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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.

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Trade or Business Deductions: Political Contributions, Lobbying, Executive Compensation

Federal Taxation I: Individuals, Employees, and Sole Proprietors

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