment property –Item discounted is from same line of business in which employee works –Discount cannot exceed gross profit on property or 20% on services –Benefit is offered on nondiscriminatory basis Are nontaxable if: –Discount is not on realty or investment property –Item discounted is from same line of business in which employee works –Discount cannot exceed gross profit on property or 20% on services –Benefit is offered on nondiscriminatory basis

18. Taxation of Business Entities C17-18 Working Condition Fringes Not taxable if employee could have deducted cost of item if they had actually paid for them –Includes personal use of auto by full-time auto salespeople and employee business expenses that would be eliminated by the 2% floor on miscellaneous itemized deductions Not taxable if employee could have deducted cost of item if they had actually paid for them –Includes personal use of auto by full-time auto salespeople and employee business expenses that would be eliminated by the 2% floor on miscellaneous itemized deductions

19. Taxation of Business Entities C17-19 De Minimis Benefits (slide 1 of 2) These benefits are so small that accounting for them is impractical Examples include: –Supper money –Occasional personal use of company copying machine –Company cocktail parties –Picnics for employees These benefits are so small that accounting for them is impractical Examples include: –Supper money –Occasional personal use of company copying machine –Company cocktail parties –Picnics for employees

20. Taxation of Business Entities C17-20 De Minimis Benefits (slide 2 of 2) Subsidized eating facilities operated by employer are excluded if: –Located on or near employer’s premises –Revenue equals or exceeds direct operating costs –Nondiscrimination requirements are met Subsidized eating facilities operated by employer are excluded if: –Located on or near employer’s premises –Revenue equals or exceeds direct operating costs –Nondiscrimination requirements are met

21. Taxation of Business Entities C17-21 Qualified Transportation This fringe benefit is designed to encourage the use of mass transit for commuting to work –Includes: Transportation in commuter highway vehicle and transit passes –Limit on the exclusion for 2009 was originally set at $120 per month ($115 in 2008) –However, ARRTA of 2009 increased this amount to $230 a month (starting in March 2009) and carries it through 2010 Qualified parking (limited to $230 per month) –May be provided directly by the employer or may be in the form of cash reimbursements This fringe benefit is designed to encourage the use of mass transit for commuting to work –Includes: Transportation in commuter highway vehicle and transit passes –Limit on the exclusion for 2009 was originally set at $120 per month ($115 in 2008) –However, ARRTA of 2009 increased this amount to $230 a month (starting in March 2009) and carries it through 2010 Qualified parking (limited to $230 per month) –May be provided directly by the employer or may be in the form of cash reimbursements

22. Taxation of Business Entities C17-22 Moving Expenses Employer payment or reimbursement of employee’s qualified moving expenses is excludible –No deduction by employee is allowed for reimbursed moving expenses Employer payment or reimbursement of employee’s qualified moving expenses is excludible –No deduction by employee is allowed for reimbursed moving expenses

23. Taxation of Business Entities C17-23 Qualified Retirement Planning Services Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income –Designed to motivate more employers to provide retirement planning services Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income –Designed to motivate more employers to provide retirement planning services

24. Taxation of Business Entities C17-24 Nondiscrimination Provisions For no-additional-cost services, qualified employee discounts, and qualified retirement planning services –If the plan is discriminatory in favor of highly compensated employees, these key employees are denied exclusion treatment –Non-highly compensated employees can still exclude these benefits from income For no-additional-cost services, qualified employee discounts, and qualified retirement planning services –If the plan is discriminatory in favor of highly compensated employees, these key employees are denied exclusion treatment –Non-highly compensated employees can still exclude these benefits from income

25. Taxation of Business Entities C17-25 Foreign Earned Income (slide 1 of 2) Income from personal services in a foreign country can be excluded from income To qualify for the exclusion, must be either: –A bona fide resident of foreign country, or –Present in foreign country at least 330 days during any 12 consecutive months Income from personal services in a foreign country can be excluded from income To qualify for the exclusion, must be either: –A bona fide resident of foreign country, or –Present in foreign country at least 330 days during any 12 consecutive months

