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My1040ez com 2. My1040ez com Employees' Pay Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tests for Deducting PayTest 1—Reasonableness Test 2—For Services Performed Kinds of PayAwards Bonuses Education Expenses Fringe Benefits Loans or Advances Property Reimbursements for Business Expenses Sick and Vacation Pay Introduction You can generally deduct the amount you pay your employees for the services they perform. My1040ez com The pay may be in cash, property, or services. My1040ez com It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. My1040ez com For information about deducting employment taxes, see chapter 5. My1040ez com You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. My1040ez com Empowerment zone employment credit (Form 8844). My1040ez com Indian employment credit (Form 8845). My1040ez com Work opportunity credit (Form 5884). My1040ez com Credit for employer differential wage payments (Form 8932). My1040ez com Reduce your deduction for employee wages by the amount of employment credits you claim. My1040ez com For more information about these credits, see the form on which the credit is claimed. My1040ez com Topics - This chapter discusses: Tests for deducting pay Kinds of pay Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits See chapter 12 for information about getting publications and forms. My1040ez com Tests for Deducting Pay To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. My1040ez com These and other requirements that apply to all business expenses are explained in chapter 1. My1040ez com In addition, the pay must meet both of the following tests. My1040ez com Test 1. My1040ez com It must be reasonable. My1040ez com Test 2. My1040ez com It must be for services performed. My1040ez com The form or method of figuring the pay does not affect its deductibility. My1040ez com For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. My1040ez com Test 1—Reasonableness You must be able to prove that the pay is reasonable. My1040ez com Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. My1040ez com If the pay is excessive, the excess pay is disallowed as a deduction. My1040ez com Factors to consider. My1040ez com Determine the reasonableness of pay by the facts and circumstances. My1040ez com Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. My1040ez com To determine if pay is reasonable, also consider the following items and any other pertinent facts. My1040ez com The duties performed by the employee. My1040ez com The volume of business handled. My1040ez com The character and amount of responsibility. My1040ez com The complexities of your business. My1040ez com The amount of time required. My1040ez com The cost of living in the locality. My1040ez com The ability and achievements of the individual employee performing the service. My1040ez com The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation. My1040ez com Your policy regarding pay for all your employees. My1040ez com The history of pay for each employee. My1040ez com Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. My1040ez com Employee-shareholder salaries. My1040ez com If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. My1040ez com The excessive part of the salary would not be allowed as a salary deduction by the corporation. My1040ez com For more information on corporate distributions to shareholders, see Publication 542, Corporations. My1040ez com Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. My1040ez com For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. My1040ez com Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. My1040ez com If you give property to an employee as an employee achievement award, your deduction may be limited. My1040ez com Achievement awards. My1040ez com An achievement award is an item of tangible personal property that meets all the following requirements. My1040ez com It is given to an employee for length of service or safety achievement. My1040ez com It is awarded as part of a meaningful presentation. My1040ez com It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. My1040ez com Length-of-service award. My1040ez com An award will qualify as a length-of-service award only if either of the following applies. My1040ez com The employee receives the award after his or her first 5 years of employment. My1040ez com The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years. My1040ez com Safety achievement award. My1040ez com An award for safety achievement will qualify as an achievement award unless one of the following applies. My1040ez com It is given to a manager, administrator, clerical employee, or other professional employee. My1040ez com During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value). My1040ez com Deduction limit. My1040ez com Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. My1040ez com $400 for awards that are not qualified plan awards. My1040ez com $1,600 for all awards, whether or not qualified plan awards. My1040ez com A qualified plan award is an achievement award given as part of an established written plan or program that does not favor highly compensated employees as to eligibility or benefits. My1040ez com A highly compensated employee is an employee who meets either of the following tests. My1040ez com The employee was a 5% owner at any time during the year or the preceding year. My1040ez com The employee received more than $115,000 in pay for the preceding year. My1040ez com You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding year. My1040ez com An award is not a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. My1040ez com To figure this average cost, ignore awards of nominal value. My1040ez com Deduct achievement awards as a nonwage business expense on your return or business schedule. My1040ez com You may not owe employment taxes on the value of some achievement awards you provide to an employee. My1040ez com See Publication 15-B. My1040ez com Bonuses You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. My1040ez com However, the total bonuses, salaries, and other pay must be reasonable for the services performed. My1040ez com If the bonus is paid in property, see Property , later. My1040ez com Gifts of nominal value. My1040ez com If, to promote employee goodwill, you distribute food or merchandise of nominal value to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. My1040ez com Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. My1040ez