Self Employed Business- Schedule C

Question 1

Recordkeeping

Answer 1

A taxpayer cannot approximate or estimate deductions, and generally must have documentary evidence, such as receipts, canceled checks, or bills, to support expenses. Documentary evidence should show the amount, date, place, and essential character of the expense. Documentary evidence is not needed if the expense, other than lodging, is less than $75 or for a transportation expense for which a receipt is not readily available.

Question 2

Period of limitations

Answer 2

Owe additional tax and (2), (3), and (4) do not apply 3 years
Do not report income and it is more than 25% of the gross income shown on return 6 years
File a fraudulent return No limit
Do not file a return No limit
File a claim for credit or refund after filing return Later of 3 years or 2 years after tax was paid
File a claim for a loss from worthless securities 7 years

Question 3

Partnership

Answer 3

Pass-through entity. Ordinary business income (loss) and separately stated items on partner’s K-1.

Must have at least 2 partners.
Partners can be individuals, corporations, trusts, estates, or other partnerships.

Question 4

Limited liability company (LLC)

Answer 4

Default tax treatment is disregarded entity (single member) and partnership (multi-member)
Can elect to be treated as a corporation (including S corporation) no more than two months and 15 days after the beginning of the tax year the election is to take effect, or anytime in the preceding tax year.
Cannot change entity type for 60-months (without IRS permission).

Question 5

Qualified joint venture (QJV)

Answer 5

An unincorporated business jointly owned by a married couple
The only members are a married couple who file a joint return
Each spouse is treated as a sole proprietor and claims a share of the income and expenses on Schedule C based on their respective interest in the business, with the combined interest on the two Schedule Cs totaling 100%
The business is co-owned by both spouses and both spouses materially participate in business (mere joint ownership of property is not enough)

Question 6

S corporation

Answer 6

Pass-through entity. Ordinary business income (loss) and separately stated items on shareholder K-1.

100 shareholder limit (no partnership, corporation, or nonresident alien shareholders).
1 class of stock.
S-election made no more than two months and 15 days after the beginning of the tax year the election is to take effect, or in the year prior.

Question 7

C Corporation

Answer 7

C Corporation pays a flat 21% tax at the entity level. Shareholders pay tax on dividends (double taxation) at the individual level.

Closely held if at any time during the last half of the tax year, more than 50% of the value of its outstanding stock is, directly or indirectly, owned by or for five or fewer individuals, including certain trusts and private foundations.
Affiliated group - Parent corporation has at least 80% of the total voting power and the total value of the stock of such corporation.

Question 8

Independent contractor

Answer 8

Self-employed; subject to SE tax
Independent profession offering services to general public
Employer controls only the result of the work, not the means and methods to complete

Question 9

Statutory employee

Answer 9

Subject to social security and Medicare (FICA), and FUTA tax
Not subject to federal income tax (unless backup WH applies)
Examples: commissioned delivery drivers (not milk); full-time life insurance agent for one agency; full-time traveling sales agent (wholesaler/retailer)

Question 10

Statutory nonemployee

Answer 10

Similar to independent contractor, considered self-employed; subject to SE tax. Includes:

Direct sellers/Real estate agents – paid by sales, not by hours worked
Companion sitters – unless employed by agency

Question 11

Common law employees

Answer 11

Anyone performing services for an employer and employer controls how and what will be done. Employer generally has:

Behavioral control – directs the what, where and how
Financial control – directs financial decisions
Employment relationship – benefits, contract, permanency

Question 12

Employing a spouse or parent

Answer 12

Subject to federal income and FICA taxes
Not subject to FUTA tax

Question 13

Child employed by parents

Answer 13

Not subject to FICA if under 18
Not subject to FUTA if under 21
Subject to federal income tax, regardless of age
Business must be a sole proprietor or partnership with both parents as partners

Question 14

Trust fund recovery penalty

Answer 14

A responsible party who willfully fails to properly withhold, account for, deposit or pay employment taxes may be held personally liable for a penalty equal to the full amount of the unpaid trust fund tax, plus interest.

Question 15

Electronic Federal Tax Payment System (EFTPS)

Answer 15

System for making electronic transfers to pay federal tax deposits (employment, excise, corporate income tax)
The penalty for failure to use EFTPS when required is 10% of the amount not deposited using EFTPS.
Monthly deposit schedule if tax liability is $50,000 or less.
Semi-weekly deposit schedule if tax liability is more than $50,000

Question 16

Federal Insurance Contributions Act (FICA)

Answer 16

FICA consists of social security tax (6.2%), and Medicare tax (1.45%) tax

7.65% withheld from employee wages; 7.65% paid in by employer

Wages above $200,000 are subject to 0.9% additional Medicare tax (withheld from employee)

Question 17

Federal Unemployment Tax Act (FUTA)

