Manuel is not subject to the business interest deduction limitation and paid the following amounts in Year 1 for interest:
Compute Manuel’s business interest deduction for Year 1. |
With regard to deductible taxes, which of the following statements is false?
No deduction is allowed for state or local inheritance taxes. On the federal estate tax return, a credit may be allowed; but for income tax purposes, no deduction is available.
| In August of Year 1, Jack, a calendar-year taxpayer, leased a building for 6 years beginning August 1 of Year 1 and ending July 31 of Year 7. Under the terms of the lease, his rent is $54,000 per year. He paid the first year’s rent on August 1 of Year 1. What amount can Jack deduct as rent expense on his Year 1 income tax return? |
Prepaid expenses covering a year or less are normally deductible when paid. However, prepayments for interest and rent must be allocated even when the prepayment is for a year or less. Since the lease began August 1, Jack may deduct the cost of only 5 months of rent. Therefore, Jack’s current-year deduction is limited to $22,500 [($54,000 ÷ 12 months) × 5 months].
All of the following costs must be included in valuing inventory using the full-absorption method EXCEPT
On March 1, Year 1, Fred, a cash-basis sole proprietor, leased a dance studio from Swing Room Renters for 3 years at $1,200 per month. During Year 1, Fred paid $28,000 on the lease, and in Year 2 he paid $6,000. What is the amount Fred can deduct on his income tax return for Year 2?
Rental expenses are generally deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Fred will deduct $14,400 (12 months × $1,200 rent per month) as rent expense in the current year.
Bob works on the loading dock for the Loaden Partnership from 7:00 a.m. to 3:00 p.m., Monday – Friday. Susan, the full-time secretary, works a 4-day week. Max, the bookkeeper, is the sole proprietor of the Books-I-Keep Accounting Service and is a licensed accountant. Max works a different schedule each week for Loaden but is very conscientious and reliable. How many of these individuals are considered employees?
On January 2 of the current year, Melanie paid $9,000 to acquire a lease on a new building for a term of 20 years. At her request, the lease also included two renewal options of 5 years each. Of the $9,000, $6,000 was for the original lease and $1,500 for each of the two renewal options. Melanie is a cash-basis taxpayer. What is her allowable deduction for the current year?
A cash-basis taxpayer normally deducts expenses in the year paid. However, the lease is an asset with a useful life that extends substantially beyond the close of the taxable year, so the cost of it must be capitalized and amortized over the life of the lease [Reg. 1.461-1(a)]. The term of the lease is treated as including all periods for which the lease may be renewed. The taxpayer’s allowable deduction in the current year is $300 ($9,000 ÷ 30-year useful life).
| All of the following tests are to be met for an employee’s pay to be deductible as an expense EXCEPT |
Section 162(a)(1) allows a deduction for a reasonable allowance of salaries or other compensation for personal services actually rendered. The employer is not required to have legal control over the individual. The degree of control exercised by an employer determines whether the compensated individual is an employee or an independent contractor. Greater control is exercised over the former than the latter.
Sluggo, a slot machine manufacturer, paid and incurred the following expenses during the year:
Raw materials | $50,000 |
Materials and supplies | 10,000 |
Freight-in on raw materials | 3,500 |
Freight on shipments of finished slot machines | 5,000 |
Direct labor | 35,000 |
Indirect labor | 15,000 |
Allocable overhead expenses for production | 20,000 |
The beginning inventory of finished goods was $35,000, and the ending inventory was $20,000. What is the amount of Sluggo’s cost of goods sold for the year?
Cost of goods sold is computed by starting with the beginning inventory, adding the cost of materials purchased during the year and the cost of production, and subtracting the ending inventory. Under Sec. 263A, manufacturers are required to use the full absorption method of costing, which means that both direct and indirect production costs must be included. Freight in charges are always added to the cost of the goods purchased. Costs to ship to the purchaser are selling expenses, not costs of inventory.
Beginning inventory | $ 35,000 | ||
Raw materials and labor: | |||
Direct labor | $35,000 | ||
Indirect labor | 15,000 | ||
Raw materials | 53,500 | ||
Materials and supplies | 10,000 | ||
Production overhead | 20,000 | 133,500 | |
Goods available for sale | $168,500 | ||
Less: Ending inventory | (20,000) | ||
Cost of goods sold | $148,500 |
Which of the following tests is NOT used to determine whether an employee’s pay is deductible as an expense?
