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1040x Tax Form

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1040x Tax Form

1040x tax form Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. 1040x tax form Hybrid method. 1040x tax form Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). 1040x tax form Accounting Periods You must use a tax year to figure your taxable income. 1040x tax form A tax year is an annual accounting period for keeping records and reporting income and expenses. 1040x tax form An annual accounting period does not include a short tax year (discussed later). 1040x tax form You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). 1040x tax form Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. 1040x tax form A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. 1040x tax form You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. 1040x tax form This section discusses: A calendar year. 1040x tax form A fiscal year (including a period of 52 or 53 weeks). 1040x tax form A short tax year. 1040x tax form An improper tax year. 1040x tax form A change in tax year. 1040x tax form Special situations that apply to individuals. 1040x tax form Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. 1040x tax form Special situations that apply to corporations. 1040x tax form Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. 1040x tax form If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. 1040x tax form If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. 1040x tax form See Change in Tax Year, later. 1040x tax form Generally, anyone can adopt the calendar year. 1040x tax form However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. 1040x tax form Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. 1040x tax form If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. 1040x tax form 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. 1040x tax form If you make this election, your 52-53-week tax year must always end on the same day of the week. 1040x tax form Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. 1040x tax form For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. 1040x tax form Election. 1040x tax form   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. 1040x tax form The month in which the new 52-53-week tax year ends. 1040x tax form The day of the week on which the tax year always ends. 1040x tax form The date the tax year ends. 1040x tax form It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. 1040x tax form   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. 1040x tax form   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. 1040x tax form Example. 1040x tax form Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. 1040x tax form For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. 1040x tax form Short Tax Year A short tax year is a tax year of less than 12 months. 1040x tax form A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. 1040x tax form Tax on a short period tax return is figured differently for each situation. 1040x tax form Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. 1040x tax form Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. 1040x tax form Example 1. 1040x tax form XYZ Corporation was organized on July 1, 2012. 1040x tax form It elected the calendar year as its tax year. 1040x tax form Therefore, its first tax return was due March 15, 2013. 1040x tax form This short period return will cover the period from July 1, 2012, through December 31, 2012. 1040x tax form Example 2. 1040x tax form A calendar year corporation dissolved on July 23, 2012. 1040x tax form Its final return is due by October 15, 2012. 1040x tax form It will cover the short period from January 1, 2012, through July 23, 2012. 1040x tax form Death of individual. 1040x tax form   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. 1040x tax form The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. 1040x tax form In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. 1040x tax form Example. 1040x tax form   Agnes Green was a single, calendar year taxpayer. 1040x tax form She died on March 6, 2012. 1040x tax form Her final income tax return must be filed by April 15, 2013. 1040x tax form It will cover the short period from January 1, 2012, to March 6, 2012. 1040x tax form Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. 1040x tax form The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. 1040x tax form Figure tax for a short year under the general rule, explained below. 1040x tax form You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. 1040x tax form General rule. 1040x tax form   Income tax for a short tax year must be annualized. 1040x tax form However, self-employment tax is figured on the actual self-employment income for the short period. 1040x tax form Individuals. 1040x tax form   An individual must figure income tax for the short tax year as follows. 1040x tax form Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. 1040x tax form You must itemize deductions when you file a short period tax return. 1040x tax form Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. 1040x tax form Subtract the amount in (2) from the amount in (1). 1040x tax form The result is your modified taxable income. 1040x tax form Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. 1040x tax form The result is your annualized income. 1040x tax form Figure the total tax on your annualized income using the appropriate tax rate schedule. 1040x tax form Multiply the total tax by the number of months in the short tax year and divide the result by 12. 1040x tax form The result is your tax for the short tax year. 1040x tax form Relief procedure. 1040x tax form   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. 1040x tax form It may result in less tax. 1040x tax form Under this procedure, the tax is figured by two separate methods. 1040x tax form If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. 1040x tax form For more information, see section 443(b)(2) of the Internal Revenue Code. 1040x tax form Alternative minimum tax. 1040x tax form   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. 1040x tax form Multiply the AMTI by 12. 1040x tax form Divide the result by the number of months in the short tax year. 1040x tax form Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. 1040x tax form The result is the annualized AMT. 1040x tax form Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. 1040x tax form   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. 1040x tax form For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. 1040x tax form Tax withheld from wages. 1040x tax form   You can claim a credit against your income tax liability for federal income tax withheld from your wages. 1040x tax form Federal income tax is withheld on a calendar year basis. 1040x tax form The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. 1040x tax form Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. 1040x tax form For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. 1040x tax form See Accounting Periods, earlier, for a description of permissible tax years. 1040x tax form To change to a proper tax year, you must do one of the following. 1040x tax form If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. 1040x tax form Attach a completed Form 1128 to the amended tax return. 1040x tax form Write “FILED UNDER REV. 1040x tax form PROC. 1040x tax form 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. 1040x tax form If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. 1040x tax form Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. 1040x tax form See the Instructions for Form 1128 for exceptions. 1040x tax form If you qualify for an automatic approval request, a user fee is not required. 1040x tax form Individuals Generally, individuals must adopt the calendar year as their tax year. 1040x tax form An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. 1040x tax form Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. 1040x tax form A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. 1040x tax form The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). 1040x tax form The following discussions provide the rules for partnerships, S corporations, and PSCs. 1040x tax form Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. 1040x tax form The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. 1040x tax form The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. 1040x tax form The partnership can establish a business purpose for a different tax year. 1040x tax form The rules for the required tax year for partnerships are as follows. 1040x tax form If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. 1040x tax form If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. 1040x tax form A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. 1040x tax form If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. 1040x tax form If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. 1040x tax form Least aggregate deferral of income. 1040x tax form   The tax year that results in the least aggregate deferral of income is determined as follows. 1040x tax form Figure the number of months of deferral for each partner using one partner's tax year. 1040x tax form Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. 1040x tax form Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). 1040x tax form Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). 1040x tax form Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. 1040x tax form   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. 1040x tax form If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. 1040x tax form However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. 1040x tax form Example. 1040x tax form A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. 1040x tax form A uses the calendar year and B uses a fiscal year ending November 30. 1040x tax form P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. 1040x tax form Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. 1040x tax form 5 -0- -0- B 11/30 0. 1040x tax form 5 11 5. 1040x tax form 5 Total Deferral 5. 1040x tax form 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. 1040x tax form 5 1 0. 1040x tax form 5 B 11/30 0. 1040x tax form 5 -0- -0- Total Deferral 0. 1040x tax form 5 When determination is made. 1040x tax form   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. 1040x tax form However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. 1040x tax form This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. 1040x tax form Short period return. 1040x tax form   When a partnership changes its tax year, a short period return must be filed. 1040x tax form The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. 1040x tax form   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. 1040x tax form The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. 1040x tax form 706-1. 1040x tax form ” More information. 1040x tax form   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. 1040x tax form S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. 1040x tax form A permitted tax year is any of the following. 1040x tax form The calendar year. 1040x tax form A tax year elected under section 444 of the Internal Revenue Code. 1040x tax form See Section 444 Election, below for details. 1040x tax form A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. 1040x tax form Any other tax year for which the corporation establishes a business purpose. 1040x tax form If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. 1040x tax form For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. 1040x tax form Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. 1040x tax form The corporation makes an election under section 444 of the Internal Revenue Code. 1040x tax form See Section 444 Election, below for details. 1040x tax form The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. 1040x tax form The corporation establishes a business purpose for a fiscal year. 1040x tax form See the Instructions for Form 1120 for general information about PSCs. 1040x tax form For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. 1040x tax form Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. 1040x tax form Certain restrictions apply to the election. 1040x tax form A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). 1040x tax form The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. 1040x tax form A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. 1040x tax form It is not a member of a tiered structure (defined in section 1. 1040x tax form 444-2T of the regulations). 1040x tax form It has not previously had a section 444 election in effect. 1040x tax form It elects a year that meets the deferral period requirement. 1040x tax form Deferral period. 1040x tax form   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. 1040x tax form Retaining tax year. 1040x tax form   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. 1040x tax form This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. 1040x tax form Adopting or changing tax year. 1040x tax form   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. 1040x tax form The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. 1040x tax form This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. 1040x tax form If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. 1040x tax form Example 1. 1040x tax form BD Partnership uses a calendar year, which is also its required tax year. 1040x tax form BD cannot make a section 444 election because the deferral period is zero. 1040x tax form Example 2. 1040x tax form E, a newly formed partnership, began operations on December 1. 1040x tax form E is owned by calendar year partners. 1040x tax form E wants to make a section 444 election to adopt a September 30 tax year. 1040x tax form E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. 1040x tax form Making the election. 1040x tax form   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. 1040x tax form Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. 1040x tax form For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. 1040x tax form Note. 1040x tax form If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. 1040x tax form   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. 1040x tax form Example 1. 1040x tax form AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. 1040x tax form AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. 1040x tax form Example 2. 1040x tax form The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. 1040x tax form AB must file Form 8716 by March 17, 2013. 1040x tax form Example 3. 