Chapter 11

1. Chapter 11 Individuals as Employees and Proprietors

2. The Big Picture (slide 1 of 3) Mark and Mary Herman come to you for tax advice. Mark Herman is a self-employed consultant. Last year, Mark’s business generated revenue of $165,000 and incurred expenses of $18,000 for rent and utilities. Mark also spent $8,000 purchasing depreciable equipment. He paid a part-time secretary $12,000 for administrative work. He hired an assistant and paid her $40,000. Mark paid $3,000 for his own health insurance and $500 for term life insurance He did not contribute to any retirement plans.

3. The Big Picture (slide 2 of 3) Mary (Mark’s wife) also works as a consultant but for a large firm. Her salary last year was $85,000. Mary’s employer paid $3,000 of premiums for her health insurance and provided $50,000 of group term life insurance. Mary is not covered by a qualified retirement plan. She contributed $5,500 to a traditional IRA. Mary routinely travels for her job. She was reimbursed by her employer for all travel expenses. In addition, Mary spent $500 on other unreimbursed employee business expenses.

4. The Big Picture (slide 3 of 3) What are the tax consequences of these items? Can Mark and Mary deduct the expenses they incurred? Are there other tax planning opportunities that the couple may be missing or tax issues of which they should be aware? Read the chapter and formulate your response.

5. Employee vs. Self-Employed(slide 1 of 2) Business expenses for self-employed persons are deductible for AGI Reported on Schedule C Unreimbursed business expenses for employees are generally deductible from AGI subject to 2% of AGI floor Reported on Form 2106 (Employee Business Expenses) and Schedule A (Itemized Deductions) 5

6. Employee vs. Self-Employed(slide 2 of 2) Person is classified as an employee if: Subject to will and control of another with respect to what shall be done and how it shall be done Another furnishes tools or the place of work Income based on time spent rather than task performed Other factors 6

7. The Big Picture – Example 1 Self-employed Individual Return to the facts of The Big Picture on p. 11-1. Mark is a consultant whose major client accounts for 60% of his billings. He does the routine consulting work at the client’s request. He is paid a monthly retainer in addition to amounts charged for extra work. Mark is a self-employed individual. Even though most of his income comes from one client, he still has the right to determine how the end result of his work is attained.

8. The Big Picture – Example 2 Employee Vs. Self-employed Return to the facts of The Big Picture on p. 11-1. Ellen is a recent MBA graduate hired by Mark to assist him in the performance of services for the client mentioned in Example 1. Ellen is under Mark’s supervision; he reviews her work and pays her an hourly fee. Ellen is Mark’s employee.

9. Advantages of Qualified Fringe Benefits Cost of qualified fringe benefits is deductible by employer Value of qualified fringe benefits is excluded from employee’s gross income 9

10. Employer-Sponsored Accident and Health Plans (slide 1 of 2) Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function 10

11. Employer-Sponsored Accident and Health Plans (slide 2 of 2) Payments for expenses that do not meet the Code’s definition of medical care must be included in gross income Amounts received for medical expenses deducted on a prior return must be included in gross income 11

12. Employer paid insurance premiums for employee’s long-term care are excludible subject to annual limits as follows: Long-Term Care Insurance (slide 1 of 2)

13. Long-Term Care Insurance (slide 2 of 2) • Exclusion of benefits received from policy is limited to the greater of: • $330 in 2014 for each day patient receives long-term care (indexed amount for 2013 is $320) • The actual cost of the care • Reduced by any amounts received from other third parties (e.g., damages received)

14. Meals and Lodging Not taxable to employee if: Furnished by employer On employer’s business premises For convenience of employer In the case of lodging, employee is required to accept lodging as a condition of employment 14

15. Meals and Lodging Not taxable to employee if: Furnished by employer On employer’s business premises For convenience of employer In the case of lodging, employee is required to accept lodging as a condition of employment 15

