6 Self-Employment Flashcards
1
Q
What is self-employment income?
A
Income generally earned by a sole proprietor or independent contractor from a trade or business, reported on 1040 schedule C.
2
Q
How is gross income calculated for a business that sells products or commodities?
A
Gross sales receipts - cost of goods sold + other gross income (ex. rentals) = gross income from the business
3
Q
How do you calculate cost of goods sold?
A
beginning inventory + inventory-related purchases during the year + costs to produce inventory (labor, depreciation, material, and supplies) - year-end inventory = COGS
4
Q
What expenses are allowed deductions from gross income?
A
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.
5
Q
What is a trade or business?
A
A regular and continuous activity that is entered into with the expectation of making a profit.
6
Q
What is “regular”?
A
Regular means the taxpayer devotes a substantial amount of business time to the activity.
7
Q
What is an activity that is not engaged in for a profit?
A
a hobby (personal)
8
Q
When is an activity presumed not to be a hobby?
A
If it results in a profit in any 3 of 5 consecutive tax years (2 of 7 for the breeding and racing of horses).
9
Q
How are hobby related income and expenses treated?
A
Expenses related to a hobby are not deductible, but any income is included in gross income.
10
Q
What to qualities must an expense have to be deductible?
A
It must be both ordinary and necessary. Implicit in the “ordinary and necessary” requirement is that the expenditures be reasonable.
11
Q
What is “ordinary”?
A
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.
12
Q
What is “necessary”?
A
Necessary implies that an expenditure must be appropriate and helpful in developing or maintaining the trade or business.
13
Q
What is considered compensation?
A
Cash and the FMV of property paid to an employee as reasonable compensation are deductible by the employer.
14
Q
How are advance rental payments deducted by a lessee?
A
They may be deduced by the lessee only during the tax periods to which the payments apply.
15
Q
How should cash-method taxpayers treat prepaid rent expense?
A
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).
16
Q
What are business meals?
A
Business meals include food and beverages provided to a business associate. The cost of meals include any sales tax, delivery fees, or tips.
17
Q
Who is considered a business associate?
A
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.
18
Q
When are meals not deductible?
A
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.
19
Q
What meals are 100% deductible?
A
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.
20
Q
What businesses are not considered restaurants?
A
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.
21
Q
What percentage of meals not provided by a restaurant deductible?
A
50%, related expenses such as taxes, tips, and parking fees are also included.
22
Q
How is transportation to and from a business meal treated?
A
it is not limited and is 100% deductible.
23
Q
What is the limit for meals that do not have substantiating evidence?
A
The IRS denies deductions for any meal expense over $75 for which the claimant did not provide substantiating evidence.
24
Q
What are travel expenses?
A
Travel expenses include transportation, lodging, and meal expenses in an employment-related context.
25
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.
26
Is travel for commuting between home and work deductible?
NO
27
Is travel for attending investment meetings deductible?
NO
28
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
29
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.
30
What are the two rules for allowing lodging when not traveling away from home?
1. 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.
2. 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.
31
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.
32
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.
33
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.
34
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.
35
Are taxes paid or accrued in a trade or business deductible?
Yes
36
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.
37
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.
38
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.
39
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.
40
Are federal income taxes deductible?
No
41
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.
42
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.
43
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).
44
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.
45
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.
46
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.
47
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.
48
Are worthless corporate securities considered bad debts?
No, they are generally treated as a capital loss.
49
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.
50
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.
51
What are examples of costs of obtaining a loan?
recording fees and mortgage commissions
52
When is interest on a loan deductible?
Interest is deductible when paid, as are payments in lieu of interest, for cash-basis taxpayers.
53
How are prepayment penalties on loans treated?
They are treated as interest and are deductible when paid.
54
How are points on a loan treated?
They are treated as interest, they must be amortized over the period of the loan. However, ordinary points on acquisition indebtedness of a principal residence may be treated as currently deductible loan costs. Points paid on refinancing must be amortized.
