Business Expenses PDF

SU 4: Business Expenses 9 4.2 COST OF GOODS SOLD (COGS) Cost of goods sold is the value of inventory sold during the course of the tax year. Cost of goods sold is not a “bu...

SU 4: Business Expenses 9 4.2 COST OF GOODS SOLD (COGS) Cost of goods sold is the value of inventory sold during the course of the tax year. Cost of goods sold is not a “business deduction,” but it does reduce gross revenues. 1. Cost of goods sold is calculated using the following formula: Beginning inventory $ XXX Plus: Raw materials $XXX Labor XXX Materials and supplies XXX Overhead XXX Cost of goods in inventory XXX Less: Ending inventory (XXX) COGS $ XXX a. Beginning inventory is the ending inventory from the previous year. b. Raw materials include the cost of all materials or parts purchased for manufacture into a finished product. Raw materials also include the cost of freight-in. c. Labor includes all direct and indirect labor costs that are attributable to the manufacturing of a product and are included in COGS. 1) Any labor costs not properly attributable to COGS may be deducted as selling or administrative expenses. d. Materials and supplies used in manufacturing goods, such as hardware or chemicals, are charged to COGS. e. Overhead expenses that are necessary for the manufacturing of a finished product are charged to COGS. f. The cost of inventory must be reduced by any trade discounts received. 1) Costs to ship to the purchaser are selling expenses, not costs of inventory. g. Goods included in beginning inventory that are donated to charity reduce the goods available for sale in the amount of their adjusted basis. 2. Manufacturers are required to use the full absorption method of costing. Therefore, both direct and indirect production costs must be included in cost of goods sold. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 10 SU 4: Business Expenses 4.3 INTEREST EXPENSE Generally, the amount of interest agreed upon by the lender and the borrower can be deducted when paid or accrued. 1. Current Deductible Interest a. Interest on debt whose proceeds were used to purchase or finance a business-related property b. A prepayment penalty on a loan c. Unstated interest to the extent that the difference between interest under the contract at the applicable federal rate and the contract interest reduces the basis of the purchased property d. Prepaid interest in any form must be amortized over the period of the loan e. Investment interest to the extent of investment income f. Points or loan origination fees 1) Because points are prepaid interest, they must be amortized over the life of the loan. g. Capitalized interest 1) When real property is produced for use in trade or business or for sale to customers, the uniform capitalization rules require some interest expense to be capitalized. a) The amount of interest that is generally capitalized is an amount equal to expenditures made to produce the property. b) The production period must either exceed 2 years or exceed 1 year and have a cost exceeding $1 million. h. Interest on income tax owed is not deductible i. Interest on employment tax deficiency is deductible j. The allocation of loan proceeds and related interest is generally dependent upon how the loan proceeds are used, not the use of the property that secures the loan Refinancing 2. When a debt is refinanced, the deductibility of the interest is determined by how the new loan proceeds are used. a. If the refinanced loan proceeds are used for personal reasons (e.g., to buy a sports boat for recreational purposes), the related interest is not deductible. b. If the loan proceeds are used for business purposes, the corresponding interest will be deductible as business interest expense. 3. Interest on borrowed funds used to purchase an interest in assets used in a trade or business may be deductible. a. The interest deduction allowed on the borrowed funds attributed to an active trade or business is limited to the proportion of the assets devoted to an active trade or business. 4. If a taxpayer borrows money from a third party to pay off a loan already outstanding and the interest is otherwise deductible, the individual may deduct the interest portion of the payment. a. If a cash-basis individual borrows money from the same person to whom the already outstanding loan is owed so that the borrower could pay off that first loan, then the borrower cannot deduct the interest of the first loan until payments begin on the second loan. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 4: Business Expenses 11 Limitations 5. The business interest deduction is limited to the sum of business interest income, 30% of the business’s adjusted taxable income, and floor plan financing interest. Disallowed business interest may be carried forward indefinitely. For S corporations and partnerships, the limitation is generally applied at the corporate or partnership level. Any business interest deduction is taken into account in determining the non-separately stated taxable income or loss of the S corporation and partnership. a. The adjusted taxable income is computed without regard to 1) Any item of income, gain, deduction, or loss that is not properly allocable to a trade or business 2) Business interest or business interest income 3) Net operating loss deduction 4) Qualified business income deduction (QBID) 5) Any deductions allowable for depreciation, amortization, or depletion b. Floor plan financing interest refers to interest paid or accrued on debt used to finance the acquisition of a motor vehicle held for sale or lease and secured by the inventory. c. The deduction limitation does not apply to small businesses with average gross receipts of $29 million or less. d. For S corporations and partnerships, the deduction may also be applied at the shareholder and partner level. 1) But the adjusted taxable income of the shareholder and partner is determined without regard to the shareholder’s and partner’s distributive share of any items of income, gain, deduction, or loss of the S corporation or partnership. e. Any excess taxable income (the S corporation’s and partnership’s unused business interest deduction due to the limitation) is passed through to shareholders and partners. 