26. Taxation of Business Entities C17-26 Foreign Earned Income (slide 2 of 2) Exclusion amount is limited to $91,400 –For married persons, both of whom have foreign earned income, the exclusion is computed separately for each spouse Exclusion amount is limited to $91,400 –For married persons, both of whom have foreign earned income, the exclusion is computed separately for each spouse

27. Taxation of Business Entities C17-27 Employee Expenses Fall into one of the following categories: –Transportation –Travel –Moving –Education –Entertainment –Other Fall into one of the following categories: –Transportation –Travel –Moving –Education –Entertainment –Other

28. Taxation of Business Entities C17-28 Transportation Expenses (slide 1 of 2) Transportation expense defined –Very limited, only from job site to job site and commuting to temporary work place –Commuting from home to work and back is nondeductible Exceptions: –Additional costs incurred to transport heavy tools –Employees with more than one job Transportation expense defined –Very limited, only from job site to job site and commuting to temporary work place –Commuting from home to work and back is nondeductible Exceptions: –Additional costs incurred to transport heavy tools –Employees with more than one job

29. Taxation of Business Entities C17-29 Transportation Expenses (slide 2 of 2) Amount deductible –Actual expenses Must keep adequate records of all expenses and depreciation is limited, or –Automatic mileage method 55 cents per mile for business miles for 2009 –Adjustment to basis of auto is required for depreciation considered allowed Plus parking, tolls, etc. Adequate documentation of mileage required Amount deductible –Actual expenses Must keep adequate records of all expenses and depreciation is limited, or –Automatic mileage method 55 cents per mile for business miles for 2009 –Adjustment to basis of auto is required for depreciation considered allowed Plus parking, tolls, etc. Adequate documentation of mileage required

30. Taxation of Business Entities C17-30 Travel Expenses (slide 1 of 2) Travel expense defined –Expenses while “away from tax home” on business –Includes transportation, lodging, 50% meals, and miscellaneous expenses Travel expense defined –Expenses while “away from tax home” on business –Includes transportation, lodging, 50% meals, and miscellaneous expenses

31. Taxation of Business Entities C17-31 Travel Expenses (slide 2 of 2) “Away from home” requirement –Need not be a 24-hour period but must be longer than ordinary work day and taxpayer will need to rest during release time –Being “away” should be a temporary situation (not in excess of 1 year) –“Tax Home” generally means business location, post, or station of the taxpayer “Away from home” requirement –Need not be a 24-hour period but must be longer than ordinary work day and taxpayer will need to rest during release time –Being “away” should be a temporary situation (not in excess of 1 year) –“Tax Home” generally means business location, post, or station of the taxpayer

32. Taxation of Business Entities C17-32 Combined Business/Pleasure Travel ( s lide 1 of 4) Only actual expenses for business are deductible –Meals, lodging and other expenses must be allocated between business and personal days Deductibility of transportation costs depends on whether the trip is domestic or foreign Only actual expenses for business are deductible –Meals, lodging and other expenses must be allocated between business and personal days Deductibility of transportation costs depends on whether the trip is domestic or foreign

33. Taxation of Business Entities C17-33 Combined Business/Pleasure Travel ( s lide 2 of 4) For domestic travel –If primary purpose of trip is business, transportation is deductible in full –If primary purpose is pleasure, no deduction for transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible For domestic travel –If primary purpose of trip is business, transportation is deductible in full –If primary purpose is pleasure, no deduction for transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible

34. Taxation of Business Entities C17-34 Combined Business/Pleasure Travel ( s lide 3 of 4) For foreign travel –Transportation expense must be allocated between business and personal unless: Trip is 7 days or less, Less than 25% of time was for personal purposes, or Taxpayer had no substantial control over arrangements for the trip For foreign travel –Transportation expense must be allocated between business and personal unless: Trip is 7 days or less, Less than 25% of time was for personal purposes, or Taxpayer had no substantial control over arrangements for the trip

35. Taxation of Business Entities C17-35 Combined Business/Pleasure Travel ( s lide 4 of 4) Travel days are considered business days Weekends, legal holidays and intervening days are business days if both the preceding and succeeding days are business days If trip is primarily for pleasure, no transportation expenses are deductible Travel days are considered business days Weekends, legal holidays and intervening days are business days if both the preceding and succeeding days are business days If trip is primarily for pleasure, no transportation expenses are deductible