55
How is prepaid interest treated?
Prepaid interest in any form must be amortized over the period of the loan. Any undeducted balance is deductible in full when the loan is paid off.
56
Are expenditures for business gifts deductible?
Yes, they must be ordinary and necessary.
57
What is the deduction limit for gifts?
$25 per recipient per year for excludable items. The $25 limit does not apply to incidental (ex. advertising) items costing (the giver) $4 each or less, and other promotional materials, including signs and displays. A husband and wife are treated as one taxpayer, even if they file separate returns and have independent business relationships with the recipient. Any item that might be considered either a gift or entertainment generally will be considered entertainment and, therefore, not deductible.
58
What is an employee achievement award?
Tangible personal property awarded as part of a meaningful presentation for safety achievement or length of service. Tangible personal property does not include cash, cash equivalents, gift cards/coupons/certificates, vacations, meals, lodging, event tickets, stocks, bonds, and other securities.
59
What is the deduction limit for employee achievement awards?
Up to $400 of the cost of the employee achievement awards is deductible by an employer for all nonqualified plan awards. Deduction of qualified plan awards is limited to $1,600 per year.
60
What is a qualified plan award?
An employee achievement award provided under an established written program that does not discriminate in favor of highly compensated employees. If the average of all employee achievement awards is greater than $400, then it is not a qualified plan award.
61
What are startup-costs?
Costs incurred to prepare to enter into the trade or business, to secure suppliers and customers, and to obtain certain supplies and equipment (noncapital)
62
How much can taxpayers deduct for start-up costs?
UP to $5,000 in the taxable year in which the business begins.
63
What are organizational costs?
Examples of organizational costs are legal and accounting fees to draft a corporate charter, costs of state filings, and expenses of meetings with directors, shareholders, or partners.
64
How much can taxpayers deduct for organizational costs?
Up to $5,000 in the taxable year in which the business begins.
65
When does a taxpayer incur deductible start-up and organizational costs?
All deductible expenses occur prior to the start or purchase of the business.
66
How does a taxpayer treat start-up or organizational costs in excess of $5,000?
They are capitalized and amortized proportionally over a 180-month period beginning with the month in which the active trade or business begins.
67
What is total of start-up or organizational costs deducted for the first year?
The total equals the sum of the $5,000 limit and the amortized amount allocated to the first year. These amounts are reduced, but not below zero, by the cumulative cost of the start-up costs or organizational costs that exceed $50,000
68
Are interest and taxes on vacant land deductible?
Yes
69
Are medical reimbursement plans deductible?
The cost of such a plan for employees is deductible by the employer
70
How are intangibles treated?
The cost of intangibles must generally be capitalized, amortization is allowed if the intangible has a determinable useful life or was acquired as part of an acquisition of another business. `
71
Is an expenditure related to producing tax-exempt income deductible?
No, ex - interest on a loan used to purchase tax-exempt bonds.
72
When might a trade or business expenditure that is ordinary, necessary, and reasonable be nondeductible in regards to public policy?
If allowing the deduction would frustrate public policy the expenditure may be nondeductible
73
What are examples of expenditures that would frustrate public policy?
- fines and penalties paid to the government for violation of the law
- illegal bribes and kickbacks
- two-thirds of damages for violation of federal antitrust law
- expenses of dealers in illegal drugs (as determined at the federal level) - however, adjustment to gross receipts is permitted for the cost of merchandise
74
Are miscellaneous ordinary and necessary business expenses deductible?
Yes
75
What are examples of miscellaneous expenses?
- costs of advertising
- bank fees
- depreciation
- amortization
- office supplies, etc.
76
What are capital expenditures?
Capital expenditures are made in acquiring or improving property that will have a useful life of longer than 1 year.
77
When is the capital expenditure recovered if the property is not a depreciable asset?
At the time of disposition
78
What schedule do individuals use to report rental property activity?
Schedule E
79
How is rental property depreciation treated?
