Chapter 9: Business Income, Deductions, and Accounting Methods

(LO-1) Gross Receipts Test: The average annual gross receipts cannot exceed $_________ for the 3-year period preceding the current year

31 million

(LO-1) Gross Receipts Test: What should be done if there are not 3 years of data?

Use the period for which gross receipts are available

(LO-1) True or False: Tax shelters never qualify under the gross receipts test.

True

(LO-1) What generally is considered business gross income?

All income from “whatever source derived”

(LO-1) Examples of Business Gross Income

• Revenue from sales activities and services

• Rent Income

(LO-1) True or False: Excluded income, like municipal bond interest, is included in Business Gross Income

False

(LO-1) Section 162 allows taxpayers to deduct expenses for ________ activities that are __________

Trade or Business, Ordinary and Necessary

(LO-1) Ordinary Expense

An expense that is normal or appropriate for the business

(LO-1) Necessary Expense

An expense that is helpful or conducive to the business activity

(LO-1) Trade or Business Activities

Activities that are profit-motivated

(LO-1) Examples of expenses that Section 162 deems as deductible

• Advertising

• Car and Truck Expenses

• Depreciation

• Employee Compensation and Benefits

• Insurance

• Interest

• Legal Fees

• Office Expenses

• Rent

• Repairs

• Supplies

• Travel

• Utilities

(LO-1) Expenses are deductible to the extent they are ___________

Reasonable (in amount) and not extravagant or exorbitant

(LO-1) Test for Extravagance

Compare amounts of the expense to a market price or an amount charged to unrelated parties

(LO-2) Deductible or Nondeductible: Expenses against public policy (such as fines, penalties, illegal bribes, illegal kickbacks, and illegal service/goods payments)

Nondeductible

(LO-2) Deductible or Nondeductible: Political contributions and most lobbying costs

Nondeductible

(LO-2) True or False: Businesses must capitalize expenditures for tangible assets with a useful life/period of economic benefit of more than 1 year

True

(LO-2) How does tax handle capital assets?

Capitalize then recover the cost (except land) by deducting depreciation expense

(LO-2) How does tax handle intangible assets?

Capitalize then recover the cost through amortization or upon disposition of the asset

(LO-2) Deductible or Nondeductible: Expenses that do not help generate taxable income

Nondeductible

(LO-2) Deductible or Nondeductible: Interest expenses on loans where proceeds are invested in municipal bonds

Nondeductible

(LO-2) Deductible or Nondeductible: Life insurance premiums paid for officers or other key employees where the business is named the beneficiary (compensate business due to a key employee’s death)

Nondeductible

(LO-2) Deductible or Nondeductible: Personal Expenditures

Nondeductible

(LO-2) Deductible or Nondeductible: Personal expenses paid for by small business owners

Nondeductible

(LO-2) Mixed-Motive Expenditures

Expenditures motivated by both personal and business reasons. Deductibility depends on the type of expense.

(LO-2) True or False: Mixed-Motive Expenditures have strict-record keeping requirements.

True

(LO-2) Deductible or Nondeductible: Entertainment, such as night clubs, theaters, country clubs, and sporting events

Nondeductible

(LO-2) What is the exception to entertainment that would make it deductible as a business expense?

If it’s primarily for the benefit of the taxpayer’s employee or when designed as compensation

(LO-2) Deductible or Nondeductible: Meals

Deductible (50%)

(LO-2) What are the conditions for the deductibility of meals?

• Ordinary and necessary business expense

• Reasonable in amount

• Taxpayer or employee is present when meal is furnished/provided

• Meal is provided to current/potential business client/business contact

(LO-2) If a meal is provided during or act an entertainment activity, how can it be deductible?

• Must be purchased separately from the entertainment

• Cost must be stated separately on the invoices or receipts

(LO-2) General deductibility rule for travel and transportation costs

Deduct cost of travel or transportation for business purposes only

(LO-2) What can be included in transportation costs?

