Chapter 9
Deductions: Employee and
Self-Employed-Related Expenses
Individual Income Taxes
Copyright ©2009 Cengage Learning
Individual Income Taxes
C9-1
Employee vs. Self-Employed
(slide 1 of 2)
• Business expenses for self-employed
persons are deductible FOR AGI
– Reported on Schedule C
• Unreimbursed business expenses for
employees are generally deductible FROM
AGI subject to 2% of AGI floor
– Reported on Form 2106 (Employee Business
Expenses) and Schedule A (Itemized
Deductions)
Individual Income Taxes
C9-2
Employee vs. Self-Employed
(slide 2 of 2)
• Person is classified as an employee if:
– Subject to will and control of another with
respect to what shall be done and how it shall
be done
– Another furnishes tools or the place of work
– Income based on time spent rather than task
performed
Individual Income Taxes
C9-3
Employee Expenses
• Fall into one of the following categories:
–
–
–
–
–
–
Transportation
Travel
Moving
Education
Entertainment
Other
Individual Income Taxes
C9-4
Transportation Expenses
(slide 1 of 2)
• Transportation expense defined
– Very limited, only from job site to job site and
commuting to/from temporary work place
– Commuting from home to work and back is
nondeductible
• Exceptions:
– Additional costs incurred to transport heavy tools
– Employees with more than one job
Individual Income Taxes
C9-5
Transportation Expenses
(slide 2 of 2)
• Amount deductible
– Actual expenses
• Must keep adequate records of all expenses and
depreciation is limited, or
– Automatic mileage method
• 50.5 cents per mile for business miles for 2008
– Adjustment to basis of auto is required for depreciation
considered allowed
• Plus parking, tolls, etc.
• Adequate documentation of mileage required
Individual Income Taxes
C9-6
Travel Expenses
(slide 1 of 2)
• Travel expense defined
– Expenses while “away from tax home”
overnight on business
– Includes transportation, lodging, 50% meals,
and miscellaneous expenses
Individual Income Taxes
C9-7
Travel Expenses
(slide 2 of 2)
• “Away from home” requirement
– Need not be a 24-hour period but must be
longer than ordinary work day and taxpayer
will need to rest during release time
– Being “away” should be a temporary situation
(not in excess of 1 year)
– “Tax Home” generally means business location,
post, or station of the taxpayer
Individual Income Taxes
C9-8
Restrictions on Travel Expenses
(slide 1 of 2)
• Convention travel expenses
– No deduction for travel unless directly related to
taxpayer’s trade or business
• Example: Doctor attending out-of-town seminar on estate
planning would not have deductible travel expenses
– Restrictions apply to the deductibility of travel
expenses of the taxpayer’s spouse or dependent
• Generally, accompaniment by the spouse or dependent must
serve a bona fide business purpose, and
• The expenses must be otherwise deductible
Individual Income Taxes
C9-9
Restrictions on Travel Expenses
(slide 2 of 2)
• Education travel expenses
– Travel as a form of education is not deductible
• Example: Spanish language professor traveling to
Spain to work on the language would not have
deductible travel expenses
• Example: Spanish history professor traveling to
Spain to study historical documents available only
in Spanish museums would have deductible travel
expenses
Individual Income Taxes
C9-10
Combined Business/Pleasure Travel
(slide 1 of 4)
• Only actual expenses for business are
deductible
– Meals, lodging and other expenses must be
allocated between business and personal days
• Deductibility of transportation costs
depends on whether the trip is domestic or
foreign
Individual Income Taxes
C9-11
Combined Business/Pleasure Travel
(slide 2 of 4)
• For domestic travel
– If primary purpose of trip is business,
transportation is deductible in full
– If primary purpose is pleasure, no deduction for
transportation allowed, but other expenses (e.g.,
lodging) associated with business days are
deductible
Individual Income Taxes
C9-12
Combined Business/Pleasure Travel
(slide 3 of 4)
• For foreign travel
– Transportation expenses must be allocated
between business and personal unless:
• Trip is 7 days or less,
• Less than 25% of time was for personal purposes, or
• Taxpayer had no substantial control over
arrangements for the trip
Individual Income Taxes
C9-13
Combined Business/Pleasure Travel
(slide 4 of 4)
• Travel days are considered business days
• Weekends, legal holidays and intervening
days are business days if both the preceding
and succeeding days are business days
• If trip is primarily for pleasure, no
transportation expenses are deductible
Individual Income Taxes
C9-14
Moving Expenses
• Deductible for moves in connection with the
commencement of work at a new principal place
of work
• Two tests must be met for moving expenses to be
deductible
– Distance test
– Time test
Individual Income Taxes
C9-15
Moving Expenses - Distance Test
• Distance from old home to new job must be
at least 50 miles farther than from old home
to old job
• New home location not relevant for
decision
Individual Income Taxes
C9-16
Example of Distance Test
• Gail lived 20 miles
from her old job
• Gail’s new job is 75
miles from her old
home
• Gail meets the
distance test
20 mi.
