Which of the following is not a requirement for using Schedule C-EZ instead of Schedule C?
a. Filed Schedule C-EZ in the prior year
b. Have no employees
c. Have business expenses of $5,000 or less
a. Correct. There is no requirement that the taxpayer must have filed Schedule C-EZ in the prior year in order to use the schedule in the current year.
Ordinary and Necessary
Unless otherwise covered by a specific section of the Tax Code, a business expense is deductible if it is "ordinary and necessary." An expense is considered "ordinary" if
incurring it is a common and accepted practice in the
taxpayer's field of business. It is considered "necessary" if it is appropriate and helpful in developing and maintaining the trade or business. Thus, an expense need not be essential or indispensable in order to be deductible.
Reasonableness of Salaries
The regulations define "reasonable compensation"as an amount that would ordinarily be paid for like
services by like enterprises under like circumstances.
What Constitutes a Trade or Business?
A taxpayer is considered as being "engaged in a trade or
business" if the activity is one entered into with at least
the expectation of making a profit and the taxpayer devotes a substantial part of his business time to it, or if the taxpayer operates it through an agent or employee who devotes a substantial part of his time to it
Expenses incurred to decide whether to go into business and which business to enter can be expensed
up to $5,000; the balance is amortized over a period of 180 months. If the start-up expenses exceed $50,000, the immediate deduction is reduced dollar for dollar, until no dedcution after 55,000.
Fines and penalties
Fines and penalties for violating the law, such as traffic fines or penalties for building violations, are nondeductible even where incurred in connection with the taxpayer's trade or business, and even though the violation was inadvertent.
Current Expenses Versus Capital Expenses (Sec. 162 and Sec. 263)
Capital expenditures are not
deductible but may be recovered through depreciation over a period of years.
A capital expenditure represents an investment of capital either to acquire property having a useful life of more than 1 year or to increase the value of such property or to
prolong its life.
A "repair" is defined as an expenditure made to maintain
the taxpayer's business property in an ordinary, efficient operating condition, whereas an improvement
materially adds to the value or utility of the property or appreciably prolongs its useful life.
Income and Expenses Attributable to Rents and Royalties
Taxpayers who actively participate
in a rental real estate activity may be able to deduct losses in excess of income, up to a maximum of $25,000. However, the allowance is phased out for adjusted gross income over $100,000 and is
completely lost when adjusted gross income exceeds $150,000. Married couples must file jointly to claim
the $25,000 allowance.
Domestic Production Activities
Deduction (Sec. 199)
The domestic production activities deduction (also referred to as the manufacturer's deduction) is a deductible expense that is designed to encourage domestic production activities. Like depreciation, it is a non-cash outlay (no actual expenditure is required in order to qualify for the deduction).
Which of the following expenses is a deductible
a. Basic service charge for the first telephone line to a taxpayer's home even if the phone is used in a deductible home office.
b. Interest on a tax deficiency related toSchedule C.
c. Business gifts (within limits).
Correct. Business gifts are deductible within set limits.
Which costs are not currently deductible?
b. Advertising expenses
c. Capital improvements
c. Correct. No current deduction is allowed for capital improvements, although some may be depreciable.
Vacation Home Rules (Sec. 280A)
A taxpayer is considered to use a dwelling unit as a residence during the tax year if he used it for personal
purposes more than 14 days or more than 10% of the number of days during the tax year it is rented at a fair rental, whichever is greater.
If the residence is not used for personal purposes (i.e., personal use does not exceed the greater of 14 days or 10% of rental) but it is rented out for 15 days or more
during the year, then rental expenses fall within the passive
loss rules. See ¶709A.
Rental for less than 15 days.
If a taxpayer uses the unit as
a residence and rents it for less than 15 days during the year, no rental expenses can be deducted. However, if the taxpayer itemizes deductions, he can deduct mortgage interest on a second home, taxes, and casualty and theft losses. No rental income is included in gross income in this case.
Deducting expenses where personal use exceeds the
greater of 14 days or 10% of rental and rental is 15 days or more.
Deductions (other than mortgage interest, property taxes, and casualty losses) cannot exceed rental
income. A taxpayer must deduct rental expenses in the following order: (1) mortgage interest, real estate taxes, and casualty losses that are for rental use; (2) operating
expenses, except depreciation and other basis adjustments;
and (3) depreciation and other basis adjustments.
With respect to the vacation home rules, which statement is not correct?
a. A home owner who rents out the home for less than 15 days has to report the income.
b. A home owner who rents out the home for less than 15 days cannot deduct any maintenance or depreciation on the home.
c. A home owner who rents out a home for 15 days or more and uses the home for more than 14 days or 10% of the rental period can deduct expenses (other than mortgage interest, real estate taxes, and casualty losses)
only to the extent of rental income.
a. Correct. A home owner who rents out the home for fewer than 15 days does not have to report the income.
b. Incorrect. A home owner who rents out the home for fewer than 15 days is not allowed to deduct any
maintenance or depreciation on the home.
c. Incorrect. A home owner who rents out a home for 15 days or longer and uses the home for longer than 14 days or 10% of the rental period is allowed to deduct expenses (other than mortgage interest, real estate taxes, and casualty losses) only to the extent of rental income.