Employer Reimbursements and Outplacement Services

If you are an employer and reimburse a prospective employee for the costs of traveling to an interview, you can deduct the allowance as a business expense. You do not have to treat the reimbursement as wages or as payments subject to employment taxes.

If you provide outplacement services for discharged employees to help them find new employment, you can deduct your costs as a business expense. Some of your costs may fall into specific deduction categories. For example, if you rent a separate office for use by discharged employees looking for new employment, you treat the cost of the office as a rental deduction. Utilities related to the office are deducted along with other utility costs.

Employer Job Candidate Search Expenses

Employers may incur various costs to attract and hire new employees. These are fully deductible ordinary and necessary business expenses, such as:

• Advertising in newspapers, magazines or online

• Agency job placement fees

Distance Test

The distance between your new job or business location and your former home must be at least 50 miles more than the distance between your old job or business location and your former home. If you move to another city or state, generally you have no difficulty in satisfying the distance test. Where you simply move across town, be sure that the move is of a sufficient distance to make your expenses deductible.

In calculating the distance test, use the most commonly traveled routes between locations. You need not measure distance “as the crow flies.”

What if you have been out of work a long time or you are changing from part-time to full-time employment? In this case, the new job location must be at least 50 miles from your former home. If you're a recent graduate who is moving to a first job or business, your new work location must be at least 50 miles from your former home.

Usually the distance between your new home and job locations is not considered. However, if the distance between your new home and new job location is more than the distance between your old home and new job location, you may not be able to deduct your moving expenses. The only way to deduct moving expenses in this situation is to show that you are required to live in your new home as a condition of employment or the move results in an actual decrease in commuting time or expense.

Work in Your New Location (Time Test)

If you are an employee, you must remain on the job at your new location for at least 39 weeks during the 12-month period that starts with your arrival at the new location. You need not stay with the same employer for all those weeks. You can get another job in the same location and deduct moving expenses as long as the total employment time is at least 39 weeks. In general, only full-time employment is used to satisfy the 39-week requirement, although there is a special rule for certain seasonal employment.

If you are laid off or fired from your employment without any willful misconduct on your part, the 39-week test is waived. The time test is also waived if you fail to meet the 39-week requirement because of circumstances beyond your control—strikes, temporary absences, illness, natural disasters, and such. The time is waived if you are transferred from your new job to another location for your employer's benefit. According to the IRS, this waiver does not apply if you request a transfer for your benefit. The waiver does not apply if you resign, are fired for willful misconduct, or reach the mandatory retirement age of your new employment where you anticipated this retirement.

If you are self-employed or a partner or an LLC member, there is a 78-week test. You must work full-time in your business for 78 weeks in a 24-month period beginning with the move to the new location. At least 39 weeks must occur within the first 12 months of arrival.

You need not wait out the time requirements before claiming the deduction for moving expenses. You can deduct your costs in the year of the move under the assumption that you will meet the time test. If you do not (e.g., if you move again before the end of the 39 or 78 weeks), then you must report your deduction as income in the subsequent year. Alternatively, you can amend the earlier return to delete the deduction for moving expenses.

If you are not sure whether you will meet the time test, you can file your return for the year of the move without the deduction and then amend it after the time test has been satisfied.

Change in Employment Status

If you change your employment status to that of an employee (e.g., if you shut down your business and find a job in your new location), you need only meet the 39-week test. If you change your employment status from employee to self-employed person before satisfying the 39-week test, you must meet the 78-week test to deduct moving expenses.

Deductible Moving Expenses

Only certain moving expenses are deductible. You may deduct the actual cost of moving your household goods and personal effects. What constitutes a personal effect has been rather liberally interpreted. For example, one taxpayer was able to deduct moving costs for a sailboat. The cost of packing, crating, and transporting furniture, the related insurance, and some storage costs are examples of deductible expenses.

You can also deduct the travel costs for you and members of your household. You need not all travel together. For example, you may relocate immediately, and your family may follow when your old home is sold or when the school year ends. Keep track of all transportation expenses for you and members of your household.

