Our daughter incurred a deductible expense. My wife paid for the expense because my daughter didn't have her wallet handy and then my daughter paid my wife back. My daughter would like to deduct the expense on her taxes. For record-keeping purposes, she has the cancelled check showing my wife paid the expense initially and then another cancelled check showing she reimbursed my wife for the expense. Assuming it's a legitimate expense and deduction, is my daughter entitled to the deduction?
People pay deductible expenses with borrowed money all the time, and it is still deductible. Credit card companies pay debts and the holder of the car can still deduct the expense.
I don't see why there should be a problem in your case.
You haven't provided any information at all to answer whether the expense is an allowable deduction for your daughter. You haven't stated whether the expense was business or personal, whether the daughter is a dependent, or any number of other facts that might help provide a better answer than "it depends".
But you started by asking whether there would be sufficient record-keeping in the scenario you provide. There are certain types of expenses that by statute require certain records be kept in order to be deductible (e.g. mileage, charity), but generally there is no specific record-keeping requirement for an expense to be deductible.
Cancelled checks alone are generally NOT adequate records, as all they document is a date, amount, payee, and payer. A cancelled check could be for a gift, loan, loan repayment, purchase, bribe, tax, penalty, and all other sorts of transactions; there is nothing about the cancelled check that proves it was any particular one of these transactions.
According to Pub 542, in addition to cancelled checks, you should also keep sales slips, invoices, and receipts, which represent another party's statement of what service or product the expenditure was for, and frequently, who received the product/service. If the check amounts match each other and a receipt, and the two checks were negotiated with a few days of each other, it's pretty safe to connect the dots and prove the expense of the daughter. The more deviation from a quick turnaround and precise dollar amount, the more likely an expense could be successfully challenged, if inquiries were made. In particular, spanning two tax years between paying the expense and reimbursing the wife could cause problems.
Unless payment is made in cash, there is *always* a bank/credit card company involved. I don't see how the wife is playing the same role as a bank or credit card company here, as the daughter does not have an established account with the wife, does not receive periodic statements, is not subject to account holder identification and withholding requirements, etc. (Stu, I'm playing devil's advocate here because maybe I'll find I'm wrong and get some free legal education ).
It was a deductible medical expense - a payment to a medical provider. My daughter (who supports herself and is not our dependent) itemizes her deductions and is able to deduct such expenses. In this case, my wife made the payment to the provider and my daughter subsequently repaid her. So I guess you could think of it as a loan, though the flow of payment went from my wife to the provider and then from my daughter to my wife (rather than from my wife to my daughter and then to the provider as would be the normal case with a loan).
The general question is this: if a taxpayer has any legitimately deductible expense - whether it be medical, mortgage interest, rental property expense or whatever - and someone else pays for that expense initially and then the taxpayer reimburses the person - is the expense still deductible to the taxpayer? Are there different rules on this for different categories of expenses? And finally, would it make any difference if the money were not repaid, that is, if it were a gift rather than a loan. To keep things simple, assume in that case that the amounts involved would be below any gift tax limits. Thanks!
Normally when money is borrowed the taxpayer has the cash, pays the debt with the cash and gets the deduction, even though it wasn't his money.
In some cases money is borrowed, but the lender pays the bill directly and the taxpayer pays it back to the lender. For example lenders on construction loans generally pay the creditors directly rather than relying on the borrower to pay it. But the payment has the same effect as if the borrower had paid it directly.
And then sometimes a hospital will sell a debt to a collection agency. If the debtor pays the medical bill to the collection agency, is it still deductible? She's not paying the hospital and not paying the person who she incurred the debt to. But it is still a medical expense, and she still pays it.
However you slice it, a deductible debt was incurred, and it was paid, directly or indirectly by the taxpayer. I don't see why having a pre-existing periodic account should have any effect on that. As in the case of all informal or family transactions, proving the intent and all the elements of the deductible expense may be tougher. But the payments should still be deductible.
To repeat the point I am making, record-keeping is not a factor that determines whether something is deductible or not, except where specified by statute or regulation. However, record keeping *is* a factor if you are challenged to *prove* the deduction. The better your records, the easier it is to end the challenge in your favor (i.e. have a "no change" audit). "Better" records, in my opinion, are those that a reasonable, disinterested party would conclude tell a complete and accurate story of who paid how much to whom, for what, and when.
For example, under the famous "Cohan rule" (tax court case involving entertainer George M. Cohan) some business deductions are allowed without any records to support them at all. But you might have to go to court to end the challenge, and not everyone wants to take that risk.
If large dollar amounts are involved, and you have poor or no records, you are probably inviting a headache with the IRS. In your scenario, if there is a clear record of the advance and reimbursement being made close together and tied to a specific service receipt or invoice, your daughter should have little to be concerned about.
Would not this problem have been avoided if the check were made out to the daughter and notated as a short-term zero-interest loan to be paid back? For little sums like this might have been, friends often make short term loans like that and keep no records. Most of such occasions do not involve deductible payments. If the mother's payment and daughter's repayment were both in cash, would that bring down the ire of the IRS even if found out? I doubt it.
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