com For more information on this deduction limit, see Meals and lodging , later. My1040ez com Education Expenses If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. My1040ez com Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. My1040ez com For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. My1040ez com Fringe Benefits A fringe benefit is a form of pay for the performance of services. My1040ez com You can generally deduct the cost of fringe benefits. My1040ez com You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. My1040ez com You also may not owe employment taxes on the value of the fringe benefits. My1040ez com See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. My1040ez com Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited. My1040ez com Certain fringe benefits are discussed next. My1040ez com See Publication 15-B for more details on these and other fringe benefits. My1040ez com Meals and lodging. My1040ez com You can usually deduct the cost of furnishing meals and lodging to your employees. My1040ez com Deduct the cost in whatever category the expense falls. My1040ez com For example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold. My1040ez com If you operate a nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen service, salaries, depreciation, etc. My1040ez com Deduction limit on meals. My1040ez com You can generally deduct only 50% of the cost of furnishing meals to your employees. My1040ez com However, you can deduct the full cost of the following meals. My1040ez com Meals whose value you include in an employee's wages. My1040ez com Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. My1040ez com This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience. My1040ez com Meals you furnish to your employees at the work site when you operate a restaurant or catering service. My1040ez com Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. My1040ez com Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). My1040ez com This does not include meals you furnish on vessels primarily providing luxury water transportation. My1040ez com Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. My1040ez com This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. My1040ez com Employee benefit programs. My1040ez com Employee benefit programs include the following. My1040ez com Accident and health plans. My1040ez com Adoption assistance. My1040ez com Cafeteria plans. My1040ez com Dependent care assistance. My1040ez com Education assistance. My1040ez com Life insurance coverage. My1040ez com Welfare benefit funds. My1040ez com You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. My1040ez com For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc. My1040ez com ). My1040ez com Life insurance coverage. My1040ez com You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business, if you are directly or indirectly the beneficiary of the policy. My1040ez com See Regulations section 1. My1040ez com 264-1 for more information. My1040ez com Welfare benefit funds. My1040ez com A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. My1040ez com Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. My1040ez com Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. My1040ez com If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. My1040ez com Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. My1040ez com The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. My1040ez com The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. My1040ez com These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. My1040ez com For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. My1040ez com Loans or Advances You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. My1040ez com However, if the employee performs no services, treat the amount you advanced as a loan. My1040ez com If the employee does not repay the loan, treat it as income to the employee. My1040ez com Below-market interest rate loans. My1040ez com On certain loans you make to an employee or shareholder, you are treated as having received interest income and as having paid compensation or dividends equal to that interest. My1040ez com See Below-Market Loans in chapter 4. My1040ez com Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. My1040ez com The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property. My1040ez com You can claim the deduction only for the tax year in which your employee includes the property's value in income. My1040ez com Your employee is deemed to have included the value in income if you report it on Form W-2, Wage and Tax Statement, in a timely manner. My1040ez com You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. My1040ez com Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. My1040ez com These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. My1040ez com Restricted property. My1040ez com If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. My1040ez com However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. My1040ez com “Substantially vested” means the property is not subject to a substantial risk of forfeiture. My1040ez com This means that the recipient is not likely to have to give up his or her rights in the property in the future. My1040ez com Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. My1040ez com However, your deduction may be limited. My1040ez com If you make the payment under an accountable plan, deduct it in the category of the expense paid. My1040ez com For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. My1040ez com If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. My1040ez com See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. My1040ez com Sick and Vacation Pay Sick pay. My1040ez com You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. My1040ez com However, your deduction is limited to amounts not compensated by insurance or other means. My1040ez com Vacation pay. My1040ez com Vacation pay is an employee benefit. My1040ez com It includes amounts paid for unused vacation leave. My1040ez com You can deduct vacation pay only in the tax year in which the employee actually receives it. My1040ez com This rule applies regardless of whether you use the cash or accrual method of accounting. My1040ez com Prev Up Next Home More Online Publications
Understanding Your CP286 Notice
We send this notice when we approve Form 8716, Election To Have a Tax Year Other Than a Required Tax Year.
