How to handle 2006 reimbursed expenses not yet invoiced.

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? If I use Quicken's P/L report, they act like any other expense and offset income. But when i get reimbursed for them in 2007, those expense categories will be credited, making it look like I earned income in an expense category (I've always assumed that's what a negative expense becomes). Intuitively, what feels right is to back out any of these reimbursible expenses on my records, perhaps not in Quicken, but when doing my Schedule C. Is this proper treatment? We aren't talking big numbers here. The total amount in the Parking expense category right now is about $30 and other reimbursibles are in the same range. I'd just like the solution to be simple and legal Thanks, jo

> > > > > > > > >
Reply to
jo
Loading thread data ...

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. Stu

Moderator: In the case of "jo", it would help to work against a retainer which may be difficult to get.

There is a worse problem in accrual accounting where billings and retainers become revenue in the period in which they occur.

Reply to
Stuart A. Bronstein

Stuart A. Bronstein wrote:

Thanks,Stu and Moderator. As I interpret what you're saying, it matches what my inclination was. Right? (another reason to never just import Quicken figures into Turbo Tax). Now I could complicate this by mentioning that it may happen that someone stiffs me. It hasn't happened yet, but I operate on such a flimsy basis of trust with people all over the country that it is entirely possible. I can think of one who currently is a prime candidate. In that case, am I right that the reimbursible expense I incurred would become an actual expense next year. Many/most of my colleagues do get retainers, and I occasionally ask for up front money if I know I'm going to have to shell out a lot of money for a particular document ("lot" doesn't come near what the rest of you in "real" businesses consider a lot). I just seem to do well with a very casual and trusting style of business so far (it's very small,part time since I'm on disability). Asking for retainers on one hand seems more professional, but on the other hand, these people don't know me at all, except for my presence on certain genealogy research internet lists, so they would have to trust sending money to a stranger. I imagine unused retainers could also add their own brand of complication at year end. As long as I don't get stiffed by anyone and know how to treat the expected reimbursed expenses, I'll continue as is. Related: What's the best way to handle them in Quicken H &B? Should/can I transfer them to an A/R account just for the year end period and transfer them back to an expense (if that's possible) next year, so that when they ARE reimbursed, the expense washes and doesn't go negative? If I'm not being clear, feel free to ask. jo

Reply to
jo

But if they lose the case, the client doesn't have to pay anything. Is that treated as cancellation of debt income? Seth

Reply to
Seth Breidbart

Under the contract there's no debt if they lose, so probably not. I imagine that in that case the lawyer could treat it as an expense at the time it is clear that it won't be paid back, similar to an option expiring. Stu

Reply to
Stuart A. Bronstein

So the IRS claims that from X's point of view, the payment is a loan to Y, but from Y's point of view, there is no debt? Is the IRS allowed to get away with such an inconsistent position?

It seems to me the lawyer is paying out money in Year 1 in hopes (expectation) of receiving more money in Year 2; since the payments are "ordinary and necessary business expenses" I'd think they'd be deductible for a cash-basis taxpayer. Seth

Reply to
Seth Breidbart

I don't specifically know how the IRS wants to treat clients when they lose. But I don't see that their position is inconsistent. From the client's standpoint, it's a contingent debt. They owe it if they win. From the standpoint of the lawyer they're saying that the money spent on out of pocket costs might be paid back, so they are not deductible when paid. I suppose they might be deductible by the client if they were business expenses, but that would be seldom or never the case.

One would think. But that's not the IRS position.

Stu

Reply to
Stuart A. Bronstein

Costs incurred in 2006 that will not be reimbursed until

2007 should, as a general rule, be deducted in 2006 by a cash-basis taxpayer. Under the general rule of deductibility, the cost has been incurred in 2006 and any deduction therefore is allowable only for the year in which incurred. Under the tax benefit rule, amounts received as reimbursement in 2007 are included in income for 2007, effectively offsetting the deduction claimed for 2006. This does, in fact, produce a bit of a distortion in the "true reflection of income" principle because your net taxable income is understated for 2006 and overstated for 2007; however, the distortion is generally relatively benign and is usually outweighed by the record-keeping and administrative complexities that would arise if the incurred expense were carried over until reimbursement was received. To the extent that a cost is incurred and then reimbursed in the same tax year, the items are generally netted against each other, and only the excess reported as either a deductible expense or as income. The analogy to expenses an attorney advances to a client is probably inapt in this case. Generally, under state law, a lawyer is not permitted to pay the costs of representation for the client, which costs remain the client's obligation. The lawyer may, however, advance those costs to the client provided that such advancement is made with the understanding that the client remains ultimately responsible for any unpaid costs and is required to repay such amounts to the lawyer. In other words, under applicable state law, the lawyer really is loaning those funds to the client and is not paying an expense that is properly part of the lawyer's cost of doing business and merely adding those costs to the amount of compensation the client owes to the lawyer. It should also be noted that other expenses that lawyers typically bill their clients for do not fall under this "loan" theory, e.g., per-page costs for printing and copying draft documents in the course of representing a client in structuring a transaction. These costs are properly costs incurred by the lawyer directly as a cost of doing business, for which the client is not primarily liable, and are deductible when incurred (for a cash basis lawyer); any subsequent reimbursement, if occurring in a later tax year, is treated under the tax benefit rule as income in that later year. In general, the costs described by the OP are her own costs of doing business, not expenses for which the client is primarily liable but as to which the OP has agreed to advance the necessary funds to the client to pay such costs. As a result, the OP should be claiming the deduction for such costs in the year in which incurred, and should be including in income any reimbursement received in a later tax year. To the extent that a cost and the related reimbursement occur in the same tax year, the OP should net the two amounts and only report the excess cost as a deduction, or the excess reimbursement as income.
Reply to
Shyster1040

