Business Expenses Flashcards
Payments made to employees are normally currently deductible as business expenses EXCEPT
A. Wages paid to employees for constructing a new building to be used in the business.
B. Vacation pay paid to an employee even when the employee chooses not to take a vacation.
C. Reasonable salaries paid to employee-shareholders for services rendered.
D. Payments made to the beneficiary of a deceased employee that are reasonable in relation to the employee’s past services.
Wages paid to employees for constructing a new building to be used in the business.
Normally, Sec. 162(a)(1) allows a deduction for a reasonable allowance for salaries or other compensation for personal services actually rendered. However, Sec. 263A requires all direct costs and a proper share of indirect costs allocable to property produced by the taxpayer to be capitalized. Wages paid to employees for constructing a new building would be direct costs allocable to that building. Those costs are capitalized and depreciated as part of the cost of the building rather than currently deductible.
During the current year, Mr. Y, a cash-basis sole proprietor, paid the following:
Base wages to his four employees
$100,000
Year-end bonuses paid to two employees
for establishing new sales records
$20,000
Christmas gifts to his four employees in
appreciation for past services ($50 per gift)
$200
What is the total amount Mr. Y can deduct on his current-year income tax return?
A. $120,100
B. $120,000
C. $120,200
D. $100,000
$120,200
Section 162(a)(1) permits a deduction for a reasonable allowance for salaries or other personal services actually rendered, including bonuses. In addition, Sec. 274(b) limits the deduction for gifts up to $25 per recipient per year. However, this section applies only to gifts excludable under Sec. 102. Section 102(c) explicitly disallows an exclusion from income for employee gifts. Thus, the entire $200 of employee gifts is deductible. Generally, such amounts are taxable to the employee, although they may be tax-exempt as a de minimis fringe benefit or a qualified employee achievement award. Mr. Y may deduct $120,200 on his current-year return ($100,000 base wages + $20,000 bonuses + $200 gifts to employees).
Which of the following statements regarding deductible taxes is correct?
- Local benefit taxes for business assets are deductible only if they are for maintenance, repair, or interest charges related to those benefits.
- Real estate taxes on business property included in monthly mortgage payments placed in escrow cannot be deducted unless the lender actually paid the taxing authority.
- Taxes on gasoline, diesel fuel, and other motor fuels that you use in your business should be deducted as part of the cost of the fuel.
- Any tax imposed by a state or local government on personal property used in your trade or business is deductible.
A. 2 and 4.
B. 1 and 3.
C. 1, 2, 3, and 4.
D. 1, 2, and 4.
1, 2, 3, and 4.
Local benefit taxes for businesses are deductible if the local benefit does not increase the value of the property. When real estate taxes are paid into an escrow account with the monthly mortgage payment, the taxes cannot be deducted until the escrow funds are withdrawn and paid to the taxing authority. Taxes on gasoline, diesel fuel, and other motor fuels are expensed. The rule is if the cost of the property is currently expensed and deductible, so is the tax. Any tax by state or local government on personal property in a trade or business is deductible.
Ellie operates a restaurant business, and Joyce works as a waitress only Monday through Friday from 7 a.m. to 4 p.m. Ellie provides Joyce with a free breakfast and lunch each day, including Saturday and Sunday. Ellie values the breakfast at $5 a day and lunch at $7 a day. How much should Ellie add to Joyce’s weekly paycheck for meals that she ate?
A. $0
B. $60
C. $24
D. $84
$24
The meals that Ellie provides Joyce are non-taxable fringe benefits provided to Joyce. Therefore, the meals may be deductible by Ellie and not included in Joyce’s gross income if the meals are provided while Joyce is at work. However, the meals provided on Saturday and Sunday do not qualify as fringe benefits and must be included in gross income. The $24 ($5 breakfast + $7 lunch for 2 days) is included in Joyce’s weekly gross income.
