40.7 Deductions for Professionals

The following expenses incurred by self-employed professionals in the course of their work are generally allowed as deductions from income when figuring profit (or loss) from their professional practices on Schedule C:

• Dues to professional societies.
• Operating expenses and repairs of car used on professional calls.
• Supplies.
• Subscriptions to professional journals.
• Rent for office space.
• Cost of fuel, light, water, and telephone used in the office.
• Salaries of assistants.
• Malpractice insurance (40.6).
• Cost of books, information services, professional instruments, and equipment with a useful life of one year or less. Professional libraries are depreciable if their value decreases with time. Depreciation rules are discussed in 42.1.
• Fees paid to a tax preparer for preparing Schedule C and related business forms.

Caution

Doctor’s Malpractice Insurance

A self-employed doctor may deduct the premium costs of malpractice insurance. However, a doctor who is not self-employed but employed by someone else, say a hospital, may deduct the premium costs only as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor. Whether malpractice premiums paid to a physician-owned carrier are deductible depends on how the carrier is organized. If there is a sufficient number of policyholders who are not economically related and none of whom owns a controlling interest in the insuring company, a deduction is allowed provided the premiums are reasonable and are based on sound actuarial principles.

In one case, physicians set up a physician-owned carrier that was required by state insurance authorities to set up a surplus fund. The physicians contributed to the fund and received nontransferable certificates that were redeemable only if they retired, moved out of the state, or died. The IRS and Tax Court held the contributions to the fund were nondeductible capital expenses.

In another case, a professional corporation of anesthesiologists set up a trust to pay malpractice claims, up to specified limits. The IRS and Tax Court disallowed deductions for the trust contributions on the grounds that the PC remained potentially liable. Malpractice claims within the policy limits might exceed trust funds and the PC would be liable for the difference. Since risk of loss was not shifted to the trust, the trust was not a true insurance arrangement.

- - - - - - - - - -

Professionals as employees.

Professionals who are not in their own practice may not deduct professional expenses on Schedule C. Salaried professionals may deduct professional expenses only as miscellaneous itemized deductions on Schedule A, subject to the 2% adjusted gross income (AGI) floor (19.1). However, “statutory” employees may use Schedule C (40.6).

The cost of preparing for a profession.

You may not deduct the cost of a professional education (33.16).

The IRS does not allow a deduction for the cost of a license to practice. However, the Tax Court has allowed attorneys to amortize over their life expectancy bar admission fees paid to state authorities.

Payment of clients’ expenses.

An attorney may follow a practice of paying his or her clients’ expenses in pending cases. The IRS will disallow a deduction claimed for these payments on the grounds that the expenses are those of the client, not the attorney. The courts agree with the IRS position where there is a net fee agreement. In a net fee agreement, expenses first reduce the recovery before the attorney takes a fee. However, where the attorney is paid under a gross fee agreement, an appeals court has reversed a Tax Court decision that disallowed the deduction of the attorney’s payment of client expenses. Under a gross fee agreement, the attorney’s fee is based on the gross award; the prior payment of expenses does not enter into the fee agreement and so is not reimbursed. Because he would not be reimbursed, an attorney claimed his payment of client expenses was deductible. An appeals court accepted this argument and allowed the deduction. The court allowed the deduction although California law disapproved of the practice of paying client expenses without a right of reimbursement. The court believed that there is no ethical difficulty with the practice and other jurisdictions approve of it. It is necessary for and it is the practice of personal injury firms to pay the costs of many of their clients.

If you are not allowed a current deduction for payment of clients’ expenses, you may deduct your advance as a bad debt if the claim is worthless in another year (40.6).

An attorney might deduct a payment to a client reimbursing the client for a bad investment recommended by the attorney. A court upheld the deduction on the grounds that the reimbursement was required to protect the reputation of an established law practice. However, no deduction is allowed when malpractice insurance reimbursement is available but the attorney fails to make a claim.

Daily business lunches with associates have been held to lack business purpose.

Courts agree with the IRS that professionals do not need to have lunch together every day to talk shop. The cost of the meals is therefore not deductible.