Chapter 11
Individuals as Employees
and Proprietors
Essentials of Taxation
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1
The Big Picture (slide 1 of 3)
• Mark and Mary Herman come to you for tax advice.
• Mark Herman is a self-employed consultant.
– Last year, Mark’s business generated revenue of $165,000
and incurred expenses of $18,000 for rent and utilities.
– Mark also spent $8,000 purchasing depreciable equipment.
– He paid a part-time secretary $12,000 for administrative
work.
– He hired an assistant and paid her $40,000.
– Mark paid $3,000 for his own health insurance and $500
for term life insurance
– He did not contribute to any retirement plans.
The Big Picture (slide 2 of 3)
• Mary (Mark’s wife) also works as a consultant but for
a large firm.
– Her salary last year was $85,000.
– Mary’s employer paid $3,000 of premiums for her health
insurance and provided $50,000 of group term life
insurance.
– Mary is not covered by a qualified retirement plan.
• She contributed $5,500 to a traditional IRA.
– Mary routinely travels for her job.
• She was reimbursed by her employer for all travel expenses.
– In addition, Mary spent $500 on other unreimbursed
employee business expenses.
The Big Picture (slide 3 of 3)
• What are the tax consequences of these
items?
– Can Mark and Mary deduct the expenses
they incurred?
– Are there other tax planning opportunities
that the couple may be missing or tax issues
of which they should be aware?
• Read the chapter and formulate your
response.
Employee vs. Self-Employed
(slide 1 of 2)
• Business expenses for self-employed persons
are deductible for AGI
– Reported on Schedule C
• Unreimbursed business expenses for
employees are generally deductible from AGI
subject to 2% of AGI floor
– Reported on Form 2106 (Employee Business
Expenses) and Schedule A (Itemized Deductions)
5
Employee vs. Self-Employed
(slide 2 of 2)
• Person is classified as an employee if:
– Subject to will and control of another with respect
to what shall be done and how it shall be done
– Another furnishes tools or the place of work
– Income based on time spent rather than task
performed
– Other factors
6
The Big Picture – Example 1
Self-employed Individual
• Return to the facts of The Big Picture on p. 11-1.
• Mark is a consultant whose major client accounts for
60% of his billings.
– He does the routine consulting work at the client’s request.
– He is paid a monthly retainer in addition to amounts
charged for extra work.
• Mark is a self-employed individual.
– Even though most of his income comes from one client, he
still has the right to determine how the end result of his
work is attained.
The Big Picture – Example 2
Employee Vs. Self-employed
• Return to the facts of The Big Picture on p. 11-1.
• Ellen is a recent MBA graduate hired by Mark
to assist him in the performance of services for
the client mentioned in Example 1.
• Ellen is under Mark’s supervision; he reviews
her work and pays her an hourly fee.
• Ellen is Mark’s employee.
Advantages of Qualified
Fringe Benefits
• Cost of qualified fringe benefits is deductible
by employer
• Value of qualified fringe benefits is excluded
from employee’s gross income
9
Employer-Sponsored Accident and Health
Plans (slide 1 of 2)
• Premiums paid by employer for insurance
coverage of employee, spouse, and
dependents are not taxable to employee
• Amounts received from insurance are not
taxable when received for medical care or
for permanent loss of body part or
function
10
Employer-Sponsored Accident and Health
Plans (slide 2 of 2)
• Payments for expenses that do not meet the
Code’s definition of medical care must be
included in gross income
• Amounts received for medical expenses
deducted on a prior return must be included in
gross income
11
Long-Term Care Insurance
(slide 1 of 2)
• Employer paid insurance premiums for employee’s longterm care are excludible subject to annual limits as follows:
12
Long-Term Care Insurance
(slide 2 of 2)
• Exclusion of benefits received from policy is
limited to the greater of:
• $330 in 2014 for each day patient receives long-term
care (indexed amount for 2013 is $320)
• The actual cost of the care
– Reduced by any amounts received from other third
parties (e.g., damages received)
