Exam 2 ACTG 401 Individual Taxation

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  1. 6: Deductions for AGI
    • –Can be claimed even if taxpayer does not itemize
    • –Important in determining the amount of certain itemized deductions 
    • *Certain itemized deductions are limited to amounts in excess of specified percentages of AGIe.g., Medial expenses (10 % of AGI), misc. itemized deductions ( 2% of AGI)
  2. 6: Deductions from AGI:
    • -In total, must exceed the standard deduction to provide any tax benefit
    • -Called “below the line” or itemized deductions
  3. 6: Deductions for AGI- Partial list includes:
    • -Trade or business expenses
    •     *Includes 100% of health insurance premiums paid by a self-employed individual
    • -Reimbursed employee business expenses (hmm. Really?)
    • -Deductions from losses on sale or exchange of property
    • -Deductions from rental and royalty property -Alimony
    • -One-half of self-employment tax paid
  4. 6: Deductions for AGI Partial list includes (continued):
    • -Contributions to pension, profit sharing, annuity plans, IRAs, etc.
    • -Penalty on premature withdrawals from time savings accounts or deposits
    • -Moving expenses (business related – See pages 9-12/14)
    • -Interest on student loans (limited – See page 10-15)
    • -Qualified tuition and related expenses under § 222 (Chapter 9)
    • -Up to $250 for teacher supplies for elementary and secondary school teachers (Chapter 9)
  5. 6: Deductions from AGI Itemized deductions include:
    • -Medical expenses (in excess of 10% of AGI) -Certain state and local taxes
    • -Contributions to qualified charitable organizations
    • -Personal casualty losses (in excess of 10 % of AGI and a $100 floor per casualty)
    • -Certain personal interest expense (e.g., mortgage interest on a personal residence)
    • -Miscellaneous itemized deductions (in excess of 2% of AGI)
  6. 6: Trade or Business Deductions
    • In order for business expenses to be deductible, they must be:
    • -Ordinary: normal, usual, or customary for others in similar business, and not capital in nature
    • -Necessary: prudent businessperson would incur same expense
    • -Reasonable: question of fact
    • -Incurred in conduct of business
  7. 6: Section 212 Expenses
    • Section 212 allows deductions for ordinary and necessary expenses paid or incurred for the following:
    • -The production or collection of income
    • -The management, conservation, or maintenance of property held for the production of income
    • -Expenses paid in connection with the determination, collection, or refund of any tax
  8. 6: Section 212 Expenses Cont.
    • § 212 expenses that are deductions for AGI include:
    • -Expenses related to rent and royalty income
    • -Expenses paid in connection with the determination, collection, or refund of taxes related to the income of sole proprietorships, rents and royalties, or farming operations

    • All other § 212 expenses are itemized deductions (deductions from AGI)
    • -For example, investment-related expenses (e.g., safe deposit box rentals, investment advice) are deductible as itemized deductions attributable to the production of investment income
  9. 6: Methods of Accounting
    • The method of accounting affects when deductions are taken
    • -Cash: expenses are deductible only when paid
    • -Accrual: expenses are deductible when incurred

    Deduction for reserves is not allowed (warranty, liability, allowance for doubtful accounts, etc.)
  10. 6: Expenditures Contrary To Public Policy
    Deductions are disallowed for certain specific types of expenditures that are considered contrary to public policy

    -Examples: penalties, fines, illegal bribes or kickbacks, two-thirds of treble damage payments for violation of anti-trust law
  11. 6: Expenses Relating To An Illegal Business
    Usual expenses of operating an illegal business are deductible

    -However, deduction for fines, bribes to public officials, illegal kickbacks, and other illegal payments are disallowed

    -Trafficking in controlled substances: only cost of goods sold can reduce gross income
  12. 6:Political Contributions And Lobbying Activities
    Generally, no business deduction is allowed for payments made for political purposes or for lobbying

    • Exceptions are allowed for lobbying:
    • -To influence local legislation (city and county),
    • -To monitor legislation, and
    • -De minimis in-house expenses (limited to $2,000)If greater than $2,000, none can be deducted
  13. 6: Excessive Executive Compensation
    • For publicly held corporations:
    • -Deduction for compensation of CEO and four other highest compensated officers is limited to $1 million each

