Interactive Review
Course #10070
Business Expenses
Deducting Business Expenses 2
Employees' Pay 1
Retirement Plans 1
Rent Expense 1
Interest 1
Taxes 1
Insurance 1
Costs You Can Deduct or Capitalize 1
Amortization 1
Depletion 1
Business Bad Debts 1
Electric and Clean-Fuel Vehicles 1
Other Expenses 1
Total Review Questions 14
What Can I Deduct?
1. An expense does not have to be indispensable to be considered necessary.
When Can I Deduct an Expense?
2. Under the cash method, you can deduct a contested liability only in the year you pay the liability.
3. A corporation recognizes gain or loss when it pays for employee services with its own stock.
4. SIMPLE IRA salary reduction contributions are not subject to social security, Medicare, and federal unemployment (FUTA) taxes.
Rent paid in advance
5. If you pay rent in advance, you can deduct only the amount that applies to your
use of the rented property during the tax year.
6. You can only deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business if your business property is used to secure the loan.
7. You can deduct the employment taxes you must pay from your own funds as taxes.
8. If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year.
Costs You Can Deduct or Capitalize
9. The costs of research and experimentation are capital expenses and you cannot choose to deduct these costs as a current business expense.
10. You can elect to amortize certain costs for setting up and organizing your business.
11. If you have an economic interest in mineral property or standing timber, you cannot take a deduction for depletion.
12. If you make a loan to a client, supplier, employee, or distribu-
tor for a business reason and it becomes worthless, you have a business bad debt.
Electric and Clean-Fuel Vehicles
13. You can claim a d eduction for Clean-Fuel Vehicle Property only if the property is used in a trade or business.
14. Education expenses you incur to meet the minimum requirements of your present trade or business, or those that qualify you for a new trade or business, are not deductible.
Copyright
© 2005 By
CPE Accounting and Tax Institute
All Rights Reserved
1A. True - Correct Return
A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. It is important to distinguish business expenses from:
. The expenses used to figure cost of goods sold.
. Capital expenses.
. Personal expenses.
1B. False – Incorrect. Return
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. An expense does not have to be indispensable to be considered necessary.
2A. True – Correct Return
Under the cash method, you can deduct a contested liability only in the year you pay the liability. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions. See Contested Liability in Publication 538 for more information.
2B. False – Incorrect Return
You can deduct a contested liability only in the year you pay the liability under the cash method. Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U.S. possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them. Under an accrual method of accounting, you generally deduct business expenses when both of the following apply:
1. The all-events test has been met. The test is met when:
a. All events have occurred that fix the fact of liability, and
b. The liability can be determined with reasonable accuracy.
2. Economic performance has occurred.
3A. True – Incorrect Return
A corporation recognizes no gain or loss when it pays for employee services with its own stock. If you transfer property (including your company’s stock) to an employee as payment for services, you can generally deduct it as wages. The amount you can deduct is the property’s fair market value on the date of the transfer less any amount the employee paid for the property. You can claim the deduction only for the tax year in which your employee includes the property’s value in income. Your employee is deemed to have included the value in income if you report it on Form W-2 in a timely manner.
You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer. Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer.
3B. False – Correct Return
No gain or loss is recognized by a corporation when it pays for employee services with its own stock. These rules also apply to property transferred to an independent contractor, generally reported on Form 1099-MISC. If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. However, if the
recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid.
4A. True – Incorrect Return
You can deduct your contributions and your employees can exclude these contributions from their gross income. SIMPLE IRA contributions are not subject to federal income tax withholding. However, salary reduction contributions are subject to social security, Medicare, and federal unemployment (FUTA) taxes. Matching and non-elective contributions are not subject to these taxes.
4B. False – Correct Return
SIMPLE IRA salary reduction contributions are subject to social security, Medicare, and federal unemployment (FUTA) taxes. Do not include SIMPLE IRA contributions in the “Wages, tips, other compensation” box of Form W-2. However, salary reduction contributions must be included in the boxes for social security wages and Medicare wages. Also include the proper code in Box 12. For more information, see the
instructions for Forms W-2 and W-3.
5A. True – Correct Return
Generally, rent paid in your trade or business is deductible in the year paid or accrued. If you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year.
5B. False – Incorrect Return
If you pay rent in advance, you can deduct only the amount that applies to your
use of the rented property during the tax year. You can deduct the rest of your payment only over the period to which it applies. Generally, rent paid in your trade or business is deductible in the year paid or accrued.
Example 1. You leased a building for 5 years beginning July 1. Your rent is $12,000 per
year. You paid the first year’s rent ($12,000) on June 30. You can deduct only $6,000 (6/12 × $12,000) for the rent that applies to the first year.
