Tax Ch6

MACRS depreciation convention

A half-year convention applies to personal property. Under this convention, property placed in service (or disposed of) during the tax year is considered placed in service (or disposed of) at the midpoint of the tax year. A mid-month convention applies to real property. Under this convention, property is considered placed in service (or disposed of) in the middle of the month for the first month of service and the last month of service. A mid-quarter convention applies when more than 40% of the cost of all personal property is placed in service during the last quarter of the taxable year. Under the mid-quarter convention, personal property is treated as placed in service (or disposed of) in the middle of the quarter. In determining whether 40% of the aggregate basis of MACRS property is placed in service during the last 3 months of the tax year, property placed in service and disposed of within the same tax year is disregarded.

Amortization

Amortizable property is intangible property that is used for business and is of limited life. For example, goodwill, going-concern value, licenses, covenants not to compete, franchises, trademarks, patents, and copyrights. Method. Straight-line method over 15 years. (Code Section 197).

bonus depreciation

Bonus Depreciation 2011 - 100% 2012 - 50% First year Code Sec. 280F limitation increased by $8,000 Sec. 179 deduction for autos between 6,000 and 14,000 pounds -- $25,000 Relevant only for 2012 (100% bonus allowed for 2011) No limit on depreciation or 179 for vehicles weighing more than 14,000 pounds

Student Loan Interest and Qualified Education Expenses

Deductible "for" AGI. Thus, a student can claim the student loan interest deduction even if the standard deduction is used. $2,500 for student loan interest and up to $4,000 qualified tuition & fees To be eligible for the deduction, the education loan must be used solely to pay for any of the following expenses: tuition, student activity fees, room and board, books and supplies, and other related expenses. The deduction is phased out for single taxpayers with modified AGI between $60,000 and $75000, and for married taxpayers with modified AGI between 120,000 and 150,000. Single Taxpayers <65,000 = 4,000 Single Taxpayers > 65,000 < 80,000 = 2,000 Married < 130,000 = 4,000 Married >130,000; < 160,000 = 2,000

Business Investigation and Start Up Costs

Deductible in the year paid or incurred if the taxpayer is currently in a similar line of business as the start-up business. If not in a similar line of business and the new business is: not acquired by the taxpayer, then start-up costs are not deductible. Acquired by the taxpayer, start-up costs must be capitalized. However, for amounts paid or incurred after 10/22/04, a taxpaer may elect to deduct up to $5000 of start-up costs for the tax year in which business begins. The $5000 amount must be reduced (but not below zero) by the amount which start-up costs exceed $50,000. Remaining expenditures are deducted ratably over the 180-month peroid beginning with the month in which business begins.

Deductions FOR AGI

Deductions for AGI are always deductible, even by nonitemizers. Subtracted from income in calculating AGI often reduce earned income subject to self employment taxes state income taxes are often based on federal AGI

Deductions FROM AGI

Deductions from AGI are will only be deducted if in excess of the taxpayer's available standard deduction. Subtracted from AGI itself when computing taxable income generally allowed as an alternative to the standard deduction often subject to limitations calculated as a percentage of AGI

Depreciation 179 election

For 2012, an election may be made to expense up to $139,000 of tangible personal property used in a trade or business, rather than capitalize and depreciate it. Phaseout. The expense allowance is phased out on a dollar-for-dollar basis for purchases exceeding $560,000.

Deductions for Losses

For individual tax payers, deductible losses are limited to: Losses incurred in a trade or business. (Business) Losses incurred in a transaction entered into for profit. (Investment) Losses from casualty or theft. Business and Investment losses are deductible FOR AGI, which losses from casualty or theft are deductible FROM AGI. Losses must be recognized during the year and not compensated by insurance. Losses on personal-use property (other than by casualty and theft) are not deductible.