36. Taxation of Business Entities C17-36 Moving Expenses Deductible for moves in connection with the commencement of work at a new principal place of work Two tests must be met for moving expenses to be deductible –Distance test –Time test Deductible for moves in connection with the commencement of work at a new principal place of work Two tests must be met for moving expenses to be deductible –Distance test –Time test

37. Taxation of Business Entities C17-37 Distance Test Distance from old home to new job must be at least 50 miles farther than from old home to old job New home location not relevant for decision Distance from old home to new job must be at least 50 miles farther than from old home to old job New home location not relevant for decision

38. Taxation of Business Entities C17-38 Example of Distance Test Gail lived 20 miles from her old job Gail’s new job is 75 miles from her old home Gail meets the distance test Gail lived 20 miles from her old job Gail’s new job is 75 miles from her old home Gail meets the distance test Old Job Old Job New Job New Job Old Residence Old Residence 20 mi. 75 mi.

39. Taxation of Business Entities C17-39 Time Test (slide 1 of 2) Taxpayer must be full-time employee for 39 of the 52 weeks following the move, or Self-employed must work in new location for 78 weeks during the next two years following the move –39 of the weeks must be in the first 12 months Test waived if die, disabled, discharged, or transferred Taxpayer must be full-time employee for 39 of the 52 weeks following the move, or Self-employed must work in new location for 78 weeks during the next two years following the move –39 of the weeks must be in the first 12 months Test waived if die, disabled, discharged, or transferred

40. Taxation of Business Entities C17-40 Time Test (slide 2 of 2) If time test not met during taxable year, two alternatives: –Take the deduction in year moved. If test is not met in following year, either: Include the amount deducted in gross income in the following year, or File amended return for year of move –Alternatively, wait until time test is met and then file amended return for year of move If time test not met during taxable year, two alternatives: –Take the deduction in year moved. If test is not met in following year, either: Include the amount deducted in gross income in the following year, or File amended return for year of move –Alternatively, wait until time test is met and then file amended return for year of move

41. Taxation of Business Entities C17-41 Deductible Moving Expenses ‘‘Qualified’’ moving expenses include reasonable expenses of: –Moving household goods and personal effects to new location –Expenses of travel for taxpayer and family to new location Lodging Actual auto costs (not depreciation) or mileage rate of $.24 per mile for each car in 2009 –Meals are not deductible as moving expense ‘‘Qualified’’ moving expenses include reasonable expenses of: –Moving household goods and personal effects to new location –Expenses of travel for taxpayer and family to new location Lodging Actual auto costs (not depreciation) or mileage rate of $.24 per mile for each car in 2009 –Meals are not deductible as moving expense

42. Taxation of Business Entities C17-42 Tax Treatment of Moving Expenses Unreimbursed moving expenses are deductible for AGI Reimbursement or payment by employer: –For qualified moving expenses, amount is excluded from gross income, but no deduction for related expenses –For nonqualified moving expenses, amount is included in gross income and no deduction is allowed Unreimbursed moving expenses are deductible for AGI Reimbursement or payment by employer: –For qualified moving expenses, amount is excluded from gross income, but no deduction for related expenses –For nonqualified moving expenses, amount is included in gross income and no deduction is allowed

43. Taxation of Business Entities C17-43 Education Expenses (slide 1 of 3) Education expenses are deductible if they are incurred: –To maintain or improve existing skills, or –To meet the requirements of the employer, profession, licensing, or state law Education expenses are deductible if they are incurred: –To maintain or improve existing skills, or –To meet the requirements of the employer, profession, licensing, or state law

44. Taxation of Business Entities C17-44 Education Expenses (slide 2 of 3) Education expenses are not deductible if they are incurred: –To meet minimum educational standards for existing job, or –To qualify taxpayer for new trade or business Education expenses are not deductible if they are incurred: –To meet minimum educational standards for existing job, or –To qualify taxpayer for new trade or business

