||2008 Tax Year
This chapter covers business expenses that may not have been explained to you, as a business owner, in previous chapters of
Topics - This chapter discusses:
Travel, meals, and entertainment
Bribes and kickbacks
Penalties and fines
Repayments (claim of right)
Other miscellaneous expenses
Useful Items - You may want to see:
Employer's Tax Guide to Fringe Benefits
Travel, Entertainment, Gift, and Car Expenses
Sales and Other Dispositions of Assets
Tax Benefits for Education
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 for travel, meals, and entertainment
incurred by your employees. 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
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.
A “reimbursement or allowance arrangement” provides for payment of advances, reimbursements, and charges for travel, meals, and entertainment
expenses incurred by your employees during the ordinary course of business. Upon satisfying your established substantiation
requirements, you can
deduct the allowable amount on your tax return. Because of differences between accounting methods and tax law, these amounts
may not be the same. For
example, you may deduct 100% of the cost of meals on your business books and records. However, for tax purposes, only 50%
of these costs are allowed
by law as a tax deduction.
A reimbursement or allowance arrangement (including per diem allowances, discussed later) depends on whether you have: (1)
an accountable plan or
(2) a nonaccountable plan. If you reimburse these expenses under an accountable plan, then you can deduct the amount allowable
to the extent of the
tax law as travel, meal, and entertainment expenses on your tax return.
If you reimburse these expenses under a nonaccountable plan, then you must 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
both wages and an expense reimbursement, you must specify the amount attributable to reimbursement and report it accordingly.
11-1, Reporting Reimbursements.
An accountable plan, requires your employees to meet all of the following requirements. They must:
Have paid or incurred deductible expenses while performing services as your employees,
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.
An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements
are also met.
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 are not allowed to deduct these expenses as reimbursed under an accountable plan. Instead, treat
the reimbursed expenses as
paid under a nonaccountable plan, discussed later.
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
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.
You give an advance within 30 days of the time the employee has incurred the expense.
Your employees adequately account for their expenses within 60 days after the expenses were paid or incurred.
Your employees return any excess reimbursement within 120 days after the expenses were paid or incurred.
You give a periodic statement (at least quarterly) to your employees that asks them to either return or adequately account
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 reimbursement on line 24b, Schedule C (Form 1040) or line
2, Schedule C-EZ (Form
If you are filing an income tax return for a corporation, the reimbursement should be included with the amount claimed
on the Other
line of Form 1120, U.S. Corporation Income Tax Return. If you are filing any other business income tax return, such as a
or S corporation return, deduct the reimbursement on the appropriate line of the return as provided in the instructions for
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
|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
|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
|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
|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 may 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.
The federal rate can be figured using any one of the following methods.
For per diem amounts:
The regular federal per diem rate.
The standard meal allowance.
The high-low rate.
For car expenses:
The standard mileage rate.
A fixed and variable rate (FAVR).
Your employee is considered to have accounted to you for car expenses that do not exceed the standard mileage rate.
For 2007, the standard mileage
rate for each business mile is 48.5 cents per mile for all business miles.
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 2007-63 in Internal Revenue Bulletin 2007-42. You can read Revenue Procedure 2007-63 at
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
Lodging expense, and
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 may 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 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
Per diem rates are available on the Internet. You can access per diem rates at
This is a simplified method of computing the federal per diem rate for lodging and meal expenses for traveling within
the continental United
States. It eliminates the need to keep a current list of the per diem rate in effect for each city in the continental United
Under the high-low method, the per diem amount for travel during 2007 is $246 ($58 for M & IE) for certain high-cost
locations. All other areas
have a per diem amount of $145 ($48 for M & IE). The high-cost locations eligible for the $246 per diem amount under the high-low
listed in Publication 1542.
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,
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
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.
Under an accountable plan, you can generally deduct only 50% of any otherwise deductible business-related meal and entertainment
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.
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.
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.
For tax years beginning in 2007, 75% of the 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 are deductible.
See Publication 463 for a detailed discussion of individuals subject to the Department of Transportation's hours of
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, discussed in Publication 15-B, or unless they are compensation to your employees and you treat them as provided
under a nonaccountable
The expense of providing recreational, social, or similar activities (including the use of a facility) for your employees
is deductible. 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.
