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CHAPTER 3 Business Income & Expenses Part I Income Tax Fundamentals 2014 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill 2014 Cengage Learning 1
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Defining Trade or Business & Tests for Deductibility A trade or business is not specifically defined in the Internal Revenue Code, but is generally an activity conducted for a profit For a deduction to generally be considered deductible for a trade/business, it must: o Be ordinary and necessary o Have a legitimate business purpose o Be reasonable, in light of the fees that are generated as a result of the expense 2014 Cengage Learning2
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Self-Employment Tax Taxpayers with net earnings of $400 or more required to pay self-employment tax ◦ File Schedule SE with Form 1040 Tax equals ◦ Social security tax (12.4% on the first $113,700) plus ◦ Medicare tax (2.9% of all net earnings) Taxpayer gets a deduction for AGI equal to half of the self-employment tax 2014 Cengage Learning3
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Transportation Certain transportation expenses for business purposes are deductible by taxpayers Taxpayer doesn’t have to be away from tax home to get transportation deduction ◦ Commuting is never deductible, except if: Traveling between home and work locations outside the metro area where taxpayer has regular place of business Traveling between home and temporary work when taxpayer has regular place of business Travel when taxpayer’s principal place of business is home Plus can deduct additional cost of hauling tools/instruments 2014 Cengage Learning4
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Travel Expenses To deduct, travel expenses must result from a documented business reason - Deductibility dependent on (a) where travel occurred and (b) whether trip is classified as business, pleasure or combination If primarily business trip in U.S. ◦ All travel costs (to/from) are deductible ◦ Travel expenses split between business and personal If primarily business trip outside U.S. ◦ Travel costs (to/from) split between business and personal based on number of days ◦ Other travel costs deductible, if associated with business If primarily pleasure trip (in or outside U.S.) ◦ Travel costs (to/from) are not deductible ◦ Meals, lodging, local transportation and incidental expenses are split between personal and business 2014 Cengage Learning5
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Per Diem Substantiation 3 methods of calculating per diem Regular Federal Rate Method (lodging, meals & incidentals) o A federal rate is specified per day, varying based on the travel location o Per diem amounts for each part of country updated regularly at US General Services Administration (GSA) website High-Low Method (lodging, meals & incidentals) o Easier to use if employees travel extensively o A few high areas are specified by IRS ($242/day) and the rest are low areas ($163/day) o If chose this method, must continue throughout the year Per diem eliminates necessity of keeping copious records Rates are split into meals (only 50% deductible) and lodging 2014 Cengage Learning6
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Per Diem Substantiation Meals and Incidental Expenses (M&IE) Method o Allows a per diem for meals and incidentals, plus actual lodging receipts o Use either high-low M&IE rates ($65 and $52) o If taxpayer doesn’t incur meal expenses when traveling, allowed an incidental expense allowance of $5/day o If taxpayer is self-employed and elects a per diem method, he/she must choose this one Note: sometimes rates revised more often than annually 2014 Cengage Learning7
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Educational Expenses What’s deductible? o Cost of courses, lodging costs, 50% meals/entertainment and travel (if primarily to obtain qualifying education) o Must be paid to meet requirements of taxpayer’s employer/law/regulation or to maintain or improve existing skills o But education must not lead to qualification in a new trade or business 2014 Cengage Learning8
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Bad Debts Bad debts arise when taxpayer sells good/services on credit and accounts receivable later becomes uncollectible ◦ Deduction for bad debts allowed up to amount previously included in income - cash basis taxpayers cannot take bad debts expense as they never reported original income Must use specific charge-off method ◦ IRS requires proof of worthlessness 2014 Cengage Learning 9
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Office in Home (OIH) Deduction for business use of a home is allowed only by exception, including o Home used regularly and exclusively as principal place of business or required for the “convenience of employer” when regular office not provided or o The regular place to manage business or meet with clients/patients or o Office is separate structure and used exclusively for business or o Dwelling unit is used for inventory storage and home is taxpayer’s sole place of business 2014 Cengage Learning10
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Complete Form 8829 – “Expenses for Business Use of Your Home” o If taxpayer is self-employed o Allowable deduction carries from 8829 to bottom of Schedule C o If taken as an employee business expense allowable deduction carries to Schedule A But can only take if necessary for employer convenience and Employer does not provide a regular office 2014 Cengage Learning OIH – Form 8829 11
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