Necessary Expenses

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Necessary Expenses

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Necessary Expenses are the allowable payments you make to support you and your family's health and welfare and/or the production of income. This expense allowance does not apply to business entities. Our Publication 1854 explains the National Standard Expenses and gives the allowable amounts. We derive these amounts from the Bureau of Labor Statistics ( BLS ) Consumer Expenditure Survey. We also use information for the Bureau of the Census to determine local expenses for housing, utilities, and transportation.

Note: If the IRS determines that the facts and circumstances of your situation indicates that using the scheduled allowance of necessary expenses is inadequate to provide for basic living expenses, we will allow for your actual expenses.  However, you must provide documentation that supports a determination that using national and local expense standards leaves you an inadequate means of providing for basic living expenses.

Expenses Not Generally Allowed -- We typically do not allow you to claim tuition for private schools, public or private college expenses, charitable contributions, voluntary retirement contributions, payments or unsecured debts such as credit card bills, cable television charges and other similar expenses as necessary living expenses. However, we can allow these expenses when you can prove that they are necessary for the health and welfare of you or your family or for the production of income.

Offer in Compromise - Collection Financial Standards

Collection Financial Standards are used to help determine a taxpayer's ability to pay a delinquent tax liability.

Allowances for food, clothing and other items, known as the National Standards, apply nationwide except for Alaska and Hawaii , which have their own tables. Taxpayers are allowed the total National Standards amount for their family size and income level, without questioning amounts actually spent.  Maximum allowances for housing and utilities and transportation, known as the Local Standards, vary by location. Unlike the National Standards, the taxpayer is allowed the amount actually spent or the standard, whichever is less.

 National Standards for Allowable Living Expenses:

Food, Clothing and Other Items

National Standandards for reasonable amounts have been established for five necessary expenses: food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous.

All standards except miscellaneous are derived from the Bureau of Labor Statistics ( BLS ) Consumer Expenditure Survey (CES). The miscellaneous standard has been established by the IRS .

http://www.irs.gov/businesses/small/article/0,,id=104627,00.html

 

National Standards for Alaska :

http://www.irs.gov/businesses/small/article/0,,id=104935,00.html

 

National Standards for Hawaii :

http://www.irs.gov/businesses/small/article/0,,id=104937,00.html

 

 

Housing and Utilities Allowable Living Expenses

The housing and utilities standards are derived from Census and BLS data, and are provided by state down to the county level.

http://www.irs.gov/businesses/small/article/0,,id=104696,00.html

 

 

Allowable Transportation Expenses: 

The transportation standards consist of nationwide figures for monthly loan or lease payments referred to as ownership costs, and additional amounts for monthly operating costs broken down by Census Region and Metropolitan Statistical Area ( MSA ). Public transportation is included under operating costs. A conversion chart has been provided with the standards which shows which IRS districts fall under each Census Region, as well as the counties included in each MSA . The ownership cost portion of the transportation standard, although it applies nationwide, is still considered part of the Local Standards.

The ownership costs provide maximum allowances for the lease or purchase of up to two automobiles if allowed as a necessary expense. The operating costs are derived from BLS data.  If a taxpayer has a car payment, the allowable ownership cost added to the allowable operating cost equals the allowable transportation expense. If a taxpayer has no car payment, or no car, only the operating costs portion of the transportation.

http://www.irs.gov/businesses/small/article/0,,id=104623,00.html

Employee Business Expenses

If you are an employee, you may be able to deduct your work–related expenses as an itemized deduction (subject to limitations) on Schedule A, Form 1040. These employee business expenses include the cost of business travel away from home, local transportation, entertainment, gifts, and other ordinary and necessary expenses related to your job.

Deductible travel expenses are the ordinary and necessary expenses of temporarily traveling away from your tax home overnight on business. They include the cost of transportation, meals (subject to certain limits), lodging and other expenses related to your business travel. For travel expense purposes, generally, your tax home is the entire city or general area where your principal place of business is located, regardless of where you maintain your family residence. 

