1. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 3 Business Expenses & Retirement Plans Income Tax Fundamentals 2008 edition Gerald E. Whittenburg Martha Altus-Buller Student’s copy

2. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Rental Income/Expenses  Net Rental Income/Loss is part of gross income Report on Schedule E - Part I Report on Schedule C if provide service to tenants exceeding customary level  Vacation Homes - if both personal and rental use of residence, must allocate expenses Deductions limited based on period of time residence used for personal vs. rental purposes

3. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Passive Loss Limitations  Rule: When taxpayer is not actively involved in an activity – losses are passive and may not be deducted in excess of passive gains, but Loss can be carried forward and deducted in future years or Can be deducted when investment is sold  Examples of passive activities Limited partnership tax shelters

4. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.  Rental property is specifically designated as passive  However, when taxpayer is actively involved* in the management of rental real estate May take up to $25,000 of rental loss against ordinary income (even though passive) The $25,000 loss capability is reduced by 50¢ for each $1 modified AGI > $100,000 *Actively involved defined as screening tenants, maintaining property, etc. Passive Loss Limitations - Exception

5. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Bad Debts  Bad debts arise when taxpayer sells good/services on credit and accounts receivable later become uncollectible Deduction for bad debts allowed up to amount previously included in income Cash basis taxpayers cannot take bad debts as they never reported original income  Must use specific charge-off method IRS requires proof of worthlessness

6. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Net Operating Losses (NOL)  NOLs are losses resulting from business and casualty items only Since inequities may occur for a taxpayer with an NOL, he/she may carry NOL back 2 years, then forward 20  First, carry it back to the second prior year [and deduct against income from that year] and then to the prior year [or until used in full] File amendments for prior years (1040X) or 1045 (for quick refund)  May make an irrevocable election to forgo carry back, then carries forward But must elect this in year of loss

7. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Types of Individual Retirement Account [IRA]  Traditional IRA Deduction for AGI Distributions in retirement are taxable  Roth IRA No current deduction Distributions in retirement are nontaxable

8. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Contributing/Deducting - IRA  Roth or traditional IRA contribution limited to lesser of: 100% of earned income or $4000  Spouse with no earned income will be able to contribute up to $4,000  For 2007, taxpayers and spouses 50 and over can contribute an additional $1000/year [catch-up provisions]  Contribution limits will increase in 2008 Can make contributions up through April 15, 2008 for 2007

9. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Keogh Plan  Participants must meet minimum age and years of service requirements  Retirement plan geared towards self- employed individuals  Tax free contributions are limited to lesser of 20% of net earned income or $45,000 Net earned income includes business profits if significantly generated from taxpayer’s personal services Must reduce net earned income by ½ self- employment tax for contribution calculation

10. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Simplified Employee Pension [SEP]  Same dollar limits as Keogh plans, but contributions made to SEP-IRA IRA account with higher funding limits  Participants must meet minimum age and years of service requirements  Pay early withdrawal penalty if receive distributions prior to age 59.5  Must start drawing by age 70.5

11. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Qualified Retirement Plan  Contributions by an employer to qualified retirement plans are tax deductible Employee contributions are pre-tax Tax on earnings is deferred  To achieve qualified plan status, an employer- sponsored retirement plan must Be for exclusive benefit of employees Be nondiscriminatory Have certain participation and coverage requirements Comply with minimum vesting requirements Have uniform distribution rules

12. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Limitations on Certain Qualified Plans  §401(k) Employee chooses to defer some compensation into plan  Defer means to forego current compensation with reduction going to qualified retirement plan  Maximum % of wages that may be contributed is 15%  Not to exceed $15,500/year for all salary reduction plans $20,500/year if 50 or older An employer may match to encourage participation, this is excludable from income When distributions occur, contributions/earnings taxable

13. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Roth §401(k)  Beginning in 2006, employer may set up Roth §401(k) Employees may defer same amount as traditional 401(k), but no reduction in current taxable income Withdrawals/earnings generally tax free upon distribution  Expected to be popular with high income taxpayers because no AGI limit and higher contribution than a Roth IRA

14. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Low Income Retirement Plan Contribution Credit  Credit to encourage low-income taxpayer participation in retirement savings Single taxpayers with AGI <= $26,000 MFJ with AGI <= $52,000 HH with AGI <= $39,000  Tax credit for percentage of retirement plan contribution based upon AGI Credit equal to 50%, 20% or 10% of contribution See table on p. 3-21

15. ©2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Savings Incentive Match Plan for Employees (SIMPLE)  Designed for use by employers with less than 100 employees  SIMPLE-IRA Employees can defer up to $10,500 per year into SIMPLE-IRA  $13,000 if 50 or older  Contribution expressed as percentage of income  Employer must either: Match employees’ contributions dollar for dollar up to 3% of gross wages or Contribute 2% of gross wages of all employees who make over $5,000 per year - even if they don’t elect salary deferral  Contributions are fully vested when made; first 2 years early withdrawals are subject to 25% penalty