11.   Other Expenses

What's New

Standard mileage rate. Beginning in 2013, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for business use is 56.5 cents per mile. For more information, see Car and truck expenses under Miscellaneous Expenses.

Introduction

This chapter covers business expenses that may not have been explained to you, as a business owner, in previous chapters of this publication.

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.

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. If you are self-employed and report your income and expenses on Schedule C or C-EZ (Form 1040), see Publication 463.

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. Generally, you also must show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your trade or business. For more information on travel, meals, and entertainment, including deductibility, see Publication 463.

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. If the expenses are substantiated, you can deduct the allowable amount on your tax return. 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. For example, you can deduct 100% of the cost of meals on your business books and records. However, only 50% of these costs are allowed by law as a tax deduction.

How you deduct a business expense under a reimbursement or allowance arrangement depends on whether you have:

  • An accountable plan, or

  • A nonaccountable plan.

If you reimburse these expenses under an accountable plan, deduct them as travel, meals, or entertainment expenses.

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. 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. See Table 11-1 , Reporting Reimbursements.

Accountable Plans

An accountable plan requires your employees to meet all of the following requirements. Each employee must:

  1. Have paid or incurred deductible expenses while performing services as your employee,

  2. Adequately account to you for these expenses within a reasonable period of time, and

  3. Return any excess reimbursement or allowance within a reasonable period of time.

An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements are also met.

  • The advance is reasonably calculated not to exceed the amount of anticipated expenses.

  • You make the advance within a reasonable period of time of your employee paying or incurring the expense.

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. Instead, treat the reimbursed expenses as paid under a nonaccountable plan, discussed later.

Adequate accounting.   Your employees must adequately account to you for their travel, meals, and entertainment expenses. They must give you documentary evidence of their travel, mileage, and other employee business expenses. 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.

Excess reimbursement or allowance.   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. The employee must return any excess reimbursement or other expense allowance to you within a reasonable period of time.

Reasonable period of time.   A reasonable period of time depends on the facts and circumstances. 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.
  1. You give an advance within 30 days of the time the employee pays or incurs the expense.

  2. Your employees adequately account for their expenses within 60 days after the expenses were paid or incurred.

  3. Your employees return any excess reimbursement within 120 days after the expenses were paid or incurred.

  4. 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.

How to deduct.   You can claim a deduction for travel, meals, and entertainment expenses if you reimburse your employees for these expenses under an accountable plan. Generally, the amount you can deduct for meals and entertainment is subject to a 50% limit, discussed later. 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).

  If you are filing an income tax return for a corporation, include the reimbursement on the Other deductions line of Form 1120, U.S. Corporation Income Tax Return. 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.

Table 11-1. 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.
Actual expense reimbursement:  
Adequate accounting and return of excess both required but excess not returned
The excess amount as wages in box 1.
Per diem or mileage allowance up to the federal rate:  
Adequate accounting made and excess returned
No amount.
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. The amount up to the federal rate is reported only in box 12—it is not reported in box 1.
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. The amount up to the federal rate is reported only in box 12—it is not reported in box 1.
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.
No reimbursement plan The entire amount as wages in box 1.

Per Diem and Car Allowances

You can reimburse your employees under an accountable plan based on travel days, miles, or some other fixed allowance. 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. Your employee must actually substantiate to you the other elements of the expense, such as time, place, and business purpose.

Federal rate.   The federal rate can be figured using any one of the following methods.
  1. For car expenses:

    1. The standard mileage rate.

    2. A fixed and variable rate (FAVR).

  2. For per diem amounts:

    1. The regular federal per diem rate.

    2. The standard meal allowance.

    3. The high-low rate.

Car allowance.   Your employee is considered to have accounted to you for car expenses that do not exceed the standard mileage rate. Beginning in 2013, the standard business mileage rate is 56.5 cents per mile.

  You can choose to reimburse your employees using a fixed and variable rate (FAVR) allowance. 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.) plus a flat amount to cover your employees' fixed costs (such as depreciation, insurance, etc.). For information on using a FAVR allowance, see Revenue Procedure 2010-51, available at www.irs.gov/irb/2010-51_IRB/ar14.html and Notice 2012-72, available at www.irs.gov/irb/2012-50_IRB/ar10.html.

Per diem allowance.   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.

