This section of the exam covers information regarding a business's finances, including its income, expenses, deductions and credits, assets, analysis of financial records and methods by which Enrolled Agents counsel business clients.
Business income is defined as any income that is realized as a result of business activity, typically through the sale of products and services. Business income is a type of earned income and for tax purposes is classified as ordinary income. Business income can often be offset by business expenses and losses. Payments that are received in the form of property or services are included as income at the fair market value.
IRS Topic 407 "Business Income" provides a brief description of income as it relates to businesses. Enrolled Agents should have knowledge of topics relating to business income, including:
- Gain or loss on disposition of depreciable property
- Gross business income
- Net income
- Net operating losses and loss limitations
- Cancellation of business debt
Business Expenses, Deductions and Credits
Business expenses, discussed in IRS Publication 535 "Business Expenses," include the wide variety of costs to which a business is subject. Expenses are the opposite of income and include payments to suppliers, employee wages, factory leases and depreciation. Enrolled Agents must know the various types of business expenses and the filing requirements. Important topics to know include:
- Business bad debts
- Business credits
- Business rental deduction
- Business travel, entertainment and gift expenses
- Casualty and theft losses
- Depreciation, amortization and depletion
- Domestic production activities
- Employee pay – compensation deductibility, fringe benefits, education expenses, loans and advances, etc.
- Employment taxes
- Federal excise tax
- Insurance expenses
- Interest expenses – deductible and nondeductible
- Rent expense – conditional sales contract, leveraged leases, etc.
- Reporting requirements for employees – W-2, W-4, Form 1099
- Alternative minimum tax net operating loss deduction
- Home office
Business assets are property or equipment that were purchased exclusively or primarily for business use, including vehicles, real estate, computers, office furniture and other fixtures. Business assets are listed on the firm's balance sheet as items of ownership and can be written off and either depreciated or expensed. As an enrolled agent, you will need to know about business assets, including:
- Calculating the basis of assets
- Disposition of depreciable property
- Like-kind exchange of assets (1031 exchange)
Analysis of Financial Records
The understanding and analysis of financial records is important to the enrolled agent. Financial statement analysis involves the process of reviewing and evaluating a company's financial records (such as the balance sheet) to gain an understanding of the financial health of the company. This provides an evaluative means of determining the past, current and forecasted performance of a company. Enrolled Agents must be familiar with various terms and aspects of financial records analysis, including:
- Accounting methodology – accrual, cash, hybrid, OCBOA
- Balance sheet
- Business type – service, retail, manufacturer, farm
- Depreciation and amortization
- Depreciation recovery
- Income statement
- Pass-through activity (Form K-1)
- Related party activity
- Tax versus books reconciliation
- Loans to and from owners
Advising the Business Taxpayer
Just as an enrolled agent can advise individuals, they are also qualified and expected to provide counsel to business taxpayers. These services vary and can including advising clients regarding:
- Accounting methods and procedures
- Business life cycle – startup, decline, etc.
- Client habits – separation of business and personal accounts
- Depositing obligations – employee taxes, excise tax
- Filing obligations – due dates, extensions
- Industry type
- Related party transactions
- Reporting business obligations – IRC sections 1099 and 1031 exchanges
- Requirements for record keeping
- Transfer elections in/out of the business
- Types of business entities
- Worker classification
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