Travel costs include transportation and lodging to get from your old home to your new one. If you travel by your car, you can use a standard mileage allowance in 2016 of 19¢ per mile, plus tolls and parking. (You cannot deduct your mileage at the business mileage rate even though the move is business-motivated.) Alternatively, you can deduct your actual expenses for gas, oil, and repairs on the trip, plus tolls and parking. You cannot deduct the cost of meals on the trip from your old home to your new home.

If your employer pays your moving expenses or you receive reimbursement from your employer, you cannot deduct your costs. Your employer will not include the reimbursements in your income if the employer believes that you would have been entitled to a deduction had you not received reimbursement.

As an employer, if you pay employee moving expenses, you may deduct the costs even though they are not taxable to the employee.

Deductible Expenses

If education costs are deductible, the following types of expenses may be deducted:

• Tuition and fees

• Books

• Travel costs to and from school. If you drive, you can use the standard mileage rate for business, which is 54¢ per mile in 2016.

These travel costs include going to or from home to school, as well as travel between work and school. If you attend a seminar at a resort, see Chapter 8 to determine whether or to what extent you may deduct your education-related travel costs.

However, you may not deduct the cost of travel as a form of education. Thus, for example, an architect cannot deduct the cost of a trip to Rome to look at ancient Roman architecture as an educational expense. However, if the architect takes education courses in Rome on architecture, then the cost of the trip may become deductible.

Employer-Paid Education

If your employer pays for the cost of your courses, you cannot take a deduction. Employer-provided education may be a tax-free fringe benefit on which you are not taxed. Such benefits are discussed in Chapter 7. If you have a C corporation and the corporation pays your education costs, the corporation can deduct the costs whether or not you are taxed on the benefits.

Personal Education Incentives

There are a number of personal tax incentives designed to encourage higher education, whether or not it is job-related. Here are some to consider:

• American opportunity tax credit. There is a credit per student of up to $2,500 for the cost of tuition and fees for the first 4 years of college (100% of the first $2,000 of these costs, plus 25% of the next $2,000). The full credit can be claimed for the taxpayer, spouse, or dependents, but only if modified adjusted gross income (MAGI) is not over $80,000 if single, or $160,000 on a joint return. The credit phases out for MAGI between $80,000 and $90,000 if single, or $160,000 to $180,000 on a joint return. No credit can be claimed if MAGI is over $90,000 if single, or $180,000 on a joint return. No credit can be claimed by a married person who files a separate return. The credit is 40% refundable (you can receive a refund for up to this portion even though it exceeds your tax liability for the year).

• Lifetime learning credit. There is a credit of up to $2,000 (20% of up to $10,000) per return for the cost of tuition and fees for any college, graduate school, or vocational training. Like the American opportunity scholarship, the lifetime learning credit can be claimed for the taxpayer, spouse, or dependents, but only if modified AGI for 2016 is below threshold amount (the phaseout range for singles is $55,000 to $65,000; for joint filers it is $111,000 to $131,000). Unlike the American opportunity scholarship, there is no limit on the number of years you can claim this credit. This credit cannot be claimed if the American opportunity credit is elected for any student (but you can claim the credit for any other eligible student). For example, if your child begins college and you take a graduate course, you can elect the American opportunity credit for your child and the lifetime learning credit for yourself if your modified AGI is below the threshold amount.

• Deduction for tuition and fees. There is an above-the-line deduction of up to $4,000 ($2,000 for certain higher-income taxpayers) for tuition and related expenses for higher education. However, the deduction can be claimed only if modified AGI is no more than $65,000 for singles and $130,000 on a joint return ($80,000 for singles and $160,000 on joint returns for the $2,000 deduction limit). Even $1 of excess AGI means no deduction can be taken. This deduction expires at the end of 2016 unless extended for 2017; see the Supplement.

• Interest on student loans. Interest of up to $2,500 on student loans is deductible as an adjustment to gross income on page 1 of Form 1040. The full deduction can only be claimed if your AGI in 2016 is below a threshold amount ($65,000 for singles or $130,000 on a joint return). The deduction phases out over the next $15,000 of adjusted gross income for singles or $30,000 for joint filers, so that no deduction can be claimed once adjusted gross income exceeds $80,000 for singles or $160,000 on a joint return.

