Mixed Personal and Business Expenses
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In this lecture we will look at expenses that are part
business and part personal.
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We will look at to what extent they are deductible and
what the tax code does to make sure that people don’t
take advantage of the business expense deduction
unfairly.
Federal Income Taxation Lecture 11
Slide 1
Hobby Losses
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Business expenses are generally only deductible if the business is
entered into for profit not just for a hobby or for fun.
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E.g., if you go to baseball games and try to catch foul balls so that
you can sell them for profit on Ebay, that doesn’t mean the tickets are
deductible.
An activity is presumed to be entered for profit if you actually
make a profit in 3 of 5 consecutive years.
Otherwise, the taxpayer has to show that it is a business and not
just a hobby. Otherwise, the activity is considered a business only if
the circumstances indicate that it’s a business.
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E.g., whether it’s carried out in a businesslike manner, whether it’s
objectively likely to generate a profit, etc.
Federal Income Taxation Lecture 11
Slide 2
Rental Income from Taxpayer’s Dwelling
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[If the taxpayer owns a separate rental property, all its expenses are
deductible.]
If a building owned by the taxpayer is used for personal
purposes…
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…but, it is also used as a rental
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Examples: lived in by taxpayer or family member or friend not paying
market rent
E.g., when the taxpayer is on vacation or for part of the year
Then the “profit motivated” expenses are deductible’ but only the
percentage of those expenses that corresponds to:
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number of rental days divided by total number of days used
Federal Income Taxation Lecture 11
Slide 3
Home Offices
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The percentage of housing expense that corresponds to a home office can
be deductible as a business expense, but only if:
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1) It’s used as a principal place of business for the taxpayer’s trade; OR
2) it’s used as a meeting place with clients, customers, etc.; OR
3) it’s a separate structure from the home used entirely for business; OR
4) the taxpayer is an employee using the office “for the convenience of
his/her employer”
The office must be used as a “business” and not just managing
investments. (Although day trading can be a business.)
The home office also has to be the taxpayer’s principal place of business.
So, if the taxpayer has another principal office, the home office cannot
qualify as a tax deduction.
Cars, computers, etc. can also be business expenses but using a car to
commute to work does not qualify.
Federal Income Taxation Lecture 11
Slide 4
Business Travel Expenses
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Travel expenses are deductible if it’s for a business purpose and
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The travel expenses are reasonable and appropriate
The expenses are incurred when the taxpayer is away from home
The expenses are necessary for the business, not taxpayer preference
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If a taxpayer maintains 2 residences for work purposes, the
expenses are NOT deductible; the travel has to be away from one’s
principal residence.
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If a trip is mixed business and pleasure, the cost of the trip may be
deducted minus expenses that related to the pleasure component.
Federal Income Taxation Lecture 11
Slide 5
Business Meals and Entertainment
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Business meals and entertainment are deductible if:
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1) the item was related to the business conduct or meeting
2) the item (meal, golf game, etc.) was preceded by (or happens during) a
bona fide business discussion
(The activity cannot be primarily for social purposes or just to build
goodwill.)
Meal and entertainment deductions (other than de minimis fringe benefits
like coffee in the office) are limited to 50% of the expense.
Club dues, etc., are not deductible even if done to network with other
business people.
Travel, and expenses outside North America, are not deductible unless
there was a reason it could not be done in North America.
Adequate records, receipts, etc., must be kept for all such deductions!
Federal Income Taxation Lecture 11
Slide 6
Child Care Expenses
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Childcare is not generally deductible because it’s a personal expense, even
if it’s necessary for the parent to work. However, there is a tax credit for a
percentage of the child care expenses necessary to work. This is
determined by a complex formula that works something like this:
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1) Figure out the number of dependents (which, for this purpose includes
children under 13 and mentally incompetent dependents)
2) Take the amount actually spent on child care, but only up to $3,000 if
there’s one dependent and $6,000 for two or more
3) Take a percentage of that amount, which is:
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35%, for those with AGI of $15,000 or less
Subtract one percentage point for each $2,000 AGI over $15,000, but only up to a
minimum of 20%
4) Multiply the % in 3 by the $ amount in 2 to determine your tax credit
Federal Income Taxation Lecture 11
Slide 7
Commuting Expenses
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Commuting expenses to work are generally not deductible because
the location of the home, a personal decision, is the reason the
commute is necessary.
However, commuting to a temporary assignment location in a
different area is a business travel expense.
Also, if the taxpayer is away from home on business, the commute
within that city to and from work locations is deductible, as long as
it meets the other rules regarding business travel (discussed earlier
in the course).
Expenses relating to transporting tools of the business (such as a
trailer to carry lawn care equipment for a landscaping company)
are deductible as an ordinary business expense.
Federal Income Taxation Lecture 11
Slide 8
Clothing for Business
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Unreimbursed clothing expenses paid for by the employee are
deductible if:
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The clothing is used exclusively at work
The employer requires the employees to wear that clothing to work
The clothing is not suitable for general use.
However, note (importantly) that even if clothing doesn’t meet the
above conditions, if it’s paid for by the employer, it’s generally not
considered income to the employee and can be written off by the
employer as an ordinary business expense.
Federal Income Taxation Lecture 11
Slide 9
Legal Expenses
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Legal fees related directly to the production of income can be
deducted as an ordinary business expense.
However, if legal fees are to protect the business for a long time to
come, the expenses must be capitalized like any other infusion of
capital to a business.
Personal legal expenses are not deductible if they are “personal” in
nature, even if they are necessary to protect a business.
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E.g., a divorce that’s sought to protect an investment from the other
spouse is not deductible.
A deduction is allowed for legal expenses incurred with regard to
preparing and filing tax returns and seeking refunds, etc.
Federal Income Taxation Lecture 11
Slide 10
Educational Expense Relating to Business
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Education in general is not deductible. However, once you’re in a
profession, continuing education to keep your license or to
maintain your level of training or skill is a business expense.
A wide variety of federal tax incentives, deductions and credits
apply to financing an education.
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E.g., Hope Scholarship credit, lifetime learning credit, interest on
student loans being deductible; allowance of IRA withdrawals, etc.
A detailed review of these is beyond the scope of the course.
Qualified Tuition Programs (§529 accounts): These accounts allow
income allocated for higher education of a beneficiary (e.g., oneself
or one’s child) to grow tax free. Contributions to a §529 accounts
are not deductible but the earnings of the account are not taxable to
anyone. Note that contributions are gifts for gift tax purposes.
Federal Income Taxation Lecture 11
Slide 11