2. The Big Picture (slide 1 of 2)
• Morgan, a recent college graduate who majored in
finance, has accepted a job with Kite Corporation.
– The job is in sales and will require travel and some
entertainment (i.e., business lunches).
• She will be based in a major metropolitan area in
another state.
– Kite has no available space in the locale, so she will have
to maintain her own work facility.
– In addition to her salary, Morgan will receive a travel
allowance.
• However, Kite has made it clear that the allowance will not cover
all of her travel expenses.
2
3. The Big Picture (slide 2 of 2)
• Morgan is delighted with the new job since it
will enable her to maintain a flexible work
schedule.
– Furthermore, working out of her own apartment
avoids a time-consuming and costly commute.
• What are some of the income tax problems
presented by this situation?
– Read the chapter and formulate your response.
3
4. Employee vs. Self-Employed
(slide 1 of 2)
• Business expenses for self-employed persons
are deductible for AGI
– Reported on Schedule C
• Unreimbursed business expenses for
employees are generally deductible from AGI
subject to 2% of AGI floor
– Reported on Form 2106 (Employee Business
Expenses) and Schedule A (Itemized Deductions)
4
5. Employee vs. Self-Employed
(slide 2 of 2)
• Person is classified as an employee if:
– Subject to will and control of another with respect
to what shall be done and how it shall be done
– Another furnishes tools or the place of work
– Income based on time spent rather than task
performed
5
6. Employee Expenses
• Fall into one of the following categories:
– Transportation
– Travel
– Moving
– Education
– Entertainment
– Other
6
7. Transportation Expenses
(slide 1 of 2)
• Transportation expense defined
– Very limited, only from job site to job site and
commuting to/from temporary work place
– Commuting from home to work and back is
nondeductible
• Exceptions:
– Additional costs incurred to transport heavy tools
– Employees with more than one job
7
8. Transportation Expenses
(slide 2 of 2)
• Amount deductible
– Actual expenses
• Must keep adequate records of all expenses and
depreciation is limited, or
– Automatic mileage method
• 55.5 cents per mile for business miles for 2012
– Adjustment to basis of auto is required for depreciation
considered allowed
• Plus parking, tolls, etc.
• Adequate documentation of mileage required
8
9. The Big Picture - Example 9
Commuting Expense
• Return to the facts of The Big Picture on p. 9-1.
• Because Morgan will have an office in her
home, the apartment will be her principal place
of business.
– Thus, any transportation from her home to
business sites will not be disallowed as a
commuting expense
9
10. The Big Picture - Example 11
Automatic Mileage Method
• Return to the facts of The Big Picture on p. 9-1.
• During Morgan’s senior year in college, her parents
gave her one of the family cars—a 2009 Chevrolet
Impala.
– Morgan has no idea as to the car’s original cost or the
odometer reading at the time the car was registered in her
name.
– She has, however, kept track of the miles driven for
business since she accepted her new job.
• Morgan should use the automatic mileage method in
claiming business use of the car.