Jack Roston operates a small manufacturing business as a sole proprietorship. His business, Roston Rubber, manufactures industrial rubber seals and also makes rubber bands used in packaging. He uses the accrual method of accounting. He incurred the following expenses during 2020. What was his cost of goods sold? (Disregard uniform capitalization rules for this computation.) Beginning inventory, raw materials $14,000 Beginning inventory, work in process $20,000 Beginning inventory, finished goods $100,000 Ending inventory, raw materials $15,000 Ending inventory, work in process $12,000 Ending inventory, finished goods $110,000 Purchases $2,000,000 Salaries, factory $200,000 Salaries, sales $50,000 Chemicals used in manufacturing process $10,000 Office supplies $5,000 Freight-in on raw material purchases $3,000
A. $2,207,000
B. $2,210,000
C. $2,268,000
D. $2,265,000
$2,210,000
Cost of goods sold is computed by starting with the beginning inventory, adding the cost of materials purchased during the year and the cost of production, and subtracting the ending inventory. Under Sec. 263A, manufacturers are required to use the full absorption method of costing, which means that both direct and indirect production costs must be included. Freight charges are always added to the cost of the goods purchased. Costs to ship to the purchaser are selling expenses, not costs of inventory. Beginning inventory (raw materials, WIP, and finished goods) $134,000
Materials and labor: Labor $200,000 Chemicals $10,000 Freight-in on raw materials $3,000 Purchases $2,000,000
$2,213,000
Goods available for sale
$2,347,000
Less: Ending inventory (raw materials, WIP, and finished goods)
$(137,000)
Cost of goods sold
$2,210,000
All of the following statements about fringe benefits for 2020 are true EXCEPT
A. An employer cannot use the vehicle cents-per-mile rule to figure the value of an employee’s use of an automobile first made available to the employee for personal use in 2020, if the fair market value of the automobile is more than $50,400.
B. Employee wages do not include the value of any property or service that has so little value that accounting for it would be unreasonable or administratively impracticable.
C. An employer can treat all meals furnished to employees on their premises as furnished for the employer’s convenience if half of these employees are furnished the meals for a substantial nonpay business reason.
D. An employer can exclude qualified transportation fringe benefits from an employee’s wages even if they are provided in place of pay.
An employer can treat all meals furnished to employees on their premises as furnished for the employer’s convenience if half of these employees are furnished the meals for a substantial nonpay business reason.
More than one-half of all meals furnished to employees on an employer’s premises must be furnished for a substantial nonpay business reason.
Which of the following expenses is deductible as compensation?
A. Payment for an employee to take classes required for the job.
B. Lump-sum payments for sick pay that are compensated by insurance.
C. Wages paid to employees for constructing a new building to be used in the business.
D. A loan or an advance for services actually performed when repayment is not expected.
A loan or an advance for services actually performed when repayment is not expected.
A deduction as wages is allowed for certain loans and advances to an employee, even if it is doubtful that the loan will be repaid. The loan is deductible only if it is for personal services actually performed. Otherwise, it is treated as a loan and cannot be deducted.
During the year, Mr. Jones had the following expenditures relating to commercial real estate that he owns: County property tax $1,850 State property tax $920 Assessment for sewer construction $1,200 Charges for sewer and water service $810 What is the amount Mr. Jones can deduct as real estate taxes on his commercial real estate for the year?
A. $4,780
B. $2,770
C. $3,970
D. $1,850
$2,770
Section 164 allows state and local property taxes as a deduction. There are certain restrictions to the deduction under Sec. 164(b)(1). The tax must be an ad valorem tax and imposed on an annual basis. The state and county property taxes meet the restrictions. The assessment for the sewage construction is not imposed on an annual basis; thus, it is not deductible. The water and sewer charges are not ad valorem; thus, they are not deductible. However, if these taxes are for local benefit and they increase the value of the property, they may be added to the property’s basis.
Which of the following statements describes an incorrect treatment of employee benefit programs?
A. A cafeteria plan that discriminates in favor of certain employees as to eligibility to participate in the plan results in the employees being taxed on the sum of the value of all of the benefits offered by the plan.
