Taxation of Business Entities C17-1 Chapter 17 Individuals as Employees and Proprietors Individuals...

C17-C17-11Taxation of Business EntitiesTaxation of Business Entities

Chapter 17Chapter 17

Individuals as Employees and Proprietors

Individuals as Employees and Proprietors

Copyright ©2010 Cengage Learning

Taxation of Business Entities


Employee vs. Self-Employed(slide 1 of 2)


• Business expenses for self-employed persons are deductible for AGI– Reported on Schedule C

• Business expenses for employees are generally deductible from AGI subject to 2% of AGI floor– Reported on Form 2106 (Employee Business

Expenses) and Schedule A (Itemized Deductions)

• Business expenses for self-employed persons are deductible for AGI– Reported on Schedule C

• Business expenses for employees are generally deductible from AGI subject to 2% of AGI floor– Reported on Form 2106 (Employee Business

Expenses) and Schedule A (Itemized Deductions)




• Person is classified as an employee if:– Subject to will and control of another with

respect to what shall be done and how it shall be done

– Another furnishes tools or the place of work– Income based on time spent rather than task

performed

• Person is classified as an employee if:– Subject to will and control of another with

respect to what shall be done and how it shall be done

– Another furnishes tools or the place of work– Income based on time spent rather than task

performed


Advantages of Qualified Fringe Benefits

Advantages of Qualified Fringe Benefits

• Cost of qualified fringe benefits is deductible by employer

• Value of qualified fringe benefits is excluded from employee’s gross income

• Cost of qualified fringe benefits is deductible by employer

• Value of qualified fringe benefits is excluded from employee’s gross income


Employer-Sponsored Accident and Health Plans

Employer-Sponsored Accident and Health Plans

• Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee

• Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function

• Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee

• Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function


Long-Term Care Insurance (slide 1 of 2)Long-Term Care Insurance (slide 1 of 2)

• Employer paid insurance premiums for employee’s long-term care are excludible subject to annual limits as follows:

Insured’s Age before Close of Tax Year 2008 200940 or less $ 310 $ 32041 to 50 580 60051 to 60 1,150 1,19061 to 70 3,080 3,180More than 70 3,850 3,980

• Employer paid insurance premiums for employee’s long-term care are excludible subject to annual limits as follows:

Insured’s Age before Close of Tax Year 2008 200940 or less $ 310 $ 32041 to 50 580 60051 to 60 1,150 1,19061 to 70 3,080 3,180More than 70 3,850 3,980


Long-Term Care Insurance (slide 2 of 2)Long-Term Care Insurance (slide 2 of 2)

• Exclusion of benefits received from policy is limited to the greater of:

• $280 in 2009 for each day patient receives long-term care (indexed amount for 2008 is $270)

• The actual cost of the care

– Reduced by any amounts received from other third parties (e.g., damages received)

• Exclusion of benefits received from policy is limited to the greater of:

• $280 in 2009 for each day patient receives long-term care (indexed amount for 2008 is $270)

• The actual cost of the care

– Reduced by any amounts received from other third parties (e.g., damages received)


Meals and LodgingMeals and Lodging

• Not taxable to employee if:– Furnished by employer

• On employer’s business premises

• For convenience of employer

– In the case of lodging, employee is required to accept lodging as a condition of employment

• Not taxable to employee if:– Furnished by employer

• On employer’s business premises

• For convenience of employer

– In the case of lodging, employee is required to accept lodging as a condition of employment


Group Term Life InsuranceGroup Term Life Insurance

• Premiums on the first $50,000 of group term life insurance are excluded from gross income– If plan discriminates in favor of certain key

employees (e.g., officers), they are not eligible for the exclusion

• Key employees must include in gross income the greater of

– Actual premiums paid by the employer, or – The amount calculated from the IRS tables

• Premiums on the first $50,000 of group term life insurance are excluded from gross income– If plan discriminates in favor of certain key

employees (e.g., officers), they are not eligible for the exclusion

• Key employees must include in gross income the greater of

– Actual premiums paid by the employer, or – The amount calculated from the IRS tables


Other Fringe Benefits (slide 1 of 3)