1040x tax form B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. 1040x tax form B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. 1040x tax form B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. 1040x tax form Note. 1040x tax form The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. 1040x tax form Extension of time for filing. 1040x tax form   There is an automatic extension of 12 months to make this election. 1040x tax form See the Form 8716 instructions for more information. 1040x tax form Terminating the election. 1040x tax form   The section 444 election remains in effect until it is terminated. 1040x tax form If the election is terminated, another section 444 election cannot be made for any tax year. 1040x tax form   The election ends when any of the following applies to the partnership, S corporation, or PSC. 1040x tax form The entity changes to its required tax year. 1040x tax form The entity liquidates. 1040x tax form The entity becomes a member of a tiered structure. 1040x tax form The IRS determines that the entity willfully failed to comply with the required payments or distributions. 1040x tax form   The election will also end if either of the following events occur. 1040x tax form An S corporation's S election is terminated. 1040x tax form However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. 1040x tax form A PSC ceases to be a PSC. 1040x tax form If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. 1040x tax form Required payment for partnership or S corporation. 1040x tax form   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. 1040x tax form The required payment for that year (or any preceding tax year) is more than $500. 1040x tax form    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. 1040x tax form   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. 1040x tax form If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. 1040x tax form If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. 1040x tax form Applicable election year. 1040x tax form   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. 1040x tax form Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. 1040x tax form Required distribution for PSC. 1040x tax form   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. 1040x tax form If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. 1040x tax form The amount deferred is treated as paid or incurred in the following tax year. 1040x tax form   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). 1040x tax form Back-up election. 1040x tax form   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. 1040x tax form If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). 1040x tax form Making back-up election. 1040x tax form   The general rules for making a section 444 election, as discussed earlier, apply. 1040x tax form When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. 1040x tax form However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. 1040x tax form Activating election. 1040x tax form   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. 1040x tax form The due date for filing Form 8752 and making the payment is the later of the following dates. 1040x tax form May 15 of the calendar year following the calendar year in which the applicable election year begins. 1040x tax form 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. 1040x tax form   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. 1040x tax form ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). 1040x tax form A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. 1040x tax form However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. 1040x tax form Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. 1040x tax form See the Instructions for Form 1128 for details. 1040x tax form Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. 1040x tax form A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. 1040x tax form An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. 1040x tax form Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. 1040x tax form See the Instructions for Form 1128 for details. 1040x tax form Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. 1040x tax form Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. 1040x tax form You choose an accounting method when you file your first tax return. 1040x tax form If you later want to change your accounting method, you must get IRS approval. 1040x tax form See Change in Accounting Method, later. 1040x tax form No single accounting method is required of all taxpayers. 1040x tax form You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. 1040x tax form In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. 1040x tax form You must use the same accounting method from year to year. 1040x tax form An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. 1040x tax form If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. 1040x tax form Methods you can use. 1040x tax form   In general, you can compute your taxable income under any of the following accounting methods. 1040x tax form Cash method. 1040x tax form Accrual method. 1040x tax form Special methods of accounting for certain items of income and expenses. 1040x tax form A hybrid method which combines elements of two or more of the above accounting methods. 1040x tax form The cash and accrual methods of accounting are explained later. 1040x tax form Special methods. 1040x tax form   This publication does not discuss special methods of accounting for certain items of income or expenses. 1040x tax form For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. 1040x tax form The following publications also discuss special methods of reporting income or expenses. 1040x tax form Publication 225, Farmer's Tax Guide. 1040x tax form Publication 535, Business Expenses. 1040x tax form Publication 537, Installment Sales. 1040x tax form Publication 946, How To Depreciate Property. 1040x tax form Hybrid method. 1040x tax form   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. 1040x tax form However, the following restrictions apply. 1040x tax form If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. 1040x tax form See Exceptions under Inventories, later. 1040x tax form Generally, you can use the cash method for all other items of income and expenses. 1040x tax form See Inventories, later. 1040x tax form If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. 1040x tax form If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. 1040x tax form Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. 1040x tax form Business and personal items. 1040x tax form   You can account for business and personal items using different accounting methods. 1040x tax form For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. 1040x tax form Two or more businesses. 1040x tax form   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. 1040x tax form No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. 1040x tax form Note. 1040x tax form If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. 1040x tax form Cash Method Most individuals and many small businesses use the cash method of accounting. 1040x tax form Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. 1040x tax form See Inventories, later, for exceptions to this rule. 1040x tax form Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. 1040x tax form If you receive property and services, you must include their fair market value (FMV) in income. 1040x tax form Constructive receipt. 1040x tax form   Income is constructively received when an amount is credited to your account or made available to you without restriction. 1040x tax form You need not have possession of it. 1040x tax form If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. 1040x tax form Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. 1040x tax form Example. 1040x tax form You are a calendar year taxpayer. 1040x tax form Your bank credited, and made available, interest to your bank account in December 2012. 1040x tax form You did not withdraw it or enter it into your books until 2013. 1040x tax form You must include the amount in gross income for 2012, the year you constructively received it. 1040x tax form You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. 1040x tax form You must report the income in the year the property is received or made available to you without restriction. 1040x tax form Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. 1040x tax form This includes business expenses for which you contest liability. 1040x tax form However, you may not be able to deduct an expense paid in advance. 1040x tax form Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. 1040x tax form Expense paid in advance. 1040x tax form   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. 1040x tax form   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. 1040x tax form 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. 1040x tax form   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. 1040x tax form See Change in Accounting Method, later. 1040x tax form Example 1. 1040x tax form You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. 1040x tax form The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. 1040x tax form Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. 1040x tax form Example 2. 1040x tax form You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. 1040x tax form The 12-month rule applies. 1040x tax form Therefore, the full $10,000 is deductible in 2012. 1040x tax form Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. 1040x tax form (See Special rules for farming businesses, later. 1040x tax form ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. 1040x tax form See Gross receipts test, below. 1040x tax form A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. 1040x tax form See Gross receipts test, below. 1040x tax form A tax shelter. 1040x tax form Exceptions The following entities are not prohibited from using the cash method of accounting. 1040x tax form Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. 1040x tax form A qualified personal service corporation (PSC). 1040x tax form Gross receipts test. 1040x tax form   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. 1040x tax form A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. 1040x tax form    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. 1040x tax form See Gross receipts test for qualifying taxpayers, for more information. 1040x tax form Generally, a partnership applies the test at the partnership level. 1040x tax form Gross receipts for a short tax year are annualized. 1040x tax form Aggregation rules. 1040x tax form   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. 1040x tax form Change to accrual method. 1040x tax form   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. 1040x tax form Special rules for farming businesses. 1040x tax form   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. 1040x tax form However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. 1040x tax form For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). 1040x tax form   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. 1040x tax form For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. 1040x tax form See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. 1040x tax form Qualified PSC. 1040x tax form   A PSC that meets the following function and ownership tests can use the cash method. 1040x tax form Function test. 1040x tax form   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. 1040x tax form Ownership test. 1040x tax form   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. 1040x tax form Employees performing services for the corporation in a field qualifying under the function test. 1040x tax form Retired employees who had performed services in those fields. 1040x tax form The estate of an employee described in (1) or (2). 1040x tax form Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. 1040x tax form   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. 1040x tax form Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. 1040x tax form Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. 1040x tax form   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. 1040x tax form Change to accrual method. 1040x tax form   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. 1040x tax form A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. 1040x tax form Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. 1040x tax form The purpose of an accrual method of accounting is to match income and expenses in the correct year. 1040x tax form Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. 1040x tax form Under this rule, you report an amount in your gross income on the earliest of the following dates. 1040x tax form When you receive payment. 1040x tax form When the income amount is due to you. 1040x tax form When you earn the income. 1040x tax form When title has passed. 1040x tax form Estimated income. 1040x tax form   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. 1040x tax form Change in payment schedule. 1040x tax form   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. 1040x tax form Continue this procedure until you complete the services, then account for the difference. 1040x tax form Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. 1040x tax form However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. 1040x tax form However, you cannot postpone including any payment beyond that tax year. 1040x tax form Service agreement. 1040x tax form   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. 1040x tax form This includes an agreement providing for incidental replacement of parts or materials. 1040x tax form However, this applies only if you offer the property without a service agreement in the normal course of business. 1040x tax form Postponement not allowed. 1040x tax form   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. 1040x tax form You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. 1040x tax form You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. 1040x tax form Examples. 1040x tax form   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. 1040x tax form Example 1. 1040x tax form You manufacture, sell, and service computers. 1040x tax form You received payment in 2012 for a one-year contingent service contract on a computer you sold. 1040x tax form You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. 1040x tax form Example 2. 1040x tax form You are in the television repair business. 1040x tax form You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. 1040x tax form You include the payments in gross income as you earn them. 1040x tax form Example 3. 