B. The cost of group term life insurance coverage, up to $50,000, is excluded from income.
C. A qualified benefit can be excluded from income because of specific provisions of law.
D. An employer provides qualifying dependent care assistance to his or her employees. The employer can exclude from the employees’ wages up to $5,000 in assistance for each employee.
A cafeteria plan that discriminates in favor of certain employees as to eligibility to participate in the plan results in the employees being taxed on the sum of the value of all of the benefits offered by the plan.
Section 125 defines a cafeteria plan as a written plan under which all participants are employees and the participants may choose among benefits consisting of cash and qualified benefits. If a cafeteria plan discriminates in favor of certain employees as to eligibility to participate in the plan, the favored employees are taxed on the taxable benefits they could have received under the plan.
Allyn transferred office equipment used in his business to Wilson, an employee, as payment for services. At the time of the transfer, the equipment had a fair market value of $4,000 and an adjusted basis to Allyn of $4,750. How should Allyn report this transfer on his income tax return?
A. Wage expense $0; loss on sale $4,750.
B. Wage expense $4,000; loss on sale $750.
C. Wage expense $4,750; loss on sale $0.
D. Wage expense $4,000; loss on sale $0.
Wage expense $4,000; loss on sale $750.
When property is transferred to an employee as compensation, the employer is entitled to a deduction of its fair market value on the date of the transfer. A gain or loss is realized on the date of the transfer as the difference between the fair market value and adjusted basis. Allyn will deduct $4,000 as wages and recognize a $750 loss on the sale of the equipment ($4,000 – $4,750).
All of the following tests are to be met for an employee’s pay to be deductible as an expense EXCEPT
A. The taxpayer has control over the employee.
B. Payments for services an employee rendered are reasonable. This test is based on the circumstances when the contract for the services is made, not those existing when the amount of pay is questioned.
C. Payments are made for services actually performed.
D. Depending upon the taxpayer’s method of accounting, payments are made or expenses are incurred for services rendered during the year.
The taxpayer has control over the employee.
Section 162(a)(1) allows a deduction for a reasonable allowance of salaries or other compensation for personal services actually rendered. The employer is not required to have legal control over the individual. The degree of control exercised by an employer determines whether the compensated individual is an employee or an independent contractor. Greater control is exercised over the former than the latter.
During the year, Ms. V had the following expenditures relating to her commercial real estate: County property tax $1,100 Assessment for street construction $500 State property tax $600 Assessment for sewage construction $1,200 What is the amount Ms. V can deduct as real estate taxes on her commercial real estate for the year?
A. $2,900
B. $2,800
C. $1,700
D. $3,400
$1,700
Section 164 allows state and local property taxes as a deduction. There are certain restrictions to the deduction under Sec. 164(b)(1). The tax must be an ad valorem tax and imposed on an annual basis. The state and county property taxes meet the restrictions. The assessments for the sewage system and street construction will most likely tend to increase the value of the property. Therefore, the taxes assessed are added to the property’s adjusted basis and are not currently deductible.
Manuel is not subject to the business interest deduction limitation and paid the following amounts in Year 1 for interest:
-$1,000 interest on a loan used to buy a new computer used 80% for business.
-$2,000 interest on a construction loan for his new business location, to be completed in May Year 2.
-$10,000 interest on a second mortgage on his home. The original loan amount was $100,000; $50,000 was used to make improvements to his home, $25,000 was spent on a new truck for the business, and the remainder was invested in tax-exempt bonds.
Compute Manuel’s business interest deduction for Year 1.
A. $5,300
B. $7,800
C. $3,300
D. $5,800
$3,300
The deduction for personal interest under Sec. 163 has been eliminated. The interest on the construction loan should be capitalized and depreciated over the asset’s useful life. Manuel may deduct 80% of the loan used to buy a new computer and 25% of the interest on the second mortgage, for a total of $3,300 [($1,000 × 80%) + ($10,000 × 25%)]; $5,000 of the interest is deductible as an itemized deduction, not as business interest.
