CONCEPTS IN
FEDERAL TAXATION
October 12,
2012
CHAPTER 6:
BUSINESS EXPENSE
ADMINISTRATIVE
 Homework and reading pushed back a week
 Next week’s homework is chapter 7
 Midterm 2 and project due dates stay the same
 Midterm 2 will cover chapters 6-9
 Midterm 1 will be handed back next week
HOMEWORK PROBLEMS
HW Problems
Assignment #7
Chapter 6
P30, 38, 47, 55
#30
For each of the following situations, explain whether a
deduction should be allowed for entertainment expenses :
a. Gayle, a dentist, invites 50 of her best patients to her
daughter’s wedding reception. The cost of the reception related
to the presence of her patients is $5,000 .
 The wedding reception is not an ordinary and necessary
expense of Gayle’s business (dentist)
 The reception is a personally motivated event which lacks a
business purpose
 Gayle cannot deduct the $5,000 of entertainment expenses
#30
b. Stan is one of 5 shift supervisors responsible for 100
employees at Label House, Inc. He regularly meets with the
other shift supervisors at the plant. In addition, Stan makes it
a practice to go to lunch at least once a week with each of the
other 4 shift supervisors in order to network. During the
current year, Stan pays $1 ,500 for his and the other
supervisors’ lunches. Stan’s job description does not require
him to entertain the other supervisors .
 Because Stan’s supervisory position is not af fected by the
entertainment (not required as part of his job), the lunches
are not an ordinary and necessary expense of his job
 The expenses related to Stan’s meals are personal expenses
 Stan may not deduct the $ 1 ,500
#30
c. Jan is a real estate broker who holds an open house for a
dif ferent client each Sunday afternoon. During the open house,
she provides cookies and soft drinks for whoever visits the
house. Jan pays $2,000 for open house entertainment .
 Advertising and promotional expenses are an ordinary and
necessary expense of a real estate broker
 The $2,000 Jan paid for refreshments at the open house is
deductible
#30
d. Felicia is vice-president of sales for Drivitt, Inc. She invited
the company’s major clients and some of her coworkers from
Drivitt to her annual Super Bowl party. Most guests attend with
their spouses. The party is held in a separate room at a local
sports bar and costs her $1 ,500 .
 The expense of the party does not qualify as an entertainment
expense because it fails both the directly related and
associated with tests
 The directly related test requires that the entertainment
expense meet four tests, one of which is that a bona fide
business activity take place during the entertainment
 This is probably not the case, because the setting for the
entertainment is a bar
#30
 For the entertainment to qualify under the associated with
test, two requirements must be met:
1. There must exist a clear business purpose
 Felicia could probably establish that this test is met
2. Entertainment must occur either preceding or following a
substantial business discussion
 This did not occur
 The $1,500 entertainment expense is not deductible
MEALS AND ENTERTAINMENT
A. 50% limitation
B. Must be ordinary and necessary business expense
C. Deductible only if
a.
b.
Directly related to business activity
Associated with business activity
D. Meal costs include food, beverage, tax and tips
E. Entertainment include clubs, theaters, sports events
a.
b.
Face amount of ticket
Skybox
F. Private clubs not deductible
G. Taxpayer or employee of taxpayer must be present
MEALS AND ENTERTAINMENT
H. Reciprocal entertainment not allowed
I. Exceptions to 50% limitation
a.
b.
c.
Expenses treated as compensation
Expenses incurred for another person and receive reimbursement
from that person—accountable plan (the reimbursing person is
subject to the 50% limit)
Recreational/social expenses to benefit employees (de minimis
fringe benefit)
#38
Chai is self-employed and travels to New Orleans for a business
conference. The following facts are related to the trip:
Round trip airfare
Hotel daily rate for single
Conference registration fee
Meals---$54 per day
Incidentals---$27 per day
$375
120
190
54
27
#38
a. If Chai spends 4 days at the conference and 2 days
sightseeing, what amount may he deduct as travel expense ?
 Based on time spent on business and personal activities, the
trip is primarily for business (67% business; 33% personal)
 Transportation is fully deductible (airfare)
 The conference registration fee is deductible
 Only expenses related to the 4 days devoted to business can
be deducted
 Meals are limited to 50% of the deductible amount
#38
 The expenses are deducted as follows:
Airfare
Hotel ($120 x 4)
Conference registration
Meals ($54 x 4 x 50%)
Incidentals ($27 x 4)
Total deduction
$
375
480
190
108
108
$ 1 ,261
#38
b. If he spends 2 days at the conference and 4 days sightseeing,
what amount may he deduct as travel expense ?