1040x tax form You own a dance studio. 1040x tax form On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. 1040x tax form You give eight lessons in 2012. 1040x tax form Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. 1040x tax form Example 4. 1040x tax form Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. 1040x tax form You must include the entire payment in income in 2012 since part of the services may be performed after the following year. 1040x tax form Guarantee or warranty. 1040x tax form   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. 1040x tax form Prepaid rent. 1040x tax form   You cannot postpone reporting income from prepaid rent. 1040x tax form Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. 1040x tax form You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. 1040x tax form Books and records. 1040x tax form   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. 1040x tax form Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. 1040x tax form IRS approval. 1040x tax form   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. 1040x tax form Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. 1040x tax form However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. 1040x tax form An agreement includes a gift certificate that can be redeemed for goods. 1040x tax form Amounts due and payable are considered received. 1040x tax form How to report payments. 1040x tax form   Generally, include an advance payment in income in the year in which you receive it. 1040x tax form However, you can use the alternative method, discussed next. 1040x tax form Alternative method of reporting. 1040x tax form   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. 1040x tax form Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. 1040x tax form Example 1. 1040x tax form You are a retailer. 1040x tax form You use an accrual method of accounting and account for the sale of goods when you ship the goods. 1040x tax form You use this method for both tax and financial reporting purposes. 1040x tax form You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. 1040x tax form However, see Exception for inventory goods, later. 1040x tax form Example 2. 1040x tax form You are a calendar year taxpayer. 1040x tax form You manufacture household furniture and use an accrual method of accounting. 1040x tax form Under this method, you accrue income for your financial reports when you ship the furniture. 1040x tax form For tax purposes, you do not accrue income until the furniture has been delivered and accepted. 1040x tax form In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. 1040x tax form You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. 1040x tax form For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. 1040x tax form Information schedule. 1040x tax form   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. 1040x tax form Total advance payments received in the current tax year. 1040x tax form Total advance payments received in earlier tax years and not included in income before the current tax year. 1040x tax form Total payments received in earlier tax years included in income for the current tax year. 1040x tax form Exception for inventory goods. 1040x tax form   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. 1040x tax form You account for the advance payment under the alternative method (discussed earlier). 1040x tax form You have received a substantial advance payment on the agreement (discussed next). 1040x tax form You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. 1040x tax form These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. 1040x tax form   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. 1040x tax form You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. 1040x tax form If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. 1040x tax form Note. 1040x tax form You must report any advance payments you receive after the second year in the year received. 1040x tax form No further deferral is allowed. 1040x tax form Substantial advance payments. 1040x tax form   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. 1040x tax form Example. 1040x tax form You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. 1040x tax form In 2008, you entered into a contract for the sale of goods properly includible in your inventory. 1040x tax form The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. 1040x tax form You receive the following advance payments under the contract. 1040x tax form 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. 1040x tax form In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. 1040x tax form Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. 1040x tax form   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. 1040x tax form You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. 1040x tax form If no such goods are on hand, then estimate the cost necessary to satisfy the contract. 1040x tax form   No further deferral is allowed. 1040x tax form You must include in gross income the advance payment you receive each remaining year of the contract. 1040x tax form Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. 1040x tax form IRS approval. 1040x tax form   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. 1040x tax form Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. 1040x tax form The all-events test has been met. 1040x tax form The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. 1040x tax form Economic performance has occurred. 1040x tax form Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. 1040x tax form If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. 1040x tax form If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. 1040x tax form Example. 1040x tax form You are a calendar year taxpayer. 1040x tax form You buy office supplies in December 2012. 1040x tax form You receive the supplies and the bill in December, but you pay the bill in January 2013. 1040x tax form You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. 1040x tax form Your office supplies may qualify as a recurring item, discussed later. 1040x tax form If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). 1040x tax form Workers' compensation and tort liability. 1040x tax form   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. 1040x tax form If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. 1040x tax form Taxes. 1040x tax form   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. 1040x tax form are paid. 1040x tax form However, you can elect to treat taxes as a recurring item, discussed later. 1040x tax form You can also elect to ratably accrue real estate taxes. 1040x tax form See chapter 5 of Publication 535 for information about real estate taxes. 1040x tax form Other liabilities. 1040x tax form   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. 1040x tax form Interest. 1040x tax form   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. 1040x tax form Compensation for services. 1040x tax form   Generally, economic performance occurs as an employee renders service to the employer. 1040x tax form However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. 1040x tax form For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. 1040x tax form Vacation pay. 1040x tax form   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. 1040x tax form If you pay it later than this, you must deduct it in the year actually paid. 1040x tax form An amount is vested if your right to it cannot be nullified or cancelled. 1040x tax form Exception for recurring items. 1040x tax form   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. 1040x tax form The exception applies if all the following requirements are met. 1040x tax form The all-events test, discussed earlier, is met. 1040x tax form Economic performance occurs by the earlier of the following dates. 1040x tax form 8½ months after the close of the year. 1040x tax form The date you file a timely return (including extensions) for the year. 1040x tax form The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. 1040x tax form Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. 1040x tax form This exception does not apply to workers' compensation or tort liabilities. 1040x tax form Amended return. 1040x tax form   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. 1040x tax form You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. 1040x tax form Recurrence and consistency. 1040x tax form   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. 1040x tax form A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. 1040x tax form Materiality. 1040x tax form   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. 1040x tax form   An item considered material for financial statement purposes is also considered material for tax purposes. 1040x tax form However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. 1040x tax form Matching expenses with income. 1040x tax form   Costs directly associated with the revenue of a period are properly allocable to that period. 1040x tax form To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. 1040x tax form fasab. 1040x tax form gov/accepted. 1040x tax form html) are an important factor. 1040x tax form   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. 1040x tax form Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. 1040x tax form However, the matching requirement is considered met for certain types of expenses. 1040x tax form These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. 1040x tax form Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. 1040x tax form Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. 1040x tax form 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. 1040x tax form If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. 1040x tax form See Change in Accounting Method, later, for information on how to get IRS approval. 1040x tax form See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. 1040x tax form Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. 1040x tax form Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. 1040x tax form See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. 1040x tax form Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. 1040x tax form If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. 1040x tax form However, see Exceptions, next. 1040x tax form See also Accrual Method, earlier. 1040x tax form To figure taxable income, you must value your inventory at the beginning and end of each tax year. 1040x tax form To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. 1040x tax form See Identifying Cost and Valuing Inventory, later. 1040x tax form The rules for valuing inventory are not the same for all businesses. 1040x tax form The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. 1040x tax form Your inventory practices must be consistent from year to year. 1040x tax form The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. 1040x tax form Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. 1040x tax form These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). 1040x tax form A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. 1040x tax form irs. 1040x tax form gov/pub/irs-irbs/irb01–02. 1040x tax form pdf. 1040x tax form A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. 1040x tax form irs. 1040x tax form gov/pub/irs-irbs/irb02–18. 1040x tax form pdf. 1040x tax form In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). 1040x tax form Qualifying taxpayer. 1040x tax form   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). 1040x tax form Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. 1040x tax form You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. 1040x tax form Gross receipts test for qualifying taxpayers. 1040x tax form   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. 1040x tax form List each of the test years. 1040x tax form For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. 1040x tax form Step 2. 1040x tax form Determine your average annual gross receipts for each test year listed in Step 1. 1040x tax form Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. 1040x tax form Step 3. 1040x tax form You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. 1040x tax form Qualifying small business taxpayer. 1040x tax form   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). 1040x tax form Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. 1040x tax form You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. 1040x tax form Your principle business activity is an eligible business. 1040x tax form See Eligible business, later. 1040x tax form You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. 1040x tax form Note. 1040x tax form Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. 1040x tax form A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. 1040x tax form See Special rules for farming businesses under Cash Method, earlier. 1040x tax form Gross receipts test for qualifying small business taxpayers. 1040x tax form   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. 1040x tax form List each of the test years. 1040x tax form For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. 1040x tax form Step 2. 1040x tax form Determine your average annual gross receipts for each test year listed in Step 1. 1040x tax form Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. 1040x tax form Step 3. 1040x tax form You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. 1040x tax form Eligible business. 1040x tax form   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. 1040x tax form You have an eligible business if you meet any of the following requirements. 1040x tax form Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). 1040x tax form NAICS codes 31-33 (manufacturing). 1040x tax form NAICS code 42 (wholesale trade). 1040x tax form NAICS codes 44-45 (retail trade). 1040x tax form NAICS codes 5111 and 5122 (information industries). 1040x tax form Your principal business activity is the provision of services, including the provision of property incident to those services. 1040x tax form Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. 1040x tax form   Information about the NAICS codes can be found at http://www. 1040x tax form census. 1040x tax form gov/naics or in the instructions for your federal income tax return. 1040x tax form Gross receipts. 1040x tax form   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. 1040x tax form See the definit
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Reminder To Home-Based Businesses: Simplified Option for Claiming Home Office Deduction Now Available; May Deduct up to $1,500; Saves 1.6 Million Hours A Year