Isaac transferred office equipment used in his business to Taylor, an employee, as payment for services. The value of the services provided by Taylor was $3,000. At the time of the transfer, the equipment had a fair market value of $3,500 and an adjusted basis to Isaac of $3,000. How does Isaac report this transfer on his income tax return?
A. Wage expense $3,000; gain on sale $0.
B. Wage expense $3,000; gain on sale $500.
C. Wage expense $0; gain on sale $3,500.
D. Wage expense $3,500; gain on sale $500.
Wage expense $3,500; gain on sale $500.
When property is transferred to an employee as compensation, the employer is entitled to a deduction of its fair market value on the date of the transfer. A gain or loss is realized on the date of the transfer as the difference between the fair market value and adjusted basis. Isaac will deduct $3,500 as wage expense and recognize a $500 gain on sale.
In 2019, Bob purchased a lease for an office for 4 years, beginning January 1, 2020, to use in his tax practice. Of the $21,600 he paid, $5,000 was for the purchase of the existing lease with 4 years remaining and no options to renew. The remaining amount was for monthly lease payments paid in advance. How much can Bob deduct for 2020?
A. $0
B. $3,800
C. $5,400
D. $1,500
$5,400
Assuming that Bob is a cash-basis taxpayer, generally, rental expenses are deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Bob can deduct $5,400 in 2020 ($21,600 prepaid rent ÷ 4 years).
On July 1 of the current year, Mel leased property for 2 years for $700 a month. On September 30 of the current year, the owner of the property told him if he paid the total in advance for the remainder of the lease the rent would be reduced to $675 a month. Mel accepted his offer and on October 1 of the current year, he paid the owner $14,175. How much can Mel deduct as rental expense in the current year?
A. $4,125
B. $2,025
C. $16,300
D. $4,050
$4,125
Prepaid rent may not be deducted by either a cash-basis or an accrual-basis taxpayer. To do so would violate the requirement that the taxpayer’s method of accounting must clearly reflect income [Sec. 446(b)]. Furthermore, an expenditure that creates an asset having a useful life extending substantially beyond the close of the taxable year is not deductible [Reg. 1.461-1(a)]. Only the $4,125 of rental expense allocable to the current year is deductible. The amount that Mel can deduct is calculated as follows: July $700 August $700 September $700 October $675 November $675 December $675 Total rental expense $4,125
On March 1 of the current year, Sharon, a cash-basis sole proprietor, leased a dance studio from Shelby Room Renters for 3 years at $1,200 per month. During the current year, Sharon paid $28,800 on the lease. What is the amount Sharon can deduct on her income tax return for the current year?
A. $12,000
B. $14,400
C. $26,400
D. $28,800
$12,000
Rental expenses are generally deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Sharon will deduct $12,000 of rent expense in the current year (10 months of current year rent × $1,200 rent per month).
For a taxpayer engaged in a trade or business, cash transactions over which dollar amount must be reported to the IRS?
A. $1,000
B. $50,000
C. No reporting requirements exist in this case.
D. $10,000
$10,000
Any taxpayer in a trade or business who receives more than $10,000 cash in a single or several related transactions in a 12-month period must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business. The form must be filed by the 15th day after the cash is received.
Ray owns a delivery truck and delivers bread to retailers locally for the Gorman Bakery. He owns his delivery route. In 2020, Ray received a W-2 with gross wages of $30,000 in Box 1. Ray’s federal income tax rate is 15%. For the year 2020, Ray is considered what type of employee and had what amount withheld for federal income tax?
Employee Type FIT
A. Common law $4,500
B. Statutory $4,500
C. Common law $0
D. Statutory $0
Statutory $0
Publication 15 states the following for statutory employees: “If someone who works for you is not an employee under the common law rules . . . do not withhold federal income tax from his or her pay. Although the following persons may not be common law employees, they may be considered employees by statute for Social Security, Medicare, and FUTA tax purposes under certain conditions. An agent (or commission) driver who delivers food, beverages (other than milk), laundry, or dry cleaning for someone else.”
