Chapter 7: Business Expenses and Deferred Compensation Flashcards
What expenses go on schedule C?
Expenses connected with a trade or business
What expenses go on schedule E?
Expenses connected with real estate or royalties (rent)
What expenses go on schedule F?
Expenses connected to farm income
Requirements for business expenses to be deductible under tax law
Ordinary
Necessary
Reasonable
Deduction of employee business expenses
Effective 2018 to at least 2025 employee business expenses are not deductible
Definition of an employer- employee relationship
Generally exists when the employer has the right to control and direct the individual who provides the services with regard to end result and the means by which the result is accomplished
Threshold for filing 1099-misc
$600 or more in payments to an individual independent contractor
FICA Tax split
Total 15.3%
OASDI (social security) 12.4% on income up to $142,800 in 2021(employee split 6.2%ea)
Hospital insurance (Medicare) 2.9% on all income (employee split 1.45%ea)
Factors considered to in determining employee vs independent contractor
- behavioral control (amount of instruction and training provided)
- financial control (work costs paid by worker or employer)
- relationship of the parties (what benefits are provided/ contracts adhered to)
Travel expenses paid by an employee
Not deductible (2018-2025)
If reimbursed are excludable from employee’s gross income if paid under an “accountable plan” where employee must account for expenses to employer
Travel expenses
Transportation, meals, lodging and other reasonable and necessary expenses incurred by a taxpayer while “away from home” in pursuit of a trade or business
Transportation expenses
Local transportation expenses when taxpayer is not away from home
deductible for self employed individuals under certain conditions
Qualifications for expenses to count as travel expense
- purpose of the trip must be connected with trade, business, or rental real estate activity
- taxpayer must be away from their tax home overnight (or for long enough to require sleep/rest before returning home)
- must be on a temporary, not indefinite basis
Tax home
The location of a taxpayer’s principal place of business (regardless of where family residence is maintained)
When permanent work location is a significant distance from family home
Transport to work probably not travel if work location is permanent.
Work location = tax home
Indefinite work assignment
Work assignments of more than one year (if one year or less: depends on facts of case)
If assignment is indefinite, individual’s tax home shifts to new location and travel is not deductible
Cost of meals on one-day business trips
Generally not deductible since taxpayer was not away from home overnight
Trips with mixed business and pleasure purpose
If primarily pleasure: only expenses directly related to the business activity are deductible (not proportional)
If primarily business: travel to and from is fully deductable and all other expenses are allocated proportionally
Determining between a primarily business and primarily personal trip
Mostly determined based on time spent on which activities but may still be able to show primary purpose was business
Travel expenses for an accompanying family member
No deductions allowed unless for a bona fide business purposes
Deductions for foreign travel
Disallowed unless it can be shown that a meeting is directly related to the taxpayer’s trade or business and that it was reasonable for the meeting to be held outside the US
Travel expenses for education
Disallowed as a deduction
Limit on in deduction for luxury water travel
limited to 2x the highest per diem amount allowable for a day of domestic travel by employees in the executive branch of the federal gov ($465/day in 2019)
Travel to a convention, seminar, or meeting for investment activities
Disallowed
Limitation on expenses to attend meetings on a US cruise ship
$2,000 max
Deductibility of transportation related to trade or business
For AGI deduction
Not subject to limitations
Deductibility of transportation expenses related to rental real estate and royalty income
For AGI deduction
Not subject to limitations
Deductibility of unreimbursed employee transportation expenses
Not deductible
Deductibility of commuting expenses
Nondeductible personal expenses
Transportation expenses
For local transportation rather than travel
Transportation expenses incurred to go from one work location to another
Deductible for self employed individuals
Limited to milage between job 1 and job 2 even if individual goes home in between
Investment related Transportation expenses
Not deductible after 2017
Options for deduction of automobile expenses
- actual expenses (repairs, gas, oil, depreciation etc) based on percentage of business miles to total miles
Or - standard milage rate
Standard milage rate for 2021
$0.56/mile
Automobile expenses that can be deducted in addition to the standard milage rate
- parking and tolls
- interest on a car loan
- personal taxes on a car
Restrictions on the standard milage rate
- cannot be used for cars for hire for for 5 or more cars in simultaneous use by a taxpayer
Changing from using the standard milage rate to the actual expense method
- basis of car must be reduced by depreciation component of standard rate x miles
- MACRS cannot be used for computing depreciation, only straight line method under alternative depreciation system
When can you not change from the actual costs method to the standard mileage rate
- if car was previous depreciated under MACRS rules, or