Limitations to the Deductibility of Expenses and Losses

Hobby expenses and losses - expenses deducted to extent of income only Personal expenses and losses - generally not deductible, unless specifically authorized by Code No deduction for expenses that frustrate public policy: Fines or penalties paid to government Illegal kickbacks, bribes, and other illegal payments Illegal trafficking in controlled substances (although expenses incurred in other illegal businesses are generally deductible) Lobbying - expenses deductible only if incurred to influence legislation at local level in which taxpayer has direct interest (e.g., local business lobbying city officials on local zoning laws) Political contributions - no deduction Meals & entertainment - fifty percent deductible for expenses "directly related to" or "associated with" taxpayer's business, if such expenses are substantiated. Self Employed Individuals - 50% deductible for AGI Nonreimbursed Employee's - 50% deductible and subject to 2% of AGI floor from AGI as misc. itemizied deduction Expenses and interest related to tax-exempt income are not deductible (because income is not taxable) Transactions between related parties: Losses not deductible, but may be used to offset gain subsequently realized by buyer on "re-sale" of property Payment by accrual method taxpayer to related cash method taxpayer may not be deducted by payer until tax year in which recipient reports payment in income. No deduction allowed for payment of expenses of another (e.g., payment by shareholder of corporate business expense).

Employee Business Related Expenses

If an individual is an employee, unreimbursed employment expenses are deductible as miscellaneous itemized deductions, to the extent they exceed 2% of the taxpayer's AGI. The following are examples of typical employment related expenses deductible as miscellaneous itemized deductions: Professional society dues Subscriptions to professional journals Travel expenses Home office expenses Note: Commuting expenses incurred going to and from work are not deductible. However, the expenses of going from one job to another job on the same workday are deductible.

Employee vs Self Employed

Independent contractors sell services to the public, and are considered self-employed. All trade or business expenses are deductible FOR AGI. The following criteria should be considered when determining if an individual is an employee or self-employed: 1. Does the individual work for many clients, or just one? 2. Does the individual make services available to the public? 3. Does the individual determine work hours and schedules? 4. Does the individual received payments from one firm, or many firms?

MACRS depreciation limitations

Passenger Cars: 1st year - 3160 2nd year - 5100 3rd year - 3050 subsequent years - 1875 Trucks and Vans 1st year - 3360 2nd year - 5300 3rd year - 3150 subsequent years - 1875

Production of Income Expenses

Production of income expenses are generally deductible FROM AGI as miscellaneous itemized deductions, to the extent they exceed 2% of AGI. Production of income expenses are related to the production of non business income, such as investment expenses and tax planning and compliance expenses. They must meet the same criteria for deductibility as trade or business expenses, except they do not have to relate to a trade or business The following is a list of typical production of income expenses which are deductible FROM AGI. Safe deposit box rentals Subscriptions to investment related journals and newspapers Legal and accounting fees related to investments Cost of having a tax return prepared by a CPA Tax planning expenses Tax advice for divorce proceedings **There is an exception for expenses associated with the production of rent and royalty income, which are deductible FOR AGI.

R & E

Qualifying expenditures. Experimental and laboratory costs for pilot models, plant processes, products, formulas, inventions, or similar properties. These costs include R&E salaries. Non qualifying expenditures. Ordinary testing or inspection of materials or products for quality control, management studies, consumer surveys, advertising, or promotions. Tax treatment. R&E expenditures may be expensed immediately, or if elected, amortized over a minimum of 5 years.

Health Insurance and HSA's

Self-employed taxpayers allowed to deduct health insurance premiums "for" AGI Self-employed taxpayers and small employers (< 50 employees) with "high deductible" insurance may deduct contributions to health savings accounts of up to $6,250 for 2012 ($3,100 if taxpayer has "self-only" high deductible medical insurance). Neither earnings nor qualified distributions of HSAs are taxable.

classifications of allowable deductions

There are four categories of allowable deductions allowed for individual taxpayers. 1. Trade or business deductions. Deductions applicable to trade or business including the business related expenses of employees. Generally there are deductible FOR AGI. 2. Deductions incurred for the production of income. Generally, these are deductible FROM AGI as miscellaneous itemized deductions subject to the 2% floor. 3. Deductions for losses. Losses incurred on the sale of business or investment assets are generally deductible FOR AGI (though they may be subject to capital loss limitation) 4. Personal Expenses. Personal expenses are generally NOT deductible unless expressly permitted. Allowable personal deductions, such as medical expenses, are deductible as itemized deductions, subject to various limitations.

