“Taxes: Vol. I”, Copyright Owen M. Dewing, Library of Congress 2007
IRS Audits
& Schedule C
Owen M. Dewing
CPA/EA/CIFA/PE
grnknitmte@aol.com
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Junior Auditor
_________________
2008
NSA NATIONAL
CONVENTION
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IRS Tax Audits – Schedule C
Changes in IRS over the last decade
I.
A.
Reduction in staff of BMF and International
B.
Retirement of experienced auditors
C.
New Staff
A. Trained by individuals with less than 3 years experience
B. New individuals
i. RA & RO trained to take a more aggressive approach.
ii. Most of the skill level within IRS has been exhausted.
iii. IRS now looking for outside hires.
II.
IRS Scrutiny of 1040
A. IRS now to emphasize the 1040 every year.
B. Treasury checks with emphasis on Schedule C.
i. Red Flags
ii. IRS Audit technique
C. Year 2006 on there is also a red flag for un-reimbursed
employee expenses on Schedule A.
III.
Audit Guides
A. Audit Letters
B. IDR – Information Document Request
C. Case history
i. Request from IRS
ii. Keep a history of everything that takes place on the
case.
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iii. Send all correspondence with return receipt and
signature.
IV. POW
A. Do not let your client speak directly with IRS
i. Allows IRS to broaden the search
ii. Client will inadvertently open new areas of scrutiny
B. POA filed
Auditor Approach
V.
A.
Hobby vs. Business
B.
Record keeping
C.
Client needs
A. Business Plan
B. Credit Card only for Business
C. Separate Checking Account
VI.
Chapters
1] Home Office
2] Auto Expenses
3] Assets
4] Expenses
5] Start Up
6] Hiring Spouse/Child
7] Benefits
8] Travel
9] Meals & Entertainment
10] Continuing Professional Education
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I.
CHANGES IN THE IRS OVER LAST DECADE
A. Reduction in staff at BMF and International There are changes in
the IRS over the last decade. The Large Corporation Group in BMF
and International Group have been significantly reduced. Change in
emphasis due to political and social changes has all but decimated
theses groups.
B. Retirement of Skilled Auditors From the mid 1990’s on senior
experienced staff have looked for other employment or retired. This
has caused a significant “brain drain” in the existing staff of IRS.
Much of the experience and ability to close cases without added
paper work has been lost. Individuals that could understand
situations due to their experience are gone. This is even filtering
into the appeals process since the talent pool is diminished.
C. The New Staff New auditors have issues with training, experience
and a new mind set which encourages them to step over the line in
cases.
i.
Training– new hires are being taught and trained by
individuals with less than three years experience. This is
down from the minimum five years which was common in
the past. Problem for the auditors and professionals
dealing with an audit for client:
ii.
New individuals – The newly trained auditors have less
training, less experience to draw upon, and a smaller pool
to draw from internally.
a. RO & RA Trained to take a more aggressive approach –
The texts and training material for IRS has taken a more
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aggressive approach to the training of the new auditors.
IRS is placing an emphasis on 1040 particularly in
SB/SE. Most likely because they feel that individuals will
be less likely to defend than corporations.
A. Political Issues – There have been changes in IRS
over decades that deal with changes in Congress
and the White House. This is also affected in IRS.
B. Costs – IRS believes that even though there is a
magnitude of more than 100 times more tax to be
collected from BMF side of the house, less
expense is incurred in going after the Schedule C
tax filer.
b. Most of the skill level in IRS has been exhausted - The
existing staff of IRS employees is loosing daily
significant skills in auditing with retirement and people
leaving the service for outside positions. New auditors
are the last of the internal group from IRS so they need
some training.
c. Outside Hiring - IRS has placed ads in USA Jobs and
other outside sources to replenish the staff of IRS.
Some individuals have MA Accounting, law degrees, etc.
II. IRS Scrutiny of 1040’s
A. IRS to emphasize 1040 every year - In the past few years IRS
placed an emphasis on 1120 and 1120 S for audit. Now IRS has
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decided that they will look at 1040’s every year. This means that
the most likely item to trigger an audit is Schedule C. Clients with a
Schedule C, home office, and un-reimbursed employee expenses
from Schedule A are guaranteed an audit and most likely a detailed
rather than letter audit.
B. Treasury Emphasis on Schedule C – The Schedule C return places
the form 1040 for the taxpayer for computer check in other areas. A
simple Schedule C may not be enough for an audit but it
significantly increases the value of the return in IRS system. The
IRS computer then checks the return for home office, auto
expenses [make sure the taxpayer has mileage log], un-reimbursed
employee expenses, etc. All your Schedule C clients should expect
scrutiny.
i. Red Flags – items the IRS computer will search if a Schedule C
return is filed.
A.
Office Deduction
B.
Depreciation
C.
Rental Property
D.
Auto Expenses
E.
Schedule A
1. Un-reimbursed Employee Expenses
2. Medical Expenses
3. Charitable Contribution
F.
Assets
G.
Travel
H.
Meals
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ii.
I.
Entertainment
J.
Continuing Professional Education [CPE]
IRS Audit Techniques – The client letter will request that
the taxpayer provide all their information to IRS for a tax
year. This should come as an IDR [Information Document
Request].
a.
Only provide the documents specifically requested
b.
Send the material if it is a mail or letter request. If
you have Power of Attorney [POA] Form 2848
then you speak with the agent.
c.
Auditors are now in “fishing season” so watch for
the hook.
C. IRS is “unofficially” doing a project on un-reimbursed employee
expenses – this means that if you file a Schedule C and have a
Schedule A with un-reimbursed employee expenses IRS will place
additional scrutiny on the return. This has caused problems already
for individuals that are college professors, individuals working for
other federal agencies, and preparers.
III.
Audit Guides
A. Audit Letters – If you or your client receives an audit letter, read it
carefully as see what it requests. Only provide the information
requested. The IRS will ask you to provide all the material for a
return and multiple years which are designed to cast a wide net or
troll in the hope to find some information which would lead to an
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additional assessment of tax. IRS loves to speak with the client at
the IRS office or the job site of the client in the hope of discovering
“additional information.” No matter how well intentioned the client,
they will inevitably provide more information than needed and
increase the likelihood of added tax. IRS auditors are trained to ask
questions to fluster and anger the client into divulging information
which may mean added taxes. As the representative of the client
taxpayer whatever the IRS says is business, not personal, and you
may respond.
B. IDR – Information Document Request Form 4564 Information
Document Request [IDR] This is the form that will be sent to a client
with the tax years in question and the particular documents requested.
Read what IRS asks and only provide what is asked in the IDR. This
will limit the scope of the audit. If the IRS wants other documents
make them file an IDR for each document. This way you do not have
to show up with a fishing hat at the IRS office because the auditor is
trying to expand the search by casting a large net. The form will have
canned paragraphs and segments citing the Internal Revenue Code
why they would be asking for the documents. IRS will likely cite:
Section 6001 – “Every person liable for any tax imposed by this title, or
for the collection thereof, shall keep such records, render such
statements, make such returns, and comply with such rules and
regulations as the Secretary may from time to time prescribe.
Whenever in the judgment of the Secretary it is necessary , he may
require any person, by notice served upon such person or by
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regulations, to make such returns, render such statements, or keep
such records, ass the Secretary deems sufficient to show whether or
not such person is liable for tax under this title.”
Section 7602 – “For the purpose of ascertaining the correctness of any
return, making a return where none has been made, determining the
liability at law or in equity of any transferee or fiduciary or any person
in respect of any internal revenue tax, or collecting any such liability,
the Secretary is authorized – To examine any books, papers, records,
or other such data which may be relevant or material to such inquiry.
C. Case history - In dealing with the case, you need to know what IRS
has already done. This is the history of the case.
A. Request from IRS - You have the right as a representative,
to request a detailed history of what has been done on the
case. You should be keeping a record of everything that
happens on the case because you can be sure that the IRS
is doing it.
B. Keep a history of everything that takes place on the case. –
a folder with a legal pad and all documents relating to the
case is a start. Write down on the legal pad every time you
contact the client, contact the IRS, mail or fax information.
I find that the date and time to the minute shows a
significant degree of professionalism which also lets IRS
know that you are thorough. The more professional and
thorough the fewer problems and better results from the
audit.
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C. Send all correspondence with return receipt and signature.
– Send information to IRS Certified with return receipt and
mark the information in the case history. Faxes should be
sent with a cover and acknowledgement that the fax was
received.
IV. POW
Do not let your client speak directly with IRS - Think of a World War II POW
camp where it is name, rank and serial number. You may provide the
requested information; however, you do not need to give more than requested
by the Form 4564
A. Allows IRS to broaden the search
B. Client will inadvertently open new areas of scrutiny
V.
Audit Approach
A. Hobby vs. Business
How do you distinguish between a business and a hobby?
Generally, a hobby is an activity that is carried on for personal pleasure or
recreation. It is not an activity entered into with the intention of making a profit.
In determining whether you are carrying on an activity for profit, all the facts are
taken into account. No one factor alone is decisive. Among the factors to consider
are whether:

You carry on the activity in a businesslike manner

The time and effort you put into the activity indicate you intend to make it profitable

You depend on income from the activity for your livelihood

Your losses are due to circumstances beyond your control (or are normal in the
startup phase of your type of business)
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
You change your methods of operation in an attempt to improve profitability

You, or your advisors, have the knowledge needed to carry on the activity as a
successful business