10
11. Travel Expenses
(slide 1 of 2)
• Travel expense defined
– Expenses while “away from tax home” overnight
on business
– Includes transportation, lodging, 50% meals, and
miscellaneous expenses
11
12. Travel Expenses
(slide 2 of 2)
• “Away from home” requirement
– Need not be a 24-hour period but must be longer
than ordinary work day and taxpayer will need to
rest during release time
– Being “away” should be a temporary situation (not
in excess of 1 year)
– “Tax Home” generally means business location,
post, or station of the taxpayer
12
13. Restrictions on Travel Expenses
(slide 1 of 2)
• Convention travel expenses
– No deduction for travel unless directly related to
taxpayer’s trade or business
• Example: Doctor attending out-of-town seminar on
estate planning would not have deductible travel
expenses
– Restrictions apply to the deductibility of travel
expenses of the taxpayer’s spouse or dependent
• Generally, accompaniment by the spouse or dependent
must serve a bona fide business purpose, and
• The expenses must be otherwise deductible
13
14. Restrictions on Travel Expenses
(slide 2 of 2)
• Education travel expenses
– Travel as a form of education is not deductible
• Example: Spanish language professor traveling to Spain
to work on the language would not have deductible
travel expenses
• Example: Spanish history professor traveling to Spain
to study historical documents available only in Spanish
museums would have deductible travel expenses
14
15. Combined Business/Pleasure Travel
(slide 1 of 4)
• Only actual expenses for business are
deductible
– Meals, lodging and other expenses must be
allocated between business and personal days
• Deductibility of transportation costs depends
on whether the trip is domestic or foreign
15
16. Combined Business/Pleasure Travel
(slide 2 of 4)
• For domestic travel
– If primary purpose of trip is business,
transportation is deductible in full
– If primary purpose is pleasure, no deduction for
transportation allowed, but other expenses (e.g.,
lodging) associated with business days are
deductible
16
17. Combined Business/Pleasure Travel
(slide 3 of 4)
• For foreign travel
– Transportation expenses must be allocated between
business and personal unless:
• Trip is 7 days or less,
• Less than 25% of time was for personal purposes, or
• Taxpayer had no substantial control over arrangements
for the trip
17
18. Combined Business/Pleasure Travel
(slide 4 of 4)
• Travel days are considered business days
• Weekends, legal holidays and intervening days
are business days if both the preceding and
succeeding days are business days
• If trip is primarily for pleasure, no
transportation expenses are deductible
18
19. Moving Expenses
• Deductible for moves in connection with the
commencement of work at a new principal
place of work
• Two tests must be met for moving expenses to
be deductible
– Distance test
– Time test
19
20. Moving Expenses - Distance Test
• Distance from old home to new job must be at
least 50 miles farther than from old home to
old job
• New home location not relevant for decision
20
21. Example of Distance Test
• Gail lived 20 miles
from her old job 20 mi. Old
Old
• Gail’s new job is 75 Job
Job
miles from her old Old
Old
home Residence
Residence
• Gail meets the
distance test 75 mi.
New
New
Job
Job
21
22. Moving Expenses - Time Test
(slide 1 of 2)
• Taxpayer must be full-time employee for 39
weeks in the 12-month period following the
move, or
• Self-employed must work in new location for
78 weeks during the next two years following
the move
– 39 of the weeks must be in the first 12 months
• Test waived if die, disabled, discharged, or
transferred
22
23. Moving Expenses - Time Test
(slide 2 of 2)
• If time test not met during taxable year, two
alternatives:
– Take the deduction in year moved. If test is not
met in following year, either:
• Include the amount deducted in gross income in the
following year, or
• File amended return for year of move
– Alternatively, wait until time test is met and then
file amended return for year of move
23
24. Deductible Moving Expenses
• ‘‘Qualified’’ moving expenses include
reasonable expenses of:
– Moving household goods and personal effects to
new location
– Expenses of travel for taxpayer and family to new
location
• Lodging
• Actual auto costs (not depreciation) or mileage rate of
$.23 per mile for each car in 2012
– Meals are not deductible as moving expense
24
25. Tax Treatment of
Moving Expenses
• Unreimbursed moving expenses are deductible
for AGI
• Reimbursement or payment by employer:
– For qualified moving expenses, amount is
excluded from gross income, but no deduction for
related expenses
– For nonqualified moving expenses, amount is
included in gross income and no deduction is
allowed
25
26. The Big Picture - Example 28
Moving Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Even though this is her first job, Morgan will
be entitled to a moving expense deduction.
– This presumes that she is not reimbursed by Kite
Corporation for these expenses.
– The mileage on her car also is allowed.
• Her deduction is for AGI and can be claimed
even if she chooses the standard deduction
option.
