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Chapter 6

Chapter 6. Self-Employed Business Income Schedule C “A fine is a tax for doing something wrong. A tax is a fine for doing something right.” Anonymous. LO #1- Income and Expenses of the Self-Employed. Trade or Business – any activity that is engaged in for profit

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Chapter 6

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  1. Chapter 6 Self-Employed Business Income Schedule C “A fine is a tax for doing something wrong. A tax is a fine for doing something right.” Anonymous

  2. LO #1- Income and Expenses of the Self-Employed • Trade or Business – any activity that is engaged in for profit • Self-employed income is reported on Schedule C

  3. LO #1- Income and Expenses of the Self-Employed • Gross receipts include • Direct sales to customer • Work performed as an independent contractor • Amount reported to a “statutory employee” • Independent contractors usually receive a Form 1099-MISC to report income

  4. LO #1- Income and Expenses of the Self-Employed • Cost of Good Sold - reduction from sales to produce gross profit • Accrual Method of Accounting – must be used if inventory is a material income-producing factor

  5. LO #1- Income and Expenses of the Self-Employed: Concept Check 6-1 1. Schedule C is used only when an individual is an employee of a company. False • The income reported on a Schedule C will always match the amount the individual receives on one or more 1099-MISC. False

  6. LO #1- Income and Expenses of the Self-Employed: Concept Check 6-1 3. If inventory is a material income-producing factor, the accrual method of accounting must be used to account for inventory. True or False? True

  7. LO # 2 Ordinary & Necessary Trade or Business Expenses • To be deductible, expenses must be ordinary, necessary, and reasonable • Ordinary – expenses must be customary or usual • Necessary – expenses that are appropriate and helpful rather than essential • Reasonable – expenses must be reasonable in amount and reasonable in relation to its purpose

  8. LO # 2 Ordinary & Necessary Trade or Business Expenses • Forbidden Expenses • Bribes, kickbacks, and other illegal payments • Lobbying and political expenses • Fine and penalty payments • Not deductible even if ordinary, necessary, and reasonable

  9. LO # 2 Ordinary & Necessary Trade or Business Expenses: Concept Check 6-2 • For an expense to be deductible on Schedule C, the expense must be ________, ________, and ________. Ordinary, necessary, and reasonable • Certain types of expenditures are expressly forbidden from being deductible from income on Schedule C. What are two examples of forbidden expenses? ________ and ________ fines and penalties, bribes, lobbying

  10. LO #3 Depreciation • Component of Depreciation 1. Basis (usually the cost of the asset). 2. Depreciation Periods (Asset Class Lives). 3. Depreciation Convention (half-year, mid-quarter, mid-month). • Depreciation Method (200% or 150% Declining Balance or Straight-line). • Reported on Schedule C, Schedule E, and Form 2106

  11. LO #3 Depreciation • Basis • Asset purchased; Basis = Cost • Personal to Business; Basis = Lesser of FMV or cost • Non-taxable Exchange; Basis = Cost less the any deferred gain • Inherited; Basis = FMV at the date of death

  12. LO #3 DepreciationConcept Check 6-3 • Shelly purchased a laptop computer for her personal use last year for $2,200. This year, she started her own business and transferred the computer to business use. The value of the computer at transfer was $1,300. What is Shelly’s depreciable basis in her computer? $1,300 • Jackson purchased a van for $22,000 and used it 100% for business. In the current year, he deducted $4,400 in depreciation related to the van. What is Jackson’s adjusted basis in the van at the end of the current year? $17,600

  13. LO #3 Depreciation • Typical Depreciation Periods • 3 years Specialized tools, Racehorses • 5 years Auto, Trucks, Computers • 7 years Furniture, Fixtures, Equipment • 27.5 years Residential Real Property • 39 years Non-residential Real Property

  14. LO #3 DepreciationConcept Check 6-4 1. An auto used in a trade or business would be depreciated over what period of time for MACRS tax purposes? a. 3 years. b. 5 years. c. 7 years. d. 10 years Answer: B 2. An apartment complex would be depreciated over what period of time for MACRS tax purposes? a. 10 years. b. 20 years. c. 27 ½ years. d. 39 years Answer: C 3. A warehouse would be depreciated over what period of time for MACRS tax purposes? a. 10 years. b. 20 years. c. 27 ½ years. d. 39 years Answer: D

  15. LO #3 Depreciation • Depreciation Conventions • Half-year Convention • Mid-Quarter Convention • Mid-Month Convention • Year of Disposal – convention is the same in the year of disposal.