You were successful in making a profit in similar activities in the past

The activity makes a profit in some years, and how much profit it makes

You can expect to make a future profit from the appreciation of the assets used in the
activity
The importance of knowing whether you are involved in an activity for profit or as
a hobby is that the amount of expenses you can deduct if the activity is a hobby
are limited to the amount of income from the same activity.
B. Record keeping
C. Client needs
A. Business Plan
B.
Credit Card only for Business
C.
Separate Checking Account
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VI. Chapters
Chapter 1
YOUR HOME OFFICE
Many people are afraid to take this deduction due to the rumors that it creates a “red flag”
with the IRS. Actually, a home-office has the ability to create many other deductions along
with it. As with anything that deals with the IRS, learning the rules and how you can use
them for your advantage is the secret. The rules on deductibility of home-office expenses are
can be very tight; understanding the rules can provide wonderful tax write-offs that pass IRS
scrutiny. In 1999, the rules governing home-offices were revised and give the taxpayer much
more flexibility.
To deduct expenses related to the business use of part of your home, you must meet
specific requirements. Even then, your deduction may be limited.
This section describes the tests that you must meet to qualify for the deduction. To qualify
to claim expenses for business use of your home, you must meet the following tests.
1. Your use of the business part of your home must be:
• Exclusive,
• Regular,
• For your trade or business, and
2. The business part of your home must be one of the following:
• Your principal place of business,
• A place where you meet or deal with patients, clients, or customers in the normal
course of your trade or business,
Or
• A separate structure (not attached to your home) you use in connection with your trade or
business.
That little item (2), your principle place of business, opened the door to anyone who only
has his or her own office in their home as a regular workplace. It does not have to be a
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Requirements for Home Office Deduction
No
Is part of your home used in
connection with a trade or business?
Yes?
No
Do you regularly use your home
office for your business?
Yes
Do you use your home office
exclusively for business?
YES
NO
No
Yes
Is your home your principle
place of business?
Do you store inventory or run a
day care center at home?
No
Do you perform
administrative or
management tasks at home
and no other fixed location?
Yes
Yes
No
Yes
Do you meet clients or
customers at home?
No
Yes
Do you use a separate
structure exclusively for
business?
No
YOU QUALIFY FOR HOME OFFICE
DEDUCTION
NO HOME OFFICE
DEDUCTION
POSSIBLE
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whole room; it can be part of a room. It doesn’t have to be just a room; it can also include
closet space, garage space, carport or a parking pad for your primary business vehicle or
tools (tractors, cement mixers, clown cars, drill presses...)
Under the present rules, pretty much everyone who operates a business will have a
legitimate claim to an office in the home. So, for the IRS, the odds of finding fault with this
deduction on a tax return from 1999 onward decrease dramatically.
This change does potentially open the home-office deduction to people who do their incomeproducing work outside of the home — such as plumbers, repairmen, contractors, therapists,
computer technicians and other consultants — but who need to do their billing, scheduling
and other paperwork or administrative/management tasks out of a home office.
Examples of Expenses
Certain expenses are deductible whether or not you use your home for business. However, if
you qualify to claim business use of the home expenses, you can use the business part of
these expenses to figure your business use of the home deduction. These expenses include
the following.
•
Real estate taxes.
•
Deductible mortgage interest.
•
Casualty losses.
Other expenses are deductible only if you use your home for business. You can use the
business part of these expenses to figure your business use of the home deduction. These
expenses generally include (but are not limited to) the following.
•
Depreciation*
•
Insurance.
•
Rent - This can be a major tax break for those that do not own a home. If you
itemize and you are a renter, then you are one in only a handful of Americans that
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rent and file Schedule A. With no deduction on Schedule A (Itemized Deductions),
a renter can find a great tax break by having a home-based business.
•
Repairs.
•
Security system.
•
Utilities and services. That could include gas, electric, water, sewer, and garbage.
•
Cleaning of your office space - this is a great place to hire your children to perform
these duties. You will learn more details on hiring family members later in this
book.
•
Computers, Fax Machines, Printers, Phones - Often items you already are using
and own. Some or all of the expense may be deducted.
•
Improvements such as Painting, Wallpaper, Carpeting, Drapery, etc.
•
Desks, Sofas, Tables, and Other Furniture.
•
Landscaping, Snow Removal, Lawn Work, Leaf Removal.
•
I keep track of little things such as light bulbs, toilet paper, cleaning products,
vacuum cleaner bags, etc. All of these will really add up.
Junior Auditor Say’s: If you sell your house while operating a business out of it,
you won’t be able to use the new exclusion unless you used it for personal
purposes for two out of five years before the date of sale, and depreciation will be
“recaptured” at 25%.
Junior Auditor say’s: Two years (24 months) before you plan to sell it, convert it
back to a personal residence. The portion of the home used as an office will
qualify for the exclusion if used for personal purposes for two out of five years
before the date of sale, but depreciation will still be recaptured.
As a schedule C taxpayer with a qualified home-office, you can save self-employment and
Medicare taxes (15.3 percent) by moving many of the indirect expenses from your personal
itemized Schedule A to your Schedule C (business deduction). For renters this is the only
way to deduct the expenses of running your household.
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Figuring the Deduction
After you determine that you meet the tests under Qualifying for a Deduction, you can begin
to figure how much you can deduct. Depending upon the type of use, you will need to know
the following terms:
•
Indirect Expenses
•
Direct Expenses
Types of Home Expenses
Expense
Direct
Description
Things you buy only for your home
Deductibility
Deductible in full
office
Indirect
Things you buy to keep your entire
Deductible based upon the
home up and running
percentage of your home used
as a business
Unrelated
Things you buy only for parts of your
Not deductible
home that are not used for business
Indirect Expenses
These are expenses that you will not be able to write off 100 percent completely, since you
live in the home and use them for other means. Usually the following are examples of
indirect expenses:
•
Rent
•
Mortgage Interest
•
Home Insurance
•
Utilities
•
Lawn Care
•
General Maintenance
The amount that you may deduct will depend upon the percentage of use of your home in
relationship to your business. You will need to figure the percentage of your home used for
business and the limit on the deduction, deduct the expenses of running your household.
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Business Percentage
To find the business percentage, compare the size of the part of your home that you use for
business to your whole house. Use the resulting percentage to figure the business part of
the expenses for operating your entire home. You can use any reasonable method to
determine the business percentage. The following are two commonly used methods for
figuring the percentage.
•
Divide the area (length multiplied by the width) used for business by the total area
of your home.
•
Divide the number of rooms used for business by the total number of rooms in
your home. You can use this method if the rooms in your home are all about the
same size.
Example 1:
•
You use one room in your home for business.
•
Your home has five rooms, all of about equal size.
•
Your office is 20% (1 ÷ 5) of the total area of your home.
Your business percentage is 20%.
Example 2:
•
Your office is 360 square feet (18 feet x 20 feet)
•
Your home is 1,200 square feet.
•
Your office is 30% (360 ÷ 1,200) of the total area of your home.
Your business percentage is 30%.
Direct Expenses:
These are expenses that directly relate to your business and not to the rest of your home
and are 100 percent deductible. These would include room improvements to your office,
paint, drapes, and carpet that are designed for your office.
Another Benefit of the Home Office
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Your “Home Based Business” can also help you deduct your transportation expenses.
Understanding the value of the home office can create you another great deduction. If you
are an employee, you can convert your personal commuting expenses into tax-deductible
business driving by keeping an office in your home.
The tax rule on commuting expenses is as follows: Your first trip of the day (from home to
office) is nondeductible, as is your last trip of the day (from office to home). All businessrelated driving in between is tax-deductible, either at your actual cost or at the IRS standard
mileage rate.
Junior Auditor say’s: Make your first and last business stops of the day in your athome office. If your home office is the first and last business stop of the
day, driving to work and back becomes tax-deductible transportation.
When you do not have a profit from your business, you are not able to take the home office
deduction. However, I still encourage my clients to fill out the paperwork and submit. This
helps determine that you have a business not a hobby and will give you the mileage
validation listed above.
Junior Auditor say’s: You can carry losses over to the next year. As with all
deductions, keeping good records is extremely vital. I suggest if you plan to use
this deduction that you create a Business Journal and record your times and
activities of business each and every day. Otherwise, plan on having your mileage
discarded if audited.
Example: Steve has a office for his writing and publishing business in his home
He purchases the following items:

Bamboo wood floor for his office

A separate telephone line for his office

Carpet for house living room

Computer and printer for his work
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
Lap top for family

New desk & chairs for office

Leather chair he uses is moved to business office

Cleaning service for house and office

Office supplies, paper etc.
What type of expense is each item?
Direct
Home
Indirect Home
Office Expense Expense (% of
100%
Business
Deductible
Bamboo
for
Use
Long-Term
Not
Operating
Asset Expense
Deductible
Expense
Deductible)
floor Mortgage
home interest and real
office
Business
Office
Office desk &
Lap top for
supplies
furniture
family
Business
Leather Chair
Carpet
estate taxes
Utilities
telephone
for
living room
Homeowners
Computer for
insurance
business
Maid or
cleaning
service
Chapter 2
AUTO EXPENSES: How to pay for your vehicle in five years!
This is a very important deduction and can be one of your largest personal expenses. If you
use your car for business, you can choose from two different methods to deduct businessuse charges. The most common method is to deduct the amount per mile that the IRS
allows in any given year for business travel. In 2008, it is 50.5 cents a mile. I often tell my
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clients to get one twenty dollar bill and then drive down the road throwing the $20 bill out
the window every 39.6 miles. This will show you what you are giving away unless you learn
how to record your business miles and take this deduction.
Alternatively, you can itemize: take a depreciation deduction on the cost of your vehicle and
add to that all the costs of running and maintaining your car (gas, oil, parking fees, repairs,
insurance premiums, tolls, tires, licenses and registration fees).
Once you begin taking the mileage method, you must stay with that method until
you purchase a new vehicle.
The Junior Auditor say’s: The key here is to make sure that wherever you drive,
you turn the mileage into business miles. As stated previously, you may deduct as
business mileage the miles driven between two business locations or places of
employment. Establishing your home office as your regular work place becomes
critical to qualify for this great deduction.
You Must Keep Good Records!
For some reason, this seems to be the area where most of us become lazy. Keep your
business journal with you and RECORD YOUR MILEAGE EVERY TIME YOU GET INTO YOUR
CAR. If you drive 20,000 business miles a year, you will receive a $ 10,100 reduction in your
income. At the lower rate, this will mean a $1,515 tax reduction. At the highest level of
taxation, it becomes a $ 3,535 tax reduction. And this does not even account for the savings
on self employment tax.
Regardless of which method you decide to use, you can still deduct all parking fees and tolls
while doing business. Often you pay this in cash. Just write down the date, place, and
business event and you have a legitimate tax reduction. Plug the meter, WRITE IT DOWN!
The Junior Auditor say’s: Intent is crucial in receiving this deduction. If you go to
COSTCO to purchase an item and end up doing business, then your intent does
not allow a business mileage deduction. However, if your intent is to find people
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to do business with and end up purchasing an item at COSTCO, then you have a
deduction. The purpose of this is not to find a way to cheat on your taxes. The
purpose is to understand the mind-set of an entrepreneur and create tax
deductions as you create wealth. You can create a tax deduction just about every
time you get in the car!
Auto Depreciation
Depreciation was discussed in Chapter 3, but the auto you drive is a depreciable asset. When
you purchase a vehicle and use it for your work you may depreciate the entire cost including
sales tax, destination charges and other fees the seller charges. Registration and license fees
do not qualify for depreciation. The percentage of depreciation will depend upon the
percentage of business use of the vehicle. Although automobiles have a five year recovery
period, they are depreciated over a total of six calendar years.
Depreciation Limits for Passenger Vehicles Placed in Service in 2007
1st Tax year
$3,060
2nd Tax Year
$4,800
3rd Tax Year
$2,850
Each following year
$1,775
Depreciation Limits for Tucks and Vans Placed in Service in 2007
1st Tax Year
$3,260
2nd Tax Year
$5,200
3rd Tax Year
$3,150
Each following year
$1,875
Auto Depreciation Table
[Using mid year convention]
YEAR
200% Declining
150% Declining
Balance
Balance
Straight Line Method
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1
20%
15%
10%
2
32%
25.5%
20%
3
19.2%
17.85%
20%
4
11.5%
16.66%
20%
5
11.5%
16.6%
20%
6
5.76%
8.33%
10%
The highest depreciation starts in 200% but will change to straight line by year 3. Check
with The Tax Insider for the greatest advantage!!
Two Cars are Better than One
If you use the actual expense method you might think that you would get a larger deduction
on your vehicle if you drive one 100% of the time for business. Now let us see what can
happen with two cars and comparing actual versus mileage rate.
The Junior Auditor says: Remember that when you use two vehicles you get
depreciation on both and added savings on your return. Remember, if you have
only one vehicle, you will use the vehicle on off hours and personal reasons. The
IRS would believe 80% of your mileage but at 90% you better have a mileage
log for the year because this would be a flag for audit. Check your mileage at the
beginning of the business year and start your log. The IRS may ask for receipts
from maintenance on your vehicle during the year and those receipts will show
the mileage on your vehicle at that time. Keep your mileage correct and benefit
from the deduction on your return.
The reason two cars are usually better than one is due to the added depreciation of the
second vehicle and what you can claim over a five year period of depreciation.
Internal Revenue Service will require that you have a good reason to use two cars instead of
one for business. Some examples of reasons;
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1. One vehicle carries more passengers and cargo and the other vehicle gets much
better gas mileage.
2. You would like to spread the mileage so one vehicle does not accumulate too many
miles.
Example - Raul owns two vehicles. For his job he needs to drive 40,000 miles per
year for business and 10,000 for personal needs. Let us see what his deductions
would be with one car or two cars.
One Car for Work
Car 1
Car 2
Total Miles
40,000
10,000
Business Miles
40,000
0
Business %
100%
0
Total Costs
$10,000
$3,000
Total Auto Deduction
$10,000
$0
Two Business Cars
Car 1
Car 2
Total Miles
40,000
10,000
Business Miles
32,000
8,000
Business %
80%
80%
Total Costs
$10,000
$3,000
$8,000
$2,400
Total Auto Deduction
Our example show that if two cars are used for business that you can deduct an extra $400
on your form.
The Junior Auditor says: It also shows that you may now depreciate both vehicles
over a five year period. Using the two vehicles allows 80% depreciation on the
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total value of the two vehicles which means a greater total depreciation than
normally on one vehicle. Remember to keep good records for the
deduction!
Deduct Your “Temporary Work Location”
There is even a way to deduct some of your routine work commutes. Typically, you cannot
deduct the cost of commuting to and from work. However, if you have a regular place of
business, you can deduct the daily transportation costs of traveling from your home to a
“temporary work location.” A temporary work location is any locale where you perform
services on an irregular or short-term basis.
For example, daily transportation expenses incurred by a doctor traveling between a clinic
and a hospital or between the doctor’s residence and a temporary work location could be
deducted as business-related. As well as, an executive or salesperson that makes infrequent
visits to customers or clients at their offices may deduct those expenses.
If you have a home office, expenses incurred in getting from your home office and other job
sites can be deducted. Your “commute” from the bedroom to your home office is the only
portion not deductible.
Want An Additional Tax Break On Your Vehicle?
Buy a large SUV with a gross loaded weight of 6,000 pounds. You can then depreciate the
vehicle at a much higher rate. Under 6,000 pounds you are limited to $3,260 your first year.
Over 6,000 pounds it climbs all the way to $25,000. This involves using actual expenses
rather than mileage.
Junior Auditor says: Remember the vehicle must be used more than 50% of the
time for business and you will have to continue each of the five years staying
above the 50% level or face a recapture of depreciation. IRS will check the
business percentage use, if audited, which would cause an adjustment,
translation more tax.
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Executives or business owners also may want to think about trading in their luxury sedans
for sport utility vehicles, because of the way the tax laws are written. The IRS does not
consider sport utility vehicles that weigh more than 6,000 pounds (like a Chevy Suburban)
“cars”. That means you can fully depreciate those vehicles in just five years compared with
luxury cars that have a maximum depreciation level of $15,335 over the same period.
Other SUVs over 6,000 pounds include the Ford Excursion and Toyota Land Cruiser.
“Depreciation rules on company-owned autos for business purposes are usually strict.”
Regardless of how much is spent on luxury cars--anything under 6,000 pounds, that is--the
depreciation allowance is capped at $3,060 the first year and dwindles to $1,775 from the
fourth year onward. You will probably trade in that vehicle before you have recovered its
cost in depreciation.
Now, look at what can be written off if you buy a $45,000 SUV over 6,000 pounds. Up to
$25,000 of the initial cost can be written off in the first year as a business equipment
expense. Then another $4,000, or 20% of the balance, can be written off as depreciation.
The next year, 32% of the balance can be depreciated. At the end of five years, the entire
cost will have been written off.
Junior Auditor says: If the SUV is not being used entirely for business, the
deductions are proportional to use. As with any listed property for a business, you
should keep usage logs, in this case mileage. If you are audited and you wrote off
a $45,000 vehicle, you can count on an audit adjustment. (More tax due)
Get Back What You Paid For Your Car
If you have a car that is used 75% of the time for business, everything related to that car
would be 75% deductible. That would include your new CD player and the Ichiro Bubblehead
Doll on your front dash. Focus on our objective here. If you can convert personal expenses
into business expenses and are in the 28% tax bracket, you have, in effect, created a 28%
discount on the cost of anything that qualifies as a business expense.
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Suddenly, that item that was too pricey at $100 becomes a bargain at $72 ($100-28). The
trick, as with many tax strategies, is to get the government to help lower your overall costs.
Chapter 3
ASSETS:
Appreciate your assets but depreciate them for your business
Example: Juan purchases a new computer to keep track of his soaring sales. The
computer is not part of Juan’s product inventory because it was bought to be
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used in his business not to be resold. Since it will last for more than one year
Juan must depreciate it or expense it under Section 179.
Long-term assets are things that last for more than one year. Long-term assets that you
have purchased to use in your business are not part of inventory. They are completely
deductible as capital expenses that you may depreciate over several years, or in many cases
they may qualify to be deducted in a single year under Section 179.
Computers, printers, fax machines, desks, chairs, lamps, filing cabinets, couches and plants
in your office can be included in your business expenses. If they were previously purchased,
you can depreciate them over a five or seven year period. If you use your home for business
purposes, many of your personal expenses can be converted into deductible business
expenses.
A great deduction happens when you put your “office” furniture and equipment, on a
depreciation schedule. This would include any desks, chairs, computers, couches, lamps or
other furnishings that you put into your office. If you buy a leather sofa for $2,000 and put it
in your family room, it costs you $2,000. If you’re in the 35% bracket and you put the same
sofa in your home office, the IRS contributes $700 to the purchase of it.
You can deduct up to $125,000, in 2008, worth of business equipment (section 179) -computers, fax machines, copiers, phone systems, or other fixed assets -- as a current
expense using the first year expense deduction. Otherwise, you would have to deduct the
cost of the equipment over several years via the tax code’s depreciation schedules.
Eligible property generally is property other than residential rental property, nonresidential
real property, and listed property that is used 50 percent or less for business. You must first
DEPRECIATION
Type of Property
PERIOD
3 years
Computer software
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Tractor units for over the road use
Any race horse over 2 years old when placed in
service
Any other horse over 12 years old when placed in
service
5 years
Automobiles, taxis, buses, and trucks
Computers and peripheral equipment
Office machinery ( typewriters, calculators, and
copiers)
Any
property
used
in
research
and
experimentation
Breeding cattle and dairy cattle
Appliances, carpets, furniture, and so on
7 years
Office furniture and fixtures(such as desks, files,
and safes)
Agricultural machinery and equipment
Any property that does not have a class life and
has not been designated by law in any other class
10 years
Vessels,
barges,
tugs,
and
similar
water
transportation
Any single-purpose horticulture or agricultural
structure
Any tree or vine bearing fruits or nuts
15 years
Improvements made directly to land or added to
it (such as shrubbery, fences, roads and bridges)
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Any retail motor fuels outlet, such as convenience
store
20 years
Farm
buildings
(other
than
single-purpose
agricultural or horticultural structures)
27.5 years
Residential
rental
property-for
example,
an
apartment building
39 years
Nonresidential real property, such as a home
office, office building, store or warehouse
use the property after September 10, 2001, and you generally must be the first one to use
the property.
Deducting Capital Expenses
There are two ways to deduct capital expenses. You
1. You can depreciate them, deducting some of the cost each year over the assets useful life.
2. You may deduct most of the cost in one year using section 179 of Internal Revenue Code
[IRC].
Using Section 179 you can deduct up to $125,000 in long term assets purchased each year. Due to
the size of the deduction and the time value of money most home businesses no
longer need to depreciate long term assets. This HUGE change in the tax law can greatly benefit
you! Discuss this and other asset depreciation needs with The Tax Insider.
Personal Property Converted to Business Use
If you use property in your home office that was used previously for personal purposes, you cannot
take a section 179 deduction for the property. You can depreciate it, however. The method of
depreciation you use depends on when you first used the property for personal purposes.
If you began using the property for personal purposes after 1986 and change it to business use in
2008, depreciate the property under MACRS.
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The basis for depreciation of property changed from personal to business use is the lesser of the
following.
1. The adjusted basis of the property on the date of change.
2. The fair market value of the property on the date of change.
CAPITAL VERSUS CURRENT EXPENSE
Will the asset benefit
your business for
more than one year?
Yes
No
Is the expense for
an improvement
to long-term
property?
Yes
No
CURRENT
EXPENSE
CAPITAL
EXPENSE
YOUR FUTURE AND SECTION 179
Year
Section 179 Deduction
Property value limit
Limit
2004
$102,000
$410,000
2005
$105,000
$420,000
2006
$108,000
$432,000
2007
$105,000 + inflation
$420,000 + inflation
adjustment
adjustment
$125,000
$500,000
2008 What will happen
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If you began using the property for personal purposes after 1980 and before 1987 and change it to business use
in 2008 you generally depreciate the property under the accelerated cost recovery system (ACRS). However, if
the depreciation under ACRS system is greater in the first year than the depreciation under MACRS system
(Modified Accelerated Cost Recovery System), then you must depreciate it under MACRS.
An Office Building Is Not Personal Property
You’ll notice that this $25,000 deduction opportunity refers to “personal property.” This is important
to note: Real estate is not personal property. Nonresidential real estate, such as office or industrial
properties, has to be depreciated over 39 years. And only the building qualifies for depreciation (i.e.,
you cannot depreciate unimproved land.)
I lived in a home as my principle residence for the first 2 of the last 5 years. For the last 3 years, the home was
a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the
depreciation I took while it was rented out?
If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years
and lived in it for at least 2 years, you can exclude up to $250,000 of the gain ($500,000 on a joint
return in most cases). However, you cannot exclude the portion of the gain equal to depreciation
allowed or allowable for periods after May 6, 1997. Since you cannot exclude all of the gain,
report the entire gain realized on Form 1040, SCHEDULE D line 8. Report the amount of exclusion
you qualify for on the line directly below the line on which you report the gain. Write Section 121
exclusion in column (a) of that line and show the amount of the exclusion in column (f) as a loss
(in parentheses).
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REQUIREMENTS TO DEDUCT LONG-TERM PROPERTY UNDER SECTION 179
No
Is it long-term
tangible
property?
Yes
No
Property you
bought yourself?
Yes
No
Property used over
50% for business?
Yes
No
Property purchased
with cash?
Yes
PROPERTY
DEDUCTIBLE UNDER
SECTION 179
PROPERTY NOT
DEDUCTIBLE UNDER
SECTION 179
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Frequently Asked Questions about Depreciation
I lived in a home as my principle residence for the first 2 of the last 5 years. For the last 3
years, the home was a rental property before selling it. Can I still avoid the capital gains tax
and, if so, how should I deal with the depreciation I took while it was rented out?
If, during the 5-year period ending on the date of sale, you owned the home for at least 2
years and lived in it for at least 2 years, you can exclude up to $250,000 of the gain
($500,000 on a joint return in most cases). However, you cannot exclude the portion of
the gain equal to depreciation allowed or allowable for periods after May 6, 1997. Since
you cannot exclude all of the gain, report the entire gain realized on Form 1040,
SCHEDULE D line 8. Report the amount of exclusion you qualify for on the line directly
below the line on which you report the gain. Write Section 121 exclusion in column (a) of
that line and show the amount of the exclusion in column (f) as a loss (in parentheses).
What kinds of property can be depreciated for tax purposes?
Only property used in a trade or business or to produce income can be depreciated.
Additionally, the property must be something that wears out or becomes obsolete and it
must have a determinable useful life substantially beyond the tax year. The kinds of
property that can be depreciated include machinery, equipment, buildings, vehicles, and
furniture. Depreciation is a very complex subject. For more information, call The Tax
Insider.
Can the entire acquisition cost of a computer that I purchased for my business be deducted
as a business expense or do I have to use depreciation?
The computer that you purchased for your business would be reported on Form 4562,
Depreciation and Amortization, Part V. A computer is depreciated over a 5-year period. If
the computer is used more than 50% for business, then you also have an option to
expense it in one year (a section 179 deduction) on the business portion, Form 4562 Part
I if the business had taxable income at least as great as the section 179 deduction
claimed.
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Chapter 4
EXPENSES
How to qualify as a business deduction
To qualify as business deductions, your expenses must be:

