Chapter 8 Business Income, Deductions, and Accounting Methods

1. [LO 1] What is an “ordinary and necessary” business expenditure?

2. [LO 1] Is cost of goods sold
deductible as a business expense for a business selling inventory? Explain.

3. [LO 1] Tom is an
attorney who often represents individuals injured while working (worker
liability claims). This year -Tom spent
$50 on a book entitled Plumbing For
Dummies and paid $500 to take a course on plumbing residences and rental
housing. Can you imagine circumstances
in which these expenditures would be deductible as “ordinary and necessary” for
an attorney. Explain.
4. [LO 1] Jake is a professional dog trainer who purchases and trains dogs
for use by law enforcement agencies.
Last year Jake purchased 500 bags of dog food from a large pet food
company at an average cost of $30 per bag.
This year, however, Jake purchased 500 bags of dog food from a local pet
food company at an average cost of $45 per bag.
Under what circumstances would the IRS likely challenge the cost Jake’s
dog food as unreasonable?
5. [LO 2] What kinds of deductions are
prohibited as a matter of public policy?
Why might Congress deem it important to disallow deductions for expenditures
against public policy?
6. [LO 2] Provide an example of an
expense associated with the production of tax-exempt income, and explain what
might happen if Congress repealed the prohibition against deducting expenses
incurred to produce tax-exempt income.
7. [LO 2] {Research} Jerry is a self-employed rock star and this year he
expended $1,000 on special “flashy” clothes and outfits. Jerry would like to deduct the cost of these
clothes as work-related because the clothes are not acceptable to Jerry’s sense
of fashion. Under what circumstances can
Jerry deduct the cost of these work clothes?

8. [LO 2] Jimmy is a sole proprietor of a small dry
cleaning business. This month Jimmy paid
for his groceries by writing checks from the checking account dedicated to the
dry cleaning business. Why do you
suppose Jimmy is using his business checking account rather than his personal
checking account to pay for personal expenditures?
9. [LO 2] Tim employs three sales representatives who
often take clients to dinner and provide entertainment in order to increase
sales. This year Tim reimbursed the
representatives $2,500 for the cost of meals and $8,250 for the cost of entertaining
clients. Describe the conditions under
which Tim can claim deductions for meals and entertainment.
10. [LO
2] Jenny uses her car for both business
and personal purposes. She purchased the
auto this year and drove 11,000 miles on business trips and 9,000 miles for personal
transportation. Describe how Jenny will
determine the amount of deductible expenses associated with the auto.
11. [LO
1, LO 2] What expenses are deductible when a taxpayer combines both business
and personal activities on a trip? How do the rules for international travel
differ from the rules for domestic travel?

12. [LO 2] Clyde lives and
operates a sole proprietorship in Dallas, Texas. This year Clyde found it necessary to travel
to Fort Worth (about 25 miles away) for legitimate business reasons. Is Clyde’s trip likely to qualify as “away
from home,” and why would this designation matter?
13. [LO 2] Describe the record-keeping
requirements for business deductions expenses including mixed-motive
expenditures.

14. [LO 3] Explain why the domestic
production activities deduction is sometimes described as an “artificial”
expense and the apparent rationale for this deduction. How might a business begin to determine the
domestic portion of revenues and expenses for products that are assembled in
the United States from parts made overseas?
15. [LO 3] Describe the calculation
of the domestic production activities deduction.

16. [LO 3] Describe the limits placed on the domestic
production activities deduction and explain the apparent reason for each
limitation.
17. [LO 3] Explain the difference between calculating a loss deduction for
a business asset that was partially damaged in an accident and a loss deduction
for a business asset that was stolen or completely destroyed in an accident.
18. [LO 3]
How do casualty loss deductions differ when a business asset is
completely destroyed as opposed to the destruction of a personal-use asset?
19. [LO
4] What is the difference between a full tax year and a short tax year? Describe circumstances in which a business
may have a short tax year.
20. [LO
4] Explain why a taxpayer might choose
one tax year end over another if given a choice.
21. [LO 4] Compare and contrast the
different year ends available to sole proprietorships, flow-through entities,
and C corporations.
22. [LO
4] Why does the law generally require partnerships to adopt a tax year
consistent with the year used by the partners?