• Dependent care– Up to $5,000 of care costs paid for by employer

can be excluded

• Athletic facilities– Value of use of athletic facilities located on

employer premises can be excluded

• Dependent care– Up to $5,000 of care costs paid for by employer

can be excluded

• Athletic facilities– Value of use of athletic facilities located on

employer premises can be excluded




• Educational assistance programs– Employer-provided educational assistance for

undergraduate and graduate education is excludible

• Exclusion limited to $5,250 per year

• Includes tuition, fees, books, and supplies

• Educational assistance programs– Employer-provided educational assistance for

undergraduate and graduate education is excludible

• Exclusion limited to $5,250 per year

• Includes tuition, fees, books, and supplies




• Adoption assistance programs– Employee adoption expenses paid or

reimbursed by employer are excludible• Exclusion limited to $12,150

• Exclusion phases-out as AGI increases from $182,180 to $222,180

• Adoption assistance programs– Employee adoption expenses paid or

reimbursed by employer are excludible• Exclusion limited to $12,150

• Exclusion phases-out as AGI increases from $182,180 to $222,180


Cafeteria Plans Cafeteria Plans

• Allows employees to choose between cash and certain nontaxable benefits– If cash is chosen, the amount received is

taxable– If a nontaxable benefit is chosen, the benefit

remains nontaxable

• Provide tremendous flexibility in tailoring the employee pay package to fit individual needs

• Allows employees to choose between cash and certain nontaxable benefits– If cash is chosen, the amount received is

taxable– If a nontaxable benefit is chosen, the benefit

remains nontaxable

• Provide tremendous flexibility in tailoring the employee pay package to fit individual needs


Flexible Spending Plans Flexible Spending Plans

• Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income– Called a use or lose plan since reduction in pay

cannot be recovered if covered expenses are less than expected

• Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income– Called a use or lose plan since reduction in pay

cannot be recovered if covered expenses are less than expected


Classes of Nontaxable Employee Benefits

Classes of Nontaxable Employee Benefits

• No-additional-cost services

• Qualified employee discounts

• Working condition fringes

• De minimis fringes

• Qualified transportation fringes

• Qualified moving expense reimbursements

• Qualified retirement planning services

• No-additional-cost services

• Qualified employee discounts

• Working condition fringes

• De minimis fringes

• Qualified transportation fringes

• Qualified moving expense reimbursements

• Qualified retirement planning services


No Additional Cost Services No Additional Cost Services

• Are nontaxable if:– Employee receives services (not property)– Employer incurs no substantial additional cost

in providing the services– Services offered are within line of business in

which employee works– Benefit is offered on nondiscriminatory basis

• Are nontaxable if:– Employee receives services (not property)– Employer incurs no substantial additional cost

in providing the services– Services offered are within line of business in

which employee works– Benefit is offered on nondiscriminatory basis


Qualified Employee DiscountsQualified Employee Discounts

• Are nontaxable if:– Discount is not on realty or investment property– Item discounted is from same line of business

in which employee works– Discount cannot exceed gross profit on

property or 20% on services– Benefit is offered on nondiscriminatory basis

• Are nontaxable if:– Discount is not on realty or investment property– Item discounted is from same line of business

in which employee works– Discount cannot exceed gross profit on

property or 20% on services– Benefit is offered on nondiscriminatory basis


Working Condition FringesWorking Condition Fringes

• Not taxable if employee could have deducted cost of item if they had actually paid for them– Includes personal use of auto by full-time auto

salespeople and employee business expenses that would be eliminated by the 2% floor on miscellaneous itemized deductions

• Not taxable if employee could have deducted cost of item if they had actually paid for them– Includes personal use of auto by full-time auto

salespeople and employee business expenses that would be eliminated by the 2% floor on miscellaneous itemized deductions


De Minimis Benefits(slide 1 of 2)


• These benefits are so small that accounting for them is impractical

• Examples include:– Supper money – Occasional personal use of company copying

machine – Company cocktail parties – Picnics for employees

• These benefits are so small that accounting for them is impractical

• Examples include:– Supper money – Occasional personal use of company copying

machine – Company cocktail parties – Picnics for employees




• Subsidized eating facilities operated by employer are excluded if:– Located on or near employer’s premises– Revenue equals or exceeds direct operating

costs– Nondiscrimination requirements are met

• Subsidized eating facilities operated by employer are excluded if:– Located on or near employer’s premises– Revenue equals or exceeds direct operating

costs– Nondiscrimination requirements are met


Qualified TransportationQualified Transportation

• This fringe benefit is designed to encourage the use of mass transit for commuting to work– Includes:

• Transportation in commuter highway vehicle and transit passes

– Limit on the exclusion for 2009 was originally set at $120 per month ($115 in 2008)

– However, ARRTA of 2009 increased this amount to $230 a month (starting in March 2009) and carries it through 2010

• Qualified parking (limited to $230 per month)– May be provided directly by the employer or may be in

the form of cash reimbursements

• This fringe benefit is designed to encourage the use of mass transit for commuting to work– Includes:

• Transportation in commuter highway vehicle and transit passes

– Limit on the exclusion for 2009 was originally set at $120 per month ($115 in 2008)

– However, ARRTA of 2009 increased this amount to $230 a month (starting in March 2009) and carries it through 2010