Ordinary and necessary -- defined by the courts and the IRS as “reasonable and
customary.”

Paid or incurred during the taxable year.

Connected with the conduct of a trade or business.
The term “reasonable and customary” depends on your specific business and the business
customs in your locale. The expenses don’t have to necessarily be reasonable and customary
to you, but simply to your particular trade or industry. There are innumerable cases of
“hobbies” converted into “businesses” with expenses allowed.
In one case, a husband and wife produced, exhibited and sold their sculptured works. Their
expenses were considered ordinary and necessary business expenses. In another case, a
coal miner operated a kennel for bird dogs. For 11 consecutive years, he lost money. But the
courts allowed the deductions and the losses because there was a profit objective.
In a more recent case, a high school teacher’s golfing activity was declared an activity with a
profit motive, so he could legally deduct what once was his “hobby.”
Focus on your profit-making motive. Remember that it’s not what you pay in taxes that
count, it’s what you keep.
What Can I Deduct?
To be deductible, a business expense must be both ordinary and necessary. An ordinary
expense is one that is common and accepted in your trade or business. A necessary expense
is one that is helpful and appropriate for your trade or business. An expense does not have
to be indispensable to be considered necessary.
It is important to separate business expenses from the following expenses:
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
The expenses used to figure the cost of goods sold

Capital Expenses

Personal Expenses
Note: If you have an expense that is partly for business and partly personal, separate the
personal part from the business part.
Cost of Goods Sold
If your business manufactures products or purchases them for resale, some of your
expenses may be included in figuring the cost of goods sold. You deduct the cost of goods
sold from your gross receipt to figure your gross profit for the year.
If you use an expense to figure the cost of goods sold, you cannot deduct it again as a
business expense.
The following are types of expenses that go into figuring the cost of goods sold.
1. The cost of product or raw materials, including the cost of having them shipped to
you.
2. The cost of storing the products you sell.
3. Direct labor costs (including contributions to pensions or annuity plans) for workers
who produce the products.
4. Factory overhead expenses.
Capital Expenses
You must capitalize, rather than deduct, some costs. These costs are a part of your
investment in your business and are called capital expenses. There are, in general, three
types of costs you capitalize.
1. Going into business.
2. Business assets.
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3. Improvements.
Personal Expenses
Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense
for something that is used partly for business and partly for personal purposes, divide the total cost
between the business and personal parts. You can deduct as a business expense only the business part.
Schedule C and Business Expense
Advertising
These important marketing costs should not be forgotten at tax time; they are all deductible
business expenses. If you send out free samples of your product, that is a deductible cost of
promotion. So is hiring someone to write your press releases or leaflet for the neighborhood.
Do not forget the expense of business cards.
You can deduct advertising to sell a particular product or service, to help establish goodwill,
or just get your business known. Advertising costs include what you pay for:

Business cards

Brochures

Advertisements in local yellow pages

Newspaper and magazine advertisements

Trade publication advertisements

Catalogs

Advertisements on the Internet

Fees you pay to advertising and public relation agencies

Package design costs, and

Signs & display racks
Catalogs
The cost of catalogs you use in your selling business for more than one year must be capitalized. The
cost can then be recovered as explained under Cost Recovery, earlier. If the catalogs are used in
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your selling business for one year or less, you can deduct the full cost in the tax year you pay for
them.
Journal Subscriptions
If you subscribe to a journal for direct sellers or related to your business, you can deduct the annual
subscription fee as a business expense.
Samples and Promotional Items
You can deduct the cost of samples you give to your customers and the cost of promotional
items such as posters. You cannot deduct the cost of any samples you use personally. (This
is where you must pay close attention to what you call things. “The meaning of what the
word is, “is”)
Some non qualifying costs include:

Trying to influence government legislation

Help wanted ads you place to recruit workers, but they can still be deducted as
ordinary and necessary business operating expenses
Car & Truck Expenses
Gas, insurance, repairs and all costs associated with a vehicle you purchase for your
business. Whether it is by mileage rate or actual costs or actual costs the expense can be
used to reduce your profits. In Chapter 2, we discussed auto expense and this is the
location on your tax return to place the information.
Commissions
If you must pay a bonus, percentage, or other type of commission to direct sellers working
under you, you can deduct it. Report the full amount of any commissions you receive as
business income, and deduct the commissions you pay as ordinary and necessary business
expenses.
Example: Alice has her own direct-selling business and sponsors three other direct sellers.
These direct sellers report their sales to her each month. She in turn adds their sales to hers
and reports the total to the direct seller who sponsored her. In April, the people working
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under her each had $600 in sales and she had $900 in sales of her own. She reports to the
company (or her sponsor) $2,700 ($600 + $600 + $600 + $900) in monthly sales for her
group even though her income is only $900.
Alice received a commission or “performance bonus” for March equal to 10% of the $2,700,
or $270, in sales. She reports the entire $270 as business income on her tax return.
Alice must pay the direct sellers working under her a commission of 7% on their monthly
sales of $600. She paid each of them $42 (7% of $600) for their April sales. She deducts the
total, $126, as a business expense on her tax return.
Contract Labor
Enter the total cost of contract labor for the tax year. Make sure you do not deduct contract
labor deducted elsewhere on your return such as contract labor you included in Part III of
Schedule C. This is where
individual
you paid or companies, but did not withhold for taxes, and
must report. If the payment is greater than $600 you must also file a 1099-MISC. Again, the
cost of the contract labor reduces your profit and taxes.
Depletion
If your have depletion expense it will go on Schedule C. If it is timber depletion then attach
Form T. Call Tax Insider for questions.
Depreciation and Section 179 Deduction
Depreciation on equipment, furniture, and materials you are depreciating on MACRS or
section 179, etc. are placed on the form. Remember that in Chapter 3 we discussed
depreciation.
You get the opportunity to deduct items by using Section 179 to deduct items you purchased
in 2005 for use in your business. The form 4562 is attached to your tax return. It is required
when:
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