16. Meals and Lodging Not taxable to employee if: Furnished by employer On employer’s business premises For convenience of employer In the case of lodging, employee is required to accept lodging as a condition of employment 16

17. Meals and Lodging Not taxable to employee if: Furnished by employer On employer’s business premises For convenience of employer In the case of lodging, employee is required to accept lodging as a condition of employment 17

18. Group Term Life Insurance Premiums on the first $50,000 of group term life insurance are excluded from gross income For each $1,000 of coverage in excess of $50,000, the employee must include the amounts calculated using the IRS tables If plan discriminates in favor of certain key employees (e.g., officers), they are not eligible for the exclusion In such a case, key employees must include in gross income the greater of Actual premiums paid by the employer, or The amount calculated from the IRS tables 18

19. Group Term Life Insurance 19

20. Other Fringe Benefits (slide 1 of 3) Dependent care Up to $5,000 of care costs paid for by employer can be excluded Athletic facilities Value of use of athletic facilities located on employer premises can be excluded 20

21. Other Fringe Benefits (slide 2 of 3) Educational assistance programs Employer-provided educational assistance for undergraduate and graduate education is excludible Exclusion limited to $5,250 per year Includes tuition, fees, books, and supplies 21

22. Other Fringe Benefits (slide 3 of 3) Adoption assistance programs Employee adoption expenses paid or reimbursed by employer are excludible Exclusion limited to $13,400 Exclusion phases-out as AGI increases from $201,010 to $241,010 22

23. Cafeteria Plans Allow employees to choose between cash and certain nontaxable benefits If cash is chosen, the amount received is taxable If a nontaxable benefit is chosen, the benefit remains nontaxable Provide tremendous flexibility in tailoring the employee pay package to fit individual needs 23

24. Flexible Spending Plans Allow employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income Called a use or lose plan since reduction in pay cannot be recovered if covered expenses are less than expected 24

25. Classes of Nontaxable Employee Benefits No-additional-cost services Qualified employee discounts Working condition fringes De minimis fringes Qualified transportation fringes Qualified moving expense reimbursements Qualified retirement planning services 25

26. No Additional Cost Services Are nontaxable if: Employee receives services (not property) Employer incurs no substantial additional cost in providing the services Services offered are within line of business in which employee works Benefit is offered on nondiscriminatory basis 26

27. Qualified Employee Discounts Are nontaxable if: Discount is not on realty or investment property Item discounted is from same line of business in which employee works Discount cannot exceed gross profit on property or 20% of the customer price on services Benefit is offered on nondiscriminatory basis 27

28. Working Condition Fringes Not taxable if employee could have deducted cost of item if they had actually paid for them Includes personal use of auto by full-time auto salespeople and employee business expenses that would be eliminated by the 2% floor on miscellaneous deductions 28

29. De Minimis Fringes (slide 1 of 2) These benefits are so small that accounting for them is impractical Examples include: Supper money Occasional personal use of company copying machine Company cocktail parties Picnics for employees 29

30. De Minimis Fringes (slide 2 of 2) Subsidized eating facilities operated by employer are excluded if: Located on or near employer’s premises Revenue equals or exceeds direct operating costs Nondiscrimination requirements are met 30

31. Qualified Transportation Fringes This fringe benefit is designed to encourage the use of mass transit for commuting to work Includes: Transportation in commuter highway vehicle and transit passes Limit on the exclusion for 2014 is $130 per month Qualified parking Limit on the exclusion for 2014 is $250 per month Qualified bicycle commuting reimbursement Can exclude up to $20 per month received from an employer as reimbursement for the cost of commuting by bicycle i.e., Bicycle purchase, improvement, repair, and storage May be provided directly by the employer or may be in the form of cash reimbursements 31