  16. LO #3 DepreciationConcept Check 6-5 • A taxpayer can choose any depreciation convention as long as he or she is consistent in doing so. False • A taxpayer must use mid-quarter convention for personal property if more than 40% of the property is purchased in the fourth quarter. True • The half-year convention is the most often used convention for personal property. True

  17. LO #3 DepreciationConcept Check 6-5 • To depreciate an apartment complex, a taxpayer should use the half-year convention. False • The taxpayer must use the same depreciation convention in the year of disposal as the convention used in the year of acquisition. True

  18. LO #3 Depreciation • Depreciation Methods • 200% Declining Balance Switching to Straight-line • 150% Declining Balance Switching to Straight-line • Straight-line

  19. LO #3 DepreciationConcept Check 6-6 1. Shu purchased a piece of business equipment for $12,000 on May 3, 2006. This equipment is the only business asset Shu purchased during the year. What is Shu’s depreciation expense related to the equipment? $1,715 2. If Shu sold the equipment on January 5, 2008, what would the depreciation expense be for 2008? $1,049 3. Davis purchased an apartment complex on March 5, 2006 for $330,000. What is Davis’s depreciation expense related to the complex? $9,501

  20. LO #3 Depreciation • Maximum IRC Section 179 expense • 2003 $100,000 • 2004 $102,000 • 2005 $105,000 • 2006 $108,000 • Property must be used in a trade or business • Section 179 expense cannot create an NOL

  21. LO #3 DepreciationConcept Check 6-7 • Assume the same asset purchase as Concept Check #6-6. Shu purchased a piece of business equipment for $12,000 on May 3, 2006. This equipment is the only business asset purchased during the year and the business has substantial income. What is Shu’s deduction for the equipment assuming §179 expense is elected? Would there be any additional MACRS regular depreciation? §179 Expense = $12,000; Additional MACRS = $0 2. What if the equipment Shu purchased had cost $150,000. What would the total expense deduction be if §179 were elected? §179 Expense = $108,000; Additional MACRS = $6,002

  22. LO #3 Depreciation • Listed property • Assets that have both a business and personal use component to them • Examples: autos, boats, computer equipment • Section 179 is not allowed if listed property is used less than 50% for business • Straight-line depreciation is required for listed property used less than 50% for business

  23. LO #3 Depreciation • Luxury Automobile Limitations • Autos less than 6,000 pounds • Light trucks or vans less than 6,000 lbs. have slightly higher limits AutoTruck • 1st year $2,960 $3,260 • 2nd year $4,800 $5,200 • 3rd year $2,850 $3,150 • 4th and after $1,775 $1,875 • SUV greater than 6,000 lbs – Section 179 is limited to $25,000

  24. LO #3 DepreciationConcept Check 6-8 • Zachary purchased a Ford Expedition (more than 6,000 lbs.) for $39,000 in March 2006. What is the maximum depreciation expense allowed assuming Zachary is eligible for §179 expense election? a. $7,800. b. $25,000. c. $3,260. d. $27,800. Answer: D 2. Assume the same facts as number 1 above. However, the Expedition was used only 80% for business. What is the maximum depreciation expense allowed assuming Zachary is eligible for §179 expense election? a. $7,800. b. $22,240. c. $2,608. d. $20,000. Answer: B

  25. LO #3 Depreciation • Leased Vehicles • “Lease inclusion amount”- the amount included in income when a leased vehicle is over the luxury auto levels • See Rev. Proc. 2006-18 for amounts • The total business lease amount is deductible

  26. LO #4 Transportation and Travel • Ordinary and necessary travel expenses are deductible • Transportation – expenses of getting from one workplace to another work place within the taxpayer’s home area • Travel – refers to business travel away from home that requires an overnight stay

  27. LO #4 Transportation and Travel • Deductible Local Transportation Cost • Getting from one workplace to another workplace • Visiting clients and customers • Business meeting away from the taxpayer’s regular workplace • Getting from home to a temporary workplace • Transportation between a home office and temporary work location is deductible

  28. LO #4 Transportation and Travel • Automobile Expenses • Standard Mileage Rate 44 ½ cents in 2006 • Actual Expenses – actual business auto costs are deducted • Actual expenses usually gives a larger deduction but requires more record keeping

  29. LO #4 Transportation and Travel • Travel Cost for Business Travel • Requires an overnight stay • Travel, meals, lodging and other incidental expenses are allowed • Should not last more than one year • Limitations exist if the trip is partly personal or if there are lavish or extravagant expenditures

  30. LO #4 Transportation and Travel • Meal and Entertainment • Business meals costs are deductible but are limited to 50% • Must be directly related or associated with business • Standard meal per diem is $39 per day • Cannot be lavish or extravagant