You are claiming depreciation on property placed in business during 2005;
You are claiming depreciation on listed property regardless of the date it was placed
in service;
You are claiming a section 179 expense deduction.
Listed property generally includes:
 Passenger automobiles weighing 6,000 pounds or less;
 Any other property used for transportation if the nature of the property lends itself
to personal use, such as motorcycles, pickup trucks, etc.
 Any equipment used for entertainment or recreational purposes;
 Cellular telephones or other similar telecommunications equipment;
 Computers or peripheral equipment.
Employees Benefits Programs
Here you deduct contributions to employee benefit programs that are not an incidental part
of pension or profit sharing programs that might be included on line 19 of Schedule C.
Do not include on line 14 any contributions you made on your behalf as a self-employed
person to an accident or health plan for group-term life insurance. You may be able to
deduct on Form 1040, line 29, the amount you paid for health insurance on behalf of
yourself, your spouse, and dependents, even if you do not itemize your deductions
Insurance
Generally, you can deduct the ordinary and necessary cost of insurance as a business
expense, if it is for your trade, business, or profession.
Interest
Business interest expense is an amount charged for the use of money you borrowed for
business activities.
Legal and Professional Fees
Legal and professional fees, such as fees charged by accountants, that are ordinary and
necessary expenses directly related to operating your business are deductible as business
expenses. However, you usually cannot deduct legal fees paid to acquire business assets.
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Those are added to the basis of the property.
If the fees include payments for work of a personal nature (such as making a will), you
can take a business deduction only for the part of the fee related to your business. The
personal portion of legal fees for producing or collecting taxable income, doing or keeping
your job or for tax advice may be deductible on Schedule A (Form 1040) if you itemize
deductions.
Retirement Plans
Retirement plans are savings plans that offer you tax advantages to set aside money for
your own, and your employees', retirement. Enter deduction for contribution to a pension,
profit sharing or annuity plan, or plans for benefit of your employees. If the plan included
you as a self employed person, enter the contributions made as an employer on your
behalf on Form 1040. line 28, not on Schedule C.
Office Supplies
Keep track of money spent on paper clips, legal pads, pens, toner cartridges, file folders
and all other office supplies.
Unless you have deducted the cost in any earlier year, you generally can deduct the cost
of materials and supplies actually consumed and used during the tax year.
If you keep incidental materials and supplies on hand, you can deduct the cost
of the incidental materials and supplies you bought during the tax year if all
three of the following requirements are met.
• You do not keep a record of when they are used.
• You do not take an inventory of the amount on hand at the beginning and end of the tax
year.
• Your taxable income is clearly reflected by this method.
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Rent Expense
Rent is any amount you pay for the use of property you do not own. In general, you can
deduct rent as an expense only if the rent is for property you use in your trade or
business. If you have or will receive equity in or title to the property, the rent is not
deductible.
Repairs & Maintenance
Deduct the cost of repairs and maintenance for your business. You should include labor,
supplies, and other items that do not add to the value or increase the life of the property.
You can not deduct “the value” of your own labor. You can not deduct amounts spent to
restore or replace property. These items must be capitalized.
Office Expense
All office expenses for the year may be deducted.
Taxes & Licenses expenses
You can deduct various federal, state, local, and foreign taxes directly attributable to your
trade or business as business expenses.
License and regulatory fees paid each year to state or local governments are generally
deductible business expenses. Some licenses and fees related to starting your business
might have to be amortized.
Travel
Enter your expenses for lodging and transportation connected with overnight travel for
business while away from your tax home.
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Meals
Enter your total deductible business meal and entertainment expenses. Include meal
expenses while traveling away from home for business. Check Chapter 9 of Junior
Auditor guide.
Utilities
Deduct only utility expenses for your trade or business. If you use your home phone for
business you can only deduct expenses for any additional costs you incurred for business
which is more than the base rate for the first phone line.
Wages [Employees' Pay]
You can generally deduct the pay you give your employees for the services they perform
for your business. Enter the total salaries and wages for the tax year. Here is where your
W-2 employees will be reported.
Other Types of Business Expenses
Every letter you send for your business is worth a mini-tax deduction. Make your mail part of
your business.
Bank Service Charges
Review your bank statement to see if you are being charged for operating your business
accounts. If the answer is “yes,” then you have found another deduction.
See chapter 9 of Publication 535 for more information.
Computer
If you use a computer in your business, you can depreciate it. However, if you use it 50% or
less in your business, you must use the Alternative Depreciation System (ADS) under MACRS
to figure your depreciation deduction. For more information, see chapter 4 in Publication
946.
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Home Meetings If you have business meetings in your home, you can deduct expenses for the meetings only
when they meet certain tests.
• The expenses of entertaining business associates in your home are deductible if they meet
the rules discussed under Meals and Entertainment, later, and you can prove your expenses.
• The expenses of maintaining your home as a place of business are deductible if you meet
the tests discussed under Business Use of Your Home, later.
Example: Barbara and Bill hold bi-weekly meetings in their home for the direct sellers who
work under them. They discuss selling techniques, solve business problems, and listen to
presentations by company representatives.
Because the meetings are for business, Barbara and Bill can deduct 50% of the cost of the
food and beverages they provide. They keep a copy of their grocery receipts for these
refreshments and record the date, time, and business nature of each meeting. Because the
meetings are held in their living room rather than in a special area set aside only for
business, they cannot deduct any of their home expenses for the meetings.
Club Dues and Membership Fees
Generally, you cannot deduct amounts you pay or incur for membership in any club
organized for business, pleasure, recreation, or any other social purpose. This includes
country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs
operated to provide meals under circumstances generally considered conducive to business
discussions. The purpose and activities of a club, not its name, will determine whether or not
you can deduct the dues.
Exception - None of the following organizations will be treated as a club organized for
business, pleasure, recreation, or other social purpose, unless one of its main purposes is to
conduct entertainment activities for members or their guests or to provide members or their
guests with access to entertainment facilities.
• Boards of trade.
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• Business leagues.
• Chambers of commerce.
• Civic or public service organizations.
• Professional associations.
• Trade associations.
Tax Preparation Fees
You can deduct as a trade or business expense the cost of preparing that part of your tax
return relating to your business as a sole proprietor. The remaining cost may be deductible
on Schedule A (Form 1040) if you itemize deductions.
You can also take a business deduction for the amount you pay or incur in resolving asserted
tax deficiencies against your business as a sole proprietor.
Service Charges
You can deduct service charges you pay on orders for goods. The service charge can be a
flat charge or it can be based on other criteria.
Business Gifts
You can also deduct up to $25 for each business-related gift given to a client or business associate
during a tax year. You will need to keep the receipts as proof, but the result can save you at tax
time, particularly if you typically send several gifts at holiday time each year.
Internet & Email Services
Do not forget to deduct your monthly bill for your online service providers. If you use those
100 percent for business, you can take the full deduction. Otherwise you must determine the
percentage of usage in relationship to your business and deduct according to the
percentage.
THE TELEPHONE
The telephone is the home-based business’ best friend. You will find many deductions by
simply keeping track of your expenses. Unfortunately, no matter how much a home phone
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may be used for business calls, the tax law doesn’t permit deductions for any part of the
basic monthly service charge for the first telephone line into a residence.
However, that prohibition does not apply to optional services on your first line. Thus, charges
for such options as caller ID, call waiting, extra directory listings and equipment rental can
be deducted in proportion to your business use.
If you have a second telephone line at home, both basic and optional service charges on the
second line can be deducted in proportion to your business usage.
Toll charges on long-distance business calls can be deducted in full.
Business Use of Your Home
If you use part of your home for business, you may be able to deduct
expenses for the business use of your home. These expenses may
include mortgage interest, insurance, utilities, repairs, and depreciation.
Read Chapter 1 again, or call Tax Insider
Frequently Asked Tax Questions and Answers
If I take out a loan for the purpose of starting up a business, can I deduct the interest on my
taxes?
No. No immediate deduction is allowed for startup expenditures. However, once
you begin to operate your business (when it becomes an active trade or business)
you may amortize your interest expense over a period of 60 months.
I gave my friend a loan to do business, but the business went bankrupt and she did not pay
me back. Can I deduct this bad loan?
If someone owes you money that you cannot collect, you have a bad debt. There
are two kinds of bad debts - business and non-business.
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How do you distinguish between a business and a hobby?
Generally, a hobby is an activity that is carried on for personal pleasure or
recreation. It is not an activity entered into with the intention of making a profit.
In determining whether you are carrying on an activity for profit, all the facts are
taken into account. No one factor alone is decisive. Among the factors to consider
are whether:

You carry on the activity in a businesslike manner

The time and effort you put into the activity indicate you intend to make it profitable

You depend on income from the activity for your livelihood

Your losses are due to circumstances beyond your control (or are normal in the
startup phase of your type of business)

You change your methods of operation in an attempt to improve profitability

You, or your advisors, have the knowledge needed to carry on the activity as a
successful business

You were successful in making a profit in similar activities in the past

The activity makes a profit in some years, and how much profit it makes

You can expect to make a future profit from the appreciation of the assets used in the
activity
The importance of knowing whether you are involved in an activity for profit or as
a hobby is that the amount of expenses you can deduct if the activity is a hobby
are limited to the amount of income from the same activity.
Chapter 5
START UP
WHAT TO KNOW WHEN STARTING A BUSINESS
Forms of Business
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The most common forms of business structures are the sole proprietorship, partnership, and
corporation. When beginning a business, you must decide which form of business structure
to use. Legal and tax considerations enter into this decision. Your business legal form will
determine how it is treated for tax purposes. The business entities can be taxed as a
separate entity or the business losses and profits can be “passed thru” to the owners, who
must include this amount on their tax returns. The C corporation is the only type of business
which is not “pass through”.
Sole Proprietorships
A sole proprietorship is an unincorporated business that is owned by one individual. It is the
simplest form of business organization to start and maintain. According to Small Business
Administration 90% of all businesses are sole proprietorships. The business has no existence
apart from you, the owner. Its liabilities are your personal liabilities and you undertake the
risks of the business for all assets owned, whether or not used in the business. You include
the income and expenses of the business on your own tax return. The business owner
personally owns all of the assets of the business and controls its operations.
Partnerships
A partnership is the relationship existing between two or more persons who join to carry on
a trade or business. Each person contributes money, property, labor, or skill, and expects to
share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses,
etc., from its operations, but it usually does not pay income tax. Instead, it “passes through” any profits
or losses to its partners. Each partner includes his or her share of the partnership’s items on his or her
tax return.
S Corporations
An eligible domestic corporation can avoid double taxation (once to the corporation and
again to the shareholders) by electing to be treated as an S corporation. An S corporation
generally is exempt from federal income tax other than tax on certain capital gains and
passive income. Its shareholders include on their tax returns their share of the corporation’s
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separately stated items of income, deduction, loss, and credit, and their share of nonseparately stated income or loss.
Corporations
The profit of a corporation is taxed to the corporation when earned, and then is
taxed to the shareholders when distributed as dividends. However, shareholders
cannot deduct any loss of the corporation.
The most obvious benefit of the C corporation is that the corporation can deduct 100% of
the health insurance it pays for its employees, including employees who are shareholders in
the corporation. It also can fully deduct the costs of any medical reimbursement plan. C
corporations also can deduct fringe benefits such as qualified education costs, group term
life insurance up to $50,000 per employee, employer-provided vehicles and public
transportation passes.
Another benefit of C corporations is the tax rate applied to modest profits. The first $50,000
in annual profits is taxed at a rate of 15%, compared to 28 percent on traditional taxation.
However, the money must stay in the corporation and has the potential of double taxation. C
corporations can be very complicated, as can their tax treatment; owners also have to watch
out for pitfalls including (but not limited to) the accumulated earnings tax and the personal
holding company tax. Don’t try and go it alone, make sure you have a good tax adviser for
this option.
Limited Liability Company
A limited liability company (LLC) is an entity formed under state law by filing articles of
organization as an LLC. None of the members of an LLC are personally liable for its debts. An
LLC may be classified for federal income tax purposes as either a partnership, a corporation,
or an entity disregarded as an entity separate from its owner by applying the rules in
regulations section 301 .7701-3. LLCs are a bit of a hybrid of other forms of business. Like C
corporations and S corporations, LLCs can provide you with some protection against personal
liability. But for tax purposes, LLCs are treated more like partnerships. LLCs carry fewer
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restrictions than other entities. And because they’re considered relatively easy to operate,
LLCs are often compared favorably to S corps, despite the self-employment tax issue. For
example, members can decide how to split profits and losses regardless of how much money
or capital they put into the LLC. There’s no limit on the number of members that an LLC can
have (S corps are restricted to 100 shareholders), nor on the type of entity that can be a
member. And LLCs can even opt to be treated as C corporations or S corporations for tax
purposes, if they prefer that.
Business Taxes
The form of business you operate determines what taxes you must pay and how you pay
them. The following are the four general kinds of business taxes.