Although commuting costs are not deductible, some local transportation expenses are. Deductible local transportation expenses include the ordinary and necessary expenses of going from one workplace (away from the residence) to another. If you have an office in your home which is maintained for the convenience of your employer and that is used exclusively on a regular basis as your principle place of business (e.g., if your employer does not provide you with office space), you may deduct the cost of traveling between your home office and work places associated with your employment. You may deduct the cost of going between your residence and a temporary work location outside of the metropolitan area where you live and normally work. If you regularly work at one or more regular business locations away from your residence, you may deduct the cost of going to a temporary work location in that business within your metropolitan area. For these purposes, a temporary work location is a location where you realistically expect to work for 1 year or less. Transportation expenses include the cost of transportation by car, air, rail, bus, taxi, etc.

Business entertainment expenses and business gift expenses may be deductible, but subject to certain limits.

You must keep records to prove the expenses you deduct.

Business Use of Home

Whether you are self–employed or are an employee, you may be able to deduct certain expenses for the part of your home you use for business.

To deduct business–use–of–the–home expenses, part of your home must be used regularly and exclusively as one of the following:

1.       Regularly and exclusively as the principal place of business for your trade or business;

2.       Regularly and exclusively as the place where you meet and deal with your patients, clients, or customers in the normal course of your trade or business; or

3.       In connection with your trade or business, if you use a separate structure that is not attached to your home.

Under the principal-place-of-business test, you must determine that your home is the principal place of your trade or business after considering where your most important activities are performed and most of your time is spent, in order to deduct expenses for the business use of your home.

Your home office will also qualify as your principal place of business for deducting expenses for its use if you meet the following requirements:

1.       You use it exclusively and regularly for administrative or management activities of your trade or business; and

2.       You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

In general, because of the exclusive–use rule, you cannot deduct business expenses for any part of your home that you use for both personal and business purposes. For example, if you are an attorney and use the den of your home to write legal briefs and also for personal purposes, you may not deduct any business–use–of–your–home expenses. The only exceptions to the exclusive–use rule are for qualified day–care providers and for persons storing inventory or product samples used in their business.

If you are an employee, additional rules apply. Even if you meet the exclusive and regular use tests, you cannot take any deductions for the business use of your home unless:

·         the business use of your home is for the convenience of your employer; and

·         you do not rent any part of your home to your employer and use the rented part to perform services as an employee.

Deductible expenses for business use of your home include the business portion of real estate taxes, deductible mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance and repairs. You may not deduct expenses for lawn care in general or for painting a room not used for business.

When figuring the amount you can deduct for the business use of your home, you can use the entire amount of expenses attributable solely to the portion of the home used in your business. The amount you can deduct for expenses attributable to the whole house depends on the percentage of your home used for business. To figure this percentage, you may divide the number of square feet used for business by the total square feet in your home. Or, if the rooms are approximately the same size, divide the number of rooms used for business by the total number of rooms in your home. You figure the business portion of your expenses by applying this percentage to the total of each expense. Qualified day–care providers must account for personal use of any area not used exclusively for business when calculating the percentage of the home used for business.

If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. However, those business expenses that can not be deducted because of the gross income limitation can be carried forward to the next year but will be subject to the deduction limit for that year.

Business Travel Expenses

Travel expenses are the ordinary and necessary expenses of traveling away from home for your business, profession, or job. Generally, employees deduct these expenses using Form 2106) or Form 2106-EZ and on Schedule A, Form 1040. You cannot deduct expenses that are lavish or extravagant or that are for personal purposes.

You are traveling away from home if your duties require you to be away from the general area of your tax home for a period substantially longer than an ordinary day's work, and you need to get sleep or rest to meet the demands of your work while away.

Generally, your tax home is the entire city or general area where your main place of business or work is located, regardless of where you maintain your family home. For example, you live with your family in Chicago but work in Milwaukee where you stay in a hotel and eat in restaurants. You return to Chicago every weekend. You may not deduct any of your travel, meals, or lodging in Milwaukee because that is your tax home. Your travel on weekends to your family home in Chicago is not for your work, so these expenses are also not deductible. If you regularly work in more than one place, your tax home is the general area where your main place of business or work is located.

In determining which is your main place of business, take into account the length of time you are normally required to spend at each location for business purposes, the degree of business activity in each area, and the relative significance of the financial return from each area. However, the most important consideration is the length of time spent at each location.