IRS YouTube Video:

Simplified Home Office Deduction: English / Spanish / ASL

IR-2014-24, March 7, 2014

WASHINGTON — The Internal Revenue Service today reminded people with home-based businesses that this year for the first time they can choose a new simplified option for claiming the deduction for business use of a home.

In tax year 2011, the most recent year for which figures are available, some 3.3 million taxpayers claimed deductions for business use of a home (commonly referred to as the home office deduction) totaling nearly $10 billion.

The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and recordkeeping burden on small businesses by an estimated 1.6 million hours annually.

The new option is available starting with the 2013 return taxpayers are filing now.  Normally, home-based businesses are required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions.  Instead, taxpayers claiming the optional deduction need only complete a short worksheet in the tax instructions and enter the result on their return. Self-employed individuals claim the home office deduction on Schedule C Line 30, farmers claim it on Schedule F  Line 32 and eligible employees claim it on Schedule A Line 21. 

Though homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method.

Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees, are still fully deductible.

Long-standing restrictions on the home office deduction, such as the requirement that a home office be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.

Further details on the home office deduction and the new option can be found in Publication 587, posted on IRS.gov.

 

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Page Last Reviewed or Updated: 07-Mar-2014

The 1040x Tax Form

1040x tax form 11. 1040x tax form   Other Expenses Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: Reimbursement of Travel, Meals, and EntertainmentReimbursements Miscellaneous ExpensesMeaning of generally enforced. 1040x tax form Kickbacks. 1040x tax form Form 1099-MISC. 1040x tax form Exception. 1040x tax form Tax preparation fees. 1040x tax form Covered executive branch official. 1040x tax form Exceptions to denial of deduction. 1040x tax form Indirect political contributions. 1040x tax form Type of deduction. 1040x tax form Repayment—$3,000 or less. 1040x tax form Repayment—over $3,000. 1040x tax form Method 1. 1040x tax form Method 2. 1040x tax form Repayment does not apply. 1040x tax form Year of deduction (or credit). 1040x tax form Telephone. 1040x tax form What's New Standard mileage rate. 1040x tax form  Beginning in 2013, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for business use is 56. 1040x tax form 5 cents per mile. 1040x tax form For more information, see Car and truck expenses under Miscellaneous Expenses. 1040x tax form Introduction This chapter covers business expenses that may not have been explained to you, as a business owner, in previous chapters of this publication. 1040x tax form Topics - This chapter discusses: Travel, meals, and entertainment Bribes and kickbacks Charitable contributions Education expenses Lobbying expenses Penalties and fines Repayments (claim of right) Other miscellaneous expenses Useful Items - You may want to see: Publication 15-B Employer's Tax Guide to Fringe Benefits 463 Travel, Entertainment, Gift, and Car Expenses 526 Charitable Contributions 529 Miscellaneous Deductions 544 Sales and Other Dispositions of Assets 970 Tax Benefits for Education 1542 Per Diem Rates See chapter 12 for information about getting publications and forms. 1040x tax form Reimbursement of Travel, Meals, and Entertainment The following discussion explains how to handle any reimbursements or allowances you may provide to your employees under a reimbursement or allowance arrangement for travel, meals, and entertainment expenses. 1040x tax form If you are self-employed and report your income and expenses on Schedule C or C-EZ (Form 1040), see Publication 463. 1040x tax form To be deductible for tax purposes, expenses incurred for travel, meals, and entertainment must be ordinary and necessary expenses incurred while carrying on your trade or business. 1040x tax form Generally, you also must show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your trade or business. 1040x tax form For more information on travel, meals, and entertainment, including deductibility, see Publication 463. 1040x tax form Reimbursements A “reimbursement or allowance arrangement” provides for payment of advances, reimbursements, and allowances for travel, meals, and entertainment expenses incurred by your employees during the ordinary course of business. 1040x tax form If the expenses are substantiated, you can deduct the allowable amount on your tax return. 1040x tax form Because of differences between accounting methods and tax law, the amount you can deduct for tax purposes may not be the same as the amount you deduct on your business books and records. 1040x tax form For example, you can deduct 100% of the cost of meals on your business books and records. 1040x tax form However, only 50% of these costs are allowed by law as a tax deduction. 1040x tax form How you deduct a business expense under a reimbursement or allowance arrangement depends on whether you have: An accountable plan, or A nonaccountable plan. 1040x tax form If you reimburse these expenses under an accountable plan, deduct them as travel, meals, or entertainment expenses. 1040x tax form If you reimburse these expenses under a nonaccountable plan, report the reimbursements as wages on Form W-2, Wage and Tax Statement, and deduct them as wages on the appropriate line of your tax return. 1040x tax form If you make a single payment to your employees and it includes both wages and an expense reimbursement, you must specify the amount of the reimbursement and report it accordingly. 1040x tax form See Table 11-1 , Reporting Reimbursements. 1040x tax form Accountable Plans An accountable plan requires your employees to meet all of the following requirements. 1040x tax form Each employee must: Have paid or incurred deductible expenses while performing services as your employee, Adequately account to you for these expenses within a reasonable period of time, and Return any excess reimbursement or allowance within a reasonable period of time. 1040x tax form An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements are also met. 1040x tax form The advance is reasonably calculated not to exceed the amount of anticipated expenses. 1040x tax form You make the advance within a reasonable period of time of your employee paying or incurring the expense. 1040x tax form If any expenses reimbursed under this arrangement are not substantiated, or an excess reimbursement is not returned within a reasonable period of time by an employee, you cannot treat these expenses as reimbursed under an accountable plan. 1040x tax form Instead, treat the reimbursed expenses as paid under a nonaccountable plan, discussed later. 1040x tax form Adequate accounting. 1040x tax form   Your employees must adequately account to you for their travel, meals, and entertainment expenses. 1040x tax form They must give you documentary evidence of their travel, mileage, and other employee business expenses. 1040x tax form This evidence should include items such as receipts, along with either a statement of expenses, an account book, a day-planner, or similar record in which the employee entered each expense at or near the time the expense was incurred. 1040x tax form Excess reimbursement or allowance. 1040x tax form   An excess reimbursement or allowance is any amount you pay to an employee that is more than the business-related expenses for which the employee adequately accounted. 1040x tax form The employee must return any excess reimbursement or other expense allowance to you within a reasonable period of time. 1040x tax form Reasonable period of time. 1040x tax form   A reasonable period of time depends on the facts and circumstances. 1040x tax form Generally, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time. 1040x tax form You give an advance within 30 days of the time the employee pays or incurs the expense. 1040x tax form Your employees adequately account for their expenses within 60 days after the expenses were paid or incurred. 1040x tax form Your employees return any excess reimbursement within 120 days after the expenses were paid or incurred. 1040x tax form You give a periodic statement (at least quarterly) to your employees that asks them to either return or adequately account for outstanding advances and they comply within 120 days of the date of the statement. 1040x tax form How to deduct. 1040x tax form   You can claim a deduction for travel, meals, and entertainment expenses if you reimburse your employees for these expenses under an accountable plan. 1040x tax form Generally, the amount you can deduct for meals and entertainment is subject to a 50% limit, discussed later. 1040x tax form If you are a sole proprietor, or are filing as a single member limited liability company, deduct the travel reimbursement on line 24a and the deductible part of the meals and entertainment reimbursement on line 24b, Schedule C (Form 1040) or line 2, Schedule C-EZ (Form 1040). 1040x tax form   If you are filing an income tax return for a corporation, include the reimbursement on the Other deductions line of Form 1120, U. 1040x tax form S. 1040x tax form Corporation Income Tax Return. 1040x tax form If you are filing any other business income tax return, such as a partnership or S corporation return, deduct the reimbursement on the appropriate line of the return as provided in the instructions for that return. 1040x tax form Table 11-1. 1040x tax form Reporting Reimbursements IF the type of reimbursement (or other expense allowance) arrangement is under THEN the employer reports on Form W-2 An accountable plan with: Actual expense reimbursement:  Adequate accounting made and excess returned No amount. 1040x tax form Actual expense reimbursement:  Adequate accounting and return of excess both required but excess not returned The excess amount as wages in box 1. 1040x tax form Per diem or mileage allowance up to the federal rate:  Adequate accounting made and excess returned No amount. 1040x tax form Per diem or mileage allowance up to the federal rate:  Adequate accounting and return of excess both required but excess not returned The excess amount as wages in box 1. 1040x tax form The amount up to the federal rate is reported only in box 12—it is not reported in box 1. 1040x tax form Per diem or mileage allowance exceeds the federal rate:  Adequate accounting made up to the federal rate only and excess not returned The excess amount as wages in box 1. 1040x tax form The amount up to the federal rate is reported only in box 12—it is not reported in box 1. 