Example 2. Last January you leased property for 3 years for $6,000 a year. You paid the
full $18,000 (3 × $6,000) during the first year of the lease. Each year you can deduct only
$6,000, the part of the lease that applies to that year.
6A. True – Incorrect Return
It does not matter what type of property secures the loan. Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. You can deduct interest on a debt only if you meet all the following requirements.
• You are legally liable for that debt.
• Both you and the lender intend that the debt be repaid.
• You and the lender have a true debtor-creditor relationship.
6B. False – Correct Return
You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. It does not matter what type of property secures the loan. If you use the proceeds of the loan for a trade or business expense, interest relates to your trade or business. If you are liable for part of a
business debt, you can deduct only your share of the total interest paid or accrued.
Example. You and your brother borrow money. You are liable for 50% of the note. You
use your half of the loan in your business, and you make one-half of the loan payments. You can deduct your half of the total interest payments as a business deduction.
You should treat the taxes you withhold from your employees’ pay as wages on your tax return. You can deduct the employment taxes you must pay from your own funds as taxes.
Example. You pay your employee $18,000 a year. However, after you withhold various
taxes, your employee receives $14,500. You also pay an additional $1,500 in employment taxes. You should deduct the full $18,000 as wages. You can deduct the $1,500 you pay from your own funds as taxes. For more information on employment taxes, see Publication 15 (Circular E).
As an employer, you may have to make payments to a state unemployment compensation fund or to a state disability benefit fund. Deduct these payments as taxes.
Expenses such as insurance are generally allocable to a period of time. You can deduct
insurance expenses for the year to which they are allocable.
Example. In the current year, you signed a 3-year insurance contract. Even though you paid the premiums for current year, one year after, and two years after when you signed the contract, you can only deduct the premium for current year on your current tax return. You can deduct in one year after and two years after the premium allocable to those years.
You can usually deduct insurance premiums in the tax year to which they apply.
If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. However, see Prepayment, later. If you use an accrual method of accounting, you cannot deduct insurance premiums before the tax year in which you incur a liability for them. In addition, you cannot deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies). For more
information about the accrual method of accounting, see chapter 1. For information about
the exception for recurring items, see Publication 538. You cannot deduct expenses in
advance, even if you pay them in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year
9A. True – Incorrect Return
The costs of research and experimentation are generally capital expenses. However, you can choose to deduct these costs as a current business expense. Your choice to deduct these costs is binding for the year it is made and for all later years unless you get IRS approval to make a change.
9B. False – Correct Return
If you meet certain requirements, you may choose to defer and amortize research and experimental costs. Research and experimental costs are reasonable costs you incur in your trade or business for activities intended to provide information that would eliminate uncertainty about the development or improvement of a product. Uncertainty exists if the information available to you does not establish how to develop or improve a product or
the appropriate design of a product. Whether costs qualify as research and experimental
costs depends on the nature of the activity to which the costs relate rather than on the nature of the product or improvement being developed or the level of technological advancement. The costs of obtaining a patent, including attorneys’ fees paid or incurred in making and perfecting a patent application, are research and experimental costs. However, costs paid or incurred to obtain another’s patent are not research and experimental costs.
10A. True – Correct Return
You can elect to amortize certain costs for setting up and organizing your business. The amortization period starts with the month your active trade or business begins. You generally cannot recover other costs until you sell the business or otherwise go out of business. To amortize, the cost must qualify as one of the following.
• A business start-up cost.
• An organizational cost for a corporation.
• An organizational cost for a partnership
10B. False – Incorrect Return
You can elect to amortize certain costs for setting up and organizing your business. The cost must qualify as one of the following:
A business start-up cost is amortizable if it meets both the following tests:
Start-up costs include costs for the following items.
facilities, etc.
You can amortize an organizational cost only if it meets all the following tests.
The following are examples of organizational costs.
11A. True – Incorrect Return
If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. Depletion is the using up of natural resources by mining, quarrying, drilling, or felling. The depletion deduction allows an owner or operator to account for the reduction of a product’s reserves. There are two ways of figuring depletion: cost depletion and percentage depletion. For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost depletion.
11B. False – Correct Return
You can take a deduction for depletion if you have an economic interest in mineral property or standing timber. You have an economic interest if both the following apply:
• You have acquired by investment any year in mineral deposits or standing timber.
• You have a legal right to income from the extraction of the mineral or cutting of the
timber to which you must look for a return of your capital investment. A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of mineral property is not an economic interest.
