81. Joe operates a business that locates and purchases specialized assets for clients, among other activities. Joe uses the accrual method of accounting but he doesn’t keep any significant inventories of the specialized assets that he sells. Joe reported the following financial information for his business activities during year 0. Determine the effect of each of the following transactions on the taxable business income.
a. Joe has signed a contract to sell gadgets to the city. The contract provides that sales of gadgets are dependent upon a test sample of gadgets operating successfully. In December, Joe delivers $12,000 worth of gadgets to the city that will be tested in March. Joe purchased the gadgets especially for this contract and paid $8,500.
b. Joe paid $180 for entertaining a visiting out-of-town client. The client didn’t discuss business with Joe during this visit, but Joe wants to maintain good relations to encourage additional business next year.
c. On November 1, Joe paid $600 for premiums providing for $40,000 of “key man” insurance on the life of Joe’s accountant over the next 12 months.
d. At the end of the year (year 1), Joe’s business reports $9,000 of accounts receivable.
Based upon past experience, Joe believes that at least $2,000 of his new receivables will be uncollectible.
e. In December of year 0, Joe rented equipment for a large job. The rental agency required a minimum rental of three months ($1,000 per month), but Joe completed the job before year-end.
f. Joe hired a new sales representative as an employee and sent her to Dallas for a week to contact prospective out-of-state clients. Joe ended up reimbursing his employee $300 for airfare, $350 for lodging, $250 for meals, and $150 for entertainment. Joe requires the employee to account for all expenditures in order to be reimbursed.
g. Joe uses his BMW (a personal auto) to travel to and from his residence to his factory. However, he switches to a business vehicle if he needs to travel after he reaches the factory. Last month, the business vehicle broke down and he was forced to use the BMW both to travel to and from the factory and to visit work sites. He drove 120 miles visiting work sites and 46 miles driving to and from the factory from his home.
h. Joe paid a visit to his parents in Dallas over the Christmas holidays. While he was in the city, Joe spent $50 to attend a half-day business symposium. Joe paid $200 for airfare, $50 for meals during the symposium, and $20 on cab fare to the symposium.
a. Joe has signed a contract to sell gadgets to the city. The contract provides that sales of gadgets are dependent upon a test sample of gadgets operating successfully. In December, Joe delivers $12,000 worth of gadgets to the city that will be tested in March. Joe purchased the gadgets especially for this contract and paid $8,500.
If Joe elects the full-inclusion method he will recognize the entire payment of $12,000 as income minus the $8,500 cost of goods sold in year 0.
b. Joe paid $180 for entertaining a visiting out-of-town client. The client didn’t discuss business with Joe during this visit, but Joe wants to maintain good relations to encourage additional business next year.
Joe can only deduct $90 (180/2) for the entertainment even though no business was discussed. However, it is mentioned he will be conducting additional business the following year; it is indicator the visitor is one of his clients.
The cost of entertainment that occurs in a setting with little possibility of conducting a business discussion, such as a theatre or sports venue, will only be deductible if the entertainment directly precedes or follows a substantial business discussion, thereby satisfying the “associated with” test.
c. On November 1, Joe paid $600 for premiums providing for $40,000 of “key man” insurance on the life of Joe’s accountant over the next 12 months.
Joe deducts $0, the $600 premium on the life insurance of Joe’s account is tax exempt.
Expenses that do not help businesses generate taxable income are not allowed to offset taxable income. It also disallows deductions for life insurance premiums businesses pay on policies that cover the lives of officers or other key employees and compensate the business for the disruption and lost income they may experience due to a key employee’s death.
To determine the effect of each transaction on Joe's taxable business income, we need to consider the rules and regulations set by the tax authorities. Here's an analysis of each transaction:
a. Joe's delivery of gadgets: This transaction involves the sale of gadgets to the city. Since Joe uses the accrual method of accounting, the income from this contract will be recognized when the gadgets are delivered in March. Therefore, this transaction will have no effect on the taxable business income for year 0.
b. Entertainment expense: Joe paid $180 to entertain a client. To be deductible as a business expense, the entertainment should be directly related to the active conduct of the business, or associated with the active conduct of the business. Since the client visit did not involve any business discussion, this expense is considered a non-deductible personal expense. Therefore, it will have no effect on the taxable business income for year 0.
c. Key man insurance premium: The payment of $600 for key man insurance is considered an ordinary and necessary business expense and is deductible in the year it is paid. Therefore, this expense will reduce the taxable business income for year 0.
d. Accounts receivable and estimation of uncollectible amounts: Joe's accounts receivable valued at $9,000 will be included in the taxable business income for year 0. However, Joe estimates that $2,000 of the receivables will be uncollectible. According to the tax rules, a reasonable estimate of uncollectible amounts can be deducted. Therefore, the estimated uncollectible amount of $2,000 will reduce the taxable business income for year 0.
e. Equipment rental for a large job: The rental expense of $3,000 ($1,000 per month for three months) will be deductible in the year it is paid, which is year 0. Therefore, this expense will reduce the taxable business income for year 0.
f. Reimbursement of employee expenses: The reimbursed expenses (airfare, lodging, meals, and entertainment) totaling $1,050 will be deductible as business expenses in the year they are reimbursed. Therefore, these expenses will reduce the taxable business income for year 0.
g. Personal vehicle usage: Joe's use of the BMW for business purposes (visiting work sites) will be allowed for deduction based on the standard mileage rate or actual expenses incurred (including depreciation, gas, and maintenance) multiplied by a business use percentage. The mileage driven for business purposes (120 miles) and commuting purposes (46 miles) will be used to calculate the deductible portion. This deduction will reduce the taxable business income for year 0.
h. Business symposium expenses during personal visit: The expenses related to the business symposium (symposium fee, airfare, meals, and cab fare) totaling $320 will be deductible if they are directly related to the active conduct of the business. Since Joe attended the symposium while visiting his parents, the expenses are treated as personal expenses and are non-deductible. Therefore, they will have no effect on the taxable business income for year 0.
It is important to note that the analysis provided here is a general overview and should not be considered as tax advice. It is advisable to consult a tax professional or accountant for accurate and personalized guidance based on Joe's specific situation and the applicable tax regulations.