REG - Business Income & Deductions Flashcards
(41 cards)
What is Gross Income for a business?
Sales less cost of goods sold plus other income.
How is cost of goods sold computed for a business?
- inventory is valued at the lower of (1) cost or (2) market (LCM).
- specific identification, FIFO, and LIFO are allowed.
- if LIFO is used for taxes, it must also be used for book income
- LCM cannot be used with LIFO
What types of expenses are deductible by a business?
All ordinary (customary and not a capital expenditure) and necessary (appropriate and helpful) expenses incurred in a trade or business are deductible.
- business expenses that violate public policy (e.g., fines or illegal kickbacks) are not deductible
- no deduction or credit allowed for any amount paid or incurred that consists of trafficking in controlled substances.
- business expenses must be reasonable
(1) excessive salaries may be disallowed to the extent unreasonable
(2) reasonableness of compensation generally arises only when employer - EE relationship exceeds that of a normal employer - EE (e.g., EE is also a shareholder)
(3) use test of what a different enterprise would pay to unrelated EE
Is local telephone service deductible?
For individual TP’s, any charge for basic local telephone service with respect to the first telephone line to any residence of the TP is treated as nondeductible personal expense.
-disallowance doesn’t apply to charges for long-distance calls, equipment rental, and optional services provided by a telephone co., or attributable to additional telephone lines to a TP’s residence other than the first line.
What are uniform capitalization rules (UNICAP)?
Rules that generally require all costs incurred (direct & indirect) in manufacturing or constructing real or personal property, or in purchasing or holding property for sale, to be capitalized as part of the cost of the property.
What are the rules for application of UNICAP?
1) costs become part of the basis of the property and are recovered through depreciation or amortization, or are included in inventory and recovered through cost of goods sold as an offset to selling price.
2) rules apply to inventory, property other than inventory produced or held for sale to customers, and to assets or improvements to assets constructed by a TP for the TP’s own use in a trade or business or in an activity engaged in for profit.
3) TPs subject to the rules are required to capitalize not only direct costs, but also most indirect costs that benefit the assets produced or acquired for resale, including general, admin, and overhead costs.
4) retailers and wholesalers must include in inventory all costs incident to purchasing and storing inventory such as wages of employees responsible for purchasing inventory, handling, processing, repacking and assembly of goods, and off-site storage costs. Rules do not apply to “small retailers and wholesalers”.
5) interest must be capitalized if the debt is incurred or continued to finance the construction or production of real property, property with a recovery period of twenty years, property that takes more than 2 years to produce, or property with a production period exceeding one year and a cost exceeding $1 million.
6) UNICAP rules do not apply to advertising, selling, and research and experimentation expenditures, mine development and exploration costs, property held for personal use, and to freelance authors, photographers, and artists whose personal efforts create the product.
Are business meals, entertainment, and travel expenses deductible?
1) receipts must be kept for all lodging expenses and for other expenses of $75 or more except transportation expenditures where receipts are not readily available.
2) adequate contemporaneous records must be kept for business meals and entertainment to substantiate the amount of expense (the 4 W’s: who, when, where, and why)
3) business meals and entertainment must be directly related or associated with the active conduct of a trade or business to be deductible.
4) amount of the otherwise allowable deduction for food, beverage, and entertainment costs is reduced by 50% after determining the amount otherwise deductible.
5) cost of a ticket to any entertainment activity is limited (prior to the 50% rule) to its face value.
6) no deduction is generally allowed for expenses with respect to an entertainment, recreational, or amusement facility (e.g., yachts, fishing camps, etc.)
7) no deduction is allowed for dues paid to country clubs, golf clubs, athletic clubs, airline or hotel clubs, etc.). Dues paid to professional organizations, business leagues, trade assc., etc. are deductible.
8) transportation and travel expenses are deductible if incurred in the active conduct of a trade or business
- includes local transportation between 2 job locations
- includes those incurred while temporarily “away from tax home” overnight (meals, lodging, transport, expenses incidental to travel)
- actual automobile expenses can be deducted, or standard mileage rate of $0.575 per mile (2015) plus parking and tolls.
- no deduction for travel as a form of education, or for attending a convention, seminar, etc.
What is the business gift limitation?
Limited to $25 per recipient per year.
- advertising or promo gifts costing $4 or less are not limited
- gifts of tangible personal property costing $400 or less are deductible if awarded as an employee achievement award for length of service or safety achievement
- gifts of tangible personal property costing $1,600 or less are deductible if awarded as an employee achievement award under a qualified plan for length of service or safety achievement as long as the plan is written and nondiscriminatory, and the average cost of all awards under the plan during the year doesn’t exceed $400.
