Discussion:Are you REQUIRED to claim incurred business expenses?

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Discussion Forum Index --> Basic Tax Questions --> Are you REQUIRED to claim incurred business expenses?


Discussion Forum Index --> Tax Questions --> Are you REQUIRED to claim incurred business expenses?

Jlkcpa1 (talk|edits) said:

17 February 2012
According to the code, a taxpayer is allowed to take deductions for business expenses (i.e. sole proprietor). Does that mean they have to take all the expenses they incurred, or can they choose not to take some if, because of EIC, they get a larger refund? I'm only talking about a small expense amount ($350) so it really doesn't make a big difference, but I'm just wondering about the proper way to handle this. Thanks for your help.

JR1 (talk|edits) said:

February 17, 2012
Failure to claim them all is indeed EIC fraud. Go straight to jail.

Trillium (talk|edits) said:

17 February 2012
See Discussion:Tax evasion and avoidance, which links to many of the earlier iterations of this question, including several that cover non-EIC situations, too.

RBruce (talk|edits) said:

17 February 2012
That is a very interesting question. I was always taught that there is no law that requires you to claim a deduction or tax benefit. Refusing to itemize can often result in less alternative minimum tax for example. But I never considered the effect on refundable credits. I'll try to look this up this weekend if I get time.

MilTaxEA (talk|edits) said:

17 February 2012
I can't remember the section of the code that requires it, but, yes, you are required to take all allowable deductions for the business. This applies even if EIC is not in the picture.

MilTaxEA (talk|edits) said:

17 February 2012
Revenue Ruling 56-407 states that under Section 1402(a), you are required (with the exception of some farms) to take all allowable deductions when caluclating net self-employment income.

Gazoo (talk|edits) said:

18 February 2012
Hold on, there will be some smart aleck that comes along and wants to know the exceptions.

"(with the exception of some farms)." That would be psychiatric hospitals (nut farms). Just in case anyone is wondering.

Fsteincpa (talk|edits) said:

18 February 2012
What about those items that you have no back up documentation for?

You don't keep a mileage log.

I love being a smart aleck.

Coddington (talk|edits) said:

18 February 2012
This linked article by Jim Maule provides a decent overview of this area of law.

Podolin (talk|edits) said:

18 February 2012
"Failure to claim them all is indeed EIC fraud. Go straight to jail." Makes preparing returns for EIC clients pretty scary. What if they forget (really, not purposely) a deduction, or they do not even know something is deductible? And what if preparer, in course of preparation, asks about a deduction he'd expect to see but is absent, and taxpayer just looks up at the ceiling? There are a lot of us smart alecks, or smart asses, depending. I will now click on Trillium's link.

JR1 (talk|edits) said:

February 18, 2012
Intent matters.

DaveFogel (talk|edits) said:

18 February 2012
You can view James Edward Maule's entire article (rather than just the summary that Coddington linked to above) entitled "No Thanks, Uncle Sam, You Can Keep Your Tax Break" here.

Cottcpa (talk|edits) said:

18 February 2012
JLK, as a general proposition outside of the EIC context, the answer is no, a taxpayer is not required to recognize allowable deductions. Since 1933 the tax court has recognized the maxim that "Deductions are a matter of legislative grace."


Follow JR's and Dave's advice in this situation - the EIC context is an exception. I think FStein's argument would probably hold water but it's not worth the risk.


One practitioner gave me some good advice on this forum a couple of years ago. Specifically, do not prepare returns for EIC clients. I've followed it ever since.

Fsteincpa (talk|edits) said:

18 February 2012
Going to read Dave's link now. As Cott said, holding water and flying are two separate issues. I have some strong opinions on the hypocrisy of tax breaks. Just because the EIC is a tax break, or tax welfare to low income individuals, as opposed to heaping amounts of corporate welfare that people are fine with, doesn't mean we shouldn't try to maximize it's benefit.

Maximizing it's benefit is not meant to read maximize via fraudulent means, but through every legal, and/or arguable method available. There is a huge difference between having one of your returns questioned, as opposed to having 30 or more that are shady so to say.

My issue is also sometimes a matter of principle issue in that the IRS says we cannot take mileage if we have no mileage log, but then, some are saying that they would enforce mileage on a return if it reduced the EIC. I'd fight that, for sure. Might not win, but they shouldn't be allowed to have it both ways.