12A. True – Correct Return
If someone owes you money you cannot collect, you have a bad debt. There are two kinds of bad debts, business and non-business. Generally, a business bad debt is one that
comes from operating your trade or business. You can deduct business bad debts on your
business tax return. All other bad debts are non-business bad debts and are deductible only as short-term capital losses on Schedule D (Form 1040). A business bad debt is a loss from the worthlessness of a debt that was either:
• Created or acquired in your trade or business, or
• Closely related to your trade or business when it became partly or totally worthless.
A debt is closely related to your trade or business if your primary motive for incurring the debtis business related.
12B. False – Incorrect Return
If you make a loan to a client, supplier, employee, or distributor for a business reason and it becomes worthless, you have a business bad debt.
Example. John Smith, an advertising agent, made loans to certain clients to keep their business. One of these clients went bankrupt and could not repay him. Since the main reason for making the loan was business related, the debt was a business debt and John can take a business bad debt deduction.
13A. True – Incorrect Return
The deduction for Clean-Fuel Vehicle Property may be claimed regardless of whether the property is used in a trade or business. The deduction is allowed only in the tax year you place the property in service. You cannot claim the deduction for the part of the property’s cost you claim as a section 179 deduction.
Clean-fuel vehicle property is either of the following kinds of property.
1. A motor vehicle produced by an original equipment manufacturer and designed to be propelled by a clean-burning fuel. These include designated hybrid gas-electric automobiles which, at this time, only include the Ford Escape, Honda Insight, Honda Civic Hybrid, and Toyota Prius. Those designated automobiles do not qualify for the electric vehicle credit. For other than those designated automobiles, the only part of a vehicle’s basis that qualifies for the deduction is the part attributable to:
a. A clean-fuel engine that can use a clean-burning fuel,
b. The property used to store or deliver the fuel to the engine, or
c. The property used to exhaust gases from the combustion of the fuel.
2. Any property installed on a motor vehicle (including installation costs) to enable it to
be propelled by a clean-burning fuel if:
a. The property is an engine (or modification of an engine) that can use a clean-burning
fuel, or
b. The property is used to store or deliver that fuel to the engine or to exhaust gases
from the combustion of that fuel.
For vehicles that may be propelled by both a clean-burning fuel and any other fuel, your deduction is generally the additional cost of permitting the use of the clean-burning fuel.
13B. False – Correct Return
You may claim the Clean-Fuel Vehicle Property deduction whether or not the property is used in a trade or business. Clean-fuel vehicle property does not include an electric vehicle that qualifies for the electric vehicle credit. You must recapture the deduction for clean-fuel vehicle property if the property ceases to qualify within 3 years after the date you placed it in service. The property will cease to qualify if it is changed in any of the following ways.
1. It is modified so that it can no longer be propelled by a clean-burning fuel.
2. It ceases to be a qualified clean-fuel vehicle property (for example, by failing to
meet emissions standards).
3. It becomes non-qualifying property.
Individuals can claim the deduction for clean-fuel vehicle property used for non-business purposes by including the deduction in the total on line 35 of Form1040. Also, enter the amount of your deduction and “Clean Fuel” on the dotted line next to line 35. Employees who use clean-fuel vehicle property for business, or partly for business and partly for non-business purposes, should include the entire deduction in the total on line 35 of Form 1040. Also, enter the amount of your deduction and “Clean Fuel” on the dotted line next to line 35. Sole proprietors must claim deductions for clean-fuel vehicle property and
clean-fuel vehicle refueling property used for business on the Other expenses line of either Schedule C (Form 1040) or Schedule F (Form 1040). If clean-fuel vehicle property is used partly for non-business purposes, claim the non-business part of the deduction as explained above for individuals non-business use.
14A. True – Correct Return
Education expenses you incur to meet the minimum requirements of your present trade or
business, or those that qualify you for a new trade or business, are not deductible. Ordinary and necessary expenses paid for the cost of the education of your and your employees are deductible, but you must be able to show the education maintains or improves skills required in your trade or business, or that it is required by law or regulations, for keeping your license to practice, status, or job. For example, an attorney can deduct the cost of attending Continuing Legal Education (CLE) classes that are required by the state bar association to maintain his or her license to practice law.
14B. False – Incorrect Return
Education expenses are not deductible if you incur them to meet the minimum requirements of your present trade or business, or those that qualify you for a new trade or business. This is true even if the education maintains or improves skills presently required in your business. To be deductible, you must be able to show the education maintains or improves skills required in your trade or business, or that it is required by law or regulations, for keeping your license to practice, status, or job.
Copyright © 2007 By
CPE Accounting and Tax Institute
All Rights Reserved