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Tax chapt 9

19
Indicate the amount (if any) that Josh can deduct as ordinary and necessary business deductions in each of the following expenditures and explain your solution.
Josh borrowed $50,000 from the First State Bank using his business assets as collateral. He used the money to buy City of Blanksville bonds. Over the course of a year, Josh paid interest of $4,200 on the borrowed funds, but he received $3,500 of interest on the bonds.
$0. The interest expense is not deductible because it is associated with tax-exempt income.
20
Josh purchased a piece of land for $45,000 in order to get a location to expand his business. He also paid $3,200 to construct a new driveway for access to the property.
$0. The cost of the land and driveway should be capitalized. They will provide “long-term benefits.”
21
This year Josh paid $15,000 to employ the mayor’s son in the business. Josh would typically pay an employee with these responsibilities about $10,000 but the mayor assured Josh that after his son was hired, some city business would be coming his way.
$10,000. Only amounts considered reasonable in amount are deductible. The excess salary payment of $5,000 to the mayor’s son is not deductible either because it is unreasonable in amount or a bribe.
22
Josh paid his brother, a mechanic, $3,000 to install a robotic machine for Josh’s business. The amount he paid to his brother is comparable to what he would have paid to an unrelated party to do the same work. Once the installation was completed by his brother, Josh began calibrating the machine for operation. However, by the end of the year, he had not started using the machine in his business.
$0. The cost to install the machine should be capitalized as part of the cost of the machine. It is a cost necessary to operate the machine.
32
Ralph invited a potential client to dinner and the theater. Ralph paid $250 for the dinner and $220 for the theater tickets in advance. They first went to dinner and then they went to the theater.
What amount can Ralph deduct if, prior to the dinner, he met with the potential client to discuss future business prospects?
$235 (50% of the cost of the dinner and theater) is deductible.
33
Ralph invited a potential client to dinner and the theater. Ralph paid $250 for the dinner and $220 for the theater tickets in advance. They first went to dinner and then they went to the theater.What amount can Ralph deduct if he and the client only discussed business during the course of the dinner?

$235 (50% of the cost of the dinner and theater) is deductible. Entertainment is directly related to business if there is an active discussion aimed at generating revenue and the discussion occurs in a business setting. A restaurant is an acceptable business setting.
34
Ralph invited a potential client to dinner and the theater. Ralph paid $250 for the dinner and $220 for the theater tickets in advance. They first went to dinner and then they went to the theater.What amount can Ralph deduct if he and the potential client tried to discuss business during the course of the theater performance but did not discuss business at any other time?

$0 is deductible. The cost of entertainment that occurs in a setting with little possibility of conducting a business discussion, such as a theater or sports venue, will only be deductible if the entertainment directly precedes or follows a substantive business discussion. In this situation, they did not have any other business discussions so there is not deduction.
35
Ralph invited a potential client to dinner and the theater. Ralph paid $250 for the dinner and $220 for the theater tickets in advance. They first went to dinner and then they went to the theater.What amount can Ralph deduct if the potential client declined Ralph’s invitation, so Ralph took his accountant to dinner and the theater to reward his accountant for a hard day at work? At dinner, they discussed the accountant’s workload and upcoming assignments.

$235 (50% of cost of the dinner and theater) is deductible. Business discussions with business associates are directly related to business. Business associates include anyone the taxpayer reasonably expects to do business with, such as customers, suppliers, employees, or advisors.
40
This year R drove 12,000 miles in his personal auto, of which 3,000 miles were for business. Total costs to operate his car were:What amount can R deduct if he is self-employed?

What amount can R deduct if he is an employee?

SEE PIC

Standard mileage method
Actual method
52-53
Melissa recently paid $400 for round-trip airfare to San Francisco to attend a business conference for three days. Melissa also paid the following expenses:
$250 fee to register for the conference, $300 per night for three night’s lodging, $200 for meals, and $150 for cab fare.What amount of the travel costs can Melissa deduct as business expenses?

$1,800. Business was the primary reason for the trip.
54
Suppose that while Melissa was on the coast, she also spent two days sightseeing the national parks in the area. To do the sightseeing, she paid $1,000 for transportation, $800 for lodging, and $450 for meals during this part of her trip, which she considers personal in nature. What amount of the travel costs can Melissa deduct as business expenses?
$1,800. Sightseeing costs are not deductible, but since the primary purpose of the trip appears to be business (3 days business v. 2 days personal) the cost of her business trip remains deductible.
55
Melissa recently paid $400 for round-trip airfare to San Francisco to attend a business conference for three days. Melissa also paid the following expenses:
$250 fee to register for the conference, $300 per night for three night’s lodging, $200 for meals, and $150 for cab fare.
Suppose that Melissa made the trip to San Francisco primarily to visit the national parks and only attended the business conference as an incidental benefit of being present on the coast at that time. What amount of the airfare can Melissa deduct as a business expense?
$1,400. The airfare is not deductible because business is not the primary purpose of the trip.
56
Suppose that Melissa’s permanent residence and business was located in San Francisco. She attended the conference in San Francisco and paid $250 for the registration fee. She drove 100 miles over the course of three days and paid $90 for parking at the conference hotel. In addition, she spent $150 for breakfast and dinner over the three days of the conference. She bought breakfast on the way to the conference hotel and she bought dinner on her way home each night from the conference. What amount of these costs can Melissa deduct as business expenses?
$398. Because her travel did not require her to be away from home overnight, meals are not deductible. See next slide.
58
Kimberly is a self-employed taxpayer. She recently spent $1,000 for airfare to travel to Italy. What amount of the airfare is deductible in each of the following alternative scenarios?
Her trip was entirely for personal purposes.
$0 is deductible. Travel is deductible only when incurred primarily for business.
59
Kimberly is a self-employed taxpayer. She recently spent $1,000 for airfare to travel to Italy. What amount of the airfare is deductible in each of the following alternative scenarios?On the trip, she spent eight days on personal activities and two days on business activities.

$0 is deductible. The trip does not appear to be motived primarily for business (2 days business v. 8 days personal).
60
Kimberly is a self-employed taxpayer. She recently spent $1,000 for airfare to travel to Italy. What amount of the airfare is deductible in each of the following alternative scenarios?On the trip, she spent seven days on business activities and three days on personal activities.

$700 is deductible. The trip appears to be motived primarily for business (7 days business v. 3 days personal). But it is foreign travel that lasts longer than one week. Hence, the cost of the airfare must be prorated.
61
Kimberly is a self-employed taxpayer. She recently spent $1,000 for airfare to travel to Italy. What amount of the airfare is deductible in each of the following alternative scenarios?Her trip was entirely for business purposes.

$1,000 is deductible. Because personal vacation was not a consideration in making the trip, the full cost of the airfare is deductible.
64
J receives $100,000 of revenue from a qualified domestic production activity which has $55,000 of related expenses and $12,000 of wages. J has modified AGI of $47,000.
QDPR (revenue) $100,000
Allocated expenses (55,000)
QPAI (qualifying income) $ 45,000Modified AGI is $47,000 so no limit
QPAI $ 45,000
DMD percentage x 9%
DMD $ 4,050
Not to exceed $6,000 (50% of wages of $12,000)

65
Andrew is considering starting a business of constructing and selling prefabricated greenhouses. There are three very different methods to constructing these greenhouses, and each method results in different revenue and cost projections. Below, Andrew has projected the qualifying revenue and costs for each method. The selling price includes qualifying receipts. The allocable expenses include wages and allocable expenses are included in total costs.SEE PIC 66

a. Estimate the tax benefit from the domestic production activities deduction for each construction technique. You may assume that Andrew has sufficient AGI to utilize the deduction and that his marginal tax rate is 30 percent.

b. Which construction technique should Andrew use if his marginal tax rate is 30 percent?

a. 68
b. 69
74
B’s gross income is $50,000, composed of business income of $19,000 and nonbusiness income of $31,000. His deductions amount to $59,000, composed of business deductions of $31,000 and nonbusiness deductions of $28,000. His NOL is computed as follows:
Business income $19,000
Business deductions (31,000)
Business income/(loss) ($12,000)
Nonbusiness income 31,000
Nonbusiness deductions (28,000) Nonbusiness income/(loss) 3,000
Net operating loss ($9,000)
75
T’s gross income is $50,000, composed of business income of $34,000 and nonbusiness income of $16,000. His deductions amount to $59,000, composed of business deductions of $28,000 and nonbusiness deductions of $31,000. His NOL is computed as follows:
Business income $34,000
Business deductions (28,000)
Business income/(loss) $ 6,000
Nonbusiness income 16,000
Nonbusiness deductions (31,000) Nonbusiness income/(loss) (15,000)
Net operating loss None
82
A tornado demolishes the roof of an office building owned by SPG. The value of the building before the tornado was $500,000 and after the tornado was $400,000. SPG’s basis in the building was $350,000 and it received $80,000 of insurance reimbursement.
SPG also suffered a loss from the theft of a delivery truck. The value of the truck before the theft was $40,000. SPG’s basis in the truck was $50,000 and it received $35,000 of insurance reimbursement.
83
SPG may deduct a casualty loss of $35,000.
96
BBL, an accrual method taxpayer, signs a binding contract for PDP to provide repair services. BBL pays $1,500 and agrees to pay an additional $6,000 on the contract when the repairs are completed. The repairs will start in the fall of next year.When can BBL claim the deduction for the repair services?

BBL is receiving services from another. Thus, it can only deduct $7,500 next year because that is when all of the repair services will be received.
97
During November and December of the current year, XYZ provides installation services to ABC for an agreed price of $50,000. At the end of the year, XYZ has not yet billed for the services. Both ABC and XYZ are accrual method taxpayers.
When can XYZ claim a deduction for the cost of the installation services provided?
XYZ is providing services to another. As such, economic performance occurs as XYZ performs the services and XYZ can deduct the cost of the services in the current year.
98
Same facts.
When can ABC claim a deduction for the installation services received?
ABC is receiving services from another. As such, economic performance occurs as XYZ performs the services. ABC can deduct $50,000 for services in the current year.
99
On December 1, 20×1, ABC enters into a $100,000 snow removal contract with Snow Movers Co. The contract provides that the snow removal service will begin January 1, 20×2 and end March 15, 20×2. Both ABC and Snow Movers are accrual method taxpayers.
When can ABC claim a deduction for the snow removal services if it pays on December 15, 20×1?
On December 1, 20×1, ABC enters into a $100,000 snow removal contract with Snow Movers Co. The contract provides that the snow removal service will begin January 1, 20×2 and end March 15, 20×2. Both ABC and Snow Movers are accrual method taxpayers.
ABC has prepaid for services it is to receive from another. As such, economic performance occurs when paid if the other is reasonably expected to provide all of the services within 3.5 months after payment. March 15, 20×2 is 3 months after the payment date of December 15, 20×1. Thus, ABC can deduct $100,000 in 20×1.
101
In January of year 0, Justin paid $4,800 for an insurance policy that covers his business property for accidents and casualties. Justin is a calendar-year taxpayer who uses the cash method of accounting. What amount of the insurance premium may Justin deduct in year 0 in each of the following alternative scenarios?The policy covers the business property from April 1 of year 0 through March 31 of year 1.

$4,800. The entire premium is deductible under the 12-month rule because the insurance coverage does not exceed 12 months and does not extend beyond the end of next year.
102
In January of year 0, Justin paid $4,800 for an insurance policy that covers his business property for accidents and casualties. Justin is a calendar-year taxpayer who uses the cash method of accounting. What amount of the insurance premium may Justin deduct in year 0 in each of the following alternative scenarios?The policy begins on February 1 of year 1 and extends through January 31 of year 2.

$0. Even though the contract period is 12 months or less, Justin must capitalize the cost of the prepayment because the contract period extends beyond the end of next year.
103
In January of year 0, Justin paid $4,800 for an insurance policy that covers his business property for accidents and casualties. Justin is a calendar-year taxpayer who uses the cash method of accounting. What amount of the insurance premium may Justin deduct in year 0 in each of the following alternative scenarios?Assume Justin paid $6,000 for a 24-month policy that covers from April 1, year 0 through March 31, year 2.

$2,250. Because the length of the insurance coverage is longer than 12 months, Justin may only deduct the portion of the premium pertaining to this year, which is $2,250 (9 months ÷ 24 months x $6,000).
104
In January of year 0, Justin paid $4,800 for an insurance policy that covers his business property for accidents and casualties. Justin is a calendar-year taxpayer who uses the cash method of accounting. What amount of the insurance premium may Justin deduct in year 0 in each of the following alternative scenarios?Assume that instead of paying an insurance premium, Justin paid $4,800 to rent his business property from April 1 of year 0 through March 31 of year 1.

$4,800. The 12-month rule for capitalizing expenditures applies to rent (but not interest) payments for a cash method taxpayer. In contrast, for an accrual method taxpayer both rent and interest are deducted over the period relating to the lease or loan term because of economic performance.
105
Circuit Corporation (CC) is a calendar-year, accrual-method taxpayer. CC manufactures and sells electronic circuitry. On November 15, year 0, CC enters into a contract with Equip Corp (EC) that provides CC with exclusive use of EC’s specialized manufacturing equipment for the five-year period beginning on January 1 of year 1. Pursuant to the contract, CC pays EC $100,000 on December 30, year 0. How much of this expenditure is CC allowed to deduct in year 0 and in year 1?
$0 in year 0 and $20,000 in year 1. Because CC is leasing property from EC, economic performance on the contract occurs ratably over the five-year period from January 1 of year 1 through December 31 of year 5. CC is not allowed to deduct any of the expenditure in year 0 and is allowed to deduct one-fifth of the contract price in year 1 (and in each of the four succeeding years).
108
This year (year 0) Elizabeth agreed to a three-year service contract with an engineering consulting firm to improve efficiency in her factory. The contract requires Elizabeth to pay the consulting firm $1,500 for each instance that Elizabeth requests its assistance. The contract also provides that Elizabeth only pays the consultants if their advice increases efficiency as measured 12 months from the date of service. This year Elizabeth requested advice on three occasions and she has not yet made any payments to the consultants.How much should Elizabeth deduct in year 0 under this service contract if she uses the accrual method of accounting?

$0. Because the liability is contingent on a future event (increase in efficiency) occurring after the end of the year, the liability is not fixed. Therefore, as an accrual-method business, Elizabeth is not allowed to recognize any deduction for this contract in year 0 even though the consultants have provided services on three different occasions by the end of the year.
109
This year (year 0) Elizabeth agreed to a three-year service contract with an engineering consulting firm to improve efficiency in her factory. The contract requires Elizabeth to pay the consulting firm $1,500 for each instance that Elizabeth requests its assistance. The contract also provides that Elizabeth only pays the consultants if their advice increases efficiency as measured 12 months from the date of service. This year Elizabeth requested advice on three occasions and she has not yet made any payments to the consultants.How much should Elizabeth deduct in year 0 under this service contract if she uses the cash method of accounting?

$0. Under the cash-method, Elizabeth can only deduct amounts paid to the consultants by the end of the year. Since she has not paid the consultants anything by year-end, so she could not deduct any expense associated with the contract.
117
XYZ estimates that about $1,000 of the receivables from its plumbing services will be uncollectible this year. Included in that estimate is a $300 amount owned by client P whose account is uncollectible.What amount of bad debt expense may XYZ deduct for the year:
if it is on the cash method?
if it is on the accrual method?

If XYZ uses the cash method, it would not be able to claim any deduction because it did not receive payment from client P. Thus, it has no basis in the uncollectible debt.
If XYZ uses the accrual method, it would be able to claim a deduction of $300 for the specific bad debt.
However, for financial reporting purposes, it would recognize $1,000 of bad debt expense. The $700 difference is a timing difference that would require reconciliation on its corporate tax return (Form 1120, schedule M-1 or M-3).

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