6 Self-Employment Flashcards
What is self-employment income?
Income generally earned by a sole proprietor or independent contractor from a trade or business, reported on 1040 schedule C.
How is gross income calculated for a business that sells products or commodities?
Gross sales receipts - cost of goods sold + other gross income (ex. rentals) = gross income from the business
How do you calculate cost of goods sold?
beginning inventory + inventory-related purchases during the year + costs to produce inventory (labor, depreciation, material, and supplies) - year-end inventory = COGS
What expenses are allowed deductions from gross income?
Ordinary and necessary expenses paid or incurred during a tax year in carrying on a trade or business. These deductions apply to sole proprietors as well as other business entities.
What is a trade or business?
A regular and continuous activity that is entered into with the expectation of making a profit.
What is “regular”?
Regular means the taxpayer devotes a substantial amount of business time to the activity.
What is an activity that is not engaged in for a profit?
a hobby (personal)
When is an activity presumed not to be a hobby?
If it results in a profit in any 3 of 5 consecutive tax years (2 of 7 for the breeding and racing of horses).
How are hobby related income and expenses treated?
Expenses related to a hobby are not deductible, but any income is included in gross income.
What to qualities must an expense have to be deductible?
It must be both ordinary and necessary. Implicit in the “ordinary and necessary” requirement is that the expenditures be reasonable.
What is “ordinary”?
Ordinary implies that the expense normally occurs or is likely to occur in connection with businesses similar to the one operated by the taxpayer claiming the deduction. The expenditures need not occur frequently.
What is “necessary”?
Necessary implies that an expenditure must be appropriate and helpful in developing or maintaining the trade or business.
What is considered compensation?
Cash and the FMV of property paid to an employee as reasonable compensation are deductible by the employer.
How are advance rental payments deducted by a lessee?
They may be deduced by the lessee only during the tax periods to which the payments apply.
How should cash-method taxpayers treat prepaid rent expense?
They should amortize prepaid rent expense over the period to which it applies. The exception to this rule is if the rental contract is for 12 months or less and the payments do not extend beyond the end of the next taxable year (ie the 12-month rule).
What are business meals?
Business meals include food and beverages provided to a business associate. The cost of meals include any sales tax, delivery fees, or tips.
Who is considered a business associate?
Business associate is defined as a person with whom the taxpayer could reasonably expect to engage or deal with in the active conduct of the taxpayer’s trade or business, such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional advisor, whether established or prospective.
When are meals not deductible?
If neither the taxpayer nor an employee of the taxpayer is present at the meal and any meal or portion thereof that are lavish or extravagant under the circumstances.
What meals are 100% deductible?
Meals purchased from a restaurant. The term “restaurant” means a business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises.
What businesses are not considered restaurants?
A business that primarily sales prepackaged food or beverages not for immediate consumption, such as a grocery store, specialty food store, beer, wine, or liquor store, drug store, convenience store, newsstand, or vending machine or kiosk.
What percentage of meals not provided by a restaurant deductible?
50%, related expenses such as taxes, tips, and parking fees are also included.
How is transportation to and from a business meal treated?
it is not limited and is 100% deductible.
What is the limit for meals that do not have substantiating evidence?
The IRS denies deductions for any meal expense over $75 for which the claimant did not provide substantiating evidence.
What are travel expenses?
Travel expenses include transportation, lodging, and meal expenses in an employment-related context.
When are travel expenses of a taxpayer’s spouse allowed?
When there is a bona fide business purpose for the spouse’s presence, the spouse is an employee, and the expenses would otherwise be deductible.
Is travel for commuting between home and work deductible?
NO
Is travel for attending investment meetings deductible?
NO
Is travel as a form of education deductible?
NO - ex. a Spanish teacher cannot deduct a trip to Spain to improve his or her Spanish language skills
When are lodging deductions when not traveling away from home allowed?
A rule allows for lodging deductions when not traveling away from home, if qualified under one of two tests of rules.
What are the two rules for allowing lodging when not traveling away from home?
- the deduction is allowed if all the facts and circumstances indicate the lodging is for carrying on a taxpayer’s trade or business. One factor under this test is whether the taxpayer incurs an expense because of a bona fide condition or requirement of employment imposed by the taxpayer’s employer.