At this stage of the game, most of the EIC clients are in and gone. I have 300 returns in already and in some stage of processing. Just did a query and there are 43 returns with EIC in it. Looking at the names and my knowledge of the situations, at least 85% of them are simply W-2 EIC's. I don't have a lot of transient clients. We aren't shuffling new clients in and out every year and we do our due diligence to the best of our ability. It also helps that we have a smaller community and my one preparer comes to me after each new client and tells me where she knows them from. lol.

Me, I don't discriminate against people for anything. All are good until they show me otherwise. Learned that a long time ago when I prejudged this scrabbly old couple, they stank a litle that day and he had the worlds worst toupe on. Anyway, I thought to myself, great, this should be fun. Well, they are a pair of my nicest clients and their interest and dividend income is about $11,000 each year. Project that out to money in bank numbers.

To me, people are people and they all deserve good courteous service.

Fraud is a whole different thing. Once you detect shadiness, run, do not walk. I take clients at their word, unless actions speak differently. I do not condone, nor would I recommend helping someone commit EIC fraud. Maximizing via legitimate means is ok, and if you aren't, you are being negligent to your client.

I've never left expenses off of a Schedule C or F to obtain a higher EIC, but if I was in a situation where I had the ability to and a proper legal argument, I wouldn't rule it out.

Now, with all the above being said, if you are dealing with honest clients, then that kind of situation really doesn't pop up. If you have to go through the mechanics each and every year and have to think about whether you should or shouldn't do that, then you should tell that client to go elsewhere.

From an EIC standpoint, you should feel comfortable about every one you file. If you don't, that particular client isn't worth having.

I've had clients who would bring me in stuff and I wasn't comfortable, I sat them down and explained how things are and gave them a choice. Some left, most stayed and some became bookkeeping clients. But, again, this shouldn't be something you have to do often.

Case in point is contractors unreimbursed business expenses. There is a company here and most of their guys go to this one other accountant because he gets them all sorts of money back. These guys share a room when they are away and then each guy takes the full amount on his return. I don't let them do that, it's not worth it. Rumor has it, this particular accountant, and I won't give his designation, EA, CPA, or PA, well, this guy is rumored to be getting his practices returns audited for fraud. This is the first year I've had a few of his clients come in. It's not worth it.

Fsteincpa (talk|edits) said:

18 February 2012
Home office is another deduction that I would have no problem leaving off. Many do as a matter of fear over audit. If that expense left off increases the EIC, I'm going to battle with IRS if they say I must take it.

NYea (talk|edits) said:

19 February 2012
Cott writes: JLK, as a general proposition outside of the EIC context, the answer is no, a taxpayer is not required to recognize allowable deductions. Since 1933 the tax court has recognized the maxim that "Deductions are a matter of legislative grace."


I don't believe the phrase "deductions are a matter of legislative grace" suggests that taking deductions is optional. It does suggest (I think it was in the SC in New Colonial Ice v Helvering) that taxpayers may only take deductions that are authorized by Congress. In the legal memo ILM 200022051 cited by Maule, one paragraph in reference to earnings from self-employment reads (emphasis added):


Revenue Ruling 56-407, 2 C.B. 564, addressed the issue of whether taxpayers may disregard allowable deductions in computing net earnings from self-employment for self-employment tax purposes. Rev. Rul. 56-407 held that under section 1402(a), every taxpayer (with the exception of certain farm operators) MUST claim all allowable deductions in computing net earnings from self-employment for self- employment tax purposes. Because the net earnings from self- employment that are included in earned income for EIC purposes are defined by cross-reference to the definition of net-earnings from self-employment under I.R.C. section 1402(a), this ruling applies equally to the EIC.

Podolin (talk|edits) said:

19 February 2012
I just read the Maule paper. And the above posts. There is another issue. What about the degree of aggressiveness of a particular taxpayer. (Not the same as taxpayer's desire to avoid IRS audit). Some taxpayers, for various reasons, do not strive to minimize their taxes. Maybe they want to be "fair" to the government and to the rest of us, so they instruct preparer to claim only those deductions and credits for which there is NO doubt. That could knock out quite a few items that most taxpayers and preparers have no problem claiming. Not trying to prolong this, as there is no ome correct answer. How many angels can dance on the head of a pin (whatever that means)?

Cottcpa (talk|edits) said:

19 February 2012
NYea. How many times has Rev. Rule 56-407 been cited by the tax court or any federal court since 1956? IRS CCA Memorandas have referenced it a few times over the past half-century under very specific circumstances where taxpayers underreported expenses as a subterfuge intended to gain an unfair, unintended advantage, most recently CCA 200022051 dealing with the exact issue on which the original poster requested advice. Maule concludes the issue as follows:

'The attempt to cast Revenue Ruling 56-407 and CCA 200022051 as standing for the proposition that all allowable deductions must be claimed fails on two grounds. [remainder of original quote deleted] 31 Seton Hall Legis. J. 81, 137 (internal citations omitted).

