Chapter 3 Business Expenses & Retirement Plans

1. Chapter 3Business Expenses & Retirement Plans Income Tax Fundamentals 2009 edition Gerald E. Whittenburg Martha Altus-Buller Student Copy 2009 Cengage Learning

2. Rental Income/Expenses Net Rental Income/Loss is part of gross income Report on Schedule E - Part I Report on Schedule C if provide service to tenants exceeding customary level Vacation Homes If both personal and rental use of residence, must allocate expenses Deductions limited based on period of time residence used for personal vs. rental 2009 Cengage Learning

3. Passive Loss Limitations Rule: When taxpayer is not actively involved in an activity – losses are considered “passive” and may not be deducted in excess of passive gains, however: Loss can be carried forward and deducted in future years or Can be deducted when investment is sold Examples of passive activities Limited partnerships Flow through from investment in partnerships where taxpayer is not actively involved in business 2009 Cengage Learning

4. Rental property is specifically designated as passive However, when taxpayer isactively involved*in the management of rental real estate May take up to $25,000 of rental loss (even though considered passive) against ordinary income The $25,000 loss capability is reduced by 50¢ for each $1 modified AGI > $100,000 *Actively involved is defined as screening tenants, maintaining property, etc. Passive Loss Limitations -Exception 2009 Cengage Learning

5. Bad Debts Bad debts arise when taxpayer sells good/services on credit and accounts receivable later becomes uncollectible Deduction for bad debts allowed up to amount previously included in income Cash basis taxpayers cannot take bad debts expense as they never reported original income Must use specific charge-off method IRS requires proof of worthlessness 2009 Cengage Learning

6. Net Operating Losses (NOL) NOLs are losses resulting from business and casualty items only First, carry it back to the second prior year [and deduct against income from that year] and then to the prior year [or until used in full] File amendments for prior years (1040X) or 1045 (for quick claim for refund) or May make an irrevocable election to forgo carry back, then carry forward But must elect this in year of loss 2009 Cengage Learning

7. Types of Individual Retirement Accounts Traditional IRA Deduction for AGI Distributions in retirement are taxable Roth IRA No current deduction Distributions in retirement are nontaxable 2009 Cengage Learning

8. Contributing/Deducting - IRA Roth or traditional IRA contribution limited to lesser of: 100% of earned income or $5000 Spouse with no earned income will be able to contribute up to $5,000 For 2008, taxpayers and spouses 50 and over can contribute an additional $1000/year [catch-up provisions] Can make contributions up through April 15, 2009 for 2008 2009 Cengage Learning

9. Keogh Plan Participants must meet minimum age and years of service requirements Retirement plan geared towards self-employed individuals Tax free contributions are limited to lesser of 20% of net earned income or $46,000 Net earned income includes business profits if significantly generated from taxpayer’s personal services Must reduce net earned income by ½ self-employment tax for contribution calcula 2009 Cengage Learning

10. Simplified Employee Pension [SEP] Same dollar limits as Keogh plans, but contributions made to SEP-IRA IRA account with higher funding limits Participants must meet minimum age and years of service requirements Pay early withdrawal penalty if receive distributions prior to age 59.5 Must start drawing by age 70.5 2009 Cengage Learning

11. Qualified Retirement Plan Contributions by an employer to qualified retirement plans are tax deductible Employee contributions are pre-tax Tax on earnings is deferred To achieve qualified plan status, an employer-sponsored retirement plan must Be for exclusive benefit of employees Be nondiscriminatory Have certain participation and coverage requirements Comply with minimum vesting requirements Meet uniform distribution rules 2009 Cengage Learning

12. Limitations on Certain Qualified Plans §401(k) Employee chooses to defer some compensation into plan Defer means to forego current compensation with reduction going to qualified retirement plan Employees choose % of wages to contribute to plan Not to exceed $15,500/year for all salary reduction plans $20,500/year if 50 or older An employer may match to encourage participation, this is excludable from income When distributions occur, contributions/earnings taxable 2009 Cengage Learning

13. Roth §401(k) Beginning in 2006, employer may set up Roth §401(k) Employees may defer same amount as traditional 401(k), but no reduction in current taxable income Withdrawals/earnings generally tax free upon distribution Expected to be popular with high income taxpayers because no AGI limit and higher contribution than a Roth IRA 2009 Cengage Learning

14. Low Income Retirement PlanContribution Credit Credit to encourage low-income taxpayer participation in retirement savings Single taxpayers with AGI <= $26,500 MFJ with AGI <= $53,000 HH with AGI <= $39,750 Tax credit for percentage of retirement plan contribution based upon AGI Credit equal to 50%, 20% or 10% of contribution See table on p. 3-21 2009 Cengage Learning

15. Savings Incentive Match Plan for Employees (SIMPLE) Designed for use by employers with less than 100 employees SIMPLE-IRA Employees can defer up to $10,500 per year into SIMPLE-IRA $13,000 if 50 or older Contribution expressed as percentage of income Employer must either: Match employees’ contributions dollar for dollar up to 3% of gross wages or Contribute 2% of gross wages of all employees who make over $5,000 per year - even if they don’t elect salary deferral Contributions are fully vested when made; first 2 years early withdrawals are subject to 25% penalty 2009 Cengage Learning