13
Meals and Lodging
• Not taxable to employee if:
– Furnished by employer
• On employer’s business premises
• For convenience of employer
– In the case of lodging, employee is required to
accept lodging as a condition of employment
14
Meals and Lodging
• Not taxable to employee if:
– Furnished by employer
• On employer’s business premises
• For convenience of employer
– In the case of lodging, employee is required to
accept lodging as a condition of employment
15
Meals and Lodging
• Not taxable to employee if:
– Furnished by employer
• On employer’s business premises
• For convenience of employer
– In the case of lodging, employee is required to
accept lodging as a condition of employment
16
Meals and Lodging
• Not taxable to employee if:
– Furnished by employer
• On employer’s business premises
• For convenience of employer
– In the case of lodging, employee is required to
accept lodging as a condition of employment
17
Group Term Life Insurance
• Premiums on the first $50,000 of group term
life insurance are excluded from gross income
– For each $1,000 of coverage in excess of $50,000, the
employee must include the amounts calculated using the
IRS tables
• If plan discriminates in favor of certain key
employees (e.g., officers), they are not eligible
for the exclusion
– In such a case, key employees must include in gross
income the greater of
• Actual premiums paid by the employer, or
• The amount calculated from the IRS tables
18
Group Term Life Insurance
19
Other Fringe Benefits
(slide 1 of 3)
• Dependent care
– Up to $5,000 of care costs paid for by employer
can be excluded
• Athletic facilities
– Value of use of athletic facilities located on
employer premises can be excluded
20
Other Fringe Benefits
(slide 2 of 3)
• Educational assistance programs
– Employer-provided educational assistance for
undergraduate and graduate education is
excludible
• Exclusion limited to $5,250 per year
• Includes tuition, fees, books, and supplies
21
Other Fringe Benefits
(slide 3 of 3)
• Adoption assistance programs
– Employee adoption expenses paid or reimbursed
by employer are excludible
• Exclusion limited to $13,400
• Exclusion phases-out as AGI increases from $201,010
to $241,010
22
Cafeteria Plans
• Allow employees to choose between cash and
certain nontaxable benefits
– If cash is chosen, the amount received is taxable
– If a nontaxable benefit is chosen, the benefit
remains nontaxable
• Provide tremendous flexibility in tailoring the
employee pay package to fit individual needs
23
Flexible Spending Plans
• Allow employees to accept lower cash
compensation in return for employer agreeing
to pay certain costs without the employee
recognizing income
– Called a use or lose plan since reduction in pay
cannot be recovered if covered expenses are less
than expected
24
Classes of Nontaxable
Employee Benefits
•
•
•
•
•
•
•
No-additional-cost services
Qualified employee discounts
Working condition fringes
De minimis fringes
Qualified transportation fringes
Qualified moving expense reimbursements
Qualified retirement planning services
25
No Additional Cost Services
• Are nontaxable if:
– Employee receives services (not property)
– Employer incurs no substantial additional cost in
providing the services
– Services offered are within line of business in
which employee works
– Benefit is offered on nondiscriminatory basis
26
Qualified Employee Discounts
• Are nontaxable if:
– Discount is not on realty or investment property
– Item discounted is from same line of business in
which employee works
– Discount cannot exceed gross profit on property or
20% of the customer price on services
– Benefit is offered on nondiscriminatory basis
27
Working Condition Fringes
• Not taxable if employee could have deducted
cost of item if they had actually paid for them
– Includes personal use of auto by full-time auto
salespeople and employee business expenses that
would be eliminated by the 2% floor on
miscellaneous deductions
28
De Minimis Fringes (slide 1 of 2)
• These benefits are so small that
accounting for them is impractical
– Examples include:
• Supper money
• Occasional personal use of company copying
machine
• Company cocktail parties
• Picnics for employees
29
De Minimis Fringes (slide 2 of 2)