  31. LO #4 Transportation and Travel • A taxpayer can take depreciation on a business auto and use the standard mileage rate in the same year. False 2. Transportation costs are allowed only when the taxpayer visits a client. False 3. A deduction is allowed for meals, lodging, and other incidental expenses when a taxpayer travels away from home requiring sleep. True

  32. LO #4 Transportation and Travel 4. A taxpayer can deduct $39/day for meals and incidentals and $60/day for lodging without keeping receipts on a business trip (subject to the 50% limitation). True 5. Taking five clients to a Major League baseball game immediately following a substantial business discussion is deductible up to 50% of costs. True

  33. LO #5 Business Use of Your Home and Business Bad Debts • Business use of the home is deductible if the business use is: • Exclusive • Regular • For the taxpayer’s trade or business • A specific area of the home must be used only for business • Employees – use must be “for the convenience of the employer”

  34. LO #5 Business Use of Your Home and Business Bad Debts • Home office deductions are reported on Form 8829 • Calculation determined by square footage used regularly and exclusively for business • Direct business expenses are 100% deductible • Indirect home expenses are deductible based on square footage

  35. LO #5 Business Use of Your Home and Business Bad Debts • Home office deduction limited to business income • Order of deductions • Expenses deductible in any event (mortgage interest and real estate taxes) • Business use of insurance, utilities, and then depreciation

  36. LO #5 Business Use of Your Home and Business Bad Debts • Business Bad Debts • Business bad debts can be deducted as an ordinary expense if incurred in a business • Can be partially worthless or completely worthless • Business Casualty Losses • Receive an ordinary loss • Not limited by the 10% AGI floor like personal casualty losses

  37. LO #5 Business Use of Your Home and Business Bad Debts: Concept Check 6-10 • Jose uses 20% of his house exclusively for business. He had the entire exterior of the house painted and the interior of one room that he uses for an office painted for $3,000 and $500, respectively. What is the total deduction Jose can take as a home office expense for the painting? a. $ 500. b. $3,500. c. $ 700. d. $1,100. Answer: D 2. Which of the following comments is true regarding the home office deduction? a. The taxpayer must see clients at home to be allowed a home office deduction. b. The home office deduction is limited to income from Schedule C business. c. The taxpayer is allowed to take §179 on the business portion of the home itself . d. Depreciation on the home is never allowed as a home office deduction. Answer: B

  38. LO #5 Business Use of Your Home and Business Bad Debts: Concept Check 6-10 3. When a business property is partially destroyed by casualty, the loss is calculated using which of the following: a. The decrease in the FMV of the property. b. The adjusted basis of the property. c. The lower of the FMV or the adjusted basis of the property. d. The adjusted basis of the property less 10% of AGI. Answer: C

  39. LO#6 Hobby Loss Rules and Education Expenses • Hobby Losses • Expenses allowed to the extent of hobby income • Nine factors to determine whether an activity is a hobby • Burden of proof lies with the taxpayer • Order of expense deduction – mortgage interest and taxes, hobby expenses that do not reduce basis, then depreciation

  40. LO#6 Hobby Loss Rules and Education Expenses • Educational Expenses – deductible if: • Maintains or improves skills of the taxpayer; or • Meets the express requirements of the law or regulation for a job • Educational Expenses – not deductible if: • Cannot meet the minimum educational requirements for employment • Cannot qualify the taxpayer for a new trade or business

  41. LO#6 Hobby Loss Rules and Education Expenses: Concept Check 6-11 • If a taxpayer has shown a net profit for the last three years, the activity is not considered a hobby. True 2. A taxpayer can never take a net loss on an activity considered a hobby. True

  42. LO#6 Hobby Loss Rules and Education Expenses: Concept Check 6-11 3. Expenses that can be deducted elsewhere on the tax return must be the first expenses deducted from hobby income. True 4. Educational expenses that help qualify a taxpayer for a new trade or business (or profession) are deductible. False

  43. LO#7 Self-Employment Tax • Consists of two parts: • Social Security 12.40% • Medicare 2.90% • Total 15.30% • Social Security limited to first $94,200 of self-employment income • Medicare is not limited

  44. LO#7 Self-Employment Tax • Kia had $43,000 of income from a self-employed consulting practice and had no income during the year. What is Kia’s total self-employment tax? $6, 076 2. Assume the same facts as #1. In addition to her $43,000 in self-employment income, Kia received a W-2 from her employer (different from her self-employed business) with $105,000 in wages. What is Kia’s self-employment tax in this situation? $1,152 • Assume the same facts as #2 above. In addition to her $43,000 in self-employment income, Kia received a W-2 from her employer (different from her self-employed business) with $85,00 in W-2 wages. What is Kia’s self-employment tax in this situation? $2,293

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