Gleim Publications - Other Deductions Study Guide PDF

1 STUDY UNIT FIVE OTHER DEDUCTIONS 5.1 Business Meals Expense................................................ 1 5.2 Travel Expenses...........................

1 STUDY UNIT FIVE OTHER DEDUCTIONS 5.1 Business Meals Expense................................................ 1 5.2 Travel Expenses....................................................... 4 5.3 Insurance Expenses.................................................... 8 5.4 Bad Debts............................................................ 9 5.5 Business Gifts......................................................... 11 5.6 Other Business Expenses................................................ 12 5.7 Business Use of Home.................................................. 17 5.8 Statutory Employees/Nonemployees........................................ 18 5.9 Qualified Business Income Deduction (QBID)................................. 21 This study unit continues the discussion of business expenses. A deduction from gross income is allowed for all ordinary and necessary expenses paid or incurred during a tax year in carrying on a trade or business. The deduction is allowed to a sole proprietor, a partnership, or a corporation. A sole proprietor claims these deductions on Schedule C. 5.1 BUSINESS MEALS EXPENSE 1. Prior to 2018, there was a deduction for entertainment expenses, which included recreation, e.g., entertaining guests at a nightclub, sporting event, or theater; supplying vacations, trips, etc.; and furnishing a hotel suite, automobile, food and beverages, or the like to a customer or a member of the customer’s family. a. Now, only the food and beverage portion of the deduction remains and is referred to as the business meals deduction. EXAMPLE 5-1 Business Meals Expense Deduction Annie, a self-employed taxpayer, takes her client Bonnie to a baseball game where they discuss business. The cost of the tickets to the game is $100. While at the game, Annie buys Bonnie hot dogs and sodas costing $40. Because the price of the food and beverages is separately billed, Annie can deduct $20, which is 50% of the meal expense. The $100 price of the tickets is nondeductible entertainment. 2. For a business meal to be deductible, the meal must a. Be an ordinary and necessary expense b. Not be a lavish or extravagant expense, i.e., be reasonable based on facts and circumstances c. Be attended by the taxpayer or an employee of the taxpayer d. Be provided to a current or potential business customer, client, consultant, or similar business contact e. Be separately stated from any nondeductible entertainment expense or purchased separately from the entertainment Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 2 SU 5: Other Deductions Deduction Limit 3. The amount deductible for meal expense is 50% of the actual expense. The limits also apply to the taxpayer’s own meals. Related expenses, such as taxes, tips, and parking fees, but not transportation to and from a business meal, are subject to the same limit as the meal. a. The IRS has denied deductions for any meal expense over $75 for which the claimant did not provide substantiating evidence, i.e., documented dates, amounts, location, purpose, and business relationship. b. The expenses of a spouse are not deductible (i.e., they would have to be a business associate as well). c. An exclusion from employee income for employee meals furnished on the business premises of the employer applies if they are furnished to the employee for the convenience of the employer. 1) The meals are deductible by the employer as an ordinary and necessary business expense. The deduction for these meals are now also limited to 50% of the expense. a) However, meal and entertainment expenses for employee recreation (e.g., a holiday party or an annual picnic) remain 100% deductible. EXAMPLE 5-2 Business Meals Expense Deduction Limitation ABC Accounting Firm requires its employees to work until 11 p.m. every evening the month prior to tax filing deadlines. ABC contracts a catering service to provide the employees with meals every evening on the company’s premises. Such meals are for the convenience of the employer and are excluded from the employee’s income. ABC would be allowed a deduction for 50% of the cost of the meals. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 3 4. The following is a summary of the rules explained on the previous pages: General rule A taxpayer can deduct ordinary and necessary expenses to provide a meal to a client, customer, or employee if the expenses meet five qualifications. Definitions An ordinary expense is one that is common and accepted in the taxpayer’s field of business, trade, or profession. A necessary expense is one that is helpful and appropriate, although not necessarily required, for the business. Five The meal must qualifications Be an ordinary and necessary expense Not be a lavish or extravagant expense, i.e., be reasonable based on facts and circumstances Be attended by the taxpayer or an employee of the taxpayer Be provided to a current or potential business customer, client, consultant, or similar business contact Be separately stated from any nondeductible entertainment expense or purchased separately from the entertainment Other rules The taxpayer cannot deduct the cost of the meal as business meal expense if claiming the meal as a travel expense. The taxpayer generally can deduct only 50% of business meal expenses. Entertainment Facility 5. There still remains no deduction allowed for any expenses for entertainment facilities, such as yachts, hunting lodges, swimming pools, tennis courts, or bowling alleys. The membership or initiation fee is a capital expenditure that is not currently deductible, and any gain upon sale is a capital gain. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 4 SU 5: Other Deductions 5.2 TRAVEL EXPENSES While away from home overnight on business, ordinary and necessary travel expenses, including meals (subject to the 50% limit), are deductible. 