Chapter 06 - Self-Employed Business Income Schedule C

CHAPTER 6

SELF-EMPLOYED BUSINESS INCOME SCHEDULE C

Discussion Questions 1. Discuss the definition of a trade or business. Why does it matter whether a taxpayer is classified as an employee or self-employed? Answer: A trade or business is any activity that is engaged in for profit continually and regularly. The income from a sole proprietor is netted with related ordinary and necessary business expenses to determine the effect on AGI. 2. Discuss the concepts of ordinary, necessary, and reasonable in relation to trade or business expenses. Answer: According 162, in order for an expense to be deductible it must be an ordinary and necessary expenditure. The expense must also be reasonable (as established by the courts). A trade or business expense must not only be ordinary and necessary but also reasonable in amount and reasonable in relation to its purpose. The Supreme Court (in Welch, T., 1933, S Ct, 290 US 111) held that in order for an expense to be ordinary, in must be customary or usual in the taxpayers particular business. The necessary criterion refers to an expense that is appropriate and helpful, and not necessarily essential to the taxpayers business. Reasonableness is not specifically included by IRC 162, but has been added by the courts. In these cases, the courts held that a trade or business expense must not only be ordinary and necessary but also reasonable in amount and reasonable in relation to its purpose.

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3. What form is depreciation reported on and how does it relate to other forms such as Schedule C, E, F, and Form 2106? Answer: Depreciation is reported on Form 4562, and the expenses flow from that forms to other schedules in the tax return. Depreciation is the expense allowed for the wear or loss of usefulness of a business asset. The understanding of depreciation is extremely important aspect of the tax system because depreciation is a material non-cash expense. Depreciation is allowed on most assets (excluding land) used in a trade or business or any activity held for the production of income (e.g. rental property). Thus, the depreciation calculation affects nearly every aspect of a tax return of any complexity. 4. On what type of property is depreciation allowed? Answer: Depreciation is allowed on trade or business property including (but not limited to) buildings, race horses, breeding hogs, automobiles, railroad tracks, sawmill equipment, water transportation equipment, wastewater treatment plants, roads, land improvements. An exhaustive list of depreciable property can be found in IRC 168(e). 5. Discuss the word basis in relation to the financial accounting term book value. What is meant by the term adjusted basis? Answer: Basis is similar to book value. Typically, the depreciable basis of property is the initial cost of the property. Adjusted basis is the cost basis less any accumulated depreciation.

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6. Discuss the difference between personal property and real property. Give examples of each. Answer: Real property consists of land and buildings as well as any other structural components attached to land. Personal property includes equipment, furniture, and fixtures, or anything else that is not classified as real property. 7. What is a depreciation convention? What conventions are available under MACRS? Answer: A depreciation convention is a concept which is used to determine the amount of a partial year allowed in the depreciation calculation. Available conventions include the half-year convention, the mid-quarter convention, and the mid-month convention. 8. When calculating depreciation for personal property (assuming the half-year convention) using the IRS depreciation tables, does the taxpayer need to multiply the first year depreciation by one-half? What about in the year of disposal assuming the property is disposed of prior to the end of its recovery period? Answer: The half-year convention for the first year is built into the depreciation tables issued by the IRS. However, in the year of disposal, the table percentage must be multiplied by for the half-year convention and the appropriated months for mid-quarter and mid-month conventions. 9. Discuss the concept of electing 179 expense. Does the election allow a larger expense deduction in the year of asset acquisition? Answer: The taxpayer can elect to expense a certain portion of personal property purchased during the year (the election cannot be made for real property.) The maximum yearly deduction is determined in IRC 179(b)(1) and is $125,000 for 2007. The expense election is phased out dollar-for-dollar for purchases in excess of $500,000. Unused 179 deductions cannot be carried forward unless the expense is disallowed by the lack of business income.

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10. Discuss the concept of listed property. Answer: Listed property is defined as any passenger automobile or other property used as a means of transportation, property used for entertainment (boat), computer or peripheral equipment, or any cellular telephone or other telecommunications equipment. 11. Distinguish between travel and transportation expenses. Answer: Travel expenses are different from transportation expenses in that travel involves the overnight stay for business purposes. The basic travel requirement is that the trip requires sleep or rest. 12. When can a taxpayer use the standard mileage rate? Is the standard mileage rate better than the actual auto costs? Answer: A taxpayer can use the standard mileage rate if the taxpayer owns the vehicle and uses the standard mileage rate for the first year it was placed in service or if the auto is leased, the standard mileage rate must be used for the entire lease period. The actual expense method usually results in a larger deduction but also requires receipts for actual expenses, as well as a mileage log to determine business use verses personal use. 13. Discuss the limits on meals and entertainment. Are meal and entertainment expenses always limited to 50%? Answer: Generally, any business meals and entertainment expenditures are limited to 50% of the amount incurred. The 50% limit pertains to any expense for food or beverage and to any expense with respect to an activity that is generally considered to constitute entertainment, amusement, or recreation. To qualify for any deduction, meal and entertainment expenses must be both ordinary and necessary business expenses as well as be either directly related or associated with business. Directly related or associated with business primarily means that the activity took place in a business setting or the entertainment directly preceded or followed business discussions.

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14. Discuss the limits on home office expense deductibility. Answer: Home-office expenses that would not be otherwise deductible (such as insurance, utilities, and depreciation) are limited to the gross income from the business use of the home. The gross income is first reduced by regular trade or business expenses (not related to the home) and home office expenses that would be deductible in any event (mortgage interest and property taxes). If any positive income remains, the business use portions of insurance, utilities, and depreciation (depreciation is used last) can be deducted. 15. Why were the hobby loss rules established? What factors determine whether an activity is a trade or business or a hobby? Is any one factor controlling? Answer: Congress established the hobby loss rules in order to limit deductible losses from activities that are primarily for personal pleasure instead of a trade or business. Some of the factors that determine whether an activity is to be considered a hobby or a trade or business include the manner in which the taxpayer carries on the activity, the expertise of the taxpayer or his advisors, the time and effort expended by the taxpayer in carrying on the activity, the expectations that assets used in the activity may appreciate in value, the success of the taxpayer in carrying on other similar or dissimilar activities, the taxpayers history of income or losses with respect to the activity, the amount of occasional profits, if any, which are earned, the financial status of the taxpayer, and whether the activity creates elements of personal pleasure or recreation. All the facts and circumstances are to be taken into account and no one factor is determinative in the hobby determination. 16. What are the two components of the self-employment tax? Is either component limited? Answer: Self-employment tax consists of two parts, the social security tax and the Medicare tax. The tax base for the social security tax is limited. In tax year 2007, only the first $97,500 of wages and self-employment income is subject to the social security tax. The Medicare tax is not limited.

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Multiple Choice 17. Trade or business expenses are treated as: a. A deduction for AGI. b. An itemized deduction if not reimbursed. c. A deduction from AGI. d. A deduction from AGI limited to the amount in excess of 2% of AGI. Answer: a 18. Which of the following is not a trade or business expense? a. Interest on investment indebtedness. b. Property taxes on business equipment. c. Depreciation on business property. d. Cost of goods sold. Answer: a 19. Farrah, an attorney, had the following income and expenses in her business: Fee Income Expenses: Rent Expense Penalties paid for late payment of state and federal income taxes Office expenses Supplies Interest paid on note used to acquire office equipment City impound fees and parking tickets for parking violations How much net income must Farrah report from this business? a. b. c. d. $120,600 $121,500 $125,500 $136,500 $150,000 15,000 4,000 5,000 3,000 1,500 900

Answer: c

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20. Edith, a CPA, flew from Miami to San Diego to attend an accounting conference that lasted five days. Then she took four days of vacation to go sightseeing. Ediths expenses for the trip are as follows: Air fare Lodging (9 days $165) Meals (9 days $80) Taxi from airport to hotel and back Ediths travel expense deduction is: a. $1,810. b. $2,010. c. $2,630. d. $2,990. Answer: a 21. On May 5, 2002, Jill purchased equipment for $40,000 to be used in her business. She did not elect to expense the equipment under Section 179. On January 1, 2007, she sells the equipment to a scrap metal dealer. What it the cost recovery deduction for 2007? a. b. c. d. $ 892 $ 1,784 $ 2,498 No deduction allowed. $725 1,485 720 60

Answer: b 22. On April 15, 2005, Andy purchased some furniture and fixtures (7-year property) for $10,000 to be used in his business. He did not elect to expense the equipment under 179. On June 30, 2007, he sells the equipment. What is the cost recovery deduction for 2007? $ 0. $ 875. $1,429. $1,749. Answer: b

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23. Don purchased an office building on March 30, 2007 for $250,000, $25,000 of which was for the land. What is the cost recovery deduction for 2007? a. $0. b. $3,621. c. $4,574. d. $5,083. Answer: c 24. Roy purchased an office building on March 30, 2004 for $250,000. $25,000 of the price was for the land. On July 30, 2007, he sold the office building. What is the cost recovery deduction for 2007? a. $0. b. $3,125. c. $5,769. d. $6,410. Answer: b. Fourth year, 6.5 months. 25. On June 30, 2007, Ken purchased an apartment building for $500,000. Determine the cost recovery deduction for 2007. a. $4,925. b. $5,335. c. $6,955. d. $9,850. Answer: d 26. During the year, Cory purchased a log skidder (seven year property) for $55,000 for his business. Assume that he has income from his business of $30,000, and he and his wife have combined salaries and wages income of $40,000. What is the maximum deduction he can take for his business in relation to the log skidder purchase? a. b. c. d. $ 7,860 $ 30,000 $ 31,429 $ 55,000

Answer: d

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27. Section 179 expense is available for all of the following business assets except: a. Office building. b. Office furniture. c. Computer. d. Delivery truck. Answer: a 28. Jordan has two jobs. She works as a night auditor at the Moonlight Motel. When her shift at the motel is over, she works as a short order cook at the Greasy Spoon Restaurant. On a typical day, she drives the following number of miles: Home to Moonlight Motel Moonlight Motel to Greasy Spoon Restaurant Greasy Spoon Restaurant to home 4 miles 7 miles 12 miles

How many miles would qualify as transportation expenses for tax purposes? a. 4. b. 7. c. 11. d. 12. Answer: b 29. Which of the following is false with respect to the standard mileage rate? a. It can be used if the taxpayer owns the vehicle and uses the standard mileage rate for the first year it was placed in service. b. It includes parking fees, tolls, and property taxes on the vehicle. c. It encompasses depreciation or lease payments, maintenance and repairs, gasoline, oil, insurance, and vehicle registration fees. d. It does not include interest expense on acquisition of the automobile. Answer: b

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30. Frank purchased a vehicle for business and personal use. In 2007, he used the vehicle 70% for business (11,000 miles) and calculated his vehicle expenses using the standard mileage rate. Frank also paid $1,800 in interest and $480 in county property tax on the car. What is the total business deduction related to business use of the car? a. $5,335. b. $5,815. c. $7,135. d. $7,615. Answer: d 31. Jimmy took a business trip from Dallas to Brazil. He was there for a total of 7 days of which 2 were weekend. Over the weekend, he spent his time sightseeing and relaxing. His expenses were as follows: Airfare Lodging (7 days x $300) Meals (7 days x $85) Taxi fares ($600 to and from business meetings) How much is Jimmy allowed to deduct? a. b. c. d. $ $ $ $ 3,404 3,496 4,598 4,895 $ 1,400 $ 2,100 $ 595 $ 800

Answer: c 32. Jake runs a business out of his home. He uses 600 square feet of his home exclusively for the business. His home is 2400 square feet in total. Jake had $27,000 of business revenue and $22,000 of business expenses from his home based business. The following expenses related to his home: Mortgage Interest Real Estate Taxes Utilities Insurance Repairs Depreciation (on business use portion of home) $ 10,800 1,600 2,400 600 2,400 1,200

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What is Jakes Net Income from his business and determine the amount of expenses carried over to the following year, if any? a. ($14,000) and $0 carryover. b. ($650) and $0 carryover. c. $0 and $650 carryover. d. $550 and $0 carryover. Answer: c The expenses from the home office can not create a loss in the business. 33. Which of the following is not a relevant factor to be considered in deciding whether an activity is profit-seeking or a hobby? a. Manner in which the taxpayer carries on the activity. b. Expertise of the taxpayer or his or her advisers. c. Time and effort expended by the taxpayer in carrying on the activity. d. All of the above. Answer: d 34. Which of the following individuals can deduct the stated educational expenses? a. A real estate broker who attends college to get an accounting degree. b. A CPA who attends a review course to obtain his building contractors license. c. A corporate executive attending an executive MBA program. d. An accounting bookkeeper taking a CPA review course to pass the CPA exam and become a CPA Answer: c 35. Annie is self-employed and has $58,000 in income from her business. She also has investments that generated dividends of $3,000 and interest of $2,500. What is Annies self-employment tax for the year? a. b. c. d. $ $ $ $ 8,195 8,548 8,619 8,874

Answer: a

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36. The maximum tax bases and percentages for 2007 for the two portions of the selfemployment tax are: a. b. c. d. Social Security $97,500; 12.4% $97,500; 15.3% $94,200; 12.4% $94,200; 15.3% Medicare Unlimited; 2.9%. Unlimited; 15.3%. Unlimited; 2.9%. Unlimited; 15.3%.

Answer: a Problems 37. Kelly is a self-employed tax attorney whose practice primarily involves tax planning. During the year, she attended a three-day seminar regarding new changes to the tax law. She incurred the following expenses: Lodging Meals Course registration Transportation $400 $95 $350 $150

a. How much can Kelly deduct? b. Kelly believes that obtaining a CPA license would improve her skills as a tax attorney. She enrolls as a part-time student at a local college to take CPA review courses. During the current year, she spends $1,500 for tuition and $300 for books. How much of these expenses can Kelly deduct? Why? Answer: Lodging Meals (50% deductible) Registration Transportation Total Deduction $400.00 $ 47.50 $350.00 $150.00 $947.50

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Educational expenses are deductible if they are for education that (1) maintains or improves skills by the taxpayer in his employment or (2) meets the express requirement of an employer or law. However, the education expenses are not deductible if the education qualifies the taxpayer for a new trade or business. Since obtaining a CPA qualifies Kelly for a new profession (although related), the expenses are not deductible. In this situation an argument can be made that the education does not qualify Kelly for a new profession because she is already in the tax profession. This argument, however, would be an extremely aggressive position. 38. Jackie owns a temporary employment agency that hires personnel to perform accounting services for clients. During the year, her entertainment expenses for her clients include: Cab fare to and from restaurants: Gratuity at restaurants Meals Cover charges $ 350 $ 300 $4,000 $ 250

Jackie also held a holiday party for her employees, which cost $1,500. All expenses are reasonable. a. Can Jackie deduct any of these expenses? If so, how much? __________________________________________________________ b. How is the deduction classified? __________________________________________________________ Answer: (a) Cab Fare 100% deductible Gratuity 50% Meals 50% Cover Charges 50% Party 50% $ 350 $ 150 $2,000 $125 $750.

(b) The cab fare would be travel costs and the others would be considered meals and entertainment.

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39. David is a college professor who does some consulting work on the side. He uses 25% of his home exclusively for the consulting practice. He is single and 63 years old. His AGI (without consideration of consulting income) is $45,000. Other information follows: Income from consulting business Consulting expenses other than home office Total costs relating to home Interest and taxes Utilities Maintenance and repairs Depreciation (business part only) Calculate Davids AGI. Answer: AGI before business Business Proceeds Business Expenses Interest & Taxes Utilities Main. And Repairs Depreciation limited to $387 Net Business Income $4,000 -$1,500 -$1,625* -$ 375 -$ 113 -$ 387 AGI 0 $45,000 $45,000 $4,000 $1,500 $6,500 $1,500 $ 450 $1,500

*75% of this amount would be deductible on Schedule A as an itemized deduction.

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40. In 2005, Gerald loaned Main Street Bakery $55,000. In 2006, Gerald he learned that he would probably receive only $6,400 of the loan. In 2007, Gerald received $3,000 in final settlement of the loan. Calculate Geralds possible deductions with respect to the loan for 2005, 2006, and 2007. Answer: If Gerald has a business relationship [see Reg. 1.166-5(b)(2)] with Main Street Bakery, then Gerald is allowed an ordinary deduction of $52,000 in 2006. A non-business bad debt is treated as a short-term capital loss. There would be no deduction in 2004 or 2005 because the debt was not worthless and there was some prospect of collection. 41. Charles, a self-employed real estate agent, attended a conference on the impact of the new building codes on real estate investments. His unreimbursed expenses were as follows: Airfare $480 Lodging 290 Meals 100 Tuition and fees 650 How much can Charles deduct on his return? Answer: Since he is self-employed, the expenses are deducted on Schedule C as follows: Airfare Lodging Meals Tuition Fees 100% deductible 100% deductible 50% deductible $480 $290 $ 50 $650 $1,470

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42. Betsy acquired a new network system on June 5, 2007, (5-year class property) for $75,000. She expects taxable income from the business will always be about $175,000, without regard to the 179 election. Betsy will elect 179 expensing immediately. She also acquired 7 year property in July 2007 for $350,000. Determine Betsys total cost recovery deduction with respect to her purchases in 2007. Answer: The answer to this question will vary if 179 is taken on the 5 year asset. Using 179 on this asset is not incorrect but typically a taxpayer would want to take 179 on the asset with the longer life to maximize the deduction over time. 7 year Property 179 $350,000 ($125,000) limit Basis $225,000 Depre. Basis $225,000 x .1429 7 year MACRS $125,000 $ 32,153

5 year Property Basis $55,000 x .20 5 years MACRS Total Cost Recovery $ 11,000 $168,153

43. Janet purchased her personal residence in 1998 for $250,000. In January 2007 she converted it to rental property. The fair market value at the time of conversion was $210,000. a. Determine the amount of cost recovery that can be taken in 2007. b. Determine the amount of cost recovery that could be taken in 2007 if the fair market value of the property was $350,000. Answer: a. The depreciable basis is the lower of the FMV or basis at the date of conversion. Therefore, the depreciable basis is $210,000 depreciated on a 27 year mid-month method. $210,000 x .03485 = $7,318.50 b. $250,000 x .03485 = $8,712.50

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44. On February 4, 2007, Jackie purchased and placed in service a car she purchased for $21,500. The car was used exclusively for her business purposes. Compute Jackies cost recovery deduction in 2007 assuming no 179 expense was taken. Answer: $21,500 .20 = $4,300 - 5 year MACRS depreciation. However, the total is limited to $2,960 because of the luxury auto limitations.

45. Rueben acquires a warehouse on September 1, 2007 for $3 million. On March 1, 2011, he sells the warehouse. Determine Ruebens cost recovery for 2007 and 2011. Answer: 2006 2007 2008 2009 2010 $3,000,000 x .749% = $22,470 2.564% = $76,920 Same as 2004 Same as 2004 X 2.564 x 2.5/12 = $16,025

46. Michael is the sole proprietor of a small business. In June 2007, his business income is $12,000 before consideration of any 179 deduction. He spends $245,000 on furniture and equipment in 2007. If Michael elects to take the 179 deduction on a conference table that cost $25,000 (included in the $245,000 total), determine the cost recovery for 2007 with respect to the conference table. Answer: Remember, 179 cannot create a NOL. Therefore, the 179 expense is limited to $12,000. $25,000 179 ($12,000) $13,000 14.29% Total Cost Recovery $12,000 $ 1,858 $13,858

47. On June 10, 2007, Huron purchased equipment (7-year class property) for $75,000. Determine Hurons cost recovery deduction for computing 2007 taxable income. Assume Huron does not make the 179 election. Answer: $75,000 x 14.29% = $10,717.50.

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48. Brittany purchased a building for $500,000 on January 1, 1999. (Purchase price does not include land). Using the statutory percentage method, calculate the cost recovery for 1999 and 2007 if the real property is: a. Residential real property b. Warehouse Answer: a. 27.5 years 1999 2007 b. 39 years 1998 $500,000 x 2.461% = $12,305 2006 $500,000 x 2.564% = $12,820 49. Walt purchased a computer for $5,000. He could use the computer exclusively for his business, or he could allow his family to use the computer 60% of the time and 40% would be for business use. Determine the tax deduction for year of acquisition under both alternatives. What is the tax savings if Walt used the computer exclusively for business? Assume that Walt would not elect 179 expensing and that he is in the 25% tax bracket. Answer: Exclusive Business Use 5 year MACRS $5,000 x 20% = $1,000 Deduction $500,000 x 3.485% = $17,425 $500,000 x 3.636% = $18,180

60% Personal 40% Business 5 year S/L $5,000 x 40% = $2,000 x 1/5 x = $200 Deduction Tax Savings Difference in Deductions $800 x 25% = $200 Savings

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50. In 2005, Jessica bought a new truck for $45,000 to use 80% for her sole proprietorship. Total miles driven include 12,000 in 2005, 14,500 in 2006, and 13,000 in 2007. a. If Jessica uses the standard mileage method, how much may she deduct on her 2007 tax return? b. What is the deduction for 2007 assuming the actual method was used from the beginning? (calculate depreciation only the truck is not limited by the luxury auto rules.) Answer: a. 13,000 miles x .80 business use = 10,400 miles x 48.5 cents/mile = $5,044 b. $45,000 x 19.2% (Appendix Table 1 3rd year of 5 year MACRS) = $8,640 x 80% = $6,912. This depreciation is assuming the luxury auto limits do not apply. The limits do not apply to autos greater than 6,000 lbs. 51. Jose purchased a vehicle for business and personal use. In 2007, he used the vehicle 18,000 miles (80%) for business and calculated his vehicle expenses using the standard mileage rate. He paid $1,400 in interest and $150 in property taxes on the car. Calculate the total business deduction related to the car. Answer: The standard mileage rate is for depreciation, maintenance and repairs, gasoline, oil, insurance, and registration fees. Interest and taxes are deductible in addition to the standard mileage rate. 18,000 miles Business Portion x 48.5 cents Interest $1,400 x .80 Taxes $ 150 x .80 Total Deduction on Schedule C = $8,730 = $1,120 = $120 $9,970

The $30 of taxes (20% personal) is deducted on Schedule A as an itemized deduction (see chapter 5)

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52. Jordan took a business trip from New York to Denver. She spent two days in travel, conducted business for nine days, and visited friends for five days. She incurred the following expenses: Airfare $ 550 Lodging 3,000 Meals 900 Entertainment of clients 750 How much of these expenses can Jordan deduct? Answer: Since the trip is primarily for business (and not foreign travel), 100% of the travel expenses are deductible. Airfare 100% deductible Lodging 9/14 days x $3,000 Meals 9/14 days x $900 x 50% Entertainment 100% x 750 x 50% $ 550 $ 1,929 $ 289 $ 375 $ 3,143

53. Derrick owns a farm in eastern North Carolina. A hurricane hit the area and destroyed a farm building, some farm equipment, and damaged a barn. Item Adjusted Basis $85,000 $68,000 $95,000 FMV Before Damage $115,000 $49,000 $145,000 FMV After Damage $0 $0 $95,000 Insurance Proceeds $55,000 $15,000 $35,000

Building Equipment Barn

Due to the extensive damage throughout the area, the president of the United States declared all areas affected by the hurricane as a disaster area. Derrick, who files a joint return with his wife, had $45,000 of taxable income last year. Their taxable income for the current year is $150,000, excluding the loss from the hurricane. Calculate the amount of the loss by Derrick and his wife and the year in which they should deduct the loss (Hint: Chapter 5 provides information concerning nationally declared disaster areas). Answer: Proceeds Bld. $55,000 Equip $15,000 Barn* $35,000 Basis/Decrease in FMV ($85,000) = ($68,000) = ($50,000) = Gain/loss ($30,000) ($53,000) ($15,000) $( 98,000) Ord. Loss

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*Since the Barn was only partially destroyed, the loss is calculated using the lesser of the decrease in FMV or the basis. The decrease in the FMV was only $50,000. Derrick would report the losses on Form 4684 pg. 2 and have a $98,000 ordinary loss. Since the loss was in a declared disaster zone, Derrick has the choice of taking the loss against last years income and getting a refund immediately or waiting until filing his current year tax return. Since Derrick only had $45,000 of AGI, the proper strategy would be to use $45,000 of the loss against last years income (get an immediate refund) and use the remaining amount of the loss to the current year tax return. 54. Rebecca is a doctor with an AGI of $125,000 before consideration of income or loss from her dog breeding business. Her home is on 15 acres, 10 of which she uses to house the animals and provide them with ample space to play and exercise. Her records show the following related income and expenses for the current year: Income from fees and sales Expenses: Dog food Veterinary bills Supplies Publications and dues $2,500 $4,000 3,500 1,200 350

a. How must Rebecca treat the income and expenses of the operation if the dog breeding business is held to be a hobby b. How would your answer differ if the operation were held to be a business? Answer: a. Hobby Other income, Form 1040 Expenses (Schedule A Misc. Deductions) Expenses are allowed in the following order: 1. Expenses already deductible on Schedule A mainly mortgage interest and property taxes. 2. Other expenses that do not reduce basis of property (non-depreciation expenses) 3. Expenses that reduce basis (depreciation) b. A loss of $6,550 would be reported on Schedule C as a business. $2,500 $2,500 0

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55. Eric, who is single, participates in an activity that is appropriately classified as a hobby. The activity produces the following revenues and expenses: Revenue Property taxes Materials and supplies Utilities Advertising Insurance Depreciation $12,000 2,000 4,000 1,500 1,900 775 5,000

Without regard to this activity, Erics AGI is $55,000. Determine how much income Eric must report, the amount of the expenses he is permitted to deduct, and his AGI. Answer: Hobby Revenue $ 12,000 Prop. Taxes ($ 2,000) Supplies ($ 4,000) Utilities ($ 1,500) Adv. ($ 1,900) Insurance ($ 775) Income before Depre. $ 1,825 Depr. (limited to income)($ 1,825) Income from hobby $ 0

Erics AGI is $55,000. 56. In 2007, Will has self-employment earnings of $180,000. Compute Wills selfemployment tax liability and the allowable income tax deduction of the self-employment tax paid. Answer: $180,000 x .9235 = $166,230.00 FICA Limit $97,500 x 12.40% = $ 12,090 Medicare $166,230 x 2.9% = $ 4,821 Self-employment tax $ 16,911 x 50% Deduction FOR AGI $8,456

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57. Spencer used the following assets in his Schedule C trade or business in the tax year 2006: Asset Computer 1 Computer 2 Printer Computer 3 Equipment Auto Furniture 1 Furniture 2 Office Bldg. Date Purchased 03/12/04 05/05/04 08/25/07 05/25/07 03/20/05 05/01/07 02/12/05 08/15/05 04/01/07 8/25/07 05/15/07 Date Sold Business Use % 100% 100% 100% 100% 100% 80% 100% 100% 100% $3,500 $4,500 $3,000 $2,300 $2,300 $18,000 $17,000 $6,000 $230,000 Cost

Spencer is a new client and unfortunately does not have a copy of his prior year tax return. He recalls that all of the assets purchased in prior years used MACRS depreciation (no 179 expense was taken). Spencer does not wish to take a 179 deduction this year because he feels he will be more profitable in the future and would like the depreciation deduction at that time. Calculate the current year depreciation allowance for Spencers business. Correctly report the amounts on Form 4562.

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Chapter 06 - Self-Employed Business Income Schedule C

Answer: Asset Date Purch 03/12/0 4 05/05/0 4 08/25/0 7 05/25/0 7 03/20/0 5 05/01/0 7 02/12/0 5 08/15/0 5 04/01/0 7 8/25/07 05/15/0 7 Date Sold Busine ss Use Computer 1 Computer 2 Printer Computer 3 Equipment Auto Furniture 1 Furniture 2 Office Bld. 100% 100% 100% 100% 100% 80% 100% 100% 100% $3,500 $4,500 $3,000 $2,300 $2,300 $18,000 $17,000 $6,000 $230,00 0 5yr MACRS 5yr MACRS 5yr MACRS 5yr MACRS 7yr MACRS 5yr MACRS 7yr MACRS 7yr MACRS 39 SL $403 $259 $600 $460 $442 **$2,448 $1,487 $1,049 $4,184 Cost Method 2007 Expense

** The regular depreciation would be $2,880 ($18,000 .8 .2). However, the luxury auto limits depreciation to $2,448 ($3,060 x .80 business use).

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Chapter 06 - Self-Employed Business Income Schedule C

Tax Return Problem #1 Lori has a home health care business she runs as a sole proprietorship. The following are the results from business operations for the tax year 2007: Gross Receipt from Clients Business mileage 35,200 miles 45,000 miles total during the year 2007 Dodge Caravan Placed in Service 05/01/05 Postage Wages Payroll taxes State license fee Supplies Professional education registration Travel to education course Plane Taxi Lodging $110/night 2 nights Meals per diem $34 2 days Business Assets Date Purchased Cost Computer 1 5/18/07 $4,300 Computer 2 6/01/07 $5,700 Printer 3/01/06 $ 800 Copier 3/02/06 $1,700 Furniture 3/01/06 $5,000 Phone Internet service Rent Insurance $145,000

(500) (17,000) ( 1,275) ( 125) (5,300) ( 975) ( 245) ( 40) ( 220) ( 78)

(600) (450) (7,200) (2,000)

Determine Loris self-employment income and prepare Schedule C and Schedule SE. 179 expense is elected on all eligible assets (179 was not taken on assets purchased last year).

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Chapter 06 - Self-Employed Business Income Schedule C

Insert Schedule C Filled in One Page

Insert Schedule SE One Page Filled in

Tax Return Problem #2 During 2006, Cassandra Albright, who is single, works part-time at doctors office and receives a W-2. She also has a consulting practice that had the following income and expenses: Revenue $48,000 Laptop computer purchased 4/23/07 $2,300 Travel 2,500 miles for business 13,000 personal Supplies $ 500 Cell phone charge $ 540 Cassandra (SS# 333-33-3333) resides at: 1400 Medical Street Apt. 3A Lowland, CA 12345

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Chapter 06 - Self-Employed Business Income Schedule C

Cassandras W-2

Wages Federal withholding Soc. sec. wages Soc. sec. withholding Medicare withholding State withholding

$45,300 $ 4,983 $45,300 $ 2,809 $ 657 $ 2,265 $ 2,300 3,100 3,100

1099-INT 1099-DIV

Old Bank

Bake Co, Inc. Ordinary dividends $ Qualified dividends $

Cassandra had the following itemized deductions: State income tax withholding (above) State income tax paid with the 2006 return Real estate tax Mortgage interest

$ 2,265 $ 350 $ 3,450 $ 12,300

Prepare Form 1040 for Cassandra for 2007. You will need Form 1040, Schedule A, Schedule B, Schedule C, Form 4562, Schedule C, and Schedule SE. Form 1040 2 full pages Schedule A One full page Schedule B One full page Schedule C One full page Schedule SE One full page

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Chapter 06 - Self-Employed Business Income Schedule C

Tax Return Problem #3 During 2007, Jason and Vicki Hurting, who are married with two children, had the following tax information. Jason owns his own landscaping business and Vicki works as an executive assistant at a university. Jason (SS# 333-44-444) and Vicki (SS# 444-33-3333) resides at: 123 Bate Street Bright, AL 54321 They have two kids under the age of 17: Jason Jr. 555-55-5555 Born 2000 Catlin 666-66-6666 Born 2004 Vickis W-2 Wages $ 45,800 Federal withholding $ 6,870 Soc. sec. wages $ 45,800 Soc. sec. withholding $ 2,840 Medicare withholding $ 664 State withholding $ 2,290

1099-G from AL State tax refund taxable because $2,500 is deducted on last years return 1099-INT 1099-DIV First Bank of Alabama IBM, Inc Ordinary dividends Qualified dividends

$ $ $ $

897 225 125 125 $153,000 41,600 3,182 425

Jasons Landscaping Revenue Wages Payroll tax Cell phone charge Assets: Purchased Truck 2/05/07 Mower1 3/08/07 Mower2 3/08/07 Equip 6/25/07

Amount $28,000 $12,000 $ 3,400 $ 1,595

Bus. Use 100% 100% 100% 100%

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Chapter 06 - Self-Employed Business Income Schedule C

The Hurtings had the following itemized deductions: State income tax withholding (above) Real estate tax Personal property tax Mortgage interest Charitable contributions

$ $ $ $ $

2,290 2,100 425 8,300 2,400

Prepare Form 1040 for the Hurtings for 2007. You will need Form 1040, Schedule A, Schedule B, Schedule C, Form 4562, Schedule C, and Schedule SE.

Form 1040 2 full pages Schedule A One full page Schedule B One full page Schedule C One full page Schedule SE One full page

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