• Subsidized eating facilities operated by
employer are excluded if:
– Located on or near employer’s premises
– Revenue equals or exceeds direct operating costs
– Nondiscrimination requirements are met
30
Qualified Transportation Fringes
• This fringe benefit is designed to encourage the use
of mass transit for commuting to work
– Includes:
• Transportation in commuter highway vehicle and transit passes
– Limit on the exclusion for 2014 is $130 per month
• Qualified parking
– Limit on the exclusion for 2014 is $250 per month
• Qualified bicycle commuting reimbursement
– Can exclude up to $20 per month received from an employer as
reimbursement for the cost of commuting by bicycle
» i.e., Bicycle purchase, improvement, repair, and storage
– May be provided directly by the employer or may be in the
form of cash reimbursements
31
Qualified Transportation Fringes
• This fringe benefit is designed to encourage the use
of mass transit for commuting to work
– Includes:
• Transportation in commuter highway vehicle and transit passes
– Limit on the exclusion for 2015 is $130 per month
• Qualified parking
– Limit on the exclusion for 2015 is $250 per month
• Qualified bicycle commuting reimbursement
– Can exclude up to $20 per month received from an employer as
reimbursement for the cost of commuting by bicycle
» i.e., Bicycle purchase, improvement, repair, and storage
– May be provided directly by the employer or may be in the
form of cash reimbursements
32
Qualified Transportation Fringes
• This fringe benefit is designed to encourage the use
of mass transit for commuting to work
– Includes:
• Transportation in commuter highway vehicle and transit passes
– Limit on the exclusion for 2015 is $130 per month
• Qualified parking
– Limit on the exclusion for 2015 is $250 per month
• Qualified bicycle commuting reimbursement
– Can exclude up to $20 per month received from an employer as
reimbursement for the cost of commuting by bicycle
» i.e., Bicycle purchase, improvement, repair, and storage
– May be provided directly by the employer or may be in the
form of cash reimbursements
33
Moving Expenses
• Employer payment or reimbursement of
employee’s qualified moving expenses is
excludible
– No deduction by employee is allowed for
reimbursed moving expenses
34
Qualified Retirement
Planning Services
• Value of any retirement planning advice or
information provided by employer who
maintains a qualified retirement plan is
excluded from income
– Designed to motivate more employers to provide
retirement planning services
35
Nondiscrimination Provisions
• For no-additional-cost services, qualified
employee discounts, and qualified retirement
planning services
– If the plan is discriminatory in favor of highly
compensated employees, these key employees are
denied exclusion treatment
– Non-highly compensated employees can still
exclude these benefits from income
36
Foreign Earned Income
(slide 1 of 2)
• Income from personal services in a foreign
country can be excluded from income
• To qualify for the exclusion, must be either:
– A bona fide resident of foreign country, or
– Present in foreign country at least 330 days during
any 12 consecutive months
37
Foreign Earned Income
(slide 2 of 2)
• Exclusion amount is limited to $100,800 for
2015
– For married persons, both of whom have foreign
earned income, the exclusion is computed
separately for each spouse
38
Employee Expenses
• Fall into one of the following categories:
–
–
–
–
–
–
–
Transportation
Travel
Moving
Education
Entertainment
Other
Contributions to retirement accounts
39
Transportation Expenses
(slide 1 of 2)
• Transportation expense defined
– Very limited, only from job site to job site
and commuting to/from temporary work
place
– Commuting from home to work and back is
nondeductible
• Exceptions:
– Additional costs incurred to transport heavy tools
– Employees with more than one job
40
Transportation Expenses
(slide 2 of 2)
• Amount deductible
– Actual expenses
• Must keep adequate records of all expenses and
depreciation is limited, or
– Automatic mileage method
• 57.5 cents per mile for business miles for 2015
– Adjustment to basis of auto is required for depreciation
considered allowed
• Plus parking, tolls, etc.