- A safe harbor rule applies if:
- the lodging is necessary for the individual to fully participate in, or be available for, bona fide business meeting, conference, training activity, or other business function
- the lodging is for a period that does not exceed 5 calendar days and does not recur more frequently than once per calendar quarter
- the employee’s employer requires the employee to remain at the activity or function overnight (if the individual is an employee)
- the lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.
How are foreign travel expenses determined for deduction?
Traveling expenses of a taxpayer who ventures outside of the U.S. away from home must be allocated between time spent on the trip for business and time spent for pleasure.
When is no allocation required for foreign travel?
- when the trip is for no more than 1 week
- the taxpayer can establish that a personal vacation was not the major consideration
- the taxpayer was outside the U.S. for more than a week and spent less than 25% of the total time on nonbusiness activities.
How are expenses for entertainment treated?
Generally, expenses for entertainment that are ordinary and necessary to the business are no longer deductible. An exception to this disallowance is social events primarily for the benefit of employees (ex. company picnic or holiday party). Any item that might be considered either a gift or entertainment generally will be considered entertainment and, therefore, not deductible.
How are automobile expenses treated?
Actual expenses for automobile use are deductible (service, repairs, gas). Alternatively, the taxpayer may deduct the standard mileage rate (0.585 per mile for Jan-June 2022 and .0625 per mile for July-Dec 2022) plus parking fees, tolls, etc.
Are taxes paid or accrued in a trade or business deductible?
Yes
How are taxes paid or accrued to purchase property treated?
Taxes paid or accrued to purchase property are treated as part of the cost of the property. Sales tax i treated as part of the property’s cost.
How is sales tax on property recovered?
If capitalized, the sales tax may be recoverable as depreciation. If the cost of the property is currently expensed and deductible, so is the tax.
How is property tax treated?
- Tax on real and personal property is an itemized deduction for individuals
- Tax on business property is a business expense
- Tax assessed for local benefit (local improvements) that tend to increase the value of real property are added to the property’s adjusted basis and are not currently deductible as tax expense.
How are state and local taxes imposed on net income of an individual treated for federal income tax?
They are not deductible on schedule C, but they are deductible as a personal, itemized deduction. They are not a business expense of a sole proprietorship.
Are federal income taxes deductible?
No
How may individual taxpayers claim an itemized deduction for state and local taxes?
They may claim an itemized deduction for either general state and local sales taxes, or state income taxes, but not both. The itemized deduction for the sum of all taxes paid (property, income) is limited to $10k, or $5k if MFS.
How is insurance expense treated?
A trade or business insurance expense paid or incurred during the tax year is deductible. A cash-method taxpayer may not deduct a premium before it is paid.
How is prepaid insurance treated?
Prepaid insurance must be apportioned over the period of coverage. However, a cash-method taxpayer can deduct prepaid premiums if the 12-month rule applies (contract is 12 months or less and does not extend beyond the next taxable year).
What is a bad debt?
The loss that occurs when a customer does not pay amounts owed or an investment becomes worthless. Generally, a ad debt is related to a company’s accounts or trades receivables that cannot be collected.
When is a bad debt deduction allowed?
It is allowed only for a bona fide debt arising from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. Worthless debt is deductible only to the extent of adjusted basis in the debt. A cash-basis taxpayer has no basis in accounts receivable and generally has no deduction for bad debts.
What is a business bad debt?
One incurred or acquired in connection with the taxpayer’s trade or business. Partially worthless business debts may be deducted to the extent they are worthless and specifically written off. A business bad debt is treated as an ordinary loss.
What is a nonbusiness bad debt?
A debt other than one incurred or acquired in connection with the taxpayer’s trade or business. Investments are not treated as a trade or business. A partially worthless nonbusiness bad debit is not deductible. A wholly worthless nonbusiness debt is treated as a short-term capital loss.
Are worthless corporate securities considered bad debts?
No, they are generally treated as a capital loss.
How are bad debts accounted for regarding tax purposes?
The specific write-off method must be used for tax purposes. The allowance method is generally ony used for financial accounting purposes.
How are loan costs treated?
Costs of business borrowing are generally deductible. Costs of obtaining a loan, other than interest, are deductible over the period of the loan.
What are examples of costs of obtaining a loan?
recording fees and mortgage commissions
When is interest on a loan deductible?
Interest is deductible when paid, as are payments in lieu of interest, for cash-basis taxpayers.
