Study Unit 4: Business Expenses

Which of the following tests is NOT used to determine whether an employee’s pay is deductible as an expense?

• Payments for services an employee rendered are reasonable. This test is based on the circumstances at the time you contract for the services, not on those existing when the amount of pay is questioned.

• Payments for services an employee rendered are ordinary and necessary and are directly or indirectly connected with your trade or business.

• Payments are made for services actually performed.

• Depending upon the taxpayer’s method of accounting, payments are made or expenses are incurred for services rendered during the year.

Answer explanation

Section 162(a)(1) allows a deduction for a reasonable allowance of salaries or other compensation for personal services actually rendered. The salary, wage, or other payment for services an employee renders must be an ordinary and necessary expense and directly connected with your trade or business. Indirectly connected services do not qualify.

Mr. Holiday is a calendar-year, accrual-basis taxpayer. His records concerning vacation pay for his employees reflect the following:

1. • $20,000 paid January 30, 2023, for vacations earned in 2022. Nothing was vested by December 31, 2022.

2. • $100,000 vacation pay accrued and paid in 2023.

3. • $14,000 accrued in 2023 but vested by December 31, 2023; paid by February 28, 2024.

4. • $10,000 accrued but not vested by December 31, 2023.

What amount can Mr. Holiday deduct as a business expense for 2023?

• $114,000

• 
  $124,000

• 
  $134,000

• 
  $144,000

Answer explanation

Accrual-basis taxpayers deduct vacation pay when it is paid, or if vested by year-end, when paid within 2 1/2 months after the close of the tax year. Therefore, Mr. Holiday can deduct $134,000 ($20,000 + $100,000 + $14,000) in the current year.

Mr. Aspen, a cash basis CPA, pays Gail Smith to work during tax season as a data entry clerk. Mr. Aspen pays Gail the following:

Hourly wages $6,275

Bonuses 500

Loan 150

How much can Mr. Aspen deduct as compensation?

• 
  $6,275

• 
  $6,775

• $6,925

• None of the answers are correct.

Answer explanation

Section 162(a)(1) permits a deduction for a reasonable allowance for salaries or other personal services actually rendered, including bonuses. The loan is deductible only if it is doubtful the employee will repay. Otherwise, it is treated as a loan and cannot be deducted. Therefore, the wages and bonuses are deductible, but the loan is not.

Allyn transferred office equipment used in his business to Wilson, an employee, as payment for services. At the time of the transfer, the equipment had a fair market value of $4,000 and an adjusted basis to Allyn of $4,750. How should Allyn report this transfer on his income tax return?

• Wage expense $4,750; loss on sale $0.

• 
  Wage expense $4,000; loss on sale $750.

• Wage expense $4,000; loss on sale $0.

• Wage expense $0; loss on sale $4,750.

Answer explanation

When property is transferred to an employee as compensation, the employer is entitled to a deduction of its fair market value on the date of the transfer. A gain or loss is realized on the date of the transfer as the difference between the fair market value and adjusted basis. Allyn will deduct $4,000 as wages and recognize a $750 loss on the sale of the equipment ($4,000 – $4,750).

Which of the following statements describes an incorrect treatment of employee benefit programs?

• A qualified benefit can be excluded from income because of specific provisions of law.

• An employer provides qualifying dependent care assistance to his or her employees. The employer can exclude from the employees’ wages up to $5,000 in assistance for each employee.

• The cost of group term life insurance coverage, up to $50,000, is excluded from income.

• 
  A cafeteria plan that discriminates in favor of certain employees as to eligibility to participate in the plan results in all employees being taxed on the sum of the value of all of the benefits offered by the plan.

Answer explanation

Section 125 defines a cafeteria plan as a written plan under which all participants are employees and the participants may choose among benefits consisting of cash and qualified benefits. If a cafeteria plan discriminates in favor of certain employees as to eligibility to participate in the plan, the favored employees are taxed on the taxable benefits they could have received under the plan.

Which of the following fringe benefits is NOT excludable from an employee’s wages for 2023?

• 
  Qualifying adoption expenses of $15,950 provided through an adoption assistance program.

• Educational assistance expenses of $5,250 provided through an educational assistance program.

• 
  $60,000 of group term life insurance covering the death of an employee.

• Dependent care assistance of $5,000 provided through a dependent care assistance program.

Answer explanation

Under Sec. 79, the cost of qualified group term life insurance paid by an employer is included in the employee’s gross income to the extent that such cost exceeds the cost of $50,000 of such insurance. The includible cost is determined on the basis of uniform premiums prescribed by regulations, rather than actual cost.

Payments made to employees are normally currently deductible as business expenses EXCEPT

• 
  Vacation pay paid to an employee even when the employee chooses not to take a vacation.

• Wages paid to employees for constructing a new building to be used in the business.

• Reasonable salaries paid to employee-shareholders for services rendered.

• Payments made to the beneficiary of a deceased employee that are reasonable in relation to the employee’s past services.

Answer explanation

Normally, Sec. 162(a)(1) allows a deduction for a reasonable allowance for salaries or other compensation for personal services. However, Sec. 263A requires all direct costs and a proper share of indirect costs allocable to property produced by the taxpayer to be capitalized. Wages paid to employees for constructing a new building would be direct costs allocable to that building. Those costs are capitalized and depreciated as part of the cost of the building rather than currently deductible.

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?

• $24,000

• $24,800

• 
  $31,200

• $32,000

Answer explanation

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 is deductible by the employer (up to $5,000 per employee). Karla can deduct $32,000 [$24,000 wages + ($3,600 child care × 2 employees) + $800 clothing].

Which of the following statements is true in respect to determining when fringe benefits are deductible?

• 
  Education expenses paid for employees are deductible as fringe benefits.

• Cafeteria plans are written plans that allow employees to choose among two or more benefits consisting of cash and qualified benefits.

• Only those fringe benefits that are includible in an employee’s wages are deductible.

• If an employer transfers a capital asset to an employee, no gain or loss is recognized by the employer or the employee.

Answer explanation

Cafeteria plans are employer-sponsored benefit packages that offer employees a choice between taking cash and receiving qualified benefits, such as accident and health coverage or group-term life insurance coverage. No amount is included in the gross income of the participant unless cash is chosen.

On December 31, 2023, Peggy, a calendar-year, accrual-method taxpayer, accrued wages that had been earned by her employees but had not yet been paid. Peggy also completed Forms W-2 for her employees based upon the wages for the year that had been paid. All employees are cash-basis taxpayers. The accrued wages are as follows:

Peggy’s husband $2,000

Peggy’s sister 1,500

Peggy’s niece 1,000

Unrelated employees 5,000

Total accrued wages $9,500

Of the total accrued wages, what is the amount deductible by Peggy in 2023 assuming they are paid by March 15, 2024?

• $5,000

• $6,000

• $7,500

• 
  $9,500

Answer explanation

A taxpayer using the accrual method of accounting may deduct the entire salary in the current year if economic performance has occurred. However, a deduction is not allowed for wages owed to a related person. Related persons include brothers, sisters, spouses, and lineal descendants, but not nieces. Therefore, Peggy may deduct the accrued wages to her niece and the unrelated employees. The wages must be paid within 2 1/2 months after the end of the year.