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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

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
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

lo 1 income and expenses of the self employed1
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

lo 1 income and expenses of the self employed2
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

lo 2 ordinary necessary trade or business expenses
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

lo 2 ordinary necessary trade or business expenses1
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

lo 3 depreciation
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

lo 3 depreciation1
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

lo 3 depreciation2
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

lo 3 depreciation3
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.

lo 3 depreciation4
LO #3 Depreciation

Depreciation Methods

200% Declining Balance Switching to Straight-line

150% Declining Balance Switching to Straight-line

Straight-line

lo 3 depreciation5
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

lo 3 depreciation6
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

lo 3 depreciation7
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

lo 3 depreciation8
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

lo 3 depreciation9
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

lo 4 transportation and travel
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

lo 4 transportation and travel1
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

lo 4 transportation and travel2
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

lo 4 transportation and travel3
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

lo 4 transportation and travel4
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

lo 5 business use of home and business bad debts
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”

lo 5 business use of your home and business bad debts
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

lo 5 business use of your home and business bad debts1
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

lo 5 business use of your home and business bad debts2
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

lo 6 hobby loss rules and education expenses
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

lo 6 hobby loss rules and education expenses1
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

lo 7 self employment tax
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