Chapter 6
Self-Employed
Business Income
Schedule C
“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 #1- Income and Expenses of the Self-Employed
Concept Check 6-1
1. Schedule C is used only when an
individual is an employee of a
company.
False
2. The income reported on a Schedule C
will always match the amount the
individual receives on one or more
1099-MISCs.
False
6-5
LO #1- Income and Expenses of the SelfEmployed Concept Check 6-1
• 3. If inventory is a material incomeproducing factor, the accrual method of
accounting must be used to account for
inventory. True or False?
True
6-6
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
6-7
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
6-8
LO # 2 Ordinary & Necessary Trade or
Business Expenses Concept Check 6-2
1. For an expense to be deductible on
Schedule C, the expense must be
________, ________, and ________.
Ordinary, necessary, and reasonable
2. Certain types of expenditures are expressly
forbidden from being deductible from
income on Schedule C. What are two
examples of forbidden expenses?
________ and ________
fines and penalties, bribes, lobbying
6-9
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
6-10
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
6-11
LO #3 Depreciation
Concept Check 6-3
1. Shelly purchased a laptop computer for her personal
use last year for $2,200. This year, she started her
own business and transferred the computer to
business use. The value of the computer at transfer
was $1,300. What is Shelly’s depreciable basis in
her computer?
$1,300
2. Jackson purchased a van for $22,000 and used it
100% for business. In the current year, he deducted
$4,400 in depreciation related to the van. What is
Jackson’s adjusted basis in the van at the end of the
current year?
$17,600
6-12
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
6-13
LO #3 Depreciation
Concept Check 6-4
1. An auto used in a trade or business would be depreciated over what
period of time for MACRS tax purposes?
a. 3 years.
b. 5 years.
c. 7 years.
d. 10 years
Answer: B
2. An apartment complex would be depreciated over what period of time
for MACRS tax purposes?
a. 10 years.
b. 20 years.
c. 27 ½ years.
d. 39 years
Answer: C
6-14
LO #3 Depreciation
Concept Check 6-4
3. A warehouse would be depreciated
over what period of time for MACRS tax
purposes?
a. 10 years.
b. 20 years.
c. 27 ½ years.
d. 39 years
Answer: D
6-15
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.
6-16
LO #3 Depreciation
Concept Check 6-5
1. A taxpayer can choose any depreciation convention
as long as he or she is consistent in doing so.
False
2. A taxpayer must use mid-quarter convention for
personal property if more than 40% of the property is
purchased in the fourth quarter.
True
3. The half-year convention is the most often used
convention for personal property.
True
6-17
LO #3 Depreciation
Concept Check 6-5
4. To depreciate an apartment complex, a
taxpayer should use the half-year
convention.
False
5. The taxpayer must use the same
depreciation convention in the year of
disposal as the convention used in the year
of acquisition.
True
6-18
LO #3 Depreciation
• Depreciation Methods
– 200% Declining Balance Switching to
Straight-line
– 150% Declining Balance Switching to
Straight-line
– Straight-line
6-19
LO #3 Depreciation
Concept Check 6-6
• 1. Shu purchased a piece of business
equipment for $12,000 on May 3, 2014. This
equipment is the only business asset Shu
purchased during the year. What is Shu’s
depreciation expense related to the
equipment?
$1,715
• 2. If Shu sold the equipment on January 5,
2016, what would the depreciation expense
be for 2016?
$1,049
6-20
LO #3 Depreciation
Concept Check 6-6
• 3. Davis purchased an apartment
complex on March 5, 2014, for
$330,000. What is Davis’s depreciation
expense related to the complex?
$9,501
6-21
LO #3 Depreciation
• Maximum IRC Section 179 expense
– 2013
$500,000
– 2014
$500,000/$25,000
The $500,000 expired on 12/31/13 and
reverted back to $25,000. The authors
expect the $500,000 to be restored for 2014
after the fall 2014 elections.
• Section 179 expense cannot create a
NOL
6-22
LO #3 Depreciation
Concept Check 6-7
1.
Assume the same asset purchase as Concept Check #6-6.
Shu purchased a piece of business equipment for $12,000 on
May 3, 2014. This equipment is the only business asset
purchased during the year and the business has substantial
income. What is Shu’s deduction for the equipment assuming
§179 expense is elected? Would there be any additional
MACRS regular depreciation?
§179 Expense = $12,000; Additional MACRS = $0
2.
What if the equipment Shu purchased had cost $525,000.
What would the total expense deduction be if §179 were
elected?
§179 Expense = $500,000; Additional MACRS = $3,573 this is
assuming there is no 50% bonus discussed in the next
section.