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File a final Form 8752, which will terminate your section 444 election. If you have a credit on your account, you must file a final Form 8752 for us to refund the payments to you. You must also file a short period business income tax return with your final Form 8752 (Form 1065 or Form 1120S) ending December 31.
Do I need to file Form 8752 when I don’t owe a payment?
Yes. You must file Form 8752 each year the section 444 election is in effect, even if no payment is due.
What if I am no longer required to file a Form 1065 or Form 1120S? Do I need to ask the IRS to terminate my election?
Yes. You must send a final Form 1065 or Form 1120S, along with a final Form 8752.
Are there any consequences if I don’t file Form 8752 or send in my payment when I file?
Failure to file or failure to pay will result in the termination of your fiscal year election.
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My1040ez com 1. My1040ez com Deducting Business Expenses Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: What Can I Deduct?Cost of Goods Sold Capital Expenses Capital versus Deductible Expenses Personal versus Business Expenses How Much Can I Deduct?Not-for-profit limits. My1040ez com At-risk limits. My1040ez com Passive activities. My1040ez com Net operating loss. My1040ez com When Can I Deduct an Expense?Economic performance. My1040ez com Not-for-Profit ActivitiesGross Income Limit on Deductions What's New Optional safe harbor method to determine the business use of a home deduction. My1040ez com Beginning in 2013, you can use the optional safe harbor method to determine the deduction for the business use of your home. My1040ez com See Optional safe harbor method under Business use of your home , later. My1040ez com Introduction This chapter covers the general rules for deducting business expenses. My1040ez com Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit. My1040ez com Topics - This chapter discusses: What you can deduct How much you can deduct When you can deduct Not-for-profit activities Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 463 Travel, Entertainment, Gift, and Car Expenses 525 Taxable and Nontaxable Income 529 Miscellaneous Deductions 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 538 Accounting Periods and Methods 542 Corporations 547 Casualties, Disasters, and Thefts 587 Business Use of Your Home 925 Passive Activity and At-Risk Rules 936 Home Mortgage Interest Deduction 946 How To Depreciate Property Form (and Instructions) Sch A (Form 1040) Itemized Deductions 5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit See chapter 12 for information about getting publications and forms. My1040ez com What Can I Deduct? To be deductible, a business expense must be both ordinary and necessary. My1040ez com An ordinary expense is one that is common and accepted in your industry. My1040ez com A necessary expense is one that is helpful and appropriate for your trade or business. My1040ez com An expense does not have to be indispensable to be considered necessary. My1040ez com Even though an expense may be ordinary and necessary, you may not be allowed to deduct the expense in the year you paid or incurred it. My1040ez com In some cases you may not be allowed to deduct the expense at all. My1040ez com Therefore, it is important to distinguish usual business expenses from expenses that include the following. My1040ez com The expenses used to figure cost of goods sold, Capital expenses, and Personal expenses. My1040ez com Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. My1040ez com Some of your business expenses may be included in figuring cost of goods sold. My1040ez com Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. My1040ez com If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense. My1040ez com The following are types of expenses that go into figuring cost of goods sold. My1040ez com The cost of products or raw materials, including freight. My1040ez com Storage. My1040ez com Direct labor (including contributions to pension or annuity plans) for workers who produce the products. My1040ez com Factory overhead. My1040ez com Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. My1040ez com Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. My1040ez com This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million. My1040ez com For more information, see the following sources. My1040ez com Cost of goods sold—chapter 6 of Publication 334. My1040ez com Inventories—Publication 538. My1040ez com Uniform capitalization rules—Publication 538 and section 263A of the Internal Revenue Code and the related regulations. My1040ez com Capital Expenses You must capitalize, rather than deduct, some costs. My1040ez com These costs are a part of your investment in your business and are called “capital expenses. My1040ez com ” Capital expenses are considered assets in your business. My1040ez com In general, you capitalize three types of costs. My1040ez com Business start-up costs (See Tip below). My1040ez com Business assets. My1040ez com Improvements. My1040ez com You can elect to deduct or amortize certain business start-up costs. My1040ez com See chapters 7 and 8. My1040ez com Cost recovery. My1040ez com Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. My1040ez com These recovery methods allow you to deduct part of your cost each year. My1040ez com In this