• Penalty-free IRA withdrawals. Withdrawals used to pay qualified higher education costs by those under age 59½ are not subject to the 10% premature distribution penalty. However, using IRA funds for education is still costly since the distribution is subject to regular income tax and you lose the opportunity for tax-free compounding.

Unincorporated Businesses

Individuals can deduct charitable contributions only as itemized deductions. For example, if you are a partner and the partnership makes a charitable contribution, the contribution is passed through to you as a separately stated item and you then deduct it on your Schedule A as an itemized deduction. The same is true for members of LLCs and shareholders in S corporations. Self-employed individuals who file Schedule C do not take business-related charitable contributions as a business expense. Charitable contributions are reported as an itemized deduction on Schedule A. Similarly, an employee who makes a charitable contribution at work (e.g., amounts are withheld from pay as contributions to the United Fund or another charity) deducts the contribution on Schedule A as a charitable contribution (not as an employee business expense). Charitable contributions by individuals are subject to certain AGI limits.

Donations of property by a partnership, limited liability company, or S corporation can affect the owner's basis in his or her business interest.

Sometimes it is not clear whether an expense is a charitable contribution or some other business expense. For example, if you pay to run an ad in a journal of a tax-exempt organization, the expense may be an advertising expense rather than a charitable contribution.

Unincorporated businesses that donate food inventory can claim the same enhanced deduction as C corporations (explained later in this chapter).

Corporations

Corporations may make charitable contributions and deduct them on their returns. The contributions must be made to public charities. The corporation cannot take a deduction if the organization receiving the contribution benefits any private shareholder or individual.

The corporation's accounting method may affect the timing of the deduction for a contribution. Cash method corporations deduct the contribution only in the year it is actually made. Corporations on the accrual method can choose to deduct contributions made within 2½ months after the close of its year as having been made in the prior year. To do this, the board of directors of the corporation must authorize the payment of the contribution within 2½ months after the close of the year. This authorization should be reflected in the corporate minutes.

A corporation can deduct only charitable contributions that total no more than 10% of its taxable income. Taxable income for purposes of this limitation does not include the deduction for contributions, the deduction for dividends received and dividends paid, net operating loss (NOL) carrybacks, and capital loss carrybacks.

Contributions in excess of the 10% limit can be carried forward for up to 5 years. If the corporation makes contributions in the carryforward years, the current deductions are taken into account before the carryforwards. Carryovers of excess charitable contributions cannot be deducted in a subsequent year if they increase a net operating loss carryover.

Corporations cannot claim a charitable contribution deduction for amounts given to an organization that conducts lobbying activities on matters of direct financial interest to their business.

Special rule for S corporations. When an S corporation gives appreciated property, the shareholder can deduct his or her share of the fair market value of the property. However, under a special rule, the shareholder reduces his or her basis in stock of the corporation only by his or her share of the corporation's adjusted basis in the property given.

Inventory

If you donate items from your inventory, the deduction is limited to the fair market value (FMV) of the property on the date of the contribution, reduced by any gain that would have been realized if you had sold the property at its FMV instead of donating it. Be sure to remove from opening inventory any contributions you make (namely, the costs for the donated property included in prior years). These costs are not part of the cost of goods sold for the year in which the contribution is made.

If you have excess or dated inventory that you wish to dispose of but do not know of an organization interested in it, consider working with an organization that can find a place for your inventory, such as:

• Good 360 at https://good360.org

• Operation Give at www.operationgive.org

• National Association for the Exchange of Industrial Resources at www.naeir.org

• Waste to Charity at www.wastetocharity.org

• World Vision's Gifts-in-Kind Program at www.worldvision.org

Donations for the III, Needy, or Infants

If a C corporation donates items from inventory to a public charity or an operating foundation where the inventory will be used for the care of the ill, the needy, or infants, add to the deduction 50% of the difference between the basis and the FMV of the inventory (but not more than 200% of the basis of the property). The donations must be for necessities of life, such as food, clothing, and shelter, so donations of cosmetics won't qualify for this special inventory rule. This special inventory rule does not apply to S corporations.