1. No deduction is allowed for the following: a. Travel that is primarily personal in nature (if more days are spent for personal purposes than for business purposes) except for 1) Directly related business expenses while at the destination b. The travel expenses of a taxpayer’s spouse unless there is a bona fide business purpose for the spouse’s presence, the spouse is an employee, and the expenses would be otherwise deductible c. Commuting between home and work 1) A taxpayer’s “home” is considered to be a) The taxpayer’s regular or principal (if there is more than one regular) place of business or b) If the taxpayer has no regular or principal place of business because of the nature of the work, the taxpayer’s regular place of abode in a real and substantial sense. 2) If the period of work in a new location is or becomes indefinite, travel expenses are not deductible because the individual is treated as though (s)he changed the location of his or her tax homes to his or her work location. d. Travel for attending investment meetings e. Travel as a form of education (e.g., a Spanish teacher traveling to Spain to improve her Spanish) 2. For individuals subject to Department of Transportation hours of service rules, the deductible meals percentage is 80%. Automobile Expenses 3. Actual expenses for automobile use are deductible (e.g., services, repairs, gasoline, etc.). Alternatively, the taxpayer may deduct the standard mileage rate of $0.655 per mile for 2023, plus expenses, such as parking fees and tolls, that are not actual automobile expenses. Domestic Travel 4. For travel within the U.S., expenses other than transportation (e.g., airfare) are allocated based on personal or business purpose. Transportation expenses are a. 100% deductible if the primary purpose is business or b. 0% deductible if the primary purpose is personal (i.e., no proportional allocation for transportation costs when traveling within the U.S.). Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 5 Foreign Travel 5. Generally, traveling expenses (including meals and lodging) of a taxpayer who travels outside of the United States and away from home must be allocated between time spent on the trip for business and time spent for pleasure. However, no allocation is required for transportation, such as costs of getting to and from the destination, when one of the following three exceptions for a trip considered entirely for business applies. a. A trip is considered entirely for business if the traveler did not have substantial control over arranging the trip. b. When the trip is for not more than 1 week (7 consecutive days counting the day of return but not the day of departure) and a personal vacation was not the major consideration, the trip is considered entirely for business. c. When the foreign trip is longer than a week and less than 25% of the total time away from home outside the United States is spent for nonbusiness activities, the trip is considered entirely for business. For this purpose, include both the day the trip began and the day it ended. EXAMPLE 5-3 Deductible Foreign Travel Expenses Scott’s foreign trip is for more than a week, and he spends 35% of his time as a personal vacation. However, he spends the other 65% providing business-related services. Only 65% of the expenses related to the time providing business services, including transportation, lodging, local travel, etc., may be deducted. Convention Expenses 6. Deductible travel expenses include those incurred when attending a convention related to the taxpayer’s business. a. The fact that an attending individual uses vacation or leave time or that attendance at the convention is voluntary will not necessarily negate the deduction. b. Expenses for a convention or meeting in connection with investments, financial planning, or other income-producing property are not deductible. c. A taxpayer can show that his or her attendance at a convention benefits his or her trade or business by comparing the convention agenda with the official duties and responsibilities of his or her position. The fact that the convention agenda does deal with his or her specific duties lends support for the travel being ordinary and necessary in the conduct of a trade or business. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 6 SU 5: Other Deductions 7. The following chart summarizes expenses that can be deducted when traveling away from home for business purposes: IF there are expenses for... THEN the taxpayer can deduct the cost of... transportation travel by airplane, train, bus, or car between the home and the business destination. If the taxpayer was provided with a free ticket or the taxpayer was riding free as a result of a frequent traveler or similar program, the cost is zero. Travel by ship (e.g., cruise ships) for conventions has additional rules and limits. taxi, commuter bus, and fares for these and other types of transportation that take the taxpayer airport limousine between The airport or station and the hotel, and The hotel and the work location of the customers or clients, the business meeting place, or the temporary work location. baggage and shipping sending baggage and sample or display material between the regular and temporary work locations. car operating and maintaining the car when traveling away from home on business. The taxpayer can deduct the actual expenses or the standard mileage rate, as well as business-related tolls and parking. If the taxpayer rents a car while away from home on business, (s)he can deduct only the business-use portion of the expenses. lodging and meals lodging and meals if the business trip is overnight or long enough to require a stop for sleep or rest to properly perform duties. Meals include amounts spent for food, beverages, taxes, and related tips and have additional rules and limits. cleaning dry cleaning and laundry. telephone business calls while on the business trip. This includes business communication by fax machine or other communication devices. tips tips paid for any expenses in this chart. other other similar ordinary and necessary expenses related to the business travel. These expenses might include transportation to or from a business meal, public stenographer’s fees, computer rental fees, and operating and maintaining a house trailer. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 7 Reimbursed Employee Expenses 8. If reimbursements equal expenses and the employee makes an accounting of expenses to the employer, the reimbursements are excluded from the employee’s gross income (i.e., excluded from employee’s W-2), and the employer may deduct the expenses (accountable plan). a. This rule also applies if reimbursements exceeding expenses are returned to the employer and the employee substantiates the expenses. b. If excess reimbursements are not returned or if the employee does not substantiate them, the reimbursements are included in the employee’s gross income, and none of the expenses are deductible by the employee (nonaccountable plan). Unreimbursed Employee Expenses 9. Unreimbursed employee expenses are not deductible. Recordkeeping 10. Taxpayers generally must have documentary evidence, such as receipts, canceled checks, or bills, to support their expenses. Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense. A canceled check, together with a bill from the payee, ordinarily establishes the cost. a. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose. Documentary evidence is not needed for expenses, other than lodging, of less than $75. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 8 SU 5: Other Deductions 5.3 INSURANCE EXPENSES 1. Ordinary and necessary trade or business insurance expense paid or incurred during the tax year is deductible. a. A cash-method taxpayer may not deduct a premium before it is paid. b. Prepaid insurance of more than 1 year must be apportioned over the period of coverage. Ordinary & Necessary Trade/Business Insurance Expenses Casualty insurance: Credit insurance: Group hospitalization & medical -Fire -Theft -Losses from unpaid debts insurance costs paid for -Accident -Other employees -Storm Accident & health insurance Workers’ Compensation Overhead insurance premiums paid for partners -Long periods of disability from Premiums for: Deduct as: as guaranteed payments taxpayer’s injury/illness (i.e., made to the partners Employees Business insurance owner, not employee) in a partnership or the Partners Guaranteed payment shareholders in an S corp. shareholders Wages S corporation Malpractice and Liability insurance Life insurance nonperformance insurance -Covers injury to employee/client -Covers officers & employees -Taxpayer is not the beneficiary Self-employed (SE) health insurance -100% of costs Compensation for employees injured at work -Covers SE/spouse/dependents -Deduction limit = Earnings from related business SUTA fund contributions Business auto insurance Business interruption insurance -If state considers as tax -No deduction if mileage rate for car -Profit loss due to shutdown expenses is used 2. A taxpayer may not deduct the following: a. Loss of earnings except for certain overhead insurance expenses b. Self-insurance reserve funds 1) Deductible when payment made c. Premiums on a life insurance policy covering the taxpayer, an employee, or any person with a financial interest in the taxpayer’s business if the taxpayer is directly or indirectly a beneficiary d. Costs for a self-employed taxpayer eligible for coverage under the plan of his or her spouse’s employer 3. Self-employed health insurance is not deductible on Schedule C. It would be deducted on Form 1040, Schedule 1, in the adjustments to income section. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 9 5.4 BAD DEBTS Bad Debt Deduction 1. A bad debt deduction is allowed only for a bona fide debt arising from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. a. Worthless debt is deductible only to the extent of adjusted basis in the debt. b. Money lent to a relative or friend with the understanding the relative or friend may not repay it must be considered a gift by the taxpayer, not as a loan, and it may not be deducted as a bad debt. c. A cash-basis taxpayer has no basis in accounts receivable and generally has no deduction for bad debts. Business Bad Debt 2. A business bad debt is one incurred or acquired in connection with or closely related to the taxpayer’s trade or business. a. A debt is closely related if the primary motive for incurring the debt is business related. 1) If a taxpayer makes a loan to a client, supplier, employee, or distributor for a business reason and it becomes worthless, it becomes a business bad debt. b. The bad debts of corporations are always business bad debts. c. Partially worthless business debts may be deducted to the extent they are worthless and specifically written off. d. A business bad debt is treated as an ordinary loss. e. A bad debt written off in a previous tax year but recovered in the current tax year should be reported as other income. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 10 SU 5: Other Deductions Nonbusiness Bad Debt 3. A nonbusiness bad debt is a debt other than one incurred or acquired in connection with the taxpayer’s trade or business. a. Investments are not treated as a trade or business. b. A shareholder loan to protect his or her investment in the corporation is not treated as a business loan. c. A partially worthless nonbusiness bad debt is not deductible. d. A wholly worthless nonbusiness debt is deducted in the year it becomes worthless, and it is then treated as a short-term capital loss. 4. Taxpayers cannot take a bad debt deduction for a loan made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital. a. Worthless corporate securities are not considered bad debts. They are generally treated as a capital loss. 5. Taxpayers can take a bad debt deduction only if the amount owed was previously included in gross income. This applies to amounts owed from all sources of taxable income, including sales, services, rents, and interest. a. If a taxpayer uses the cash method of accounting, (s)he generally reports income when payment is received. A taxpayer cannot take a bad debt deduction for amounts owed because those amounts were never included in income. Specific Write-Off Method 6. The specific write-off method generally must be used for tax purposes. The reserve method is used for financial accounting purposes. a. If the specific write-off method is used, taxpayer can deduct specific bad debts that become either partly or totally worthless during the tax year. b. Taxpayers can deduct specific bad debts that become partly uncollectible. c. The tax deduction is limited to the amount charged off on the books during the year. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 11 5.5 BUSINESS GIFTS Expenditures for business gifts are deductible. They must be ordinary and necessary. 1. Deduction for business gift expenditure is disallowed unless the taxpayer substantiates, by adequate records, the following: a. Amount (cost) of the gift b. Date of the gift c. Description of the gift d. Business purpose for the gift e. Business relation of the recipient to the taxpayer 2. Deduction is limited to $25 per recipient per year for items excludable from income. a. If a gift is given to a member of a customer’s family, the gift is generally considered an indirect gift to the customer. This rule does not apply if there is a bona fide, independent business connection with that family member and the gift is not intended for the customer’s eventual use. b. A husband and wife are treated as one taxpayer, even if they file separate returns and have independent business relationships with the recipient. c. Incidental costs, such as engraving on jewelry or packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. d. The $25 limit does not apply to incidental (e.g, advertising) items costing (the giver) not more than $4 each and other promotional materials including signs and displays. Employee Achievement Awards 3. Up to $400 of the cost to the employer (not FMV) of employee achievement awards is deductible by an employer for all nonqualified plan awards. (Deduction of qualified plan awards is limited to $1,600 per year.) a. An employee achievement award is tangible personal property awarded to an employee as part of a meaningful presentation for safety achievement or length of service. 1) Tangible personal property does not include cash, cash equivalents, gift cards/ coupons/certificates, vacations, meals, lodging, event tickets (e.g., theater, sporting), stocks, bonds, and other securities. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 12 SU 5: Other Deductions 5.6 OTHER BUSINESS EXPENSES Some other items of business-related expense follow: Depreciation 1. Deduction for obsolescence or wear and tear of property used in a trade or business has generally been tested in the context of corporations. However, depreciation can be a deductible expense of any business. Start-Up/Organization Costs 2. Start-up/organization costs in general are capitalized and amortized proportionally over the 180-month (15-year) period beginning with the month in which the active trade or business begins. a. Start-up costs are amounts paid or incurred to create an active trade or business, investigate the creation or acquisition of a trade or business, or engage in any activity for profit or the production of income. 1) If the taxpayer is not already in the business for which they have incurred start-up costs, those costs must be capitalized and amortized only if the business is entered into. No deduction is allowed if the taxpayer does not enter into the business. 2) If the taxpayer is already in the business, a deduction is allowed for start-up costs regardless of whether the taxpayer enters the business. For example, a restaurant chain incurs qualified expenses to open a new location. These expenses may be deducted or amortized regardless of the new location opening. b. Organizational costs are amounts paid or incurred that are incidental to the creation of a corporation or partnership (i.e., direct costs). They are chargeable to a capital account, amortizable over the fixed life of the entity, and incurred before the first tax year ends (corporation) or when the first return is due (partnership). Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 13 c. The following table provides examples of costs that do or do not qualify as start up or organizational costs: Start-Up Costs Organizational Costs Surveys of potential markets, Legal services, e.g., negotiation products, labor supplies, and preparation of the partnership transportation facilities, etc. agreement (partnerships) or obtaining Grand opening advertisements a corporate charter (corporations) Training costs such as salaries Temporary directors (corporations) Qualifying and wages for employees and Organizational meetings (corporations) Costs instructors State incorporation fees (corporations) Salaries and fees for Accounting fees for organization executives and consultants or (partnerships) similar professional services Filing fees (partnerships) Acquisition of certain supplies Items expected to be beneficial and equipment (noncapital) throughout the life of the partnership Deductible interest, taxes, or Issuing and selling stock or securities, research and experimental e.g., commissions, professional fees, costs printing, and stock exchange listing (corporations) Transfer or acquisition of assets to the corporation or partnership Admitting or removing partners after Nonqualifying initial organization Costs Creation of contracts concerning operations (partnership) Syndication fees, i.e., costs for issuing and marketing interest in a partnership, e.g., brokerage registration, legal fees, and printing costs d. Taxpayers can deduct up to $5,000 of start-up and $5,000 of organizational expenditures in the taxable year in which the business begins. The total startup or organizational costs deducted for the first year equal the sum total of the $5,000 limit and the amortized amount allocated to the first year. 1) The $5,000 is reduced, but not below zero, by the cumulative cost of the start-up expenditures that exceed $50,000. The phaseout is computed separately for both start-up cost and organizational costs. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 14 SU 5: Other Deductions Vacant Land 3. Interest and taxes on vacant land are deductible. Demolition 4. If a structure is demolished, demolition costs, undepreciated (remaining) basis, and any losses sustained are not deductible. They are allocated to the land. Abandoned Assets 5. A loss is deductible in the year the assets are actually abandoned with no claim for reimbursement. The amount of the loss is the adjusted basis for determining a loss on the sale or other disposition of the property. COGS 6. Cost of goods sold reduces revenue before inclusion in gross income. Sales – COGS = Gross income Medical Reimbursement Plans 7. The cost of such a plan for employees is deductible by the employer. Political Contributions 8. Contributions to a political party or candidate and, generally, lobbying expenses are not deductible. EXAMPLE 5-4 Nondeductibility of Political Contributions Craft Store pays for advertising in the program for a political party’s convention. Proceeds are used for the party’s activities. The expense is a political contribution, which is not deductible. a. Lobbying activity equates to appearances before and communications with any council or similar governing body with respect to legislation of direct interest to the taxpayer. 1) Up to $2,000 of direct cost of lobbying activity at the state or federal level is deductible. a) This does not include payments to professional lobbyists. b) If total direct costs exceed $2,000, this de minimis exception is unavailable. Debt of Another 9. Payment of a debt of another party is generally not ordinary for a trade or business and thus is not deductible. a. A legal obligation or definite business requirement, e.g., if required by suppliers to stay in business, renders the payment deductible. Intangibles 10. The cost of intangibles must generally be capitalized. a. Amortization is allowed if the intangible has a determinable useful life, e.g., a covenant not to compete or if a code section specifically so provides. b. Generally, Sec. 197 intangibles have a 15-year life. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 15 Tax-Exempt Income 11. An expenditure related to producing tax-exempt income, e.g., interest on a loan used to purchase tax-exempt bonds, is not deductible. Nondeductible 12. Certain trade or business expenditures that are ordinary, necessary, and reasonable are nondeductible. The following are examples of expenditures disallowed as deductions: a. Fines and penalties paid to the government for violation of the law b. Illegal bribes and kickbacks (including Medicaid and Medicare referrals) provided the law is generally enforced c. Two-thirds of damages for violation of federal antitrust law d. Expenses of dealers in illegal drugs Moving Expenses 13. Expenses involved with an employer business move are deductible. a. The Tax Cuts and Jobs Act of 2017 removed the employee deduction for job-related relocation (i.e., moving expenses) except for military on active duty who move pursuant to a military order and due to a permanent change of station. 1) When an employer reimburses an employee for moving expenses, such reimbursement is included in the gross income of the employee and is deductible by the employer. Research Expenses 14. No deduction is allowed for research or experimental costs. The taxpayer must capitalize such expenditures and amortize them over 5 years. For research or experimental expenditures which are attributable to foreign research, the amortization period is 15 years. The change in accounting shall be applied only on a cut-off basis for any research or experimental expenditures paid or incurred in the first taxable year beginning after December 31, 2021, and shall be treated as a. Initiated by the taxpayer b. As made with the consent of the Secretary Environmental Clean-Up Costs 15. Environmental clean-up costs are treated as land and capitalized. Miscellaneous Business Expenses 16. Miscellaneous ordinary and necessary business expenses are deductible. Examples include costs of office supplies, advertising, professional fees, and bank fees. Fines for Nonperformance of a Contract 17. Although fines and penalties paid to a government are generally not deductible, the payment of a penalty for late performance or nonperformance of a contract is generally deductible. a. This penalty usually represents damages that one contracting party was willing to incur in order to avoid performing under the contract. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 16 SU 5: Other Deductions Costs of Removing Barriers to the Disabled and the Elderly 18. The costs of making a trade or business facility or public transportation vehicle more accessible to those who are disabled or elderly can be deducted. a. The most that can be deducted for any year is $15,000. b. The costs incurred above the limit can be added to the basis of the property and depreciated. c. A tax credit for eligible access expenditures of up to 50% of $10,000 is available for small businesses (less than $1 million in gross receipts). Charitable Contributions 19. Sole proprietorships, shareholders in S corporations, and partners in partnerships may be able to deduct charitable contributions made by their business entities. a. The deduction is taken on Schedule A of Form 1040. Government-Granted License 20. A taxpayer must amortize the capitalized costs of acquiring, issuing, or renewing a license granted by a governmental unit or agency. Deductions on Schedule C 21. A statutory employee’s business expenses are deductible on Schedule C (Form 1040). Self-Rental 22. The amount of a loss or credit attributable to a person’s passive activities is allowable as a deduction or credit only against, and to the extent of, gross income or tax attributable to those passive activities. a. If a taxpayer rents property to a business in which (s)he materially participates (i.e., the taxpayer rents to his or her own business), net rental income is nonpassive. Stated differently, rental income from self-rented property cannot be used to trigger allowance of passive losses on Form 8582. 1) Self-rental losses, on the other hand, are passive, deductible only to the extent of passive income. 2) Income is still reportable on Schedule E but cannot be entered as passive income on Form 8582. Self-Employed Education Expense Related to Business 23. Self-employed taxpayers may deduct their own education expenses on Schedule C as an other business deduction. To qualify, the education must maintain or improve the skills used in the taxpayer’s trade or business, or be necessary to keep a job, status, or rate of pay under the requirements of applicable law or regulations. A taxpayer cannot deduct expenses incurred to meet minimum requirements for a trade or profession or to qualify for a new trade or profession. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 17 5.7 BUSINESS USE OF HOME 1. Expenses incurred for the use of a person’s home for business purposes are deductible only if strict requirements are met. a. The portion of the home must be used exclusively and regularly as 1) The principal place of business for any trade or business of the taxpayer; 2) A place of business that is used by patients, clients, or customers in the normal course of the taxpayer’s trade or business; or 3) A separate structure that is not attached to the dwelling unit that is used in the taxpayer’s trade or business. b. If the taxpayer is an employee, the business use of the home is not deductible. Exclusive-Use Test 2. Any personal use of the business portion of the home by anyone results in complete disallowance of the deductions. There are two exceptions to the exclusive-use test: a. Retail/wholesale b. Day care Limitation 3. A taxpayer’s deduction of otherwise nondeductible expenses, e.g., insurance, utilities, and depreciation (with depreciation taken last), is limited to a. Gross income derived from the use; minus b. Deductions related to the home, allowed regardless of business or personal use, e.g., mortgage interest or taxes; and c. Deductions allocable to the trade or business for which the home office is used that are not home office expenses, e.g., employee compensation. Simplified Option 4. A new simplified option allows taxpayers to claim $5 per square foot of home office space, up to 2 300 ft , for a maximum deduction of $1,500. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 18 SU 5: Other Deductions 5.8 STATUTORY EMPLOYEES/NONEMPLOYEES Worker Classification 1. It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. a. Generally, employers must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. b. Employers do not generally have to withhold or pay any taxes on payments to independent contractors. c. Before an employer can determine how to treat payments made for services, the employer must first know the business relationship that exists between the employer and the person performing the services. 1) In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. Common Law Rules 2. Facts that provide evidence of the degree of control and independence fall into three categories: a. Behavioral: Does the company control or have the right to control what the worker does and how the worker does the job? b. Financial: Are the business aspects of the worker’s job controlled by the employer (e.g., how the worker is paid, whether expenses are reimbursed, who provides tools/supplies)? c. Type of Relationship: Are there written contracts or employee-type benefits (e.g., pension plan, insurance, vacation pay)? Will the relationship continue, and is the work performed a key aspect of the business? 3. Employers must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another. a. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and, finally, to document each of the factors used in coming up with the determination. b. If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS. The form may be filed by either the employer or the worker. 1) The IRS will review the facts and circumstances and officially determine the worker’s status. It can take 6 months to get a determination, but an employer who continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 19 Statutory Employees 4. If workers are independent contractors under the common law rules, such workers may still be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet the three conditions described under “Social Security and Medicare Taxes” below. a. A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is the payer’s agent or is paid on commission. b. A full-time life insurance sales agent whose principal business activity is selling life insurance, annuity contracts, or both, primarily for one life insurance company. c. An individual who works at home on materials or goods that the payer supplies and that must be returned to the payer or to a person the payer names if the payer also furnishes specifications for the work to be done. d. A full-time traveling or city salesperson who works on the payer’s behalf and turns in orders to the payer from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. 