Clyde operated a food distribution business. He leased a small warehouse in 2020 for $60,000 per year for a 3-year term. The lease was to start on July 1, 2020. Clyde paid the first year’s rent in advance in May 2020. Clyde then began to make monthly payments of $5,000 starting on July 1, 2021, and continuing on the first of the month for the balance of 2021. What rent expense may Clyde claim in 2021?
Assuming that Clyde is a cash-basis taxpayer, generally, rental expenses are deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Clyde will be able to deduct $60,000 of rent because he can deduct the allocated portion of the $30,000 prepaid rent and the $30,000 of current rent expenses paid.
On January 1, 2021, Carrie leased property for her business for 5 years for $6,200 per year. Carrie paid the full $31,000 during the first year of the lease. What is Carrie’s rental deduction for the year 2021?
Rent is any amount paid for property that is not owned. Rent that is not unreasonable is deductible. Prepaid rent and lease payments are deductible only for amounts that apply to the use of rented property during the tax year. The balance can be deducted only over the period to which it applies. Since Carrie’s payment for the first year would be $6,200, that is all she is able to deduct for the current tax year. In the remaining 4 years of the lease, she will be able to deduct the remainder.
In 2020, Bob purchased a lease for an office for 4 years, beginning January 1, 2021, to use in his tax practice. Of the $21,600 he paid, $5,000 was for the purchase of the existing lease with 4 years remaining and no options to renew. The remaining amount was for monthly lease payments paid in advance. How much can Bob deduct for 2021?
Assuming that Bob is a cash-basis taxpayer, generally, rental expenses are deductible by a cash-basis taxpayer-lessee in the tax year in which they are paid. However, the general rule does not apply to advance rental payments. Advance rental payments made by a cash-basis taxpayer-lessee are generally not deductible in the tax year in which they are made but must be allocated over the period of time for which the premises may be used as a result of such payments. Bob can deduct $5,400 in 2021 ($21,600 prepaid rent ÷ 4 years).
| Mr. Adams, a sole proprietor, derives his entire income from the operation of his grocery store business. On which schedule of Form 1040 should he deduct the state income taxes imposed on this income? | |
You buy an interest in a partnership (which is not subject to the business interest deduction limitation) for $20,000 using borrowed funds. The partnership’s only assets include machinery used in the business valued at $60,000 and stocks valued at $15,000. In 2021, you paid $2,000 interest on the loan. How much interest is deductible as interest attributed to a trade or business?
The interest deduction allowed on the borrowed funds attributed to an active trade or business is limited to the proportion of the partnership assets devoted to an active trade or business. The machinery consists of 80% ($60,000 ÷ $75,000) of the business assets used in an active trade or business. The stocks are not considered part of an active trade or business. Therefore, 80% of the $2,000, or $1,600, is deductible as interest attributed to an active trade or business.
During the year, Mr. Stone had the following expenditures relating to commercial real estate that he owns:
County property tax | $1,200 |
State property tax | 600 |
Assessment for street construction | 500 |
Charges for sewer and water service | 800 |
What is the amount Mr. Stone can deduct as real estate taxes on his commercial real estate for the year?
Section 164(a)(1) allows state and local real property taxes as a deduction. Assessments for street construction and charges for sewer and water services fall under 164(c). The deduction is denied in those certain cases.
On September 1 of the current year, Mr. Z, a cash-basis, calendar-year, self-employed mechanic, borrowed $10,000 at 10% for 5 years to purchase equipment with a useful life of 10 years. Z paid the lender a loan origination fee of $3,000 on the loan date. This fee was solely for the use of the money. How much of the $3,000 fee may Z deduct on his Schedule C for the current year?
Loan origination fees or points are effectively interest paid in advance. Prepaid interest is not deductible in advance except for the ordinary points paid on a home mortgage. The points must be amortized over the period of the loan. The loan is for a 5-year period, so the points should be amortized over 60 months (5 years × 12 months). Since 4 months are left in the current year after the loan is taken out, $200 ($3,000 ÷ 60 months × 4 months) is deductible as interest expense in the current year.