45. Taxation of Business Entities C17-45 Education Expenses (slide 3 of 3) Education expenses include: –Tuition –Books –Supplies –Transportation –Travel (including lodging and 50% meals) Education expenses include: –Tuition –Books –Supplies –Transportation –Travel (including lodging and 50% meals)

46. Taxation of Business Entities C17-46 Deduction for Qualified Tuition and Related Expenses (slide 1 of 3) A deduction is allowed for AGI for qualified tuition and related expenses involving higher education (i.e., postsecondary) –This provision expired at the end of 2007, but has been extended through 2009 A deduction is allowed for AGI for qualified tuition and related expenses involving higher education (i.e., postsecondary) –This provision expired at the end of 2007, but has been extended through 2009

47. Taxation of Business Entities C17-47 Deduction for Qualified Tuition and Related Expenses (slide 2 of 3) For 2004 - 2009, the maximum deduction depends on filing status and AGI Filing StatusAGI LimitMax Deduction Single$65,000$4,000 Married$130,000$4,000 Single$65,001 to$2,000 $80,000 * Married$130,001 to$2,000 $160,000 * *No deduction is allowed if AGI exceeds this amount For 2004 - 2009, the maximum deduction depends on filing status and AGI Filing StatusAGI LimitMax Deduction Single$65,000$4,000 Married$130,000$4,000 Single$65,001 to$2,000 $80,000 * Married$130,001 to$2,000 $160,000 * *No deduction is allowed if AGI exceeds this amount

48. Taxation of Business Entities C17-48 Deduction for Qualified Tuition and Related Expenses (slide 3 of 3) Qualified tuition and related expenses include whatever is required for enrollment –Usually, student activity fees, books, room and board are not included Expenses need not be work related Deduction is not available for married persons filing separately Qualified tuition and related expenses include whatever is required for enrollment –Usually, student activity fees, books, room and board are not included Expenses need not be work related Deduction is not available for married persons filing separately

49. Taxation of Business Entities C17-49 Entertainment Expenses (slide 1 of 2) Deductions are very restricted due to abuse possibilities –Amount allowed 50% of meals and entertainment 100% of transportation costs Amounts cannot be lavish or extravagant Deductions are very restricted due to abuse possibilities –Amount allowed 50% of meals and entertainment 100% of transportation costs Amounts cannot be lavish or extravagant

50. Taxation of Business Entities C17-50 Entertainment Expenses (slide 2 of 2) Entertainment expenses are classified as either: –Directly related to business Actual business meeting or discussion occurs during meal or entertainment –Associated with business Meal or entertainment that directly precedes or follows business meeting or discussion Entertainment expenses are classified as either: –Directly related to business Actual business meeting or discussion occurs during meal or entertainment –Associated with business Meal or entertainment that directly precedes or follows business meeting or discussion

51. Taxation of Business Entities C17-51 Restrictions on Entertainment Expenses (slide 1 of 2) Club dues –Generally not deductible Exception: Clubs formed for public service and community volunteerism (e.g., Kiwanis, Rotary) –Business entertainment expenses incurred at club are still deductible (50%) Club dues –Generally not deductible Exception: Clubs formed for public service and community volunteerism (e.g., Kiwanis, Rotary) –Business entertainment expenses incurred at club are still deductible (50%)

52. Taxation of Business Entities C17-52 Restrictions on Entertainment Expenses (slide 2 of 2) Business gifts –Business gifts of tangible personalty with a value of $25 or less per person per year are deductible Incidental costs (e.g., gift-wrapping) are not included in the cost of the gift in applying the limit –If the value is $4 or less (e.g., pen with company name) then not subject to $25 limit Gifts to employers or superiors are not deductible Business gifts –Business gifts of tangible personalty with a value of $25 or less per person per year are deductible Incidental costs (e.g., gift-wrapping) are not included in the cost of the gift in applying the limit –If the value is $4 or less (e.g., pen with company name) then not subject to $25 limit Gifts to employers or superiors are not deductible