1040x tax form A nonaccountable plan with: Either adequate accounting or return of excess, or both, not required by plan The entire amount as wages in box 1. 1040x tax form No reimbursement plan The entire amount as wages in box 1. 1040x tax form Per Diem and Car Allowances You can reimburse your employees under an accountable plan based on travel days, miles, or some other fixed allowance. 1040x tax form In these cases, your employee is considered to have accounted to you for the amount of the expense that does not exceed the rates established by the federal government. 1040x tax form Your employee must actually substantiate to you the other elements of the expense, such as time, place, and business purpose. 1040x tax form Federal rate. 1040x tax form   The federal rate can be figured using any one of the following methods. 1040x tax form For car expenses: The standard mileage rate. 1040x tax form A fixed and variable rate (FAVR). 1040x tax form For per diem amounts: The regular federal per diem rate. 1040x tax form The standard meal allowance. 1040x tax form The high-low rate. 1040x tax form Car allowance. 1040x tax form   Your employee is considered to have accounted to you for car expenses that do not exceed the standard mileage rate. 1040x tax form Beginning in 2013, the standard business mileage rate is 56. 1040x tax form 5 cents per mile. 1040x tax form   You can choose to reimburse your employees using a fixed and variable rate (FAVR) allowance. 1040x tax form This is an allowance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your employees' variable operating costs (such as gas, oil, etc. 1040x tax form ) plus a flat amount to cover your employees' fixed costs (such as depreciation, insurance, etc. 1040x tax form ). 1040x tax form For information on using a FAVR allowance, see Revenue Procedure 2010-51, available at www. 1040x tax form irs. 1040x tax form gov/irb/2010-51_IRB/ar14. 1040x tax form html and Notice 2012-72, available at www. 1040x tax form irs. 1040x tax form gov/irb/2012-50_IRB/ar10. 1040x tax form html. 1040x tax form Per diem allowance. 1040x tax form   If your employee actually substantiates to you the other elements (discussed earlier) of the expenses reimbursed using the per diem allowance, how you report and deduct the allowance depends on whether the allowance is for lodging and meal expenses or for meal expenses only and whether the allowance is more than the federal rate. 1040x tax form Regular federal per diem rate. 1040x tax form   The regular federal per diem rate is the highest amount the federal government will pay to its employees while away from home on travel. 1040x tax form It has two components: Lodging expense, and Meal and incidental expense (M&IE). 1040x tax form The rates are different for different locations. 1040x tax form Publication 1542 lists the rates in the continental United States. 1040x tax form Standard meal allowance. 1040x tax form   The federal rate for meal and incidental expenses (M&IE) is the standard meal allowance. 1040x tax form You can pay only an M&IE allowance to employees who travel away from home if: You pay the employee for actual expenses for lodging based on receipts submitted to you, You provide for the lodging, You pay for the actual expense of the lodging directly to the provider, You do not have a reasonable belief that lodging expenses were incurred by the employee, or The allowance is computed on a basis similar to that used in computing the employee's wages (that is, number of hours worked or miles traveled). 1040x tax form Internet access. 1040x tax form    Per diem rates are available on the Internet. 1040x tax form You can access per diem rates at www. 1040x tax form gsa. 1040x tax form gov/perdiemrates. 1040x tax form High-low method. 1040x tax form   This is a simplified method of computing the federal per diem rate for travel within the continental United States. 1040x tax form It eliminates the need to keep a current list of the per diem rate for each city. 1040x tax form   Under the high-low method, the per diem amount for travel during January through September of 2013 is $242 ($65 for M&IE) for certain high-cost locations. 1040x tax form All other areas have a per diem amount of $163 ($52 for M&IE). 1040x tax form The high-cost locations eligible for the higher per diem amount under the high-low method are listed in Publication 1542. 1040x tax form   Effective October 1, 2013, the per diem rate for high-cost locations increased to $251 ($65 for M&IE). 1040x tax form The rate for all other locations increased to $170 ($52 for M&IE). 1040x tax form For October, November, and December 2013, you can either continue to use the rates described in the preceding paragraph or change to the new rates. 1040x tax form However, you must use the same rate for all employees reimbursed under the high-low method. 1040x tax form   For more information about the high-low method, see Notice 2013-65, available at www. 1040x tax form irs. 1040x tax form gov/irb/2013-44_IRB/ar13. 1040x tax form html. 1040x tax form See Publication 1542 (available on the Internet at IRS. 1040x tax form gov) for the current per diem rates for all locations. 1040x tax form Reporting per diem and car allowances. 1040x tax form   The following discussion explains how to report per diem and car allowances. 1040x tax form The manner in which you report them depends on how the allowance compares to the federal rate. 1040x tax form See Table 11-1. 1040x tax form Allowance less than or equal to the federal rate. 1040x tax form   If your allowance for the employee is less than or equal to the appropriate federal rate, that allowance is not included as part of the employee's pay in box 1 of the employee's Form W-2. 1040x tax form Deduct the allowance as travel expenses (including meals that may be subject to the 50% limit, discussed later). 1040x tax form See How to deduct under Accountable Plans, earlier. 1040x tax form Allowance more than the federal rate. 1040x tax form   If your employee's allowance is more than the appropriate federal rate, you must report the allowance as two separate items. 1040x tax form   Include the allowance amount up to the federal rate in box 12 (code L) of the employee's Form W-2. 1040x tax form Deduct it as travel expenses (as explained above). 1040x tax form This part of the allowance is treated as reimbursed under an accountable plan. 1040x tax form   Include the amount that is more than the federal rate in box 1 (and in boxes 3 and 5 if they apply) of the employee's Form W-2. 1040x tax form Deduct it as wages subject to income tax withholding, social security, Medicare, and federal unemployment taxes. 1040x tax form This part of the allowance is treated as reimbursed under a nonaccountable plan as explained later under Nonaccountable Plans. 1040x tax form Meals and Entertainment Under an accountable plan, you can generally deduct only 50% of any otherwise deductible business-related meal and entertainment expenses you reimburse your employees. 1040x tax form The deduction limit applies even if you reimburse them for 100% of the expenses. 1040x tax form Application of the 50% limit. 1040x tax form   The 50% deduction limit applies to reimbursements you make to your employees for expenses they incur for meals while traveling away from home on business and for entertaining business customers at your place of business, a restaurant, or another location. 1040x tax form It applies to expenses incurred at a business convention or reception, business meeting, or business luncheon at a club. 1040x tax form The deduction limit may also apply to meals you furnish on your premises to your employees. 1040x tax form Related expenses. 1040x tax form   Taxes and tips relating to a meal or entertainment activity you reimburse to your employee under an accountable plan are included in the amount subject to the 50% limit. 1040x tax form Reimbursements you make for expenses, such as cover charges for admission to a nightclub, rent paid for a room to hold a dinner or cocktail party, or the amount you pay for parking at a sports arena, are all subject to the 50% limit. 1040x tax form However, the cost of transportation to and from an otherwise allowable business meal or a business-related entertainment activity is not subject to the 50% limit. 1040x tax form Amount subject to 50% limit. 1040x tax form   If you provide your employees with a per diem allowance only for meal and incidental expenses, the amount treated as an expense for food and beverages is the lesser of the following. 1040x tax form The per diem allowance. 1040x tax form The federal rate for M&IE. 1040x tax form   If you provide your employees with a per diem allowance that covers lodging, meals, and incidental expenses, you must treat an amount equal to the federal M&IE rate for the area of travel as an expense for food and beverages. 1040x tax form If the per diem allowance you provide is less than the federal per diem rate for the area of travel, you can treat 40% of the per diem allowance as the amount for food and beverages. 1040x tax form Meal expenses when subject to “hours of service” limits. 1040x tax form   You can deduct 80% of the cost of reimbursed meals your employees consume while away from their tax home on business during, or incident to, any period subject to the Department of Transportation's “hours of service” limits. 1040x tax form   See Publication 463 for a detailed discussion of individuals subject to the Department of Transportation's “hours of service” limits. 1040x tax form De minimis (minimal) fringe benefit. 1040x tax form   The 50% limit does not apply to an expense for food or beverage that is excluded from the gross income of an employee because it is a de minimis fringe benefit. 1040x tax form See Publication 15-B for additional information on de minimis fringe benefits. 1040x tax form Company cafeteria or executive dining room. 1040x tax form   The cost of food and beverages you provide primarily to your employees on your business premises is deductible. 1040x tax form This includes the cost of maintaining the facilities for providing the food and beverages. 1040x tax form These expenses are subject to the 50% limit unless they qualify as a de minimis fringe benefit, as just discussed, or unless they are compensation to your employees (explained later). 1040x tax form Employee activities. 1040x tax form   The expense of providing recreational, social, or similar activities (including the use of a facility) for your employees is deductible and is not subject to the 50% limit. 1040x tax form The benefit must be primarily for your employees who are not highly compensated. 1040x tax form   For this purpose, a highly compensated employee is an employee who meets either of the following requirements. 1040x tax form Owned a 10% or more interest in the business during the year or the preceding year. 1040x tax form An employee is treated as owning any interest owned by his or her brother, sister, spouse, ancestors, and lineal descendants. 