Travel expenses paid or incurred in connection with a temporary work assignment away from home are deductible. However, travel expenses paid in connection with an indefinite work assignment are not deductible. Any work assignment in excess of one year is considered indefinite. Also, you may not deduct travel expenses at a work location if it is realistically expected that you will work there for more than one year, whether or not you actually work there that long. If you realistically expect to work at a temporary location for less than one year, and the expectation changes so that at some point you realistically expect to work there for more than one year, travel expenses become nondeductible when your expectation changes.

You may deduct travel expenses, including meals and lodging, you had in looking for a new job in your present trade or business. You may not deduct these expenses if you had them while looking for work in a new trade or business or while looking for work for the first time. If you are unemployed and there is a substantial break between the time of your past work and your looking for new work, you may not deduct these expenses, even if the new work is in the same trade or business as your previous work.

Travel expenses for conventions are deductible if you can show that your attendance benefits your trade or business. Special rules apply to conventions held outside the North American area.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

1.       Travel by airplane, train, bus, or car between your home and your business destination,

2.       Using your car while at your business destination,

3.       Fares for taxis or other types of transportation between the airport or train station and your hotel, the hotel and the work location, and from one customer to another, or from one place of business to another,

4.       Meals and lodging, and

5.       Tips you pay for services related to any of these expenses.

Instead of keeping records of your meal expenses and deducting the actual cost, you can generally use a standard meal allowance ranging from $31 to $51 for certain high cost areas, depending on where you travel.

The deduction for business meals is generally limited to 50% of the un-reimbursed cost.

Business Expenses

Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit.

What Can I Deduct?
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. 

It is important to separate business expenses from the following expenses;

  • The expenses used to figure the cost of goods sold
  • Capital Expenses
  • Personal Expenses

Note – If you have an expense that is partly for business and partly personal separate the personal part from the business part.

Cost of Goods Sold
If your business manufactures products or purchases them for resale, some of your expenses may be included in figuring cost of goods sold. You deduct cost of goods sold from your gross receipt to figure your gross profit for the year.

If you use an expense to figure the cost of goods sold, you cannot deduct it again as a business expense. 

The following are types of expenses that go into figuring cost of goods sold.

  1. The cost of product or raw materials, including the cost of having them shipped to you.
  2. The cost of storing the products you sell.
  3. Direct labor costs (including contributions to pensions or annuity plans) for workers who produce the products.
  4. Factory overhead expenses.

Capital Expenses
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. There are, in general, three types of costs you capitalize.

  1. Going into business.
  2. Business assets.
  3. Improvements.

Personal Expenses
Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct as a business expense only the business part.

Business Use of Your Home
If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to Publication 587, Business Use of Your Home.

Business Use of Your Car
If you use your car in your business, you can deduct car expenses. Refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Other Types of Business Expenses

  • Employees' Pay - You can generally deduct the pay you give your employees for the services they perform for your business.
  • Retirement Plans - Retirement plans are savings plans that offer you tax advantages to set aside money for your own, and your employees', retirement.
  • Rent Expense - Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.
  • Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities.
  • Taxes - You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses.

Insurance - Generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession.

Necessary Expenses Defines under the Standars of  §301.6343-1(b)(4) of the Regulations

The IRS Offer in Compromise Regulations cross references §301.6343-1(b)(4) of the levy regulations.  This means that if you have an “economic hardship” within the meaning of these regulations, those expenses will be treated as necessary expenses in computing your reasonable collection potential  for OIC purposes.  §301.6343-1(b)(4) is as follows:

(4) Economic hardship

(i) General rule. --The levy is creating an economic hardship due to the financial condition of an individual taxpayer. This condition applies if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses. The determination of a reasonable amount for basic living expenses will be made by the director and will vary according to the unique circumstances of the individual taxpayer. Unique circumstances, however, do not include the maintenance of an affluent or luxurious standard of living.

(ii) Information from taxpayer. --In determining a reasonable amount for basic living expenses the director will consider any information provided by the taxpayer including

(A) The taxpayer's age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;

(B) The amount reasonably necessary for food, clothing, housing (including utilities, home-owner insurance, home-owner dues, and the like), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer's production of income (such as dues for a trade union or professional organization, or child care payments which allow the taxpayer to be gainfully employed);

(C) The cost of living in the geographic area in which the taxpayer resides;

(D) The amount of property exempt from levy which is available to pay the taxpayer's expenses;

(E) Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and

(F) Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.
 

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