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Deduct ’Unreasonable’ Expenses? Yes, You Can!

  • 26 August 2014
  • Author: Cari Holbrook
  • Number of views: 3373
Deduct ’Unreasonable’ Expenses?  Yes, You Can!

Jerry is a business valuation specialist being brought in as an expert witness on a case in federal court. As a busy owner of an S Corporation, he’s decided to fly by private jet to his court appearance so that he can eliminate the time and hassle of a commercial flight. Can Jerry deduct this elaborate expense? Absolutely. And here’s why:

In order for a business expense to be tax deductible, that expense must be “ordinary and necessary,” as defined by the IRS.  An ordinary expense, the IRS states, is one that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is helpful and appropriate for the taxpayer’s trade or business.

Now, you’re likely thinking, “Flying by private jet doesn’t seem very ordinary OR necessary.” If you are, you’ve fallen into the trap of assuming “ordinary and necessary” means “reasonable.” But it doesn’t.

Appearing in federal court is an ordinary part of Jerry’s job—it’s not uncommon for him to be asked to do this. Travelling across country to make the appearance in person is necessary—otherwise he wouldn’t be able to testify as required. So whether Jerry decides to travel by private jet, commercial flight, train, automobile, or horse and buggy is of no consequence. In fact, the IRS even states that “an expense does not have to be indispensable to be considered necessary.”

Does the term “reasonable” factor in at all? Yes, but only as it relates to compensation.  Owners of C Corporations can really lose out in this type of scenario because only reasonable compensation is deductible. The compensation expense that is above and beyond what is reasonable is no longer a tax deductible expense at the corporate level. It’s also considered a disguised dividend to the business owner, and is taxed as such for the business owner as well.

One clue we provided about Jerry is that his business is, instead, an S Corp. One reason to do this (remembering that every situation is unique) is to avoid being double taxed. An S Corp often reaps the payroll tax savings of paying its owner or owners only what is considered “reasonable’ compensation. To make up the difference, S Corp owners will often declare and pay more dividends than their C Corp counterparts.

If you find yourself with similar expenses, don’t shy away from considering tax deductions—even if they seem like splurges. As tax professionals we provide assistance and guidance in order to avoid mistakes like double taxation, disguised dividends and unbalanced compensation.

Copyright: thorstenschmitt / 123RF Stock Photo

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