    • -Does not include:
    • -Certain performance-based compensation -Payments to qualified retirement plans
    • -Payments excludible from gross income
  14. 6: Investigation Of A Business (1 of 3)
    • Investigation expenses - incurred to determine the feasibility of entering a new business or expanding an existing business
    • -Include costs such as travel, engineering, architectural surveys, marketing reports, various legal and accounting services

    • Tax treatment of these expenses depends on:
    • -The current business, if any, of the taxpayer
    • -The nature of the business being investigated
    • -The extent to which the investigation has proceeded
    • -Whether or not the acquisition actually takes place
  15. 6: Investigation Of A Business (2 of 3)
    • If the taxpayer is in a business the same as or similar to that being investigated
    • -Investigation expenses are deductible in the year paid or incurred
    • The tax result is the same whether or not the taxpayer acquires the business being investigated
  16. 6: Investigation Of A Business ( 3 of 3)
    • When the taxpayer is not in a business the same as or similar to that being investigated
    • -Tax result depends on whether new business is acquired

    • If not acquired
    • -All investigation expenses generally are nondeductible
    • If acquired
    • -Investigation expenses must be capitalized
    • -May elect to deduct the first $5,000 of expenses currently
    • -Any excess expenses can be amortized over a period of not less than 180 months (15 years)
    • -In arriving at the $5,000 immediate deduction allowed, a dollar-for-dollar reduction must be made for those expenses in excess of $50,000
  17. 6: Hobby Losses (slide 1 of 5)
    • Hobby defined
    • Activity not entered into for profit
    • *Personal pleasure associated with activity
    • *Examples: raising horses, fishing boat charter

    • If an activity is not engaged in for profit, the hobby loss rules apply
    • -Hobby expenses are deductible only to the extent of hobby income
  18. 6: Hobby Losses (slide 2 of 5)
    • 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

    • 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 (see textbook page 6-17)
  19. 6 :Hobby Losses (slide 3 of 5)
    • Presumptive rule of § 183
    • -If activity shows profit 3 out of 5 years (2 out of 7 years for horses), the activity is presumed to be a trade or business rather than a personal hobby
    • -Rebuttable presumption, shifts burden of proof to IRS

    Otherwise, taxpayer has burden to prove profit motive
  20. 6: Hobby Losses (slide 4 of 5)
    • If an activity is deemed to be a hobby
    • -Can only deduct expenses to extent of income from activity (i.e., cannot deduct hobby losses)
    • -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 are deductible in full, such as Home mortgage interest Property taxes
  21. 6: Hobby Losses (slide 5 of 5)
    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
  22. 6: Rental Vacation Homes - General, and Categories
    • May have both personal and rental use of a vacation home
    • -Determination of vacation home treatment is dependent on personal use vs. rental use

    • Categories:
    • Primarily personal use
    • Primarily rental use
    • Personal/rental use
  23. 6: Rental Vacation Homes - Primarily Personal Use
    • Rent less than 15 days:
    • -No gross income recognized from rentals and no deductible rental expenses
    •      *Mortgage interest and property taxes            treated as if on personal residence              (generally deductible in full)
    • Rent more than 14 days: Treatment depends on amount of personal use
  24. 6: Rental Vacation Homes - Primarily Rental Use
    • -If rented for 15 days or more and personal use days NOT more than the greater of 14 days or 10 percent of fair rental days
    • -Can deduct all expenses allocated to rental use even if loss results
    •     Rental loss subject to at-risk and passive loss rules
  25. 6: Rental Vacation Homes - Tax treatment of primarily rental vacation home
    • Tax treatment of income and expenses of a primarily rental vacation home
    • -Rental income included in gross income
    • -Rental expenses deductible for AGI
    • -Rental income and expenses reported on Sch. E
  26. 6: Rental Vacation Homes - Personal/Rental use
    -If rented for 15 days or more and personal use days exceed the greater of 14 days or 10 percent of fair rental days

