Professional Documents
Culture Documents
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Learning Objectives
1)
Describe the general requirements for deducting business expenses and identify common business deductions.
2)
Apply the limitations on business deductions to distinguish between deductible and nondeductible business expenses.
Identify and explain special business deductions specifically permitted under the tax laws. Explain the concept of an accounting period and describe accounting periods available to businesses. Identify and describe accounting methods available to businesses and apply cash and accrual methods to determine business income and expense deductions.
8-2
3)
4)
5)
Includes revenue from services and sales activities. Gross profit from sales - cost of goods is a return of capital. Business income does not include excluded and deferred income.
Ordinary and necessary means conducive to profit generation. Reasonable in amount means not extravagant.
8-3
Reasonableness example
Rick owns a business that employs his brother, Ben. Ben is paid $45,000 per year by Ricks business. In comparison, other employees with Bens responsibilities are only paid $30,000 per year. What is Ricks business deduction for employing Ben?
8-4
Reasonableness solution
A reasonable amount for compensating Ben is $30,000 rather than $45,000. Hence, Rick can only deduct $30,000. The extra $15,000 ($45,000 paid minus $30,000 deduction) is a gift from Rick to Ben.
8-5
No deduction for fines, bribes, lobby expenditures, or political contributions Interest on loan where proceeds invested in municipal bonds. Key man insurance premiums no deduction if business is beneficiary of life insurance.
2.
3.
4.
Capital expenditures
Does the expenditure provide future benefit (beyond this year)?
Deduct if benefit < 12 months and Benefits do not extend beyond end of next tax year. Does not apply to interest.
8-7
$10,000 for the next 10 months of utilities. $12,000 for insurance over the next 24 months. $9,600 for the next 8 months of interest on a business loan.
8-8
8-9
Expense up to $5,000 and capitalize/amortize the rest. Accrual taxpayers can only use direct write-off method.
Bad debts
Domestic production of tangible products qualifies for subsidy but income must be allocated between qualifying and nonqualifying activities. Subsidy is percentage (9 percent) of the lesser of qualified production activities income (QPAI) or modified AGI.
QPAI = domestic production gross receipts less expenses attributed to domestic production. Deduction is ultimately limited to 50% of wages allocated to qualified activities.
8-11
Formula:
DPAD example
Brian recorded $100,000 of receipts from a qualified domestic production activity.
Brian allocated $55,000 of expenses to the qualified domestic production activity including $12,000 of wages. Brian had modified AGI of $47,000.
DPAD solution
Calculate QPAI: QDGR (receipts) $100,000 expenses - 55,000 QPAI (qualifying income) $ 45,000 QPAI cannot exceed modified AGI: Modified AGI is $47,000 so no limit Calculate DPAD QPAI $ 45,000 2010 percent x 9% DPAD $ 4,050 Limit DPAD to 50% of wages 50% of wages is $6,000 DPAD =$4,050
8-13
Mixed motive?
Primary motive for some expenditures (all or nothing). Business travel (away from home overnight). Otherwise, allocate deduction to business portion. Arbitrary percentage (50% meals and entertainment). Basis for allocation (mileage or time).
Recordkeeping
Travel example
Ben paid the following to attend a business meeting in Chicago:
Airfare (first class) - $ 1,200 Hotel (three nights) - $ 750 Meals (three days) - $ 270
1. 2.
What amounts are deductible if Ben spent two days in meetings (primarily business)? What amounts are deductible if Ben spent one day in a meeting (primarily personal)?
8-15
Travel solution
Ben can deduct the following amounts: 2 days 1 day business personal
Air fare (all or none) Hotel ($250 per day) Meals ($90 per day x 50%) Total Travel Deduction $ 1,200 500 90 $ 1,790 $ 0 250 45
$ 295
8-16
8-17
Accounting periods
Annual period
Full tax year is 12 months long. Short tax year is < 12 months. Calendar year ends 12/31. Fiscal year end depends upon choice:
Year ends
Last day of a month (not December). 52/53 week year end is the same day of a specific month.
8-18
Proprietorships same as proprietor. C corporations and individuals choice made on first tax return and is consistent with book accounting period.
Match to owners period (multiple owners for partnerships so this can be complicated).
8-19
Accounting methods
8-20
Accounting methods
Cash recognize income when received. Accrual recognize income when earned or received (whichever is first generally). Hybrid mix of accrual and cash depending upon accounts (e.g. sales on accrual).
Cash method
Income recognized when actually or constructively received. Expenses recognized when paid. Pros and cons:
Flexible. Simple and relatively inexpensive. Not GAAP poor matching of income and expense. Not available for some business organizations (large C corporations typically).
8-22
Accrual income
have occurred which fix the right to receive such income and
Payment is received
8-23
Accrual question
Ben provides consulting services and bills Ace for $12,000. Ace disputes the amount claiming that $8,000 is the proper amount.
How much income should Ben recognize under the accrual method this year?
$ ________
8-24
Allowed to defer recognition for one year unless income is earned or recognized for financial records. Not applicable to payments relating to rent or interest income.
Elect one of two methods of recognition. Full inclusion method recognize prepayments as income. Deferral method include in period earned for tax or financial purposes.
8-25
What amount of income must Ben recognize: (1) if he is on the cash method? (2) if he is on the accrual method?
8-26
2. If Ben uses the accrual method, then he can elect to defer advances for services for a year.
This year Ben would recognize $300 - the income earned from September 30 (3/24 x $2,400). Next year Ben would recognize the remaining $2,100 - income can only be deferred one year.
8-27
Inventories
Inventories must be accounted for under the accrual method if sales of goods constitute a material income producing factor.
Purchases accrued with accounts payable. Sales accrued with accounts receivable.
Cash method taxpayers may use cash method for other (non-inventory) accounts.
8-28
UNICAP
Inventory (purchased or produced) must be accounted for using tax version of full absorption rules.
Indirect costs are allocated to inventories (not expensed). Costs of selling, advertising, and research need not be capitalized. Exception for small businesses (average annual gross receipts < $10 million).
8-29
Same method for financial and tax records Book-tax conformity requirement Generates lowest taxable income in time of inflation.
Specific identification
8-30
All events have occurred to establish the liability to pay. The amount is determinable with reasonable accuracy. Reserves for future liabilities not allowed.
8-31
Economic performance
Performance occurs as goods are provided or economic performance is otherwise expected within 3 months of payment.
Payment liabilities are performed only when paid. Interest and rent occurs ratably.
8-32
8-33
8-34
Capitalize
(IRC 263(a) or 471)
12-month rule
Deduct
(IRC 162)
Disallow
Meals & Entertainment Spousal Travel Club Dues Lobbying Etc.
8-35
A permissible method is adopted by using and reporting the method for one year. An impermissible method is adopted by using and reporting the method for two years.
Some changes are automatic. Permission is necessary to correct the use of an impermissible method.
8-36
Chapter Summary
LO1: we learned how to identify common business deductions. LO2: we applied various statutory limitations to determine deductible amounts. LO3: we reviewed the special deductions specifically allowed for businesses. LO4: we reviewed the accounting periods available for calculating business income. LO5: we summarized and compared the accrual and cash methods of accounting for income and deductions.
8-37