The rental property expenditures may be deducted by depreciation.
80
Is Sec. 179 (bonus depreciation) allowed for rental property?
No, with the exception to include a deduction for qualified improvement property.
81
Are there special rules that limit deductions on the rental of a residence or a vacation home?
Yes
82
What is minimum rental use for the rental of a residence or vacation home?
The property must be rented for more than 14 days during the year for deductions to be allowable.
83
What is minimum personal use for a residence or vacation home?
The vacation-home rules apply when the taxpayer uses the residence for personal purposes for greater of (a) more than 14 days or (b) more than 10% of the number of days for which the residence is rented.
84
What happens if a residence or vacation home is rented for less than 15 days?
The rental income does not need to be reported and any corresponding rental expenses cannot be deducted.
85
What happens if the residence or vacation home property passes the minimum rental-use test but fails the minimum personal-use test?
The property is considered a vacation home, and rental deductions may not exceed the gross income derived from rental activities. Expenses must b allocated between personal use and the rental use based on the number of days of use of each.
86
When a residence or vacation home property is considered a vacation home, and deductions are limited to gross income, what are the order of deductions?
1. the allocable portion of expenses deductible regardless of rental income (ex. mortgage interest and property taxes0
2. deductions that do not affect basis (ex. ordinary repairs and maintenance)
3. deductions that affect basis (depreciation)
87
What happens is the residence or vacation home property passes both the minimum rental-use test and the minimum personal-use test?
all deductions may be taken and a loss may occur, subject to the passive loss limits.
88
What is the Federal Insurance Contributions Act (FICA)?
It establishes Social Security and Medicare Tax, assessed on both employees and employers, employers are required to deposit to the IRS this payroll tax based on the employee's pay.
89
What are the amounts of FICA tax paid by employers?
Social Security - 6.2% of the first $147,000 of wages
Medicare Tax - 1.45% of all wages - there is no cap on this tax
90
What are the amounts an employer must withhold from and employee's wages for FICA?
Tier 1 - From 0 to $147k employee's wages x 7.65% (6.2% SS + 1.45% Medicare)
Tier 2 - Above $147k to $200k employee's wages x 1.45 (medicare)
Tier 3 - Above $200k of earned income, employee's wages x 2.35% (1.45% Medicare +.9% additional Medicare)
91
What is the additional Medicare tax?
The Additional Medicare Tax on earned income is a .9% tax on wages and net self-employment income in excess of a threshold. The additional tax applies to earned income exceeding $200k for single, head-of-household, or surviving spouse; $250k for married filing jointly; and $125k for married filing separately. Employers withhold an additional .9% for income beyond $200k regardless of filing status
92
What happens when there is an overwithholding of FICA tax?
For example, an overwithholding as a result of an employee having multiple employers, the overwithholding is alleviated as a credit against the employee's income tax.
93
How are FICA contributions deductible for employees and employers?
FICA contributions are not deductible for the employee, but contributions made by the employer are deductible by the employer.
94
How does FICA apply to employers of household employees?
An employer must pay FICA taxes for all household employees who are paid more than $2,400 during tax year 2022.
95
What is net investment income tax (NIIT)?
All investment income in excess of deductions allowable for such income and income from passive activities are subject to a 3.8% net investment income tax. This tax essentially applies FICA taxes to income that previously was not subject to the taxes. This tax does not apply to nonresident aliens.
96
How is net investment income tax applied?
The tax is imposed on the lesser of an individual's net investment income or any excess of modified adjusted gross income (MAGI) for the tax year over a specified threshold.
97
What are the thresholds for net investment income tax?
married filing jointly, or surviving spouse - $250k
single, or head of household - $200k
married filing separately - $125k
98
What is modified adjusted gross income (MAGI)?
The sum of AGI and excludable foreign-earned income/housing costs after any deductions, exclusions, or credits applicable to the foreign-earned income.
99
How are self-employment taxes paid?
Through estimated payments, not withholding.