In Year 1, Marge purchased a lease on an office for 5 years beginning January 1, Year 2, to use in her tax practice. Of the $50,000 she paid, $10,000 was for the purchase of the existing lease with 5 years remaining and no options to renew. The remaining amount was for monthly lease payments paid in advance. How much can Marge deduct for Year 2?
Mr. K, a widget manufacturer, incurred and paid the following expenses during the year:
Mr. K had $12,000 in beginning inventory and $20,000 in ending inventory. What is Mr. K’s cost of goods sold? |
Cost of goods sold is computed by starting with the beginning inventory, adding the cost of materials purchased during the year and the cost of production, and subtracting the ending inventory. Under Sec. 263A, manufacturers are required to use the full absorption method of costing, which means that both direct and indirect production costs must be included. Freight in charges are always added to the cost of the goods purchased. Costs to ship to the purchaser are selling expenses, not costs of inventory.
Beginning inventory | $ 12,000 | ||
Raw materials and labor: | |||
Direct labor | $145,250 | ||
Raw materials | 52,000 | ||
Production overhead | 18,000 | 215,250 | |
Goods available for sale | $227,250 | ||
Less: Ending inventory | (20,000) | ||
Cost of goods sold | $207,250 |
Mr. Beach is a calendar-year, accrual-basis taxpayer. His records concerning vacation pay for his employees reflect the following:
All of the amounts were vested as of the last day of the tax year in which the vacation pay was earned. What amount can Mr. Beach deduct as a business expense for 2021?
Accrual-basis taxpayers deduct vacation pay when it is paid. Therefore, Mr. Beach can deduct $150,000 ($50,000 + $100,000) in the current year.
| Wilma Smith leased a building for 4 years beginning in March of the current year for $1,500 per month. On March 1 of the current year, Mrs. Smith paid her landlord $33,000 in rent. How much can she deduct on her current-year tax return? |
If rent is paid in advance, only the portion that applies to the current year may be deducted. The rest of the prepayment is deductible in the year in which the rent applies. Therefore, $15,000 is deductible in the current year ($1,500 × 10 months).
| Generally, an employer can deduct the cost of which of the following fringe benefits provided to an employee? |
Although the employer qualifies for a deduction, the benefits are not necessarily tax-free to the employee. Publication 15-B provides detailed lists of tax-free fringe benefits.
Which of the following expenses is deductible as compensation?
A deduction as wages is allowed for certain loans and advances to an employee, even if it is doubtful that the loan will be repaid. The loan is deductible only if it is for personal services actually performed. Otherwise, it is treated as a loan and cannot be deducted.
| All of the following statements about fringe benefits for 2021 are true EXCEPT | |
An employer can exclude from an employee’s income up to $14,440 for qualifying adoption expenses provided by the employer.
During the year, Mr. Jones had the following expenditures relating to commercial real estate that he owns:
What is the amount Mr. Jones can deduct as real estate taxes on his commercial real estate for the year? |
Section 164 allows state and local property taxes as a deduction. There are certain restrictions to the deduction. The tax must be an ad valorem tax and imposed on an annual basis [Sec. 164(b)(1)]. The state and county property taxes meet the restrictions. The assessment for the sewage construction is not imposed on an annual basis; thus, it is not deductible. The water and sewer charges are not ad valorem; thus, they are not deductible. However, if these taxes are for local benefit and they increase the value of the property, they may be added to the property’s basis.
| Karla operates a clothing store and paid $24,000 in wages to two employees ($12,000 each). She also provided for child care for their children valued at $3,600 for each employee. The employees also received clothing from the store, having a total value of $800, for working 5 extra days. How much is deductible by Karla? |
Section 162(a)(1) allows a deduction for reasonable compensation for personal services. Section 83(a) allows the deduction to an employer equal to the fair market value of property given to the employee when the property is transferable or is not subject to a substantial risk of forfeiture. The value of the child care services provided by the employer also constitutes compensation for the employee’s services and in 2021 is deductible by the employer (up to $10,500 per employee). Karla can deduct $32,000 [$24,000 wages + ($3,600 child care × 2) + $800 clothing].