Owned a 10% or more interest in the business during the year or the preceding year. An employee is treated as owning any interest
his or her brother, sister, spouse, ancestors, and lineal descendants.
Received more than $100,000 in pay for the preceding year. You may choose to include only employees who were also in the top
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
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.
Generally, amounts paid for meals, entertainment, and amusement provided to individuals who are not your employees are not
subject to the 50%
limit. Such activities must be directly related to the active conduct of your trade or business. Examples include:
Amounts paid for meals, goods, services, or the use of a facility. You are allowed a deduction only to the extent it is included
gross income of the recipient as compensation for services or as a prize or award.
Expenses that exceed $600 and are required to be reported on an information return, for example, Form 1099-MISC. See the
Instructions for Forms 1099, 1098, 5498, and W-2G for more information about reporting requirements.
The cost of providing meals, entertainment, goods and services, or use of facilities you sell to the public. For example,
if you operate a
nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is a business expense that
The cost of providing meals, entertainment, or recreational facilities to the general public as a means of advertising or
in the community is fully deductible.
In addition to travel, meal, and entertainment expenses, other miscellaneous expenses that are deductible, subject to limitations,
Amounts paid for the reasonable cost of advertising that are directly related to your business activities. Generally, amounts
influence legislation (i.e., lobbying) are not deductible for tax purposes. See Lobbying expenses, later.
Amounts paid that are directly related to the conduct of business meetings of your employees, partners, stockholders, agents,
Some minor social activities may be allowed, however, these expenses are subject to the 50% limit.
Amounts paid that are directly related to and necessary for attending business meetings or conventions of certain tax-exempt
These organizations include business leagues, chambers of commerce, real estates boards, and trade and professional associations.
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 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
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.
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 engages in the practice of returning 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.
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
Cash payments to an organization, charitable or otherwise, may be deductible as business expenses if the payments
are not charitable contributions
or gifts. 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
made by their business on Schedule A (Form 1040).
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. However, you may deduct it as an advertising expense.
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. However, you may deduct it as a business
See Publication 526 for a discussion of donated inventory, including capital gain property.
Club dues and membership fees.
Generally, amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or any
other social purpose are not
deductible. Clubs organized for business, pleasure, recreation, or other social purpose include, but are not limited to 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.
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
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
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 injury, not any additional amount. The deduction is the smaller of the following.
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
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 may 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.
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:
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).
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.
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.
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.
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
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
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 Line 22, 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
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.
Generally, lobbying expenses are not deductible. Lobbying expenses include amounts paid or incurred for any of the
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
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
You cannot claim a charitable or business expense deduction for amounts paid to an organization if both of the following
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
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.
The Vice President.
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.
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).
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 local council or similar governing body concerning its legislation
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
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).
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.
The costs of outplacement services you provide to your employees to help them find new employment, such as career
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
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. You have been contracted to construct 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
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
Court costs or stenographic and printing charges.
Compensatory damages paid to a government.
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
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.
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 depreciated over the useful
life of the property. 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
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).
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 Schedule D (Form 1040).
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.
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.
Figure your tax for 2007 claiming a deduction for the repaid amount.
Figure your tax for 2007 claiming a credit for the prepaid amount. Follow these steps.
Figure your tax for 2007 without deducting the repaid amount.
Refigure your tax from the earlier year without including in income the amount you repaid in 2007.
Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the amount of your credit.
Subtract the answer in (3) from the tax for 2007 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 70 of Form 1040, and write “I.R.C. 1341
” next to line 70.
For 2006, you filed a return and reported your income on the cash method. In 2006, you repaid $5,000 included in your 2006
gross income under a
claim of right. Your filing status in 2007 and 2006 is single. Your income and tax for both years are as follows:
Your tax under Method 1 is $7,668. Your tax under Method 2 is $8,168, figured as follows:
Tax previously determined for 2006
Less: Tax as refigured
Decrease in 2006 tax
Regular tax liability for 2007
Less: Decrease in 2006 tax
|Refigured tax for 2007
Because you pay less tax under Method 1, you should take a deduction for the repayment in 2007.
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 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
depreciation. For more information regarding depreciation see Publication 946, How to Depreciate Property.
Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any
part attributable to personal use
is not deductible.
The cost of basic local telephone service (including any taxes) for the first telephone line you have in your home,
even though you have an office
in your home is not deductible. 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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