Certain Donations of Scientific Property and Computers

A C corporation can claim a larger deduction than ordinarily allowed if certain scientific property used for research is donated to an institution of higher education. This special rule allows the corporation to increase its deduction by 50% of the difference between its basis and the FMV of the property (but not more than 200% of the basis of the property). This special deduction is not allowed for S corporations, personal holding companies, or service organizations.

Food Inventory Donations

Donations of food qualify for the same enhanced deduction applicable to scientific property explained previously. To qualify, food must be apparently wholesome and meet all labeling standards.

Donations of Conservation Easement

Generally, a charitable deduction up to 50% of a contribution base is allowed for donations of conservation easements. A conservation easement is a restriction placed on real property for a public purpose to preserve the land or building for future generations. However, farmers and ranchers can claim a deduction up to 100% of their contribution basis (essentially adjusted gross income). And, if they cannot use up all of the deduction in the year of the contribution (because of adjusted gross income limits on contribution deductions by individuals), they can can effectively carry forward the excess for up to 15 years.

Appraisal Rules for Corporate Donations

All corporations that donate property valued at more than $5,000 must obtain a qualified appraisal. However, certain property donations are exempt from this requirement: donations of inventory, publicly traded stock, intellectual property, and vehicles for which a written statement is obtained from the charity. If the deduction for a donation is more than $500,000, the appraisal must be attached to the return.

Contributions of Intellectual Property

All types of businesses may make charitable contributions of their intellectual property. The deduction for such contributions is limited to the lesser of the basis of the property or its fair market value. Intellectual property includes:

• Patents, copyrights, and trademarks

• Trade names, trade secrets, and know-how

• Software

• Other similar property or applications

Special Deduction for Whaling Captains

Those recognized by the Alaska Eskimo Whaling Commission as whaling captains charged with the responsibilities of sanctioned whaling activities can deduct reasonable and necessary whaling expenses as a charitable contribution deduction. The deduction is limited to $10,000 per year.

Customs Expenses

If you import or export wares, you may incur special customs-related costs. These include customs fees, duties, and tariffs, as well as charges by customs brokers and international handlers. All of these fees are deductible. However, when they relate to inventory purchases, you may be able to add to inventory costs and recover them as part of the cost of goods sold.

Dues

Certain dues are deductible; others are not. Dues paid to unions are deductible. If you pay dues to professional, business, or civic organizations, they, too, are deductible, as are dues to the following:

• American Bar Association, American Institute of CPAs, American Medical Association, National Association of Enrolled Agents, and other professional associations

• Chambers of commerce, business leagues, trade associations, boards of trade, real estate boards, and business lunch clubs

• Civitan, Rotary, Lions, and other civic organizations

However, no deduction is allowed for dues to other types of clubs, such as athletic, sporting, airline, hotel, or other recreational clubs, even though membership is for business.

Subscriptions

The cost of subscriptions to business or professional publications is deductible. However, if you are on the cash basis and prepay subscriptions—that is, your subscription covers a period of more than one year—your deduction may be limited to the cost related to one year. You can deduct an allocable portion of the subscription cost in each succeeding year.

Legal Fees

Legal fees for business matters generally are deductible as an ordinary and necessary business expense. Examples of deductible legal fees include fees incurred for:

• Assistance in collecting outstanding accounts payable

• Defending against a claim of infringement of intellectual property

• Defending against charges of mismanagement of a retirement plan

• Defending against shareholder allegations of misconduct

• Defending against wrongful discharge actions

• Obtaining an IRS ruling

• Tax advice

Not all legal fees are currently deductible. Examples of nondeductible legal fees include fees incurred for:

• Acquiring a capital asset. The fees are added to the basis of the asset. For example, if you pay attorney's fees to handle the closing when you buy your office building, the fees become part of the basis of the office building and are recovered through depreciation.

