Taxation for Decision Makers, 2012 Edition

chapter 5

Business Expenses

CHAPTER OUTLINE

Setting the Stage—An Introductory Case

Criteria for Deductibility

Timing of Deductions

Costs of Starting a Business

Operating Expenses

Limited Expense Deductions

Expanded Topics—Book/Tax Differences

Revisiting the Introductory Case

Summary

Key Terms

Test Yourself

Problem Assignments

Answers to Test Yourself

The treatment of many business expenses differs for tax and financial accounting. No tax deduction is allowed for expenses unless a specific provision in the Internal Revenue Code grants it. Additionally, a number of restrictions limit the current year's deduction. For example, expenses such as start-up costs may need to be amortized over several years, expenses such as meals and entertainment are only partially deductible, and expenses such as fines are not deductible at all.

The taxpayer's method of accounting determines the year in which a deduction is taken. An accrual-basis taxpayer deducts expenses when the all-events test is met and economic performance has occurred. A cash-basis taxpayer usually deducts expenses in the year paid. Cash-basis taxpayers may be able to make early payments of expenses at year-end to accelerate their tax deductions. Before making early payments, however, taxpayers should consider their tax rates for each year. Usually the time value of money dictates taking the deduction as soon as possible. If the tax rate is higher in the later year, however, the time value of money may not be enough to offset ...