53. Taxation of Business Entities C17-53 Office in the Home (slide 1 of 3) Deductibility is very restricted due to abuse possibilities –Office must be used exclusively and on a regular basis as: The principal place of business, or A place of business used by clients, patients, or customers –For employees, office must also be for the convenience of the employer Deductibility is very restricted due to abuse possibilities –Office must be used exclusively and on a regular basis as: The principal place of business, or A place of business used by clients, patients, or customers –For employees, office must also be for the convenience of the employer

54. Taxation of Business Entities C17-54 Office in the Home (slide 2 of 3) What constitutes “principal place of business”? –Home office qualifies as a principal place of business if: Taxpayer conducts admin. and mgmt. activities in the home office, and There is no other fixed location where taxpayer conducts these activities What constitutes “principal place of business”? –Home office qualifies as a principal place of business if: Taxpayer conducts admin. and mgmt. activities in the home office, and There is no other fixed location where taxpayer conducts these activities

55. Taxation of Business Entities C17-55 Office in the Home (slide 3 of 3) Office in the home expenses cannot cause net loss from the business activity –Office in home deduction limited to business gross income in excess of other business expenses (ordering rules apply) –Excess is carried forward (subject to limit) –Form 8829 is used to report office in home expenses Office in the home expenses cannot cause net loss from the business activity –Office in home deduction limited to business gross income in excess of other business expenses (ordering rules apply) –Excess is carried forward (subject to limit) –Form 8829 is used to report office in home expenses

56. Taxation of Business Entities C17-56 Other Employee Expenses A partial list of other employee expenses that are deductible includes: –Special clothing (uniforms) –Union dues –Professional expenses –Job hunting in same profession –Educator expenses (deductible for AGI) Limited to $250 per year for supplies, etc. of elementary and secondary school teachers A partial list of other employee expenses that are deductible includes: –Special clothing (uniforms) –Union dues –Professional expenses –Job hunting in same profession –Educator expenses (deductible for AGI) Limited to $250 per year for supplies, etc. of elementary and secondary school teachers

57. Taxation of Business Entities C17-57 Classification of Employee Expenses (slide 1 of 2) Depends on whether they are reimbursed and, if reimbursed, under what type of plan

58. Taxation of Business Entities C17-58 Classification of Employee Expenses (slide 2 of 2) Employers can have three types of reimbursement plans –Accountable –Nonaccountable –No reimbursement is given Employers can have three types of reimbursement plans –Accountable –Nonaccountable –No reimbursement is given

59. Taxation of Business Entities C17-59 Accountable Plan (slide 1 of 2) Plan must require adequate accounting to the employer for expense reimbursed, and Any excess reimbursements must be returned to the employer Plan must require adequate accounting to the employer for expense reimbursed, and Any excess reimbursements must be returned to the employer

60. Taxation of Business Entities C17-60 Accountable Plan (slide 2 of 2) Adequate accounting is –Submitting a record, with receipts, to the employer, or –Using a per diem allowance that is not more than the Federal per diem rate Employee reports no income and takes no deduction to the extent of the reimbursed expenses Adequate accounting is –Submitting a record, with receipts, to the employer, or –Using a per diem allowance that is not more than the Federal per diem rate Employee reports no income and takes no deduction to the extent of the reimbursed expenses

61. Taxation of Business Entities C17-61 Substantiation for Expenditures (slide 1 of 2) No deduction allowed for an expense if the taxpayer does not have adequate records for the expense –Therefore, taxpayers need to have good records for employee or self-employed expenses In some cases, use of per diem allowance will be deemed substantiation No deduction allowed for an expense if the taxpayer does not have adequate records for the expense –Therefore, taxpayers need to have good records for employee or self-employed expenses In some cases, use of per diem allowance will be deemed substantiation

62. Taxation of Business Entities C17-62 Substantiation for Expenditures (slide 2 of 2) Records should include: –The amount of the expense –The time and place of travel or entertainment (or date of gift) –The business purpose of the expense –The business relationship of the taxpayer to the person entertained (or receiving the gift) Records should include: –The amount of the expense –The time and place of travel or entertainment (or date of gift) –The business purpose of the expense –The business relationship of the taxpayer to the person entertained (or receiving the gift)