When are bad debts excluded from income of a business?
In the year they become worthless.
- must have been a valid “debtor-creditor” relationship
- business bad debt is one incurred in the trade or business of the lender. (a) deductible against ordinary income - toward AGI, (b) deduction allowed for partial worthlessness
- business bad debts must be deducted under the specific charge-off method (cannot use the reserve method) (a)deduction allowed when a specific debt becomes partially or totally worthless, (b)bad debt deduction is available for accounts or notes receivable only if the amount owed has already been included in gross income for the current or a prior taxable year.
- a nonbusiness bad debt (not incurred in trade or business) can only be deducted (a) if totally worthless, and (b) as a short-term capital loss.
- guarantor of debt who has to pay takes same deduction as if the loss were from a direct loan (business if related to trade, business or employment; otherwise nonbusiness)
Can a cash method TP deduct receivables that become uncollectible (i.e., worthless)?
No, since the cash method TP has not yet included the receivables in GI, no deduction is allowed.
How is a “hobby” (activity not engaged in for profit) treated for deduction of expenses?
- special rules generally limit the deduction of hobby expenses to the amount of hobby gross income. No net less can be deducted.
- hobby expenses are deductible as itemized deductions in the following order:
1) first deduct taxes, interest, and casualty losses due to the hobby
2) then deduct other hobby expenses to the extent they do not exceed hobby GI reduced by the amounts in #1. - out of pocket expenses are deducted before depreciation.
- hobby expenses are aggregated with other misc itemized deductions that are subject to the 2% of AGI floor (subtract 2% of AGI from the total of misc itemized deductions and remaining is deductible).
3) activity is presumed to be for profit (not a hobby) if it produces a net profit in at least 3 out of 5 consecutive years (2 of 7 for horses)
Are life insurance premiums deductible (in whole or in part)?
No deduction is allowed for expenditures that produce tax-exempt income. If TP is beneficiary of the proceeds from the policy then no deduction is allowed because the proceeds will be excluded from GI when insured party dies.
What is a net operating loss and how is it treated?
A NOL is usually treated as a business loss but may occur even if TP is not in a separate trade or business (e.g., created by a personal casualty loss).
-NOL must be carried back 2 years and forward 20 years to offset taxable income in those years (election to only carryforward is allowed).
For purposes of NOL determination, what is a small business?
Any trade or business (including one conducted by a corporation, p-ship, or sole proprietorship) with average annual gross receipts of $5million or less for the 3-year tax period preceding the loss year is considered a small business for NOL determination.
Are NOL carryforwards or carrybacks from a different year included in the NOL computation?
No, any carryforward or carryback from another year is not allowed in computing NOL.
Can the standard deduction be used in computing the NOL for a TP?
Yes, but treated as a nonbusiness deduction and therefore subject to the amount of nonbusiness income (i.e., only nonbusiness deductions to the extent of nonbusiness income can be used for NOL computation).
Are exemptions allowed to be included in a NOL?
No, personal and dependency exemptions are disallowed in a NOL.
How are casualty losses treated for computing a NOL?
Casualty losses (even if personal) are considered business deductions.
Over what period is a NOL allowed to be offset against TI?
NOL may be carried back 2 years and forward 20 years to offset taxable income in those years.
1) carryback first made to 2nd preceding year
2) TP may elect not to carry back and only carry forward 20 yrs.
3) 3-year carryback is permitted for the portion of the NOL that relates to casualty and theft losses of individual TPs, and to NOLs attributable to presidentially declared disasters and are incurred by TPs engaged in farming or by a small business.
Are capital losses allowed in a NOL?
Yes, but the excess of capital losses over capital gains is not allowed for an NOL. (i.e., capital losses only to the extent of capital gains)
-Also the excess of nonbusiness capital losses over nonbusiness capital gains is disallowed even if overall gains exceed losses.
Can nonbusiness deductions be included in a NOL?
To the extent of nonbusiness income, nonbusiness deductions may be included in a NOL. (i.e., excess of nonbusiness deductions over nonbusiness income is not allowed).
-nonbusiness deductions are usually itemized deductions.
Are contributions to a self-employed retirement plan allowed in a NOL?
Contributions to a self-employed retirement plan are considered nonbusiness deductions (i.e., part of total nonbusiness deductions that are subject to the amount of nonbusiness income).
Are dividends or interest included in a NOL?
Dividends and interest are considered nonbusiness income (i.e., used to determine the amount of nonbusiness deductions allowed to be included in NOL calculation).
Are salary or rent considered business or nonbusiness income?
Salary and rent are considered business income.