way, you are able to recover your capital expense. My1040ez com See Amortization (chapter 8) and Depletion (chapter 9) in this publication. My1040ez com A taxpayer can elect to deduct a portion of the costs of certain depreciable property as a section 179 deduction. My1040ez com A greater portion of these costs can be deducted if the property is qualified disaster assistance property. My1040ez com See Publication 946 for details. My1040ez com Going Into Business The costs of getting started in business, before you actually begin business operations, are capital expenses. My1040ez com These costs may include expenses for advertising, travel, or wages for training employees. My1040ez com If you go into business. My1040ez com When you go into business, treat all costs you had to get your business started as capital expenses. My1040ez com Usually you recover costs for a particular asset through depreciation. My1040ez com Generally, you cannot recover other costs until you sell the business or otherwise go out of business. My1040ez com However, you can choose to amortize certain costs for setting up your business. My1040ez com See Starting a Business in chapter 8 for more information on business start-up costs. My1040ez com If your attempt to go into business is unsuccessful. My1040ez com If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories. My1040ez com The costs you had before making a decision to acquire or begin a specific business. My1040ez com These costs are personal and nondeductible. My1040ez com They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility. My1040ez com The costs you had in your attempt to acquire or begin a specific business. My1040ez com These costs are capital expenses and you can deduct them as a capital loss. My1040ez com If you are a corporation and your attempt to go into a new trade or business is not successful, you may be able to deduct all investigatory costs as a loss. My1040ez com The costs of any assets acquired during your unsuccessful attempt to go into business are a part of your basis in the assets. My1040ez com You cannot take a deduction for these costs. My1040ez com You will recover the costs of these assets when you dispose of them. My1040ez com Business Assets There are many different kinds of business assets; for example, land, buildings, machinery, furniture, trucks, patents, and franchise rights. My1040ez com You must fully capitalize the cost of these assets, including freight and installation charges. My1040ez com Certain property you produce for use in your trade or business must be capitalized under the uniform capitalization rules. My1040ez com See Regulations section 1. My1040ez com 263A-2 for information on these rules. My1040ez com Improvements Improvements are generally major expenditures. My1040ez com Some examples are: new electric wiring, a new roof, a new floor, new plumbing, bricking up windows to strengthen a wall, and lighting improvements. My1040ez com The costs of making improvements to a business asset are capital expenses if the improvements add to the value of the asset, appreciably lengthen the time you can use it, or adapt it to a different use. My1040ez com Beginning in 2014, you must capitalize as improvements costs that are for the betterment of a unit of property, restore the unit of property, or adapt the unit of property to a new or different use. My1040ez com Temporary regulations allow you to capitalize costs meeting the above criteria for tax years beginning after 2011. My1040ez com However, you can currently deduct repairs that keep your property in a normal efficient operating condition as a business expense. My1040ez com Treat as repairs amounts paid to replace parts of a machine that only keep it in a normal operating condition. My1040ez com Restoration plan. My1040ez com Capitalize the cost of reconditioning, improving, or altering your property as part of a general restoration plan to make it suitable for your business. My1040ez com This applies even if some of the work would by itself be classified as repairs. My1040ez com Capital versus Deductible Expenses To help you distinguish between capital and deductible expenses, different examples are given below. My1040ez com Motor vehicles. My1040ez com You usually capitalize the cost of a motor vehicle you use in your business. My1040ez com You can recover its cost through annual deductions for depreciation. My1040ez com There are dollar limits on the depreciation you can claim each year on passenger automobiles used in your business. My1040ez com See Publication 463. My1040ez com Generally, repairs you make to your business vehicle are currently deductible. My1040ez com However, amounts you pay to recondition and overhaul a business vehicle are capital expenses and are recovered through depreciation. My1040ez com Roads and driveways. My1040ez com The cost of building a private road on your business property and the cost of replacing a gravel driveway with a concrete one are capital expenses you may be able to depreciate. My1040ez com The cost of maintaining a private road on your business property is a deductible expense. My1040ez com Tools. My1040ez com Unless the uniform capitalization rules apply, amounts spent for tools used in your business are deductible expenses if the tools have a life expectancy of less than 1 year or their cost is minor. My1040ez com Machinery parts. My1040ez com Unless the uniform