63. Taxation of Business Entities C17-63 Nonaccountable Plan Plan that does not require adequate accounting or return of excess reimbursement or both –Reimbursed amounts received under this plan are included in gross income –Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation Plan that does not require adequate accounting or return of excess reimbursement or both –Reimbursed amounts received under this plan are included in gross income –Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation

64. Taxation of Business Entities C17-64 Unreimbursed Employee Expenses Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation –If employee could have received, but did not seek, reimbursement for whatever reason, none of the employment-related expenses are deductible Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation –If employee could have received, but did not seek, reimbursement for whatever reason, none of the employment-related expenses are deductible

65. Taxation of Business Entities C17-65 Individual Retirement Accounts (slide 1 of 8) Contribution ceiling is lesser of $5,000 ($10,000 for spousal IRAs) or 100% of earned income Person age 50 or over by year end may make catch-up contributions –Max contribution limit is increased by $1,000 for 2006 and thereafter Deductible IRA contribution may be reduced if taxpayer is an active participant in another qualified plan To extent individual is ineligible to make deductible contributions, a nondeductible IRA contribution may be made –Income accrues on account tax deferred Contribution ceiling is lesser of $5,000 ($10,000 for spousal IRAs) or 100% of earned income Person age 50 or over by year end may make catch-up contributions –Max contribution limit is increased by $1,000 for 2006 and thereafter Deductible IRA contribution may be reduced if taxpayer is an active participant in another qualified plan To extent individual is ineligible to make deductible contributions, a nondeductible IRA contribution may be made –Income accrues on account tax deferred

66. Taxation of Business Entities C17-66 Individual Retirement Accounts (slide 2 of 8) If taxpayer is covered by a qualified plan, IRA deduction is phased out within the AGI ranges listed below: Phase-out begins Phase-out ends Single & HH $55,000 $65,000 MFJ 89,000 99,000 MFS 0 10,000 If taxpayer is covered by a qualified plan, IRA deduction is phased out within the AGI ranges listed below: Phase-out begins Phase-out ends Single & HH $55,000 $65,000 MFJ 89,000 99,000 MFS 0 10,000

67. Taxation of Business Entities C17-67 Individual Retirement Accounts (slide 3 of 8) Roth IRA –Contributions are nondeductible Maximum allowable annual contribution is the smaller of –$5,000 ($10,000 for spousal IRAs) or –100% of the individual’s compensation for the year –Qualified distributions are tax-free after an initial five year holding period if: Made on or after age 59 ½ Made to beneficiary on or after participant’s death Participant becomes disabled Used to pay for qualified first-time home buyer’s expenses ($10,000 limit) Roth IRA –Contributions are nondeductible Maximum allowable annual contribution is the smaller of –$5,000 ($10,000 for spousal IRAs) or –100% of the individual’s compensation for the year –Qualified distributions are tax-free after an initial five year holding period if: Made on or after age 59 ½ Made to beneficiary on or after participant’s death Participant becomes disabled Used to pay for qualified first-time home buyer’s expenses ($10,000 limit)

68. Taxation of Business Entities C17-68 Individual Retirement Accounts (slide 4 of 8) Roth IRA (cont’d) –Other distributions may be taxable Distributions first treated as nontaxable return of capital to extent of contributions Remaining distribution treated as taxable payout of earnings Roth IRA (cont’d) –Other distributions may be taxable Distributions first treated as nontaxable return of capital to extent of contributions Remaining distribution treated as taxable payout of earnings

69. Taxation of Business Entities C17-69 Individual Retirement Accounts (slide 5 of 8) Roth IRA (cont’d) –Annual contributions are subject to phase out within the adjusted gross income ranges listed below: Phase-out begins Phase-out ends Single $ 105,000 $120,000 MFJ 166,000 176,000 MFS 0 10,000 Roth IRA (cont’d) –Annual contributions are subject to phase out within the adjusted gross income ranges listed below: Phase-out begins Phase-out ends Single $ 105,000 $120,000 MFJ 166,000 176,000 MFS 0 10,000