Old
Job
Old
Residence
75 mi.
New
Job
Individual Income Taxes
C9-17
Moving Expenses - Time Test
(slide 1 of 2)
• Taxpayer must be full-time employee for 39 weeks
in the 12-month period following the move, or
• Self-employed must work in new location for 78
weeks during the next two years following the
move
– 39 of the weeks must be in the first 12 months
• Test waived if die, disabled, discharged, or
transferred
Individual Income Taxes
C9-18
Moving Expenses - Time Test
(slide 2 of 2)
• If time test not met during taxable year, two
alternatives:
– Take the deduction in year moved. If test is not
met in following year, either:
• Include the amount deducted in gross income in the
following year, or
• File amended return for year of move
– Alternatively, wait until time test is met and
then file amended return for year of move
Individual Income Taxes
C9-19
Deductible Moving Expenses
• ‘‘Qualified’’ moving expenses include
reasonable expenses of:
– Moving household goods and personal effects
to new location
– Expenses of travel for taxpayer and family to
new location
• Lodging
• Actual auto costs (not depreciation) or mileage rate
of $.19 per mile for each car in 2008
– Meals are not deductible as moving expense
Individual Income Taxes
C9-20
Tax Treatment of
Moving Expenses
• Unreimbursed moving expenses are
deductible For AGI
• Reimbursement or payment by employer:
– For qualified moving expenses, amount is
excluded from gross income, but no deduction
for related expenses
– For nonqualified moving expenses, amount is
included in gross income and no deduction is
allowed
Individual Income Taxes
C9-21
Education Expenses
(slide 1 of 3)
• Education expenses of an employee are
deductible if they are incurred:
– To maintain or improve existing skills, or
– To meet express requirements of the employer
or requirements imposed by law to retain
employment status
Individual Income Taxes
C9-22
Education Expenses
(slide 2 of 3)
• Education expenses of an employee are not
deductible if they are incurred:
– To meet minimum educational standards for
existing job, or
– To qualify taxpayer for new trade or business
Individual Income Taxes
C9-23
Education Expenses
(slide 3 of 3)
• Education expenses include:
–
–
–
–
–
Tuition
Books
Supplies
Transportation
Travel (including lodging and 50% meals)
Individual Income Taxes
C9-24
Deduction For Qualified Tuition
and Related Expenses (slide 1 of 3)
• A deduction is allowed FOR AGI for
qualified tuition and related expenses
involving higher education (i.e.,
postsecondary)
– This provision expired at the end of 2007, but is
expected to be extended by Congress
Individual Income Taxes
C9-25
Deduction For Qualified Tuition
and Related Expenses (slide 2 of 3)
• For 2004 - 2007, the maximum deduction
depends on filing status and AGI
Filing Status
Single
Married
Single
Married
AGI Limit
$65,000
$130,000
$65,001 to
$80,000*
$130,001 to
$160,000*
Max Deduction
$4,000
$4,000
$2,000
$2,000
*No deduction is allowed if MAGI exceeds this amount
Individual Income Taxes
C9-26
Deduction For Qualified Tuition
and Related Expenses (slide 3 of 3)
• Qualified tuition and related expenses
include whatever is required for enrollment
– Usually, student activity fees, books, room and
board are not included
• Expenses need not be work related
• Deduction is not available for married
persons filing separately
Individual Income Taxes
C9-27
Entertainment Expenses
(slide 1 of 3)
• Deductions are very restricted due to abuse
possibilities
– Deductible amount allowed:
• 50% of meals and entertainment costs including related taxes,
tips, cover charges, parking fees, and room rental fees
• 100% of transportation costs
– Amounts cannot be lavish or extravagant
– Beginning in 1998, the 50% cutback for meals is eased
for certain, very limited, types of employees
Individual Income Taxes
C9-28
Entertainment Expenses
(slide 2 of 3)
• The 50% cutback rule has a number of
exceptions, such as:
– Situations where full value of meals or