Answer 17

FUTA is a federal tax to fund unemployment compensation
The employer must pay FUTA if it pays $1,500 or more in wages in any quarter, or employs one or more employees in any 20 or more weeks during the year
Report federal unemployment tax on Form 940
SUTA is the state equivalent and also reported and paid by employer

Question 18

Self-Employed Contributions Act (SECA)

Answer 18

SECA covers the social security and Medicare tax owed by self-employed individuals
Must pay 15.3% SE tax and file Schedule SE if net earnings from self-employment is $400 or more or church employee income is $108.28 or more

Question 18

1099-NEC - Nonemployee Compensation

Answer 18

Report nonemployee compensation of $600 or more made to other persons, vendors, subcontractors, and independent contractors in the course of a trade or business.
Generally, payments to a corporation (including a limited liability company (LLC) that is treated as a C or S corporation) are excluded from the reporting requirement.
Must report payments for legal services (even if paid to a corporation).
Personal payments are not reportable.
Due date to IRS and recipient January 31.

Question 19

Regular gambling withholding

Answer 19

24% gambling withholding applies when winnings exceed $5,000 for sweepstakes, wagering pools (includes poker), and lotteries.
Withholding does not apply unless winnings are at least $600 and 300 times the amount wagered for other transactions, like blackjack or similar table games.

Question 20

Backup withholding

Answer 20

TIN not provided
TIN incorrect
Notified payee underreporting or certification failure

Question 21

Information return due dates

Answer 21

Due date for filing most 1099 information returns to IRS is by Feb 28 or Mar 31 if filed electronically (exception 1099-NEC due by Jan 31)
Due date to provide a copy to recipient for most 1099 information returns is by Jan 31 (exception 1099-B due by Feb 15)
W-2 due to Social Security Administration and recipient by Jan 31

Question 22

1099-MISC

Answer 22

Report payments of $600 or more to each person for rents, prizes and awards, other income payments, medical and health care payments, crop insurance proceeds, 409(A) deferrals, gross proceeds paid to attorneys, fishing boat proceeds, etc.
$10 or more in royalties or broker payments in lieu of dividends, tax-exempt interest
Backup withholding is 24% if correct taxpayer identification number not provided
Generally, must provide to the recipient by Jan 31 and to the IRS by Feb 28 (March 31 if filed electronically)
No longer used to report nonemployee compensation. Use 1099-NEC for that purpose

Question 23

Gross receipts test

Answer 23

A taxpayer meets the gross receipts test, if the average annual gross receipts for the three-taxable-year period ending with the prior taxable year do not exceed the threshold amount. This threshold amount adjusts annually for inflation and is $27 million for 2022. When a taxpayer meets the gross receipts test, the “small business taxpayer” exception applies which allows taxpayers to use the cash method and exempts taxpayers from the requirement to capitalize inventory and certain expenses.

Question 24

Constructive receipt

Answer 24

Constructive receipt occurs when an amount is credited to an account or made available to the taxpayer without restriction. Possession is not a requirement. If an agent of the taxpayer receives income, the taxpayer is considered to receive it when the agent receives it. The taxpayer does not constructively receive income if control of its receipt is subject to substantial restrictions or limitations.

Question 25

All events test (accrual)

Answer 25

Record income when all events occur that fix the right to receive the income, which is the earliest of the date when:

The required performance takes place
Payment is due
Payment is received and the amount can be determined with reasonable accuracy
Deduct expenses when all events that determine the liability have occurred.
The amount of the liability can be figured with reasonable accuracy.
The economic performance takes place with respect to the expense.

Question 26

Cash method of accounting

Answer 26

Includes in gross income all items of income actually or constructively received during the tax year and generally deducts expenses in the tax year actually paid.

Cannot use cash method:

Corporation (not S corp or qualified PSC) when it does not meet gross receipts test
Partnership with a corporation (other than S corp) as a partner, and when partnership does not meet gross receipts test
Tax shelter
Meet gross receipts test if average annual gross receipts for 3-taxable-year period do not exceed $27 million (2022).

Question 26

12-month rule

Answer 26

A cash basis taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of:

Twelve months after the right or benefit begins, or
The end of the tax year following the tax year in which payment occurred

Question 27

Fiscal year

Answer 27

A fiscal year is 12 consecutive months ending on the last day of any month except December 31
A trust generally cannot use a fiscal year.

Question 28

Accounting for inventory

Answer 28

In order for a business to account for inventory, the business must use the accrual method of accounting for purchases and sales. To figure taxable income, inventory must be valued at the beginning and end of each tax year.

When a taxpayer meets the gross receipts test they are not required to account for inventories but rather may use a method of accounting that either treats inventories as non-incidental materials and supplies or conforms to the taxpayer’s financial accounting treatment of inventories. Meets gross receipts test if average annual gross receipts for the 3-taxable-year period ending with the prior taxable year do not exceed $27 million (2022).