32. Qualified Transportation Fringes This fringe benefit is designed to encourage the use of mass transit for commuting to work Includes: Transportation in commuter highway vehicle and transit passes Limit on the exclusion for 2015 is $130 per month Qualified parking Limit on the exclusion for 2015 is $250 per month Qualified bicycle commuting reimbursement Can exclude up to $20 per month received from an employer as reimbursement for the cost of commuting by bicycle i.e., Bicycle purchase, improvement, repair, and storage May be provided directly by the employer or may be in the form of cash reimbursements 32

33. Qualified Transportation Fringes This fringe benefit is designed to encourage the use of mass transit for commuting to work Includes: Transportation in commuter highway vehicle and transit passes Limit on the exclusion for 2015 is $130 per month Qualified parking Limit on the exclusion for 2015 is $250 per month Qualified bicycle commuting reimbursement Can exclude up to $20 per month received from an employer as reimbursement for the cost of commuting by bicycle i.e., Bicycle purchase, improvement, repair, and storage May be provided directly by the employer or may be in the form of cash reimbursements 33

34. Moving Expenses Employer payment or reimbursement of employee’s qualified moving expenses is excludible No deduction by employee is allowed for reimbursed moving expenses 34

35. Qualified Retirement Planning Services Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income Designed to motivate more employers to provide retirement planning services 35

36. Nondiscrimination Provisions For no-additional-cost services, qualified employee discounts, and qualified retirement planning services If the plan is discriminatory in favor of highly compensated employees, these key employees are denied exclusion treatment Non-highly compensated employees can still exclude these benefits from income 36

37. Foreign Earned Income (slide 1 of 2) Income from personal services in a foreign country can be excluded from income To qualify for the exclusion, must be either: A bona fide resident of foreign country, or Present in foreign country at least 330 days during any 12 consecutive months 37

38. Foreign Earned Income (slide 2 of 2) Exclusion amount is limited to $100,800 for 2015 For married persons, both of whom have foreign earned income, the exclusion is computed separately for each spouse 38

39. Employee Expenses Fall into one of the following categories: Transportation Travel Moving Education Entertainment Other Contributions to retirement accounts 39

40. Transportation Expenses(slide 1 of 2) 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 40

41. 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 57.5 cents per mile for business miles for 2015 Adjustment to basis of auto is required for depreciation considered allowed Plus parking, tolls, etc. Adequate documentation of mileage required 41

42. Travel Expenses (slide 1 of 2) Travel expense defined Expenses while “away from tax home” overnight on business Includes transportation, lodging, 50% meals, and miscellaneous expenses 42

43. Travel Expenses (slide 2 of 2) “Away from home” requirement Need not be a 24-hour period but must be longer than ordinary work day and taxpayer will need to rest during release time Being “away” should be a temporary situation (not in excess of 1 year) “Tax Home” generally means business location, post, or station of the taxpayer 43

44. Combined Business/Pleasure Travel(slide 1 of 4) Only actual expenses for business are deductible Meals, lodging and other expenses must be allocated between business and personal days Deductibility of transportation costs depends on whether the trip is domestic or foreign 44

45. Combined Business/Pleasure Travel(slide 2 of 4) For domestic travel If primary purpose of trip is business, transportation is deductible in full If primary purpose is pleasure, no deduction for transportation allowed, but other expenses (e.g., lodging) associated with business days are deductible 45

46. Combined Business/Pleasure Travel(slide 3 of 4) For foreign travel 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 46

47. Combined Business/Pleasure Travel(slide 4 of 4) Travel days are considered business days Weekends, legal holidays and intervening days are business days if both the preceding and succeeding days are business days If trip is primarily for pleasure, no transportation expenses are deductible 47

48. Moving Expenses Deductible for moves in connection with the commencement of work at a new principal place of work Two tests must be met for moving expenses to be deductible Distance test Time test 48

49. Moving Expenses - Distance Test Distance from old home to new job must be at least 50 miles farther than from old home to old job New home location not relevant for decision 49

50. Example of Distance Test Gail lived 20 miles from her old job Gail’s new job is 75 miles from her old home Gail meets the distance test Old Job 20 mi. Old Residence 75 mi. New Job 50