Chapter 6
Self-Employed
Business Income
“A fine is a tax for doing something wrong.
A tax is a fine for doing something right.”
-- Anonymous
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LO #1- Income and Expenses of the SelfEmployed
• Trade or Business – any activity
that is engaged in for profit
• Self-employed income is reported
on Schedule C
6-2
LO #1- Income and Expenses of the SelfEmployed
• Gross receipts include
– Direct sales to customers
– Work performed as an independent
contractor
– Amounts reported to a “statutory employee”
• Independent contractors usually receive
a Form 1099-MISC to report income
6-3
LO #1- Income and Expenses of the SelfEmployed
• Cost of Goods Sold - reduction from
sales to produce gross profit
• Accrual Method of Accounting – must be
used if inventory is a material incomeproducing factor
6-4
LO # 2 Ordinary & Necessary Trade or
Business Expenses
• To be deductible, expenses must be ordinary,
necessary, and reasonable
• Ordinary – expenses must be customary or
usual
• Necessary – expenses that are appropriate
and helpful rather than essential
• Reasonable – expenses must be reasonable
in amount and reasonable in relation to their
purpose
6-5
LO # 2 Ordinary & Necessary Trade or
Business Expenses
• Forbidden Expenses
– Bribes, kickbacks, and other illegal
payments
– Lobbying and political expenses
– Fines and penalty payments
• Not deductible even if ordinary,
necessary, and reasonable
6-6
LO #3 Depreciation
•
Components of Depreciation
1. Basis (usually the cost of the asset).
2. Depreciation Periods (Asset Class Lives).
3. Depreciation Convention (half-year, mid-quarter,
mid-month).
4. Depreciation Method (200% or 150% Declining
Balance or Straight-line).
•
Reported on Schedule C, Schedule E, and
Form 2106
6-7
LO #3 Depreciation
• Basis
– Asset purchased;
Basis = Cost
– Personal to Business; Basis = Lesser of
FMV or cost
– Non-taxable Exchange; Basis = Cost less
any deferred gain
– Inherited; Basis = FMV at the date of death
6-8
LO #3 Depreciation
• Typical Depreciation Periods
– 3 years
Specialized Tools,
Racehorses
– 5 years
Autos, Trucks,
Computers
– 7 years
Furniture, Fixtures,
Equipment
– 27.5 years Residential Real Property
– 39 years
Nonresidential Real Property
6-9
LO #3 Depreciation
• Depreciation Conventions
– Half-year Convention
– Mid-Quarter Convention
– Mid-Month Convention
• Year of Disposal – convention is the
same in the year of disposal.
6-10
LO #3 Depreciation
• Depreciation Methods
– 200% Declining Balance Switching to
Straight-line
– 150% Declining Balance Switching to
Straight-line
– Straight-line
6-11
LO #3 Depreciation
• Maximum IRC Section 179 expense
– 2010
– 2011
– 2012
– 2013
$500,000
$500,000
$500,000
$500,000
• Property must be used in a trade or
business. The 2012 Tax Act increased
the amount to $500,000 for 2012 and
2013.