Business Deductions Related to Capital Expenditures

The cost of captial expenditures must generally be allocated over the peroids that will benefit from the expenditures. The allocation process is generally called: depreciation for tangible property amortization for intangible property depletion for natural resources Depreciable tangible property is generally divided into two categories: (1) real property - e.g. Buildings, building improvements, and (2) personal property - e.g. machernery, equipment, trucks, autos. MACRS is mandatory for most depreciable property placed in service after 1986. salvage value is ignored under MACRS. Personal property is divided into 6 classes: 3 year, 200% classification 5 year, 200% classification 7 year, 200% classification 10 year, 200% classification 15 year, 150% classification 20 year, 150% classification Real property is divided into 3 classes: 27.5 year, straight-line -residential rental property 39 year, straight-line - nonresidential real property 50 year, straight-line - railroad gradings and tunnel bores

Business Gifts

The deduction for business gifts is limited to $25 per done each year, except: No limitation on advertising and promotional gifts costing $4 or less. Gift of tangible personal property costing $400 or less is deductible if awarded to employee in recognition of length of service or safety achievement. Gift of tangible personal property costing $1600 or less is deductible if awarded to an employee as a qualified plan award beause of length of service, productivity, or safety achievement.

Trade or Business Expenses

To be currently deductible, a trade or business expenditure: 1. Must be ordinary and necessary. commonly incurred by other businesses (not necessarily your own) and appropriate for a particular business. 2. Must be reasonable in amount. This is of main concern to closely held corporations, particularly regarding officers' salaries. One way to substantiate reasonableness is by presenting documentation of similar expenses by comparable businesses. 3. Must be related to an activity deemed to be a trade or business. taxpayer must demonstrate commitment to and substantial involvement in the activity and must have a legitimate profit motive 4. Must be business related rather than a personal expenditure. 5. Must not be a capital expenditure. 6. Cannot be incurred in the production of tax exempt income. 7. Must not be a violation of public privacy. 8. Must be paid or incurred during the taxable year.

Travel and Transportation Expense

Transportation Expenses are the costs of transporting between job locations when not in a travel status. Excludes commuting expenses between residence and job. Includes additional expenses to transport heavy and bulky tools to work. Deduct: 1) actual auto expenses or 2) standard mileage rate of 55.5 cents Deductible Travel Expenses are those incurred while away from tax home overnight in the pursuit of a trade of business and include meals, lodging, transportation, and expenses incident to travel (laundry) Only 50% of business meal and entertainment expenditures incurred in a travel status are deductible. Travel expenses at domestic destination must be allocated between business and pleasure.

Moving Expenses

Unreimbursed moving expenses are deducible if both a distance and an employment requirement are met. The distance between the former residence and new job must be at least 50 miles further than from the former residence to the formeer job. If no former job, the new job must be at least 50 miles from the former residence. The employee must be employed at least 39 weeks out of the 12 months following the move. Self Employed individual must be employed at least 78 weeks out of 24 months following the move (in addition to 39 weeks out of first 12 months). The employment requirement does not have to be met if thae taxpayer dies, the job ends because of disability, or if the taxpayer is laid off for other thakn willful misconduct. Deductible moving expenses include the cost of moving household goods and personal effects from the old to the new residence, and the costs of traveling from the old residence to the new residence. Actual auto expenses or standard mileage rate of 23.5 cents per mile is deductible.