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CHAPTER 4

CHAPTER 4. Self-Employed and Employee Expenses. Objective. Understand the difference between deductions for AGI and deductions from AGI. For versus From Deductions. Deductions for are those taken to arrive at adjusted gross income (AGI) Self-employment expenses

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CHAPTER 4

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  1. CHAPTER 4 Self-Employed and Employee Expenses

  2. Objective Understand the difference between deductions for AGI and deductions from AGI

  3. For versus From Deductions • Deductions for are those taken to arrive at adjusted gross income (AGI) • Self-employment expenses • Trade or business expenses, including some rental or royalty expenses • Deduction from are itemized deductions subtracted from AGI • Generally personal expenses, or • Expenses incurred by employees

  4. Deciding Classification of Business Expenses Are expenses from Self-Employment? Yes No Deduct For AGI Deduct From AGI Schedule C or Schedule F (if farm) Next Slide

  5. Deciding Classification of Business Expenses Are Expenses Reimbursed by employer? Previous Slide No Yes Does firm have accountable plan? If necessary for performance of job then itemize deduction on Schedule A (subject to 2% AGI) Yes No Did employee substantiate & return excess? Reimbursement included in gross wages. Deduction only allowed on Schedule A as miscellaneous itemized subject to 2% AGI No tax effect Yes No

  6. Objective Know the requirements for deducting travel and transportation expenses

  7. Travel Expenses • To be deductible, travel expenses must result from • A business reason (needs to be documented) • Overnight travel away from taxpayer’s tax home (defined as primary place of business) • Meals and entertainment expenses are only 50% deductible

  8. Travel Expenses (continued) • If primarily business trip in US: • Travel costs are deductible • Expenses must be split between business and personal reason • If primarily business trip outside US: • Travel expenses are allocated between personal and business (based on number of days) • Meals & entertainment (only 50% deductible) must be before or after a business discussion and luxury items are not deductible • If primarily pleasure trip (in or outside US): • Travel costs are not deductible • Other costs directly related to business are deductible

  9. Travel Expenses (continued) • Employees under nonaccountable plan must track actual expenses • Employees under accountable plan may either track actual expenses or use per diem method • (3 methods of calculating per diem) • Federal rate method (dependent on area) has a standard base rate of $85/day • IRS publishes per diem rates for each geographical area in US • Can access current rates at www.irs.gov • High-low method (a few “high” areas ($204/day) and the rest are low areas $125/day) • Easier to use if employees travel extensively • If employer uses high-low to reimburse employee, must continue throughout the year

  10. Travel Expenses (continued) • Meals and Incidental Expenses (M&IE) Method • Allows a per diem plus actual lodging • Either hi-low M&IE rates ($42 and $34) or federal rate method (standard base rate is $30) • If taxpayer is self employed and elects a per diem method, must choose this one!

  11. Transportation • Taxpayer doesn’t have to be away from tax home to get transportation deduction • Commuting is never deductible, except if: • traveling between home and temporary work and have regular place of business • taxpayer’s principal place of business is home -then transportation is deductible • working two jobs - cost of going from one job to another

  12. Transportation (continued) • May take standard ($.365/mile) mileage rate plus parking/tolls (car loan interest and property taxes determined separately) or actual • To use standard per mile deduction, taxpayer must • own or lease car • not rent out • not own fleet • not have depreciation other than straight line • not have taken Section 179 depreciation on auto • Interest portion of car payment is only deductible if self employed

  13. Transportation (continued) • Actual expense is calculated by receipts as multiplied by business use percent and includes: • gas, oil, repair, and maintenance • depreciation • plus property taxes and interest on car ONLY if self-employed • business-related parking/tolls FULLY deductible • Not multiplied by business use percentage • If choose actual expense - cannot change to standard • If choose standard - may change to actual, but must use straight line depreciation • Reporting • If taxpayer is self-employed, vehicle expenses reported on Schedule C (and can take auto interest) • If an employee, report on 2106 which carries to Schedule A

  14. Objective Understand when a Home Office deduction may be claimed and how deduction is computed

  15. Office in Home (OIH) • Generally may not take a deduction for business use of a home • May take home office deduction if • Home is used regularly and exclusively as the principal place of business • Or required for the “convenience of employer” • Office in home is used regularly and exclusively to manage business or meet with clients • Office is separate structure and used exclusively for business or storage of inventory (and home is taxpayer’s sole place of business)

  16. Home Office (continued) • Compute using Form 8829 • Allowable deduction carries to bottom of Schedule C if self employed • Allowable deduction carries to bottom of Schedule A if an employee business expense – but can only take if necessary for employer convenience when employer does not provide a regular office • Two columns on 8829 for OIH expenses • Direct expenses • work done directly on home office (for example new cabinetry) and • indirect expenses • applicable to entire home and allocable to OIH (such as new furnace or lawn maintenance) • Allocation done on basis of square footage

  17. Home Office (continued) • OIH deduction cannot be used to create a Net Loss for the business (other than allocable portion of mortgage interest and taxes) • Therefore, OIH is deducted using a tier system: Gross income less: Interest/taxes allocable to OIH (balance to A) less: Other business deductions less*: Maintenance, depreciation, rent, utilities (only deductible if GI remaining) *These items cannot put taxpayer into a loss • Must carry forward excess to future years – “OIH Carry Forward”

  18. Objective Know the special requirements for claiming other common business expenses

  19. Entertainment • May take a deduction for 50% of cost of entertainment connected with a business • Entertainment must be either directly related to, or associated with active conduct of business • “Directly related” costs are those related to an actual business meeting, such as a business lunch • “Associated with” costs serve a specific business purpose and must occur immediately before or after a business discussion • Deduction for the cost of entertainment facilities is severely limited • Club dues are not deductible

  20. Educational Expenses • Deductible if the education: • Maintains or improves existing skills, or • Is needed to meet requirements of taxpayer’s current employment • Cost of courses and transportation, lodging and 50% meals (if travel is required to obtain education) • Self-employed educational expenses are reported on Schedule C • Employee on Schedule A

  21. Dues, Subscriptions and Publications • Professionals may deduct the cost of dues, subscriptions and publications related to their profession • Prepaid amounts must be allocated over useful life if > one year

  22. Uniforms • Uniforms and special clothes are deductible if: • Can’t be worn outside of work and • Are required by employer • Protective wear always deductible

  23. Business Gifts • May deduct the cost of gifts up to $25 per donee per year • Husband and wife = 1 donee • No limitation for small business gifts (not cash) up to $4 each that have taxpayer’s name or company name on them • Tangible personal property (not cash) up to $400 is allowable if given to employees for safety or length of service awards ($1,600 in conjunction with a “qualified” plan)

  24. Substantiation • Taxpayers must have written proof of expenses for entertainment (E) and gifts (G) • Amount (E & G) • Time and place (E) • Date and description (G) • Business purpose (E & G) • Business relationship (E & G)

  25. Objective Be able to complete a simple Form 2106 and Schedule C

  26. Schedule C vs. C-EZ • Can use C-EZ if: • Business expenses are $2,500 or less per year • Business does not carry inventory • Business uses cash method of accounting • Don’t need to file a Form 4562 for depreciation • Don’t have an office in home • Don’t have a net loss and have only one business • Don’t have employees

  27. The End

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