The direct cost of transporting the taxpayer to and from business sites (not from home to a regular place of business)

(LO-2) What is the standard mileage rate?

$0.70/mile

(LO-2) When is travel deductible?

When the taxpayer is “away from home” overnight while traveling

(LO-2) What is included in travel expenses?

Lodging, incidentals, and meals

(LO-2) If travel is only for business, all travel costs are _________

Deductible

(LO-2) If the trip is >50% business, how is deductibility with transportation and travel handled?

• Transportation: All deductible

• Travel: All expenses related to the business portion are deductible

(LO-2) If the trip is <50% business, how is deductibility with transportation and travel handled?

• Transportation: All Nondeductible

• Travel: All expenses related to the business portion are deductible

(LO-2) Deductibility Rule for Property Use (when the property is used for both business and personal matters)

Deduct the business use portion

(LO-2) Qualification for the “Home Office” Deduction

The taxpayer must use their home (or a part of it) exclusively and regularly as either:

• The principal place of business for any of the taxpayer’s trade/business

or

• A place to meet with patients/clients in the normal course of business

(LO-2) If one is self-employed, how should the “Home Office” Deduction be handled?

Deducted for AGI, reported on Schedule C

(LO-2) True or False: The “Home Office” Deduction for self-employed individuals is limited to business income prior to the deduction and any excess does not carryforward

True

(LO-2) What are the two methods for calculating the “Home Office” Deduction?

Actual Expense and Simplified

(LO-2) True or False: To calculate the “Home Office” Deduction, taxpayers are assigned a method to use.

False

(LO-2) Actual Expense Method for “Home Office” Deduction: Specs

• Allocate actual expenses between personal and business use of the home

• Direct Expenses: 100% deductible

• Indirect Expenses: (Office Square Footage/Home Square Footage) to get a percentage to apply to indirect expenses

(LO-2) Simplified Method for “Home Office” Deduction: Specs

• Deduction: Home office square footage (maximum of 300 square feet can be considered) x $5/square foot

• Maximum Deduction is $1,500

• No depreciation expense

(LO-2) Who does the Business Interest Expense Limitation NOT apply to?

Any taxpayer that meets the gross receipts test

(LO-2) What is the business interest expense deduction limited to?

Business Interest Income + 0.3(Adjusted Taxable Income)

(LO-2) Formula for Adjusted Taxable Income

Business’ Taxable Income - Interest Income + Interest Expense + Depreciation, Amortization, and Depletion Deductions + Net Operating Loss Deduction and Section 199A Deductions

(LO-2) For losses on dispositions of business property, these business losses are _______ deductible

Often

(LO-2) True or False: Losses on sales of business property to related parties are deductible by the seller.

False

(LO-2) When can a business deduct a casualty loss?

In the year the casualty occurs or in the year the theft of an asset is discovered

(LO-2) If a casualty occurs that completely destroys business property, what is the formula for the casualty loss?

Insurance Proceeds - Adjusted Tax Basis

(LO-2) If a casualty occurs that partially destroys business property, what is the formula for the casualty loss?

Insurance Proceeds - Lesser of Asset’s Tax Basis or Decline in FMV

(LO-3) Annual Period: How long is a full tax year?

12 months

(LO-3) Annual Period: How long is a short tax year?

Less than 12 months

(LO-3) Year-Ends: Calendar Year

December 31

(LO-3) Year-Ends: Fiscal Year Options

• Last day of a month (not December)

• 52/53 week year end (example: always the last Friday of June)

(LO-3) Accounting Period of a Proprietorship

The same as the proprietor’s year-end (prevents a mismatch of income)

(LO-3) Accounting Period of Individuals

Calendar year-end

(LO-3) Accounting Period of “C” Corporations

Choice made on first return; usually consistent with the financial accounting period

(LO-3) Accounting Period of Flow-Through Entities

A “required” tax year—must match the owner(s)’ period