• Adequate documentation of mileage required
41
Travel Expenses
(slide 1 of 2)
• Travel expense defined
– Expenses while “away from tax home” overnight
on business
– Includes transportation, lodging, 50% meals, and
miscellaneous expenses
42
Travel Expenses
(slide 2 of 2)
• “Away from home” requirement
– Need not be a 24-hour period but must be longer
than ordinary work day and taxpayer will need to
rest during release time
– Being “away” should be a temporary situation (not
in excess of 1 year)
– “Tax Home” generally means business location,
post, or station of the taxpayer
43
Combined Business/Pleasure Travel
(slide 1 of 4)
• Only actual expenses for business are
deductible
– Meals, lodging and other expenses must be
allocated between business and personal days
• Deductibility of transportation costs depends
on whether the trip is domestic or foreign
44
Combined Business/Pleasure Travel
(slide 2 of 4)
• For domestic travel
– If primary purpose of trip is business,
transportation is deductible in full
– If primary purpose is pleasure, no deduction for
transportation allowed, but other expenses (e.g.,
lodging) associated with business days are
deductible
45
Combined Business/Pleasure Travel
(slide 3 of 4)
• For foreign travel
– Transportation expenses must be allocated
between business and personal unless:
• Trip is 7 days or less,
• Less than 25% of time was for personal purposes, or
• Taxpayer had no substantial control over arrangements
for the trip
46
Combined Business/Pleasure Travel
(slide 4 of 4)
• Travel days are considered business days
• Weekends, legal holidays and intervening days
are business days if both the preceding and
succeeding days are business days
• If trip is primarily for pleasure, no
transportation expenses are deductible
47
Moving Expenses
• Deductible for moves in connection with the
commencement of work at a new principal
place of work
• Two tests must be met for moving expenses to
be deductible
– Distance test
– Time test
48
Moving Expenses - Distance Test
• Distance from old home to new job must be at
least 50 miles farther than from old home to
old job
• New home location not relevant for decision
49
Example of Distance Test
• Gail lived 20 miles
from her old job
• Gail’s new job is 75
miles from her old
home
• Gail meets the
distance test
20 mi.
Old
Job
Old
Residence
75 mi.
New
Job
50
Moving Expenses - Time Test
(slide 1 of 2)
• Taxpayer must be full-time employee for 39
weeks in the 12-month period following the
move, or
• Self-employed must work in new location for
78 weeks during the next two years following
the move
– 39 of the weeks must be in the first 12 months
• Test waived if die, disabled, discharged, or
transferred
51
Moving Expenses - Time Test
(slide 2 of 2)
• If time test not met during taxable year, two
alternatives:
– Take the deduction in year moved. If test is not
met in following year, either:
• Include the amount deducted in gross income in the
following year, or
• File amended return for year of move
– Alternatively, wait until time test is met and then
file amended return for year of move
52
Deductible Moving Expenses
• ‘‘Qualified’’ moving expenses include
reasonable expenses of:
– Moving household goods and personal effects to
new location
– Expenses of travel for taxpayer and family to new
location
• Lodging
• Actual auto costs (not depreciation) or mileage rate of
23 cents per mile for each car in 2015
– Meals are not deductible as moving expense
53
Tax Treatment of
Moving Expenses
• Unreimbursed moving expenses are deductible
for AGI
• Reimbursement or payment by employer:
– For qualified moving expenses, amount is
excluded from gross income, but no deduction for
related expenses
– For nonqualified moving expenses, amount is
included in gross income and no deduction is
allowed
54
Education Expenses
(slide 1 of 3)
• Education expenses of an employee and selfemployed individual are deductible as business
expenses if they are incurred:
– To maintain or improve existing skills, or
– To meet express requirements of the employer or
requirements imposed by law to retain
employment status
55
Education Expenses
(slide 2 of 3)
• Education expenses are not deductible as a