Regular federal per diem rate.   The regular federal per diem rate is the highest amount the federal government will pay to its employees while away from home on travel. It has two components:
  1. Lodging expense, and

  2. Meal and incidental expense (M&IE).

The rates are different for different locations. Publication 1542 lists the rates in the continental United States.

Standard meal allowance.   The federal rate for meal and incidental expenses (M&IE) is the standard meal allowance. 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).

Internet access.    Per diem rates are available on the Internet. You can access per diem rates at www.gsa.gov/perdiemrates.

High-low method.   This is a simplified method of computing the federal per diem rate for travel within the continental United States. It eliminates the need to keep a current list of the per diem rate for each city.

  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. All other areas have a per diem amount of $163 ($52 for M&IE). The high-cost locations eligible for the higher per diem amount under the high-low method are listed in Publication 1542.

  Effective October 1, 2013, the per diem rate for high-cost locations increased to $251 ($65 for M&IE). The rate for all other locations increased to $170 ($52 for M&IE). 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. However, you must use the same rate for all employees reimbursed under the high-low method.

  For more information about the high-low method, see Notice 2013-65, available at www.irs.gov/irb/2013-44_IRB/ar13.html. See Publication 1542 (available on the Internet at IRS.gov) for the current per diem rates for all locations.

Reporting per diem and car allowances.   The following discussion explains how to report per diem and car allowances. The manner in which you report them depends on how the allowance compares to the federal rate. See Table 11-1.

Allowance less than or equal to the federal rate.   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. Deduct the allowance as travel expenses (including meals that may be subject to the 50% limit, discussed later). See How to deduct under Accountable Plans, earlier.

Allowance more than the federal rate.   If your employee's allowance is more than the appropriate federal rate, you must report the allowance as two separate items.

  Include the allowance amount up to the federal rate in box 12 (code L) of the employee's Form W-2. Deduct it as travel expenses (as explained above). This part of the allowance is treated as reimbursed under an accountable plan.

  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. Deduct it as wages subject to income tax withholding, social security, Medicare, and federal unemployment taxes. This part of the allowance is treated as reimbursed under a nonaccountable plan as explained later under Nonaccountable Plans.

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. The deduction limit applies even if you reimburse them for 100% of the expenses.

Application of the 50% limit.   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. It applies to expenses incurred at a business convention or reception, business meeting, or business luncheon at a club. The deduction limit may also apply to meals you furnish on your premises to your employees.

Related expenses.   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. 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. 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.

Amount subject to 50% limit.   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.
  • The per diem allowance.

  • The federal rate for M&IE.

  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. 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.

Meal expenses when subject to “hours of service” limits.   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.

  See Publication 463 for a detailed discussion of individuals subject to the Department of Transportation's “hours of service” limits.

De minimis (minimal) fringe benefit.   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. See Publication 15-B for additional information on de minimis fringe benefits.

Company cafeteria or executive dining room.   The cost of food and beverages you provide primarily to your employees on your business premises is deductible. This includes the cost of maintaining the facilities for providing the food and beverages. 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).

Employee activities.   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. The benefit must be primarily for your employees who are not highly compensated.

  For this purpose, a highly compensated employee is an employee who meets either of the following requirements.
  1. Owned a 10% or more interest in the business during the year or the preceding year. An employee is treated as owning any interest owned by his or her brother, sister, spouse, ancestors, and lineal descendants.

  2. Received more than $115,000 in pay for the preceding year. You can choose to include only employees who were also in the top 20% of employees when ranked by pay for the preceding year.

  For example, the expenses for food, beverages, and entertainment for a company-wide picnic are not subject to the 50% limit.

Meals or entertainment treated as compensation.   The 50% limit does not apply to either of the following.
  1. Expenses for meals or entertainment that you treat as:

    1. Compensation to an employee who was the recipient of the meals or entertainment, and

    2. Wages subject to withholding of federal income tax.

  2. Expenses for meals or entertainment if:

    1. 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

    2. You include that amount on a Form 1099 issued to the recipient, if a Form 1099 is required.

Sales of meals or entertainment.   You can deduct the cost of meals or entertainment (including the use of facilities) you sell to the public. 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. The 50% limit does not apply to this expense.

Providing meals or entertainment to general public to promote goodwill.   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. The 50% limit does not apply to this expense.