Question 29

Entertainment

Answer 29

Taxpayers may no longer deduct entertainment expenses, even if directly related to the active conduct of a trade or business. EXCEPTION: Expenses for recreational, social or similar activities primarily for the benefit of all employees (not just highly compensated) remain deductible (holiday parties, company picnics, etc.)

Question 30

Deductible business meals

Answer 30

Deduct 50% of the cost of business meals that meet the following criteria:

Ordinary and necessary business meals (not lavish or extravagant)
Taxpayer (or employee) must be present
Provided to a current or potential customer, client, or similar business contact
If provided in connection with entertainment the meals must be purchased or stated separately on the receipt

Question 31

Travel expenses

Answer 31

A taxpayer may deduct business-related travel expenses incurred while away from a tax home (location of main workplace, not personal residence) for periods requiring rest that last substantially longer than an ordinary days work.

Question 32

Business bad debts

Answer 32

Debt becomes totally worthless when there is no longer a chance the debtor will pay
Taxpayer does not have to wait until a debt is due before it is determined to be totally worthless
A deduction may be claimed only if the amount owed was previously included in gross income
Must include amounts later collected (up to the previous bad debt deduction that reduced tax) in gross income

Question 33

Self-employed health insurance deduction

Answer 33

Premiums for medical, dental, and long-term care for taxpayer, spouse, and dependents are deductible if the taxpayer is:

A self-employed individual with a net profit (Schedule C or F)
A partner with net earnings (Schedule K-1 (Form 1065))
A more than 2% S corp shareholder with wages (Form W-2)
Plans must be established under the business but the policy may be in name of the business or individual. Report premiums as guaranteed payments (partners)/wages (S shareholders) and reimburse any premiums paid by partner/shareholder.

Question 33

Business casualty and theft loss

Answer 33

Must be business or income-producing property.
Loss = adjusted basis – combined salvage value, insurance, or other reimbursements. FMV is not considered.
Not subject to the same limitations as loss on personal-use property.
If federally declared disaster may deduct in current or preceding tax year.

Question 34

Capitalized interest

Answer 34

Interest on debt to produce real property or certain tangible personal property is added to the basis of the property and deducted ratably over the life of the loan. For this purpose, tangible personal property includes:

property with a class life of 20 years or more
property with an estimated production period of more than 2 years (1 year if estimated cost of production exceeds $1 million)
A limitation on the deduction for business interest may apply. The limitation does not apply if average annual gross receipts for the 3-taxable-year period ending with the prior taxable year do not exceed $27 million (2022).

Question 35

Deductible interest

Answer 35

Interest paid or accrued on business related debt is deductible as a business expense if all 3 requirements are met:

Taxpayer is legally liable for debt
Both parties intend the debt to be repaid
Debtor-creditor relationship exists

Question 36

Gift expenses

Answer 36

Cannot deduct business gifts made in excess of $25 to a person during the tax year.
Gifts to a customer’s family members are considered a gift to the customer (unless there is a bona fide business connection with the family member).
The $25 cap may not be avoided by spouses giving separate gifts.
Incidental costs (engraving, wrapping, mailing) are not included in the total gift cost.
Promotional materials (less than $4) are not considered gifts subject to the limitation.

Question 37

Rental expenses

Answer 37

Deduct rent paid for the use of property in the taxpayer’s business in the year paid or accrued. Rent not deductible:

If the taxpayer will receive equity in the property
If the rent is unreasonable (related party)
In the current year if paid more than 12 months in advance (12-month rule)

Question 38

Organizational costs

Answer 38

Includes costs to create a corporation or partnership such as:

Legal fees
State incorporation fees
Costs for organizational meetings or temporary directors
Does not include costs for issuing stock, securities or interests, or costs associated with asset transfer. These nondeductible costs are added to basis and not amortized.

Question 39

Start-up costs

Answer 39

Includes costs in connection with creating or investigating the creation or acquisition of a business:

Market surveys
Ads for business opening
Wages for training (employees and trainers)
Travel to secure vendors or customers
Salaries for executives and consultants

Question 40

Deducting start-up and organizational costs

Answer 40

Amortize business start-up and organizational costs over 180 months beginning with the initial month of operation.
May elect to deduct up to $5,000 of start-up costs and $5,000 of organizational costs in year the business begins. Reduce by costs that exceed $50,000 in each category. Costs not deducted may be amortized.
Costs a cash-basis taxpayer cannot deduct because payment is not made by the end of the year, can be deducted in the year of payment.