Ms. Zickert, a slot machine manufacturer, paid and incurred the following expenses during the current year: Raw materials $75,000 Materials and supplies $8,000 Freight-in on raw materials $5,000 Freight on shipment of finished slot machines $6,000 Direct labor $40,000 Indirect labor $22,000 Allocable overhead expenses for production $28,000 Beginning inventory $40,000 Ending inventory $29,000 What was the amount of Ms. Zickert’s cost of goods sold for the current year?
A. $224,000
B. $189,000
C. $218,000
D. $195,000
$189,000
Cost of goods sold is computed by starting with the beginning inventory, adding the cost of materials purchased during the year and the cost of production, and subtracting the ending inventory. Under Sec. 263A, manufacturers are required to use the full absorption method of costing, which means that both direct and indirect production costs must be included. Freight charges are always added to the cost of the goods purchased. Costs to ship to the purchaser are selling expenses, not costs of inventory.
Beginning inventory
$40,000
Raw materials and labor: Labor $62,000 Raw materials $80,000 Materials and supplies $8,000 Production overhead $28,000
$178,000
Goods available for sale
$218,000
Less: Ending inventory
$(29,000)
Cost of goods sold
$189,000
Bob works on the loading dock for the Loaden Partnership from 7:00 a.m. to 3:00 p.m., Monday - Friday. Susan, the full-time secretary, works a 4-day week. Max, the bookkeeper, is the sole proprietor of the Books-I-Keep Accounting Service and is a licensed accountant. Max works a different schedule each week for Loaden but is very conscientious and reliable. How many of these individuals are considered employees?
A. 3
B. 2
C. 1
D. None.
2
Publication 15 states, “Generally, a worker who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed. . . . [However,] generally, people in business for themselves are not employees. For example, doctors, lawyers, veterinarians, construction contractors, and others in an independent trade in which they offer their services to the public are usually not employees.”
Rory incurs the following amounts related to the rental of a piece of equipment: Legal fees $500 Commission on sale $1,500 Miscellaneous fees $2,000 Yearly rental payment $4,000 Initial lease term 5 years Optional renewal 3 years Assuming that less than 75% of the cost of acquiring the entire lease is attributable to the basic or initial term of the lease, what amount is amortized each year?
A. $250
B. $500
C. $800
D. $700
$500
The costs of acquiring a lease are capitalized and amortized over the life of the lease. Since less than 75% of the cost of acquiring the entire lease is attributable to the basic or initial term of the lease, the term of the lease is treated as including all periods for which the lease may be renewed (Sec. 178). Therefore, $500 is amortized [($500 + $1,500 + $2,000) ÷ (5 years + 3 years)].
Laura, a cash-basis taxpayer, leased a floor of a building for 6 years with an option to renew for an additional 4 years. Laura paid $3,000 to acquire the lease (one-third of which is attributable to the option) and also paid both the first and last years’ rent of $8,000 per year. How much can Laura deduct the first year?
A. $8,300
B. $19,000
C. $8,500
D. $8,000
$8,300
A cash-basis taxpayer normally deducts expenses in the year paid. However, the lease is an asset with a useful life that extends substantially beyond the close of the taxable year, so the cost of it must be capitalized and amortized over the life of the lease [Reg. 1.461-1(a)]. Since less than 75% of the cost of acquiring the entire lease is attributable to the basic or initial term of the lease, the term of the lease is treated as including all periods for which the lease may be renewed (Sec. 178). Also, advance rental payments must be allocated over the period of time for which the premises may be used as a result of such payments. The taxpayer’s allowable deduction for the first year is $8,300 ($3,000 ÷ 10-year useful life + $8,000 current year’s rent).
Carlos leased 200 acres of farmland for use in his farming operations. The lease term was 10 years starting on January 1, 2013. The annual rental was $100,000. Early in the lease, Carlos constructed a $50,000 drying facility on the leased land. As of January 1, 2020, Carlos assigned all his lease rights to Lindsey for the balance of the lease. Lindsey paid Carlos $150,000 on January 1 for the lease term and for the value of the drying facility – $125,000 allocated to the lease term and $25,000 to the drying facility. Additionally, Lindsey paid the $100,000 annual rent payment to the lessor. If the drying facility were depreciated, the deprecation deduction would be $2,000. What is the total amount Lindsey may deduct on her 2020 tax return for the leased 200 acres including depreciation, if any?
