Business Income, Deductions and Accounting Methods
What sources of income is included in business income?
Gross profit from inventory sales, income from services provided to customers, and income from renting property
If a taxpayer's "business" activity doesn't meet the for-profit requirement, how is it treated?
As a hobby and expenses are deducted as a misc itemized deduction (subject to the 2% of AGI floor)
Business expenditures must be both _______ and ________ to be deductible
Ordinary and necessary
What is an ordinary expense?
an expense that is normal and appropriate for the business under the circumstances
What is a necessary expense?
An expense that is helpful or conducive to the business activity, but needs not be essential or indispensable
Ordinary and necessary business expenses are deductible to what amount?
Only to the extent that they are reasonable in amount
What are some expenses that businesses can't deduct?
Fines, penalties, illegal bribes, or illegal kickbacks
A business must capitalize it's expenditures for which types of assets?
Tangible assets that have a useful life of more than one year
Are personal, living or family expenses deductible for a business?
No, unless it is a personal item that is specially adapted for business use
Rick went out to dinner with a prospective client to discuss business and after attended the theater. Rick paid $190 for dinner and $350 for the tickets. What amount of these expenses can Rick deduct as a business expense?
$270 (190 + 350 = 540 / 2 = 270) 50% of meals and entertainment are deductible for business expenses
What is the domestic production activities deduction or DPAD?
an artificial business deduction for tax purposes designed to reduce the tax burden on domestic manufacturers to make investments in domestic facilities more attractive
What is Qualified Production Activities Income or QPAI?
The net income from selling or leasing property that was manufactured in the U.S.
What is the formula for calculating DPAD?
9% times the lesser of (1) the business's taxable income before the deduction or (2) QPAI
When can businesses deduct casualty losses?
In the year the casualty occurs or in the year the theft of the asset is discovered. The amount of the deduction depends on whether the asset was completely destroyed or stolen or partially destroyed
What are the 3 types of tax years and their year end date?
A calendar year ends on 12/31 A fiscal year ends on the last day of a month other than December A 52/53 week year ends on the same day each year
What are the 2 primary methods of accounting for businesses?
Cash and accrual - businesses may also chose a hybrid method where some accounts are on the cash method and some on the accrual method
What is the 12-month rule relating to the cash method of accounting?
Used for prepaid business expenses to simplify the process of determining whether to capitalize or immediately expense payments that create benefits for a short period of time (insurance, rent, etc.)
What is the rule for interest and rental income pre-payments?
Businesses must recognize prepaid rental and interest income immediately upon receipt
When costs are subject to inflation over time, a business would get the best of both worlds if it adopted which inventory cost-flow method for financial reporting purposes and which inventory cost-flow method for tax purposes?
FIFO for Financial reporting purposes and LIFO for tax purposes
What is the All-Events test for deductions?
For a business to recognize a deduction, all events that establish its liability giving rise to the deduction must have occurred and it must be able to determine the amount of the liability with reasonable accuracy
What is the economic performance test with respect to liabilities?
Requirement that specifies that businesses may not recognize a deduction for an expense until the underlying activity generating the associated liability has occurred
When are businesses allowed to deduct bad debt expense?
Only when the debt actually becomes worthless within the taxable year