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Posted by Shyster1040 on January 12, 2007, 7:12 am
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>>> My clients reimburse minor expenses I incur while doing
>>> genealogy research for them (parking, reproduction..).
>>> Until I invoice them and receive payment, these expenses
>>> appear on my [Quicken] records as categories under Office
>>> Expenses, not as A/R, since I'm on an cash basis. So what
>>> should I do with these expenses that are on my records
>>> across the year end boundary because I haven't invoiced for
>>> them yet?
>> Contingent fee lawyers run into this problem a lot. The IRS
>> says that you have to treat the expenses as loans to the
>> client. So there is no deduction when the expense is made,
>> and no income when it is paid back.
> I was all settled in with your advice until "Shyster" (I think
> that is the last poster's nickname) said that this only applies
> to accrual based businesses. He maintains that as a cash
> basis business, I must treat them as expenses this year and
> income when they are reimbursed. Can you comment? Now I'm
> betwixt an between.
While the contingency fee discussion has gone on elsewhere,
I'll answer it here since it concerns Jo's question.
The general rule is that litigation expenses a lawyer pays
for a client are advances on behalf of the client in the
nature of a loan, and thus are not deductible by the lawyer
when paid. As a corollary, if the lawyer subsequently
receives reimbursement in another year, the amount of the
reimbursement is not included in the lawyer's income for
that subsequent year. If the lawyer is not reimbursed by
the client, the lawyer is entitled to a deduction for a
worthless debt for the year in which the lawyer can
establish that the debt is worthless (i.e., that recovery
from the client cannot be had).
If the lawyer is working on contingency, the same rule
applies; the advanced costs are treated as loans to the
client and are not deductible by the lawyer when paid. If
the client loses, and thus is not obligated to pay the
lawyer any amount, then the advanced costs become worthless
debts in the year in which the matter closes without
recovery.
For a general discussion of these matters, see, e.g., Canelo
v. Commissioner, 53 T.C. 217 (1969); see also, PLR 9432002
(3/30/1994).
The exception to this is where the lawyer works on a gross
fee contract under which the lawyer bears the litigation
costs and such costs are not to be reimbursed out of any
recovery and the lawyer takes as a fee a portion of the
gross recovery. In that case, litigation costs paid by the
lawyer are deductible by the lawyer when paid. See Boccardo
v. Commissioner, 56 F.3d 1016 (9th Cir. 1995).
The rationale for the difference is that, in the net fee
contingency case (i.e., where costs are deducted out of the
recovery and the net is then split between the lawyer and
the client), the lawyer has an "expectation of repayment"
that renders the litigation costs in the nature of loans,
and as such are not deductible until the year in which that
expectation is defeated, e.g., by losing the case. In the
gross fee contingency case, however, the lawyer has no
"expectation of repayment" when the litigation costs are
paid. In that instance, the economic expenditure is borne
by the lawyer ab initio, and is deductible when paid;
alternatively, one could think of it as a "debt" that
immediately becomes worthless, I suppose.
In terms of the client, if the client is unconditionally
obligated to reimburse the lawyer (i.e., no contingencies
exist), then the client will have income from discharge of
indebtedness if the lawyer is never reimbursed and
ultimately properly writes the advanced costs off as a bad
debt.
On the other hand, if the lawyer is working on a contingency
fee basis under which advanced costs are reimbursed only out
of any recovery, the client will not have any income from
discharge of indebtedness if the case is lost and the lawyer
becomes entitled to a bad debt deduction. In this case,
because of the contingent fee, the client's obligation to
pay the costs is contingent on there actually being a
recovery; until there is a recovery, the client is not under
any obligation to pay a sum certain, and therefore does not
owe a debt. See, e.g., Zarin v. Commissioner, 916 F.2d 110
(3rd Cir. 1990)(gambler's agreement to pay gambling debt
unenforceable under state law therefore no income from
discharge of indebtedness).
So, if a lawyer takes a case on the usual contingency fee
basis, where the lawyer advances costs and is reimbursed out
of the gross amount recovered, if any, the lawyer cannot
deduct the costs as paid. If there is a recovery, the
lawyer is reimbursed, and the client is entitled to a
deduction at the time the recovery is actually or
constructively received.
If there is no recovery, the lawyer can deduct the costs
paid when the matter is closed; however, the client does not
have any income from discharge of indebtedness because there
was no unconditional debt since the condition precedent -
winning a recovery - never occurred.