26
27. Education Expenses
(slide 1 of 3)
• Education expenses of an employee are
deductible if they are incurred:
– To maintain or improve existing skills, or
– To meet express requirements of the employer or
requirements imposed by law to retain
employment status
27
28. Education Expenses
(slide 2 of 3)
• Education expenses of an employee are not
deductible if they are incurred:
– To meet minimum educational standards for
existing job, or
– To qualify taxpayer for new trade or business
28
30. Deduction For Qualified Tuition and
Related Expenses (slide 1 of 3)
• A deduction is allowed for AGI for qualified
tuition and related expenses involving higher
education (i.e., postsecondary)
30
31. Deduction For Qualified Tuition and
Related Expenses (slide 2 of 3)
• The maximum deduction depends on filing
status and AGI
Filing Status AGI Limit Max Deduction
Single $65,000 $4,000
Married $130,000 $4,000
Single $65,001 to $2,000
$80,000*
Married $130,001 to $2,000
$160,000*
*No deduction is allowed if MAGI exceeds this amount
31
32. Deduction For Qualified Tuition and
Related Expenses (slide 3 of 3)
• Qualified tuition and related expenses include
whatever is required for enrollment
– Usually, student activity fees, books, room and
board are not included
• Expenses need not be work related
• Deduction is not available for married persons
filing separately
32
33. The Big Picture - Example 31
Education Expenses
• Return to the facts of The Big Picture on p. 9-1.
• After starting her new job, Morgan enrolls in
the night program of a local law school.
– Although Morgan does not plan to practice law,
she feels that a law degree would advance her
career.
• Except for the tuition she pays (see the
discussion of § 222), none of her expenses
relating to the education will be deductible.
33
34. Entertainment Expenses
(slide 1 of 3)
• Deductions are very restricted due to abuse
possibilities
– Deductible amount allowed:
• 50% of meals and entertainment costs including related
taxes, tips, cover charges, parking fees, and room rental
fees
• 100% of transportation costs
– Amounts cannot be lavish or extravagant
– In certain situations, the 50% cutback for meals is
eased for certain, very limited, types of employees
34
35. Entertainment Expenses
(slide 2 of 3)
• The 50% cutback rule has a number of
exceptions, such as:
– Situations where full value of meals or
entertainment is included in income
– Meals and entertainment are provided in a
subsidized eating facility or where the de minimis
fringe benefit rule is met
– Employer-paid recreational activities for
employees
• e.g., the annual Christmas party or spring picnic
35
36. Entertainment Expenses
(slide 3 of 3)
• Entertainment expenses are classified as
either:
– Directly related to business
• Actual business meeting or discussion occurs during
meal or entertainment
– Associated with business
• Meal or entertainment that directly precedes or follows
business meeting or discussion
36
37. Restrictions on Entertainment
Expenses (slide 1 of 3)
• Club dues
– Generally not deductible
• Exception: Clubs formed for public service and
community volunteerism (e.g., Kiwanis, Rotary)
– Business entertainment expenses incurred at club
are still deductible (50%)
37
38. Restrictions on Entertainment
Expenses (slide 2 of 3)
• Ticket purchases for entertainment
– Amounts paid in excess of face value of ticket are
not deductible
– Limitation on deductibility of luxury skybox
expenditures
38
39. Restrictions on Entertainment
Expenses (slide 3 of 3)
• Business gifts
– Business gifts of tangible personalty with a value
of $25 or less per person per year are deductible
• Incidental costs (e.g., gift-wrapping) are not included in
the cost of the gift in applying the limit
– If the value is $4 or less (e.g., pen with company
name) then not subject to $25 limit
• Gifts to employers or superiors are not
deductible
39
40. Office in the Home
(slide 1 of 3)
• Deductibility is very restricted due to abuse
possibilities
– Office must be used exclusively and on a regular
basis as:
• The principal place of business, or
• A place of business used by clients, patients, or
customers
– For employees, office must also be for the
convenience of the employer
40
41. Office in the Home
(slide 2 of 3)
• What constitutes “principal place of
business”?