1040x tax form Received more than $115,000 in pay for the preceding year. 1040x tax form You can choose to include only employees who were also in the top 20% of employees when ranked by pay for the preceding year. 1040x tax form   For example, the expenses for food, beverages, and entertainment for a company-wide picnic are not subject to the 50% limit. 1040x tax form Meals or entertainment treated as compensation. 1040x tax form   The 50% limit does not apply to either of the following. 1040x tax form Expenses for meals or entertainment that you treat as: Compensation to an employee who was the recipient of the meals or entertainment, and Wages subject to withholding of federal income tax. 1040x tax form Expenses for meals or entertainment if: A recipient of the meals or entertainment who is not your employee has to include the expenses in gross income as compensation for services or as a prize or award, and You include that amount on a Form 1099 issued to the recipient, if a Form 1099 is required. 1040x tax form Sales of meals or entertainment. 1040x tax form   You can deduct the cost of meals or entertainment (including the use of facilities) you sell to the public. 1040x tax form For example, if you run a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is a business expense that is fully deductible. 1040x tax form The 50% limit does not apply to this expense. 1040x tax form Providing meals or entertainment to general public to promote goodwill. 1040x tax form   You can deduct the cost of providing meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. 1040x tax form The 50% limit does not apply to this expense. 1040x tax form Director, stockholder, or employee meetings. 1040x tax form   You can deduct entertainment expenses directly related to business meetings of your employees, partners, stockholders, agents, or directors. 1040x tax form You can provide some minor social activities, but the main purpose of the meeting must be your company's business. 1040x tax form These expenses are subject to the 50% limit. 1040x tax form Trade association meetings. 1040x tax form   You can deduct expenses directly related to and necessary for attending business meetings or conventions of certain tax-exempt organizations. 1040x tax form These organizations include business leagues, chambers of commerce, real estate boards, and trade and professional associations. 1040x tax form Nonaccountable Plans A nonaccountable plan is an arrangement that does not meet the requirements for an accountable plan. 1040x tax form All amounts paid, or treated as paid, under a nonaccountable plan are reported as wages on Form W-2. 1040x tax form The payments are subject to income tax withholding, social security, Medicare, and federal unemployment taxes. 1040x tax form You can deduct the reimbursement as compensation or wages only to the extent it meets the deductibility tests for employees' pay in chapter 2. 1040x tax form Deduct the allowable amount as compensation or wages on the appropriate line of your income tax return, as provided in its instructions. 1040x tax form Miscellaneous Expenses In addition to travel, meal, and entertainment expenses, there are other expenses you can deduct. 1040x tax form Advertising expenses. 1040x tax form   You generally can deduct reasonable advertising expenses that are directly related to your business activities. 1040x tax form Generally, you cannot deduct amounts paid to influence legislation (i. 1040x tax form e. 1040x tax form , lobbying). 1040x tax form See Lobbying expenses , later. 1040x tax form   You can usually deduct as a business expense the cost of institutional or goodwill advertising to keep your name before the public if it relates to business you reasonably expect to gain in the future. 1040x tax form For example, the cost of advertising that encourages people to contribute to the Red Cross, to buy U. 1040x tax form S. 1040x tax form Savings Bonds, or to participate in similar causes is usually deductible. 1040x tax form Anticipated liabilities. 1040x tax form   Anticipated liabilities or reserves for anticipated liabilities are not deductible. 1040x tax form For example, assume you sold 1-year TV service contracts this year totaling $50,000. 1040x tax form From experience, you know you will have expenses of about $15,000 in the coming year for these contracts. 1040x tax form You cannot deduct any of the $15,000 this year by charging expenses to a reserve or liability account. 1040x tax form You can deduct your expenses only when you actually pay or accrue them, depending on your accounting method. 1040x tax form Bribes and kickbacks. 1040x tax form   Engaging in the payment of bribes or kickbacks is a serious criminal matter. 1040x tax form Such activity could result in criminal prosecution. 1040x tax form Any payments that appear to have been made, either directly or indirectly, to an official or employee of any government or an agency or instrumentality of any government are not deductible for tax purposes and are in violation of the law. 1040x tax form   Payments paid directly or indirectly to a person in violation of any federal or state law (but only if that state law is generally enforced, defined below) that provides for a criminal penalty or for the loss of a license or privilege to engage in a trade or business are also not allowed as a deduction for tax purposes. 1040x tax form Meaning of “generally enforced. 1040x tax form ”   A state law is considered generally enforced unless it is never enforced or enforced only for infamous persons or persons whose violations are extraordinarily flagrant. 1040x tax form For example, a state law is generally enforced unless proper reporting of a violation of the law results in enforcement only under unusual circumstances. 1040x tax form Kickbacks. 1040x tax form   A kickback is a payment for referring a client, patient, or customer. 1040x tax form The common kickback situation occurs when money or property is given to someone as payment for influencing a third party to purchase from, use the services of, or otherwise deal with the person who pays the kickback. 1040x tax form In many cases, the person whose business is being sought or enjoyed by the person who pays the kickback is not aware of the payment. 1040x tax form   For example, the Yard Corporation is in the business of repairing ships. 1040x tax form It returns 10% of the repair bills as kickbacks to the captains and chief officers of the vessels it repairs. 1040x tax form Although this practice is considered an ordinary and necessary expense of getting business, it is clearly a violation of a state law that is generally enforced. 1040x tax form These expenditures are not deductible for tax purposes, whether or not the owners of the shipyard are subsequently prosecuted. 1040x tax form Form 1099-MISC. 1040x tax form   It does not matter whether any kickbacks paid during the tax year are deductible on your income tax return in regards to information reporting. 1040x tax form See Form 1099-MISC for more information. 1040x tax form Car and truck expenses. 1040x tax form   The costs of operating a car, truck, or other vehicle in your business are deductible. 1040x tax form For more information on how to figure your deduction, see Publication 463. 1040x tax form Charitable contributions. 1040x tax form   Cash payments to an organization, charitable or otherwise, may be deductible as business expenses if the payments are not charitable contributions or gifts and are directly related to your business. 1040x tax form If the payments are charitable contributions or gifts, you cannot deduct them as business expenses. 1040x tax form However, corporations (other than S corporations) can deduct charitable contributions on their income tax returns, subject to limitations. 1040x tax form See the Instructions for Form 1120 for more information. 1040x tax form Sole proprietors, partners in a partnership, or shareholders in an S corporation may be able to deduct charitable contributions made by their business on Schedule A (Form 1040). 1040x tax form Example. 1040x tax form You paid $15 to a local church for a half-page ad in a program for a concert it is sponsoring. 1040x tax form The purpose of the ad was to encourage readers to buy your products. 1040x tax form Your payment is not a charitable contribution. 1040x tax form You can deduct it as an advertising expense. 1040x tax form Example. 1040x tax form You made a $100,000 donation to a committee organized by the local Chamber of Commerce to bring a convention to your city, intended to increase business activity, including yours. 1040x tax form Your payment is not a charitable contribution. 1040x tax form You can deduct it as a business expense. 1040x tax form See Publication 526 for a discussion of donated inventory, including capital gain property. 1040x tax form Club dues and membership fees. 1040x tax form   Generally, you cannot deduct amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or any other social purpose. 1040x tax form This includes country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions. 1040x tax form Exception. 1040x tax form   The following organizations are not treated as clubs organized for business, pleasure, recreation, or other social purpose unless one of the main purposes is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities. 1040x tax form Boards of trade. 1040x tax form Business leagues. 1040x tax form Chambers of commerce. 1040x tax form Civic or public service organizations. 1040x tax form Professional organizations such as bar associations and medical associations. 1040x tax form Real estate boards. 1040x tax form Trade associations. 1040x tax form Credit card convenience fees. 1040x tax form   Credit card companies charge a fee to businesses who accept their cards. 1040x tax form This fee when paid or incurred by the business can be deducted as a business expense. 1040x tax form Damages recovered. 1040x tax form   Special rules apply to compensation you receive for damages sustained as a result of patent infringement, breach of contract or fiduciary duty, or antitrust violations. 1040x tax form You must include this compensation in your income. 1040x tax form However, you may be able to take a special deduction. 1040x tax form The deduction applies only to amounts recovered for actual economic injury, not any additional amount. 1040x tax form The deduction is the smaller of the following. 1040x tax form The amount you received or accrued for damages in the tax year reduced by the amount you paid or incurred in the year to recover that amount. 1040x tax form Your losses from the injury you have not deducted. 1040x tax form Demolition expenses or losses. 1040x tax form   Amounts paid or incurred to demolish a structure are not deductible. 