Question 41

Achievement award – tangible personal property

Answer 41

An employee achievement award must be tangible personal property which does not include cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements to receive tangible personal property), or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

Question 42

Achievement award – types

Answer 42

Length of service – no earlier than the 5th anniversary; no more frequently than every 5 years
Safety achievement – managers, clerical and professional employees excluded; no more than 10% of employees may be awarded per year

Question 43

Achievement award – income exclusion

Answer 43

Can exclude up to $1,600 annually per employee ($400 for nonqualified awards)
Award must be tangible personal property (not cash or cash equivalents).
Given for length of service or safety achievements; cannot be disguised pay

Question 44

Section 125 cafeteria plan

Answer 44

Employees choose between certain qualified benefits on a pre-tax basis (not wages and not subject to employment taxes or withholding) and cash or other taxable benefits. Examples of qualified benefits include:

Accident and health benefit plans
Adoption assistance
Dependent care assistance
Group term life insurance
Health savings accounts

Question 45

Meals excluded from wages

Answer 45

De minimis meals such as doughnuts, coffee, employee picnics, etc.
Meals on business premises (for employer’s convenience) are excluded from employee’s wages and 50% deductible by the employer.

Question 46

Nonaccountable plan

Answer 46

Payments to an employee for travel and other necessary expenses of the business under a nonaccountable plan are treated as supplemental wages and subject to the withholding and payment of FICA, FUTA, and income taxes.

No substantiation of expenses required
Return of payments in excess of expense not required
Advances made whether expenses are expected to be incurred or not
Payment could otherwise be treated as wages

Question 47

Accountable plan

Answer 47

Amounts paid to reimburse employees for out of pocket business expenses under an accountable plan are not wages and are not subject to the withholding and payment of FICA, FUTA, and income taxes.

Must be a business expense paid while performing services as an employee
Must be substantiated in a reasonable period of time
Unsubstantiated amounts must be returned to employer
Fixed allowances like per diem and standard mileage are tax-free reimbursements when they do not exceed federal rates.

Question 48

Covered employee compensation limit

Answer 48

Deductible compensation for a covered employee of a publicly held corporation may not exceed $1 million per year.

Principal Executive Officer (PEO)
Principal Financial Officer (PFO)
3 highest compensated officers for the taxable year

Question 49

General business credit

Answer 49

Reported on Form 3800
Not refundable (can only be subtracted from tax liability)
Cannot reduce tax liability below the tentative minimum tax or 25% of the regular tax in excess of $25,000, whichever is greater
Carryback unused credit to 1 prior year or carryforward up to 20 years

Question 50

At-risk

Answer 50

A taxpayer is not at risk for amounts such as the following:

Nonrecourse loans that are not secured by the taxpayer’s own property.
Cash, property, or borrowed amounts used in the activity that are protected against loss by a guarantee, stop-loss agreement, or other similar arrangements (excluding casualty insurance and insurance against tort liability).
Amounts borrowed for use in the activity from a person (or relative of that person) that has an interest in the activity, other than as a creditor.

Question 51

Not-for-profit activity

Answer 51

Certain taxpayers cannot use a loss from a not-for-profit activity to offset other income.
Limit applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.
Presumption of profit motive if the activity produces profit in at least 3 of the last 5 tax years including the current year (2 of the last 7 if primarily breeding, training, showing or racing horses).

Question 52

Rental real estate professional exception

Answer 52

A loss from rental real estate may offset ordinary income if:

More than 750 hours of material participation in real property trade or business makes up more than half of the taxpayer’s work, or
Rental losses are not more than $25,000 and taxpayer or spouse actively participates. Subject to phase-out of 50% of amount above $100,000.

Question 53

Passive activity

Answer 53

Passive loss offsets income from other passive activities.
Generally, unable to deduct a loss from a passive activity. Carry forward any excess passive activity loss (PAL) to the next tax year.
There are two types:
Business activities and taxpayer does not materially participate.
Rental activities, even with material participation, unless taxpayer is real estate professional.

Question 54

Material participation

Answer 54

Participation is material if meeting any of the following tests:

More than 500 hours of participation in the activity.
More than 100 hours and at least as much as any other participant.
Taxpayer provides substantially all of the participation in the activity.

Question 55

Nonrecourse liabilities of partnership

Answer 55

No partner bears the economic risk of loss (e.g., secured by asset).
Increase partner’s basis for distributions, but not at-risk rules.
EXCEPTION – Qualified nonrecourse financing can increase at-risk basis.

Question 56

Recourse liabilities of partnership

Answer 56

Any partner bears the economic risk of loss.
Increase partner’s basis for distributions and at-risk rules.

Question 57

S corporation and partnership loss limitations

Answer 57

There are four potential limitations on S corporation and partnership losses. These limitations (in the order in which they apply) include:

Outside basis (can carry forward indefinitely)
Amount at-risk (includes recourse liability)
Passive activity losses that exceed passive activity income
Excess business loss