Interactive Review
Course #10075
Tax Guide for Small Business
(Individuals who use Schedule C or C-EZ)
1A. True – Incorrect Return
If you and your spouse jointly own and operate an unincorporated business and
share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. Do not use Schedule C or C-EZ. Instead, file Form 1065. For more information, see Publication 541. Exception. If you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession, you can treat the business either as a sole proprietorship or a partnership. A change in your reporting position will be treated as a conversion of the entity.
1B. False – Correct Return
You can treat the business either as a sole proprietorship or a partnership, if you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession. The only states with community property laws are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
2A. True – Correct Return
A calendar tax year is 12 consecutive months beginning January 1 and ending December 31. You must adopt the calendar tax year if any of the following apply.
• You keep no books.
• You have no annual accounting period.
• Your present tax year does not qualify as a fiscal year.
• Your use of the calendar tax year is required under the Internal Revenue Code or the
Income Tax Regulations.
If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor, you must continue to use the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. If you adopt the calendar tax year, you must maintain your books and records and report your income and expenses for the period from January 1 through December 31 of each year.
2B. False – Incorrect Return
If you keep no books, have no annual accounting period, your present tax year does not qualify as a fiscal year, or your use of the calendar tax year is required under the Internal Revenue Code or the Income Tax Regulations, you must adopt the calendar tax year. A calendar tax year is 12 consecutive months beginning January 1 and ending December 31.
You must figure your taxable income and file an income tax return for an annual accounting period called a tax year. Also, you must consistently use an accounting method that clearly shows your income and expenses for the tax year. When preparing a statement of income and expenses generally your income tax return), you must use your books and records for a specific interval of time called an accounting period. The annual accounting period for your income tax return is called a tax year. You can use one of the following tax years.
• A calendar tax year.
• A fiscal tax year.
Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations.
3A. True – Incorrect Return
A disposition of property includes the following transactions.
• You sell property for cash or other property.
• You exchange property for other property.
• You receive money as a tenant for the cancellation of a lease.
• You receive money for granting the exclusive use of a copyright throughout its life in a
particular medium.
• You transfer property to satisfy a debt.
• You abandon property.
• Your bank or other financial institution forecloses on your mortgage or repossesses your
property.
• Your property is damaged, destroyed, or stolen, and you receive property or money in
payment.
• Your property is condemned, or disposed of under the threat of condemnation, and you
receive property or money in payment.
3B. False – Correct Return
A disposition of property occurs if you receive money as a tenant for the cancellation of a lease. If you dispose of business property, you may have a gain or loss that you report on Form 1040. However, in some cases you may have a gain that is not taxable or a loss that is not deductible. Basis, adjusted basis, amount realized, fair market value, and amount recognized are defined next. You need to know these definitions to figure your gain or loss.
Basis. The cost or purchase price of property is usually its basis for figuring the gain or loss from its sale or other disposition. However, if you acquired the property by gift, inheritance, or in some way other than buying it, you must use a basis other than its cost.
Adjusted basis. The adjusted basis of property is your original cost or other basis plus certain additions, and minus certain deductions such as depreciation and casualty losses. In determining gain or loss, the costs of transferring property to a new owner, such as selling expenses, are added to the adjusted basis of the property.
Amount realized. The amount you realize from a disposition is the total of all money you receive plus the fair market value of all property or services you receive. The amount you realize also includes any of your liabilities that were assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage.
Fair market value. Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts.
Amount recognized. Your gain or loss realized from a disposition of property is usually a recognized gain or loss for tax purposes. Recognized gains must be included in gross income. Recognized losses are deductible from gross income. However, a gain or loss realized from certain exchanges of property is not recognized. Also, you cannot deduct a loss from the disposition of property held for personal use.
You must classify your gains and losses as either ordinary or capital gains or losses. You must do this to figure your net capital gain or loss. Generally, you will have a capital gain or loss if you dispose of a capital asset. For the most part, everything you own and use for personal purposes or investment is a capital asset.
4A. True – Correct Return
Your general business credit for the year consists of your carryforward of business credits from prior years plus the total of your current year business credits. In addition, your general business credit for the current year may be increased later by the carryback of business credits from later years. You subtract this credit directly from your tax. Although you may not owe AMT, you must still figure your tentative minimum tax on Form 6251 if you claim a general business credit. After you fill in Form 6251, attach it to your tax return.
4B. False – Incorrect Return
Your carryforward of business credits from prior years plus the total of your current year business credits is your general business credit for the year. To claim a general business credit, you will first have to get the forms you need to claim your current year business credits. In addition to the credit form, you may also need to file Form 3800. You must file Form 3800 if any of the following apply.
• You have more than one of the credits listed above (other than the empowerment zone and renewal community employment credit (Form 8844), New York Liberty Zone business employee credit (Form 8884), or renewable electricity and refined coal business production credit (Form 8835, Section B)).