- if an election was made under section 179 to expense part or all of the cars cost in the year of acquisition
Deduction of entertainment expenses
Disallowed for 2018-2025
Deduction for business meals
Generally 50% deductible (or 50% excluded)
Business meals provided by restaurants in 2021 and 2022
100% deductible
Substantiation requirements for business meals
- purpose of meal
- who attended the meal
- amount of meal
- date of meal
Requirements for a taxpayer to be able to deduct a business meal expense
- expense is ordinary and necessary expense of business
- expense is not lavish or extravagant in the circumstances
- the taxpayer or employee of the taxpayer is present at meal
- food or beverages are provided to current or potential business customer/client/consultant/business contact
- If meal is during or at an entertainment activity then it may only be deducted if paid for separately or stated separately form the cost of entertainment
Per diem system
A way to simplify the keeping of records regarding travel expenses
Taxpayer only needs to substantiate time, place, and business purposes of the trip and can then use IRS prepared per diem tables
Per diem requirements
- expenses must be reasonably expected to be incurred
- amount of expenses should be in reasonable proximity of actual expenses
M&IE
Meals and incidental expenses
Business gifts
Deductible but subject to an annual ceiling of $25 per donee
- multiple gifts are aggregate for purpose of applying ceiling
- families are treated as a single donee
- promotional materials are not gifts
- employee achievement awards for length of service or safety, under $400 are excluded
- business gifts not subject to 50% reduction
Moving expenses for moves in connection with job or business
NOT deductible for 2018- 2025 except for members of the armed forces on active duty moving pursuant to military order and incident to a permanent change of station
Expect to return for employees & self employed in 2026
Education expenses necessary in the pursuit of a trade or business
Deductible
(Vs generally education expenses considered non-deductible personal expense)
Education tax credits
American opportunity tax credit
Lifetime learning credit
Phase out for education tax credit
Modified AGI over $80,000 (single) or $160,000 (MFJ)
Phased out complete at $90,000 (single) or $180,000 (MFJ)
Educational assistance plan for employees
Amounts received for tuition/other people expenses are exludable from employee’s gross income
Qualified state tuition plan withdrawals
529 plans
Withdrawals excluded from gross income if used for educational expenses
Requirements for education expenses to be deductible
(for an employee or self employed individual)
- expense incurred to maintain or improve skills required for trade or business
- expense incurred too meet requirements imposed by law for retention of business, rank, compensation rate
Ineligible if conditions above are met but:
- education is required to meet minimum education requirements for trade or business
- education qualifies taxpayer for a NEW trade or business
2018-2025 ONLY available as a deduction for the self employed
Office in home expense deduction availability
From 2018-2025 only available to the self employed
Requirements for taking the Office in home expense deduction
- self-employed individuals
- office exclusively used under any of the following conditions:
– principal place of business for any trade or business of the taxpayer
– place for meeting or dealing with patients, client or customers in the normal course of business
– office in home is ina separate structure, not attached to the dwelling unit, used exclusively and regularly for business
Principal place of business
- most important or significant place of business
- where primary business services are performed
When does an office in home qualify as a principal place of business
- the office is used by the taxpayer for administrative or management of the taxpayer’s trade or business, AND
- there is no other fixed location of the trade or business where the taxpayer conducts substantial administrative or management activities of the trade or business
Categories of expenses for home office deductions
- expenses directly related to the office
- expenses indirectly related to the office (pro-rata share of expenses that benefit the entire house, generally based on square footage)
Order of home office expense deductions
- all non-office expenses must be deducted first
- then 100% of direct home office expenses and pro-rata share of indirect
BUT total home office expenses cannot create a business loss
Issues with depreciating a home office
Makes the home office business property
Meaning that if home is sold the sale price attributable to the business property is NOT eligible for the sale or principal residence exclusion
Home business office expenses excluded based on gross income limitation
Can be carried forward, but remain subject to gross income limitation and are subject to specific ordering rules (mortgage and real estate taxes 1st, the other deductions, then depreciation)
Safe harbor deduction for home office expenses
$5 x square feet of qualified use (up to a 300 sq ft max)
Maximum total deduction under safe harbor $1500†
Can be elected every year (subject to allowability of home office deduction)
Qualified pension and profit sharing plans
Deferred compensation plans that must meet strict requirements (including not discriminating in favor of highly paid employees, operating strictly for the benefit of employees) to be qualified for certain tax benefits