Director, stockholder, or employee meetings.   You can deduct entertainment expenses directly related to business meetings of your employees, partners, stockholders, agents, or directors. You can provide some minor social activities, but the main purpose of the meeting must be your company's business. These expenses are subject to the 50% limit.

Trade association meetings.   You can deduct expenses directly related to and necessary for attending business meetings or conventions of certain tax-exempt organizations. These organizations include business leagues, chambers of commerce, real estate boards, and trade and professional associations.

Nonaccountable Plans

A nonaccountable plan is an arrangement that does not meet the requirements for an accountable plan. All amounts paid, or treated as paid, under a nonaccountable plan are reported as wages on Form W-2. The payments are subject to income tax withholding, social security, Medicare, and federal unemployment taxes. You can deduct the reimbursement as compensation or wages only to the extent it meets the deductibility tests for employees' pay in chapter 2. Deduct the allowable amount as compensation or wages on the appropriate line of your income tax return, as provided in its instructions.

Miscellaneous Expenses

In addition to travel, meal, and entertainment expenses, there are other expenses you can deduct.

Advertising expenses.   You generally can deduct reasonable advertising expenses that are directly related to your business activities. Generally, you cannot deduct amounts paid to influence legislation (i.e., lobbying). See Lobbying expenses , later.

  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. For example, the cost of advertising that encourages people to contribute to the Red Cross, to buy U.S. Savings Bonds, or to participate in similar causes is usually deductible.

Anticipated liabilities.   Anticipated liabilities or reserves for anticipated liabilities are not deductible. For example, assume you sold 1-year TV service contracts this year totaling $50,000. From experience, you know you will have expenses of about $15,000 in the coming year for these contracts. You cannot deduct any of the $15,000 this year by charging expenses to a reserve or liability account. You can deduct your expenses only when you actually pay or accrue them, depending on your accounting method.

Bribes and kickbacks.   Engaging in the payment of bribes or kickbacks is a serious criminal matter. Such activity could result in criminal prosecution. 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.

  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.

Meaning of “generally enforced.   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. For example, a state law is generally enforced unless proper reporting of a violation of the law results in enforcement only under unusual circumstances.

Kickbacks.   A kickback is a payment for referring a client, patient, or customer. 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. 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.

  For example, the Yard Corporation is in the business of repairing ships. It returns 10% of the repair bills as kickbacks to the captains and chief officers of the vessels it repairs. 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. These expenditures are not deductible for tax purposes, whether or not the owners of the shipyard are subsequently prosecuted.

Form 1099-MISC.   It does not matter whether any kickbacks paid during the tax year are deductible on your income tax return in regards to information reporting. See Form 1099-MISC for more information.

Car and truck expenses.   The costs of operating a car, truck, or other vehicle in your business are deductible. For more information on how to figure your deduction, see Publication 463.

Charitable contributions.   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. If the payments are charitable contributions or gifts, you cannot deduct them as business expenses. However, corporations (other than S corporations) can deduct charitable contributions on their income tax returns, subject to limitations. See the Instructions for Form 1120 for more information. 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).

Example.

You paid $15 to a local church for a half-page ad in a program for a concert it is sponsoring. The purpose of the ad was to encourage readers to buy your products. Your payment is not a charitable contribution. You can deduct it as an advertising expense.

Example.

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. Your payment is not a charitable contribution. You can deduct it as a business expense.

See Publication 526 for a discussion of donated inventory, including capital gain property.

Club dues and membership fees.   Generally, you cannot deduct amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or any other social purpose. 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.

Exception.   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.
  • Boards of trade.

  • Business leagues.

  • Chambers of commerce.

  • Civic or public service organizations.

  • Professional organizations such as bar associations and medical associations.

  • Real estate boards.

  • Trade associations.

Credit card convenience fees.   Credit card companies charge a fee to businesses who accept their cards. This fee when paid or incurred by the business can be deducted as a business expense.

Damages recovered.   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. You must include this compensation in your income. However, you may be able to take a special deduction. The deduction applies only to amounts recovered for actual economic injury, not any additional amount. The deduction is the smaller of the following.
  • 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.

  • Your losses from the injury you have not deducted.

Demolition expenses or losses.   Amounts paid or incurred to demolish a structure are not deductible. These amounts are added to the basis of the land where the demolished structure was located. Any loss for the remaining undepreciated basis of a demolished structure would not be recognized until the property is disposed of.