• You have a carryback or carryforward of any of these credits (other than from Form 8844, Form 8884, or Section B of Form 8835).
• Any of these credits (other than the amount from Form 8586, Form 8844, Form 8884, or Section B of Form 8835) is from a passive activity.
5A. True – Incorrect Return
Bartering is an exchange of property or services. You must include in your gross receipts, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as the fair market value unless the value can be shown to be otherwise.
Example - You are a self-employed lawyer. You perform legal services for a client, a small corporation. In payment for your services, you receive shares of stock in the corporation. You must include the fair market value of the shares in income.
Example - You are a member of a barter club that uses credit units to credit or debit members’ accounts for goods or services provided or received. As soon as units are credited to your account, you can use them to buy goods or services or sell or transfer the units to other members. You must include the value of credit units you received in your gross receipts for the tax year in which the units are credited to your account. The dollar value of units received for services by an employee of the club, who can use the units in the same manner as other members, must be included in the employee’s gross income for the tax year in which received. It is wages subject to social security and Medicare taxes (FICA), federal unemployment taxes (FUTA), and income tax withholding.
5B. False – Correct Return
The fair market value of property or services at the time received in bartering, must be included in your gross income.
Example - You are an artist and create a work of art to compensate your landlord for the rent-free use of your apartment. You must include the fair rental value of the apartment in your gross receipts. Your landlord must include the fair market value of the work of art in his or her rental income.
Example - You are a self-employed accountant. Both you and a house painter are members of a barter club, an organization that each year gives its members a directory of members and the services each member provides. Members get in touch with other members directly and bargain for the value of the services to be performed. In return for accounting services you provided for the house painter’s business, the house painter painted your home. You must include in gross receipts the fair market value of the services you received from the house painter. The house painter must include the fair market value of your accounting services in his or her gross receipts.
6A. True – Incorrect Return
If you recover a bad debt or any other item deducted in a previous year, include the recovery in income on Schedule C or C-EZ. However, if all or part of the deduction in earlier years did not reduce your tax, you can exclude the part that did not reduce your tax. If you exclude part of the recovery from income, you must include with your return a computation showing how you figured the exclusion.
6B. False – Correct Return
You can exclude from income in the current year, recovery of that part of a bad debt or any other item deducted in a previous year that did not reduce your tax.
Example - Joe Smith, a sole proprietor, had gross income of $8,000, a bad debt deduction of $300, and other allowable deductions of $7,700. He also had 2 personal exemptions for a total of $6,200. He would not pay income tax even if he did not deduct the bad debt. Therefore, he will not report as income any part of the $300 he may recover in any future year.
This rule does not apply to depreciation. In the following situations, you have to recapture the depreciation deduction. This means you include in income part or all of the depreciation you deducted in previous years.
Listed property. If your business use of listed property falls to 50% or less in a tax year after the tax year you placed the property in service, you may have to recapture part of the depreciation deduction. You do this by including in income on Schedule C part of the depreciation you deducted in previous years. Use Part IV of Form 4797, Sales of business Property, to figure the amount to include on Schedule C.
Section 179 property. If you take a section 179 deduction for an asset and before the end of the asset’s recovery period the percentage of business use drops to 50% or less, you must recapture part of the section 179 deduction. You do this by including in income on Schedule C part of the deduction you took. Use Part IV of Form 4797 to figure the amount to include on Schedule C. See chapter 2 in Publication 946 to find out when you recapture the deduction.
Sale or exchange of depreciable property. If you sell or exchange depreciable property at a gain, you may have to treat all or part of the gain due to depreciation as ordinary income. You figure the income due to depreciation recapture in Part III of Form 4797.
7A. True – Incorrect Return
All income you earn is taxable to you. You cannot avoid tax by having the income paid to a third party.
Example. You rent out your property and the rental agreement directs the lessee to pay the rent to your son. The amount paid to your son is gross income to you.
7B. False – Correct Return
By having income you earn paid to a third party, you cannot avoid tax. All income you earn is taxable to you. You cannot avoid tax by having the income paid to a third party. Accounting for your income for income tax purposes differs at times from accounting for financial purposes. Figure your business income on the basis of a tax year and according to your regular method of accounting. If the sale of a product is an income-producing factor in your business, you usually have to use inventories to clearly show your income. Dealers in real estate are not allowed to use inventories.
8A. True – Correct Return
If you contribute inventory (property that you sell in the course of your business), the amount you can claim as a contribution deduction is the smaller of its fair market value on the day you contributed it or its basis. The basis of donated inventory is any cost incurred for the inventory in an earlier year that you would otherwise include in your opening inventory for the year of the contribution. You must remove the amount of your contribution deduction from your opening inventory. It is not part of the cost of goods sold. If the cost of donated inventory is not included in your opening inventory, the inventory’s basis is zero and you cannot claim a charitable contribution deduction. Treat the inventory’s cost as you would ordinarily treat it under your method of accounting. For example, include the purchase price of inventory bought and donated in the same year in the cost of goods sold for that year.