However, ordinary sorts of costs associated with the general
operation of a law firm are generally deductible when paid
by the lawyer, even if the lawyer then bills the client for
those costs. For example, the costs of on-line research,
photocopying, word-processing, and the like. See, e.g., PLR
9432002 (3/30/1994).
The difference between the treatment of litigation expenses,
such as filing fees, deposition fees, and the like, and
ordinary office costs, is that in the first case, these
expenses are costs imposed on the client, and, unless the
lawyer is operating under a gross fee agreement, are borne
by the client. On the other hand, the costs of operating a
law firm are general, do not relate to the particular client
in any real way, and are not costs that are normally imposed
on the client. For example, the fee for filing a paper in
court is imposed on the person for whom the paper is filed,
not on the person doing the filing. On the other hand, the
cost of the paper used to draft that document is, generally,
imposed on the person who typed it up, and the fact that the
typist may determine his fee for typing based in part on the
cost to him of the paper is irrelevant - when the typist
paid for the paper, he was not paying that cost on behalf of
the person for whom he typed the document.
There is, of course, a middle ground; if, for example, the
typist and the client agreed before hand that the typist
would go out and buy a certain type of paper to use in
typing the document, then the typist might be regarded as
acting as the client's agent when he bought the paper, in
which case he paid the expense on behalf of the client.
Technically, the typist would not be permitted to deduct the
cost of the paper when paid, and would not have any
offsetting income when he was later reimbursed; however, if
he was never reimbursed, he would then have a bad debt
deduction.
In your case, the expenses that you mentioned, parking fees,
copying, mileage, etc, are more analogous to the general
costs of operating a law firm than they are to the sorts of
court costs and other litigation expenses that lawyers
typically pay on behalf of their clients.
In other words, even though you are acting as your client's
agent when you go to the local library to do some research,
the research is the activity you're doing on behalf of the
client, but paying the parking meter is not; i.e., incurring
that expense was not a necessary part of the service you
were performing for the client - you could have walked to
the library instead, or driven to a non-metered space and
walked from there.
As such, the better argument appears to be that you should
treat your parking, copying, and similar expenses as
business expenses that are deductible by you when paid, and
include the gross amount of your fee in income when received
from the client.
On the other hand, if you incur a significant expense in
order to acquire something that the client specifically
asked you to get, and incurring that expense was a necessary
precondition to obtaining the thing sought - for example, a
client asks you to buy an old family painting from a third
party for the client - then that expense should be treated
as an amount paid on behalf of the client, i.e., as an
advance in the nature of a loan to the client, should not be
deducted when paid, and should instead be offset against the
reimbursement you receive later on. In that case, and
particularly if the payment and the reimbursement occur in
different tax years, make sure that you keep really good
records, because the IRS gets really snitty if it thinks
someone is trying to hide income by not reporting it.
In fact, if you do an income offset in a later year because
it is a reimbursement of an expense paid on behalf of a
client in an earlier year, you should seriously consider
attaching a Form 8275, Disclosure Statement, to your return
for the year of reimbursement in order to CYA against the
assertion of penalties. If you guess wrong and the income
offset is denied (and it's too late to amend the earlier
return to claim a deduction), then at least you have a good
claim that you weren't negligent and therefore shouldn't be
penalized.
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Posted by DORFMONT@aol.com (Linda Dorfmo on January 13, 2007, 2:12 am
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My corporate client has this situation in his business. He
has a separate category of income "Reimbursement of Project
Costs" on his income line. He books the reimbursement
payments whenever they come in. He has a separate category
of expenses "Direct Project Costs" which he bills for and
deducts as they are incurred. These costs are part of Cost
of Goods Sold along with Direct Project Labor. We don't
worry about whether the costs are reimbursed in the same
year they are incurred. It all washes out eventually. His
clients are major engineering firms and government agencies
so payment is not in doubt.
Linda Dorfmont E.A., CFP, CSA
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by Shyster1040 on January 15, 2007, 2:26 am
Please log in for more thread options My corporate client has this situation in his business. He
has a separate category of income "Reimbursement of Project
Costs" on his income line. He books the reimbursement
payments whenever they come in. He has a separate category
of expenses "Direct Project Costs" which he bills for and
deducts as they are incurred. These costs are part of Cost
of Goods Sold along with Direct Project Labor. We don't
worry about whether the costs are reimbursed in the same
year they are incurred. It all washes out eventually. His
clients are major engineering firms and government agencies
so payment is not in doubt.
Is your corporate client on the long term contract method
with regard to these projects, or not?
