5TH EOITION

•
e uClons
for Professionals
• Maximize your professional deductions
Attorney Steph&rl Fishman, • Understand ho me office rules
author 01 th e bestseller, Deduct It! • Avoid problems with the IRS
FlFTH EDITION JANUARY 2010

Ed i"" D IANA FITZPATRICK

Cov" D,.iS" SUSAN PUTNEY

p"",r",><l ;ng JI M BRUCE

Ind., MEDEAM TNNICH

I>'inting DELTA PK INTING SOLUT IONS, INC

fi ,r,,,,'n, S"I'I", • .
T.. <kduc,"''' f", 1'.0", ..",., 1, I By S"P"'" F;..hm, n. __ 5,h <d .
r ' 'm.
I"" I"<I<, hiN icy ,pI>;';'1"'"'''',,«,
,0<1 i.-.l<, .
ISB N. ! J , 978· 1" UJ·I079·5 (ph, . , "k. P'P<')
ISMN_10, 1_' 13J_1079_6 (pbk. , . Il, I"P"')
" P,.,f.......... ·T..,,"'n·· Ltw ,.J
l<~i~ .. jo n•• Uni"d S", ... 2. P",f<'''''n.1
<O'I"'",io"<--T.,.,",n __ Un i,<d s",,,. J . T.. d<duc,ion, __ Un i,<d S,,,,,.
I. T i,k.
KRi 49},!'7F57 lOO9.
3.3.7306' 7_,",22
2009021429

wry,i"", C> l007, l OO9, ,0<1 2010 by Nolo. All , i ~", ",,,,~d . Th< NOLO
".J.m .... i, '-'Si",,.J in ,he U,S. !'",",. 0<1 T,.J.m " k Olli«. P,i ,,<d in ' "'
U.S.A .

No 1"" of ,hi, ruNi",,",n m,y "' "'produc<d, "",,d in , """", I ,y,,<m, "'
",",m;,,«1 ;n '"f fm", m "r '"r m"",, ,""""k, , ,,,,h,n",,1, p"",oeopyinS-
tt<oroinS- " ' ",he,wi..,. wh ..... , p,jo t w,;,!<n I'<'o<i"joo, R<p",(!""ion I'",hih~ jo .>
do "'" .prl, '" '"' Iv,." <on" in<J in ,hi, prod"", wh<n .-.prod",,<d lv, p""" ,,1
U"'. Fo. ;.(o,m"ion 0. ""I, pu",h."" 0' ""1"''''' p" m;'m "h pr..« <on'",'
'"' Sp«;"1 Sol<. D<",."m"". Co il 300·9\S·. nS 0' ", j" '0 Nolo, 9\0 P"' <r ,,,,<to
S"kd<y, C,lilv,n ;' 94710,

w.l><iow >Ce""", p"'" . ( , ~kh 10,, 1i,fo,m""," $I>ould hoIp )'0" "'"'- m,., 01
)'0" ' CW" ",.1 p ""'lom~ Bot '"~ ... , ~ ""' . ",!>;ti,ulO f<H """,n •• «<1 ad,,",.
from. ' ""_"", 010 ,"w)'",-II)'O" "",n' ,ho holp of. , <>it>«! p,..,.,-........ I_ ..d
.......Iw,l" ",""' 0"' ,;,,,",,io", in whkh .... '''n, ,h.t".. p>d ;d • • _ "", ,"~ . "
.ttm,..., kon>«l '" p, .. ,k. "'U, ""•.
i,
Table of Contents

Your Tal( Deduction Companion _____________________________ 1

1 Tal( Deduction Basics._______.___

How T.x OMuction. Work ______________________ A
Th~ Valueof a Tax O~ d uctio" _ _ _ _ _ _ _ _ _ _ __
--,
Wh.l Profe.siona l. Can Deducl _______ ._______ ._____ ._______ ._____ .__ . l0

