Organizing Income and Expenses for Tax Purposes Part 3

Last month in Legal Log we discussed the usefulness of records to document revenue, expenditures, investment of cash and equipment and inventory for tax returns in a typical balloon-related business. This month we look at how to organize usual expenses to simplify reporting deducible business expenses.

Expense Categories
There are various ways to plan the various business expense records for federal income tax purposes. One source has been the expense categories listed in Schedule C of the federal individual income tax return (Form 1040), the federal partnership return (Form 1065) and the corporate tax return (Form 1140). With adjustments for the type of expenses common in a commercial balloon enterprise, they serve as a useful guide for organizing expense records for a ballooning related business. Of course, the specific categories used greatly depend on the particular information needs of each business owner. The following is an example of how to organize these expense records. These categories also can be used to designate each expenditure or payment in software accounting programs. Particular recurring expenses in these major categories can and should be set up as subcategories.

1. Advertising expense should include advertisements on television, radio, cable channels, newspapers, magazines, telephone directory yellow pages, advertising brochures, club newsletters, and giveaways with advertising matter. Mail advertising can be included in this category.

2. Deduct Bad Debts when an account, loan or debt that is due for services rendered, or from the sale or lease of inventory or property, becomes uncollectible. Deduct a bad debt in the year it becomes worthless.

3. Bank Service Charges includes all charges made by a bank related to your business checking or other business bank accounts. This not only means the charges for the account, but also for any special charges such as returned check charges, fund transfers, checking printing fees and all other bank-imposed charges on the account.

4. Car and Truck Expenses covers all operational costs for the business use of the vehicle(s). This includes gasoline, oil, maintenance, repairs, sales taxes or gasoline taxes (only if included in the price of the fuel or expense and not stated separately). These expenses also cover vehicle licenses and registrations, inspection fees, garage rent, and depreciation, and any other operational costs. If you use the vehicle for both business and personal purposes, the deduction must be pro-rated to the proportion attributable to the business use. (WARNING: the vehicle depreciation is not available unless you use the vehicle predominantly over 50% for business). Parking fees and tolls also should be set out with these expenses.

   One needs adequate documentation (records or other evidence) to prove the business use and the business expenses related to the vehicle, especially for mileage of so-called mixed use vehicles. (The IRS expects a mileage log to be produced documenting every business trip to the mile, and kept on a contemporaneous basis.) The IRS has adopted specific procedures on how lease payments on long-term leased vehicles may be treated as an expense; however, these payments still must be prorated for mixed use vehicles.

   Instead of deducting the actual operating costs, one may compute the deduction at a fixed rate per mile based upon business miles used. The mileage rate is set at one level for the first 15,000 miles of business use and a lower rate for every additional mile in a year. For 1995, that initial rate is 31 cents per mile. If the vehicle has depreciated fully, apply the lower rate for all business use. Full depreciation using the mileage rate occurs when a taxpayer has claimed 60,000 miles at the maximum standard rate.

   The standard rate does not include parking fees, tolls and certain state and local sales or use taxes (but does include gasoline taxes). These excluded items also may be claimed besides the standard rate. The election to use the standard rate than actual expenses must be made for the first year of use for vehicles placed in service after 1980. The disadvantage to the standard rate is that, usually, the deduction through the actual expenses will substantially exceed the amount computed through the standard rate.

5. All Commissions, Wages and Salaries paid to others, or any other payment for services rendered, are deductible. This includes payments to irregular crew members or payments to pilots who are independent contractors who conduct flights that the commercial aeronaut schedules. Of course, this also includes salaries or wages paid to regular employees. When payment is in the form of services or property, they are valued at fair market value.

6. Depletion, Amortization and Depreciation are deductions to allow for the exhaustion, wear and tear, and obsolescence of property, the depletion of resources, and writing off the costs of other intangible property. Depreciation is allowed only for things like buildings, machinery, equipment and vehicles. Land is generally not depreciated. Inventories and stock of trade are not depreciated. Patents, copyrights, leases, licenses, franchise contracts, and other intangible property can be amortized, if these have a limited period of existence. Goodwill, trade names and certain trademark uses are not depreciable, unless acquired from another entity.

   Depreciation begins when the business begins to use the asset. The amount varies with the type of property and when the item was placed in service. Most depreciated property placed in service must use a method known as Accelerated Cost Recovery System (ACRS). ACRS determines the deduction by using a statutory percentage of the basis of the item for each year the item is eligible for depreciation. There is an alternative ACRS schedule, and an option for a first-year expense deduction. The 1986 Tax Reform Act substantially modified the ACRS system. All older property (used since 1980) must use depreciation schedules from the older Class Life Asset Depreciation Range (CLADR) system.
   

   Examples of depreciated property for a commercial balloon enterprise include:
   1. The hot air balloon and its accessory equipment (inflation fan, tools, tether ropes, fire extinguisher, and miscellaneous items).
   2. Chase vehicle and trailer.
   3. Propane storage tanks.
   4. Equipment storage shed, or office building.
   5. Standard and Cellular Telephone equipment.
   6. Cameras and Audio Visual Equipment.
   7. Aircraft or CB radio.
   8. Office equipment and furniture.
   9. Professional library.
   10. Personal computer, and certain software programs.

7. Dues and Publications includes membership dues for trade and professional organizations, and business organizations such as the chamber of commerce (if such membership promotes one’s personal business interests.) For the aeronaut, dues can be for national aeronautic groups, local ballooning groups, and various business associations.

   You may deduct the cost of subscriptions to professional journals, technical journals, or trade journals. Assuming it meets the ordinary and necessary test, the cost of other publications, books and manuals also should be deductible. Thus, you should be able to deduct the cost of newsletters related to ballooning and aeronautics, or on business management. Books and manuals, if the useful life is more then one year, should be depreciated over their likely useful life.

   While computer software is generally depreciated, as the useful life exceeds one year, in recent years "off the shelf" software sold at retail is being updated on a frequent and ongoing basis. In this instance, such software programs or their periodic updates might be an expense, similar to a subscription to a publication, if the useful life of a particular version is one year or less. Tax return software is updated annually and would be deducted, and not depreciated, as it would be obsolete the following year unless you then use an updated version there had been no changes in federal tax laws, regulations and form. (A virtual impossibility!)

   The treatment of on-line services (e.g., the Internet, CompuServe, America Online, Prodigy, and the new Microsoft Network, as well as the telephone charges associated with these services, presumably, are treated as expenses and not as depreciated property, even though the software required to access such services may have to be depreciated.