capitalization rules apply, the cost of replacing short-lived parts of a machine to keep it in good working condition, but not add to its life, is a deductible expense. My1040ez com Heating equipment. My1040ez com The cost of changing from one heating system to another is a capital expense. My1040ez com Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. My1040ez com However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. My1040ez com You can deduct the business part. My1040ez com For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you generally can deduct 70% of the interest as a business expense. My1040ez com The remaining 30% is personal interest and generally is not deductible. My1040ez com See chapter 4 for information on deducting interest and the allocation rules. My1040ez com Business use of your home. My1040ez com If you use part of your home for business, you may be able to deduct expenses for the business use of your home. My1040ez com These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. My1040ez com To qualify to claim expenses for the business use of your home, you must meet both of the following tests. My1040ez com The business part of your home must be used exclusively and regularly for your trade or business. My1040ez com The business part of your home must be: Your principal place of business, or A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or A separate structure (not attached to your home) used in connection with your trade or business. My1040ez com You generally do not have to meet the exclusive use test for the part of your home that you regularly use either for the storage of inventory or product samples, or as a daycare facility. My1040ez com Your home office qualifies as your principal place of business if you meet the following requirements. My1040ez com You use the office exclusively and regularly for administrative or management activities of your trade or business. My1040ez com You have no other fixed location where you conduct substantial administrative or management activities of your trade or business. My1040ez com If you have more than one business location, determine your principal place of business based on the following factors. My1040ez com The relative importance of the activities performed at each location. My1040ez com If the relative importance factor does not determine your principal place of business, consider the time spent at each location. My1040ez com Optional safe harbor method. My1040ez com Beginning in 2013, individual taxpayers can use the optional safe harbor method to determine the amount of deductible expenses attributable to certain business use of a residence during the tax year. My1040ez com This method is an alternative to the calculation, allocation, and substantiation of actual expenses. My1040ez com The deduction under the optional method is limited to $1,500 per year based on $5 a square foot for up to 300 square feet. My1040ez com Under this method, you claim your allowable mortgage interest, real estate taxes, and casualty losses on the home as itemized deductions on Schedule A (Form 1040). My1040ez com You are not required to allocate these deductions between personal and business use, as is required under the regular method. My1040ez com If you use the optional method, you cannot depreciate the portion of your home used in a trade or business. My1040ez com Business expenses unrelated to the home, such as advertising, supplies, and wages paid to employees, are still fully deductible. My1040ez com All of the requirements discussed earlier under Business use of your home still apply. My1040ez com For more information on the deduction for business use of your home, including the optional safe harbor method, see Publication 587. My1040ez com If you were entitled to deduct depreciation on the part of your home used for business, you cannot exclude the part of the gain from the sale of your home that equals any depreciation you deducted (or could have deducted) for periods after May 6, 1997. My1040ez com Business use of your car. My1040ez com If you use your car exclusively in your business, you can deduct car expenses. My1040ez com If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. My1040ez com Generally, commuting expenses between your home and your business location, within the area of your tax home, are not deductible. My1040ez com You can deduct actual car expenses, which include depreciation (or lease payments), gas and oil, tires, repairs, tune-ups, insurance, and registration fees. My1040ez com Or, instead of figuring the business part of these actual expenses, you may be able to use the standard mileage rate to figure your deduction. My1040ez com Beginning in 2013, the standard mileage rate is 56. My1040ez com 5 cents per mile. My1040ez com If you are self-employed, you can also deduct the business part of interest on your car loan, state and local personal property tax on the car, parking fees, and tolls, whether or not you claim the standard mileage rate. My1040ez com For more information on car expenses and the rules for using the standard mileage rate, see Publication 463. My1040ez com How Much Can I Deduct? Generally, you can deduct the full amount of a business expense if it meets the criteria of ordinary and necessary and it is not a capital expense. My1040ez com Recovery of amount deducted (tax benefit rule). My1040ez com If you recover part