During 2021, Ms. Smith had the following expenditures relating to commercial real estate she owns:
What is the amount Ms. Smith may deduct as real estate taxes on her commercial real estate for 2021?
Sales and/or local property taxes are an itemized deduction for individuals and a business expense for businesses. Thus, the $1,975 and the $980 are deductions as real estate taxes. Assessments for sewer construction are local improvements. These are taxes for things not currently deductible as a tax expense that tend to increase the value of real property and are added to the property’s adjusted basis. Charges for sewer and water service would not be deducted as real estate tax.
The FX Partnership manufactures garden hoses for sale. In the month of January, its sales were $80,000. During that month, the partnership had the following:
What is the cost of goods sold for the FX Partnership for the month of January? |
Cost of goods sold is computed by starting with the beginning inventory, adding the cost of materials purchased during the year and the cost of production, and subtracting the ending inventory. Under Sec. 263A, manufacturers are required to use the full absorption method of costing, which means that both direct and indirect production costs must be included. Freight charges are always added to the cost of the goods purchased.
Costs to ship to the purchaser are selling expenses, not costs of inventory.
Beginning inventory | $ 0 | |
Raw materials and labor: | ||
Direct labor | $27,000 | |
Raw materials | 36,585 | |
Production overhead | 6,000 | 69,585 |
Goods available for sale | $ 69,585 | |
Less: Ending inventory | (10,000) | |
Cost of goods sold | $ 59,585 |
On May 1, Year 1, Tom, a cash-basis taxpayer, leased office space from Downtown Plaza for 5 years beginning June 1, Year 1, for $1,000 per month. During Year 1, Tom paid $30,000, half of the lease amount, to Downtown Plaza. Tom made no payments during Year 2. How much can Tom deduct in Year 2?
Rory incurs the following amounts related to the rental of a piece of equipment:
Legal fees | $500 |
Commission on sale | $1,500 |
Miscellaneous fees | $2,000 |
Yearly rental payment | $4,000 |
Initial lease term | 5 years |
Optional renewal | 3 years |
What amount is amortized each year?
The costs of acquiring a lease are capitalized and amortized over the life of the lease. The term of the lease is treated as including all periods for which the lease may be renewed. Therefore, $500 is amortized [($500 + $1,500 + $2,000) ÷ (5 years + 3 years)].
The costs of acquiring a lease are capitalized and amortized over the life of the lease. The term of the lease is treated as including all periods for which the lease may be renewed. Therefore, $500 is amortized [($500 + $1,500 + $2,000) ÷ (5 years + 3 years)].
Section 162(a)(1) permits a deduction for a reasonable allowance for salaries or other compensation for personal services actually rendered. In determining what is reasonable, it is important to compare what other businesses would pay for similar services under similar circumstances (Reg. 1.162-7). Since May is below average in performance, he should receive the fair value of his services and not twice that of the next highest-paid player in the league.
Authors’ Note: The Sec. 162(m) limit of $1 million on deductible compensation does not apply to Mickie May’s compensation unless the Goliaths are a publicly held company and May is the company’s CEO, CFO, or one of the next three highest-paid executives. These conditions do not appear to be applicable in this case.
| Laura, a cash-basis taxpayer, leased a floor of a building for 6 years with an option to renew for an additional 4 years. Laura paid $3,000 to acquire the lease (one-third of which is attributable to the option) and also paid both the first and last years’ rent of $8,000 per year. How much can Laura deduct the first year? |
A cash-basis taxpayer normally deducts expenses in the year paid. However, the lease is an asset with a useful life that extends substantially beyond the close of the taxable year, so the cost of it must be capitalized and amortized over the life of the lease [Reg. 1.461-1(a)]. The term of the lease is treated as including all periods for which the lease may be renewed. Also, advance rental payments must be allocated over the period of time for which the premises may be used as a result of such payments. The taxpayer’s allowable deduction for the first year is $8,300 ($3,000 ÷ 10-year useful life + $8,000 current year’s rent).
Mr. Holiday is a calendar-year, accrual-basis taxpayer. His records concerning vacation pay for his employees reflect the following:
What amount can Mr. Holiday deduct as a business expense for 2021?
