CH. 9 - Business Income & Deductions

Question 1

What is the definition of gross income as it relates to business income?

Answer 1

It is generally the same as for individuals; gross income includes “all income from whatever source derived.”

Question 2

Generally speaking, what makes up gross income for businesses?

Answer 2

Gross profit from inventory sales (ie sales minus COGS), income from services provided to customers, and income from renting property to customers.

Question 3

Gross receipt test

Answer 3

determines if a business qualifies as a “small” business under an annual gross receipts test if its average annual gross receipts for the three prior taxable years does not exceed an indexed threshold set at $27 million for 2022. For purposes of the test, includes total sales (net of returns and allowances but not cost of goods sold), amounts received for services, and income from investments (including tax-exempt interest).

Question 4

A business meets the gross receipts test (for 2022) if the average annual gross revenue receipts for the three prior taxable years does not exceed _______?

Answer 4

27 million

Question 5

True or false: a business expense does not need to in pursuit of profit to be eligible to be deductible.

Answer 5

False; the law requires that a business expense be made in the pursuit of profit rather than the pursuit of other, presumably personal, motives in order to be deductible.

Question 6

Business expenditures must be both _____ and _______ to be deductible.

Answer 6

Ordinary and necessary.

An ordinary expense is one what is normal or appropriate for the business under the circumstances (but does not need to be typical or repetitive in nature).

A necessary expense is an expense that is helpful or conductive to the business activity, but the expenditure need not be essential or indispensable.

Question 7

What are some examples of common ordinary and necessary business expenses?

Answer 7

-advertising
-vehicle expenses
-insurance
-interest expense
-legal fees
-rent
-repairs
-utilities
-wages
etc

Question 8

Ordinary and necessary business expenses are deductible only to the extent they are _________

Answer 8

reasonable in amount.

Question 9

Reasonable in amount

Answer 9

an expenditure is reasonable when the amount paid is neither extravagant nor exorbitant.

Question 10

Arm’s length amount

Answer 10

price in transactions among unrelated taxpayers, where each transacting party negotiates for their own benefit.

Question 11

What are the key facts of limitations on business deductions?

Answer 11

-No business deductions are allowable for expenditures that are against public policy (bribes) or are political contributions.
-Expenditures that benefit a period longer than 12 months generally must be capitalized
-No deductions are allowable for expenditures associated with the production of tax-exempt income
-personal expenditures are not deductible

Question 12

True or false: political contributions made by businesses are deductible.

Answer 12

False; they are not. Lobbying expenses are also not deductible.

Question 13

Businesses must _______ expenditures for __________ assets such as buildings, machinery and equipment, furniture and fixtures, and similar property that has useful lives of more than one year.

Answer 13

Capitalize; tangible

Question 14

Businessee _________ the cost to create or acquire ________ assets such as patents, purchase goodwill, start-up costs, and organizational expenditures. They recover the costs either through _________ or upon disposition of the assets.

Answer 14

capitalize; intangible; amortization

Question 15

True or false: expenditures that generate tax-exempt income are not allowed to offset taxable income

Answer 15

True!

Question 16

Personal expenses

Answer 16

expenses incurred for personal motives. Personal expenses are not deductible for tax purposes.

Question 17

Educational expenses are not deductible as a business expense unless the taxpayer _______________ and the education _____________

Answer 17

self-employed; maintains or improves skills required by the individual in an existing-trade or business.

Question 18

Mixed-motive expenditures

Answer 18

activities that involve a mixture of ­business and personal objectives.

Question 19

What are the key facts of mixed-motive expenditures?

Answer 19

-Special limits are imposed on expenditures that have both personal and business benefits
-Entertainment expenses are generally not deductible
-For 2022, the cost of business meals provided by restaurants is 100% deductible. Other business meals are typically 50% deductible
-Contemporaneous written records of business purpose are required

Question 20

True or false: entertainment expenditures are generally deductible as business expenses.

Answer 20

False; they are not deductible.

Question 21

What are the two exceptions to the ban on deducting entertainment expenses?

Answer 21

1. Expenditures primarily for the benefit of the taxpayers employees
2. Entertainment expenses designed and treated as compensation (for example, deducting all-expenses paid trip to outstanding employee)

Question 22

What requirements must the cost of food and beverages meet to qualify as a deductible business expense?

Answer 22

1. The meal must be ordinary and necessary under the circumstances and the amount must be reasonable
2. The taxpayer or an employee must be present when the meal is furnished, and the meal must be provided to a current or potential client or business contact.
3. If the meal is provided during or at an entertainment activity, the meal most be purchased separately from the entertainment or the cost stated separately on invoices or receipts.

Question 23

Business deductions for food and beverages are generally limited to ________% of the cost

Answer 23

50%

Question 24

True or false:if a taxpayer uses a vehicle for business, the taxpayer can deduct the costs of operating the vehicle plus depreciation on the vehicle’s tax basis

Answer 24

True!