• Actions that are personal in nature, such as legal fees to pursue a personal injury action, even if the injury occurred during a business trip; to prepare a will even if it includes a business; and to settle a divorce even if it relates to reserving your interest in a business. The portion of fees that can be allocated to tax advice, however, is deductible.

• Incorporating a business or setting up a partnership or LLC. These costs are treated as incorporation fees or organizational costs for a partnership, and are currently deductible up to a set dollar limit; excess amounts must be amortized, as discussed in Chapter 14.

• Suing for infringement. The costs are added to the basis of the intellectual property.

Accounting and Tax Preparation Fees

If you pay an accountant to show you how to set up your books or to keep your books for you, the accounting fees are deductible. Also deductible are fees for accounting advice, such as advice on whether to change your method of accounting or your method of inventory. The same is true for fees for accounting representation at an IRS audit.

Accounting fees incurred in investigating whether to buy a business are not currently deductible but may qualify as start-up expenses. The treatment of start-up costs is discussed in Chapter 14.

If you pay an accountant or other tax professional (paid preparer) to complete your tax return or contest a tax deficiency for your business (Form 1065, Form 1120, or Form 1120S), the cost is fully deductible on the appropriate return. If you are self-employed, the allocable cost of preparing Schedule C or contesting a tax deficiency related to it is a deductible business expense that can be claimed on Schedule C. The balance of tax preparation fees is deductible as a miscellaneous itemized expense on Schedule A, subject to the 2%-of-AGI rule.

Recovering Legal Fees and Other Costs from the Government

If you are involved in a tax dispute with the IRS and you win, you may be able to make the government pay any reasonable costs of your tax contest. You must have exhausted your administrative remedies and have substantially prevailed in your tax dispute. The IRS has the burden of proving that its position in going after you was substantially justified. If the IRS did not follow published regulations, revenue rulings, revenue procedures, information releases, notices or announcements, private letter rulings, determination letters, or technical advice memoranda issued to you, then there is a rebuttable presumption that the IRS's position was not substantially justified. Also, the fact that the IRS has lost in other appellate courts on substantially similar issues must be taken into account in determining whether the IRS's position was not substantially justified. If you succeed, you can recover attorney's fees at the rate of $200 per hour in 2016. In limited circumstances, a higher award may be possible.

If you are successful in your claim to recover costs from the government (e.g., if the IRS fails to prove that it was substantially justified in its position), you cannot also take a deduction for these costs. If you have already taken a deduction for your costs, you must include the government's award in your income.

The opportunity to recover legal fees from the government is limited to an individual with a net worth below $2 million. When married persons file jointly, jointly petition the court for a recovery of costs, and incur the costs jointly, each spouse qualifies for a separate $2 million net worth limit. However, the limit will be evaluated jointly. When they file jointly but petition the court separately and have separate costs, the limit is evaluated separately. In the case of businesses, the net worth requirement is below $7 million and fewer than 500 employees.

Lobbying Costs

Fees paid to professional lobbyists to influence legislation on the federal, state, or local level are not deductible. However, in-house lobbying costs up to $2,000 are deductible.

Postage and Shipping

The costs of postage, delivery charges, courier and messenger charges, and other mailing and shipping costs are deductible. However, freight charges to obtain inventory are part of the cost of goods sold. Similarly, freight charges for business assets, such as furniture or equipment, are added to the basis of these assets and recovered through depreciation.

The IRS has ruled privately that a business can deduct deposited funds for a postal meter as long as they relate to stamps that will be used within 3½ months of the end of the deposit year.

Books, Software, Apps, and Equipment

Books, software, apps, and professional equipment that normally have a life of one year or less can be deducted. For example, if you buy a business book that is updated annually (such as this book), you can deduct its cost. By the same token, if you buy tax return preparation software that applies to one tax year, you can deduct its cost. However, if you buy a professional library or other equipment that can be expected to last for more than a year, its cost is subject to depreciation (also, first-year expensing and the de minimis safe harbor rule may apply). See Chapter 14 for depreciation rules.