6-23
LO #3 Depreciation
50 % Bonus in 2013* Expired but
may be restored for 2014
MACRS < 20 year lives
Fully Deductible/No limits other
than Luxury Auto Limits
Lessens Importance of Section
179
6-24
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
6-25
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
Auto
Truck
– 1st year *
$11,160
$11,460
– 2nd year
$ 5,100
$ 5,500
– 3rd year
$ 3,050
$ 3,350
– 4th and after $ 1,875
$ 1,975
* Assuming the 50% bonus is restored – if not the
limit is $3,160 and $3,460 trucks with no bonus
• SUVs greater than 6,000 lbs – Section 179 is
limited to $25,000
6-26
LO #3 Depreciation
Concept Check 6-8
1.
Zachary purchased a Ford Expedition (more than 6,000 lbs.) for
$39,000 in March 2014. What is the maximum depreciation expense
allowed assuming Zachary is eligible for the §179 expense election?
a.
b.
c.
d.
Answer:
2.
$ 7,800.
$25,000.
$27,800.
$33,400.
C
Assume the same facts as number 1 above. However, the
Expedition was used only 80% for business. What is the maximum
depreciation expense allowed assuming Zachary is eligible for §179
expense election?
a. $ 7,800.
b. $ 20,000.
c. $ 22,240.
d. $ 26,720.
Answer: C
6-27
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. 2014-21 for amounts
• The total business lease amount is
deductible
6-28
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
6-29
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
6-30
LO #4 Transportation and Travel
• Automobile Expenses
– Standard Mileage Rate- 56 cents per mile
for 2014
– Actual Expenses- actual business auto
costs are deducted
• Actual expenses usually gives a larger
deduction but require more record
keeping
6-31
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
6-32
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
6-33
LO #4 Transportation and Travel
1. A taxpayer can take depreciation on a business
auto and use the standard mileage rate in the same
year.
False
2. Transportation costs are allowed only when the
taxpayer visits a client.
False
3. A deduction is allowed for meals, lodging, and other
incidental expenses when a taxpayer travels away
from home requiring sleep.
True
6-34
LO #4 Transportation and Travel
4. A taxpayer can deduct $46/day for meals
and incidentals without keeping receipts on
a business trip (subject to the 50%
limitation).
True
5. Taking five clients to a Major League
baseball game immediately following a
substantial business discussion is deductible
up to 50% of costs.
True
6-35
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”
6-36
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
6-37
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
6-38
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
6-39
LO #5 Business Use of Your Home and
Business Bad Debts Concept Check 6-10
1.
Jose uses 20% of his house exclusively for business. He had the
entire exterior of the house painted and the interior of one room that
he uses for an office painted for $3,000 and $500, respectively. What
is the total deduction Jose can take as a home office expense for the
painting?
a. $ 500.
b. $3,500.
c. $ 700.
d. $1,100.
Answer: D
2.
Which of the following comments is true regarding the home office
deduction?
a. The taxpayer must see clients at home to be allowed a home office
deduction.
b. The home office deduction is limited to income from the Schedule C
business.
c. The taxpayer is allowed to take §179 on the business portion of the home
itself .
d. Depreciation on the home is never allowed as a home office deduction.
Answer: B
6-40
LO #5 Business Use of Your Home and
Business Bad Debts Concept Check 6-10
3. When a business property is partially destroyed by
casualty, the loss is calculated using which of the
following?
a. The decrease in the FMV of the property.
b. The adjusted basis of the property.
c. The lower of the decrease in FMV or the
adjusted basis of the property.
d. The adjusted basis of the property less 10% of
AGI.
Answer: C
6-41
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
6-42
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
6-43
LO #6 Hobby Loss Rules and Education
Expenses Concept Check 6-11
1. If a taxpayer has shown a net profit for
the last three years, the activity is not
considered a hobby.
True
2. A taxpayer can never take a net loss
on an activity considered a hobby.
True
6-44
LO #6 Hobby Loss Rules and Education
Expenses Concept Check 6-11
3. Expenses that can be deducted
elsewhere on the tax return must be
the first expenses deducted from
hobby income.
True
4. Education expenses that help qualify a
taxpayer for a new trade or business
(or profession) are deductible.
False
6-45
LO #7 Self-Employment Tax
• Consists of two parts:
– Social Security
– Medicare
– Total
12.40% in 2014
2.90%
15.30%
• Social security limited to first $117,000
of self-employment income in 2014
• Medicare is not limited
6-46
LO #7 Self-Employment Tax
1.
Kia had $43,000 of income from a self-employed consulting
practice and had no other income during the year. What is
Kia’s total self-employment tax?
$6,076
2. Assume the same facts as #1. In addition to her $43,000 in
self-employment income, Kia received a W-2 from her
employer (different from her self-employed business) with
$118,000 in wages. What is Kia’s self-employment tax in this
situation?
$1,152
3. Assume the same facts as #2 above. In addition to her
$43,000 in self-employment income, Kia received a W-2 from
her employer (different from her self-employed business) with
$85,000 in W-2 wages. What is Kia’s self-employment tax in
this situation?
$5,120
6-47