Education expenses.   Ordinary and necessary expenses paid for the cost of the education and training of your employees are deductible. See Education Expenses in chapter 2.

  You can also deduct the cost of your own education (including certain related travel) related to your trade or business. 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. 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.

  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. This is true even if the education maintains or improves skills presently required in your business. For more information on education expenses, see Publication 970.

Franchise, trademark, trade name.   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:
  1. Contingent on productivity, use, or disposition of the item,

  2. Payable at least annually for the entire term of the transfer agreement, and

  3. Substantially equal in amount (or payable under a fixed formula).

  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.

  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.

Impairment-related expenses.   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.

  You are disabled if you have either of the following.
  • A physical or mental disability (for example, blindness or deafness) that functionally limits your being employed.

  • A physical or mental impairment that substantially limits one or more of your major life activities.

  The expense qualifies as a business expense if all the following apply.
  • Your work clearly requires the expense for you to satisfactorily perform that work.

  • The goods or services purchased are clearly not needed or used, other than incidentally, in your personal activities.

  • Their treatment is not specifically provided for under other tax law provisions.

Example.

You are blind. You must use a reader to do your work, both at and away from your place of work. The reader's services are only for your work. You can deduct your expenses for the reader as a business expense.

Internet-related expenses.   Generally, you can deduct internet-related expenses including domain registrations fees and webmaster consulting costs. If you are starting a business you may have to amortize these expenses as start-up costs. For more information about amortizing start-up and organizational costs, see chapter 8.

Interview expense allowances.   Reimbursements you make to job candidates for transportation or other expenses related to interviews for possible employment are not wages. You can deduct the reimbursements as a business expense. However, expenses for food, beverages, and entertainment are subject to the 50% limit discussed earlier under Meals and Entertainment.

Legal and professional fees.   Fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to operating your business are deductible as business expenses. However, usually legal fees you pay to acquire business assets are not deductible. These costs are added to the basis of the property.

  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. 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. The result is the portion of the invoice attributable to business expenses. The portion attributable to personal matters is the difference between the total amount and the business portion (computed above).

  Legal fees relating to personal tax advice may be deductible on Schedule A (Form 1040), if you itemize deductions. However, the deduction is subject to the 2% limitation on miscellaneous itemized deductions. See Publication 529, Miscellaneous Deductions.

Tax preparation fees.   The cost of hiring a tax professional, such as a C.P.A., 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. Any remaining cost may be deductible on Schedule A (Form 1040) if you itemize deductions.

  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.

Licenses and regulatory fees.   Licenses and regulatory fees for your trade or business paid annually to state or local governments generally are deductible. Some licenses and fees may have to be amortized. See chapter 8 for more information.

Lobbying expenses.   Generally, lobbying expenses are not deductible. Lobbying expenses include amounts paid or incurred for any of the following activities.
  • Influencing legislation.

  • Participating in or intervening in any political campaign for, or against, any candidate for public office.

  • Attempting to influence the general public, or segments of the public, about elections, legislative matters, or referendums.

  • Communicating directly with covered executive branch officials (defined later) in any attempt to influence the official actions or positions of those officials.

  • Researching, preparing, planning, or coordinating any of the preceding activities.

  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. For information on making this allocation, see section 1.162-28 of the regulations.

  You cannot claim a charitable or business expense deduction for amounts paid to an organization if both of the following apply.
  • The organization conducts lobbying activities on matters of direct financial interest to your business.

  • A principal purpose of your contribution is to avoid the rules discussed earlier that prohibit a business deduction for lobbying expenses.

  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.

Covered executive branch official.   For purposes of this discussion, a covered executive branch official is any of the following.
  1. The President.

  2. The Vice President.

  3. 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.

  4. Any individual who:

    1. Is serving in a position in Level I of the Executive Schedule under section 5312 of title 5, United States Code,

    2. Has been designated by the President as having Cabinet-level status, or

    3. Is an immediate deputy of an individual listed in item (a) or (b).

Exceptions to denial of deduction.   The general denial of the deduction does not apply to the following.
  • 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. An Indian tribal government is treated as a local council or similar governing body.

  • 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).

  • 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).

Moving machinery.   Generally, the cost of moving machinery from one city to another is a deductible expense. So is the cost of moving machinery from one plant to another, or from one part of your plant to another. You can deduct the cost of installing the machinery in the new location. However, you must capitalize the costs of installing or moving newly purchased machinery.