A. None of the answers are correct.
B. $152,000
C. $143,667
D. $250,000
$143,667
A cash-basis taxpayer normally deducts expenses in the year paid. However, the lease is an asset with a useful life that extends substantially beyond the close of the taxable year, so the cost of it must be capitalized and amortized over the life of the lease [Reg. 1.461-1(a)]. Because 3 years remain on the lease, the cost of acquiring the lease, $125,000, must be amortized over 3 years, for a total of $41,667 per year. Therefore, Lindsey is allowed a total deduction of $143,667 ($100,000 annual rent + $2,000 depreciation + $41,667 lease payment).
On March 1, Year 1, Fred, a cash-basis sole proprietor, leased a dance studio from Swing Room Renters for 3 years at $1,200 per month. During Year 1, Fred paid $28,000 on the lease, and in Year 2 he paid $6,000. What is the amount Fred can deduct on his income tax return for Year 2?
A. $11,600
B. $14,400
C. $20,400
D. $6,000
$14,400
Rental expenses are generally deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Fred will deduct $14,400 (12 months × $1,200 rent per month) as rent expense in the current year.
Mr. Adams, a sole proprietor, derives his entire income from the operation of his grocery store business. On which schedule of Form 1040 should he deduct the state income taxes imposed on this income?
A. Schedule A.
B. Schedule E.
C. Schedule D.
D. Schedule C.
Schedule A.
Section 164 allows a deduction for state income taxes. Since this is not a deduction allowable in arriving at adjusted gross income as defined in Sec. 62, it is an itemized deduction as defined in Sec. 63(d). Itemized deductions are reported on Schedule A.
Mr. Holiday is a calendar-year, accrual-basis taxpayer. His records concerning vacation pay for his employees reflect the following:
$20,000 paid January 30, 2020, for vacations earned in 2019. Nothing was vested by December 31, 2019.
$100,000 vacation pay accrued and paid in 2020.
$14,000 accrued in 2020 but vested by December 31, 2020; paid by February 28, 2021.
$10,000 accrued but not vested by December 31, 2020.
What amount can Mr. Holiday deduct as a business expense for 2020?
A. $154,000
B. $114,000
C. $124,000
D. $120,000
$120,000
Accrual-basis taxpayers deduct vacation pay when it is paid. Therefore, Mr. Holiday can deduct $120,000 in the current year.
On June 30, 2020, Lily, who uses the accrual method of accounting and is not subject to the business interest deduction 50% limitation, borrowed $25,000 from a bank for use in her business. Lily was to repay the loan in one payment with interest on December 30, 2020. On December 30, 2020, she renewed that loan plus the interest due. The new loan was for $27,000. What is the amount of interest expense that Lily can deduct for 2020?
A. $333
B. $2,000
C. $0
D. $1,000
$2,000
If a taxpayer borrows money from a third party to pay off a loan already outstanding and the interest is otherwise deductible, the individual may deduct the interest portion of the payment. However, if a cash-basis individual borrows money from the same person to whom the already outstanding loan is owed so that the borrower could pay off that first loan, then the borrower cannot deduct the interest until payments begin on the second loan. Since Lily is on the accrual method, she can deduct the interest expense for 2020.
On January 1, 2020, Carrie leased property for her business for 5 years for $6,200 per year. Carrie paid the full $31,000 during the first year of the lease. What is Carrie’s rental deduction for the year 2020?
A. $6,200
B. $15,500
C. $31,000
D. $24,800
$6,200
Rent is any amount paid for property that is not owned. Rent that is not unreasonable is deductible. Prepaid rent and lease payments are deductible only for amounts that apply to the use of rented property during the tax year. The balance can be deducted only over the period to which it applies. Since Carrie’s payment for the first year would be $6,200, that is all she is able to deduct for the current tax year. In the remaining 4 years of the lease, she will be able to deduct the remainder.
