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Chapter 6

Business Expenses

Murphy & Higgins


Concepts in Federal Taxation, 2011 edition

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Concept Review
 All deductions are a matter of legislative grace

Just because GAAP allows a


deduction, don’t assume tax
law will too!

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Business Expenses
 All expenses must first meet the basic tests for
deductibility:
 Have a business purpose
 Be ordinary, necessary, and reasonable
 Be allowed under the legislative grace concept
 Requirements
 Expenses related to Meals, Entertainment, Automobile Usage,
Travel, and Business Gifts are deductible subject to limitations
and strict documentation requirements
 Amount
 Time and place
 Date and description
 Business purpose
 Business relationship of other person(s)

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Meals and Entertainment
 Meals and entertainment expenses must be
directly related to or associated with the active
conduct of a business activity
 The “directly related to” test is met if:
 There is more than a general expectation of business benefit
 A bona fide business activity takes place during the meal or
entertainment
 The principal reason for the meal or entertainment is business
 The expenses are related to the taxpayer and people involved in
the business activity
 The “associated with” test is met if:
 There is a clear business purpose for the meal or entertainment
 Meal or entertainment directly precedes or directly follows a
substantial business discussion

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Meals and Entertainment: Costs
 Meal costs  Limitations
 Food, beverage, tax, and  Only 50% of the allowable
tips costs may be deducted
 Exceptions to the 50%
 Entertainment costs limitation
 Expenses for clubs,  Reimbursed expenses
theaters, and sporting  Expenses that are taxable
events income to a non-employee
recipient (awards, prizes)
 Only the face amount of a
 Expenses for recreational
ticket is allowed or social activities which
 Club dues do not qualify benefit employees

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Auto Expenses
 The cost of using an automobile for business is
deductible
 Requirements
 Use of the automobile must be for travel
 Out of town
 From home to a temporary workplace
 From the regular to a temporary workplace
 From the workplace to a second job
 The cost of commuting is never deductible
 Methods
 Auto expenses may be computed under one of two methods:
 Actual Cost
 Standard Mileage Rate

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Auto Expense Methods
 Actual cost method  Standard mileage rate
 Actual cost of using the method
automobile may be  Administrative convenience
deducted concept allows a deduction
 Business percentage of based on the number of
depreciation, gas and oil, business miles driven
repairs, insurance, during the year
interest, license fees, etc.  Rate is $0.54 per mile
is deductible (2016).
 Deduction amount is often  Tolls, parking, and property
larger than the standard taxes may be added. Interest
if self-employed.
rate
 Tolls, parking, and
property taxes may be
added. Interest if self-
employed.
Travel Expenses
 Limitations
 Over 50% of the activity requiring travel must have a business
purpose

 Personal activity costs on a business trip are not deductible

 Incidental business expenses on a personal trip are deductible

 Travel for general educational purposes or for investment related


meetings is not deductible

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Business Gifts
 Cost of a gift given to a business customer
may not be fully deductible
 There is an overall limitation of $25 per person, per
year
 Gifts are not subject to the 50% entertainment limits
 Delivery, gift wrap, engraving, etc., do not count
toward the $25

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Compensation of Employees
(slide 1 of 2)

 Wages, salaries, bonuses and other compensation paid to


employees is deductible if two basic tests are met:
 Employees must perform actual service
 Payment must be reasonable in amount
 To determine if compensation is reasonable, consider:
 Duties, responsibilities and pay history of the employee
 Volume and complexity of the business
 Time required to do the work
 Ability and accomplishments of the employee
 Company pay policy
 Payments to a related party may be examined closely for
 Lack of a business purpose
 An arms-length transaction
 Reality of compensation in a closely-held business
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Compensation of Employees
(slide 2 of 2)

 Size of deduction for salary paid to a covered


employee is limited
 Covered employees = CEO and the four highest paid
officers
 $1,000,000 limit on compensation deduction per
employee
 Some amounts are exempt from the limit
 Commissions and performance based payments
 Pension plan contributions
 Fringe benefits

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Bad Debts
 Bad debts are generally deductible under the
capital recovery concept
 Business bad debts are deductible only under
the accrual method
 Nonbusiness (investment) bad debts are
deductible if the debt is bona fide
 Report as a short-term capital loss
 No deduction is allowed if the debt is voluntarily
forgiven

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Insurance, Legal Fees, and Taxes
 Insurance  Taxes
 Insurance premiums paid to  Most business related taxes are
protect a business from the deductible unless paid to the federal
following losses are deductible. government
 Fire, theft, casualty or liability  Exceptions:
 Group medical, term-life and  Sales taxes related to long-lived
worker’s compensation assets must be capitalized
 Business interruption  Property taxes related to real
estate bought or sold during the
 Legal fees year must be allocated between
 Legal fees are deductible if they buyer and seller
were paid to defend business
income, reputation, or goodwill
 If fees are related to property
ownership, they are capitalized
with the cost of the property

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Individual Deductions
For Adjusted Gross Income
 Expenses paid by individuals
 For a business purpose, or
 Specifically allowed by Congress to create equity in
tax treatment are allowed as deductions for AGI

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Accountable Plan
 Employees are required to make an adequate
accounting of their expenses
 Reimbursements = expenses
 Nothing is reported
 Reimbursements < expenses
 Reimbursement is reported as income
 Expenses = reimbursement income are deducted for AGI
 Excess expenses are deducted from AGI
 Reimbursements > expenses and excess is not
returned
 Excess reimbursement is reported as income

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Nonaccountable Plan
 Employees are not required to make an
adequate accounting of their expenses
 All reimbursements are included in income
 All expenses are deducted from AGI

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Deductions for Self-Employed Taxpayers
 To provide self-employed taxpayers equity
with the tax treatment of employees, they
are allowed to deduct:
 The cost of health insurance premiums
paid for themselves
 50% of the amount of self-employment
tax paid

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Higher Education Deduction
 Education Loan Interest - may deduct up
to $2,500 for interest paid on education loans
 Taken as a “For AGI” deduction
 Only for payments made during first 60 months of the
loan
Moving Expenses (slide 1 of 2)
 Moving expenses are deductible if they
meet two tests:
 Distance test
New job Old job

Old house

 Time test
 Employee taxpayers must be employed in the new area for
39 weeks of the 12 months after moving
 Self-employed taxpayers must be employed in the new area
for 78 weeks of the 24 months after moving
 Waived for death, disability, or required transfer
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
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Moving Expenses (slide 2 of 2)
 Qualifying Expenses
 Only two types of expenses are deductible:
 Costs of moving household goods and personal items to the
new location
 Transportation and lodging costs of moving the taxpayer and
family to the new location
 Mileage is allowed at $0.19 per mile
 None of the cost of meals is deductible

 Reimbursements
 Any reimbursement of moving expenses received
from an employer is included as income

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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.