– Home office qualifies as a principal place of
business if:
• Taxpayer conducts admin. and mgmt. activities in the
home office, and
• There is no other fixed location where taxpayer
conducts these activities
41
42. Office in the Home
(slide 3 of 3)
• Office in the home expenses cannot cause net
loss from the business activity
– Office in home deduction limited to business gross
income in excess of other business expenses
(ordering rules apply)
– Excess is carried forward (subject to limit)
– Form 8829 is used to report office in home
expenses
42
43. The Big Picture - Example 45
Deductible Home Office Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Morgan’s rent, utilities, renters’ insurance, and the
like allocable to her office will qualify for deduction.
– Because she will be working in an apartment where space
is limited, she must be careful to meet the exclusive-use
requirement for the area set aside.
• For the furnishings she acquires (e.g., desk, file
cabinet), Morgan may prefer to forgo expensing (§
179) and claim depreciation instead.
– This way the tax deduction is deferred to later, higher-
income years.
43
44. Other Employee Expenses
• A partial list of other employee expenses that
are deductible includes:
– Special clothing (uniforms)
– Union dues
– Professional expenses
– Job hunting in same profession
– Educator expenses (deductible for AGI)
• Limited to $250 per year for supplies, etc. of elementary
and secondary school teachers
44
45. The Big Picture - Example 46
Job Hunting Expenses
• Return to the facts of The Big Picture on p. 9-1.
• Recall that Morgan conducted an extensive job
search before obtaining her position with Kite
Corporation.
– Because this is her first job, the expenses she
incurred in the search are not deductible.
45
46. Contributions to Retirement Accounts
(slide 1 of 2)
• Retirement plans fall into two major
classifications depending on who is covered
– For employees – usually follow one of two income
tax approaches
• Most plans allow an exclusion from income for the
contributions the employee makes to the pension plan
• Alternatively, using the approach followed by a
traditional IRA, a contributing employee is allowed a
deduction for AGI
– Maximum deduction is $5,000 for 2012
46
47. Contributions to Retirement Accounts
(slide 2 of 2)
• Retirement plans for self-employed taxpayers
– Called Keogh (or H.R. 10) plans
• Follow the deduction approach of traditional IRAs
• Amounts contributed under a plan are deductible for
AGI
47
48. Classification of Employee Expenses
(slide 1 of 2)
• Depends on whether they are reimbursed and,
if reimbursed, under what type of plan
48
49. Classification of Employee Expenses
(slide 2 of 2)
• Employers can have three types of
reimbursement plans
– Accountable
– Nonaccountable
– No reimbursement is given
49
50. Accountable Plan
(slide 1 of 2)
• Plan must require adequate accounting to the
employer for expense reimbursed, and
• Any excess reimbursements must be returned
to the employer
50
51. Accountable Plan
(slide 2 of 2)
• Adequate accounting is
– Submitting a record, with receipts, to the
employer, or
– Using a per diem allowance that is not more than
the Federal per diem rate
• Employee reports no income and takes no
deduction to the extent of the reimbursed
expenses
51
52. Substantiation for Expenditures
(slide 1 of 2)
• No deduction allowed for an expense if the
taxpayer does not have adequate records for
the expense
– Therefore, taxpayers need to have good records for
employee or self-employed expenses
• In some cases, use of per diem allowance will be
deemed substantiation
52
53. Substantiation for Expenditures
(slide 2 of 2)
• Records should include:
– The amount of the expense
– The time and place of travel or entertainment (or
date of gift)
– The business purpose of the expense
– The business relationship of the taxpayer to the
person entertained (or receiving the gift)
53
54. Nonaccountable Plan
• Plan that does not require adequate accounting
or return of excess reimbursement or both
– Reimbursed amounts received under this plan are
included in gross income
– Expenses are deductible from AGI as
miscellaneous itemized deductions subject to the
2% of AGI limitation
54
55. Unreimbursed Employee Expenses
• Expenses are deductible from AGI as
miscellaneous itemized deductions subject to
the 2% of AGI limitation
– If employee could have received, but did not seek,
reimbursement for whatever reason, none of the
employment-related expenses are deductible