1) Each shareholder’s and partner’s deduction limit is increased by his or her distributive share of the S corporation and the partnership’s excess taxable income. EXAMPLE 4-1 Business Interest Expense ABC Corp.’s current-year taxable income before any interest expense deduction is $300,000, including $100,000 of interest income. ABC has gross receipts exceeding $29 million. During the current year, ABC incurred interest expense of $180,000. The deductible interest expense is the sum of the interest income of $100,000 plus 30% of its adjusted taxable income of $200,000 ($300,000 – $100,000). Therefore, the deductible interest expense is $160,000 [$100,000 + ($200,000 × 30%)]. 6. Interest expense incurred on borrowings used to repurchase stock is deductible in the period in which it is paid or incurred. However, other expenses related to a stock purchase on reorganization are generally not deductible. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 12 SU 4: Business Expenses 4.4 RENT EXPENSE Rent is any amount paid for property that is not owned. Rent that is not unreasonable is deductible. 1. Prepaid rent and lease payments are deductible only for amounts that apply to the use of rented property during the tax year. The balance can be deducted only over the period to which it applies. 2. The costs of acquiring a lease (i.e., commissions, bonuses, and fees) are capitalized and amortized over the life of the lease. 3. Rent for construction equipment used to build a new building is capitalized as part of the building. 4.5 TAXES Taxes paid or accrued in a trade or business are deductible. Taxes paid to purchase property are treated as part of the cost of the property. Sales Tax 1. Sales tax is treated as part of the property’s cost. a. If capitalized, the sales tax may be recoverable as depreciation. b. If the cost of the property is currently expensed and deductible, so is the tax. Occupational License 2. Occupational license taxes are deductible. The Occupational License Tax and Wagering Tax are both imposed on wagering activities. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 4: Business Expenses 13 Property Tax 3. State or local personal property taxes are an itemized deduction for individuals. Tax on business property is a business expense. Real estate taxes included in monthly mortgage payments and placed in escrow cannot be deducted until the lender actually pays the taxing authority. a. Local improvements. Taxes assessed for local benefit that tend to increase the value of real property are added to the property’s adjusted basis and are not currently deductible as tax expense. 1) Examples are taxes assessed for streets, sidewalks, sewer lines, public parking facilities, etc. 2) The tax must be an ad valorem tax and imposed on an annual basis. b. If real estate is sold, the deduction for real estate taxes must be divided between the buyer and the seller according to the number of days in the real property year. 1) The taxes are apportioned to the seller, up to but not including the date of sale, and to the buyer beginning with the date of sale, regardless of the accrual or lien dates under local law. c. If a buyer agrees to pay delinquent taxes, the amount paid is added to basis and not allowed as a deduction. The seller can deduct the property taxes paid by the seller. Income Taxes 4. State and local taxes imposed on net income of an individual are deductible. a. They are not a business expense of a sole proprietorship. 1) They are a personal, itemized deduction. b. Federal income taxes generally are not deductible. c. Individual taxpayers may claim an itemized deduction for either general state and local sales taxes or state income taxes, but not both. 1) Taxpayers can deduct either their actual sales tax amounts or a predetermined amount from an IRS table. Employment Taxes 5. An employer may deduct the employer portion of FICA taxes. An employee may not deduct FICA taxes. a. Self-employed persons deduct the employer portion of FICA (self-employment) taxes to arrive at AGI based on net earnings. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 14 SU 4: Business Expenses Federal Excise Tax 6. Excise taxes are levied on transactions, not on income or wealth. a. Federal gasoline and excise taxes and import duties are not deductible as taxes. 1) If they are paid or incurred in connection with a trade or business or with income- producing property, they may be deducted as an expense. b. When manufacturers’ or retailers’ excise taxes are reflected in the price of an article that is purchased for business or income-producing purposes, the entire price paid for such article is deductible. 1) This applies even if the excise tax is separately stated. 2) If the purchase price is deductible currently, the tax included in the purchase price is also deductible. 3) If the purchase price is capitalized and amortized or depreciated, the tax included in the purchase price is also amortized or depreciated. c. The federal tax on automobiles may not be deducted by the ultimate purchaser. d. Common Excise Taxes 1) Environmental taxes on the sale or use of ozone-depleting chemicals and imported products containing or manufactured with these chemicals 2) Communications and air transportation taxes 3) Fuel taxes 4) Tax on the first retail sale of heavy trucks, trailers, and tractors 5) Manufacturers’ taxes on the sale or use of a variety of different articles e. The manufacturer of an item may be eligible for a credit or refund of the manufacturer’s tax for certain uses, sales, exports, and price readjustments. The claim must set forth in detail the facts upon which it is based. Real Estate Taxes 7. Any state, local, or foreign taxes on business real property are deductible when paid. a. If real estate is sold, the deduction for real estate taxes must be divided between the buyer and the seller according to the number of days in the real property year. b. Real estate taxes paid into an escrow account are deductible when the funds are withdrawn and paid to the taxing authority. Penalties 8. Penalty taxes are generally not deductible. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].