Income tax.

Self-employment tax.

Employment taxes.

Excise taxes.
Information Returns
If you make or receive payments in your business, you may have to report them to the IRS
on information returns. The IRS compares the payments shown on the information returns
with each person's income tax return to see if the payments were included in income. You
must give a copy of each information return you are required to file to the recipient or payer.
In addition to the forms described below, you may have to use other returns to report
certain kinds of payments or transactions.
Form 1099–MISC.
Use Form 1099–MISC, Miscellaneous Income, to report certain
payments you make in your trade or business. These payments include the following items.
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
Payments of $600 or more for services performed for your business by people not
treated as your employees, such as subcontractors, attorneys, accountants, or
directors.

Rent payments of $600 or more, other than rents paid to real estate agents.

Prizes and awards of $600 or more that are not for services, such as winnings on TV
or radio shows.

Royalty payments of $10 or more.

Payments to certain crew members by operators of fishing boats.
You also use Form 1099–MISC to report your sales of $5,000 or more of consumer goods to
a person for resale anywhere other than in a permanent retail establishment.
Form W–2.
You must file Form W–2, Wage and Tax Statement, to report payments to
your employees, such as wages, tips, and other compensation, withheld income, social
security, and Medicare taxes, and advance earned income credit payments.
Form 8300 - You must file Form 8300, Report of Cash Payments Over $10,000 Received
in a Trade or Business, if you receive more than $10,000 in cash in one transaction or two or
more related business transactions. Cash includes U.S. and foreign coin and currency. It also
includes certain monetary instruments such as cashier's and traveler's checks and money
orders.
Business Start-Up Costs
Business start-up costs are the expenses you incur before you actually begin business
operations. Your business start-up costs will depend on the type of business you are starting.
They may include advertising, travel, surveys, and training. These costs are capital expenses.
Currently the first $5,000 of start up costs is deductible, after which the remaining costs
must be spread over 180 months [15 years]. This process is called amortization. The one
hundred and eighty months is the minimum period, you may choose a longer time frame but
it is less advantageous.
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If there is more than $50,000 in start up costs then you may not take the full $5,000
deduction. You have to reduce your deduction by the amount over $50,000. So if the total is
more than $55,000 then there is no deduction in the first year and you will have to amortize
the entire amount over 15 years or 180 months.
Depreciation
If property you acquire to use in your business has a useful life that extends substantially
beyond the year it is placed in service, you generally cannot deduct the entire cost as a
business expense in the year you acquire it. You must spread the cost over more than one
tax year and deduct part of it each year. This method of deducting the cost of business
property is called depreciation.
Business property you must depreciate includes the following items.

Office furniture.

Buildings.

Machinery and equipment.
You can choose to deduct a limited amount of the cost of certain depreciable
property in the year you place the property in service. This deduction is known as
the “section 179 deduction.”
Depreciation must be taken in the year it is allowable. Allowable depreciation not taken in a prior
year cannot be taken in the current year. If you do not deduct the correct depreciation, you may
be able to make a correction by filing Form 1040X, Amended U.S. Individual Income Tax Return,
or by changing your accounting method.
Chapter 6
HIRING YOUR CHILDREN/SPOUSE
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A child who works in his parent’s business can earn up to the standard deduction for the tax
year without owing any Federal Income Tax. In 2008 this amount is $5,450.
An additional $5,000 of the child’s salary could be designated for an IRA and escape
taxation. This amount has been targeted to be raised over the next few years. If your
business is unincorporated, you do not have to pay Social Security tax on wages paid to your
child who is under 18.
The only rule that governs paying salaries to family members is that they actually earn their
salaries and that compensation is reasonable. Another tax court ruling has established the
minimum age at six.
Keep good records on this as with all deductions. In a recent audit, my client was given a
complete deduction of over $14,000 for his three children. Do you realize that in the upper
tax bracket, that is a savings of over $4,900? In the lowest tax bracket, it is a savings of
$2,100. Also don’t forget the additional 15.3% saving on self employment tax, $2,142.
This is a HUGH DEDUCTION!!!
Advantages:

You do not need to pay FICA taxes for your child under the age of 18 that works in
your business or partnership if it is owned solely by you and your spouse;

No need to pay FUTA taxes for child who is under 21 years old;

If there is no unearned income, then you only have to withhold taxes from your
child’s pay if it exceeds $5,450 in 2008. [Junior Auditor says – if your child has
more than $250 in unearned income and their total income is more than $750.]
Your children can earn money by working in your business and pay for their own car, gas, clothing,
school expenses, and just about every imaginable expense that your children are having you pay for
right now. Now it can all be deductible!
The Junior Auditor say’s: Stop giving your kids an allowance, start giving them a
salary, and get a huge tax break.
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Just begin to think of the many things that your kids can do to earn a salary. Hire your
children to clean your office, vacuum the carpets, wash the windows, and polish the
furniture. They can be paid to keep the landscaping outside of your office nice. Whatever a
typical office building has to put out in expenses, your children can do. I have paid my
children to make computer disks that I later sold, to seal and stamp envelopes, and as they
got older help me with several computer tasks.
When hiring your children, make sure you
record the following:
• Date
• Time
• Work accomplished
You will want to establish an hourly wage or weekly salary. Write up responsibilities and
other requirements just as you would any other employee. Establish a fair wage; ask
yourself what would a typical business pay for this type of work? Just make sure that your
compensation is a fair and reasonable amount.
You must also file a W2 form for your children. This is easier than you think. Just fill out the
form and put exempt in the Social Security and Medicare boxes. You will also send in a W3
form which is just a summary of all W2s.
YOUR SPOUSE
Advantages

You do not have to pay FUTA taxes if you employ your spouse in your unincorporated
business,

Employee Benefits
1. You can take a tax deduction for the cost of the benefit and your spouse
does not have to declare the benefit as income.
2. Health Insurance – you can give your spouse health insurance coverage as
an employee benefit. [Check Chapter 8] Hello Savings!
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Rules for Employing the Family
1. Your child/spouse must be a real employee – their work must be ordinary and
necessary for the business, and the pay must be compensation for services actually
performed
2. Compensation must be reasonable – you would like to shift as much of your income
to your children, who are likely in a lower tax bracket. Conversely you wish to pay
your spouse as little as possible since there is no advantage from income shifting,
Social Security tax. You can not just pay whatever amount will result in the lowest
tax. The wages for your child/spouse must be reasonably related to the value of the
service performed.
3. Comply with the legal requirements for employment – you must comply with the same
legal requirements when you hire the child or spouse as you do with a stranger you
hire as an employee.
Chapter 7
BENEFITS
HEALTH SAVINGS ACCOUNT [HSA]
If you are looking for the best deal on the market, then the Health Savings Account [HSA]
may be what you are looking for to save taxes.
HSA are used, instead of health insurance, to pay small or routine medical expenses. You
pay the medical expenses yourself. The HSA is established with a bank, insurance company
or other financial institution. The contributions you make are tax deductible and you do not
have to pay tax on the interest or other money you earn on your account. The money can be
withdrawn to pay almost any kind of health related expense, and there is no tax on these
withdrawals.
In the event that you or a family member develops a serious health problem, then you must
also have a health insurance policy with a high deductible – it must be at least $1,000.00 for
individual and $2,000.00 for families. The money in your HSA can be used to pay the large
deductible and any co-payments you would have to make.
The HSA can save you money in two ways:
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1. You will get a tax deduction for the money you deposit in your account.
2. Premiums for your high deductible health insurance policy should be much less than
those for the traditional comprehensive policies or HMO coverage. [savings as much
as 40%]
What you need:

An HSA account, and

A high-deductible health plan that qualifies under the HAS rules.
Once you open an HSA account and HSA-qualified health plan, there is no minimum amount
you must contribute but there are maximum limits. Below are the 2005 limits:

Single - $2,650 or your annual deductible, whichever is lower.