2 Choice of Business Entity ------------------------------ ;;

TYP'" of Bu';~ .. En,;, ie •._. _____________________ ._______ ._____ ._. 17

limiti ng Your l"bility _ _ __ _ _ _ _ _ _ _ 24

The Four Ways Bu.ine.. En, i, " . Art! T.xM ___________ ._______ ._____ .__ .32
Comparing Tax Trt!.tment. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ "
Soould You Change Your Bu';"u. Entity Of Tax Treatment1 _______ .63

3 Operating hpenses ________ ____________ ~_~ _______ 71

Re<juirements for DMucting Oper.,ing &pen"'''-_____________72
Operating Expen",. Tha, Art! No, Deduc'ib!. __________________ .n
Tax Reporting __________________________________ .______78

4 Meal and Entertainment hpenses _______________._____.__.81

Wha' I, Bu,;""" En' .. uin""'n" _____________ . ___ . _ . _ ____ ~ __ .,
Who Ca n 6e Enl er,air>e<l ______________________________ __________ 83
~ ~

Deducting Ente" ai nment ExpenSfi-_________ . _ _~ _____ ____ ~ ____ 84

C.lcul><ing Your D.,duction ____________________________ ._.BB

Expe"''' Reimbu""d by CI.. nts _____ ~ _____ . _ _~ _____ . _____93

5 Car and local Travel Expenses.._______.__..__.____.______ 95
Deductible Lonl Tram.port.. . ion Expen ....._ ___ ___ .______ .___ .___ 96
The S.. nd.,d Mileage Ra'e_ •._ ______ ._•._____________ .____ ,. 101
The Actual Expen .. Method ________ _ _ ~~ ___ .______ .___ .__ . 10)
O,her Loc. 1Tr. n"",rt.,,,,,, fxpen .... __ .________ .__ .________ 118

Rtporting T,.n"",rtat"''' h pen.., on Scl>rdule C___ ~ _ ___ .______ 119

When Clien" Reimbu, ... 10u.________ .___ ._______ .__ ._________ 120
Prof~.<ional. With 8U~M« Ent it'''' ______________ ""

6 long Distance Travel Expenses.___ .________ .___ ._______ .__ .. 125

What I. 6u,iM<S Travel' ____ __________ .________ .______ 126
Wf>a, T,. ",I Expen ... ,Are Dodur'ible_. _ _.____ .________ .______1l2
How Much You Can D<:dur'-____ ____ ~ _ ___ ___ .___ ~~ ____ .__ . 134
M.>ximi>ing Your Bu.in. « T,.",I Dodur'ionL ___________ .____ . 1.4
Tr.",1 Expen .... Reimbu,<e<l by (I ie"" .. _________ .________ .__ . 148

7 The Home Office Deduction ___ - - - - - -'"

Qualifying for the Ho me Office Oed"",,,,,, .________ ._•. ____ .______ 1,2
Calculating tf>< Home Office Deduc'ion _ __ ~~ ___ .______ .___ .__ . 165
How to D<:duct Home Office Expen .... .. _ •.____ _________ .______ I75
Aud it.P ,oofmg Your Home Office D<:dur''''n. _____ .______ .___ .___ 178

8 Deductions for Outside Offices ________ ._______ .___ 181

If You R.nt You, Office . 182
If You Own You r Office __ .___ ._______ •. ___ .________ .___ ._______ .__ . 186
If You l ...... 6uikJing to Your Pr..:tice __ .____ ._____ ___ .___ ._ _. 196

9 Deducting long-Term Assets __.______.________.____. 199

Long·Term A....". ___________.___________ _ _ _ . 201 ~

Section 17'.1 Ooduclion. _ _ _ _ _ _ _ _ _________~ ,~

 D ~ PfK i.o t ""' . __ ___ ~_~ __ ~~ _ ___ ___ _____ ___ __ __ ___ ~ ____ 116
Tax Ro,po rl ing and R...,o,d K..,ping fo, SKlion 179 and D ~ pr ..., ia,io'l.. _. 2'3
l ~a"ng l"" g- T~rm A,,,,,, _ _ _ _ __ _ _ __ _ ~ _ _ __ _ ' "

