This course is the first course in a five-course US Federal Tax Specialization. It covers and focuses on the U.S. federal tax system as it relates to individuals, employees, and sole proprietors. Key concepts covered include gross income and items that are statutorily included or excluded in it, personal and business expenses that qualify as tax deductions, and the differing tax treatments for employees versus self-employed taxpayers. Unlike many other introductory courses in tax and as part of this course’s comprehensive wrap-up, learners will be provided with practical and tangible experience reporting both income and expenses on the main individual tax return used in the US, Form 1040. If you have enjoyed this course, consider enrolling in our online graduate Accounting program. The University of Illinois at Urbana-Champaign, consistently ranked as one of the nation's top three accounting programs, now offers a master’s in accounting at a very affordable tuition rate and is completely online. The iMSA is a full Master of Accountancy program and students graduate with an MS that is highly recognized. Try an open course or two, then apply for admission into the credit-bearing version as you may be eligible to take credit-bearing courses during the application process. If you are missing any prerequisites for the full degree, you can complete Coursera courses to demonstrate readiness and strengthen your application for the iMSA. For more information on this exciting iMSA online program, refer to this link: https://www.coursera.org/degrees/imsa
Trade or Business Deductions: Political Contributions, Lobbying, Executive Compensation
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From the course by University of Illinois at Urbana-Champaign
Federal Taxation I: Individuals, Employees, and Sole Proprietors
60 ratings
University of Illinois at Urbana-Champaign
60 ratings
Course 1 of 5 in the Specialization U.S. Federal Taxation
From the lesson
MODULE 5: DEDUCTIONS AND LOSSES: IN GENERAL
In this module, you will learn about deductions, which is the term used in tax to describe an expense that is allowed to reduce a taxpayer’s tax liability. You will discover what Adjusted Gross Income is, why it is important, and how to calculate it. You will also learn the proper tax treatment of semi-profitable activities, such as hobbies.
Meet the Instructors
Petro Lisowsky, PhD, CPAAssociate Professor of Accountancy
College of Business: Department of Accountancy
[MUSIC]
Welcome back.
Now that we've set up the conceptual underpinnings of what a trade or
business deduction is, and when it's deductible,
let's now turn to some specific examples of deductible and non-deductible expenses.
In this video, we'll examine trade or business deductions related to political
contributions, lobbying, executive compensation, and
cost related to investigating whether or not to open a business.
In short, political contributions are simply not deductible.
That is giving money to a politician's campaign or
to a political party for political activities is not a deductible event.
The tax law has specified that giving political contributions should
not provide a tax benefit to the donor.
Along similar lines, but somewhat different, are lobbying expenditures.
Lobbying entails work to educate or sway a politician to agree with your position.
It's not a campaign contribution that is for the election or
reelection of a politician but
more gear towards educating the politician on a specific issue.
Here lobbying expenses are not deducible if they're trying to influence state or
federal legislation or the actions of certain high ranking officials, like for
example, the Secretary of Treasury or Secretary of State, the President or
Vice President.
However, one type of business expense that is generally deductible is membership
dues paid to a trade association or other group.
Usually this type of membership fee if business related is deductible.
But what happens if the trade group also lobbies?
If this happens,
then the portion of your dues that support lobbying efforts will not be deductible.
Only dues related to non lobbying activities will be deductible.
For example, dues paid to receive daily emails on best practices or
hot trends in the industry.
Therefore a pro-rata approach is taken to allocate the membership dues
between the deductible and non-deductible portions.
There are few exceptions here on deductibility of lobbying for businesses.
First lobbying to influence local legislation, for example at the city or
county level, is deductible.
For example, money spent by a business to lobby a city council member to improve
the traffic patterns around the business will be a deductible expense.
The second exception is monitoring legislation.
If a business spends money, for example to hire a firm,
to monitor what legislation is being crafted, even it's at a federal level,
then the cost associated with hiring the firm will be deductible.
However, if payments were made to the firm to lobby the federal officials,
those payments are not deductible.
Finally, De Minimus in-house lobbying for
otherwise non-deductible lobbying is actually deductible.
Namely, if a business spends $2,000 for one of its employees or
officers to lobby a federal official, then the costs are deductible because
they're considered small enough not to matter, that is, they're de minimus.
However, once the $2,000 threshold is crossed,
then none of the expenses related to lobbying federal officials is deductible.
The next major business deduction is related to executive compensation.
Generally compensation is deductible, that is wages paid to employees and officers.
However there are some limits here as well as exceptions.
Compensation paid to shareholder-employees of closely held
corporations must be reasonable to be deductible.
That is if a person both owns a corporation and also works in it,
the person has the power to set his or her own compensation.
This has some sticky issues because the person might set his or her compensation
artificially low or artificially high, depending on other tax considerations.
Such as, whether or not the person is receiving dividend payments or
wants to avoid self employment taxes on income earned.
The Irish is actually quite vigilant about assessing one of the compensation
of owner employees is reasonable.
One way to demonstrate reasonableness, is for the taxpayer to pay him or
her self a wage that's similar to what other owners pay themselves for
a similarly size firm in the same industry.
Separately, for publicly traded corporations,
the deduction for compensation of the CEO, and
four other highest compensated officers is limited to $1 million per year each.
This is known as a Section 162(m) limitation.