business expense if they are incurred:
– To meet minimum educational standards for
existing job, or
– To qualify taxpayer for new trade or business
56
Education Expenses
(slide 3 of 3)
• Education expenses include:
–
–
–
–
–
Tuition
Books
Supplies
Transportation
Travel (including lodging and 50% meals)
57
Deduction For Qualified Tuition and
Related Expenses (slide 1 of 3)
• A deduction is allowed for AGI for qualified
tuition and related expenses involving higher
education (i.e., postsecondary)
58
Deduction For Qualified Tuition and
Related Expenses (slide 2 of 3)
• The maximum deduction depends on filing
status and AGI
Filing Status
Single
Married
Single
Married
AGI Limit
$65,000
$130,000
$65,001 to
$80,000*
$130,001 to
$160,000*
Max Deduction
$4,000
$4,000
$2,000
$2,000
*No deduction is allowed if MAGI exceeds this amount
59
Deduction For Qualified Tuition and
Related Expenses (slide 3 of 3)
• Qualified tuition and related expenses include
whatever is required for enrollment
– Usually, student activity fees, books, room and
board are not included
• Expenses need not be work related
• Deduction is not available for married persons
filing separately
60
Entertainment Expenses
(slide 1 of 2)
• Deductions are very restricted due to abuse
possibilities
– Deductible amount allowed:
• 50% of meals and entertainment costs including related
taxes, tips, cover charges, parking fees, and room rental
fees
• 100% of transportation costs
– Amounts cannot be lavish or extravagant
61
Entertainment Expenses
(slide 2 of 2)
• Entertainment expenses are classified as
either:
– Directly related to business
• Actual business meeting or discussion occurs
during meal or entertainment
– Associated with business
• Meal or entertainment that directly precedes or
follows business meeting or discussion
62
Restrictions on Entertainment Expenses
(slide 1 of 2)
• Club dues
– Generally not deductible
• Exception: Clubs formed for public service and
community volunteerism (e.g., Kiwanis,
Rotary)
– Business entertainment expenses incurred at
club are still deductible (50%)
63
Restrictions on Entertainment Expenses
(slide 2 of 2)
• Business gifts
– Business gifts of tangible personalty with a value
of $25 or less per person per year are deductible
• Incidental costs (e.g., gift-wrapping) are not included in
the cost of the gift in applying the limit
– If the value is $4 or less (e.g., pen with company
name) then not subject to $25 limit
• Gifts to employers or superiors are not
deductible
64
Office in the Home
(slide 1 of 3)
• Deductibility is very restricted due to abuse
possibilities
– Office must be used exclusively and on a regular
basis as:
• The principal place of business, or
• A place of business used by clients, patients, or
customers
– For employees, office must also be for the
convenience of the employer
65
Office in the Home
(slide 2 of 3)
• What constitutes “principal place of business”?
– Home office qualifies as a principal place of
business if:
• Taxpayer conducts admin. and mgmt. activities in the
home office, and
• There is no other fixed location where taxpayer
conducts these activities
66
Office in the Home
(slide 3 of 3)
• Office in the home expenses cannot cause net
loss from the business activity
– Office in home deduction limited to business gross
income in excess of other business expenses
(ordering rules apply)
– Excess is carried forward (subject to limit)
– Form 8829 is used to report office in home
expenses
67
Other Employee Expenses
• A partial list of other employee expenses that
are deductible includes:
–
–
–
–
–
Special clothing (uniforms)
Union dues
Professional expenses
Job hunting in same profession
Educator expenses (deductible for AGI)
• Limited to $250 per year for supplies, etc. of elementary
and secondary school teachers
68
Other Employee Expenses
• A partial list of other employee expenses that
are deductible includes:
–
–
–
–
–
Special clothing (uniforms)
Union dues
Professional expenses
Job hunting in same profession
Educator expenses (deductible for AGI)
• Limited to $250 per year for supplies, etc. of elementary
and secondary school teachers
69
Other Employee Expenses