Family - $5,250 or the amount of your annual deductible, whichever is lower.
If you are age 55 to 65 you have the option of making catch-up contributions, $700 in 2006.
Year
Maximum Catch-Up
2006
$700
2007
$800
2008
$900
2009 and later
$1,000
Remember you pay no taxes on funds you use from HSA’s to pay for medical expenses.
Medical expenses are broadly defined and dental care is just one item. If you believe that
this might be an advantage for you and your business then check with the experts at The
Tax Insider
HEALTH INSURANCE
Self-employed individual can deduct up to 100 percent of their health insurance payments in
2006. If you are self-employed, a sole proprietor, it is possible to deduct 100% now by hiring
your spouse as an employee and then adopting an employee benefit plan that covers
medical insurance of employees and their family. You will have to file for an EIN number
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and file a W-2 in this instance. You are now able to legally deduct all insurance plan
deductibles, co-pays for medicines and doctor visits. It is important that you have a policy
established in writing that covers all expenses for your employees.
A sole proprietor will have to pay Social Security and Medicare payroll taxes on all family
members 18 and over. Make sure you do not hire other people or you will be required to pay
all of these expenses for them also.
Frequently Asked Questions about Health Insurance
Can an employer pay for health care costs of an employee as a fringe benefit?
Yes, an employer may pay for health care costs of an employee as a nontaxable fringe
benefit provided it meets certain nondiscrimination rules.
If our business pays for the employee’s health care costs directly to the medical
facility, as opposed to a reimbursement, is the employee benefit reported on
Form W-2 and subject to social security withholding?
Health care costs paid directly to the medical facility is a nontaxable employee benefit
provided that it is paid as part of a qualifying accident and health plan. Be very careful with
this type of arrangement.
If an employer pays health insurance benefits for the employee and dependents,
then are both the employee’s and the dependent’s benefits income to the
employee?
If an employer provides health insurance for the employees, the benefit provided is not
taxable to the employee. An employer can generally deduct the cost of a group health plan
on the “employee benefit programs” line of their business income tax return.
Group health plan defined: This (including a self-insured plan) is a plan that provides medical
care to your employees, former employees, or their families. The plan can provide care
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directly or through insurance, reimbursement, or otherwise. The employer can exclude the
cost of providing group health insurance to an employee from his or her wages.
RETIREMENT PLANS
Self-employed business owners have a wide variety of retirement plans available -Individual Retirement Accounts (IRA), Simplified Employee Pensions (SEP) and Keogh
accounts. You can deduct contributions made to these plans, and their income is tax
deferred. Currently you can place up to $42,000 a year in a Keogh or SEP, or 25 % of your
earned income, whichever is less.
Tax-Deferred Plans for Small and Home-Based Businesses
Employers and employees have to know which retirement plans are best for them. From
IRAs to SEPs, retirement plans depend on you and your company’s needs.
Picking the right retirement plan is not easy. If you work for yourself or you need to save for
retirement on your own, you will need to do some homework to search out the right plan.
If you’re a small business owner, for instance, the decision on what type of retirement plan
and how much to contribute is up to you. After all, there is no employee benefits manager to
hand you that nice, descriptive brochure for the company plan and no simple form to sign
that will make someone else automatically deduct retirement contributions from your
monthly paycheck.
Even if all you qualify for is a $3,000 Individual Retirement Account contribution, your search
is worthwhile because of those twin benefits of tax-deduction and tax-deferral.
(401) Keogh Plans
The traditional retirement plan for large businesses is the Keogh plan. Keogh plans can be
time-consuming to set up, and require annual filings to the IRS and the Department of
Labor. This is a major reason why only 42% of the nation’s businesses with less than 100
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employees offer retirement plans to their workers, and why only 11% of businesses with
fewer than 25 employees do so.
To encourage small businesses to help their employees save for retirement, two new plans,
the SEP-IRA and the SIMPLE-IRA, have been designed to streamline the administrative
process by eliminating IRS and Labor Department filings.
The SEP-IRA
The Simplified Employee Pension IRA is an excellent choice for employers that do not want
to be required to put money in each year.
The SIMPLE-IRA
The other new plan, just introduced in 1997, is Savings Incentive Match Plan for Employees,
or the SIMPLE-IRA. Its name is well chosen. To be eligible, you must have no more than 100
employees with compensation of $5,000 or more for the preceding year. In addition, you
cannot have maintained a qualified plan during any of the three years preceding the year for
which the new plan is established.
You and any of your employees can contribute up to $ 10,000 in 2005, or 100% of your
income, whichever is less. The limits on elective deferrals for SIMPLE Plans are further
increased for taxpayers that are 50 or older. The additional catch up amount is:
$2000 in 2005
$2500 in 2006 and later years
The Traditional IRA
Even non-working spouses can now put in $4,000 beginning in 2005. The amount increases
to $5000 in 2008. This is referred to as “catch-up” contribution. If you contribute to an IRA,
you automatically get the benefit of tax-deferral. The earnings on your investment are not
taxed until you take the money out at retirement.
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What people find confusing is whether the contributions are tax- deductible.
Whatever you do for your own retirement planning, do something. After all, retirement plans
are some of the best tax shelters anywhere and the person who benefits is you.
If you haven’t started an IRA yet (and millions of people haven’t) or made a contribution to
your already established IRA or retirement plan this year, don’t fret - there’s still time. You
have until April 15, 2007, to contribute to a retirement plan for the 2006 tax year.
Frequently Asked Questions about Retirement Plans
I want to establish a traditional individual retirement arrangement (IRA) for my
spouse and I, but I need additional information. What is the most I can
contribute during the tax year?
If both you and your spouse work and both have taxable compensation, each of you can
contribute up to $4,000 (or the amount of each IRA owner’s compensation, if less) to a
separate traditional IRA. Even if one spouse has little or no compensation, up to $4,000 can
be contributed to each IRA if combined compensation is at least equal to the amount
contributed to both IRAs and you file a joint return. You can contribute $4,000 to a separate
IRA for your nonworking spouse if you file a joint return. Your total contribution to both your
IRA and the spousal IRA for this year is limited to the smaller of $8,000 or your taxable
compensation. You cannot contribute more than $4,000 to either IRA for the year.
Can I take an IRA deduction for the amount I contributed to a 40 1(k) plan last
year?
No. A 401(k) plan is not an IRA. However, the amount you contributed is not included as
income in box 1 of your W-2 form so you don’t pay tax on it.
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CHAPTER 8
TRAVEL
WONDERFUL WAYS TO WRITE OFF YOUR VACATION
Best summer travel tax strategies: Combine pleasure with business. You can get
generous tax deductions even for a trip that has a large element of personal
pleasure in it.
The Junior Auditor says: If a trip within the US is motivated primarily by business
reasons, you can deduct the full cost of travel to and from your destination.
Book business travel flights with a Saturday stay over to take advantage of the lower airfare.
When you do that, the IRS says that all of your travel costs are deductible -- even if you end
up spending the entire weekend sightseeing. If your business meetings are spread out over
a week, the overall trip is considered a business trip -- even though it allows plenty of time
for pleasure.
Travel and Local Transportation
Travel expenses generally are those business related expenses for trips that require you to
spend the night away from home - for example, the cost of travel to a distant city to attend
a business-related function or convention. Local transportation expenses generally are those
business related expenses for trips you make in the area of your tax home - for example, the
cost of transportation to call on customers or make deliveries in the city where you work and
its suburbs. You must be able to prove your expenses for travel and transportation.
Deductions for travel and transportation are looked at closely when the IRS examines
returns.
Travel
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Generally, your tax home is your regular place of business or post of duty, regardless of
where you maintain your family home. If you temporarily travel away from your tax home on
business, you can deduct your ordinary and necessary travel expenses. You cannot deduct
lavish or extravagant expenses or those for personal or vacation purposes.
You can deduct all your travel expenses, subject to certain limits, if your trip was entirely
business related. This includes expenses for attending a seminar, meeting, convention, or
other function if you can show that your attendance benefits your business. If your trip was
primarily for business and, while at your business destination, you extended your stay for a
vacation, made a non-business side trip, or had other non-business activities, you can deduct
only your business-related travel expenses. These expenses include the travel costs of
getting to and from your business destination and any business-related expenses at your
business destination.
Example: You live in Atlanta and conduct your direct selling business from there
and take a business trip to New Orleans. On your way home, you stop in Mobile to
visit your parents. You spend $830 for the 9 days you are away from home for
transportation, meals, lodging, and other travel expenses. If you had not stopped
in Mobile, you would have been gone only 6 days, and your total cost would have
been $730. You can deduct $730 for your trip, including the cost of round-trip
transportation to and from New Orleans. The cost of your meals is subject to the
50% limit on meals explained later.
If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip
is a nondeductible personal expense. However, you can deduct any expenses you have while
at your destination that is directly related to your business.
The Junior Auditor says: I have found it is much easier and a better deduction to use per
diem rates when deducting my meals when I am traveling. Rates do vary depending upon
what part of the country you are in. See Publication 1524 for amounts.
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There are several different ways to deduct meal and lodging expenses when you are on the
road.
The Basic Method
Keeping careful track of actual food and lodging costs is the method with which most small
businesses are familiar. Save your receipts, document your costs and the business purposes
of your activities and take your deductions.
Per-Diem for Businesses
You as the employer can give your employees a per diem allowance. The simplest way of
doing this, known as the high-low method, lets you choose from only two different rates for
meals, hotels and incidental expenses for business trips within the continental United States.
Per-diem allowances within the U.S. under this method are $204 per day in so-called “highcost” areas, which include major cities such as New York, Chicago, Washington, D.C., and
San Francisco. Most of the country, however, falls under a per diem rate of $125 per day.
For more details on per diem rates, go to the IRS Web site and search for “per diem rates.”
One advantage of the per diem route is that you don’t have to keep track of the actual
receipts for meals and hotel costs. However, the paperwork burden is not entirely
eliminated: You and your employees still have to keep track of the time, place and purpose
of each business expense.
If you decide to use the high-low method, you have to use it for all travel for the entire year.
The Federal Meals-And-Lodging Travel Rate Method
Instead of the high-low method, you can choose to take per diem deductions, or reimburse
your employees, based on the federal per diem rates, which vary depending on the location.
These per diem rates actually can be more favorable than those under the high-low rate, but
you’ll want to take a look at the rates in the cities you are traveling to and do a comparison
before deciding which works to your advantage.
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Per Diem for Sole Proprietor
If you are an unincorporated sole proprietor, you also are entitled to take per diem
deductions for meals, but not per diems for hotels.
You can use the government’s meal per diem rates (which are $30, $34, $38, $42 or $46,
depending on the city), but you cannot use the federal travel rate method or the high-low
method for taking lodging deductions. You’ll have to keep track of those actual hotel
expenses regardless of whether you use the per diem rates or deduct actual meal expenses.
A sole proprietor is not locked in to taking either the per diem deduction or actual meal
expenses for all your trips for the whole year. You can decide with each trip which method to
use for that trip. You do, however, have to be consistent in using the same method for the
entire trip.
Foreign Travel per Diems
Foreign trips are subject to different rules and per diem rates and requirements. If you
happen to have a qualifying business trip overseas — and the rules for deducting overseas
travel differ significantly from those governing domestic business travel — you can check out
the foreign per diem possibilities at the State Department site (search for “foreign per diem
rates”).
Local Transportation
You can deduct local transportation expenses for your business. Generally, local
transportation expense is the cost of getting from one workplace to another in the course of
your business when traveling within the city or general area that is your tax home, or of
getting from your home to a temporary work location. It includes the following kinds of trips
you make in the area where you live and work.
•
Visiting clients or customers.
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•
Attending business meetings away from your workplace.
Transportation expenses include train, bus, and cab fares, car rental fees, and the cost of
driving and maintaining your car for business transportation. Meals and lodging are not
included in transportation expenses.
Commuting Expenses
You cannot deduct the cost of transportation between your home and your main or regular
place of work. The cost of commuting is a nondeductible personal expense, regardless of the
distance or whether work is performed during the trip.
Example: Barbara sells Avon at her flower shop office. She picks up the material
and delivers to her co workers.
Barbara’s expense of delivering items is not deductible. Her cost of getting to the office is a
commuting expense. The fact that she carries products does not make her commuting
expense a deductible business expense.
Two Places of Work
If you work at two places in one day, you can deduct the expense of getting from one
workplace to the other. However, if you do not go directly from one location to the other,
deduct only the amount it would have cost you to go directly from the first location to the
second.
Frequently Asked Questions:
For business travel, are there limits on the amounts deductible for meals?
Meal expenses are deductible only if your trip is overnight or long enough that you need to
stop for sleep or rest to properly perform your duties. Generally, the deduction for unreimbursed business meals is limited to 50% of the cost.
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Instead of keeping records of your meal expenses and deducting the actual cost, you can
generally deduct a standard meal allowance ranging from $30 to $46 depending on where
and when you travel.
Independent Contractors
If you hire individuals as independent contractors and they incur travel, entertainment and
meal, expenses which you pay, then you can take the deduction. The deductible items would
not be listed on a 1099-MISC you file with the IRS to show how much you paid the
independent contractor.
Example: John, an accountant, hires Robert to drive to another city and audit
materials for his client. In the course of the work Robert incurs expenses of $500
while out of town for two days. Robert brings back an adequate accounting of the
expenses and John pays back Robert $500. John can deduct all of the travel and
50% of meal and entertainment expenses. On the form 1099-MISC, John does
not include $500 on how much he paid Robert.
Chapter 9
Meals, Entertainment
IRS rules for business-related meals, entertainment and gifts allow you substantial
opportunities to convert personal expenses into deductions.
You can deduct 50 percent of ordinary and necessary business expenses for entertaining a
client, customer or employee if it is directly related to your business or associated with your
business. It is essential to keep excellent records for business entertainment expenses. For
example, if you take someone out for a meal, be sure to document the date, the amount,
the place the meal took place, the business purpose of the meal, and the business
relationship. If you hold a party, you should keep a copy of the guest list, noting your
respective business relationships.
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How would you like to get a discount of 5% to nearly 20% on your meals and entertainment
expenses? If your meals and entertainment expenses were deductible, a $100 meal would
cost only $87.50 if you were in the 25% tax bracket.
Tax laws allow you to deduct half of your meals and entertainment expenses if they are
business-related. Any expenses for food and drink provided under circumstances considered
favorable to a business discussion, or when a business discussion is held, can be deducted.
If you are self-employed, you can deduct them as part of your adjustments to income.
Entertaining Business Clients
By far, the most commonly used aspect of this deduction relates to entertainment and food,
however. The custom of entertaining business clients or potential business clients with food and drink
in restaurants and hotels converts into deductible expenses. When you go out with friends or
relatives for a meal or drink, do you ever pick up the check? If they are or could be potential clients
or customers for your business, and you discussed business with them, then that check would be
deductible.
Even if you do not talk business at the meal, it will be deductible if the meal follows or
precedes a business discussion. Recognize that no actual business need come from the
meeting so long as business was discussed. Be careful, if you meet with some one regularly
and exchange picking up the tab, you can face a tremendous penalty. If caught by the
Internal Revenue Service, the deduction will be disallowed as a sham and subject you to
fraud penalties. However, do not hesitate to deduct legitimate expenses.
Not only can you deduct meals, but you can also deduct business entertainment expenses.
Money spent for business entertainment, amusement or recreation can be deducted if you
can show the expense:
•
Directly preceded or followed a substantial business discussion;
Or;
•
Directly related to the active conduct of your trade or business.
Examples of potentially deductible expenses include entertaining guests at nightclubs,
theaters, sports games, or even vacation trips. Do not waste much energy building up
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deductible entertainment expenses unless you are prepared to do it right. This area is always
a target of audits and is one of the most abused of all expenses. Make sure that each receipt
(or notation in your appointment book or business diary) has ALL FIVE of the following
components:
•
The amount of expenditure;
•
The date of the expenditure;
•
The name, address or location, and type of expenditure, such as dinner or theater,
if the information is not apparent in the name or designation of the place;
•
The reason for the expenditure or the business benefit derived or expected to be
gained. While this sounds complicated, it is really easy.
•
Information about the person or persons entertained, including the name, title or
other designation sufficient to establish the business relationship to you.
You must have a receipt or other documentary evidence for meals or entertainment
expenses of $75 or more. Currently, for expenditures of less than $75, you do not need a
receipt. Fully acceptable substantiation would include a diary or written planner in which you
enter the above descriptive information. If you put this information in your business software
records, even in an audit, the entries would be complete substantiation under the law.
The Junior Auditor says – Keep All Receipts no matter what.
While most meals or entertainment expenses can only be deducted for half of the cost,
certain meal and entertainment expenses remain fully deductible:
•
Expenses reimbursed under an “accounting plan;”
•
Expenses incurred for recreational or social activities provided by the employer for
the benefit of its employees. These might be the annual company picnic or holiday
party;
•
Expenses for goods, services and facilities made available to the general public,
such as promotional tickets or customer samples;
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•
Expenses related to the ticket package costs for sporting events arranged primarily
for the purpose of charitable fund-raising.
The deductions for meals and entertainment allow you substantial opportunities to convert
your personal expenditures into business deductions. Do not fail to claim them and do not
fail to keep them because of lack of adequate substantiation. In the 28 % tax bracket, $100
worth of entertainment expenses costs you $ 86.00. No matter how much money you’re
making, it would be worth $ 14.00 in tax savings to spend 20 seconds noting the name of
your business clients and the business discussion on the back of your ticket stub or receipt.
You may be able to deduct business-related entertainment expenses you have for
entertaining a client, customer, or employee. The rules and definitions are summarized in
Table A-1.
You can deduct entertainment expenses only if they are both ordinary and necessary and
meet one of the following tests.

Directly-related test.