• Qualified parking (limited to $230 per month)– May be provided directly by the employer or may be in

the form of cash reimbursements


Moving ExpensesMoving Expenses

• Employer payment or reimbursement of employee’s qualified moving expenses is excludible– No deduction by employee is allowed for

reimbursed moving expenses

• Employer payment or reimbursement of employee’s qualified moving expenses is excludible– No deduction by employee is allowed for

reimbursed moving expenses


Qualified Retirement Planning Services

Qualified Retirement Planning Services

• Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income– Designed to motivate more employers to

provide retirement planning services

• Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income– Designed to motivate more employers to

provide retirement planning services


Nondiscrimination ProvisionsNondiscrimination Provisions

• For no-additional-cost services, qualified employee discounts, and qualified retirement planning services– If the plan is discriminatory in favor of highly

compensated employees, these key employees are denied exclusion treatment

– Non-highly compensated employees can still exclude these benefits from income

• For no-additional-cost services, qualified employee discounts, and qualified retirement planning services– If the plan is discriminatory in favor of highly

compensated employees, these key employees are denied exclusion treatment

– Non-highly compensated employees can still exclude these benefits from income


Foreign Earned Income (slide 1 of 2)


• Income from personal services in a foreign country can be excluded from income

• To qualify for the exclusion, must be either:– A bona fide resident of foreign country, or– Present in foreign country at least 330 days

during any 12 consecutive months

• Income from personal services in a foreign country can be excluded from income

• To qualify for the exclusion, must be either:– A bona fide resident of foreign country, or– Present in foreign country at least 330 days

during any 12 consecutive months




• Exclusion amount is limited to $91,400 – For married persons, both of whom have

foreign earned income, the exclusion is computed separately for each spouse

• Exclusion amount is limited to $91,400 – For married persons, both of whom have

foreign earned income, the exclusion is computed separately for each spouse


Employee ExpensesEmployee Expenses

• Fall into one of the following categories:– Transportation– Travel– Moving– Education– Entertainment– Other

• Fall into one of the following categories:– Transportation– Travel– Moving– Education– Entertainment– Other


Transportation Expenses(slide 1 of 2)


• Transportation expense defined– Very limited, only from job site to job site and

commuting to temporary work place– Commuting from home to work and back is

nondeductible• Exceptions:

– Additional costs incurred to transport heavy tools

– Employees with more than one job

• Transportation expense defined– Very limited, only from job site to job site and

commuting to temporary work place– Commuting from home to work and back is

nondeductible• Exceptions:

– Additional costs incurred to transport heavy tools

– Employees with more than one job




• Amount deductible– Actual expenses

• Must keep adequate records of all expenses and depreciation is limited, or

– Automatic mileage method

• 55 cents per mile for business miles for 2009– Adjustment to basis of auto is required for depreciation

considered allowed

• Plus parking, tolls, etc.

• Adequate documentation of mileage required

• Amount deductible– Actual expenses

• Must keep adequate records of all expenses and depreciation is limited, or

– Automatic mileage method

• 55 cents per mile for business miles for 2009– Adjustment to basis of auto is required for depreciation

considered allowed

• Plus parking, tolls, etc.

• Adequate documentation of mileage required


Travel Expenses(slide 1 of 2)


• Travel expense defined– Expenses while “away from tax home” on

business– Includes transportation, lodging, 50% meals,

and miscellaneous expenses

• Travel expense defined– Expenses while “away from tax home” on

business– Includes transportation, lodging, 50% meals,

and miscellaneous expenses




• “Away from home” requirement– Need not be a 24-hour period but must be

longer than ordinary work day and taxpayer will need to rest during release time

– Being “away” should be a temporary situation (not in excess of 1 year)

– “Tax Home” generally means business location, post, or station of the taxpayer

• “Away from home” requirement– Need not be a 24-hour period but must be

longer than ordinary work day and taxpayer will need to rest during release time

– Being “away” should be a temporary situation (not in excess of 1 year)

– “Tax Home” generally means business location, post, or station of the taxpayer


Combined Business/Pleasure Travel(slide 1 of 4)


• Only actual expenses for business are deductible– Meals, lodging and other expenses must be

allocated between business and personal days

• Deductibility of transportation costs depends on whether the trip is domestic or foreign

• Only actual expenses for business are deductible– Meals, lodging and other expenses must be

allocated between business and personal days

• Deductibility of transportation costs depends on whether the trip is domestic or foreign