1040x tax form These amounts are added to the basis of the land where the demolished structure was located. 1040x tax form Any loss for the remaining undepreciated basis of a demolished structure would not be recognized until the property is disposed of. 1040x tax form Education expenses. 1040x tax form   Ordinary and necessary expenses paid for the cost of the education and training of your employees are deductible. 1040x tax form See Education Expenses in chapter 2. 1040x tax form   You can also deduct the cost of your own education (including certain related travel) related to your trade or business. 1040x tax form You must be able to show the education maintains or improves skills required in your trade or business, or that it is required by law or regulations, for keeping your license to practice, status, or job. 1040x tax form For example, an attorney can deduct the cost of attending Continuing Legal Education (CLE) classes that are required by the state bar association to maintain his or her license to practice law. 1040x tax form   Education expenses you incur to meet the minimum requirements of your present trade or business, or those that qualify you for a new trade or business, are not deductible. 1040x tax form This is true even if the education maintains or improves skills presently required in your business. 1040x tax form For more information on education expenses, see Publication 970. 1040x tax form Franchise, trademark, trade name. 1040x tax form   If you buy a franchise, trademark, or trade name, you can deduct the amount you pay or incur as a business expense only if your payments are part of a series of payments that are: Contingent on productivity, use, or disposition of the item, Payable at least annually for the entire term of the transfer agreement, and Substantially equal in amount (or payable under a fixed formula). 1040x tax form   When determining the term of the transfer agreement, include all renewal options and any other period for which you and the transferrer reasonably expect the agreement to be renewed. 1040x tax form   A franchise includes an agreement that gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities within a specified area. 1040x tax form Impairment-related expenses. 1040x tax form   If you are disabled, you can deduct expenses necessary for you to be able to work (impairment-related expenses) as a business expense, rather than as a medical expense. 1040x tax form   You are disabled if you have either of the following. 1040x tax form A physical or mental disability (for example, blindness or deafness) that functionally limits your being employed. 1040x tax form A physical or mental impairment that substantially limits one or more of your major life activities. 1040x tax form   The expense qualifies as a business expense if all the following apply. 1040x tax form Your work clearly requires the expense for you to satisfactorily perform that work. 1040x tax form The goods or services purchased are clearly not needed or used, other than incidentally, in your personal activities. 1040x tax form Their treatment is not specifically provided for under other tax law provisions. 1040x tax form Example. 1040x tax form You are blind. 1040x tax form You must use a reader to do your work, both at and away from your place of work. 1040x tax form The reader's services are only for your work. 1040x tax form You can deduct your expenses for the reader as a business expense. 1040x tax form Internet-related expenses. 1040x tax form   Generally, you can deduct internet-related expenses including domain registrations fees and webmaster consulting costs. 1040x tax form If you are starting a business you may have to amortize these expenses as start-up costs. 1040x tax form For more information about amortizing start-up and organizational costs, see chapter 8. 1040x tax form Interview expense allowances. 1040x tax form   Reimbursements you make to job candidates for transportation or other expenses related to interviews for possible employment are not wages. 1040x tax form You can deduct the reimbursements as a business expense. 1040x tax form However, expenses for food, beverages, and entertainment are subject to the 50% limit discussed earlier under Meals and Entertainment. 1040x tax form Legal and professional fees. 1040x tax form   Fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to operating your business are deductible as business expenses. 1040x tax form However, usually legal fees you pay to acquire business assets are not deductible. 1040x tax form These costs are added to the basis of the property. 1040x tax form   Fees that include payments for work of a personal nature (such as drafting a will, or damages arising from a personal injury) are not allowed as a business deduction on Schedule C or C-EZ. 1040x tax form If the invoice includes both business and personal charges, compute the business portion as follows: multiply the total amount of the bill by a fraction, the numerator of which is the amount attributable to business matters, the denominator of which is the total amount paid. 1040x tax form The result is the portion of the invoice attributable to business expenses. 1040x tax form The portion attributable to personal matters is the difference between the total amount and the business portion (computed above). 1040x tax form   Legal fees relating to personal tax advice may be deductible on Schedule A (Form 1040), if you itemize deductions. 1040x tax form However, the deduction is subject to the 2% limitation on miscellaneous itemized deductions. 1040x tax form See Publication 529, Miscellaneous Deductions. 1040x tax form Tax preparation fees. 1040x tax form   The cost of hiring a tax professional, such as a C. 1040x tax form P. 1040x tax form A. 1040x tax form , to prepare that part of your tax return relating to your business as a sole proprietor is deductible on Schedule C or Schedule C-EZ. 1040x tax form Any remaining cost may be deductible on Schedule A (Form 1040) if you itemize deductions. 1040x tax form   You can also claim a business deduction for amounts paid or incurred in resolving asserted tax deficiencies for your business operated as a sole proprietor. 1040x tax form Licenses and regulatory fees. 1040x tax form   Licenses and regulatory fees for your trade or business paid annually to state or local governments generally are deductible. 1040x tax form Some licenses and fees may have to be amortized. 1040x tax form See chapter 8 for more information. 1040x tax form Lobbying expenses. 1040x tax form   Generally, lobbying expenses are not deductible. 1040x tax form Lobbying expenses include amounts paid or incurred for any of the following activities. 1040x tax form Influencing legislation. 1040x tax form Participating in or intervening in any political campaign for, or against, any candidate for public office. 1040x tax form Attempting to influence the general public, or segments of the public, about elections, legislative matters, or referendums. 1040x tax form Communicating directly with covered executive branch officials (defined later) in any attempt to influence the official actions or positions of those officials. 1040x tax form Researching, preparing, planning, or coordinating any of the preceding activities. 1040x tax form   Your expenses for influencing legislation and communicating directly with a covered executive branch official include a portion of your labor costs and general and administrative costs of your business. 1040x tax form For information on making this allocation, see section 1. 1040x tax form 162-28 of the regulations. 1040x tax form   You cannot claim a charitable or business expense deduction for amounts paid to an organization if both of the following apply. 1040x tax form The organization conducts lobbying activities on matters of direct financial interest to your business. 1040x tax form A principal purpose of your contribution is to avoid the rules discussed earlier that prohibit a business deduction for lobbying expenses. 1040x tax form   If a tax-exempt organization, other than a section 501(c)(3) organization, provides you with a notice on the part of dues that is allocable to nondeductible lobbying and political expenses, you cannot deduct that part of the dues. 1040x tax form Covered executive branch official. 1040x tax form   For purposes of this discussion, a covered executive branch official is any of the following. 1040x tax form The President. 1040x tax form The Vice President. 1040x tax form Any officer or employee of the White House Office of the Executive Office of the President and the two most senior level officers of each of the other agencies in the Executive Office. 1040x tax form Any individual who: Is serving in a position in Level I of the Executive Schedule under section 5312 of title 5, United States Code, Has been designated by the President as having Cabinet-level status, or Is an immediate deputy of an individual listed in item (a) or (b). 1040x tax form Exceptions to denial of deduction. 1040x tax form   The general denial of the deduction does not apply to the following. 1040x tax form Expenses of appearing before, or communicating with, any committee or member of any local council or similar governing body concerning its legislation (local legislation) if the legislation is of direct interest to you or to you and an organization of which you are a member. 1040x tax form An Indian tribal government is treated as a local council or similar governing body. 1040x tax form Any in-house expenses for influencing legislation and communicating directly with a covered executive branch official if those expenses for the tax year do not exceed $2,000 (excluding overhead expenses). 1040x tax form Expenses incurred by taxpayers engaged in the trade or business of lobbying (professional lobbyists) on behalf of another person (but does apply to payments by the other person to the lobbyist for lobbying activities). 1040x tax form Moving machinery. 1040x tax form   Generally, the cost of moving machinery from one city to another is a deductible expense. 1040x tax form So is the cost of moving machinery from one plant to another, or from one part of your plant to another. 1040x tax form You can deduct the cost of installing the machinery in the new location. 1040x tax form However, you must capitalize the costs of installing or moving newly purchased machinery. 1040x tax form Outplacement services. 1040x tax form   The costs of outplacement services you provide to your employees to help them find new employment, such as career counseling, résumé assistance, skills assessment, etc. 1040x tax form are deductible. 1040x tax form   The costs of outplacement services may cover more than one deduction category. 1040x tax form For example, deduct as a utilities expense the cost of telephone calls made under this service and deduct as rental expense the cost of renting machinery and equipment for this service. 