100
How does FICA tax apply to self-employment?
The FICA tax liability is imposed on net earnings from self-employment at the employer rate plus the employee rate:
Tier 1 - from $0 to 147k; net earnings from self-employment x 15.3%
Tier 2 - above $147k to $200k; net earnings from self-employment x 2.9%
Tier 3 - above $200k ($250k MFJ, $125k MFS); net earnings from self-employment x 3.8% (2.9% Medicare +.09% Additional Medicare)
101
How do you calculate net earnings from self-employment?
Net income from self-employment - (net income from self-employment x .0765) = net earnings from self-employment
102
What items are not included in net income from self-employment?
- rents
- gain or loss from disposition of business property
- capital gain or loss
- nonbusiness interest
- dividends
- income or expenses related to personal activities
- wages, salaries, or tips received as an employee
- self-employment tax
- self-employment health insurance
103
How does additional Medicare tax apply to self-employment income?
The additional .9% is only imposed on the employee portion of self-employment tax and therefore is not deductible.
104
How would an individual with wages and self-employment net earnings calculate their liabilities for additional Medicare tax?
1. calculate the tax on any wages in excess of the applicable threshold without regard to any withholding
2. reduce the applicable threshold by the amount of Medicare wages received, but not below zero
3. calculate the tax on any self-employment net earnings in excess of the reduced threshold
105
What are federal unemployment taxes (FUTA)?
This tax is imposed on employers. The tax is 6% of the first $7,000 of wages paid to each employee. The employee does not pay any portion of FUTA.
106
Are fringe benefits included in an employee's gross income?
An employee's gross income does not include the cost of any qualified fringe benefit supplied or paid for by the employer.
107
Are employee discounts included in an employee's gross income?
Certain employee discounts on the selling price of qualified property or services of their employer are excluded from gross income. The employee discount may not exceed:
- the gross profit percentage normally earned on merchandise
- 20% of the price offered to customers in the case of qualified services.
108
What are de minimis fringe benefits?
When the value of property or services (not cash) provided to an employee is excludable as a de minimis fringe benefit if the value is so minimal that accounting for it would be unreasonable and impracticable.
109
What are examples of de minimis fringe benefits?
- occasional use of company copy machines
- occasional company parties or picnics
- occasional taxi fare or meal money due to overtime work
- traditional noncash holiday gifts with a small FMV
110
Is the use of an employer-provided car excludable as de minimis fringe benefits?
Use of an employer-provided car more than once a month for commuting and membership to a private country club or athletic facility are never excludable as de minimis fringe benefits.
111
Is an on-premise athletic facility provided by an employer excluded from gross income of employees?
Yes
112
What are qualified transportation fringe benefits?
Up to $280 a month may be excluded for the value of employer-provided transit passes and transportation in an employer-provided "commuter highway vehicle". Additionally, an exclusion of up to $280 per month is available for employer-provided parking. Employees may use both of these exclusions.
113
How much may be excluded by employees for employer-provided educational assistance?
Up to $5,250. Payments made by an employer to an employee or lender between March 27, 2020, and January 1, 2026, on any qualified educational loan incurred by the employee for his or her education may be excluded by the employer from the employee's taxable wages.
114
What items are not excludable educational assistance payments?
- meals
- lodging
- transportation
- tools
- supplies that the employee retains after the course
115
Are proceeds of a life insurance policy for which the employer paid the premiums excluded from the employee's gross income?
Yes, the cost of group term life insurance up to a coverage amount of $50,000 is excluded from the employee's gross income. in addition, the plan cannot discriminate in favor of highly compensated employees. Premiums paid by the employer for excess coverage (over $50k) are included in gross income. The exclusion applies only to coverage of the employee, payments for coverage of an employee's spouse or dependent are included as gross income.
116
Are accident and health plan benefits excluded from an employee's gross income?
Yes, benefits received by an employee under an accident and health plan under which the employer paid the premiums or contributed to an independent fund are excluded from gross income of the employee.