entertainment is included in income
– Meals and entertainment are provided in a
subsidized eating facility or where the de
minimis fringe benefit rule is met
– Employer-paid recreational activities for
employees
• e.g., the annual Christmas party or spring picnic
Individual Income Taxes
C9-29
Entertainment Expenses
(slide 3 of 3)
• Entertainment expenses are classified as
either:
– Directly related to business
• Actual business meeting or discussion occurs during
meal or entertainment
– Associated with business
• Meal or entertainment that directly precedes or
follows business meeting or discussion
Individual Income Taxes
C9-30
Restrictions on Entertainment
Expenses (slide 1 of 3)
• Club dues
– Generally not deductible
• Exception: Clubs formed for public service and
community volunteerism (e.g., Kiwanis, Rotary)
– Business entertainment expenses incurred at
club are still deductible (50%)
Individual Income Taxes
C9-31
Restrictions on Entertainment
Expenses (slide 2 of 3)
• Ticket purchases for entertainment
– Amounts paid in excess of face value of ticket
are not deductible
– Limitation on deductibility of luxury skybox
expenditures
Individual Income Taxes
C9-32
Restrictions on Entertainment
Expenses (slide 3 of 3)
• Business gifts
– Business gifts of tangible personalty with a
value of $25 or less per person per year are
deductible
• Incidental costs (e.g., gift-wrapping) are not
included in the cost of the gift in applying the limit
– If the value is $4 or less (e.g., pen with
company name) then not subject to $25 limit
• Gifts to employers or superiors are not
deductible
Individual Income Taxes
C9-33
Office in the Home
(slide 1 of 3)
• Deductibility is very restricted due to abuse
possibilities
– Office must be used exclusively and on a
regular basis as:
• The principal place of business, or
• A place of business used by clients, patients, or
customers
– For employees, office must also be for the
convenience of the employer
Individual Income Taxes
C9-34
Office in the Home
(slide 2 of 3)
• What constitutes “principal place of
business”?
– Home office qualifies as a principal place of
business if:
• Taxpayer conducts admin. and mgmt. activities in
the home office, and
• There is no other fixed location where taxpayer
conducts these activities
Individual Income Taxes
C9-35
Office in the Home
(slide 3 of 3)
• Office in the home expenses cannot cause
net loss from the business activity
– Office in home deduction limited to business
gross income in excess of other business
expenses (ordering rules apply)
– Excess is carried forward (subject to limit)
– Form 8829 is used to report office in home
expenses
Individual Income Taxes
C9-36
Other Employee Expenses
• A partial list of other employee expenses
that are deductible includes:
–
–
–
–
–
Special clothing (uniforms)
Union dues
Professional expenses
Job hunting in same profession
Educator expenses (deductible FOR AGI)
• Limited to $250 per year for supplies, etc. of
elementary and secondary school teachers
Individual Income Taxes
C9-37
Contributions to Retirement
Accounts (slide 1 of 2)
• Retirement plans fall into two major
classifications depending on who is covered
– For employees – usually follow one of two
income tax approaches
• Most plans allow an exclusion from income for the
contributions the employee makes to the pension
plan
• Alternatively, using a traditional IRA, a contributing
employee is allowed a deduction for AGI
– Maximum deduction is $5,000 for 2008
Individual Income Taxes
C9-38
Contributions to Retirement
Accounts (slide 2 of 2)
• Retirement plans for self-employed
taxpayers
– Called Keogh (or H.R. 10) plans
• Follow the deduction approach of traditional IRAs
• Amounts contributed under a plan are deductible
for AGI
Individual Income Taxes
C9-39
Classification of Employee
Expenses (slide 1 of 2)
• Depends on whether they are reimbursed
and, if reimbursed, under what type of plan
Individual Income Taxes
C9-40
Classification of Employee
Expenses (slide 2 of 2)
• Employers can have three types of