1040x tax form   For information on whether the value of outplacement services is includable in your employees' income, see Publication 15-B. 1040x tax form Penalties and fines. 1040x tax form   Penalties paid for late performance or nonperformance of a contract are generally deductible. 1040x tax form For instance, you own and operate a construction company. 1040x tax form Under a contract, you are to finish construction of a building by a certain date. 1040x tax form Due to construction delays, the building is not completed and ready for occupancy on the date stipulated in the contract. 1040x tax form You are now required to pay an additional amount for each day that completion is delayed beyond the completion date stipulated in the contract. 1040x tax form These additional costs are deductible business expenses. 1040x tax form   On the other hand, penalties or fines paid to any government agency or instrumentality because of a violation of any law are not deductible. 1040x tax form These fines or penalties include the following amounts. 1040x tax form Paid because of a conviction for a crime or after a plea of guilty or no contest in a criminal proceeding. 1040x tax form Paid as a penalty imposed by federal, state, or local law in a civil action, including certain additions to tax and additional amounts and assessable penalties imposed by the Internal Revenue Code. 1040x tax form Paid in settlement of actual or possible liability for a fine or penalty, whether civil or criminal. 1040x tax form Forfeited as collateral posted for a proceeding that could result in a fine or penalty. 1040x tax form   Examples of nondeductible penalties and fines include the following. 1040x tax form Fines for violating city housing codes. 1040x tax form Fines paid by truckers for violating state maximum highway weight laws. 1040x tax form Fines for violating air quality laws. 1040x tax form Civil penalties for violating federal laws regarding mining safety standards and discharges into navigable waters. 1040x tax form   A fine or penalty does not include any of the following. 1040x tax form Legal fees and related expenses to defend yourself in a prosecution or civil action for a violation of the law imposing the fine or civil penalty. 1040x tax form Court costs or stenographic and printing charges. 1040x tax form Compensatory damages paid to a government. 1040x tax form Political contributions. 1040x tax form   Contributions or gifts paid to political parties or candidates are not deductible. 1040x tax form In addition, expenses paid or incurred to take part in any political campaign of a candidate for public office are not deductible. 1040x tax form Indirect political contributions. 1040x tax form   You cannot deduct indirect political contributions and costs of taking part in political activities as business expenses. 1040x tax form Examples of nondeductible expenses include the following. 1040x tax form Advertising in a convention program of a political party, or in any other publication if any of the proceeds from the publication are for, or intended for, the use of a political party or candidate. 1040x tax form Admission to a dinner or program (including, but not limited to, galas, dances, film presentations, parties, and sporting events) if any of the proceeds from the function are for, or intended for, the use of a political party or candidate. 1040x tax form Admission to an inaugural ball, gala, parade, concert, or similar event if identified with a political party or candidate. 1040x tax form Repairs. 1040x tax form   The cost of repairing or improving property used in your trade or business is either a deductible or capital expense. 1040x tax form Routine maintenance that keeps your property in a normal efficient operating condition, but that does not materially increase the value or substantially prolong the useful life of the property, is deductible in the year that it is incurred. 1040x tax form Otherwise, the cost must be capitalized and depreciated. 1040x tax form See Form 4562 and its instructions for how to compute and claim the depreciation deduction. 1040x tax form   The cost of repairs includes the costs of labor, supplies, and certain other items. 1040x tax form The value of your own labor is not deductible. 1040x tax form Examples of repairs include: Reconditioning floors (but not replacement), Repainting the interior and exterior walls of a building, Cleaning and repairing roofs and gutters, and Fixing plumbing leaks (but not replacement of fixtures). 1040x tax form Repayments. 1040x tax form   If you had to repay an amount you included in your income in an earlier year, you may be able to deduct the amount repaid for the year in which you repaid it. 1040x tax form Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. 1040x tax form Type of deduction. 1040x tax form   The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. 1040x tax form For instance, if you repay an amount you previously reported as a capital gain, deduct the repayment as a capital loss on Form 8949. 1040x tax form If you reported it as self-employment income, deduct it as a business deduction on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). 1040x tax form   If you reported the amount as wages, unemployment compensation, or other nonbusiness ordinary income, enter it on Schedule A (Form 1040) as a miscellaneous itemized deduction that is subject to the 2% limitation. 1040x tax form However, if the repayment is over $3,000 and Method 1 (discussed later) applies, deduct it on Schedule A (Form 1040) as a miscellaneous itemized deduction that is not subject to the 2% limitation. 1040x tax form Repayment—$3,000 or less. 1040x tax form   If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. 1040x tax form Repayment—over $3,000. 1040x tax form   If the amount you repaid was more than $3,000, you can deduct the repayment, as described earlier. 1040x tax form However, you can instead choose to take a tax credit for the year of repayment if you included the income under a “claim of right. 1040x tax form ” This means that at the time you included the income, it appeared that you had an unrestricted right to it. 1040x tax form If you qualify for this choice, figure your tax under both methods and use the method that results in less tax. 1040x tax form Method 1. 1040x tax form   Figure your tax for 2013 claiming a deduction for the repaid amount. 1040x tax form Method 2. 1040x tax form   Figure your tax for 2013 claiming a credit for the repaid amount. 1040x tax form Follow these steps. 1040x tax form Figure your tax for 2013 without deducting the repaid amount. 1040x tax form Refigure your tax from the earlier year without including in income the amount you repaid in 2013. 1040x tax form Subtract the tax in (2) from the tax shown on your return for the earlier year. 1040x tax form This is the amount of your credit. 1040x tax form Subtract the answer in (3) from the tax for 2013 figured without the deduction (step 1). 1040x tax form   If Method 1 results in less tax, deduct the amount repaid as discussed earlier under Type of deduction. 1040x tax form   If Method 2 results in less tax, claim the credit on line 71 of Form 1040, and write “I. 1040x tax form R. 1040x tax form C. 1040x tax form 1341” next to line 71. 1040x tax form Example. 1040x tax form For 2012, you filed a return and reported your income on the cash method. 1040x tax form In 2013, you repaid $5,000 included in your 2012 gross income under a claim of right. 1040x tax form Your filing status in 2013 and 2012 is single. 1040x tax form Your income and tax for both years are as follows:   2012  With Income 2012  Without Income Taxable Income $15,000 $10,000 Tax $ 1,819 $ 1,069   2013  Without Deduction 2013  With Deduction Taxable Income $49,950 $44,950 Tax $8,423 $7,173 Your tax under Method 1 is $7,173. 1040x tax form Your tax under Method 2 is $7,673, figured as follows: Tax previously determined for 2012 $ 1,819 Less: Tax as refigured − 1,069 Decrease in 2012 tax $ 750 Regular tax liability for 2013 $8,423 Less: Decrease in 2012 tax − 750 Refigured tax for 2013 $ 7,673 Because you pay less tax under Method 1, you should take a deduction for the repayment in 2013. 1040x tax form Repayment does not apply. 1040x tax form   This discussion does not apply to the following. 1040x tax form Deductions for bad debts. 1040x tax form Deductions from sales to customers, such as returns and allowances, and similar items. 1040x tax form Deductions for legal and other expenses of contesting the repayment. 1040x tax form Year of deduction (or credit). 1040x tax form   If you use the cash method of accounting, you can take the deduction (or credit, if applicable) for the tax year in which you actually make the repayment. 1040x tax form If you use any other accounting method, you can deduct the repayment or claim a credit for it only for the tax year in which it is a proper deduction under your accounting method. 1040x tax form For example, if you use the accrual method, you are entitled to the deduction or credit in the tax year in which the obligation for the repayment accrues. 1040x tax form Subscriptions. 1040x tax form   Subscriptions to professional, technical, and trade journals that deal with your business field are deductible. 1040x tax form Supplies and materials. 1040x tax form   Unless you have deducted the cost in any earlier year, you generally can deduct the cost of materials and supplies actually consumed and used during the tax year. 1040x tax form   If you keep incidental materials and supplies on hand, you can deduct the cost of the incidental materials and supplies you bought during the tax year if all the following requirements are met. 1040x tax form You do not keep a record of when they are used. 1040x tax form You do not take an inventory of the amount on hand at the beginning and end of the tax year. 1040x tax form This method does not distort your income. 1040x tax form   You can also deduct the cost of books, professional instruments, equipment, etc. 1040x tax form , if you normally use them within a year. 1040x tax form However, if the usefulness of these items extends substantially beyond the year they are placed in service, you generally must recover their costs through depreciation. 1040x tax form For more information regarding depreciation see Publication 946, How To Depreciate Property. 1040x tax form Utilities. 1040x tax form   Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. 1040x tax form However, any part due to personal use is not deductible. 1040x tax form Telephone. 1040x tax form   You cannot deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home. 1040x tax form However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are deductible business expenses. 1040x tax form Prev  Up  Next   Home   More Online Publications