of an expense in the same tax year in which you would have claimed a deduction, reduce your current year expense by the amount of the recovery. My1040ez com If you have a recovery in a later year, include the recovered amount in income in that year. My1040ez com However, if part of the deduction for the expense did not reduce your tax, you do not have to include that part of the recovered amount in income. My1040ez com For more information on recoveries and the tax benefit rule, see Publication 525. My1040ez com Payments in kind. My1040ez com If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. My1040ez com You cannot deduct the cost of your own labor. My1040ez com Similarly, if you pay a business expense in goods or other property, you can deduct only what the property costs you. My1040ez com If these costs are included in the cost of goods sold, do not deduct them again as a business expense. My1040ez com Limits on losses. My1040ez com If your deductions for an investment or business activity are more than the income it brings in, you have a loss. My1040ez com There may be limits on how much of the loss you can deduct. My1040ez com Not-for-profit limits. My1040ez com If you carry on your business activity without the intention of making a profit, you cannot use a loss from it to offset other income. My1040ez com See Not-for-Profit Activities , later. My1040ez com At-risk limits. My1040ez com Generally, a deductible loss from a trade or business or other income-producing activity is limited to the investment you have “at risk” in the activity. My1040ez com You are at risk in any activity for the following. My1040ez com The money and adjusted basis of property you contribute to the activity. My1040ez com Amounts you borrow for use in the activity if: You are personally liable for repayment, or You pledge property (other than property used in the activity) as security for the loan. My1040ez com For more information, see Publication 925. My1040ez com Passive activities. My1040ez com Generally, you are in a passive activity if you have a trade or business activity in which you do not materially participate, or a rental activity. My1040ez com In general, deductions for losses from passive activities only offset income from passive activities. My1040ez com You cannot use any excess deductions to offset other income. My1040ez com In addition, passive activity credits can only offset the tax on net passive income. My1040ez com Any excess loss or credits are carried over to later years. My1040ez com Suspended passive losses are fully deductible in the year you completely dispose of the activity. My1040ez com For more information, see Publication 925. My1040ez com Net operating loss. My1040ez com If your deductions are more than your income for the year, you may have a “net operating loss. My1040ez com ” You can use a net operating loss to lower your taxes in other years. My1040ez com See Publication 536 for more information. My1040ez com See Publication 542 for information about net operating losses of corporations. My1040ez com When Can I Deduct an Expense? When you can deduct an expense depends on your accounting method. My1040ez com An accounting method is a set of rules used to determine when and how income and expenses are reported. My1040ez com The two basic methods are the cash method and the accrual method. My1040ez com Whichever method you choose must clearly reflect income. My1040ez com For more information on accounting methods, see Publication 538. My1040ez com Cash method. My1040ez com Under the cash method of accounting, you generally deduct business expenses in the tax year you pay them. My1040ez com Accrual method. My1040ez com Under an accrual method of accounting, you generally deduct business expenses when both of the following apply. My1040ez com The all-events test has been met. My1040ez com The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. My1040ez com Economic performance has occurred. My1040ez com Economic performance. My1040ez com You generally cannot deduct or capitalize a business expense until economic performance occurs. My1040ez com If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided, or the property is used. My1040ez com If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. My1040ez com Example. My1040ez com Your tax year is the calendar year. My1040ez com In December 2013, the Field Plumbing Company did some repair work at your place of business and sent you a bill for $600. My1040ez com You paid it by check in January 2014. My1040ez com If you use the accrual method of accounting, deduct the $600 on your tax return for 2013 because all events have occurred to “fix” the fact of liability (in this case the work was completed), the liability can be determined, and economic performance occurred in that year. My1040ez com If you use the cash method of accounting, deduct the expense on your 2014 return. My1040ez com Prepayment. My1040ez com You generally cannot deduct expenses in advance, even if you pay them in advance. My1040ez com This rule applies to both the cash and accrual methods. My1040ez com It applies to prepaid interest, prepaid insurance premiums, and any other expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. My1040ez com Example. My1040ez com In 2013, you sign a 10-year lease and immediately pay your rent for the first 3 years. My1040ez com Even though you paid the rent for 2013, 2014, and 