Alternatively, the taxpayer may simply deduct a standard amount for each business mile driven.

Question 25

Travel expenses are only deductible if the taxpayer is __________

Answer 25

away from home overnight while traveling

Question 26

What is included in travel expenses?

Answer 26

expenditures incurred while “away from home ­overnight,” including the cost of transportation, meals, lodging, and ­incidental expenses.

Question 27

What are the rules for deducting travel expenses on domestic mixed-motive trips?

Answer 27

-If the primary purpose of the trip is business, the transportation costs are fully deductible, but meals (50% unless provided by a restaurant), lodging, and incidental expenditures are limited to those incurred during the business portion of the travel.

-If the primary purpose of the trip is personal, the taxpayer may not deduct ANY transportation costs to arrive at the location but may deduct meals (limited to 50% unless provided by a restaurant), lodging, transportation, and incidental expenditures for the business portion of the trip.

Question 28

What are the rules for deducting travel expenses on foreign mixed-motive trips?

Answer 28

-Like domestic travel, if foreign travel is primarily for personal purposes, then only those expenses directly associated with business activities are deductible.

-Unlike domestic travel, when foreign travel is primarily for business purposes, a portion of the round-trip transportation costs is not deductible.

Question 29

If a $1000 computer is used for both business and personal uses, but only 60% is for business, how much of the asset can be deducted as a business expense?

Answer 29

$600 ($1000 x 60%)

Question 30

What is the limitation on the deduction of interest paid or accrued on indebtedness allocable to a trade or business?

Answer 30

The amount of the deduction is limited to the sum of:
1. business interest income
and
2. 30% of the adjusted taxable income of the taxpayer for the taxable year

Question 31

What are the key facts on the business interest limitation?

Answer 31

-THe deduction of business interest expense is limited to business interest income plus 30% of the businesses adjusted taxable income
-The business interest limitation does not apply to businesses qualifying as a small business under the $27 million gross receipts test
-Adjusted taxable income is taxable income allocable to the business computed without interest income and before the depreciation and interest expense deductions
-Disallowed business interest expense can be carried forward indefinitely

Question 32

What is adjusted taxable income?

Answer 32

the amount of revenue less expense before interest expense and after adding back depreciation.

Aka It represents the taxable income allocable to a business activity. This income is defined as taxable income of the taxpayer computed without regard to:
1. any item of income, gain, deduction, or loss that is not properly allocable to a trade or business.
2. Any business interest expense or business interest income
3. The amount of any net operating loss deduction
4. Deductions allowable for depreciation, amortization, or depletion
5. Any deduction for qualified business income under 199A

Question 33

True or false: businesses are generally allowed to deduct losses incurred while selling or disposing of business assets.

Answer 33

True

Question 34

When an asset is destroyed or stolen by a force outside of their control, businesses (can/cannot) deduct the loss.

Answer 34

They can

Question 35

When an asset is completely destroyed (or stolen), the business calculates the loss for tax purposes by ___________

Answer 35

substituting the insurance proceeds, if any, for the amount realized. Aka, the loss is the amount of insurance proceeds minus the adjusted tax basis of the asset.

Question 36

When an asset is partially destroyed by a force outside of their control, the business calculates the loss for tax purposes by ___________

Answer 36

The amount of the loss is the amount of the insurance proceeds minus the lesser of (1) the asset’s adjusted tax basis or (2) the decline in the value of the asset due to the casualty (damage).

Question 37

accounting period

Answer 37

a fixed period in which a business reports income and deductions.

Question 38

Tax year

Answer 38

a fixed period in which a business reports income and ­deductions, generally 12 months.

Question 39

What are the three types of tax years?

Answer 39

1. A calendar year, ending on December 31st
2. A fiscal year, which end on the last day of a month other than December
3. A 52/53-week year. This is a fiscal year that ends on the same day of the week that is the last such day in the month or on the same day of the week nearest the end of the month.

Question 40

Fiscal year

Answer 40

a year that ends on the last day of a month other than ­December.

Question 41

What are the key facts of accounting periods?

Answer 41

-Individuals and proprietorships generally account for income using a calendar-year end.
-Corporations are allowed to choose a fiscal year
-Partnerships and other flow-through entities generally use a tax year consistent with their owners’ tax years.

Question 42

True or false: businesses can choose the type of tax year they would like to use.

Answer 42

False; corporations are allowed to choose their fiscal year, but:
-sole proprietors use a calendar year (since they are reporting business income on their indvidual returns)
-Flow-through entities: Adopt tax years consistent with the owner’s tax year.
-C corporations: generally allowed to select a calendar, fiscal, or 52/53 week year end.

Question 43

True or false: once it has chosen and established a tax year, a business must receive permission from the IRS to change it

Answer 43

True!