• For domestic travel– If primary purpose of trip is business,

transportation is deductible in full – If primary purpose is pleasure, no deduction for

transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible

• For domestic travel– If primary purpose of trip is business,

transportation is deductible in full – If primary purpose is pleasure, no deduction for

transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible




• For foreign travel– Transportation expense must be allocated

between business and personal unless:• Trip is 7 days or less,

• Less than 25% of time was for personal purposes, or

• Taxpayer had no substantial control over arrangements for the trip

• For foreign travel– Transportation expense must be allocated

between business and personal unless:• Trip is 7 days or less,

• Less than 25% of time was for personal purposes, or

• Taxpayer had no substantial control over arrangements for the trip




• Travel days are considered business days

• Weekends, legal holidays and intervening days are business days if both the preceding and succeeding days are business days

• If trip is primarily for pleasure, no transportation expenses are deductible

• Travel days are considered business days

• Weekends, legal holidays and intervening days are business days if both the preceding and succeeding days are business days

• If trip is primarily for pleasure, no transportation expenses are deductible


Moving Expenses Moving Expenses

• Deductible for moves in connection with the commencement of work at a new principal place of work

• Two tests must be met for moving expenses to be deductible– Distance test – Time test

• Deductible for moves in connection with the commencement of work at a new principal place of work

• Two tests must be met for moving expenses to be deductible– Distance test – Time test


Distance TestDistance Test

• Distance from old home to new job must be at least 50 miles farther than from old home to old job

• New home location not relevant for decision

• Distance from old home to new job must be at least 50 miles farther than from old home to old job

• New home location not relevant for decision


Example of Distance TestExample of Distance Test

• Gail lived 20 miles from her old job

• Gail’s new job is 75 miles from her old home

• Gail meets the distance test

• Gail lived 20 miles from her old job

• Gail’s new job is 75 miles from her old home

• Gail meets the distance test

OldJob

OldJob

New Job

New Job

Old Residence

Old Residence

20 mi.

75 mi.


Time Test(slide 1 of 2)


• Taxpayer must be full-time employee for 39 of the 52 weeks following the move, or

• Self-employed must work in new location for 78 weeks during the next two years following the move– 39 of the weeks must be in the first 12 months

• Test waived if die, disabled, discharged, or transferred

• Taxpayer must be full-time employee for 39 of the 52 weeks following the move, or

• Self-employed must work in new location for 78 weeks during the next two years following the move– 39 of the weeks must be in the first 12 months

• Test waived if die, disabled, discharged, or transferred




• If time test not met during taxable year, two alternatives:– Take the deduction in year moved. If test is not

met in following year, either:• Include the amount deducted in gross income in the

following year, or

• File amended return for year of move

– Alternatively, wait until time test is met and then file amended return for year of move

• If time test not met during taxable year, two alternatives:– Take the deduction in year moved. If test is not

met in following year, either:• Include the amount deducted in gross income in the

following year, or

• File amended return for year of move

– Alternatively, wait until time test is met and then file amended return for year of move


Deductible Moving ExpensesDeductible Moving Expenses

• ‘‘Qualified’’ moving expenses include reasonable expenses of:– Moving household goods and personal effects

to new location– Expenses of travel for taxpayer and family to

new location• Lodging• Actual auto costs (not depreciation) or mileage rate

of $.24 per mile for each car in 2009

– Meals are not deductible as moving expense

• ‘‘Qualified’’ moving expenses include reasonable expenses of:– Moving household goods and personal effects

to new location– Expenses of travel for taxpayer and family to

new location• Lodging• Actual auto costs (not depreciation) or mileage rate

of $.24 per mile for each car in 2009

– Meals are not deductible as moving expense


Tax Treatment of Moving Expenses Tax Treatment of Moving Expenses

• Unreimbursed moving expenses are deductible for AGI

• Reimbursement or payment by employer:– For qualified moving expenses, amount is

excluded from gross income, but no deduction for related expenses

– For nonqualified moving expenses, amount is included in gross income and no deduction is allowed

• Unreimbursed moving expenses are deductible for AGI

• Reimbursement or payment by employer:– For qualified moving expenses, amount is

excluded from gross income, but no deduction for related expenses

– For nonqualified moving expenses, amount is included in gross income and no deduction is allowed


Education Expenses(slide 1 of 3)


• Education expenses are deductible if they are incurred:– To maintain or improve existing skills, or– To meet the requirements of the employer,

profession, licensing, or state law

• Education expenses are deductible if they are incurred:– To maintain or improve existing skills, or– To meet the requirements of the employer,

profession, licensing, or state law




• Education expenses are not deductible if they are incurred:– To meet minimum educational standards for

existing job, or– To qualify taxpayer for new trade or business

• Education expenses are not deductible if they are incurred:– To meet minimum educational standards for

existing job, or– To qualify taxpayer for new trade or business




• Education expenses include:– Tuition– Books– Supplies– Transportation– Travel (including lodging and 50% meals)