On December 1, 2019, Michael, a self-employed cash-basis taxpayer, borrowed $100,000 to use in his business. The loan was to be repaid on November 30, 2020. Michael paid the entire interest of $12,000 on December 1, 2019. What amount of interest was deductible on Michael’s 2020 income tax return?
A. $0
B. $12,000
C. $11,000
D. $1,000
$11,000
Deductions are allowed under the cash method of accounting in the taxable year when paid. However, prepaid interest must be capitalized. Thus, $11,000 [$12,000 interest × (11 months ÷ 12 months)] of interest attributable to the 2020 tax year may be deducted on Michael’s 2020 income tax return and not earlier.
On January 2 of the current year, Melanie paid $9,000 to acquire a lease on a new building for a term of 20 years. At her request, the lease also included two renewal options of 5 years each. Of the $9,000, $6,000 was for the original lease and $1,500 for each of the two renewal options. Melanie is a cash-basis taxpayer. What is her allowable deduction for the current year?
A. $9,000
B. $300
C. $0
D. $450
$300
A cash-basis taxpayer normally deducts expenses in the year paid. However, the lease is an asset with a useful life that extends substantially beyond the close of the taxable year, so the cost of it must be capitalized and amortized over the life of the lease [Reg. 1.461-1(a)]. Since less than 75% of the cost of acquiring the entire lease is attributable to the basic or initial term of the lease ($6,000 ÷ $9,000 = 67%), the term of the lease is treated as including all periods for which the lease may be renewed (Sec. 178). The taxpayer’s allowable deduction in the current year is $300 ($9,000 ÷ 30-year useful life).
Mr. Aspen, a cash basis CPA, pays Gail Smith to work during tax season as a data entry clerk. Mr. Aspen pays Gail the following: Hourly wages $6,275 Bonuses $500 Loan $150 How much can Mr. Aspen deduct as compensation?
A. $6,275
B. None of the answers are correct.
C. $6,925
D. $6,775
$6,775
Section 162(a)(1) permits a deduction for a reasonable allowance for salaries or other personal services actually rendered, including bonuses. The loan is deductible only if it is doubtful the employee will repay. Otherwise, it is treated as a loan and cannot be deducted. Therefore, the wages and bonuses are deductible, but the loan is not.
On June 30, 2020, Sally, who uses the cash method of accounting and is not subject to the business interest deduction limitations, borrowed $25,000 from a bank for use in her business. Sally was to repay the loan in one payment with $2,000 interest on December 30, 2020. On December 30, 2020, she renewed that loan plus the interest due. The new loan was for $27,000. What is the amount of interest expense that Sally can deduct for 2020?
A. $2,000
B. $333
C. $1,000
D. $0
$0
If a taxpayer borrows money from a third party to pay off a loan already outstanding and the interest is otherwise deductible, the individual may deduct the interest portion of the payment. However, if a cash-basis individual borrows money from the same person to whom the already outstanding loan is owed so that the borrower could pay off that first loan, then the borrower cannot deduct the interest of the first loan until payments begin on the second loan. Thus, Sally cannot deduct interest expense for 2020.
During the year, Mr. Brick had the following expenditures relating to commercial real estate that he owns: County property tax $1,600 State property tax $800 Assessment for sewer construction $1,300 Charges for sewer and water service $650 What is the amount Mr. Brick can deduct as real estate taxes on his commercial real estate for the year?
A. $1,600
B. $2,400
C. $4,350
D. $3,200
$2,400
Section 164 allows state and local property taxes as a deduction. There are certain restrictions to the deduction under Sec. 164(b)(1). The tax must be an ad valorem tax and imposed on an annual basis. The state and county property taxes meet the restrictions. The assessment for the sewage construction is not imposed on an annual basis; thus it is not deductible. The water and sewer charges are not ad valorem; thus they are not deductible. However, if these taxes are for local benefit and they increase the value of the property, they may be added to the property’s basis.