Associated test.
Both of these tests are explained later under “What Entertainment Expenses Are Deductible.”
An ordinary expense is one that is common and accepted in your field of trade, business, or
profession. A necessary expense is one that is helpful and appropriate for your business. An
expense does not have to be required to be considered necessary.
Club Dues and Membership Fees - You cannot deduct dues (including initiation
fees) for membership in any club organized for:

Business,

Pleasure,
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
Recreation, or

Other social purpose.
This rule applies to any membership organization if one of its principal purposes is either:

To conduct entertainment activities for members or their guests, or

To provide members or their guests with access to entertainment facilities, discussed
later.
The purposes and activities of a club, not its name, will determine whether or not you can
deduct the dues. You cannot deduct dues paid to:

Country clubs,

Golf and athletic clubs,

Airline clubs,

Hotel clubs, and

Clubs operated to provide meals under circumstances generally considered to be
conducive to business discussions.
If you give a customer tickets to a theater performance or sporting event and you do not go
with the customer to the performance or event, you have a choice. You can treat the tickets
as either a gift or entertainment, whichever is to your advantage.
If you go with the customer to the event, you must treat the cost of the tickets as an
entertainment expense. You cannot choose, in this case, to treat the tickets as a gift.
What Entertainment Expenses Are Deductible?
This section explains different types of entertainment expenses that you may be able to
deduct. It also explains the directly-related test and the associated test.
Entertainment -
Entertainment includes any activity generally considered to provide
entertainment, amusement, or recreation. Examples include entertaining guests at
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nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts;
or on hunting, fishing, vacation, and similar trips.
Entertainment also may include meeting personal, living, or family needs of individuals, such
as providing meals, a hotel suite, or a car to customers or their families.
A meal as a form of entertainment - Entertainment includes the cost of a meal you
provide to a customer or client, whether the meal is a part of other entertainment or by
itself. A meal expense includes the cost of food, beverages, taxes, and tips for the meal. To
deduct an entertainment-related meal, you or your employee must be present when the food
or beverages are provided.
Deduction may depend on your type of business -
Your kind of business may
determine if a particular activity is considered entertainment. For example, if you are a dress
designer and have a fashion show to introduce your new designs to store buyers, the show
generally is not considered entertainment. This is because fashion shows are typical in your
business. But, if you are an appliance distributor and hold a fashion show for the spouses of
your retailers, the show generally is considered entertainment.
Separating costs - If you have one expense that includes the costs of entertainment, and
other services (such as lodging or transportation), you must allocate that expense between
the cost of entertainment and the cost of other services. You must have a reasonable basis
for making this allocation. For example, you must allocate your expenses if a hotel includes
entertainment in its lounge on the same bill with your room charge.
Taking turns paying for meals or entertainment -
If a group of business
acquaintances take turns picking up each others' meal or entertainment checks without
regard to whether any business purposes are served, no member of the group can deduct
any part of the expense.
Lavish or extravagant expenses - You cannot deduct expenses for entertainment that
are lavish or extravagant. An expense is not considered lavish or extravagant if it is
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reasonable considering the facts and circumstances. Expenses will not be disallowed just
because they are more than a fixed dollar amount or take place at deluxe restaurants,
hotels, nightclubs, or resorts.
Allocating between business and non-business - If you entertain business and nonbusiness individuals at the same event, you must divide your entertainment expenses
between business and non-business. You can deduct only the business part. If you cannot
establish the part of the expense for each person participating, allocate the expense to each
participant on a pro rata basis.
Example You entertain a group of individuals that includes yourself, four business
prospects, and six social guests. Only 5/11 of the expense qualifies as a business
entertainment expense. You cannot deduct the expenses for the six social guests
because those costs are non business expenses.
Trade association meetings - You can deduct entertainment expenses that are directly
related to and necessary for attending business meetings or conventions of certain exempt
organizations if the expenses of your attendance are related to your active trade or business.
These organizations include business leagues, chambers of commerce, real estate boards,
trade associations, and professional associations.
Entertainment tickets - Generally, you cannot deduct more than the face value of an
entertainment ticket, even if you paid a higher price. For example, you cannot deduct service
fees you pay to ticket agencies or brokers or any amount over the face value of the tickets
you pay to scalpers.
Exception for events that benefit charitable organizations -
Different rules apply
when the cost of a ticket to a sports event benefits a charitable organization. You can take
into account the full cost you pay for the ticket, even if it is more than the face value, if all of
the following conditions apply.
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The event's main purpose is to benefit a qualified charitable organization.

The entire net proceeds go to the charity.

The event uses volunteers to perform substantially all the event's work.
Example 1 - You purchase tickets to a college football game through a ticket
broker. After having a business discussion, you take a client to the game. Net
proceeds from the game go to colleges that qualify as charitable organizations.
However, since the colleges also pay individuals to perform services, such as
coaching and recruiting, you can only use the face value of the tickets in
determining your business deduction.
Example 2
-
You purchase tickets to a golf tournament organized by the local
police department. All net proceeds will be used to buy new equipment. The
police officers will run the tournament. You can deduct the entire cost of the
tickets as a business expense if they otherwise qualify as an entertainment
expense.
Skyboxes and other private luxury boxes - If you rent a skybox or other private luxury
box for more than one event at the same sports arena, you generally cannot deduct more
than the price of a non-luxury box seat ticket.
To determine whether a skybox has been rented for more than one event, count each game
or other performance as one event. For example, renting a skybox for a series of playoff
games is considered renting it for more than one event. All skyboxes you rent in the same
arena, along with any rentals by related parties, are considered in making this determination.
Related parties include:

Family members (spouses, ancestors, and lineal descendants),

Parties who have made a reciprocal arrangement involving the sharing of skyboxes,

Related corporations,

A partnership and its principal partners, and
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
A corporation and a partnership with common ownership.
Example - You pay $4,000 to rent a 12-seat skybox at Team Stadium for three baseball
games. The cost of regular non-luxury box seats at each event is $30 a seat. You can
deduct (subject to the 50% limit) $720 ((12 seats × $20 each) × 3 events).
Food and beverages in skybox seats -
If expenses for food and beverages are
separately stated, you can deduct these expenses in addition to the amounts allowable for
the skybox, subject to the requirements and limits that apply. The amounts separately stated
for food and beverages must be reasonable. You cannot inflate the charges for food and
beverages to avoid the limited deduction for skybox rentals.
Directly-Related Test
To meet the directly-related test for entertainment expenses (including entertainmentrelated meals), you must show that:

You did engage in business with the person during the entertainment period, and

The main purpose of the combined business and entertainment was the active
conduct of business,

You had more than a general expectation of getting income or some other specific
business benefit at some future time.
You must consider all the facts, including the nature of the business transacted and the
reasons for conducting business during the entertainment. It is not necessary to devote
more time to business than to entertainment. However, if the business discussion is only
incidental to the entertainment, the entertainment expenses do not meet the directly-related
test.
The Junior Auditor says: You do not have to show that business income or other
business benefit actually resulted from each entertainment expense.
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Clear business setting - If the entertainment takes place in a clear business setting and
is for your business or work, the expenses are considered directly related to your business or
work. The following situations are examples of entertainment in a clear business setting.

Entertainment in a hospitality room at a convention where business goodwill is
created through the display or discussion of business products.

Entertainment that is mainly a price rebate on the sale of your products (such as a
restaurant owner providing an occasional free meal to a loyal customer).

Entertainment of a clear business nature occurring under circumstances where there
is no meaningful personal or social relationship between you and the persons
entertained. An example is entertainment of business and civic leaders at the opening
of a new hotel or play when the purpose is to get business publicity rather than to
create or maintain the goodwill of the persons entertained.
Expenses not considered directly related.
Entertainment expenses generally are not
considered directly related if you are not there or in situations where there are substantial
distractions that generally prevent you from actively conducting business. The following are
examples of situations where there are substantial distractions.

A meeting or discussion at a nightclub, theater, or sporting event.

A meeting or discussion during what is essentially a social gathering, such as a
cocktail party.

A meeting with a group that includes persons who are not business associates at
places such as cocktail lounges, country clubs, golf clubs, athletic clubs, or vacation
resorts.
Associated Test
Even if your expenses do not meet the directly-related test, they may meet the associated
test. [See Figure A]
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To meet the associated test for entertainment expenses (including entertainment-related
meals), you must show that the entertainment is:

Associated with the active conduct of your trade or business, and

Directly before or after a substantial business discussion (defined later).
Associated with trade or business - Generally, an expense is associated with the active
conduct of your trade or business if you can show that you had a clear business purpose for
having the expense. The purpose may be to get new business or to encourage the
continuation of an existing business relationship.
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Substantial business discussion - Whether a business discussion is substantial depends
on the facts of each case. A business discussion will not be considered substantial unless you
can show that you actively engaged in the discussion, meeting, negotiation, or other
business transaction to get income or some other specific business benefit.
The meeting does not have to be for any specified length of time, but you must show that
the business discussion was substantial in relation to the meal or entertainment. It is not
necessary that you devote more time to business than to entertainment. You do not have to
discuss business during the meal or entertainment.
Meetings at conventions - You are considered to have a substantial business discussion
if you attend meetings at a convention or similar event, or at a trade or business meeting
sponsored and conducted by a business or professional organization. However, your reason
for attending the convention or meeting must be to further your trade or business. The
organization that sponsors the convention or meeting must schedule a program of business
activities that is the main activity of the convention or meeting.
Directly before or after business discussion - If the entertainment is held on the same
day as the business discussion, it is considered to be held directly before or after the
business discussion.
If the entertainment and the business discussion are not held on the same day, you must
consider the facts of each case to see if the associated test is met. Among the facts to
consider are; the place, date, and duration of the business discussion. If you or your
business associates are from out of town, you must also consider the dates of arrival and
departure, and the reasons the entertainment and the discussion did not take place on the
same day.
Example - A group of business associates comes from out of town to your place of
business to hold a substantial business discussion. If you entertain those
business guests on the evening before the business discussion, or on the evening
of the day following the business discussion, the entertainment generally is
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considered to be held directly before or after the discussion. The expense meets
the associated test.
Expenses for spouses - You generally cannot deduct the cost of entertainment for your
spouse or for the spouse of a customer. However, you can deduct these costs if you can
show that you had a clear business purpose, rather than a personal or social purpose, for
providing the entertainment.
Example - You entertain a customer. The cost is an ordinary and necessary
business expense and is allowed under the entertainment rules. The customer's
spouse joins you because it is impractical to entertain the customer without the
spouse. You can deduct the cost of entertaining the customer's spouse. If your
spouse joins the party because the customer's spouse is present, the cost of the
entertainment for your spouse is also deductible.
50% Limit
In general, you can deduct only 50% of your business-related meal and entertainment
expenses. The 50% limit applies to employees or their employers, and to self-employed
persons (including independent contractors) or their clients, depending on whether the
expenses are reimbursed.
The 50% limit applies to business meals or entertainment expenses you have
while:

Traveling away from home (whether eating alone or with others) on business,

Entertaining customers at your place of business, a restaurant, or other location, or

Attending a business convention or reception, business meeting, or business luncheon
at a club.
Included expenses - Expenses subject to the 50% limit include:

Taxes and tips relating to a business meal or entertainment activity,
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
Cover charges for admission to a nightclub,

Rent paid for a room in which you hold a dinner or cocktail party, and

Amounts paid for parking at a sports arena.
However, the cost of transportation to and from a business meal or a business-related
entertainment activity is not subject to the 50% limit.
Application of 50% limit - The 50% limit on meal and entertainment expenses applies if
the expense is otherwise deductible and is not covered by one of the exceptions discussed
later. The 50% limit also applies to certain meal and entertainment expenses that are not
business related. It applies to meal and entertainment expenses you have for the production
of income, including rental or royalty income. It also applies to the cost of meals included in
deductible educational expenses.
When to apply the 50% limit - You apply the 50% limit after determining the amount
that would otherwise qualify for a deduction. You first have to determine the amount of meal
and entertainment expenses that would be deductible under the other rules discussed in this
publication.
Example 1 - You spend $200 for a business-related meal. If $40 of that amount is not
allowable because it is lavish and extravagant, the remaining $160 is subject to the
50% limit. Your deduction cannot be more than $80 (50% × $160).
Example 2 -You purchase two tickets to a rock concert and give them to a client. You
purchased the tickets through a ticket agent. You paid $250 for the four tickets, which
had a face value of $40 each ($160 total). Your deduction cannot be more than $80
(50% × $160).
Exceptions to the 50% Limit
Generally, business-related meal and entertainment expenses are subject to the 50% limit.
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Expenses not subject to 50% limit.
Your meal or entertainment expense is not subject to
the 50% limit if the expense meets one of the following exceptions.
1 - Employee's reimbursed expenses. If you are an employee, you are not subject to the
50% limit on expenses for which your employer reimburses you under an accountable plan.
2 - Advertising expenses.
You are not subject to the 50% limit if you provide meals,
entertainment, or recreational facilities to the general public as a means of advertising or
promoting goodwill in the community. For example, neither the expense of sponsoring a
television or radio show nor the expense of distributing free food and beverages to the
general public is subject to the 50% limit.
3 - Self-employed.
If you are self-employed, your deductible meal and entertainment
expenses are not subject to the 50% limit if all of the following requirements are met.

You have these expenses as an independent contractor.

Your customer or client reimburses you or gives you an allowance for these expenses
in connection with services you perform.