Trillium (talk|edits) said:

19 February 2012
The original poster wanted advice for a client hoping to increase EIC by reducing deductions, which is a much narrower issue than has developed in later posts.

But the real reason that I posted is two-fold:

  • That quote from Maule misrepresents his overall conclusions (as far as I recall them from one of the earlier incarnations of this debate), which were much more balanced and, in my memory at least, admirably in-depth with regard to multiple arguments pro/con, [edited to add: although see my second post below for more on this] and
  • That quote [now deleted] violates TaxAlmanac's copyright policies and will need to be edited out - no time for me to do that now, but Cott, if you'd like to paraphrase it and replace the quote with your paraphrase that would be appreciated, and if you don't want to do that, I'll catch up with it later on this weekend.

Coddington (talk|edits) said:

19 February 2012
The quote seems to be a fair representation of the professor's views. In 2006, when this came up on the ABA-Tax listserve, (prior to the article coming out), Professor Maule said that a universal rule mandating that taxpayers must claim all deductions would totally defy logic.

Cottcpa (talk|edits) said:

19 February 2012
Trillium, how does the quote violate the copyright policies? The language is taken from a published article, and a citation is provided. If this is a violation, please explain what I need to do the next time I want to reference the language in a published work. Also it's not a misrepresentation; NYea proposes that Rev Rule 56-407 acts as primary authority that taxpayers "MUST claim all allowable deductions," and he references Maule's article so as to imply that Maule argued the same. Clearly he did not.

Trillium (talk|edits) said:

19 February 2012
Sorry, Cott, I should have posted some links.
  • The starting point is the Website Use and Contribution Terms link shown on the upper right corner of each page.
  • Also see TaxAlmanac Policies and guidelines.
  • This help page provides some specific advice: "To be safe, do not copy more than a couple of sentences of text from anywhere, and document any references you do use. You can copy material that you are sure is in the public domain, but even for public domain material you should still document your source. Also note that most Web pages are not in the public domain."

Your quote could fall with the legal right of "fair use" IMO for an article that is copyrighted, and thus not in the public domain (as you say, you did properly provide attribution), but as you can see, TaxAlmanac is stricter than that - mainly because the site is relying on its users not to get the site into trouble on copyright issues.

RBruce (talk|edits) said:

19 February 2012
IMHO, you cannot make a false or fraudulent report under penalties of perjury which misstates your net income, regardless of whether it results in additional tax. But if you decide you really won't ever make a profit on your business and have not done so in 3 out of 5 years, you could claim the income and deny yourself the expenses under 183. If you have a home office, you can move a television and a recliner in there to ruin its exclusive business use. And we all know that a good deal of entertainment expense could go either way depending on your state of mind. Of course one need not itemize deductions, but could take the standard deduction.

26 USC 7207: Any person who willfully delivers or discloses to the Secretary any list, return, account, statement, or other document, known by him to be fraudulent or to be false as to any material matter, shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both. Any person required pursuant to section 6047 (b), section 6104(d), or subsection (i) or (j) ofsection 527 to furnish any information to the Secretary or any other person who willfully furnishes to the Secretary or such other person any information known by him to be fraudulent or to be false as to any material matter shall be fined not more than $10,000 ($50,000 in the case of a corporation), or imprisoned not more than 1 year, or both.

In Commissioner of Internal Revenue v. F. Tellier 383 us 687 Senator Williams is quoted in 50 Cong.Rec. 3849.9 as saying '(T)he object of this bill is to tax a man's net income; that is to say, what he has at the end of the year after deducting from his receipts his expenditures or losses. It is not to reform men's moral characters; that is not the object of the bill at all. The tax is not levied for the purpose of restraining people from betting on horse races or upon 'futures,' but the tax is framed for the purpose of making a man pay upon his net income, his actual profit during the year. The law does not care where he got it from, so far as the tax is concerned, although the law may very properly care in another way.' 50 Cong.Rec. 3849.9

It is not strictly necessary for one to understate their tax to be guilty of tax evasion. “[o]ne of the more basic tenets running through all the cases is that the purpose behind the statute is to prosecute those who intentionally falsify their tax returns regardless of the precise ultimate effect that such falsification may have.” U.S. v. Divarco & Arnold, "72-1 U. S. Tax Cas. at 84,628.

