Unit 4: Business Expenses Flashcards
To be deductible, a business expense must be both:
Ordinary and necessary
What is an ordinary expense?
One that is common and accepted in the taxpayer’s industry
What is a necessary expense?
One that is helpful and appropriate for the particular trade or business
Under the accrual method of accounting, a taxpayer generally deducts or capitalizes business expenses when both of the following apply:
- “All events” have occurred that fix the fact of liability, and the liability can be determined with reasonable accuracy
- Economic performance has occurred: the property or services are provided, (or used).
Exception for recurring items?
Expenses for certain recurring items may be treated as incurred during the tax year even though economic performance has not occurred.
The exception for recurring items applies if all of the following requirements are met:
- The all-events test described above has been met
- Economic performance occurs by the earlier of the following dates
- 8 1/2 months after the close of the year
- The date the taxpayer files a timely return, including extensions
- The item is recurring, and the taxpayer consistently treats similar items as incurred in the tax year in which the all-events test is met.
- And either
- The item is not material, or
- Accruing the item in the year in which the all-events test is met
results in a better match against income than accruing the item
in the year of economic performance
Business start-up costs include:
Investigating whether to open a business, legal costs to purchase an existing business, and training new employees before the business actually opens.
Start=up costs are amounts paid or incurred for:
- Creating an active trade of business, or
- Investigating the creation or acquisition of an active trade or business
The following costs related to a new business may be deductible as current expenses, without the need for amortization, in 2022:
- Up to $5,000 to organize a corporation, partnership, or LLC, and
- Up to $5,000 of start-up costs.
Common start-up costs include:
- An analysis or survey of potential markets and other investigative costs
- Paying for government permits, business licenses, and fees
- Advertisements to announce the opening of a business
- Salaries and wages for employees who are being trained and their instructors
- Travel costs for securing prospective distributors, suppliers, or customers
- Salaries and fees for executives and consultants, or for similar professional services.
If organizational or start-up costs incurred exceed $50,000:
There is a dollar-for-dollar reduction in the available immediate deduction until the current deduction for either item is eliminated.
Organizational costs or start-up costs that are not currently deductible may be amortized ratably over:
180 months (15 years)
Qualifying organizational costs must be:
- Directly related to the creation or formation of the business
- Chargeable to a capital account
- For a partnership, the costs must have been incurred by the due date of the tax return (excluding extensions) for the year in which the business begins
- For a corporation, incurred before the end of the first tax year in which the corporation begins business operations.
Examples of qualifying organization costs include
- The cost of temporary directors
- The cost of organizational meetings
- Organization and filing fees for a corporation, limited partnership, or any other legal entity (such as the costs of forming an LLC or LLO)
- Legal and accounting fees for setting up the business.
If a taxpayer completely disposes of a business before the end of the amortization period, the taxpayer can deduct:
Any remaining unamortized start-up costs or organizational costs. However, the business can deduct these deferred only to the extent they qualify as a loss.
Costs incurred in expanding an already-existing business are generally deductible as:
Ordinary and necessary business expenses.
If an individual taxpayer attempts to go into business and is ultimately unsuccessful, the cost incurred may fall into one of two categories:
- Costs incurred before making a decision to purchase or start a specific business, which are considered personal and thus nondeductible
- Costs incurred in a bona-fide attempt to purchase (or start) as specific business, which are capital costs that may be claimed as a capital loss on Schedule D, form 1040. Doing this, the taxpayer is limited to a “capital loss limit” of $3,000 per year over any capital gains they might have.
If a property is sold, the deductible portion of the real estate taxes must:
Be allocated between the buyer and the seller according to the number of days in the property tax year that each owned the property.