2015, you can only deduct the rent for 2013 on your 2013 tax return. My1040ez com You can deduct the rent for 2014 and 2015 on your tax returns for those years. My1040ez com Contested liability. My1040ez com Under the cash method, you can deduct a contested liability only in the year you pay the liability. My1040ez com Under the accrual method, you can deduct contested liabilities such as taxes (except foreign or U. My1040ez com S. My1040ez com possession income, war profits, and excess profits taxes) either in the tax year you pay the liability (or transfer money or other property to satisfy the obligation) or in the tax year you settle the contest. My1040ez com However, to take the deduction in the year of payment or transfer, you must meet certain conditions. My1040ez com See Regulations section 1. My1040ez com 461-2. My1040ez com Related person. My1040ez com Under an accrual method of accounting, you generally deduct expenses when you incur them, even if you have not yet paid them. My1040ez com However, if you and the person you owe are related and that person uses the cash method of accounting, you must pay the expense before you can deduct it. My1040ez com Your deduction is allowed when the amount is includible in income by the related cash method payee. My1040ez com See Related Persons in Publication 538. My1040ez com Not-for-Profit Activities If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. My1040ez com Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit. My1040ez com The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. My1040ez com It does not apply to corporations other than S corporations. My1040ez com In determining whether you are carrying on an activity for profit, several factors are taken into account. My1040ez com No one factor alone is decisive. My1040ez com Among the factors to consider are whether: You carry on the activity in a businesslike manner, The time and effort you put into the activity indicate you intend to make it profitable, You depend on the income for your livelihood, Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business), You change your methods of operation in an attempt to improve profitability, You (or your advisors) have the knowledge needed to carry on the activity as a successful business, You were successful in making a profit in similar activities in the past, The activity makes a profit in some years, and You can expect to make a future profit from the appreciation of the assets used in the activity. My1040ez com Presumption of profit. My1040ez com An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. My1040ez com Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. My1040ez com The activity must be substantially the same for each year within this period. My1040ez com You have a profit when the gross income from an activity exceeds the deductions. My1040ez com If a taxpayer dies before the end of the 5-year (or 7-year) period, the “test” period ends on the date of the taxpayer's death. My1040ez com If your business or investment activity passes this 3- (or 2-) years-of-profit test, the IRS will presume it is carried on for profit. My1040ez com This means the limits discussed here will not apply. My1040ez com You can take all your business deductions from the activity, even for the years that you have a loss. My1040ez com You can rely on this presumption unless the IRS later shows it to be invalid. My1040ez com Using the presumption later. My1040ez com If you are starting an activity and do not have 3 (or 2) years showing a profit, you can elect to have the presumption made after you have the 5 (or 7) years of experience allowed by the test. My1040ez com You can elect to do this by filing Form 5213. My1040ez com Filing this form postpones any determination that your activity is not carried on for profit until 5 (or 7) years have passed since you started the activity. My1040ez com The benefit gained by making this election is that the IRS will not immediately question whether your activity is engaged in for profit. My1040ez com Accordingly, it will not restrict your deductions. My1040ez com Rather, you will gain time to earn a profit in the required number of years. My1040ez com If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. My1040ez com If you do not have 3 (or 2) years of profit, the limit can be applied retroactively to any year with a loss in the 5-year (or 7-year) period. My1040ez com Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. My1040ez com The period is extended only for deductions of the activity and any related deductions that might be affected. My1040ez com You must file Form 5213 within 3 years after the due date of your return (determined without extensions) for the year in which you first carried on the activity, or, if earlier, within 60 days after receiving written notice from the Internal Revenue Service proposing to disallow deductions attributable to the activity. My1040ez com Gross Income Gross income from a not-for-profit activity includes the total of all gains from the sale, exchange, or other disposition of property, and all other gross receipts derived from the activity. My1040ez com Gross income from the activity also includes capital gains and rents received for the use of property which is held in connection with the activity. My1040ez com You can determine gross income from any not-for-profit activity by subtracting the cost of