• Education expenses include:– Tuition– Books– Supplies– Transportation– Travel (including lodging and 50% meals)


Deduction for Qualified Tuition and Related Expenses (slide 1 of 3)


• A deduction is allowed for AGI for qualified tuition and related expenses involving higher education (i.e., postsecondary)– This provision expired at the end of 2007, but

has been extended through 2009

• A deduction is allowed for AGI for qualified tuition and related expenses involving higher education (i.e., postsecondary)– This provision expired at the end of 2007, but

has been extended through 2009




• For 2004 - 2009, the maximum deduction depends on filing status and AGIFiling Status AGI Limit Max DeductionSingle $65,000 $4,000Married $130,000 $4,000Single $65,001 to $2,000

$80,000*

Married $130,001 to $2,000$160,000*

*No deduction is allowed if AGI exceeds this amount

• For 2004 - 2009, the maximum deduction depends on filing status and AGIFiling Status AGI Limit Max DeductionSingle $65,000 $4,000Married $130,000 $4,000Single $65,001 to $2,000

$80,000*

Married $130,001 to $2,000$160,000*

*No deduction is allowed if AGI exceeds this amount




• Qualified tuition and related expenses include whatever is required for enrollment– Usually, student activity fees, books, room and

board are not included

• Expenses need not be work related

• Deduction is not available for married persons filing separately

• Qualified tuition and related expenses include whatever is required for enrollment– Usually, student activity fees, books, room and

board are not included

• Expenses need not be work related

• Deduction is not available for married persons filing separately


Entertainment Expenses(slide 1 of 2)


• Deductions are very restricted due to abuse possibilities– Amount allowed

• 50% of meals and entertainment

• 100% of transportation costs

• Amounts cannot be lavish or extravagant

• Deductions are very restricted due to abuse possibilities– Amount allowed

• 50% of meals and entertainment

• 100% of transportation costs

• Amounts cannot be lavish or extravagant




• Entertainment expenses are classified as either:– Directly related to business

• Actual business meeting or discussion occurs during meal or entertainment

– Associated with business• Meal or entertainment that directly precedes or

follows business meeting or discussion

• Entertainment expenses are classified as either:– Directly related to business

• Actual business meeting or discussion occurs during meal or entertainment

– Associated with business• Meal or entertainment that directly precedes or

follows business meeting or discussion


Restrictions on Entertainment Expenses (slide 1 of 2)


• Club dues– Generally not deductible

• Exception: Clubs formed for public service and community volunteerism (e.g., Kiwanis, Rotary)

– Business entertainment expenses incurred at club are still deductible (50%)

• Club dues– Generally not deductible

• Exception: Clubs formed for public service and community volunteerism (e.g., Kiwanis, Rotary)

– Business entertainment expenses incurred at club are still deductible (50%)




• Business gifts– Business gifts of tangible personalty with a

value of $25 or less per person per year are deductible

• Incidental costs (e.g., gift-wrapping) are not included in the cost of the gift in applying the limit

– If the value is $4 or less (e.g., pen with company name) then not subject to $25 limit

• Gifts to employers or superiors are not deductible

• Business gifts– Business gifts of tangible personalty with a

value of $25 or less per person per year are deductible

• Incidental costs (e.g., gift-wrapping) are not included in the cost of the gift in applying the limit

– If the value is $4 or less (e.g., pen with company name) then not subject to $25 limit

• Gifts to employers or superiors are not deductible


Office in the Home(slide 1 of 3)


• Deductibility is very restricted due to abuse possibilities– Office must be used exclusively and on a

regular basis as:• The principal place of business, or• A place of business used by clients, patients, or

customers

– For employees, office must also be for the convenience of the employer

• Deductibility is very restricted due to abuse possibilities– Office must be used exclusively and on a

regular basis as:• The principal place of business, or• A place of business used by clients, patients, or

customers

– For employees, office must also be for the convenience of the employer




• What constitutes “principal place of business”?– Home office qualifies as a principal place of

business if:• Taxpayer conducts admin. and mgmt. activities in

the home office, and• There is no other fixed location where taxpayer

conducts these activities

• What constitutes “principal place of business”?– Home office qualifies as a principal place of

business if:• Taxpayer conducts admin. and mgmt. activities in

the home office, and• There is no other fixed location where taxpayer

conducts these activities




• Office in the home expenses cannot cause net loss from the business activity– Office in home deduction limited to business

gross income in excess of other business expenses (ordering rules apply)

– Excess is carried forward (subject to limit)– Form 8829 is used to report office in home

expenses

• Office in the home expenses cannot cause net loss from the business activity– Office in home deduction limited to business

gross income in excess of other business expenses (ordering rules apply)