    • -Expense treatment:
    •       *Rental expenses deducted in three step       process
    •       *No rental loss allowed
    •             But carryforward of disallowed rental                         expenses
  27. 6: Rental Vacation Homes - Allocation of Expenses
    • Allocation of expenses between personal and rental
    • -Mortgage interest and real estate taxes
    •    Courts have allowed allocation based on days in year
    • -Other expenses are allocated based on total days used
  28. 6: Rental Vacation Homes - Treatment of allocated personal portion of vacation home expenses.
    • Primarily rental use: taxes deductible from AGI, mortgage interest nondeductible (personal interest)
    • Personal/rental use: mortgage interest and taxes deductible from AGI
    • Personal portion of other expenses (e.g., insurance, maintenance) nondeductible
  29. 6: Expenditures Incurred for Taxpayer’s Benefit or Obligation
    • No deduction is allowed for payment of another taxpayer’s expenses
    • -Must be incurred for taxpayer’s benefit or arise from taxpayer’s obligation
    • -Exception: Payment of medical expenses for a dependent
  30. 6: Capital Expenditures
    • -Amounts are capitalized
    • -Asset may be subject to depreciation (or cost recovery), amortization, or depletion
  31. 6: Transactions Between Related Parties (1 of 2)
    • Section 267 disallows losses from sales or exchanges of property between related parties
    • Related parties include:
    • -Brothers, sisters, spouse, ancestors, descendants (children and grandchildren)
    • -A corporation owned more than 50% by the taxpayer
  32. 6: Transactions Between Related Parties (slide 2 of 2)
    • Section 267 also requires the matching principle be applied for unpaid expenses and interest when different accounting methods used
    • -Example: An accrual basis, closely held corporation, cannot deduct accrued, but unpaid, salary to cash basis related party employee/shareholder until it is actually paid
  33. 6: Expenses and Interest Relating to Tax-Exempt Income
    Expenses relating to production of tax-exempt income are nondeductible

    -Example: interest expense on loan where funds used to acquire municipal bonds
  34. 7: Bad Debts
    • If an account receivable arising from credit sale of goods or services becomes worthless
    • -A bad debt deduction is permitted only if income arising from creation of the receivable was previously included in income
    • -No deduction is allowed if taxpayer is on the cash basis since no income is reported until the cash has been collected
  35. 7: Business Bad Debts
    • Specific charge-off method must be used for accrual basis taxpayers
    • -Exception: Reserve method is allowed for some financial institutions
    • -Deduct as ordinary loss in the year when debt is partially or wholly worthless
  36. 7: Nonbusiness Bad Debts
    • Nonbusiness bad debt definition
    • -Debt unrelated to the taxpayer’s trade or business

    • Deduct as short-term capital loss in year amount of worthlessness is known with certainty
    • -No deduction is allowed for partial worthlessness of a nonbusiness bad debt
  37. 7: Classification of Bad Debts
    • Individuals will generally have nonbusiness bad debts unless:
    • -In the business of loaning money, or 
    • -Bad debt is associated with the individual’s trade or business

    Determination is made either at the time the debt was created or when it became worthless
  38. 7: Worthless Securities
    Loss on worthless securities is deductible in the year they become completely worthless

    • -These losses are capital losses deemed to have occurred on the last day of the year in which the securities became worthless
    • -Capital losses may be of limited benefit due to the $3,000 capital loss limitation
  39. 7: Section 1244 Stock (slide 1 of 2)
    Sale or worthlessness of § 1244 stock results in ordinary loss rather than capital loss for individuals

    • -Ordinary loss treatment (per year) is limited to $50,000 ($100,000 for MFJ taxpayers)
    • *Loss in excess of per year limit is treated as capital loss
  40. 7: Section 1244 Stock (slide 2 of 2)
    Section 1244 loss treatment is limited to stock owned by original purchaser who acquired the stock from the corporation

    • Corporation must meet certain requirements for stock to qualify
    •      -Major requirement is limit of $1 million         of capital contributions (at the time the       stock is issued)

    Section 1244 does not apply to gains
  41. 7: Definition of Casualty & Theft
    Losses or damages to the taxpayer’s property that arise from fire, storm, shipwreck, or other casualty or theft

    • -Loss is from event that is identifiable, damaging to taxpayer’s property, and sudden, unexpected, and unusual in nature
    • -Events not treated as casualties include losses from disease and insect damage
  42. 7: When Casualty & Theft Is Deductible
    Casualties: year in which loss is sustained