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by jo on January 16, 2007, 3:34 am
Please log in for more thread options >>>> My clients reimburse minor expenses I incur while doing
>>>> genealogy research for them (parking, reproduction..).
>>>> Until I invoice them and receive payment, these expenses
>>>> appear on my [Quicken] records as categories under Office
>>>> Expenses, not as A/R, since I'm on an cash basis. So what
>>>> should I do with these expenses that are on my records
>>>> across the year end boundary because I haven't invoiced for
>>>> them yet?
>>> Contingent fee lawyers run into this problem a lot. The IRS
>>> says that you have to treat the expenses as loans to the
>>> client. So there is no deduction when the expense is made,
>>> and no income when it is paid back.
>> I was all settled in with your advice until "Shyster" (I think
>> that is the last poster's nickname) said that this only applies
>> to accrual based businesses. He maintains that as a cash
>> basis business, I must treat them as expenses this year and
>> income when they are reimbursed. Can you comment? Now I'm
>> betwixt an between.
> .....
The amounts we are talking about are what accountants have
told me in the past are laughingly "immaterial". However I
still would like to do it the proper way. The nature of my
(very small part time business) is genealogy research. The
expenses I speak of are necessary to provide the service to
the client. For instance, I must drive the the City
Archives, park at a meter, look at microfilm for two hours(
that part is straight service), and hopefuly find a birth,
marriage or death certificate to copy from the film. I
can't walk to the C.A.-- inconvenient and impossible for me
to lug research materials with me even it were not
inconvenient because I have a chronic pain disability.
I work in about 2 hr intervals , and parking runs about $2.
Copying a document can be $1.50- up, depending on how many
pages. Sounds like nothing, but it adds up over the course
of an extended family project. There are also somewhat
larger copying costs for documents like newer marriages and
wills-- can be $20, $2 per page, or other variations.
Documents are the core of my business so all expenses in
getting them are agreed to be the client's responsibility.
However, I also copy what I get for the client for myself; I
treat that as just the cost of doing business.
It would be nice if I were organized enough to get the
billing out perfectly timed so that client payments would
wash these reimbursible expenses in the same year but that
never happens. So, experts, what should a small potatoes
business person like myself do? I imagine the IRS would say
"cash basis"===> write it off this year and take income next
year, but I also imagine if I talked to two different
agents, I'd get two different opinions. The bottom line is
the totals are so little that the IRS would probably not
care a bit how I did it, but I'm trying to grow the business
and make everything very professional, neat, clean,
perfectly organized and accounted for. Can we "fight" about
it some more<g>?? I do appreciate you guys chiming in on
this on my behalf.
jo
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by Shyster1040 on January 16, 2007, 7:21 pm
Please log in for more thread options All of the expenses you've listed would be your own ordinary
and necessary business expenses, and are unlikely to be
treated as amounts advanced by you to your clients. As
such, you should deduct them when you pay them rather than
capitalizing them and using them as an offset to the income
you eventually receive.
Only if a client specifically asked you to drive to Library
A and make a copy of a document the client has specifically
identified (e.g., the probated will of President Abraham
Lincoln), and to then send that copy to the client via a
particular delivery service (e.g., please send it to me
overnight via FedEx), would there be any sort of legitimate
argument that those expenses were advances to your client
and should be offset against any income you receive rather
than being deducted when paid. However, even in the case I
just described, that argument is a weak one and the better
argument is still the one that those expenses are yours
alone and should be deducted when paid rather than saved up
and offset against the income you receive in the future.
The basic reason being that, even though these are costs
incurred in carrying out your client's specific instructions
(rather than incurred based on your best judgment about how
to reach the goal the client wants), these expenses are
still no different in kind or character from the ordinary
garden variety expenses you incur in carrying on your trade
or business of genealogy research. As such, the more
conservative position to take is that such expenses are
deductible when paid.
About the only situation where the argument that you should
not immediately deduct your expenses is where a client asks
you to go and buy a unique item for them. For example, if a
client told you that she knew that the original probated
will of Abraham Lincoln was being sold at auction and asked
you to go and buy it for her, the cost to you of bidding and
paying for the will would not be an immediately deductible
cost but would instead be an advance to the client in the
nature of a loan, and would be offset against the money the
client eventually pays you rather than being deducted when
paid.
The bottom line is: all of the expenses you've described so
far are your own ordinary and necessary business expenses
and are highly unlikely to be treated as advances to your
clients in the nature of loans. As such, you should be
deducting those costs when you incur them and not saving
them up (i.e., capitalizing them) and offsetting them
against the payment you ultimately receive from the client
for work done.
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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