55
56. Miscellaneous Itemized
Deductions
• Miscellaneous itemized deductions subject to
the 2% of AGI limitation
– Certain miscellaneous expenses must be added
together and the amount in excess of 2% of
taxpayer’s AGI is deductible from AGI (i.e.,
itemized deduction reported on Sch. A)
56
57. Examples of Miscellaneous Itemized
Deductions Subject to 2% Floor
• Most reimbursed expenses under a nonaccountable
plan
• Unreimbursed employee expenses
• Section 212 expenses not related to rents and
royalties
• Tax return preparation fee
• Hobby expenses
• Investment expenses (except interest and taxes)
57
58. Examples of Miscellaneous Itemized
Deductions Not Subject to 2% Floor
• Impairment-related work expenses of
handicapped individuals
• Gambling losses to the extent of winnings
• Certain terminated annuity payments
58
59. Computing 2% of AGI Limitation
(slide 1 of 2)
• Example
Taxpayer, a single individual, provides the following
information for 2012:
• $30,000 AGI
• $ 6,500 deductible interest expense and taxes paid
• $ 1,500 employee business expenses, and
• $ 500 tax return preparation fee
59
60. Computing 2% of AGI Limitation
(slide 2 of 2)
• Example (cont’d)
Interest and taxes $6,500
Misc. expenses:
Employee bus. exp. $1,500
Tax return prep. 500
Total $2,000
Less 2% AGI - 600 1,400
Itemized deductions $7,900
60
61. Refocus On The Big Picture (slide 1 of 4)
• Several tax issues might arise as a result of Morgan’s
new job.
– The first tax issue relates to the dependency exemption.
• If Morgan was living at home and accepted the job late in the year,
she could qualify as a dependent of her parents.
– If so, they might also be able to claim the qualified tuition deduction
(or the lifetime learning credit).
– If, however, her employment began early in the year, it
may not be possible for her parents to claim her as a
dependent either because
• She is not a qualifying child due to the self-supporting limitation,
or
• She is not a qualifying relative due to the gross income limitation
—see Chapter 3.
61
62. Refocus On The Big Picture (slide 2 of 4)
• Other tax issues would include the following.
• Job hunting expenses - Morgan’s ‘‘extensive search’’ for employment
suggests that she may have incurred job hunting expenses
– Such expenses are not deductible in a first job setting.
• Moving Expenses - Her qualified moving expenses are not so restricted.
– Moving expenses are deductions for AGI.
• Office in the home deduction - Under the circumstances, Morgan is
justified in claiming an office in the home deduction.
– The deduction would include a portion of the rent paid for the apartment,
depreciation on office equipment, and other operating expenses (e.g., utilities).
– She must be careful not to violate the ‘‘exclusive use’’ restriction.
• Travel – Morgan is required to travel as part of her job and so will use her
car for business.
– Thus, she will need to make a choice between the automatic mileage method
and the actual cost method.
62
63. Refocus On The Big Picture (slide 3 of 4)
• Commuting expenses - Since her tax home is in her apartment,
she will have no nondeductible commuting expenses.
• Travel Allowance – Tax treatment depends on whether it is an
accountable plan
– If she renders an adequate accounting (and has to return any excess) to
Kite Corporation, then her allowance need not be reported on her
Federal income tax return.
• Nonreimbursed amounts, however, must be allocated between meals and
entertainment (subject to the 50% cutback) and other employment-related
expenses.
• The balance is an itemized deduction subject to the 2 percent-of-AGI floor.
– If she does not render an adequate accounting, the full allowance is
included in her gross income.
• All of the meals and entertainment expenses are subject to the 50%
cutback, and
• The total of all employment-related expenses is an itemized deduction
subject to the 2 percent-of-AGI floor.
63
64. Refocus On The Big Picture (slide 4 of 4)
• If Morgan started her job late in the year, it is unlikely
that she will be in a position to itemize her
deductions.
– Instead, she will claim the standard deduction effectively
eliminating her ability to deduct any employment-related
expenses.
• Morgan must maintain adequate substantiation
regarding all of these employment related
transactions.
– Detailed records are particularly important in arriving at
the office in the home deduction and the business use of an
automobile under the actual cost method.
64