• A partial list of other employee expenses that
are deductible includes:
–
–
–
–
–
Special clothing (uniforms)
Union dues
Professional expenses
Job hunting in same profession
Educator expenses (deductible for AGI)
• Limited to $250 per year for supplies, etc. of elementary
and secondary school teachers
70
Classification of Employee Expenses
(slide 1 of 2)
• Depends on whether they are reimbursed and,
if reimbursed, under what type of plan
71
Classification of Employee Expenses
(slide 2 of 2)
• Employers can have three types of
reimbursement plans
– Accountable
– Nonaccountable
– No reimbursement is given
72
Accountable Plan
(slide 1 of 2)
• Plan must require adequate accounting to the
employer for expense reimbursed, and
• Any excess reimbursements must be returned
to the employer
73
Accountable Plan
(slide 2 of 2)
• Adequate accounting is
– Submitting a record, with receipts, to the
employer, or
– Using a per diem allowance that is not more than
the Federal per diem rate
• Employee reports no income and takes no
deduction to the extent of the reimbursed
expenses
74
Substantiation for Expenditures
(slide 1 of 2)
• No deduction allowed for an expense if the
taxpayer does not have adequate records for
the expense
– Therefore, taxpayers need to have good records for
employee or self-employed expenses
• In some cases, use of per diem allowance will be
deemed substantiation
75
Substantiation for Expenditures
(slide 2 of 2)
• Records should include:
– The amount of the expense
– The time and place of travel or entertainment (or
date of gift)
– The business purpose of the expense
– The business relationship of the taxpayer to the
person entertained (or receiving the gift)
76
Nonaccountable Plan
• Plan that does not require adequate accounting
or return of excess reimbursement or both
– Reimbursed amounts received under this plan are
included in gross income
– Expenses are deductible from AGI as
miscellaneous itemized deductions subject to the
2% of AGI limitation
77
Unreimbursed Employee Expenses
• Expenses are deductible from AGI as
miscellaneous itemized deductions
subject to the 2% AGI limitation
– If employee could have received, but did not
seek, reimbursement for whatever reason,
none of the employment-related expenses
are deductible
78
Individual Retirement Accounts
(slide 1 of 5)
• Contribution ceiling is lesser of $5,500 ($11,000 for
spousal IRAs) or 100% of earned income
• Person age 50 or over by year end may make catch-up
contributions
– Max contribution limit is increased by $1,000 in 2014
• Deductible IRA contribution may be reduced if
taxpayer is an active participant in another qualified
plan
• To extent individual is ineligible to make deductible
contributions, a nondeductible IRA contribution may
be made
– Income accrues on account tax deferred
79
Individual Retirement Accounts
(slide 2 of 5)
80
Individual Retirement Accounts
(slide 3 of 5
• Roth IRA
– Contributions are nondeductible
• Maximum allowable annual contribution is the smaller of
– $5,500 ($11,000 for spousal IRAs) or
– 100% of the individual’s compensation for the year
– Qualified distributions are tax-free after an initial five year
holding period if:
•
•
•
•
Made on or after age 59 ½
Made to beneficiary on or after participant’s death
Participant becomes disabled
Used to pay for qualified first-time home buyer’s expenses
($10,000 limit)
81
Individual Retirement Accounts
(slide 4 of 5)
• Roth IRA (cont’d)
– Other distributions may be taxable
• Distributions first treated as nontaxable return of capital
to extent of contributions
• Remaining distribution treated as taxable payout of
earnings
82
Individual Retirement Accounts
(slide 5 of 5)
• Roth IRA (cont’d)
– Annual contributions are subject to phase out
within the AGI ranges listed below:
Single
MFJ
MFS
Phase-out begins
$ 116,000
183,000
0
Phase-out ends
$131,000
193,000
10,000
83
Individuals as Proprietors
• A sole proprietorship is not a separate taxable
entity.
– Revenues and expenses from the business entity
are reported on Schedule C, Form 1040.
– Ordinary and necessary business expenses paid or
incurred during the tax year in carrying on a trade
or business are deductible on Schedule C.