8B. False – Incorrect Return
The amount you can claim as a contribution deduction is the smaller of its fair market value on the day you contributed it or its basis, if you contribute inventory (property that you sell in the course of your business).
Example - You are a calendar year taxpayer who uses an accrual method of accounting. In 2012 you contributed property from inventory to a church. It had a fair market value of $600. The closing inventory at the end of 2011 properly included $400 of costs due to the acquisition of the property, and in 2011, you properly deducted $50 of administrative and other expenses attributable to the property as business expenses. The charitable contribution allowed for 2012 is $400 ($600 − $200). The $200 is the amount that would be ordinary income if you had sold the contributed inventory at fair market value on the date of the gift. The cost of goods sold you use in determining gross income for 2012 must not include the $400. You remove that amount from opening inventory for 2012.
9A. True – Correct Return
Labor costs are usually an element of cost of goods sold only in a manufacturing or mining business. Small merchandisers (wholesalers, retailers, etc.) usually do not have labor costs that can properly be charged to cost of goods sold. In a manufacturing business, labor costs properly allocable to the cost of goods sold include both the direct and indirect labor used in fabricating the raw material into a finished, saleable product.
9B. False – Incorrect Return
Only in a manufacturing or mining business are labor costs usually an element of cost of goods sold. Direct labor costs are the wages you pay to those employees who spend all their time working directly on the product being manufactured. They also include a part of the wages you pay to employees who work directly on the product part time if you can determine that part of their wages. Indirect labor costs are the wages you pay to employees who perform a general factory function that does not have any immediate or direct connection with making the saleable product, but that is a necessary part of the manufacturing process. Other labor costs not properly chargeable to the cost of goods sold can be deducted as selling or administrative expenses. Generally, the only kinds of labor costs properly chargeable to your cost of goods sold are the direct or indirect labor costs and certain other costs treated as overhead expenses properly charged to the manufacturing process.
10A. True – Correct Return
If you are a business that sells services, you do not have to figure the cost of goods sold if the sale of merchandise is not an income producing factor for your business. Your gross profit is the same as your net receipts (gross receipts minus any refunds, rebates, or other allowances). Most professions and businesses that sell services rather than products can figure gross profit directly from net receipts in this way.
10B. False – Incorrect Return
You do not have to figure the cost of goods sold if the sale of merchandise is not an income producing factor for your business, if you are a business that sells services.
Illustration - This illustration of the gross profit section of the income statement of a retail business shows how gross profit is figured.
Income Statement
Year Ended December 31, 2012
Gross receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $400,000
Minus: Returns and allowances . . . . . . . . . . . . . . . . ..... . . 14,940
Net receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. . $385,060
Minus: Cost of goods sold . . . . . . . . . . . . . . . . . . . . . ... 288,140
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . . . $96,920
The cost of goods sold for this business is figured as follows:
Inventory at beginning of year . . . . . . . . . . . . . . . . . . ... $37,845
Plus: Purchases . . . . . . . . . . . . . . . . .. . . . $285,900
Minus: Items withdrawn for personal use….. 2,650…... 283,250
Goods available for sale . . . . . . . . . . . . . . . . . . . . . ... $321,095
Minus: Inventory at end of year . . . . . . . . . . . . ... . . .. . . 32,955
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . … .. . $288,140
11A. True – Incorrect Return
If you use your vehicle for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expenses based on the miles driven for each purpose. For local transportation or overnight travel by car or truck, you generally can use one of the following methods to figure your expenses.
• Standard mileage rate.
• Actual expenses.
You may be able to use the standard mileage rate to figure the deductible costs of operating your car, van, pickup, or panel truck for business purposes. If you choose to use the standard mileage rate for a year, you cannot deduct your actual expenses for that year except for business-related parking fees and tolls. If you want to use the standard mileage rate for a car or truck you own, you must choose to use it in the first year the car is available for use in your business. In later years, you can choose to use either the standard mileage rate or actual expenses. If you use the standard mileage rate for a car you lease, you must choose to use it for the entire lease period including renewals). You cannot use the standard mileage rate if you:
1. Use the car for hire (such as a taxi),
2. Operate five or more cars at the same time,
3. Claimed a depreciation deduction using any method other than straight line, for
example, ACRS or MACRS,
4. Claimed a section 179 deduction on the car,
5. Claimed the special depreciation allowance on the car,
6. Claimed actual car expenses for a car you leased, or
7. Are a rural mail carrier who received a qualified reimbursement.
In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees you pay to park your car at your place of work are nondeductible commuting expenses.) If you do not choose to use the standard mileage rate, you may be able to deduct your actual car or truck expenses.