       -Exception: If declared “disaster area” by      President, can elect to deduct loss in year     prior to year of occurrence

    Thefts: year in which loss is discovered
  43. 7: Effect of Claim for Reimbursement
    • If reasonable prospect of full recovery:
    • -No casualty loss is permitted
    • -Deduct in year of settlement any amount not reimbursed

    • If only partial recovery is expected, deduct in year of loss any amount not covered
    •    -Remainder is deducted in year claim is          settled
  44. 7: Amount of Casualty and Theft Deduction
    • Amount of loss and its deductibility depends on whether:
    • -Loss is from nonpersonal (business or production of income) or personal property
    • -Loss is partial or complete
  45. 7: Amount of Nonpersonal (Business and Income Producing Property) Casualty and Theft Losses
    • Theft or complete casualty (FMV after = 0)
    • -Adjusted basis in property less insurance proceeds

    • Partial casualty
    • -Lesser of decline in value or adjusted basis in property, less insurance proceeds
  46. 7: Nonpersonal Casualty and Theft Losses
    • Losses on business, rental, and royalty properties
    • -Deduction will be for AGI
    • -Not subject to the $100 per event and the 10% of AGI limitation

    • Losses not connected with business, rental, and royalty properties
    • -Deduction will be from AGI
    • -Example - theft of a security
    •      *Theft losses of investment property are not                subject to the 2% of AGI floor on certain                    miscellaneous itemized deductions
  47. 7: Nonpersonal Casualty and Theft Gains
    Depending on the property, gain can be ordinary or capital

    • Amount of nonpersonal gains
    • -Insurance proceeds less adjusted basis in property
  48. 7: Personal Casualty and Theft Gains and Losses
    • Casualty and theft losses attributable to personal use property are subject to the $100 per event and the 10% of AGI limitations
    • -These losses are itemized deductions

    • Amount of personal casualty and theft losses
    • -Lesser of decline in value or adjusted basis in property, less insurance proceeds

    Insurance proceeds may result in gain recognition on certain casualty and thefts
  49. 7: Research and Experimental Expenditures (slide 1 of 2)
    • Definition of research and experimental (R&E) expenditures
    • -Costs for the development of an experimental model, plant process, product, formula, invention, or similar property and improvement of such existing property
  50. 7: Research and Experimental Expenditures (slide 2 of 2)
    • Three alternatives are available for R&E expenditures
    • -Expense in year paid or incurred,
    • -Defer and amortize over period of 60 months or more, or
    • -Capitalize (deductible when project abandoned or worthless)

    Tax credit of 20% of certain R&E expenditures is available
  51. 7: Domestic Production Activities Deduction (slide 1 of 4)
    • The American Jobs Creation Act of 2004 created a new deduction based on the income from manufacturing activities
    • -The Domestic Production Activities deduction is based on the following formula:
    • 9% × Lesser of
    • *Qualified production activities income
    • *Taxable (or modified adjusted gross) income or AMTI

    The deduction cannot exceed 50% of an employer’s W–2 wages paid to employees engaged in qualified production activities
  52. 7: Domestic Production Activities Deduction (slide 2 of 4)
    • Qualified production activities income is the excess of domestic production gross receipts over the sum of:
    • -Cost of goods sold attributable to such receipts
    • -Other deductions, expenses, or losses that are directly allocable to such receipts
    • -A share of other deductions, expenses, and losses that are not directly allocable to such receipts or another class of income
  53. 7:Domestic Production Activities Deduction (slide 3 of 4) - Categories
    • Domestic production gross receipts include the following five specific categories:
    • -The lease, license, sale, exchange, or other disposition of qualified production property manufactured, produced, grown, or extracted in the U.S.
    • -Qualified films largely created in the U.S.
    • -The production of electricity, natural gas, or potable water
    • -Construction (but not self-construction) performed in the U.S.
    • -Engineering and architectural services for domestic construction