– Excess is carried forward (subject to limit)– Form 8829 is used to report office in home

expenses


Other Employee ExpensesOther Employee Expenses

• A partial list of other employee expenses that are deductible includes:– Special clothing (uniforms)– Union dues– Professional expenses– Job hunting in same profession– Educator expenses (deductible for AGI)

• Limited to $250 per year for supplies, etc. of elementary and secondary school teachers

• A partial list of other employee expenses that are deductible includes:– Special clothing (uniforms)– Union dues– Professional expenses– Job hunting in same profession– Educator expenses (deductible for AGI)

• Limited to $250 per year for supplies, etc. of elementary and secondary school teachers


Classification of Employee Expenses (slide 1 of 2)


• Depends on whether they are reimbursed and, if reimbursed, under what type of plan

• Depends on whether they are reimbursed and, if reimbursed, under what type of plan




• Employers can have three types of reimbursement plans– Accountable– Nonaccountable– No reimbursement is given

• Employers can have three types of reimbursement plans– Accountable– Nonaccountable– No reimbursement is given


Accountable Plan(slide 1 of 2)


• Plan must require adequate accounting to the employer for expense reimbursed, and

• Any excess reimbursements must be returned to the employer

• Plan must require adequate accounting to the employer for expense reimbursed, and

• Any excess reimbursements must be returned to the employer




• Adequate accounting is– Submitting a record, with receipts, to the

employer, or– Using a per diem allowance that is not more

than the Federal per diem rate

• Employee reports no income and takes no deduction to the extent of the reimbursed expenses

• Adequate accounting is– Submitting a record, with receipts, to the

employer, or– Using a per diem allowance that is not more

than the Federal per diem rate

• Employee reports no income and takes no deduction to the extent of the reimbursed expenses


Substantiation for Expenditures (slide 1 of 2)


• No deduction allowed for an expense if the taxpayer does not have adequate records for the expense– Therefore, taxpayers need to have good records

for employee or self-employed expenses• In some cases, use of per diem allowance will be

deemed substantiation

• No deduction allowed for an expense if the taxpayer does not have adequate records for the expense– Therefore, taxpayers need to have good records

for employee or self-employed expenses• In some cases, use of per diem allowance will be

deemed substantiation




• Records should include:– The amount of the expense– The time and place of travel or entertainment

(or date of gift)– The business purpose of the expense– The business relationship of the taxpayer to the

person entertained (or receiving the gift)

• Records should include:– The amount of the expense– The time and place of travel or entertainment

(or date of gift)– The business purpose of the expense– The business relationship of the taxpayer to the

person entertained (or receiving the gift)


Nonaccountable PlanNonaccountable Plan

• Plan that does not require adequate accounting or return of excess reimbursement or both– Reimbursed amounts received under this plan

are included in gross income– Expenses are deductible from AGI as

miscellaneous itemized deductions subject to the 2% AGI limitation

• Plan that does not require adequate accounting or return of excess reimbursement or both– Reimbursed amounts received under this plan

are included in gross income– Expenses are deductible from AGI as

miscellaneous itemized deductions subject to the 2% AGI limitation


Unreimbursed Employee Expenses

Unreimbursed Employee Expenses

• Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation– If employee could have received, but did not

seek, reimbursement for whatever reason, none of the employment-related expenses are deductible

• Expenses are deductible from AGI as miscellaneous itemized deductions subject to the 2% AGI limitation– If employee could have received, but did not

seek, reimbursement for whatever reason, none of the employment-related expenses are deductible


Individual Retirement Accounts(slide 1 of 8)


• Contribution ceiling is lesser of $5,000 ($10,000 for spousal IRAs) or 100% of earned income

• Person age 50 or over by year end may make catch-up contributions– Max contribution limit is increased by $1,000 for 2006 and thereafter

• Deductible IRA contribution may be reduced if taxpayer is an active participant in another qualified plan

• To extent individual is ineligible to make deductible contributions, a nondeductible IRA contribution may be made – Income accrues on account tax deferred

• Contribution ceiling is lesser of $5,000 ($10,000 for spousal IRAs) or 100% of earned income

• Person age 50 or over by year end may make catch-up contributions– Max contribution limit is increased by $1,000 for 2006 and thereafter

• Deductible IRA contribution may be reduced if taxpayer is an active participant in another qualified plan

• To extent individual is ineligible to make deductible contributions, a nondeductible IRA contribution may be made – Income accrues on account tax deferred




• If taxpayer is covered by a qualified plan, IRA deduction is phased out within the AGI ranges listed below:

Phase-out begins Phase-out ends

Single & HH $55,000 $65,000

MFJ 89,000 99,000

MFS 0 10,000

• If taxpayer is covered by a qualified plan, IRA deduction is phased out within the AGI ranges listed below:


Single & HH $55,000 $65,000

MFJ 89,000 99,000

MFS 0 10,000




• Roth IRA– Contributions are nondeductible

• Maximum allowable annual contribution is the smaller of– $5,000 ($10,000 for spousal IRAs) or – 100% of the individual’s compensation for the year

– Qualified distributions are tax-free after an initial five year holding period if:

• Made on or after age 59 ½ • Made to beneficiary on or after participant’s death• Participant becomes disabled• Used to pay for qualified first-time home buyer’s expenses

($10,000 limit)

• Roth IRA– Contributions are nondeductible

• Maximum allowable annual contribution is the smaller of– $5,000 ($10,000 for spousal IRAs) or – 100% of the individual’s compensation for the year

– Qualified distributions are tax-free after an initial five year holding period if:

• Made on or after age 59 ½ • Made to beneficiary on or after participant’s death• Participant becomes disabled• Used to pay for qualified first-time home buyer’s expenses

($10,000 limit)




• Roth IRA (cont’d)– Other distributions may be taxable

• Distributions first treated as nontaxable return of capital to extent of contributions

• Remaining distribution treated as taxable payout of earnings

• Roth IRA (cont’d)– Other distributions may be taxable

• Distributions first treated as nontaxable return of capital to extent of contributions

• Remaining distribution treated as taxable payout of earnings




• Roth IRA (cont’d)– Annual contributions are subject to phase out

within the adjusted gross income ranges listed below:


Single $ 105,000 $120,000

MFJ 166,000 176,000

MFS 0 10,000

• Roth IRA (cont’d)– Annual contributions are subject to phase out

within the adjusted gross income ranges listed below:


Single $ 105,000 $120,000

MFJ 166,000 176,000

MFS 0 10,000




• Coverdell Education Savings Account– Distributions to pay for qualified higher

education expenses (QHEE) are tax-free• Exclusion may be available in year Hope credit or

lifetime learning credit is claimed– Maximum annual nondeductible contribution

for a beneficiary is $2,000• No contributions allowed after beneficiary reaches

18 years of age• No contribution allowed in year contribution made

to qualified tuition program for same beneficiary

• Coverdell Education Savings Account– Distributions to pay for qualified higher

education expenses (QHEE) are tax-free• Exclusion may be available in year Hope credit or

lifetime learning credit is claimed– Maximum annual nondeductible contribution

for a beneficiary is $2,000• No contributions allowed after beneficiary reaches

18 years of age• No contribution allowed in year contribution made

to qualified tuition program for same beneficiary




Coverdell Education Savings Account (cont’d) Annual contributions are subject to phase out within the adjusted gross income ranges listed below:


Single $ 95,000 $110,000

MFJ 190,000 220,000

Coverdell Education Savings Account (cont’d) Annual contributions are subject to phase out within the adjusted gross income ranges listed below:


Single $ 95,000 $110,000

MFJ 190,000 220,000




Coverdell Education Savings Account (cont’d)– Distributions in excess of QHEE are treated, pro

rata, as a return of capital and a distribution of earnings

• The exclusion for the distribution of earnings is calculated as follows:

Exclusion = (QHEE/Total Distributions) × Earnings

– Qualified higher education expenses (QHHE) include:

• Tuition, fees, books, supplies and equipment• Room and board if enrolled for at least one-half of full-

time course load

Coverdell Education Savings Account (cont’d)– Distributions in excess of QHEE are treated, pro

rata, as a return of capital and a distribution of earnings

• The exclusion for the distribution of earnings is calculated as follows:

Exclusion = (QHEE/Total Distributions) × Earnings

– Qualified higher education expenses (QHHE) include:

• Tuition, fees, books, supplies and equipment• Room and board if enrolled for at least one-half of full-

time course load


Payment Procedures(slide 1 of 2)


• Self-employment tax– Taxpayers with net self-employment earnings

of at least $400 must pay self-employment tax• 2009 rates

– Social Security: 12.4% of first $106,800 net self-employment income

– Medicare: 2.9% of all net self-employment income

• These rates are twice what an employee pays on wages

• Self-employment tax– Taxpayers with net self-employment earnings

of at least $400 must pay self-employment tax• 2009 rates

– Social Security: 12.4% of first $106,800 net self-employment income

– Medicare: 2.9% of all net self-employment income

• These rates are twice what an employee pays on wages




• Self-employment tax– Taxpayer receives a deduction from net self-

employment income of 7.65% for purposes of calculating the actual self-employment tax

– Taxpayer receives a for AGI deduction for 50% of the self-employment tax paid

• Self-employment tax– Taxpayer receives a deduction from net self-

employment income of 7.65% for purposes of calculating the actual self-employment tax