 Based on time spent on business and personal activities, the
trip is primarily for pleasure (33% business; 67% personal)
 Transportation is not deductible (airfare)
 Conference registration fee is still deductible
 Only expenses relating to the 2 days devoted to business can
be deducted
 Meals are limited to 50% of the deductible amount
#38
 The expenses are deducted as follows:
Airfare
Hotel ($120 x 2)
Conference registration
Meals ($54 x 2 x 50%)
Incidentals ($27 x 2)
Total deduction
$
-0240
190
54
54
$ 538
#38
c. Next year, Chai would like his wife, Li, who does not work
outside their home, to go with him to the conference. Li’s
expenses would be similar to Chai’s, except that the room rate
for double occupancy is $150. Li would probably attend one or
two sessions and the receptions at night. What portion of her
expenses can they deduct ?
For Chai:
 If the primary purpose of his trip is business (part a), then
Chai’s airfare is fully deductible
 Chai will be able to deduct the business portion of his other
expenses (50% meals)
 The conference registration fee does not have to be allocated
because the fee is business related
#38
For Chai’s wife Li:
 No portion of Li’s expenses is deductible
 Since the double occupancy rate is greater than the single
occupancy rate ($120 for single; $150 for double), Chai’s
deductible portion for the hotel room is limited to the single
occupancy rate ($120 per business night )
#38
 Chai’s deductible amount would be the same as part a or part
b depending on his business to personal activities ratio
TRAVEL EXPENSES
A. Deductible if away from home overnight
a.
b.
Tax home is area of principal business, not residence
Overnight is substantially longer than a regular workday
B. More than 50% of the activity must have business purpose
a.
b.
Incidental business expenses deductible
Personal activity costs not deductible
C. Bona fide business purpose
a.
b.
c.
Spouse cost not deductible, unless business purpose
Not for investment related meetings
Not if the travel itself is educational
#47
Howard loaned $8,000 to Bud two years ago. The terms of the
loan call for Bud to pay annual interest at 8%, with the principal
amount due in three years. Until this year, Bud had been
making the required interest payments. When Howard didn’t
receive this year’s payment, he called Bud and found out that
Bud had filed for bankruptcy. Bud’s accountant estimated that
only 40% of his debts would be paid after the bankruptcy
proceeding. No payments were received. In the next year,
Howard received $2,700 in full satisfaction of the debt under
the bankruptcy proceeding. What deductions are allowed to
Howard, assuming that the debt was:
#47
a. Related to Howard’s business?
 Because t he debt is related to Howard’s business, he will be allowed a
deduction in t he current year for an estimate of t he wor thlessness of
the debt
 Since 40% is estimated to be received, a bad debt deduction for
$4,800 ( $8,000 x 60%) will be allowed in t he current year as an
ordinar y deduction
 Upon receipt of t he $2,700 in t he next year, Howard will be allowed an
additional bad debt deduction for t he amount of t he debt not previously
deducted:
Total debt
Amount of bad debt previously deducted
Amount received in payment of bad debt
Current year bad debt
 Howard may deduct $500 t his year
$ 8,000
(4,800)
(2,700)
$ 500
#47
b. Unrelated to Howard’s business?
 If the debt is unrelated to Howard’s business, it is a
nonbusiness bad debt
 Nonbusiness bad debts are deductible as short -term capital
losses in the year in which the actual amount of loss is known
 No deduction is allowed this year for the $4,800 estimated
amount of loss ($8000 x 60%)
 Howard will have a $5,300 ($8,000 - $2,700) short-term
capital loss in the year in which he receives the payment
 Howard can only deduct $3,000 of the loss in the year he
reports the loss
 The remaining $2,300 is carried forward and deducted in
subsequent years
#47
Additional Considerations:
 If Howard has capital gains in the year he reports the loss, he
can of fset part or all of the $5,300 loss against his capital
gains
 Refer to netting procedure
#47
c. How would your answer s to par ts a and b change if Howard received
$3,300 in satisfaction of the debt in the next year?
Par t a ( business bad debt):
 If Howard receives $ 3,300, he will have to include t he tax benefit he
received from t he overstatement of t he deduction in the previous year:
Total debt
Amount of bad debt previously deducted
Amount received in payment of bad debt
Current year g ross income
$ 8,000
(4,800)
(3,300)
$ (100)
 Under the tax benefit rule, the deduction that was taken in the previous
year will be t axable income in t he current year
#47
Part b (nonbusiness bad debt):
 Howard’s short-term capital loss deduction in the year of
receipt is $4,700 ($8,000 - $3,300)
 Only deduct $3,000 if no capital gains
 Remember, Howard was not permitted to deduct estimated
nonbusiness bad debt expenses
BAD DEBTS
A. Bad debts are generally deductible as capital recoveries
B. Business purpose bad debts
a.
b.