•
84
Health Insurance Premiums
• A self-employed taxpayer may deduct 100%
of insurance premiums paid for medical
coverage as a deduction for AGI
– Includes premiums paid on behalf of the taxpayer,
the taxpayer’s spouse, and dependents
• Deduction is not allowed if eligible to
participate in a subsidized health plan
maintained by any employer of the taxpayer or
of the taxpayer’s spouse
85
Payment Procedures
(slide 1 of 2)
• Self-employment tax
– Taxpayers with net self-employment
earnings ≥$400 must pay self-employment
tax
• 2015 rates
– Social Security: 12.4% of first $118,500 net selfemployment income
– Medicare: 2.9% of all net self-employment income
• These rates are twice what an employee pays
86
Payment Procedures
(slide 2 of 2)
• Self-employment tax
– Taxpayer receives a deduction from net selfemployment income of 7.65% for purposes of
calculating the actual self-employment tax
– Taxpayer receives a for AGI deduction for onehalf of the self-employment tax paid
87
Retirement Plans for Self-Employed
Individuals (slide 1 of 2)
• H.R. 10 (Keogh) plans
– Retirement plans for self-employed and
their employees
– Plan rules are similar to corporate provisions
– Plan must be established before the end of
the tax year, but contributions may be made
up to the due date of the return
88
Retirement Plans for Self-Employed
Individuals (slide 2 of 2)
• Keogh (H.R. 10) plans (cont’d)
– Contribution limitations
• Defined contribution plan
– Lesser of $53,000 (in 2015) or 100% of earned income
• Profit sharing plans and stock bonus plans are limited to
25%
– Defined benefit plans limit the annual benefit
payable to the lesser of $210,000 (in 2015) or
100% of average compensation for 3 highest years
89
SIMPLE Plans (slide 1 of 2)
• Employers with 100 or less employees and no
other qualified plan may establish a savings
incentive match plan for employees (SIMPLE
plan)
– In form, §401(k) or IRA
– Avoids nondiscrimination rules
90
SIMPLE Plans (slide 2 of 2)
• SIMPLE Plans
– Employees make elective contributions (up to
$12,500 in 2015) to plan
• Contributions made as percentage of compensation
• Distributions from plan taxed under IRA rules
– Employers generally required to match
contributions up to 3% of compensation or provide
2% nonmatching contributions
– Person age 50 or over by year end may make
catch-up contributions of up to $3,000 for 2015
and thereafter
91
Estimated Tax for Individuals
(slide 1 of 3)
• Any taxpayer (employee or self-employed)
who will owe at least $1,000 in taxes for the
year (and meets none of the exceptions) must
make estimated tax payments
92
Estimated Tax for Individuals
(slide 2 of 3)
• To avoid penalties for underpayment, must
annually pay the smaller of:
– 90% of the current year’s tax, or
– 100% of last year’s tax
• Exception: Increased to 110% of last year’s tax if AGI
last year exceeded $150,000 ($75,000 if married filing
separately)
93
Estimated Tax for Individuals
(slide 3 of 3)
• For calendar year individual taxpayer,
estimated tax payments of ¼ of annual amount
are due
– April 15, June 15, and September 15 of the tax
year, and January 15 of the following year
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Hobby Losses (slide 1 of 8)
• Hobby defined
– Activity not entered into for profit
• Personal pleasure associated with activity
• Examples: raising horses, fishing boat charter
• If an activity is not engaged in for profit, the
hobby loss rules apply
– Hobby expenses are deductible only to the extent
of hobby income
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Hobby Losses (slide 2 of 8)
• Profit activity
– If activity is entered into for profit, taxpayer can
deduct expenses for AGI even in excess of income
from the activity
• At-risk and passive loss rules may apply
• Often it is difficult to determine if an activity
is profit motivated or a hobby
• Regulations provide nine factors to consider in making
this determination
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Hobby Losses (slide 3 of 8)
• Presumptive rule of § 183
– If activity shows profit 3 out of 5 years (2 out of 7
years for horses), the activity is presumed to be a
trade or business rather than a personal hobby
– Rebuttable presumption, shifts burden of proof to IRS
– Otherwise, taxpayer has burden to prove profit
motive
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Hobby Losses (slide 4 of 8)
Year
Income (loss)
2009
2010
2011
2012
2013
2014
2015
$500
(1,500)
700
(1,000)
900
(500)
1,200
Hobby?