– Taxpayer receives a for AGI deduction for 50% of the self-employment tax paid


Retirement Plans for Self-Employed Individuals (slide 1 of 2)


• Keogh (H.R. 10) plans– Retirement plans for self-employed and their

employees– Plan rules are similar to corporate provisions– Plan must be established before the end of the

tax year, but contributions may be made up to the due date of the return

• Keogh (H.R. 10) plans– Retirement plans for self-employed and their

employees– Plan rules are similar to corporate provisions– Plan must be established before the end of the

tax year, but contributions may be made up to the due date of the return




• Keogh (H.R. 10) plans (cont’d)– Contribution limitations

• Defined contribution plan– Lesser of $49,000 (in 2009) or 100% of earned income– Profit sharing plans and stock bonus plan are limited to

25%

– Defined benefit plans limit the annual benefit payable to the lesser of $195,000 (in 2009) or 100% of average compensation for 3 highest years

• Keogh (H.R. 10) plans (cont’d)– Contribution limitations

• Defined contribution plan– Lesser of $49,000 (in 2009) or 100% of earned income– Profit sharing plans and stock bonus plan are limited to

25%

– Defined benefit plans limit the annual benefit payable to the lesser of $195,000 (in 2009) or 100% of average compensation for 3 highest years


Hobby Losses(slide 1 of 8)


• Hobby defined– Activity not entered into for profit

• Personal pleasure associated with activity

• Examples: raising horses, fishing boat charter

– Often it is difficult to determine if an activity is profit motivated or a hobby• Regulations provide nine factors to consider in

making this determination

• Hobby defined– Activity not entered into for profit

• Personal pleasure associated with activity

• Examples: raising horses, fishing boat charter

– Often it is difficult to determine if an activity is profit motivated or a hobby• Regulations provide nine factors to consider in

making this determination




• Profit activity– If activity is entered into for profit, taxpayer

can deduct expenses for AGI even in excess of income from the activity

– At-risk and passive loss rules may apply

• Profit activity– If activity is entered into for profit, taxpayer

can deduct expenses for AGI even in excess of income from the activity

– At-risk and passive loss rules may apply




• Presumptive rule of § 183– If activity shows profit 3 out of 5 years (2 out

of 7 years for horses), it is presumed that taxpayer has profit motive• Rebuttable presumption, shifts burden of proof to

IRS

– Otherwise, taxpayer has burden to prove profit motive

• Presumptive rule of § 183– If activity shows profit 3 out of 5 years (2 out

of 7 years for horses), it is presumed that taxpayer has profit motive• Rebuttable presumption, shifts burden of proof to

IRS

– Otherwise, taxpayer has burden to prove profit motive




No, profit 3 of 5 years1,2002009

Yes, profit only 2 of 5 years(500)2008

No, profit 3 of 5 years9002007

Yes(1,000)2006

Yes7002005

Yes(1,500)2004

Yes$5002003

Hobby?Income (loss)Year




• Hobby activity– Can only deduct expenses to extent of income

from activity (i.e., cannot deduct hobby losses)

• Hobby activity– Can only deduct expenses to extent of income

from activity (i.e., cannot deduct hobby losses)




• If an activity is a hobby:– Expenses are deductible from AGI

• Treated as miscellaneous itemized deductions subject to the 2% of AGI limitation

• Exception: expenses that are deductible without regard to profit motive, such as

– Mortgage interest

– Property taxes

• If an activity is a hobby:– Expenses are deductible from AGI

• Treated as miscellaneous itemized deductions subject to the 2% of AGI limitation

• Exception: expenses that are deductible without regard to profit motive, such as

– Mortgage interest

– Property taxes




• Order in which hobby expenses are deductible:– First: Those otherwise deductible: e.g.,

home mortgage interest and property taxes – Then: Expenses that do not affect adjusted

basis: e.g., maintenance, utilities– Then: Expenses that affect adjusted basis:

e.g., Depreciation (or cost recovery)

• Order in which hobby expenses are deductible:– First: Those otherwise deductible: e.g.,

home mortgage interest and property taxes – Then: Expenses that do not affect adjusted

basis: e.g., maintenance, utilities– Then: Expenses that affect adjusted basis:

e.g., Depreciation (or cost recovery)




• Example of hobby expenses: Taxpayer sells horses raised as a hobby for $15,500

• Example of hobby expenses: Taxpayer sells horses raised as a hobby for $15,500

15,500Total

Ltd. to 50031,000Depreciation

4,00024,000Feed

2,00022,000Vet Bills

3,00013,000Taxes

$ 6,00016,000Interest

$15,500Income

AmountOrderAmount


If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

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