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Chapter 6

Chapter 6. Self-Employed Business Income “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 “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 customers Work performed as an independent contractor Amounts 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 Goods 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 # 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 their purpose

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

  7. LO #3 Depreciation Components 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

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

  9. LO #3 Depreciation Typical Depreciation Periods 3 years Specialized Tools, Racehorses 5 years Autos, Trucks, Computers 7 years Furniture, Fixtures, Equipment 27.5 years Residential Real Property 39 years Nonresidential Real Property

  10. 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.

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

  12. LO #3 Depreciation Maximum IRC Section 179 expense 2010 $500,000 2011 $500,000 2012 $500,000 2013 $500,000 Property must be used in a trade or business. The 2012 Tax Act increased the amount to $500,000 for 2012 and 2013. Section 179 expense cannot create a NOL

  13. LO #3 Depreciation 50% Bonus in 2013 MACRS < 20 year lives Fully Deductible/No limits other than Luxury Auto Limits Lessens Importance of Section 179

  14. 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

  15. 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 $11,160 $11,360 2nd year $ 5,100 $ 5,400 3rd year $ 3,050 $ 3,550 4th and after $ 1,875 $ 1,975 SUVs greater than 6,000 lbs – Section 179 is limited to $25,000

  16. 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. 2013-21 for amounts The total business lease amount is deductible

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

  18. 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

  19. LO #4 Transportation and Travel Automobile Expenses Standard Mileage Rate - 56.5 cents per mile in 2013 Actual Expenses - actual business auto costs are deducted Actual expenses usually gives a larger deduction but require more record keeping

  20. 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

  21. LO #4 Transportation and Travel Meals and Entertainment Business meal costs are deductible but are limited to 50% Must be directly related or associated with business Standard meal per diem is $46 per day – can be higher in high cost areas Cannot be lavish or extravagant

  22. LO #5 Business Use of 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”

  23. 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

  24. 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

  25. 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

  26. 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

  27. LO #6 Hobby Loss Rules and Education Expenses Education 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 Qualifies the taxpayer for a new trade or business

  28. LO #7 Self-Employment Tax Consists of two parts: Social Security 12.40% in 2013 Medicare 2.90% Total 13.30% Social security limited to first $113,700 of self-employment income in 2013 Medicare is not limited

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