Stu,

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.

jo

Reply to
jo

That had not been my understanding, but I had never specifically researched that issue. A brief look at the cases shows that the rule (advances to clients with the expectation of repayment are not deductible) applies to cash basis taxpayers. In Herrick v. Commissioner, 63 T.C. 562 (1975) the contingent fee lawyer paid his taxes on a cash basis. The court held that he had to treat advances to clients as loans and not as ordinary and necessary business expenses in the year the payments were made. This is apparently the rule at least in the 5th Circuit, Hughes & Luce v. Commissioner, 70 F.3d 16 (5th Cir. 1995), and the 9th Circuit, see Boccardo v. Commissioner, 56 F.3d

1016 (9th Cir. 1995). Stu

Reply to
Stuart A. Bronstein

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.
Reply to
Shyster1040

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

Reply to
DORFMONT

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?

Reply to
Shyster1040

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?? I do appreciate you guys chiming in on this on my behalf. jo

Reply to
jo

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.

Reply to
Shyster1040

jo wrote: (snipped....)

Well, mother always told me, it's not nice to fight. Later on all I heard was "make love, not war." (and this when I was a warrior) Then later, all I heard was "make love." anyway.....

Since I, too, an a genealogist and can relate to all the researching expenses you have, If I were to do some of it part time, or even full time, and considering reimbursements and billing hourly fees are not large amounts, I would simply account for everything on a cash basis. Any funds received from clients is income when obtained, and any expenditures are expenses in same year. It's the old KISS principle. (there I am back to make love, not war!) ChEAr$, Harlan Lunsford, EA n LA

Reply to
Harlan Lunsford

I own a single-employee C Corporation. I am also the single employee. I am not a tax pro, but my accountant is. I operate the Corporation on Cash Basis. I often spend money on the behalf of my clients in one tax year and do not get reimbursed until the next. The amounts can be rather large as these expenses include T&L, and one year included T&L for a trip to Japan that was incurred late one year and reimbursed the next.

Al expenses incurred during a year, including reimbursable expenses, are considered to be expenses for the year in which the expenses were paid.

I use QuickBooks and all Reimbursed Expenses, whether they are reimbursed in the year they were incurred or the following year, are considered by QB to be "income." The reason why QB treats these reimbursed expenses as income is that I set up the accounts that hold the reimbursed expenses as type "income" under the advice of my accountant.

When my accountant takes my QB file and prepares our corporate tax return he lists Reimbursed Expenses as Other Income on line 10 of my Form 1120 (with an attached explanatory statement) and lists Expenses such as legal fees, travel, etc that do not have specific lines on Form

1120 on Line 26 as Other Deductions, again with an explanatory statement that lists the expenses by category.

It really doesn't matter if my Reimbursed Expenses for one year exceed my Expenses for that same year though this has never happened. One reason why not is that the Expense category includes both reimbursable and non-reimbursable expenses. For example, for 2005 my reimbursed T&L was greater than my T&L (due to that trip to Japan in late 2004) but my total Expenses were still greater than my Reimbursed Expenses.

As far as I can determine, this is all normal for cash basis taxpayers.

-- Vic Roberts Replace xxx with vdr in e-mail address.

Reply to
Victor Roberts

1) how is your business organized? Is it a corporation an LLC or a Sole proprietorship???? 2) As a general rule corporations are required to use accrual. If you are an individual you are required to use the cash basis of accounting. So the answer is It depends.....

Jerry Doblie

14045 Sunnyside Ave N Seattle, WA 98133 206-365-0143

Reply to
JD

I own a very small C Corporation and we use cash basis. I think that the preference for accrual basis applies only to C Corporations above a certain size.

-- Vic Roberts Replace xxx with vdr in e-mail address.

Reply to
Victor Roberts

BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here. All logos and trade names are the property of their respective owners.