70. Taxation of Business Entities C17-70 Individual Retirement Accounts (slide 6 of 8) Coverdell Education Savings Account –Distributions to pay for qualified higher education expenses (QHEE) are tax-free Exclusion may be available in year Hope credit or lifetime learning credit is claimed –Maximum annual nondeductible contribution for a beneficiary is $2,000 No contributions allowed after beneficiary reaches 18 years of age No contribution allowed in year contribution made to qualified tuition program for same beneficiary Coverdell Education Savings Account –Distributions to pay for qualified higher education expenses (QHEE) are tax-free Exclusion may be available in year Hope credit or lifetime learning credit is claimed –Maximum annual nondeductible contribution for a beneficiary is $2,000 No contributions allowed after beneficiary reaches 18 years of age No contribution allowed in year contribution made to qualified tuition program for same beneficiary

71. Taxation of Business Entities C17-71 Individual Retirement Accounts (slide 7 of 8) Coverdell Education Savings Account (cont’d) Annual contributions are subject to phase out within the adjusted gross income ranges listed below: Phase-out begins Phase-out ends Single $ 95,000 $110,000 MFJ 190,000 220,000 Coverdell Education Savings Account (cont’d) Annual contributions are subject to phase out within the adjusted gross income ranges listed below: Phase-out begins Phase-out ends Single $ 95,000 $110,000 MFJ 190,000 220,000

72. Taxation of Business Entities C17-72 Individual Retirement Accounts (slide 8 of 8) Coverdell Education Savings Account (cont’d) –Distributions in excess of QHEE are treated, pro rata, as a return of capital and a distribution of earnings The exclusion for the distribution of earnings is calculated as follows : Exclusion = (QHEE/Total Distributions) × Earnings –Qualified higher education expenses (QHHE) include: Tuition, fees, books, supplies and equipment Room and board if enrolled for at least one-half of full- time course load Coverdell Education Savings Account (cont’d) –Distributions in excess of QHEE are treated, pro rata, as a return of capital and a distribution of earnings The exclusion for the distribution of earnings is calculated as follows : Exclusion = (QHEE/Total Distributions) × Earnings –Qualified higher education expenses (QHHE) include: Tuition, fees, books, supplies and equipment Room and board if enrolled for at least one-half of full- time course load

73. Taxation of Business Entities C17-73 Payment Procedures (slide 1 of 2) Self-employment tax –Taxpayers with net self-employment earnings of at least $400 must pay self-employment tax 2009 rates –Social Security: 12.4% of first $106,800 net self- employment income –Medicare: 2.9% of all net self-employment income These rates are twice what an employee pays on wages Self-employment tax –Taxpayers with net self-employment earnings of at least $400 must pay self-employment tax 2009 rates –Social Security: 12.4% of first $106,800 net self- employment income –Medicare: 2.9% of all net self-employment income These rates are twice what an employee pays on wages

74. Taxation of Business Entities C17-74 Payment Procedures (slide 2 of 2) Self-employment tax –Taxpayer receives a deduction from net self- employment income of 7.65% for purposes of calculating the actual self-employment tax –Taxpayer receives a for AGI deduction for 50% of the self-employment tax paid Self-employment tax –Taxpayer receives a deduction from net self- employment income of 7.65% for purposes of calculating the actual self-employment tax –Taxpayer receives a for AGI deduction for 50% of the self-employment tax paid

75. Taxation of Business Entities C17-75 Retirement Plans for Self- Employed Individuals (slide 1 of 2) Keogh (H.R. 10) plans –Retirement plans for self-employed and their employees –Plan rules are similar to corporate provisions –Plan must be established before the end of the tax year, but contributions may be made up to the due date of the return Keogh (H.R. 10) plans –Retirement plans for self-employed and their employees –Plan rules are similar to corporate provisions –Plan must be established before the end of the tax year, but contributions may be made up to the due date of the return

76. Taxation of Business Entities C17-76 Retirement Plans for Self- Employed Individuals (slide 2 of 2) Keogh (H.R. 10) plans (cont’d) –Contribution limitations Defined contribution plan –Lesser of $49,000 (in 2009) or 100% of earned income –Profit sharing plans and stock bonus plan are limited to 25% –Defined benefit plans limit the annual benefit payable to the lesser of $195,000 (in 2009) or 100% of average compensation for 3 highest years Keogh (H.R. 10) plans (cont’d) –Contribution limitations Defined contribution plan –Lesser of $49,000 (in 2009) or 100% of earned income –Profit sharing plans and stock bonus plan are limited to 25% –Defined benefit plans limit the annual benefit payable to the lesser of $195,000 (in 2009) or 100% of average compensation for 3 highest years