It is possible to perpetrate a scheme of evasion by failing to report allowable deductions. Armstrong v. United States, 354 F2d 274, 12/17/65. United States v. Bishop, 41 U. S. L. W. 4765 (U. S., filed May 29, 1973). Spies v. United States, 317 U. S. 492 (1943).

However, a taxpayer may not be able to meet his burden of proof in taking a deduction. The Internal revenue code of 1939 said: 734(b)(3)Burden of proof.— In any proceeding before the Board or any court the burden of proof in establishing that an inconsistent position has been taken (A) shall be upon the Commissioner, in case the net effect of the adjustment would be an increase in the income taxes previously determined for the prior taxable year or years, or (B) shall be upon the taxpayer, in case the net effect of the adjustment would be a decrease in the income taxes previously determined for the prior taxable year or years.

Rev. Rul. 57-538, 1957-2 CB 55, (Jan. 1, 1957), and 57-404 are right on point when they conclude that one cannot mis-report one's net income in order to obtain a tax benefit.

But the famous quote by Justice Learned Hand in S.R. Newman, 159 F2d 848 is. "If I understand the Commissioner, he wishes us to consider that these deeds may have been a preliminary step in a reprehensible scheme to lessen the wife’s income taxes. There is not the faintest ground for imputing any such purpose to the parties at bar; and, if there were, it ought not to count. Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant."

The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.United States Supreme Court Justice George Sutherland, Gregory v. Helvering (1934-5) 293 U.S. 465,460:

This issue is discussed in "TAXES - The Tax Magazine,Avoiding Taxes by Avoiding Deductions, (May 1, 2004)" but all quotes are from the original cases which I have read this evening and are in the public domain.

Taxea (talk|edits) said:

19 February 2012
Podolin your interview should answer all your questions. I am into getting the client every penny of deductions they are entitled to. With every Sch C, E or other I look at what expenses the client has given me. If anything is missing that I think they should have I ask. I also have made my own worksheets that include all expenses a small business or rental is entitled to. I have the TP fill these out because they are a reminder of items the TP might otherwise miss. I tell my clients that every penny out of pocket used for the business is deductible.

As for the OIH I encourage those who are entitled to this deduction to take it. If they have documentation of the expenses then there is no reason to fear an IRS audit. As long as I can justify the expense with proper documentation I take it.

Trillium (talk|edits) said:

19 February 2012
Cott, I do not disagree that the long paragraph you quoted supports your rebuttal with regard to the RR and CCA.

As I stated, I felt that it misrepresented Maule's overall conclusions, which I recalled as also providing other cites and/or analysis that would lead to caution in omitting deductions, even absent the EIC fraud issue. But as alluded to above, I hadn't studied the article for a few years, since one of the earlier debates of this topic (which you can find either via the search box or by following the link I provided early on in this discussion, where you'll find another post of mine and one from Miltax that link to quite a few of the prior discussions).

Having now re-read the article, I see that what I was recalling was with regard to deductions that affect self-employment taxes (understating deductions could increase the social security benefits available at a later time, opening up the issue of social security fraud), which is the one non-EIC caution that is emphasized both in the abstract and in the conclusions to Maule's article. So I shouldn't be applying that caution more globally.

I addressed your copyright policy question earlier - see a few posts up.

Cottcpa (talk|edits) said:

19 February 2012
Trillium, I updated the post. thanks for the explanation. As to SS fraud, I'll pass on any scheme that requires me to pay money today in return for a spurious IOU from Uncle Sam.

Trillium (talk|edits) said:

19 February 2012
Thanks, Cott.

NYea (talk|edits) said:

20 February 2012
Cott writes: Maule concludes the issue as follows:

'The attempt to cast Revenue Ruling 56-407 and CCA 200022051 as standing for the proposition that all allowable deductions must be claimed fails on two grounds. [remainder of original quote deleted] 31 Seton Hall Legis. J. 81, 137 (internal citations omitted).


You seem to confuse the "general rule" of whether allowable deductions are required to be taken with the "specific rule" in regards to earnings from self-emplyment. The original poster directed the post to that specific issue. There is authority for the position that allowable deductions must be taken in computing earnings from SE. Have you found any authority which provides otherwise? I think Maule's paper primarily addresses the general rule and he offers a caution in the final paragraph of the paper that suggests that the authority from the IRS controls the issue for earnings from SE.


...the last paragraph of the paper was then quoted here, but has been removed for compliance with TaxAlmanac's copyright policies. For those who haven't yet downloaded the paper, DaveFogel provided a direct link above.

