Mixed Personal and Business Expenses

1
Mixed Personal and Business Expenses

• In this lecture we will look at expenses that are
  part business and part personal.
• We will look at to what extent they are
  deductible and what the tax code does to make
  sure that people dont take advantage of the
  business expense deduction unfairly.

2
Hobby Losses

• Business expenses are generally only deductible
  if the business is entered into for profit not
  just for a hobby or for fun.
• E.g., if you go to baseball games and try to
  catch foul balls so that you can sell them for
  profit on Ebay, that doesnt mean the tickets are
  deductible.
• An activity is presumed to be entered for profit
  if you actually make a profit in 3 of 5
  consecutive years.
• Otherwise, the taxpayer has to show that it is a
  business and not just a hobby. Otherwise, the
  activity is considered a business only if the
  circumstances indicate that its a business.
• E.g., whether its carried out in a businesslike
  manner, whether its objectively likely to
  generate a profit, etc.

3
Rental Income from Taxpayers Dwelling

• If the taxpayer owns a separate rental property,
  all its expenses are deductible.
• If a building owned by the taxpayer is used for
  personal purposes
• Examples lived in by taxpayer or family member
  or friend not paying market rent
• but, it is also used as a rental
• E.g., when the taxpayer is on vacation or for
  part of the year
• Then the profit motivated expenses are
  deductible but only the percentage of those
  expenses that corresponds to
• number of rental days divided by total number of
  days used

4
Home Offices

• The percentage of housing expense that
  corresponds to a home office can be deductible as
  a business expense, but only if
• 1) Its used as a principal place of business for
  the taxpayers trade OR
• 2) its used as a meeting place with clients,
  customers, etc. OR
• 3) its a separate structure from the home used
  entirely for business OR
• 4) the taxpayer is an employee using the office
  for the convenience of his/her employer
• The office must be used as a business and not
  just managing investments. (Although day trading
  can be a business.)
• The home office also has to be the taxpayers
  principal place of business. So, if the taxpayer
  has another principal office, the home office
  cannot qualify as a tax deduction.
• Cars, computers, etc. can also be business
  expenses but using a car to commute to work does
  not qualify.

5
Business Travel Expenses

• Travel expenses are deductible if its for a
  business purpose and
• The travel expenses are reasonable and
  appropriate
• The expenses are incurred when the taxpayer is
  away from home
• The expenses are necessary for the business, not
  taxpayer preference
• If a taxpayer maintains 2 residences for work
  purposes, the expenses are NOT deductible the
  travel has to be away from ones principal
  residence.
• If a trip is mixed business and pleasure, the
  cost of the trip may be deducted minus expenses
  that related to the pleasure component.

6
Business Meals and Entertainment

• Business meals and entertainment are deductible
  if
• 1) the item was related to the business conduct
  or meeting
• 2) the item (meal, golf game, etc.) was preceded
  by (or happens during) a bona fide business
  discussion
• (The activity cannot be primarily for social
  purposes or just to build goodwill.)
• Meal and entertainment deductions (other than de
  minimis fringe benefits like coffee in the
  office) are limited to 50 of the expense.
• Club dues, etc., are not deductible even if done
  to network with other business people.
• Travel, and expenses outside North America, are
  not deductible unless there was a reason it could
  not be done in North America.
• Adequate records, receipts, etc., must be kept
  for all such deductions!

7
Child Care Expenses

• Childcare is not generally deductible because
  its a personal expense, even if its necessary
  for the parent to work. However, there is a tax
  credit for a percentage of the child care
  expenses necessary to work. This is determined by
  a complex formula that works something like this
• 1) Figure out the number of dependents (which,
  for this purpose includes children under 13 and
  mentally incompetent dependents)
• 2) Take the amount actually spent on child care,
  but only up to 3,000 if theres one dependent
  and 6,000 for two or more
• 3) Take a percentage of that amount, which is
• 35, for those with AGI of 15,000 or less
• Subtract one percentage point for each 2,000 AGI
  over 15,000, but only up to a minimum of 20
• 4) Multiply the in 3 by the amount in 2 to
  determine your tax credit

8
Commuting Expenses

• Commuting expenses to work are generally not
  deductible because the location of the home, a
  personal decision, is the reason the commute is
  necessary.
• However, commuting to a temporary assignment
  location in a different area is a business travel
  expense.
• Also, if the taxpayer is away from home on
  business, the commute within that city to and
  from work locations is deductible, as long as it
  meets the other rules regarding business travel
  (discussed earlier in the course).
• Expenses relating to transporting tools of the
  business (such as a trailer to carry lawn care
  equipment for a landscaping company) are
  deductible as an ordinary business expense.

9
Clothing for Business

• Unreimbursed clothing expenses paid for by the
  employee are deductible if
• The clothing is used exclusively at work
• The employer requires the employees to wear that
  clothing to work
• The clothing is not suitable for general use.
• However, note (importantly) that even if clothing
  doesnt meet the above conditions, if its paid
  for by the employer, its generally not
  considered income to the employee and can be
  written off by the employer as an ordinary
  business expense.

10
Legal Expenses

• Legal fees related directly to the production of
  income can be deducted as an ordinary business
  expense.
• However, if legal fees are to protect the
  business for a long time to come, the expenses
  must be capitalized like any other infusion of
  capital to a business.
• Personal legal expenses are not deductible if
  they are personal in nature, even if they are
  necessary to protect a business.
• E.g., a divorce thats sought to protect an
  investment from the other spouse is not
  deductible.
• A deduction is allowed for legal expenses
  incurred with regard to preparing and filing tax
  returns and seeking refunds, etc.

11
Educational Expense Relating to Business

• Education in general is not deductible. However,
  once youre in a profession, continuing education
  to keep your license or to maintain your level of
  training or skill is a business expense.
• A wide variety of federal tax incentives,
  deductions and credits apply to financing an
  education.
• E.g., Hope Scholarship credit, lifetime learning
  credit, interest on student loans being
  deductible allowance of IRA withdrawals, etc.
• A detailed review of these is beyond the scope of
  the course.
• Qualified Tuition Programs (529 accounts) These
  accounts allow income allocated for higher
  education of a beneficiary (e.g., oneself or
  ones child) to grow tax free. Contributions to a
  529 accounts are not deductible but the earnings
  of the account are not taxable to anyone. Note
  that contributions are gifts for gift tax
  purposes.