goods sold from your gross receipts. My1040ez com However, if you determine gross income by subtracting cost of goods sold from gross receipts, you must do so consistently, and in a manner that follows generally accepted methods of accounting. My1040ez com Limit on Deductions If your activity is not carried on for profit, take deductions in the following order and only to the extent stated in the three categories. My1040ez com If you are an individual, these deductions may be taken only if you itemize. My1040ez com These deductions may be taken on Schedule A (Form 1040). My1040ez com Category 1. My1040ez com Deductions you can take for personal as well as for business activities are allowed in full. My1040ez com For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses, belong in this category. My1040ez com Deduct them on the appropriate lines of Schedule A (Form 1040). My1040ez com For tax years beginning after December 31, 2008, you can deduct a casualty loss on property you own for personal use only to the extent it is more than $500 and exceeds 10% of your adjusted gross income (AGI). My1040ez com The 10% AGI limitation does not apply to net disaster losses resulting from federally declared disasters in 2008 and 2009, and individuals are allowed to claim the net disaster losses even if they do not itemize their deductions. My1040ez com The reduction amount returns to $100 for tax years beginning after December 31, 2009. My1040ez com See Publication 547 for more information on casualty losses. My1040ez com For the limits that apply to home mortgage interest, see Publication 936. My1040ez com Category 2. My1040ez com Deductions that do not result in an adjustment to the basis of property are allowed next, but only to the extent your gross income from the activity is more than your deductions under the first category. My1040ez com Most business deductions, such as those for advertising, insurance premiums, interest, utilities, and wages, belong in this category. My1040ez com Category 3. My1040ez com Business deductions that decrease the basis of property are allowed last, but only to the extent the gross income from the activity exceeds the deductions you take under the first two categories. My1040ez com Deductions for depreciation, amortization, and the part of a casualty loss an individual could not deduct in category (1) belong in this category. My1040ez com Where more than one asset is involved, allocate depreciation and these other deductions proportionally. My1040ez com Individuals must claim the amounts in categories (2) and (3) as miscellaneous deductions on Schedule A (Form 1040). My1040ez com They are subject to the 2%-of-adjusted-gross-income limit. My1040ez com See Publication 529 for information on this limit. My1040ez com Example. My1040ez com Adriana is engaged in a not-for-profit activity. My1040ez com The income and expenses of the activity are as follows. My1040ez com Gross income $3,200 Subtract: Real estate taxes $700 Home mortgage interest 900 Insurance 400 Utilities 700 Maintenance 200 Depreciation on an automobile 600 Depreciation on a machine 200 3,700 Loss $(500) Adriana must limit her deductions to $3,200, the gross income she earned from the activity. My1040ez com The limit is reached in category (3), as follows. My1040ez com Limit on deduction $3,200 Category 1: Taxes and interest $1,600 Category 2: Insurance, utilities, and maintenance 1,300 2,900 Available for Category 3 $ 300 The $800 of depreciation is allocated between the automobile and machine as follows. My1040ez com $600 $800 x $300 = $225 depreciation for the automobile $200 $800 x $300 = $75 depreciation for the machine The basis of each asset is reduced accordingly. My1040ez com Adriana includes the $3,200 of gross income on line 21 (other income) of Form 1040. My1040ez com The $1,600 for category (1) is deductible in full on the appropriate lines for taxes and interest on Schedule A (Form 1040). My1040ez com Adriana deducts the remaining $1,600 ($1,300 for category (2) and $300 for category (3)) as other miscellaneous deductions on Schedule A (Form 1040) subject to the 2%-of-adjusted-gross-income limit. My1040ez com Partnerships and S corporations. My1040ez com If a partnership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. My1040ez com They are reflected in the individual shareholder's or partner's distributive shares. My1040ez com More than one activity. My1040ez com If you have several undertakings, each may be a separate activity or several undertakings may be combined. My1040ez com The following are the most significant facts and circumstances in making this determination. My1040ez com The degree of organizational and economic interrelationship of various undertakings. My1040ez com The business purpose that is (or might be) served by carrying on the various undertakings separately or together in a business or investment setting. My1040ez com The similarity of the undertakings. My1040ez com The IRS will generally accept your characterization if it is supported by facts and circumstances. My1040ez com If you are carrying on two or more different activities, keep the deductions and income from each one separate. My1040ez com Figure separately whether each is a not-for-profit activity. My1040ez com Then figure the limit on deductions and losses separately for each activity that is not for profit. My1040ez com Prev Up Next Home More Online Publications