Below is a list of common tax mistakes by attorneys with respect to expense deductions. The blatant misuse of the below expenses could invite an unwanted tax audit.
- Claiming entertainment expenses when they don’t qualify as “ordinary and necessary” under IRC § 162. The activity giving rise to the expense must be “directly related to” or “associated with” the active conduct of trade or business. Treas. Reg. § 1.274-2(a), (c), and (d). Generally, if no business is discussed, no deduction is allowed. And remember, meals are subject to a 50% allowance. IRC § 274(n). *Note: meals provided by restaurants are now 100% deductible until 2022 per the Consolidated Appropriations Act of 2021.
- Claiming travel expenses used for personal reasons. Remember the four-part substantiation requirement under IRC § 274(d) for any business traveling expense.
- Claiming hobby expenses as business deductions. Your penchant for wine or horses are generally not “ordinary and necessary” to your active trade or business.
- For attorneys who are shareholders of professional corporations, using the corporation to pay personal expenses is a constructive dividend to the attorney—not a business expense of the corporation. An example is the attorney who uses the corporate credit card for personal living expenses.
- As an attorney, you think you’d escape depreciation requirements? Think again. How about depreciable books and periodicals? Remember, any tangible asset used in a trade or business that has a useful life of more than one year must be depreciated. Permanent volumes of treatises are in asset class 57.0 and can be depreciated on MACRS over 5 years (Rev. Proc. 87-56). But periodicals (i.e. New York Law Journal) and loose-leaf services, which are consumed within the taxable year are deductible in full for that tax year.
- Our last blog discussed attorneys’ improper deductions of advanced client costs (which should be treated as loans). We learned that the IRS treats advanced client costs in contingency cases as loans—not current-year deductions—and if unrecovered, written off as a bad-business debt.
The Attorneys Audit Technique Guide discusses other issues such as trust-account practices, employee misclassification, and failing to report cash receipts. As discussed in that guide, other common attorney tax transgressions include:
- leaving earned income in a trust account too long (improperly deferring income)
- improperly treating employees as independent contractors (not paying employment taxes)
- Failing to report receipt of more than $10,000 in cash (IRS/FinCen Form 8300)