You provide adequate records of these expenses to your customer or client.
In this case, your client or customer is subject to the 50% limit on the expenses.
Examples -You are a self-employed lawyer who adequately accounts for meal and
entertainment expenses to a client who reimburses you for these expenses. You are
not subject to the directly-related or associated test, nor are you subject to the 50%
limit. If the client can deduct the expenses, the client is subject to the 50% limit.
If you (the contractor) have expenses for meals and entertainment related to providing
services for a client but do not adequately account for and seek reimbursement from the
client for those expenses, you are subject to the directly-related or associated test and to the
50% limit.
4 - Charitable sports event. You are not subject to the 50% limit if you pay for a package
deal that includes a ticket to a qualified charitable sports event. For the conditions the sports
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event must meet, see Exception for events that benefit charitable organizations under
Entertainment tickets, earlier.
5 - Sale of meals or entertainment. You are not subject to the 50% limit if you actually sell
meals, entertainment, goods and services, or use of facilities to the public. For example, if
you run a nightclub, your expense for the entertainment you furnish to your customers, such
as a floor show, is not subject to the 50% limit.
. Gifts
If you give gifts in the course of your trade or business, you can deduct all or part of the
cost. This chapter explains the limits and rules for deducting the costs of gifts.
$25 limit - You can deduct no more than $25 for business gifts you give directly or
indirectly to any one person during your tax year. A gift to a company that is intended for
the eventual personal use or benefit of a particular person or a limited class of people will be
considered an indirect gift to that particular person or to the individuals within that class of
people who receive the gift.
If you give a gift to a member of a customer's family, the gift is generally considered to be
an indirect gift to the customer. This rule does not apply if you have a bona fide,
independent business connection with that family member and the gift is not intended for
the customer's eventual use.
If you and your spouse both give gifts, both of you are treated as one taxpayer. It does not
matter whether you have separate businesses, are separately employed, or whether each of
you has an independent connection with the recipient. If a partnership gives gifts, the
partnership and the partners are treated as one taxpayer.
Examples – Sam Smith sells products to Home Company. He and his wife, Sue,
gave Home Company four sandwich packages to thank them for their business.
They paid $60 for each package, or $240 total. Four of Local Company's
executives took the packages home for their families' use. Sam and Sue have no
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independent business relationship with any of the executives' other family
members. They can deduct a total of $100 ($25 limit × 4) for the cheese
packages.
Incidental costs. Incidental costs, such as engraving on jewelry, or packaging, insuring,
and mailing, are generally not included in determining the cost of a gift for purposes of the
$25 limit.
A cost is incidental only if it does not add substantial value to the gift. For example, the cost
of gift wrapping is an incidental cost. However, the purchase of an ornamental basket for
packaging fruit is not an incidental cost if the value of the basket is substantial compared to
the value of the fruit.
Exceptions -
The following items are not considered gifts for purposes of the $25 limit.
1. Signs, display racks, or other promotional material to be used on the business
premises of the recipient.
2. An item that costs $4 or less and: Examples include pens, desk sets, and plastic bags and cases.
a. Has your name clearly and permanently imprinted on the gift, and
b. Is one of a number of identical items you widely distribute?
CHAPTER 10
CONTINUED PROFESSIONAL EDUCATION [CPE]
Educational Assistance
You can exclude from your income up to $5,450 of qualified employer-provided educational
assistance. Check with The Tax Insider for details.
You may deduct your expenses for business-related education for example, a college course
or seminar. You may also deduct the cost of attending a convention or professional meeting
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as an education expense. In order to qualify for the education deduction, you must b e able
to show that the education:

Is required by law or regulation to maintain your professional status, or

Maintains or improves skills required in your business
These expenses include tuition, fees, books and other learning materials. They also include
transportation and travel. You may also deduct expenses you pay to train or educate your
employees.
EXAMPLE: Mary is a French translator and she could deduct the cost of traveling
to France to study formal French language classes. Mary is improving her skills to
be able to better perform her job. If Bob, also a translator, was on the same flight
and took the trip to see the sights and become more familiar with the French
culture and language, it will be at his own expense and not deductible.
Starting a New Business
Courts have held that you can not deduct the cost of education expenses if it is for a new
profession or business. You may increase skills in your current field and take the deduction.
Example: If a CPA decides to go to law school, then he can not deduct the cost of
going to law school since the training would qualify for a new business. [Case
Law: Jeffrey L. Weiler, 54 TC 398 (1970)].
Minimum Educational Requirements
Tax courts have held that you can not deduct the cost to meet the minimum education
requirements for a business or profession.
Example: Alice and Barbara both went on to professional degrees. Alice went to
law school and Barbara went on to medical school. Neither woman will be able to
deduct their costs.
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Don’t Forget the Seminar in Hawaii
All of your local transportation expenses you pay to and from a deductible educational
activity are deductible. The transportation from your home or business to the event and back
may be deducted. If you drive you may deduct your actual expenses or use the standard
mileage rate for vehicles.
There is no requirement that you have to take your training locally. Many companies and
organizations schedule training and education events at major resorts and vacation spots.
Example:
Susan wanted training in chemical process for her engineering
continued professional education [CPE]. There was an event in her city, but also
the national group, Association of Chemical Engineers, has the same seminar in
Maui, Hawaii. Susan may go to the training in Hawaii and take the deduction for
the trip. The airline fair, other transportation, lodging and meals are all
deductible travel expenses
Cases Supporting
David T. Gruman, TC Memo 1982-388. , Code Sec(s) 162
Case found pilot could use training
Peggy A. King, TC Memo 1962-93
Case found for taxpayer; classes improved existing skills of TP even though they
might be used for other purpose.
Ann Jorgensen v. Commissioner, TC Memo 2000-138 , Code Sec(s)
162; 274
Case found for TP teacher does not have to prove that the education and travel
was ordinary to be deductible.
Robert John Picknally, TC Memo 1977-321
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BUSINESS EXPENSE DEDUCTIONS—Expenses for education—advancement or
maintenance of status. Deduction allowed teacher/educational administrator for costs
incurred in getting PH.D in educational administration. Fact that he was unemployed during
period of study didn't matter; he was still carrying on trade of being educator. He actively
sought work in his field and did hold a fellowship and instructorship at other schools.
Reference(s): 1977 P-H Fed. ¶11,504(5).
Gerald Schwerm, TC Memo 1986-16. , Code Sec(s) 162
BUSINESS EXPENSE DEDUCTIONS—Expenses for education—advancement or
maintenance of status. Deduction allowed teacher/educational administrator for
costs incurred in getting PH.D in educational administration. Fact that he was
unemployed during period of study didn't matter; he was still carrying on trade of
being educator. He actively sought work in his field and did hold a fellowship and
instructorship at other schools.
Reference(s): 1977 P-H Fed. ¶11,504(5).
Stephen G. Sherman, TC Memo 1977-301.
BUSINESS EXPENSE DEDUCTION—Education expenses—advancement or
maintenance of status. Deduction allowed business manager for costs of fulltime
graduate education to obtain MBA. It didn't matter that he wasn't on leave from
employer (he had resigned) while taking courses or that upon graduation he
accepted position different from his previous job. He was carrying on "trade or
business" while in school.
Reference(s): 1977 P-H Fed. ¶11,504(5).
Alan Aaronson, TC Memo 1970-178
BUSINESS EXPENSES — Expenses for education—maintain skills. Education
expense deduction allowed newspaper photographer also engaged in freelance
work for cost of flying lessons. Although newspaper didn't request or impose
flying as condition to his continued employment, lessons were appropriate to
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improving range, quality, timeliness and news value of his free-lance pictures.
Flying ability also increased range of his picture-taking ability and thus improved
skills required in his business of news photography.
Reference(s): 1970 P-H Fed. ¶ 11,506(5).
Junius J. Johnson, TC Memo 1988-177. , Code Sec(s) 162.
BUSINESS EXPENSES—Traveling expenses—expected duration of job or
assignment—temporary jobs—temporary v indefinite jobs—expected and actual
duration. Deduction for lodging expenses incurred by Texas nursing professor
while pursuing doctoral studies in Hawaii was allowed where taxpayer showed
that her tax home remained in Texas. Taxpayer's stay in Hawaii was temporary
(she expected to be away from Texas university, at which she was tenured
professor, for specified period of time); she had worked at Texas university for 19
years before her education leave of absence; and after completing her studies in
Hawaii she returned to her teaching job in Texas, which was at all times her place
of employment.
Reference(s): 1988 PH Fed. ¶11,387(60). Code Sec. 162 .
Paul R. Dougherty, TC Memo 1970-42
BUSINESS EXPENSES—Expenses for education—advancement or
maintenance of status. Business expense deduction allowed
teacher for cost of international travel. Teacher, responsible for
influencing curricula in school system, toured Communist and
neighboring countries on professional tour. Tourists were mostly
teachers studying educational methods. Tour study led to credits
for graduate work in comparative education. Teacher excluded
from deductions all personal expenses. Teacher proved
expenses were to improve job skills.
Reference(s): 1970 P-H Fed. ¶ 11,504(20).
Tax Court & Board of Tax Appeals Memorandum Decisions
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Daniel R. Allemeier, Jr. v. Commissioner, TC Memo 2005-207 ,
Code Sec(s) 7491.
Education expense deductions—minimum job requirements; new trade or
business—business executives; sales and management. Dental products salesman
was entitled to deduct substantiated tuition- related education costs of pursuing
MBA: costs were deductible business expenses where MBA helped improve
taxpayer's job skills but was neither explicit job requirement nor implicit precondition to promotions. Also, MBA wasn't treated as qualifying taxpayer for new
trade/business, even though he was promoted from sales to managerial position
soon after he started MBA program, because he had already taken on managerial
responsibilities while in sales position and really just changed titles by taking on
new position, without substantially changing his job; and cases involving
taxpayers enrolled in courses leading to professional license or certification were
distinguished.
Reference(s): ¶ 1625.187(85) Code Sec. 162
Tax Court & Board of Tax Appeals Memorandum Decisions
Geraldine F. Johnson, TC Memo 1979-486. , Code Sec(s) 165.
BUSINESS EXPENSES— Expenses for education—maintaining skills. Deduction for
educational expenses re determined. Teacher-choreographer's Paris study trip
deductible to extent expenses proven.
Tax Court & Board of Tax Appeals Memorandum Decisions
James E. Lane, TC Memo 1962-179
BUSINESS EXPENSES — Expenses for education. Expenses of taking courses
related to the field in which taxpayer was teaching were deductible. The taxpayer
was a Certified Public Accountant who was asked to join the staff of a state
college as an Assistant Professor of Business. His status as a C.P.A. was
considered as the equivalent of a master's degree in training credit. He was also
given credit for four years of accounting experience and one year of teaching
experience, the maximum credit given any person coming to the College as an
assistant professor. The college made no intimation that taxpayer's existing
qualifications were not fully adequate for the position given him or that it
expected him to take any further courses or obtain any additional degrees. He
began taking courses at the University of Indiana in fields closely related to the
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field in which he was teaching. The courses were at the academic level of
taxpayer's present position. The primary purpose for taking such courses was
that of maintaining and improving skills required in his employment as a teacher.
The courses he took were undertaken in order that he could better demonstrate
to his students the functions of accounting.
Tax Court & Board of Tax Appeals Memorandum Decisions
Helen V. Oehlke, TC Memo 1967-144
BUSINESS EXPENSES—Expenses for education—advancement or maintenance of
status. Education expense deduction allowed high school art teacher in part for
trip to Europe: 90% of costs related to her efforts to improve teaching skills.
Reference(s): 1967 P-H Fed. ¶ 11,504(20).
Tax Court & Board of Tax Appeals Memorandum Decisions
Edwin F. Krist, TC Memo 1972-100.
BUSINESS EXPENSES—Educational expenses—maintaining skills. Educational
expense deduction for teacher's sabbatical traveling expenses allowed in amount
determined by Tax Court: Her primary purpose in taking trip was to maintain or
improve her skills and majority of her activities were related to her profession.
Reference(s): 1972 P-H Fed. ¶ 11,506(5).
Tax Court & Board of Tax Appeals Memorandum Decisions
Eugene J. Colangelo, TC Memo 1980-543. , Code Sec(s) 162.
BUSINESS EXPENSES—Expenses for education—maintaining or
improving skills. Expenses of operating private airplane were deductible
as business related education expense. Substantial flying maintained
and improved flight surgeon's employment skills and was essential to
his knowledge of stresses to which naval flyers were subjected.
Activities didn't qualify him for new trade or business as pilot instructor
since surgeon met licensing requirements before year at issue.
Reference(s): 1981 P-H Fed. ¶11,505(20). Code Sec. 162 .
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Tax Court & Board of Tax Appeals Memorandum Decisions
Walter T. Charlton, TC Memo 1964-59
BUSINESS EXPENSES—Expenses of professional persons—preprofessional and education expenses. Education expense deductions
allowed taxpayer, a certified public accountant, for expenses of
attending law school. The legal education was taken primarily for the
purpose of maintaining and improving skills required by taxpayer in his
profession. Taxpayer, a partner in an accounting firm, attended law
school at the advice of his father, a senior partner in the firm. Taxpayer
was qualified in all respects to perform his duties as a certified public
accountant and his continued employment with the firm was not
conditional on his obtaining a legal education. The majority of the
courses taken in law school were helpful in taxpayer's work and the
remaining courses were required for the law degree. Although taxpayer
performed substantially the same duties before and after his law
studies, his practice of accounting became more complex and his legal
education better enabled him to perform his duties. It was therefore
"appropriate and helpful" to his practice of public accounting. The
regulations recognize that the term "necessary" includes expenditures
which are appropriate and helpful. Taxpayer did not hold himself out to
be an attorney and never engaged in the practice of law. Whenever a
legal problem arose in his work he advised the client to see an attorney.
Taxpayer was listed in the telephone directory as a CPA and never has
had the intention of leaving the practice of public accounting. He never
joined any bar associations and did not acquire a new profession
because he never intended to engage in the practice of law. Many CPA
firms have at least one man with a background of law on their staffs and
taxpayer was the only accountant in his firm with a law degree.
Reference(s): 1964 P-H Fed. ¶ 11,504(5); 11,506(5); 11,515.
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Junior Auditor
_________________
2008
NSA NATIONAL
CONVENTION
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