11B. False – Correct Return
You must divide your expenses between business and personal use, if you use your vehicle for both business and personal purposes.
Example. You are the sole proprietor of a flower shop. You drove your van 20,000 miles during the year. 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use. You can claim only 80% (16,000 ÷ 20,000) of the cost of operating your van as a business expense.
12A. True – Incorrect Return
You cannot deduct on Schedule C or C-EZ the interest you paid on personal loans. If a loan is part business and part personal, you must divide the interest between the personal part and the business part.
Example. In 2012, you paid $600 interest on a car loan. During 2012 you used the car 60% for business and 40% for personal purposes. You are claiming actual expenses on the car. You can only deduct $360 (60% × $600) on Schedule C or C-EZ. The remaining interest of $240 is a nondeductible personal expense.
12B. False – Correct Return
You must divide the interest between the personal part and the business part if a loan is part business and part personal. You cannot deduct the interest you paid on personal loans. You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. Interest relates to your business if you use the proceeds of the loan for a business expense. It does not matter what type of property secures the loan. You can deduct interest on a debt only if you meet all of 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.
13A. True – Correct Return
You can deduct on Schedule C or C-EZ any tax imposed by a state or local government on personal property used in your business. You can also deduct registration fees for the right to use property within a state or local area. You can also deduct on Schedule C or C-EZ various other federal, state, local, and foreign taxes directly attributable to your business.
13B. False – Incorrect Return
Any tax imposed by a state or local government on personal property used in your business can be deducted on Schedule C or C-EZ.
Example. May and Julius Winter drove their car 7,000 business miles out of a total of 10,000 miles. They had to pay $25 for their annual state license tags and $20 for their city registration sticker. They also paid $235 in city personal property tax on the car, for a total of $280. They are claiming their actual car expenses. Because they used the car 70% for business, they can deduct 70% of the $280, or $196, as a business expense.
14A. True – Incorrect Return
You can have more than one business location, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that business. To determine your principal place of business, you must consider all the facts and circumstances. Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the following requirements.
• You use it exclusively and regularly for administrative or management activities of your business.
• You have no other fixed location where you conduct substantial administrative or management activities of your business. Alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify as your principal place of business based on the previous rules, you determine your principal place of business based on the following factors.
• The relative importance of the activities performed at each location.
• If the relative importance factor does not determine your principal place of business, you can also consider the time spent at each location.
14B. False – Correct Return
Your home must be your principal place of business for that business, to qualify to deduct the expenses for the business use of your home under the principal place of business test. For a single trade or business, you can have more than one business location, including your home.
To deduct expenses related to the part of your home used for business, you must meet specific requirements. Even then, your deduction may be limited. To qualify to claim expenses for business use of your home, you must meet the following tests.
1. Your use of the business part of your home must be:
a. Exclusive (however, see Exceptions to exclusive use, later),
b. Regular,
c. For your business, and
2. The business part of your home must be one of the following:
a. Your principal place of business,
b. A place where you meet or deal with patients, clients, or customers in the normal course of your business, or
c. A separate structure (not attached to your home) you use in connection with your business.
To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. The space does not need to be marked off by a permanent partition.
You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes.
Example. You are an attorney and use a den in your home to write legal briefs and prepare clients’ tax returns. Your family also uses the den for recreation. The den is not
used exclusively in your profession, so you cannot claim a business deduction for its use.
Exceptions to exclusive use. You do not have to meet the exclusive use test if you use part of your home in either of the following ways.
1. For the storage of inventory or product samples.
2. As a daycare facility.
15A. True – Incorrect Return
If you have more than one business, you must figure your net profit or loss for each business on a separate Schedule C. After figuring your business income and expenses, you are ready to figure the net profit or net loss from your business. You do this by subtracting business expenses from business income. If your expenses are less than your income, the difference is net profit and becomes part of your income on page 1 of Form 1040. If your expenses are more than your income, the difference is a net loss. You usually can deduct it from gross income on page 1 of Form 1040. But in some situations your loss is limited. If your deductions for the year are more than your income for the year (line 40 of your Form 1040 is a negative number), you may have a net operating loss (NOL). You can use an NOL by deducting it from your income in another year or years.
Examples of typical losses that may produce an NOL include, but are not limited to, losses incurred from the following.
• Your trade or business.
• Your work as an employee (unreimbursed employee business expenses).
• A casualty or theft.
• Moving expenses.
• Rental property.
A loss from operating a business is the most common reason for an NOL.
AUTION
15B. False – Correct Return
You must figure your net profit or loss for each business on a separate Schedule C, if you have more than one business. If you do not carry on your business to make a profit, there is a limit on the deductions you can take. You cannot use a loss from the activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, come under this limit.
Copyright © 2012 By
CPE Accounting and Tax Institute
All Rights Reserved