    • Items specifically excluded from this definition include:
    • -The sale of food and beverages prepared by a taxpayer at a retail establishment and
    • -The transmission or distribution of electricity, natural gas, or potable water
  54. 7: Domestic Production Activities Deduction (slide 4 of 4) - Eligible Taxpayers
    • Eligible taxpayers include:
    • -Individuals, partnerships, S corporations, C corporations, cooperatives, estates, and trusts
    • -For a pass-through entity (e.g., partnerships, S corporations), the deduction flows through to the individual owners
    • -For sole proprietors, a deduction for AGI results and is claimed on Form 1040, line 35 on page 1
  55. 7: Net Operating Losses (slide 1 of 3) - NOL General
    • NOLs from any one year can be offset against taxable income of other years
    • -The NOL provision is intended as a form of relief for business income and losses

    -Only losses from trade or business operations, casualty and theft losses, or losses from foreign government confiscations can create a NOL
  56. 7: Net Operating Losses (slide 2 of 3) - Carryover periods
    • -Must carryback to 2 prior years, then carryforward to 20 future years
    • *May make an irrevocable election to just carryforward
    • *When there are NOLs from two or more years, use on a FIFO basis

    • -3 year carryback is available for:
    • *Individuals with NOL from casualty or thefts
    • *Small businesses with NOLs from Presidentially declared disasters

    5-year carryback period and a 20-year carryover period are allowed for a farming loss
  57. 7: Net Operating Losses (slide 3 of 3) - Computing NOL Amount
    • Computing NOL amount
    • -Individual must start with taxable income and add back:

    • 1. Personal and dependency exemptions
    • 2. NOLs from other years
    • 3. Excess nonbusiness capital losses
    • 4. Excess nonbusiness deductions
    • 5. Excess business capital losses
  58. 8: Cost Recovery
    • Recovery of the cost of business or income-producing assets is through:
    • -Cost recovery or depreciation: tangible assets
    • -Amortization: intangible assets
    • -Depletion: natural resources
  59. 8: Nature of MACRS Property
    • Property includes both real property and personal property
    • -Real estate generally includes land and buildings permanently affixed to the land
    • -Personal property is defined as any asset that is not real estate
    •    *Personal property includes furniture, machinery,            equipment, and many other types of assets

    • Personal property should NOT be confused with personal use property
    • -Personal use property is any property (real estate or personal property) that is held for personal use rather than for use in a trade or business or an income-producing activity
    •    *losses are not allowed for personal use assets
  60. 8: MACRS General Considerations (slide 1 of 2) - Personal Use assets converted to business or income-producing use
    • Basis for cost recovery and for loss is lower of
    • -Adjusted basis or
    • -Fair market value at time property was converted

    Losses that occurred prior to conversion can not be recognized for tax purposes through cost recovery
  61. 8: MACRS General Considerations (slide 2 of 2) - Applies to:
    -Assets used in a trade or business or for the production of income

    -Assets subject to wear and tear, obsolescence, etc.

    -Assets that have a determinable useful life or decline in value on a predictable basis

    -Assets that are tangible personal property or real estate
  62. 8: MACRS: Additional First-Year Depreciation (slide 1 of 2)
    -50% additional first-year depreciation has been allowed for several years

    • -The Small Business Jobs Act of 2010 extended additional first-year depreciation for one more year
    • *Effective for qualified property acquired and placed in service before January 1, 2011

    • -The Tax Relief Act of 2010 extended additional first-year depreciation for 2011 *Increases the percentage from 50% to 100%
    • *Effective for qualified property placed in service after Sept. 8, 2010 and before Jan. 1, 2012

    • -The American Taxpayer Relief Act of 2012 extended additional first-year depreciation for 2012 and 2013, but at the 50% rate
    • *Effective for qualified property placed in service after Dec. 31, 2011 and before Jan. 1, 2014
  63. 8: MACRS: Additional First-Year Depreciation (slide 2 of 2)
    Additional first-year depreciation allows an additional percentage (50% for 2013) of cost recovery in the year the asset is placed in service

    • Qualified property includes most types of NEW property other than buildings
    •    -Property that is used but new to the             taxpayer does not qualify
  64. 8: Mid-Quarter Convention
    Applies when more than 40% of personal property is placed in service during last quarter of year

    Assets treated as if placed into service (or disposed of) in the middle of the quarter in which they were actually placed in service (or disposed of)

    Applies to personal property – not real estate
  65. 8: MACRS - Real Estate
    • Statutory Lives: 
    • -Redidential Rental = 27.5yrs
    • -NonResid. Real Estate = 39yrs

