Tax Planning and Fiscal Policy

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Slide 1

This is a scene that introduces the setting for the scenario.

It has a shot of the tax firm and a welcome message. There is a button to start labeled “Begin.”

Slide 2

Scene 1

Wade and Carmen inside the accounting firm, in a conference room.

Wade: Hi, Carmen! Nice job on the third week of the interview process. Let's discuss the recommendation that you made to Emily and Michael Baxter from your last appointment, since they had quite a few complicated tax issues.

Carmen: Okay, that would be extremely helpful.

Wade: The recommendations you made appropriately addressed the tax issues, but not the legal complications the Baxters may encounter because of the illegal gambling activity.

The issue that should be explored further is the IRS' position on hobby losses.

Carmen: Right, because in order for expenses to be deductible, the taxpayer must prove that the venture was established to make a profit. Since many ventures that taxpayers engage in as a hobby can resemble those of a trade or business, the IRS makes the determination based upon whether the activity is profit seeking or a hobby based on an analysis of the facts and circumstances. An activity is presumed to be profit seeking if the business is profitable for three out of the last five years.

Wade: That’s right!

And finally, in reference to their son, we need to determine the amount of earned income he made during the year since he decided not to attend college. If his income is greater than the personal exemption amount, his status changes from a qualifying child to a qualifying relative, which impacts the tax credits the couple can claim on their return.

Carmen: Thank you, Mr. Johnson. I will definitely keep these factors in mind as I work with our future clients.

Wade: This past week, you got a chance to look at some deductions and losses. By fully utilizing the permitted deductions and losses and reporting them on your Schedule A or C, you can significantly reduce your tax liability. This week, you’ll get a chance to deal with depreciation, cost recovery, amortization, and depletion. Okay, let's get to work!

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Scene 2

Wade and Carmen in Wade’s office

Wade: Randy Charles has contacted the office again to explain that he has other deductions and needs to amend his tax return. I'll make an appointment for this afternoon.

Carmen: That works for me. Thanks again, Mr. Johnson.

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Scene 3

Wade, Carmen, Randy Charles in the conference room

Wade: Randy, as we discussed over the phone, you found additional documents to support your business expenses and need to make adjustments to your tax return?

Randy Charles: Yes, and I’m sorry for not bringing the documents or mentioning them during our last meeting.

Wade: That's not a problem at all. Please update Carmen regarding the changes, and as usual, she will collect the information and provide recommendations.

Carmen: It's nice to see you again, Mr. Charles. I will be happy to help you with your changes.

Randy Charles: It's nice to see you again, too, Carmen. Yes, I do have a couple of changes, but I’m not sure what impact the additional changes will have on my tax liability.

Carmen: Well, let's review the documents that you brought with you.

Randy Charles: I purchased office equipment and several computers for my business that I forgot to mention on my last visit to your office. I am also leasing an automobile and an office building. I’m not sure if I can claim expenses for improvements to a building that I do not own.

Please review my documents and let me know what other information you need in order for me to obtain higher deductions against my self-employment income.

Carmen: Thank you, Mr. Charles. I just need to ask you a few more clarifying questions.

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Scene 4

Wade and Carmen in the hallway

Wade: What are your thoughts about the tax issues?

Carmen: Well, from the additional information that Mr. Charles provided, he should be able to claim the expenses. In reference to the computer and office equipment, we need to determine the in-service dates in order to calculate his depreciation expense. We also need to determine if the Section 179 deduction is the best option for him, since it would allow him to deduct an expense for the entire cost of the equipment and computer instead of depreciating them over five years.

He also mentioned that he is leasing a building. The monthly lease payments are deductible business expenses. We should also determine the amount spent on making improvements to the building, which should be capitalized and depreciated over the useful life. We need to make him aware that the improvements will revert back to the owner at the end of the lease term unless they can be removed without damaging the owner's property. Any unrecovered basis in the leasehold improvements is deducted in the year the lease is terminated.

Wade: Outstanding, Carmen! I agree with your analysis.

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Interaction Slide

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Key chapter provisions

Depreciation and Cost Recovery

Introduction: Depreciation expense is recorded against earnings on the income statement in order to spread the initial purchase price of a fixed asset over several periods. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property.

Tab 1: Improvements to leased property is considered a leasehold improvement that must be amortized using the straight line method.

Tab 2: If you lease a car, truck, or van that you use in your business, you can use the standard mileage rate or actual expenses to figure out your deductible car expense.

Tab 3: Three factors determine how much depreciation you can deduct each year:

One, your basis in the property;

Two, the recovery period for the property; and

Three, the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures, and equipment, as an expense.

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Scene 5

Circle Interaction

From the information provided, we need to perform the following steps:

1. We need to review the purchase orders for the computers, building and vehicle.

2. We need to determine whether accelerated tax depreciation methods will be taken, such as first year deprecation or the Section 179 deduction.

3. We need to examine the supporting documents for proof of deductible automobile expenses.

Carmen: We need to determine the purchase dates for the equipment and computer to determine the month to use as a basis for prorating costs for the year.

There are also accelerated depreciation methods that can be used to significantly reduce the tax liability and an election to expense certain depreciable assets under Section 179. .

Supporting documents are necessary to provide proof that the vehicle was used for business purposes. In reference to the leasehold improvements, generally, a deduction can be taken for the cost to improve any part of a building that is nonresidential real property, except for elevators or the enlargement of a building. You cannot take any depreciation or Section 179 deduction unless you can prove your business or investment use with adequate records or with sufficient evidence to support your own statements.

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Scene 6

Carmen and Wade in Wade's office

Wade: Carmen, this all sounds good. Go ahead and update his tax return and then we’ll determine what other tax planning strategies we can develop to minimize his tax liability.

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Scene 7

Carmen, Wade, and Mr. Charles in the conference room

Carmen: Thank you for waiting, Mr. Charles. We have prepared a draft of your tax return for your review.

You have three years to amend your tax return from the filing deadline. You are entitled to depreciate your office equipment and computers. The depreciation is based upon the date that the assets were placed into service, so we need to view your documentation for the purchase dates for the computer and equipment.

The purchase of vehicles is considered a capital expense because the benefits last longer than one year. The costs can be recovered by using a Section One-Seven-Nine deduction, special depreciation allowance, and depreciation deductions.

In reference to improvements for the building, we made the determination that the costs were for leasehold improvements. These costs were made to improve the property, and they should be written-off as an expense by taking depreciation over the useful life. Any unrecovered basis in the leasehold improvements is deducted in the year the lease is terminated.

Please review the draft of the return and if there are no changes, we are ready to file the changes.

Randy Charles: Thanks, Carmen! I appreciate your help once again.

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 Scene 8

In Wade's office

Wade: Okay, it's approaching the end of the day. We have reviewed depreciation and cost recovery to allocate depreciation expenses to offset employee business expenses and reduce a taxpayer’s tax liability. I recommend that you continue to review the contents of Publication Seventeen to prepare for our topic next week, which will be Employee and Self-Employee Expenses.

By the way, don’t forget to participate in this week’s discussion questions.

I’ll see you next week!