Yes
Yes
Yes
Yes
No, profit 3 of 5 years
Yes, profit only 2 of 5 years
No, profit 3 of 5 years
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Hobby Losses (slide 5 of 8)
• If an activity is deemed to be a hobby
– Can only deduct expenses to extent of income
from activity (i.e., cannot deduct hobby losses)
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Hobby Losses (slide 6 of 8)
• If an activity is a hobby:
– Expenses are deductible from AGI
• Treated as miscellaneous itemized deductions subject to
the 2% of AGI limitation
• Exception: expenses that are deductible without regard
to profit motive are deductible in full, such as
– Home mortgage interest
– Property taxes
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Hobby Losses (slide 7 of 8)
• Order in which hobby expenses are deductible:
– First: Those otherwise deductible: e.g., home
mortgage interest and property taxes
– Then: Expenses that do not affect adjusted basis:
e.g., maintenance, utilities
– Then: Expenses that affect adjusted basis: e.g.,
depreciation (or cost recovery)
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Hobby Losses (slide 8 of 8)
• Example of hobby expenses: Taxpayer sells
horses raised as a hobby for $15,500
Amount
Order
Amount
Income
$15,500
Interest
6,000
1
$ 6,000
Taxes
3,000
1
3,000
Vet Bills
2,000
2
2,000
Feed
4,000
2
4,000
Depreciation
1,000
3
Ltd. to 500
Total
15,500
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Refocus On The Big Picture (slide 1 of 5)
• Mark may deduct the ordinary and necessary business
expenses incurred by his proprietorship.
– This includes the $18,000 for rent and utilities, the $12,000 paid to his
secretary, and the $40,000 paid to his assistant.
• The $8,000 paid for equipment can either
– Be depreciated, or
– May qualify for immediate expensing under § 179.
• As a self-employed taxpayer, Mark may deduct 100% of the
$3,000 of health insurance premiums paid
– Only if he is not eligible to participate in the subsidized health plan
maintained by Mary’s employer.
Refocus On The Big Picture (slide 2 of 5)
• On the other hand, Mark cannot deduct the premiums of $500
paid for his life insurance policy.
• Mark may want to consider contributing to his own IRA or
establishing a Keogh plan or SIMPLE plan to allow for greater
contributions.
• Mark should be aware that in addition to paying income tax on
the net income earned by his business, he will also owe selfemployment tax at a combined rate of 15.3% and will be able
to claim an income tax deduction for part of the selfemployment tax paid.
Refocus On The Big Picture (slide 3 of 5)
• Mary will owe income tax on her $85,000 salary.
– The health insurance premiums of $3,000 and group term life insurance
premiums paid by her employer qualify as tax-free fringe benefits.
– In addition, as long as Mary is required to substantiate her travel
expenses as part of an accountable plan, none of the travel-related
reimbursements need to be included in Mary’s gross income.
– Because Mary is not covered by a qualified retirement plan at work, she
can also deduct the entire $5,500 contribution made to her IRA.
– While the $500 of employee business expenses are technically
deductible, they provide a tax benefit to Mary only if they exceed 2%
of the couples AGI.
• While Mary is not subject to self-employment tax, she still
incurs a 7.65% payroll tax in 2015 related to Social Security
and Medicare.
– Her employer pays the other 7.65%.
Refocus On The Big Picture (slide 4 of 5)
What If?
• In order to improve her skills in her current job, Mary is
considering entering an MBA program at a local college.
• At the same time, to save money while Mary is in school,
Mark is considering moving his office into a vacant room in
their home.
• Are Mary’s education expenses deductible?
– If the new degree is not required to meet the minimum requirements of
her existing job and does not qualify Mary for a new trade or business,
Mary’s books, tuition, and other related educational expenses are
deductible as a miscellaneous itemized deduction.
– However, like the $500 of other employee business expenses
mentioned earlier, the expenses provide a tax benefit only to the extent
that they exceed 2% of the couples AGI.
Refocus On The Big Picture (slide 5 of 5)
What If?
• Can Mark deduct expenses associated with his home
office?
– As a self-employed individual, Mark is allowed to deduct
the costs of a home office as long as the office is used
exclusively and on a regular basis as either the principal
place of business or a place of business used by his clients
and customers.
– Deductible expenses would include a portion of mortgage
interest and property taxes paid on the home; a portion of
utilities, repairs and maintenance, and other household
expenses; and depreciation on the business portion of the
home.
If you have any comments or suggestions concerning this
PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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