1) The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. 2) The work performed for the payer must be the salesperson’s principal business activity. Social Security and Medicare Taxes 5. Payers withhold Social Security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply: a. The service contract states or implies that substantially all the services are to be performed personally by the statutory employees. b. The statutory employees do not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities). c. The services are performed on a continuing basis for the same payer. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 20 SU 5: Other Deductions Statutory Nonemployees 6. There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Direct sellers and licensed real estate agents are treated as self- employed for all federal tax purposes, including income and employment taxes, if a. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output rather than to the number of hours worked and b. Services are performed under a written contract providing that they will not be treated as employees for federal tax purposes. Direct Sellers 7. Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers. Such activities include providing motivation and encouragement; imparting skills, knowledge, or experience; and recruiting. Direct sellers include persons falling within any of the following three groups: a. Persons engaged in selling (or soliciting the sale of) consumer products in the home or place of business other than in a permanent retail establishment b. Persons engaged in selling (or soliciting the sale of) consumer products to any buyer on a buy-sell basis, a deposit-commission basis, or any similar basis prescribed by regulations, for resale in the home or at a place of business other than in a permanent retail establishment c. Persons engaged in the trade or business of delivering or distributing newspapers or shopping news (including any services directly related to such delivery or distribution) Licensed Real Estate Agents 8. Licensed real estate agents include individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output. Companion Sitters 9. Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled. a. A person engaged in the trade or business of putting the sitters in touch with individuals who wish to employ them (i.e., a companion sitting placement service) will not be treated as the employer of the sitters if that person does not receive or pay the salary or wages of the sitters and is compensated by the sitters or the persons who employ them on a fee basis. b. Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 21 5.9 QUALIFIED BUSINESS INCOME DEDUCTION (QBID) 1. Calculation a. Qualified Business Income Deduction (QBID) (Section 199A) 1) When Congress passed the Tax Cuts and Jobs Act (TCJA), it reduced the C corporation tax rate to 21%. 2) Congress did not want to disadvantage owners of pass-through entities (sole proprietorships, S corporations, and partnerships) by leaving them with a substantially higher tax liability (potentially 37%) than C corporations (21%). Congress reduced this burden by creating the QBID. 3) The QBID is the last deduction before determining a taxpayer’s taxable income. It is based on determining qualified business income (QBI). 4) For the QBID, Congress divided pass-through entities into two categories: (a) specified service trades or businesses and (b) qualified trades or businesses. The reason for the two categories is that above certain thresholds of taxable income, each QBID is subject to varying limitations. a) The specifics of the limitations are complex and beyond the scope of the exam. Therefore, the coverage in this subunit is the general information needed to have a basic understanding of the QBID for the exam. b. Specified Service Trades or Businesses 1) In general, a specified service trade or business (SSTB) is any trade or business in which the principal asset is the reputation or skill of one or more of its employees. 2) Specifically, SSTBs include the following types of trades and businesses: a) Health (e.g., physicians, nurses, dentists, and other similar healthcare professionals) i) Health does not include services not directly related to a medical field, such as medical device sales, coding, billing, and payment processing. b) Law c) Accounting d) Actuarial science e) Performing arts f) Consulting g) Athletics h) Financial services (e.g., financial advisors, wealth planners, retirement advisors, investment bankers, and other professionals performing similar services) i) This includes any professional service consisting of investing, investment management, trading or dealing in securities, partnership interests, or commodities. i) Brokerage services Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 22 SU 5: Other Deductions 3) Also, an SSTB is any trade or business wherein a principal earns income (e.g., fees, licenses, or compensation) for any of the following activities: a) Endorsing products or services b) Use of the principal’s likeness, image, name, etc. c) Appearance fees for an event or media performance (e.g., radio, TV, etc.) EXAMPLE 5-5 Reputation and Skill Bill owns Bill’s Plumbing, a sole proprietorship. Bill’s Plumbing’s motto is “Bill is a very skilled plumber with a great reputation.” According to the regulations, because Bill’s Plumbing does not involve endorsements, compensation for use of one’s likeness, or appearance fees, Bill’s Plumbing’s principal asset is not the reputation or skill of one or more of its employees or owners. Thus, Bill’s Plumbing is not considered a specified service business. 