Office Expenses

The cost of miscellaneous office expenses not deducted separately (such as rent and utilities) is deductible as long as the expenses are ordinary and necessary for your business. Examples of deductible office expenses include:

• Aquarium and its maintenance

• CDs for office sound system

• Cleaning and janitorial services

• Decorator fees

• Flowers and plants

• Magazines and newspapers for the waiting room

• Snacks, coffee, tea, water, and other small refreshments

Interest on Life Insurance Policies

If you take out a loan on a life insurance policy covering the life of anyone in whom you have an insurable interest, you may not deduct the interest on the loan. So, if you borrow on a policy maintained to fund a buy-sell agreement, you may not deduct the interest. Corporations (and other nonnatural persons) generally may not deduct a portion of interest on any of their outstanding loans to the extent of any unborrowed policy cash value (cash surrender value of the policy reduced by any loans). This interest deduction rule, however, does not apply if the business owns a policy covering only one individual who owns at least 20% of the business or is an employee, officer, or director of the company.

Treble Damages for Antitrust Violations

One-third of the treble damages—3 times the actual damages—for antitrust violations is deductible; the balance is treated as a nondeductible penalty.

Restitution Payments

These payments generally are regarded as fines and are deductible. They must be compensatory and not punitive in nature. However, if restitution payments are made in lieu of a prison sentence, they are viewed as a nondeductible governmental penalty even though the funds go to a private person rather than to the government.

Related Expenses

Certain expenses related to nondeductible fines or penalties may themselves be deductible. For example, legal fees to defend your business against prosecution or civil action for a violation of a law imposing a fine or civil penalty are deductible.

Percentages of the Dividends-Received Deduction

The percentage of the dividend that can be deducted depends on the amount of stock your corporation owns and the type of company paying the dividends. Other factors may operate to further limit the percentage.

Other Limits on the Dividends-Received Deduction

In addition to the percentage limitation, other limits may apply to reduce or eliminate entirely the deduction.

Base Housing Amount

This amount is tied to the maximum foreign earned income exclusion. The base housing amount is 16% of the exclusion computed on a daily basis; this is multiplied by the number of days abroad (it's a little more technical than this, as explained in the instructions to Form 2555). Thus, because the exclusion in 2016 is $101,300, 16% of this is $16,208, which is $44.28 per day. If you're abroad for all of 2016, your maximum deduction is limited to $16,208; if you're abroad and it counts toward your qualifying period (see Chapter 4), then your deduction depends on the days there.

Housing Expenses

Housing expenses for the purpose of the deduction include reasonable costs for you (and your spouse and dependents if they live with you) during the part of the year that you qualify for the foreign earned income exclusion). However, the amount of housing expenses taken into account cannot be more than 30% of the foreign earned income exclusion (this limit is explained below).

Housing expenses include:

• Rent

• Fair rental value of housing provided in kind by your employer

• Repairs

• Utilities (other than telephone charges)

• Real and personal property insurance

• Nondeductible occupancy taxes

• Nonrefundable fees for securing a leasehold

• Rental of furniture and accessories

• Residential parking

Housing expenses do not include:

• Expenses that are lavish or extravagant under the circumstances

• Deductible interest and taxes (including deductible interest and taxes of a tenant-stockholder in a cooperative housing corporation)

• The cost of buying property, including principal payments on a mortgage

• The cost of domestic labor (maids, gardeners, etc.)

• Pay television subscriptions

• Improvements and other expenses that increase the value or appreciably prolong the life of property

• Purchased furniture or accessories

• Depreciation or amortization of property or improvements

The amount of qualified housing expenses eligible for the housing deduction is limited. The limit is generally 30% of the maximum foreign earned income exclusion (computed on a daily basis), multiplied by the number of days in your qualifying period that fall within your tax year. For 2016, this is generally $83.03 per day (30% of $101,300 366). However, the limit will vary depending upon the location of your foreign tax home.

If you incur housing expenses in a high-cost locality during 2016 (these are listed in the instructions to Form 2555), you can use housing expenses that total more than the standard limit on housing expenses $30,390 (30% of $101,300) to determine the housing amount. An individual who does not incur housing expenses in a high-cost locality is limited to maximum housing expenses of $83.03 per day ($30,390 per year).