Fsteincpa (talk|edits) said:

20 February 2012
So, let's take the situation of a cleaning guy who gets a 1099 from a few companies, he gets $18,000 a year and doesn't wish to be bothered with incidental expenses and mileage logs and such.

He only wishes to record his self-employment income.

What do you do?

CathysTaxes (talk|edits) said:

20 February 2012
Fred, I think your situation is entirely different. Many self employed people are horrible when it comes to keeping receipts and don't log their mileage, etc. I inform them that they are entitled to those expenses, but if they choose not to claim them, then I would just put the $18000 on the schedule C, and create schedule SE for the client.

In the initial post, it was to not take expenses that can be proven just so the client can qualify for EIC.

I just completed a return for a gentleman in his 70's. He's a 1099 courier. His mileage deduction puts him at 0 for taxable income. I don't record all of his expenses, why bother, he's not making any money, his tax liability is zero.

Cottcpa (talk|edits) said:

20 February 2012
NYea, I can find authority for damn near anything; the article from which you copied the last paragraph of your first post (without due credit given), even that webpage can carry authority. Your presumptuous first post relied on a revenue ruling that has never been relied on by a court of ANY competent jurisdiction, much less the US Tax Court, as if that revenue ruling was primary authority (note the distinction). You cited Professor Maule's article without actually reading it, or if you did read it, you did not understand it. Perhaps you should read it again.

NYea (talk|edits) said:

20 February 2012
No due credit for the last paragraph in the first post??

In the legal memo ILM 200022051 cited by Maule, one paragraph in reference to earnings from self-employment reads (emphasis added):

Revenue Ruling 56-407, 2 C.B. 564, addressed the issue of whether taxpayers may disregard allowable deductions in computing net earnings from self-employment for self-employment tax purposes. Rev. Rul. 56-407 held that under section 1402(a), every taxpayer (with the exception of certain farm operators) MUST claim all allowable deductions in computing net earnings from self-employment for self- employment tax purposes. Because the net earnings from self- employment that are included in earned income for EIC purposes are defined by cross-reference to the definition of net-earnings from self-employment under I.R.C. section 1402(a), this ruling applies equally to the EIC.

BTW, I use the word authority as defined in the regulations for §6662. Rev Rulings DO constitute authority. Articles and treatises rendered by tax professionals do NOT constitute authority. These are not my words but the words from the regulations. I suspect webpages likewise would not constitute authority.

Fsteincpa (talk|edits) said:

21 February 2012
But Cathy, if he only did that one job, then $18,000 gets him max EIC.

What happens then?

CathysTaxes (talk|edits) said:

21 February 2012
Fred, I'm not sure I understand your question, but let me try.

In many situations, it's better to claim expenses to get more EIC. At $18,000 for single taxpayer, he gets $2881 for one child. If he gets his income down to $16,000, he gets $3094. In your example, it's better for that taxpayer to claim expenses or he's cheating himself.

Fsteincpa (talk|edits) said:

23 February 2012
Ok, let me rephrase the question. Typing here without the benefit of the tables in front of me. Let's assume it's at an income point that generates the max EIC for any child situation. A cleaner says he/she has no expenses. Just the 1099.

CathysTaxes (talk|edits) said:

24 February 2012
Well Fred, if he has no receipts (which would be strange, he has to buy his supplies), then I would try this. I would suggest that he looks at his 'schedule' of clients. Then list all the jobs and use Mapquest to determine mileage. If he uses his clients' cleaning supplies, then he has no expenses. If he refuses to try to reconstruct his mileage log, I may send him on his way. When it comes to EIC, I don't take chances.

I have a client (carpenter) who originally was a SCorp (don't ask me why, probably some drinking buddy told him the scorp is the way to go). He treated his corp checking account as his personal account. His checks were mostly written out to Cash and rarely to his vendors. His balance was usually less than $100 because of this. He had his clients write checks out to HIM and he used his personal account to cash them, then to buy supplies with the cash (again, some drinking buddy told him to do this). So I had to go through his personal checking account with his wife (he was too lazy to do this) to try to identify what was business and what wasn't. Then he had a bad year, and the numbers said EIC. I marked it so he didn't get the EIC because he could not (or would not) say how much he really received. Oh, I got all 12 months of work at once, usually in June the following year. I pretty much forced him to close the scorp and be a sole proprietor and according to his wife, he no longer deposits his checks into their personal account, it all goes to the business account. His business account however, is 90% debit card transactions for personal use.

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