117
Accident and health plan benefits are excludable from gross income if the payments meet one of two criteria, what are the criteria?
- payments are made due to permanent injury or loss of bodily functions
- reimbursement paid to the employee for medical expenses of the employee, spouse, or dependents.
any reimbursement in excess of medical expenses is included in income.
118
Are death benefits included in gross income?
Yes, all death benefits received by the beneficiaries or the estate of an employee from or on behalf of an employer are included in gross income. This is for employer paid death benefits, not to be confused with death benefits of a life insurance plan provided by an employer.
119
When are meals excluded from an employee's gross income?
The value of meals furnished to an employee by or on behalf of the employer is excluded from the employee's gross income if the meals are furnished on the employer's business premises and for the employer's convenience. This exclusion does not cover meal allowances.
120
When is lodging excluded from an employee's gross income?
The value of lodging is excluded from gross income if the lodging is on the employer's premises, is for the convenience of the employer, and must be accepted as a condition of employment.
121
What are the restrictions for recognizing incentive stock options as income?
An employee may not recognize income when an incentive stock option is granted or exercised depending upon certain restrictions.
- the employee recognizes long-term capital gain if the stock is sold 2 years or more after the option was granted and 1 year or more after the option was exercised - the employer is not allowed a deduction
otherwise, the excess of the stock's FMV on the date of exercise over the option price is ordinary income to the employee when the stock is sold. - The employer may deduct this amount, and the gain realized is short-term or long-term capital gain.
122
What are nonqualified stock options?
An employee stock option is not qualified if it does not met numerous technical requirements to be an incentive stock option.
123
How are nonqualified stock options treated in regard to income if the FMV is ascertainable on the grant date?
- the employee has gross income equal to the FMV of the option
- the employer is allowed a deduction
- there are no tax consequences when the option is exercised
- capital gain or loss is reported when the stock is sold
124
How are nonqualified stock options treated in regard to income if the FMV is not ascertainable on the grant date?
- the excess of FMV over the option price is gross income to the employee when the option is exercised
- the employer is allowed a corresponding compensation deduction
- the employee's basis in the stock is the exercise price plus the amount taken into ordinary income
125
What are cafeteria plans?
A cafeteria plan is a benefit plan under which all participants are employees, and each participant has the opportunity to select between cash and nontaxable benefits. If the participant chooses cash, such cash is gross income. If the qualified benefits are chosen, they are excludable to the extent permitted by the internal revenue code.
126
What are the restrictions to including cafeteria plan benefits in an employee's income?
- the employee must choose the benefit before the tax year begins
- any unused benefit is forfeited
- self-employed individuals are not included
- employers may offer participation in the plan to an employee on the employee's first day of employment, but employers must offer participation after the employee completes 3 years of employment
- the plan cannot discriminate in favor of highly compensated employees
127
What must employers file if they provide a cafeteria benefit plan?
Every employer maintaining a cafeteria plan must file an information return, reporting the number of eligible and participating employees, the total cost of the plan for the tax year, and the number of highly compensated employees.
128
What are examples of nontaxable cafeteria plan benefits?
- dependent care assistance
- group term life insurance coverage up to $50,000
- disability benefits
- accident and health benefits
- group legal services
129
What are cafeteria plans unable to offer as a benefit?
- scholarships
- educational assistance
- meals or lodging (for the convenience of the employer)
130
Do deferred compensation plans other than 401(k) plans qualify for exclusion under a cafeteria plan?
NO
131
Are nonemployee beneficiaries (ex. spouses) able to participate in a cafeteria plan?
No, however they might benefit depending on the plan selection
132
What are no additional cost services?
Services provided to the employee, services must be in the employer's lime of business and offered to customers in the ordinary course of business. Employees can exclude the value of no additional cost services provided by their employer from gross income. Ex - an airline allows its employees to fly for free on flights that are not full, ie. no revenue is forgone, the value of the flight is excluded from the employee's gross income.