• Section 179 expense cannot create a
NOL
6-12
LO #3 Depreciation
50% Bonus in 2013
MACRS < 20 year lives
Fully Deductible/No limits other
than Luxury Auto Limits
Lessens Importance of Section
179
6-13
LO #3 Depreciation
• Listed property
– Assets that have both a business and
personal use component to them
– Examples: autos, boats, computer
equipment
• Section 179 is not allowed if listed property is
used less than 50% for business
• Straight-line depreciation is required for listed
property used less than 50% for business
6-14
LO #3 Depreciation
• Luxury Automobile Limitations
– Autos less than 6,000 pounds
– Light trucks or vans less than 6,000 lbs. have
slightly higher limits
–
–
–
–
1st year
2nd year
3rd year
4th and after
Auto
Truck
$11,160
$ 5,100
$ 3,050
$ 1,875
$11,360
$ 5,400
$ 3,550
$ 1,975
• SUVs greater than 6,000 lbs – Section 179 is
limited to $25,000
6-15
LO #3 Depreciation
• Leased Vehicles
– “Lease inclusion amount”- the amount
included in income when a leased vehicle is
over the luxury auto levels
– See Rev. Proc. 2013-21 for amounts
• The total business lease amount is
deductible
6-16
LO #4 Transportation and Travel
• Ordinary and necessary travel expenses
are deductible
• Transportation – expenses of getting
from one workplace to another
workplace within the taxpayer’s home
area
• Travel – refers to business travel away
from home that requires an overnight
stay
6-17
LO #4 Transportation and Travel
• Deductible Local Transportation Cost
– Getting from one workplace to another workplace
– Visiting clients and customers
– Business meeting away from the taxpayer’s regular
workplace
– Getting from home to a temporary workplace
• Transportation between a home office and
temporary work location is deductible
6-18
LO #4 Transportation and Travel
• Automobile Expenses
– Standard Mileage Rate - 56.5 cents per
mile in 2013
– Actual Expenses - actual business auto
costs are deducted
• Actual expenses usually gives a larger
deduction but require more record
keeping
6-19
LO #4 Transportation and Travel
• Travel Cost for Business Travel
– Requires an overnight stay
– Travel, meals, lodging and other incidental
expenses are allowed
– Should not last more than one year
• Limitations exist if the trip is partly
personal or if there are lavish or
extravagant expenditures
6-20
LO #4 Transportation and Travel
• Meals and Entertainment
– Business meal costs are deductible but are
limited to 50%
– Must be directly related or associated with
business
– Standard meal per diem is $46 per day –
can be higher in high cost areas
• Cannot be lavish or extravagant
6-21
LO #5 Business Use of Home and
Business Bad Debts
• Business use of the home is deductible if the
business use is:
– Exclusive
– Regular
– For the taxpayer’s trade or business
• A specific area of the home must be used only
for business
• Employees – use must be “for the
convenience of the employer”
6-22
LO #5 Business Use of Your Home and
Business Bad Debts
• Home office deductions are reported on
Form 8829
• Calculation determined by square
footage used regularly and exclusively
for business
• Direct business expenses are 100%
deductible
• Indirect home expenses are deductible
based on square footage
6-23
LO #5 Business Use of Your Home and
Business Bad Debts
• Home office deduction limited to
business income
• Order of deductions
– Expenses deductible in any event
(mortgage interest and real estate taxes)
– Business use of insurance, utilities, and
then depreciation
6-24
LO #5 Business Use of Your Home and
Business Bad Debts
• Business Bad Debts
– Business bad debts can be deducted as an
ordinary expense if incurred in a business
– Can be partially worthless or completely
worthless
• Business Casualty Losses
– Receive an ordinary loss
– Not limited by the 10% AGI floor like
personal casualty losses
6-25
LO #6 Hobby Loss Rules and Education
Expenses
• Hobby Losses
– Expenses allowed to the extent of hobby income
– Nine factors to determine whether an activity is a
hobby
– Burden of proof lies with the taxpayer
• Order of expense deduction – mortgage
interest and taxes, hobby expenses that do
not reduce basis, then depreciation
6-26
LO #6 Hobby Loss Rules and Education
Expenses
• Education Expenses – deductible if:
– Maintains or improves skills of the taxpayer;
or
– Meets the express requirements of the law
or regulation for a job
• Educational Expenses – not deductible
if:
– Cannot meet the minimum educational
requirements for employment
– Qualifies the taxpayer for a new trade or
business
6-27
LO #7 Self-Employment Tax
• Consists of two parts:
– Social Security
– Medicare
– Total
12.40% in 2013
2.90%
13.30%
• Social security limited to first $113,700
of self-employment income in 2013
• Medicare is not limited
6-28