77. Taxation of Business Entities C17-77 Hobby Losses (slide 1 of 8) Hobby defined –Activity not entered into for profit Personal pleasure associated with activity Examples: raising horses, fishing boat charter –Often it is difficult to determine if an activity is profit motivated or a hobby Regulations provide nine factors to consider in making this determination Hobby defined –Activity not entered into for profit Personal pleasure associated with activity Examples: raising horses, fishing boat charter –Often it is difficult to determine if an activity is profit motivated or a hobby Regulations provide nine factors to consider in making this determination

78. Taxation of Business Entities C17-78 Hobby Losses (slide 2 of 8) Profit activity –If activity is entered into for profit, taxpayer can deduct expenses for AGI even in excess of income from the activity –At-risk and passive loss rules may apply Profit activity –If activity is entered into for profit, taxpayer can deduct expenses for AGI even in excess of income from the activity –At-risk and passive loss rules may apply

79. Taxation of Business Entities C17-79 Hobby Losses (slide 3 of 8) Presumptive rule of § 183 –If activity shows profit 3 out of 5 years (2 out of 7 years for horses), it is presumed that taxpayer has profit motive Rebuttable presumption, shifts burden of proof to IRS –Otherwise, taxpayer has burden to prove profit motive Presumptive rule of § 183 –If activity shows profit 3 out of 5 years (2 out of 7 years for horses), it is presumed that taxpayer has profit motive Rebuttable presumption, shifts burden of proof to IRS –Otherwise, taxpayer has burden to prove profit motive

80. Taxation of Business Entities C17-80 Hobby Losses (slide 4 of 8) No, profit 3 of 5 years1,2002009 Yes, profit only 2 of 5 years(500)2008 No, profit 3 of 5 years9002007 Yes(1,000)2006 Yes7002005 Yes(1,500)2004 Yes$5002003 Hobby?Income (loss)Year

81. Taxation of Business Entities C17-81 Hobby Losses (slide 5 of 8) Hobby activity –Can only deduct expenses to extent of income from activity (i.e., cannot deduct hobby losses) Hobby activity –Can only deduct expenses to extent of income from activity (i.e., cannot deduct hobby losses)

82. Taxation of Business Entities C17-82 Hobby Losses (slide 6 of 8) If an activity is a hobby: –Expenses are deductible from AGI Treated as miscellaneous itemized deductions subject to the 2% of AGI limitation Exception: expenses that are deductible without regard to profit motive, such as –Mortgage interest –Property taxes If an activity is a hobby: –Expenses are deductible from AGI Treated as miscellaneous itemized deductions subject to the 2% of AGI limitation Exception: expenses that are deductible without regard to profit motive, such as –Mortgage interest –Property taxes

83. Taxation of Business Entities C17-83 Hobby Losses (slide 7 of 8) Order in which hobby expenses are deductible: –First: Those otherwise deductible: e.g., home mortgage interest and property taxes –Then: Expenses that do not affect adjusted basis: e.g., maintenance, utilities –Then: Expenses that affect adjusted basis: e.g., Depreciation (or cost recovery) Order in which hobby expenses are deductible: –First: Those otherwise deductible: e.g., home mortgage interest and property taxes –Then: Expenses that do not affect adjusted basis: e.g., maintenance, utilities –Then: Expenses that affect adjusted basis: e.g., Depreciation (or cost recovery)

84. Taxation of Business Entities C17-84 Hobby Losses (slide 8 of 8) Example of hobby expenses: Taxpayer sells horses raised as a hobby for $15,500 15,500Total Ltd. to 50031,000Depreciation 4,0002 Feed 2,0002 Vet Bills 3,0001 Taxes $ 6,00016,000Interest $15,500Income AmountOrderAmount

85. Taxation of Business Entities C17-85 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta