Chapter

Chapter 9: Employee Expenses and Deferred CompensationPrentice Halls Federal Taxation 2015: Individuals

Types of Employee (EE) Expenses9-2Copyright 2015 Pearson Education, Inc. Employer-Employee Relationship9-3Copyright 2015 Pearson Education, Inc. Unreimbursed Employee Expenses 9-4Copyright 2015 Pearson Education, Inc. Exceptions to 2% AGI Rule:Gambling LossesCharitable ContributionsMortgage InterestReal Estate Taxes9-5Copyright 2015 Pearson Education, Inc. Deductibility of Travel Expenses9-6Copyright 2015 Pearson Education, Inc. Definition of Travel ExpensesIncludes transportation, meals, lodging, and other reasonable and necessary expenses.Worker must be away from home during course of business activity.Travel vs. Local Transportation Expense.

9-7Copyright 2015 Pearson Education, Inc. Requirements for Travel Deduction9-8Copyright 2015 Pearson Education, Inc. Away From Home Requirement - Issues9-9Copyright 2015 Pearson Education, Inc. Location of Tax HomeTax Home = location of principal place of business.Where taxpayers family residence is maintained is not relevant.If taxpayer works permanently or for an indefinite time away from his/her residence, the taxpayer is not away from his tax home.9-10Copyright 2015 Pearson Education, Inc. Temporary v. IndefiniteIndefinite = assignments more than 1 year.If < 1 year, then need to look at facts and circumstances whether it is temporary or indefinite.9-11Copyright 2015 Pearson Education, Inc. 9-12Copyright 2015 Pearson Education, Inc. Defining OvernightNeeds to be reasonable for worker to obtain sleep or rest during release time in order to meet demands of the job. Meals on one-day trips are not deductible.

Example: Kim, a flight attendant, sometimes leaves and returns to the airport on the same day. Her meal allowance is not deductible and is considered additional wages. If Kim is required to stay overnight due to her flight schedule, then the meal money would be deductible From AGI.9-13Copyright 2015 Pearson Education, Inc. Business v. PleasureMain purpose of trip must be the pursuit of trade or business activity.If trip is primarily personal but a small amount of business is transacted, then only directly related expenses (e.g., business meals) are deductible. Taxpayer cant pro rate other travel expenses.If trip is primarily business, expenses are generally deductible. However, expenses related to personal part are nondeductible. 9-14Copyright 2015 Pearson Education, Inc. Other Travel Expense Limitations9-15Copyright 2015 Pearson Education, Inc. Transportation For vs. From AGIAGI = THE LINE9-16Copyright 2015 Pearson Education, Inc. Transportation CostsTransportation is primarily local travel. Separate category than travel which is usually away from tax home overnight.Commuting to job is considered personal and is not deductible.9-17Copyright 2015 Pearson Education, Inc. Transportation Costs (contd)Generally, other local travel engaged in is deductible as long as for a business purpose.If taxpayer has a regular work location, he/she can deduct transportation expenses from home to a temporary work location. 9-18Copyright 2015 Pearson Education, Inc. Example:

Taxpayer can deduct transportation costs of 10 miles even if he goes home between jobs. 9-19Copyright 2015 Pearson Education, Inc. Automobile ExpensesTaxpayer can choose between actual vs. standard mileage method for calculating auto expenses.Cant use standard method for taxis or for five or more autos owned at the same time by taxpayers.If change from standard method to actual, then basis of auto must be reduced by 22 mile (2014) and ADS (straight line) depreciation method must be used.9-20Copyright 2015 Pearson Education, Inc. Automobile Expenses (contd)Cannot use standard method if auto had been previously depreciated under MACRS or been subject to a 179 election.If using actual expense method, total expenses have to be allocated between business v. personal miles driven.Unreimbursed expenses are reported on Form 2106 and Schedule A.9-21Copyright 2015 Pearson Education, Inc.

9-22Copyright 2015 Pearson Education, Inc.

9-23Copyright 2015 Pearson Education, Inc. Automobile Expenses (contd)9-24Copyright 2015 Pearson Education, Inc. Meal & Entertainment ExpensesIs the expenditure lavish or extravagant? Does the expenditure meet the requirements under 212 or 162?No deduction permitted unless other code section applies. Portion considered lavish, not deductible, unless treated as compensation. Remainder subject to 274 50% limitation.Is the expenditure either directly related or associated with the active conduct of business? Not deductible unless treated as compensation.Is the expenditure for a company picnic? Expenditure 100% deductible. Was the expenditure property substantiated?Deduction can be disallowed by IRS.Deductible subject to 274 50% limitation.YESYESYESYESYESNONONONONO9-25Copyright 2015 Pearson Education, Inc. Meals and Entertainment (contd)Taxpayer must generally be present when the meal or entertainment takes place.There cannot be substantial distractions to interfere with any business discussion.Entertainment tickets deductible only up to 50% of the face value even if more than face value was paid.

9-26Copyright 2015 Pearson Education, Inc. Entertainment Facilities and Club DuesNo deduction allowed for costs to build or maintain entertainment or recreation facilities (e.g., skyboxes, ski lodges).No deduction allowed for club dues (airline clubs, golf clubs, social clubs).Professional, civic, and public service organizations (e.g., chambers of commerce, trade of association). 9-27Copyright 2015 Pearson Education, Inc. Business GiftsDeductible up to $25 per donee.Amounts > $25 are disallowed.Not subject to 50% reduction.Employee achievement awards that are under $400 per individual are deductible.9-28Copyright 2015 Pearson Education, Inc. Employee Business Expenses9-29Copyright 2015 Pearson Education, Inc. Accountable PlansAccountable plans reimbursements are included in gross income and expenses are deductible For AGI.Can use per diem allowances for meals and lodging expenses in lieu of actual expenses.Taxpayer need only substantiate the time, place, and business purpose of the trip. No other receipts of actual costs are needed.

9-30Copyright 2015 Pearson Education, Inc. Moving Expenses - 217Generally, moving expenses are personal and non-deductible.Exception limited deduction permitted for employees (EE) and self-employed (SE) people.Must meet Distance and Time requirements.9-31Copyright 2015 Pearson Education, Inc. Moving Expenses (contd)Time requirements excused if EE or SE dies, becomes disabled, or is involuntarily terminated.Moving expenses are deductible For AGI.Moving expenses paid by employer are excluded from EEs gross income as long as they are deductible under 217.Non-deductible moving expenses paid for by ER must be included into EEs wages.9-32Copyright 2015 Pearson Education, Inc. Requirements for Moving Expenses9-33Copyright 2015 Pearson Education, Inc. Definition of Moving Expenses9-34Copyright 2015 Pearson Education, Inc. Education ExpensesGenerally, considered personal expenses and are not deductible. 9-35Copyright 2015 Pearson Education, Inc. Exceptions to GR of Non-Deductibility of Educational Expenses9-36Copyright 2015 Pearson Education, Inc. Requirements for Deductibility of Educational Expenses9-37Copyright 2015 Pearson Education, Inc. Home Office ExpensesDeduction allowed part of home used in a T or B.EEs must also show that the home office is for the convenience of the ER, not the EE.

9-38Copyright 2015 Pearson Education, Inc. 38Home Office Criteria9-39Copyright 2015 Pearson Education, Inc. Home Office Expenses (contd)Principal place of business = where primary services were performed; ORTP uses office for administrative or management activities AND there is no other fixed location for the TPs administrative activities.

9-40Copyright 2015 Pearson Education, Inc. Types of Home Office Expenses9-41Copyright 2015 Pearson Education, Inc. Calculating the Home Office DeductionTotal Home Office expenses = 100% of direct expenses + pro rata share of indirect expenses.Safe Harbor - instead of deducting direct + indirect expenses, the TP can deduct $5/square foot (max of 300 sq. ft.) for home office expenses.Total expenses cant exceed the TPs gross income from the T or B. Suspended losses can be carried forward.

9-42Copyright 2015 Pearson Education, Inc. Deferred Compensation PlansUsed as a method for EEs and ERs to fund retirement accounts.Typically, the EEs and ERs receive tax deduction for the amount contributed.Amounts grow tax-deferred. EE pays tax when he/she withdraws amounts in retirement.

9-43Copyright 2015 Pearson Education, Inc. Types of Deferred Compensation Plans or Other Retirement Vehicles.9-44Copyright 2015 Pearson Education, Inc. Types of Qualified Plans9-45Copyright 2015 Pearson Education, Inc. Qualified Pension PlansERs make systematic payments to plan based on formulas or actuarial tables.Plan can provide for disability, death, or medical insurance.Noncontributory plan payments to plan made only by ER.Contributory plan EE can make voluntary payments in addition to the ERs payments.9-46Copyright 2015 Pearson Education, Inc. Qualified Pension Plans (contd)Defined Benefit plan pays a fixed benefit amount to EE based on certain formulas. This is sometimes called a traditional pension plan.Defined Contribution The ER pays in a fixed amount for each employee based on a formula. The amount of retirement benefit depends on how much the investment grows in the interim.9-47Copyright 2015 Pearson Education, Inc. Qualified Profit-Sharing Plans 401(k) plans are the most common type of profit-sharing plans.There must be a definite formula to allocate ER contributions.EEs must have option to take compensation in cash or contribute to plan.ER does not have to contribute annually, but is required to make substantial and recurring contributions.9-48Copyright 2015 Pearson Education, Inc. Roth-Type Profit-Sharing PlansEEs can contribute with after-tax dollars. Amounts in the plan are not taxed. Distributions are also tax-free as long as account has been active for 5 years or more, and EE is > 59.5 years old. 9-49Copyright 2015 Pearson Education, Inc. Qualified Stock Bonus PlanType of defined contribution plan where investments are the ER company stock.Common stock bonus program is an employee stock option plan (ESOP).ESOPs are funded by both EE and ER contributions. ER can deduct dividends paid to participants. Participants must recognize income. 9-50Copyright 2015 Pearson Education, Inc. Qualified Plans - RequirementsPlans provisions cannot discriminate in favor of highly compensated EEs.Highly compensated = 1) owns > 5% of corps stock in current or prior year; OR 2) received compensation > $115K in prior year.ER and/or EE contribute to the plan for the benefit of the EE.9-51Copyright 2015 Pearson Education, Inc. Qualified Plans (contd)ERs contributions must be uniform among all EEs (e.g., a fixed % of pay).EE must vest in ERs contribution no later than after 5 years of employment. EE immediately vests in EEs contributions.EE can elect to make pre- or after-tax contributions to the plan. The after-tax amounts are not taxable upon withdrawal.ER contributions deductible, earnings on fund are tax-exempt to plan. 9-52Copyright 2015 Pearson Education, Inc. Limitations on ER ContributionsDefined Contribution limited to lessor of: 1) $52,000; OR 2) 100% of EEs compensation.Defined Benefit limited to lessor of: 1) $210,000 (2014); OR 2) 100% of participants highest compensation for highest 3 years.9-53Copyright 2015 Pearson Education, Inc. Nonqualified (NQ) PlansUsed by ERs to provide supplemental retirement income to executives.Common forms:Executive supplemental deferred compensation plans EE contributes pre-tax salary to a 401(k)-like plan. Distributions are taxable to EE.Stock rights or transfers where there is a significant risk of forfeiture.9-54Copyright 2015 Pearson Education, Inc. Nonqualified (NQ) Plans (contd)Not subject to the discrimination rules under the Qualified plan rules, so the NQ plan can favor the highly compensated.NQ plans have restrictions on transfer of plans benefits to EE, so EE can delay recognizing income until monies are distributed.ER takes a deduction in same year EE recognizes income.9-55Copyright 2015 Pearson Education, Inc. Nonqualified (NQ) Plans (contd)For restricted property plans, EE recognizes income only when it is no longer subject to the substantial risk of forfeiture or is transferable.

9-56Copyright 2015 Pearson Education, Inc. Employee Stock Option Plans9-57Copyright 2015 Pearson Education, Inc. Qualified Incentive Stock OptionsEE cannot dispose of stock within 2 years of options grant date or within one year after exercise date.EE must still be employed by issuing company on grant date and continue until within 3 months before exercise date.EE does not have income at grant or exercise date. ER does not have deduction.EE has L-T C G/L upon sale of stock. 9-58Copyright 2015 Pearson Education, Inc. Nonqualified Stock Option PlansIf any of the requirements for an ISO is violated then it is treated as a NQ plan.ER takes a compensation deduction the same year that EE recognizes income. EE recognizes income on grant date = (FMV exercise price). 9-59Copyright 2015 Pearson Education, Inc. Plans for SE IndividualsTaxpayers who are EEs can also establish a Keogh account if they are also SE.Defined contribution plan maximum contribution of the lesser of: $52,000 or 25% earned income. After SE taxes and deduction itself is taken into account, a TP can actually contribute only 20%.SEP-IRAs have same contribution limitations as Keoghs.9-60Copyright 2015 Pearson Education, Inc. Plans for SE Individuals (contd)SE individuals can also select instead of a Keogh a SIMPLE plan, Solo 401(k) plan, or SEP IRA.Other standard IRAs are available to SE individuals as well as the general public.Solo 401(k) plans allow for a $17,500 deferral plus a 25% salary match. Total limit in 2014 is $52,000.9-61Copyright 2015 Pearson Education, Inc. SIMPLE Retirement Plans RequirementsVoluntary EE contributions must be matched by ER, or ER can unilaterally make contributions;EE must be fully vested; AND SIMPLE plans are not subject to the discrimination rules.Business must have 100 EEs.9-62Copyright 2015 Pearson Education, Inc. SIMPLE Retirement Plans Requirements (contd)EEs with $5,000 in wages are eligible to participate.EEs are permitted to contribute up to $12,000/year, and ER is required to make matching contributions.9-63Copyright 2015 Pearson Education, Inc. Individual Retirement Accounts (IRAs)Copyright 2015 Pearson Education, Inc. 9-64Differences in IRAsTYPEMAXIMUM CONTRIB-UTIONINCOME OR OTHER LIMITATIONS ?CONTRIB-UTION DEDUCT- IBLE?WITH-DRAWALS TAXABLE > BASIS?Traditional N/D IRALessor of $5,500/6,500 or 100% income.NoNoYesTraditional Deductible IRALessor of $5,500/6,500 or 100% income.

Yes, income phase-outs and existence of ER pension plan.YesYes,Basis = 0Roth IRAsLessor of $5,500/6,500 or 100% income.

Yes, but other provisions essentially remove income limitations.NoNo, unless TP takes $ out early.9-65Copyright 2015 Pearson Education, Inc. Individual Retirement Accounts (contd)Taxpayers who are 50 or older by the end of the tax year can contribute an extra $1,000 for a maximum of $6,500 in 2014.Taxpayer has until the original tax filing deadline to set up his/her IRA for that year. Example: Joe has until April 15, 2015 to set up his IRA for the 2014 tax year.

9-66Copyright 2015 Pearson Education, Inc. Individual Retirement Accounts (contd)If taxpayers elected MFJ status, then both spouses can contribute even if only one spouse has earned income.Example: John and Abigail are filing a joint return. They can contribute up to $5,500 each to an IRA as long as at least one of them earns either wages or self-employment income of $11,000. If total wages are $8,000, then Johns and Abigails combined IRA contribution cannot exceed $8,000.9-67Copyright 2015 Pearson Education, Inc. Individual Retirement Accounts (contd)For SEP-IRAs and Keogh Accounts, the taxpayer must set up the account by the last day of the tax year.Can wait until the due date of return (including extensions) to fund it. 9-68Copyright 2015 Pearson Education, Inc. Roth IRAsTaxpayer makes after-tax contributions.Amounts grow tax-free. Withdrawals are also tax-free under the following circumstances:The taxpayer is at least 59 and the account has been established for at least 5 years. The taxpayer has inherited the Roth IRA and is now receiving distributions.A first-time homebuyer can withdraw up to $10,000.The individual has become disabled.9-69Copyright 2015 Pearson Education, Inc. Roth IRAs (contd)If taxpayer does not meet conditions above, any distributions are considered first from after-tax contributions. Any early distribution over amount of contribution is ordinary income subject to a 10% penalty.If taxpayers income above the thresholds, then ability to contribute to a Roth starts to phase out.9-70Copyright 2015 Pearson Education, Inc. Roth IRAs (contd)Phase-out thresholds:Single between $114,000 and $129,000.MFJ between $181,000 and $191,000.MFS - $0However, taxpayers are permitted to roll-over traditional IRAs and convert them into Roth IRAs.

9-71Copyright 2015 Pearson Education, Inc. Roth IRAs (contd)Taxpayers will have to recognize in income any conversion amounts > after-tax contributions.No income limitations exist for conversions, so essentially the Roth IRA is available to all taxpayers.

9-72Copyright 2015 Pearson Education, Inc. Coverdell Education Savings AccountMaximum after-tax contribution $2,000 per year per child age 18.Can be used for elementary, secondary, or higher education expenses.Taxpayer can claim educational credits the same year he/she takes Coverdell distributions.9-73Copyright 2015 Pearson Education, Inc. Coverdell Education IRAs (contd)Must reduce qualified expenses by Coverdell distributions before calculating credit.Ability to make a Coverdell contribution phases out between following thresholds:MFJ between $190,000-$220,000.All other taxpayers between $95,000-$110,000.9-74Copyright 2015 Pearson Education, Inc. Health Savings Accounts (HSA)Taxpayers can contribute up to XXX into a HSA (similar to an IRA) to pay for medical expenses.Contributions are deductible For AGI, grow tax-free with distributions to pay for expenses also tax-free. 9-75Copyright 2015 Pearson Education, Inc. Health Savings Accounts (contd)Distributions that are not used to pay for qualified medical expenses are includable in gross income and subject to a 10% penalty. If taxpayer 65, then 10% penalty is waived.9-76Copyright 2015 Pearson Education, Inc. 9-77Copyright 2015 Pearson Education, Inc. Tax Planning Considerations9-78Copyright 2015 Pearson Education, Inc. Compliance and Procedural ConsiderationsCopyright 2015 Pearson Education, Inc. 9-79ENDChapter 9This work is protected by U.S. copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.9-80Copyright 2015 Pearson Education, Inc. 80