reimbursement plans
– Accountable
– Nonaccountable
– No reimbursement is given
Individual Income Taxes
C9-41
Accountable Plan
(slide 1 of 2)
• Plan must require adequate accounting to
the employer for expense reimbursed, and
• Any excess reimbursements must be
returned to the employer
Individual Income Taxes
C9-42
Accountable Plan
(slide 2 of 2)
• Adequate accounting is
– Submitting a record, with receipts, to the
employer, or
– Using a per diem allowance that is not more
than the Federal per diem rate
• Employee reports no income and takes no
deduction to the extent of the reimbursed
expenses
Individual Income Taxes
C9-43
Substantiation for Expenditures
(slide 1 of 2)
• No deduction allowed for an expense if the
taxpayer does not have adequate records for
the expense
– Therefore, taxpayers need to have good records
for employee or self-employed expenses
• In some cases, use of per diem allowance will be
deemed substantiation
Individual Income Taxes
C9-44
Substantiation for Expenditures
(slide 2 of 2)
• Records should include:
– Business relationship with other persons
involved (who)
– Type of expense (what)
– Time of expense (when)
– Place of expense (where)
– Purpose of expense (why)
– Amount of expense (how much)
Individual Income Taxes
C9-45
Nonaccountable Plan
• Plan that does not require adequate
accounting or return of excess
reimbursement or both
– Reimbursed amounts received under this plan
are included in gross income
– Expenses are deductible FROM AGI as
miscellaneous itemized deductions subject to
the 2% of AGI limitation
Individual Income Taxes
C9-46
Unreimbursed Employee
Expenses
• Expenses are deductible FROM AGI as
miscellaneous itemized deductions subject
to the 2% of AGI limitation
– If employee could have received, but did not
seek, reimbursement for whatever reason, none
of the employment-related expenses are
deductible
Individual Income Taxes
C9-47
Miscellaneous Itemized
Deductions
• Miscellaneous itemized deductions subject
to the 2% of AGI limitation
– Certain miscellaneous expenses must be added
together and the amount in excess of 2% of
taxpayer’s AGI is deductible FROM AGI (i.e.,
itemized deduction reported on Sch. A)
Individual Income Taxes
C9-48
Examples of Miscellaneous Itemized
Deductions Subject to 2% Floor
• Most reimbursed expenses under a
nonaccountable plan
• Unreimbursed employee expenses
• Section 212 expenses not related to rents and
royalties
• Tax return preparation fee
• Hobby expenses
• Investment expenses (except interest and taxes)
Individual Income Taxes
C9-49
Examples of Miscellaneous Itemized
Deductions Not Subject to 2% Floor
• Impairment-related work expenses of handicapped
individuals
• Gambling losses to the extent of winnings
• Certain terminated annuity payments
Individual Income Taxes
C9-50
Computing 2% of AGI
Limitation (slide 1 of 4)
• Example 1
Taxpayer, a single individual, provides the
following information for 2008:
$30,000 AGI
$ 4,500 deductible interest expense and taxes paid
$ 1,500 employee business expenses, and
$ 500 tax return preparation fee
Individual Income Taxes
C9-51
Computing 2% of AGI
Limitation (slide 2 of 4)
• Example 1 (cont’d)
Interest and taxes
Misc. expenses:
Employee bus. exp.
Tax return prep.
Total
Less 2% AGI
Itemized deductions
Individual Income Taxes
$4,500
$1,500
500
$2,000
600
1,400
$5,900
C9-52
Computing 2% of AGI
Limitation (slide 3 of 4)
• Example 2
Assume the same facts as in Example 1, except
that the taxpayer has only $200 of employee
business expenses
Individual Income Taxes
C9-53
Computing 2% of AGI
Limitation (slide 4 of 4)
• Example 2 (cont’d)
Interest and taxes
Misc. expenses:
Employee bus. exp.
Tax return prep.
Total
Less 2% AGI
$ 4,500
$200
. 500
$700
. 600
Itemized deductions
Take standard deduction
Individual Income Taxes
.
100
$ 4,600
$ 5,450
C9-54
If you have any comments or suggestions concerning this
PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr@oneonta.edu
SUNY Oneonta
Individual Income Taxes
C9-55