4) Trades and businesses that are specifically not considered SSTBs include a) Architects b) Engineers c) Real estate agents and brokers d) Insurance agents and brokers EXAMPLE 5-6 SSTB Danny is a partner at XYZ, LLP, a public accounting firm. Danny is single with taxable income of $500,000. Because Danny’s taxable income is above the upper taxable income threshold, the specified service business limitation applies. Thus, because XYZ is a specified service business (and Danny’s taxable income is above the upper threshold), XYZ’s business income is not QBI and thus is not eligible for the QBID. However, if Danny’s taxable income had instead been $100,000, XYZ’s business income would have been eligible for the QBID because the specified service business limitation would not have applied. c. Qualified Trades or Businesses 1) In general, a qualified trade or business is any pass-through entity not considered an SSTB. 2) Specifically, a pass-through entity can be identified as a qualified trade or business if it has QBI. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 5: Other Deductions 23 d. The QBID on line 13 of Form 1040 is generally 20% of QBI, but it is limited due to an overall limitation. 1) The overall limitation is the lesser of a) 20% × Qualified business income or b) 20% × (Taxable income – Net capital gains). 2) Therefore, if a taxpayer has net capital gains, the taxpayer’s net capital gains decrease his or her QBID. (For this deduction, net capital gains are long-term gains and qualified dividends, minus short-term losses.) 3) Before a taxpayer can apply the overall limitation, (s)he has to determine the combined QBID before the taxable income limitation. Determining the combined QBID is a three-step process. After the three steps have been used to determine the combined QBID, the taxpayer must apply the overall limitation, which becomes Step 4. e. To calculate the combined QBID and ultimately the QBID, the following must be completed: 1) Step 1 – Every pass-through entity must first determine its QBI. a) This information will be reported on a Schedule K-1 (or a Schedule C if the entity is a sole proprietorship). b) The details of this process are described in Figure 5-1 on the next page. 2) Step 2 – The sum of each pass-through entity’s QBI must then be tested against the taxpayer’s taxable income. a) If the taxpayer is in the phase-in range or upper threshold, the QBID for each respective pass-through entity is reduced or limited by the IRS. This reduction is the allowed amount of QBID for each respective pass-through entity. i) Single taxpayers reach the phase-in range once taxable income exceeds $182,100 and enter the upper threshold at $232,100. ii)Married filing jointly taxpayers reach the phase-in threshold when taxable income exceeds $364,200 and enter the upper threshold at $464,200. b) The details of this process are complex and beyond the scope of the exam. c) General rules that should be understood: i) Below the phase-in ranges, the QBID is the full 20% overall limitation. ii) Above the phase-in ranges, the QBID is subject to additional limitations. iii) For SSTBs, the QBID is completely disallowed above the upper threshold. 3) Step 3 – A taxpayer determines the applicable combined QBID by adding together the allowed QBID amount for each respective entity to arrive at a total (or combined) QBID. 4) Step 4 – The final step is for the taxpayer to apply the overall limitation to total (or combined) QBID to determine the correct amount to deduct. This amount is then reported on line 13 of Form 1040. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 24 SU 5: Other Deductions 1 Step 1 – Determine What Constitutes QBI Step 1 Ensure the entity is a relevant pass-through entity (i.e., sole proprietor, S corporation, partnership, estate, or trust). Step 2 Determine whether the entity is directly owned by the taxpayer (e.g., a K-1 is sent directly to the taxpayer as a direct owner of the pass-through entity or business income is reported on Schedule C). Step 3 Calculate the net amount of income, gain, deduction, and loss with respect to any trade or business. This includes the sale, exchange, or distribution of unrealized receivables or inventory. Also, post-2017 adjustments from changes to accounting methods or previously disallowed losses or deductions currently allowed are treated as items attributable to the trade or business for computing QBI in the current year. Limited to Amounts Effectively connected with the conduct AND Included or allowed in determining of a trade or business within the United taxable income for the taxable year States or Puerto Rico 2 3 Step 4 Remove the following from the calculation of net income 1) Capital gains and losses 2) Dividends 3) Nonoperating interest income 4) Interest income attributable to working capital 5) Gains or losses relating to transactions in commodities 4 6) Foreign currency gains 5 7) Any less-than-reasonable salary payments to owners 8) Any deduction or loss properly allocated to the items above 1 This is the same methodology for determining income from an SSTB. 2 Conceptually, Congress is allowing small business owners the ability to deduct income that results from the core operations of a small business because the entrepreneurial spirit of small business can drive domestic employment. Because the overarching goal is to spur growth and, ultimately, employment, Congress hopes to incentivize small business owners to grow their core business rather than speculate on side-ventures unrelated to their main business objectives. Therefore, qualified business income is the ordinary, noninvestment income of a business. 3 There are more reductions in total, but these are the big-picture items that are most likely to affect most taxpayers. 4 The IRS lists “excess foreign currency gains.” For most taxpayers, this effectively means any foreign currency gains. 5 If the taxpayer paid himself or herself a salary (or guaranteed payment) less than a reasonable amount to receive a higher QBI deduction, the taxpayer must reduce QBI by the amount of the less-than-reasonable salary payment. Figure 5-1 Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].