    • Method: Straight Line
    • Convention: Mid-Month

    • Residential rental real estate
    • -Includes property where 80% or more of gross rental revenues are from nontransient dwelling units
    • -e.g., Apartment building
  66. 8: Farm Property - MACRS
    • Generally, for farm assets use:
    • -MACRS 150% declining-balance method for personal property
    •     *MACRS straight-line method is required for any tree       or vine bearing fruits or nuts

    -Straight line method over the normal periods (27.5 years and 39 years) for real property

    -Cost recovery periods for farm assets are shown in Exhibit 8.2 (page 8-13)
  67. 8: Leasehold Improvement Property (slide 1 of 2) - Lessor
    • If lessor is owner of leasehold improvement property, depreciation is calculated as follows:
    • -Real Property – Use straight-line method over 27.5 or 39 year statutory recovery periods
    • -Tangible personal property – Use the shorter MACRS lives and accelerated methods

    • When these improvements are disposed of or abandoned by the lessor due to lease termination
    • -Property is treated as disposed of by the lessor
    • -A loss can be taken for the unrecovered basis
  68. 8: Leasehold Improvement Property (slide 2 of 2) - Lessee
    • If lessee is owner of leasehold improvement property
    • -Costs of leasehold improvements are recovered in accordance with the general cost recovery rules
    •     *Cost recovery period is determined without regard        to the lease term

    -Any unrecovered basis in the leasehold improvement property not retained by the lessee is deducted in the year the lease is terminated
  69. 8: Election to Expense Assets -Section 179 (slide 1 of 3) - General Rules
    Can elect to immediately expense up to $500,000 of business tangible personal property placed in service in 2013

    Cannot use § 179 for most real estate or production of income property
  70. 8: Election to Expense Assets -Section 179 (slide 2 of 3) - General Rules Cont.
    Section 179 general rules

    -Amount expensed reduces depreciable basis

    • -Any elected § 179 expense is taken before additional first-year depreciation is computed
    • *The base for calculating the standard MACRS deduction is net of the § 179 expense and the additional first-year depreciation (50% in 2013).
  71. 8: Listed Property (slide 1 of 2) -  Listed property includes:
    There can be substantial limits on cost recovery of assets considered listed property

    Listed property includes the following:

    • -Passenger automobile (GVW 6,000 lbs. or less)
    • -Other property used as a means of transportation
    • -Property used for entertainment, recreation, or amusement
    • -Computer or peripheral equipment, not used exclusively at a business establishment
  72. 8: Listed Property (slide 2 of 2) - Rules
    • To be considered as predominantly used for business, business use must exceed 50%
    • -If 50% test is met, then allowed to use statutory percentage method of cost recovery with some limitations

    • If asset is not used predominantly for business i.e., business use does not exceed 50%
    • -Must use straight-line method
    • -If business use falls to 50% or lower after year property is placed in service, must recapture excess cost recovery
  73. 8: Passenger Auto Cost Recovery Limits
    • Year           Recovery Limit
    • 1                   $3,160
    • 2                   $5,100
    • 3                   $3,050
    • Remaining until cost recovered:  $1,875

    • If a new passenger auto is used predominatly for business it qualifies for additional first-year depreciation.
    • *First year recovery limit is increased by $8,000 (3,160+8,000) for total of $11,160
  74. 8: Passenger Auto Cost Recovery Limits (slide 2 of 4)
    • Limits are for 100% business use
    • -Must reduce limits by percentage of personal use

    Limit in the first year includes any amount the taxpayer elects to expense under § 179
  75. 8: Passenger Auto Cost Recovery Limits (slide 3 of 4) - Limit on SS179 Deduction
    • For certain vehicles not subject to the statutory dollar limits imposed on passenger automobiles the § 179 deduction is limited to $25,000
    • *The limit applies to sport utility vehicles with an unloaded GVW rating of more than 6,000 pounds and not more than 14,000 pounds
  76. Passenger Auto Cost Recovery Limits (slide 4 of 4) _ Lease Autos
    Leased autos subject to inclusion amount rule