Limited to basis
Specific charge-off method
C. Nonbusiness bad debts
a.
b.
c.
Not deductible if voluntarily forgiven
Not deductible if forgiveness is a gift
Deductible if it’s a bona fide debt that becomes uncollectible
a.
b.
Short term capital loss in year of total worthlessness
Annual capital loss limit is $3,000
D. Look at table 6-1
#55
State whether the following taxes are allowed as a current
deduction for taxes paid by a business:
a. Sales tax on the purchase of a desk
 Sales tax paid on the purchase of an asset is not currently
deductible
 The sales tax must be added to the basis of the asset and can
be recovered through a depreciation deduction (discussed in
chapter 10)
 A sales tax imposed on a business for items benefiting only
the current tax year can be deducted in the current year (i.e.
supplies, small tools, other consumable items )
#55
b. State and local income, real estate, and personal property
taxes
 State and local income, real estate, and ad valorem (based on
value of property) personal property taxes are allowed as a
deduction when paid or accrued based on the taxpayer’s
accounting method
#55
c. Federal income, estate, and gift taxes
 Federal income, estate, and gift taxes may not be deducted
#55
d. An employer’s payment to the IRS of federal income and
Social Security taxes withheld from an employee’s wages
 Payment to the IRS of taxes withheld from an employee’s
wages is not deductible by the employer
 The payment to the IRS represents a transfer of a payment
from the employee to the IRS
 The employer is a middleman who facilitates the payment
 The employer deducts the gross wages paid to the employee
 The employer can deduct the employer’s share of the Social
Security tax when it is paid to the IRS
TAXES
A. Most business-related taxes are deductible except:
a.
b.
Federal income tax, gift, and estate taxes
Allowed as itemized deductions:
a.
b.
Real and personal property tax
State, local, and foreign income taxes
B. Sales tax deductible when not paid as a capital expenditure
a.
b.
Capitalized when related to purchase of capital asset
Deducted by capital recovery (depreciation)
C. Real estate tax is allocated between buyer and seller by
days owned
D. Assessment for local benefits
a.
b.
Sidewalks, streets, etc.
Tax added to property’s basis
SPRING 2012 MIDTERM – Q2
For each of the following IRA situations, determine the amount the
taxpayer can deduct. Discuss any limitations, which might be
placed, on the deduction:
a. Marissa is single and is an active participant in a qualified
employee pension plan. Determine the maximum Roth IRA
contribution that she can make if her adjusted gross income for
the year is $71 ,000.
 If Marissa did not make contributions to other IRA accounts
during the year, she is allowed to make a $5,000 contribution to
a Roth IRA
 Marissa does not receive a deduction for the contribution
 If Marissa's AGI exceeds $110,000, the amount that can she can
contribute to a Roth IRA is phased out ratably until no
contribution is allowed when her adjusted gross income equals
$125,000
SPRING 2012 MIDTERM – Q2
b. David and Donna are married and file a joint return. Each is
covered by an employee-sponsored pension plan, and their
adjusted gross income is $100,000. Determine their maximum IRA
contribution and deduction for the current year.
 They can both contribute $5,000 to IRA accounts
 Since both are covered by employer-sponsored pension plans, the
amount of the IRA deduction is reduced when their AGI reaches
$92,000
 The deduction is fully phased out when AGI exceeds $112,000
 The maximum contribution amount is not affected by this
limitation, only the deductible amount of the contribution
 The $10,000 deduction must be reduced by 40% [($100,000 $92,000) / $20,000]
 This leaves an allowable deduction for AGI of $6,000 [$10,000 ($10,000 * 40%)]
CONVENTIONAL IRAS
A. Contribution allowed
a.
b.
$5,000 of earned income per taxpayer
$6,000 if 50 or older
B. Deduction allowed
a.
b.
All if single or neither spouse covered by employer pension plan
Limited if eligible for employer plan
C. Phase outs
D. Distributions are taxable after capital recovery of any non deductible contributions
ROTH IRAS
A.
B.
C.
D.
Nondeductible contributions
Nontaxable distributions
No restrictions for participation in employer pension plan
Maximum contribution limited to $5,000 to all IRAs in
combination ($6,000 if 50 or older)
a.
b.
Reduced for contributions made to conventional IRAs
Phase out