Note this only pertains to the deduction portion of the salary.
The publicly held corporation can pay whatever salary it would like to
the CEO but it can only deduct the first $1 million of that salary.
Any salary amount over the $1 million mark is not deductible.
However, there are some ways to get around this limit.
For example, if a company pays performance based bonuses or
provides equity share grants or deferred compensation plans, where the salary is
spread out over many years, as opposed to it being lumped into one year.
These activities will allow some slack to potentially deduct above
the $1 million mark.
Here's an example of how this would work.
Lloyd Blankfein, has been the CEO of Goldman Sachs, an investment bank.
His 2013 compensation,
as made publicly available through proxy statements were as follows.
So he received a $2 million base salary, plus a $19 million bonus,
which included $13.3 million in stock and $5.6 million in cash.
So in total, Mr. Blankfein received $21 million of compensation in 2013.
The question is, how much is deductible?
Only $1 million?
Well, actually in this case, 20 million of the 21 million is the deductible.
Of his salary, one million is deductible and
the other one million is not deductible.
However, his performance-based compensation or
his bonus in stock and in cash is fully deductible.
So in all, 19 million there is deductible on Goldman Sachs corporate tax return.
The idea behind allowing the full bonus to be deducted is because it's not
a guaranteed amount, it is an amount that's at risk.
If Mr. Blankfein does not meet certain targets then he
would only have earned the $2 million salary.
Therefore, the incentives provided to Mr.
Blankfein would afford Goldman Sachs with a deduction for
the entire bonus amount plus the first $1 million of salary.
The last trade or business deduction that we'll examine is related to
the investigation of a business.
For example you're someone interested in starting a business.
You incur a variety of expenses.
For example you travel to different potential locations to scout them out.
You meet with potential suppliers and customers, you drop surveys or marketing
reports and you incur professional fees perhaps to accountants and lawyers.
All of these are expenses incurred to determine the feasibility
of entering a new business, or for that matter for expanding an existing business.
So are these expenses deductible?
And if so, when?
First to determine if the expenses are deductible we have to check whether or
not the taxpayer is already engaged in the business or not.
If the taxpayer is already engaged in the business
the investigation expenses are deductible whether or not the business is expanded or
another business is acquired.
Here the dedication occurs in the year of payments if you're a cash basis tax payer.
Or the year in which the expenses were incurred,
if you're an accrual basis taxpayer.
Second, if the taxpayer is not already engaged in a business,
the deductibility of the investigation expenses depends
on whether the business is eventually entered into or acquired.
If the business is not entered into or acquired,
then the investigation expenses are not deductible and not capitalized.
If however the tax period does enter or acquire the new business,
the expenses are capitalized.
That is these costs become an asset on the taxpayer's balance sheet.
They cannot be deducted other than on the company's last year's tax return, for
example, when the company's sold.
However, a tax payer can elect a little bit better of a tax treatment than just
having an asset sitting on its books.
Here the taxpayer can elect to immediately deduct $5,000 of
the investigation costs in the first year.
With the remaining amount to be amortized straight-line over the next 180 months or
15 years.
However, if the total investigation costs exceed $50,000, then there is a dollar for
dollar reduction of the $5,000 immediate deduction.
Therefore, by the time the total investigation costs reach $55,000,
there's no allowable immediate deduction left.
Although, the rest of the start up costs can be amortized over the next 180 months.
So let's look at an example here.
Bubba is the owner of a successful restaurant chain in New Orleans.
And he's exploring the possibility of expanding to Champaign.
How much can he deduct?
Well first, let's say he incurs $28,000 of expenses
associated with this investigation but decides not to expand.
Well here, because Bubba is already in the restaurant business, the $28,000
he incurs to investigate a new restaurant location is deductible to Bubba.
Next, let's say Bubba also investigates opening a hotel that will be
part of a hotel chain.
His expenses for this investigation are $53,000.
And let's say the hotel does begin operations on July 1st.
Here we need to assess whether Bubba entered the hotel business.
He did, therefore the investigation costs may be deductible.
So how much?
If he makes the election to immediately deduct up to $5,000 and
then amortize the rest, we need to see how much he can deduct.
First, if the total investigation expenses are $50,000 or less,
then $5,000 is immediately deducted.
However, for every dollar above $50,000 that is spent on investigation cost,
that is $1 less of the $5,000 that Bubba can immediately deduct.
Therefore, $3,000 of the $5,000 eligible for the immediate
deduction is phased out, so that he can only immediately deduct $2,000.
What happens to the rest of the expense?
Well, if you spend $53,000 total, and can immediately
deduct $2,000 of it, that means $51,000 is left.
What can he do with it?
Well, he can amortize it, straight line over 180 months,
or we take the $51,000 balance divided by 180 to get $283.33 per month.
He began operations on July 1st, so
he gets six months worth of amortization here, or $1,700.
Therefore his total current year deduction is $3,700.
Or 2,000 from the immediate deduction, and 1,700 from the amortization.
Going forward, Bubba will be able to claim $283.33 per month for
the next 14 and a half years.
So next year for the full year, he'll claim $3,700 in
amortization deductions related to the investigation costs.
So to recap, in this video we discussed specific trade or business deductions.
Namely political contributions, lobbying, executive compensation, and
expenses related to the investigation of the business.
[MUSIC]
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