Outplacement services.   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. are deductible.

  The costs of outplacement services may cover more than one deduction category. 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.

  For information on whether the value of outplacement services is includable in your employees' income, see Publication 15-B.

Penalties and fines.   Penalties paid for late performance or nonperformance of a contract are generally deductible. For instance, you own and operate a construction company. Under a contract, you are to finish construction of a building by a certain date. Due to construction delays, the building is not completed and ready for occupancy on the date stipulated in the contract. You are now required to pay an additional amount for each day that completion is delayed beyond the completion date stipulated in the contract. These additional costs are deductible business expenses.

  On the other hand, penalties or fines paid to any government agency or instrumentality because of a violation of any law are not deductible. These fines or penalties include the following amounts.
  • Paid because of a conviction for a crime or after a plea of guilty or no contest in a criminal proceeding.

  • 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.

  • Paid in settlement of actual or possible liability for a fine or penalty, whether civil or criminal.

  • Forfeited as collateral posted for a proceeding that could result in a fine or penalty.

  Examples of nondeductible penalties and fines include the following.
  • Fines for violating city housing codes.

  • Fines paid by truckers for violating state maximum highway weight laws.

  • Fines for violating air quality laws.

  • Civil penalties for violating federal laws regarding mining safety standards and discharges into navigable waters.

  A fine or penalty does not include any of the following.
  • 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.

  • Court costs or stenographic and printing charges.

  • Compensatory damages paid to a government.

Political contributions.   Contributions or gifts paid to political parties or candidates are not deductible. In addition, expenses paid or incurred to take part in any political campaign of a candidate for public office are not deductible.

Indirect political contributions.   You cannot deduct indirect political contributions and costs of taking part in political activities as business expenses. Examples of nondeductible expenses include the following.
  • 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.

  • 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.

  • Admission to an inaugural ball, gala, parade, concert, or similar event if identified with a political party or candidate.

Repairs.   The cost of repairing or improving property used in your trade or business is either a deductible or capital expense. 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. Otherwise, the cost must be capitalized and depreciated. See Form 4562 and its instructions for how to compute and claim the depreciation deduction.

  The cost of repairs includes the costs of labor, supplies, and certain other items. The value of your own labor is not deductible. 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).

Repayments.   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. 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.

Type of deduction.   The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. For instance, if you repay an amount you previously reported as a capital gain, deduct the repayment as a capital loss on Form 8949. 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).

  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. 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.

Repayment—$3,000 or less.   If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it.

Repayment—over $3,000.   If the amount you repaid was more than $3,000, you can deduct the repayment, as described earlier. 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.” This means that at the time you included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax under both methods and use the method that results in less tax.

Method 1.   Figure your tax for 2013 claiming a deduction for the repaid amount.

Method 2.   Figure your tax for 2013 claiming a credit for the repaid amount. Follow these steps.
  1. Figure your tax for 2013 without deducting the repaid amount.

  2. Refigure your tax from the earlier year without including in income the amount you repaid in 2013.

  3. Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the amount of your credit.

  4. Subtract the answer in (3) from the tax for 2013 figured without the deduction (step 1).

  If Method 1 results in less tax, deduct the amount repaid as discussed earlier under Type of deduction.

  If Method 2 results in less tax, claim the credit on line 71 of Form 1040, and write “I.R.C. 1341” next to line 71.

Example.

For 2012, you filed a return and reported your income on the cash method. In 2013, you repaid $5,000 included in your 2012 gross income under a claim of right. Your filing status in 2013 and 2012 is single. 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. 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.

Repayment does not apply.   This discussion does not apply to the following.
  • Deductions for bad debts.

  • Deductions from sales to customers, such as returns and allowances, and similar items.

  • Deductions for legal and other expenses of contesting the repayment.

Year of deduction (or credit).   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. 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. 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.

Subscriptions.   Subscriptions to professional, technical, and trade journals that deal with your business field are deductible.

Supplies and materials.   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.

  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.
  • You do not keep a record of when they are used.

  • You do not take an inventory of the amount on hand at the beginning and end of the tax year.

  • This method does not distort your income.

  You can also deduct the cost of books, professional instruments, equipment, etc., if you normally use them within a year. 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. For more information regarding depreciation see Publication 946, How To Depreciate Property.

Utilities.   Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any part due to personal use is not deductible.

Telephone.   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. 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.


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