    • -Using IRS tables, taxpayer has gross income equal to each lease year’s inclusion amount
    • -Purpose is to prevent avoidance of cost recovery dollar limits applicable to purchased autos by leasing autos
  77. 8: Alternative Depreciation System (ADS)
    • ADS is an alternative depreciation system that is used in calculating depreciation for:
    • -Alternative minimum tax (AMT)
    • -Assets used predominantly outside the U.S.
    • -Property owned by the taxpayer and leased to tax exempt entities
    • -Earnings and profits

    • Generally, use straight-line recovery without regard to salvage value
    • -For AMT, 150% declining balance is allowed for personal property
  78. 8: Amortization (slide 1 of 2) -
    • Can claim amortization deduction on § 197 intangibles
    • -Use straight-line recovery over 15 years (180 months) beginning in month intangible is acquired

    Section 197 intangibles include acquired goodwill, going-concern value, trademarks, trade names, etc.
  79. 8: Amortization (slide 2 of 2)
    • Startup expenditures are also partially amortizable under § 195
    • -Treatment is available only by election

    • Allows the taxpayer to deduct the lesser of:
    • -The amount of startup expenditures, or

    -$5,000, reduced by the amount startup expenditures exceed $50,000

    -Any amounts not deducted may be amortized ratably over 180-months beginning in month trade or business begins
  80. 8: Depletion (slide 1 of 4) - Two Methods
    Cost: determined by using the adjusted basis of the resource and allocating over the recoverable units

    Percentage: determined using percentage provided in Code and multiplying by gross income from resource sales
  81. 8: Depletion (slide 2 of 4) - Cost
    -Depletion is computed on a per unit basis

    • -Per unit amount is determined by dividing the basis of the resource by the estimated recoverable units of resource
    •  *Number of units sold in year × per unit depletion = depletion for year

    -Total depletion can not exceed total cost of the property
  82. 8: Depletion (slide 3 of 4) - Percentage
    -Depletion is computed by using the statutory percentage rate for the type of resource

    -Rate is applied to the gross income from the property
  83. 8: Depletion (slide 4 of 4)- Percentage limitations
    Percentage depletion cannot exceed 50% of the taxable income (before depletion) from the property

    Percentage depletion reduces basis in property

    • However, total percentage depletion may exceed the total cost of the property
    • *Example: Property with zero basis but still generating income
  84. 8: Intangible Drilling Costs (IDC)
    • Intangible drilling costs include
    • -Costs for making the property ready for drilling
    • -Costs of drilling the hole

    • Treatment of IDC
    • -Expense in the year incurred, or
    • -Capitalize and write off through depletion

    It is generally advantageous to write off IDC immediately
  85. 9: Employee vs. Self-Employed
    • Business expenses for self-employed persons are deductible for AGI
    • *Reported on Schedule C

    • Unreimbursed business expenses for employees are generally deductible from AGI as miscellaneous itemized deductions subject to 2% of AGI floor
    • *Reported on Form 2106 (Employee Business Expenses) and Schedule A (Itemized Deductions)
  86. 9: Employee Expenses
    • Employee expenses fall into one of the following categories:
    • Transportation
    • Travel
    • Moving
    • Education
    • Entertainment
    • Other
  87. 9: Transportation Expenses (slide 1 of 2)
    • Deductible transportation expense defined
    • -Very limited, only from job site to job site and commuting to/from 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
  88. 9: Transportation Expenses (slide 2 of 2) - Amount Deductible
    • Actual expenses
    • -Must keep adequate records of all expenses and depreciation is limited, or

    • Automatic mileage method
    • -56.5 cents per mile for business miles for 2013
    • *Adjustment to basis of auto is required for depreciation considered allowed
    • -Plus parking, tolls, etc.
    • -Documentation of mileage required
  89. 9: Travel Expenses - Travel Expense Defined
    Expenses while “away from tax home” overnight on business

    Includes transportation, lodging, 50% meals, and miscellaneous expenses
  90. 9: Combined Business/Pleasure Travel (slide 1 of 3)
    • 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
  91. 9: Combined Business/Pleasure Travel (slide 2 of 3) - Domestic Travel - Transportation
    If primary purpose of trip (> 50%) 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
  92. 9: Combined Business/Pleasure Travel (slide 3 of 3) - Foreign Travel - Transporation
    Transportation expenses 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
  93. 9: Moving Expenses - and two Tests
    Deductible for moves in connection with the commencement of work at a new principal place of work

    Unreimbursed moving expenses are deductible for AGI

    • Two tests must be met for moving expenses to be deductible
    • Distance test
    • Time test
  94. 9: Moving Expenses - Distance & Time Tests
    • Distance Test
    • -Distance from old home to new job must be at least 50 miles farther than from old home to old jobNew home location not relevant for decision
    • Time Test
    • -Taxpayer must be full-time employee for 39 weeks in the 12-month period following the move
  95. 9: Deductible 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 $0.24 per mile for each car in 2013

    Meals are not deductible as moving expense
  96. 9: Employee Education Expenses - are are deductible if
    • Education expenses of an employee are deductible if they are incurred:
    • -To maintain or improve existing skills, or
    • -To meet express requirements of the employer or requirements imposed by law to retain employment status
  97. 9: Employee Education Expenses - are NOT deductible if
    • Education expenses of an employee are not deductible if they are incurred:
    • -To meet minimum educational standards for existing job, or
    • -To qualify taxpayer for new trade or business
  98. 9: Education Expenses - Include
    • Tuition
    • Books
    • Supplies
    • Transportation
    • Travel (including lodging and 50% of meals)
  99. 9: Entertainment Expenses (slide 1 of 2)
    Deductions are very restricted due to abuse possibilities

    • -Deductible amount allowed:
    •     *50% of meals and entertainment costs         including related taxes, tips, cover               charges, parking fees, and room rental         fee

    -Amounts cannot be lavish or extravagant
  100. 9: Entertainment Expenses (slide 2 of 2) - 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
  101. 9: Restrictions on Entertainment Expenses- 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%)
  102. 9: Restrictions on Entertainment Expenses - Ticket Purchases for entertainment
    Amounts paid in excess of face value of ticket are not deductible

    Limitation on deductibility of luxury skybox expenditures
  103. 9: Restrictions on Entertainment Expenses - Business Gifts
    • Business gifts of tangible personal property 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
  104. 9: Office in the Home (slide 1 of 2)
    • 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
  105. 9: Office in the Home (slide 2 of 2) - expenses cannot cause net _____ from business activity
    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
  106. 9: Other Employee Expenses - Partial list of other employee expenses that are deductible:
    • -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
  107. 9: Contributions to Retirement Accounts
    • Retirement plans fall into two major classifications depending on who is covered
    • -For employees – usually follow one of two income tax approaches
    •      *Most plans allow an exclusion from              income for the contributions the                  employee makes to the pension plan
    •      *Alternatively, using the approach                  followed by a traditional IRA, a                    contributing employee is allowed a              deduction for AGI
    • Maximum deduction is $5,500 for 2013
  108. 9: Classification of Employee Expenses
    • Employers can have three types of reimbursement plans:
    • Accountable
    • Nonaccountable
    • No reimbursement is given
  109. 9: Accountable Plan
    Plan must require adequate accounting to the employer for expense reimbursed, and

    Any excess reimbursements must be returned to the employer
  110. 9: Substantiation for Expenditures
    Required substantiation:

    -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)
  111. 9: Nonaccountable Plan
    Plan that does not require adequate accounting to employer 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% of AGI limitation

    -Taxpayer must still be able to substantiate expenses
  112. 9: Miscellaneous Itemized Deductions
    Miscellaneous itemized deductions subject to the 2% of AGI limitation

    -Certain miscellaneous expenses must be added together and the amount in excess of 2% of taxpayer’s AGI is deductible from AGI (i.e., itemized deduction reported on Sch. A)
  113. 9: Miscellaneous Itemized Deductions - Examples
    • -Most expenses under a nonaccountable plan
    • Unreimbursed employee expenses
    • -Union dues
    • -Job hunting expenses
    • -Tax return preparation fee
    • -Hobby expensesInvestment expenses (except interest and taxes)
  114. 9: Examples of Miscellaneous Itemized  Deductions Not Subject to 2% Floor
    -Impairment-related work expenses of handicapped individuals

    -Gambling losses to the extent of winnings

    -Certain terminated annuity payments

    -Ponzi scheme theft losses
Card Set
Exam 2 ACTG 401 Individual Taxation
Flash cards using PP for last part of Chap 5; 6,7,8 & 9
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