10 Start-Up Expenses..___________________._____._______._____._.2 , 1
Wha' Are Sun-Up E. p<:n"'.' .___ __ _________ ___ __ __ ___ ____ 2, 2
Start ing > N ~ w p , ac, ic~ ________ • _ ______ ___ • _ ___ _________ ~ __ ZS3
Buying an Existing 1', at ti<;e ______ ~ _ _________ ~ _____ ___ ~ _ __ __ 2 \06
Exp:mdi ng an Exi" ing p,ac tic~ _______ __ • ____ ___ __ • ___ .____ 2S7
When Doe, > Prof."io",,1 Pr>e,i<;. 808in1 ____________________ 2S8
How '0 OMue, S"'rt.U p Exp<:n ... ._ _____ _____________ ._ ___ 2S9
Drgan 'l>!ional hpen ..'. __________________ ~ ____________ 262

11 Medical Expenses _________ ~ _ _________ ~ _______ ~ _ __ __ 263

The Pe,,,,,,. 1 DedUClion fo' MM i<;. 1bp<:n"'. _____________________ ._ 264
~1f_ E m ployM H ~ . l th I n.u,a n c ~ DMuc, ion ___ ___ __ __ ___ ___ __ __ 265
O~duc'ing Heal' h I n .u,a nc ~ .. an EmploY"" F, inge B ~ n e fi' ____ _____._ 268
Adop, ing ' MM ic.1 R. imbu",""",n ' Plan _ ___ ___ __ __ ___ ~ ____ 17.
'»'; nS' Aeeou n" ___________.______ ._____ ._______ ._____ ._ 281
H~> I ' h

12 Retirement Deductions _________.___________._______._____._ ;/93

Why You Need • Reli .."",m Pia" (or 1'1.".) ______ ._____ ._______ ._____ ._ 295
Type. of Ro,{ire me n{ pl. n. ___ ___ __ _________ __ __ __ ___ ____ 300
Ind ividu.1 R.. i, ~ m . n ' Account ' - IRA, __ _____ ___ _____ __ __ ~ __ 301
IRA. lor Bu"n....,. ___ ___ _____ ~ _ _________ ~ _____ ___ ~ _ __ __ 307
Qu.lir..d R.. i re m ~ nt Pia", ____• ____ ___ __ • ____ _____ • ___ .____ 3 11
Keogh 1'10,, ' _. ___ .___________ .__________________________ 313
Solo 0101 (1<) pl.n< ___________________ ____________ ._ ___ .3 IS
ROIh oIOl (k) Plon<. ___________ .__________________________ .316
13 Inventory _________.___________.______.__.__.______.______ 31 7

W),;" Is In~n'ory'.-----.-----~---.----~--------~------- 31S

00 You H. "" to Carry an In""ntory' _________________ .____ __3l1
Deducti ng In""ntory C.,.,<-___ ~ _ ~ _____ _____ ~ _ __ .____ _. 311
IRS R~po"ing.________________ ._. _________ ._. ____________ 324

14 More DeduC[ions _____________________.327

Ad""rtising... _________________ .__ ._. _______ .__ .__ .______ .__ .__ .__ . 329
Busi"" .. Sod D<:bt. __ ________ __ ______ __ _ _____ .____ __ 331
C.sualty Lo .... ' _________________ .______ .__ .__ .______ .______ . H8

Ch. riuble ContriOOtion. ______ ~ _ ~ __ ~~ _ ~ ____ ~ _ ~ _____ _.HO

Clothing. __________________ __ ______________________ .342

Di.. bled Acee .. T• • Credit ____ ~ _ __ __ ___ ~ _ __ __ ___ ~ _ __ __ _. 343

l ic . n ~ F""" Ou ~ <, and Sub«:ript"'n<.. _______ ._________ ._____ .H4
Educa[ ion E. ~n~' _. ___ .________ ._____________________ . 345
Gif[' _______________________________ ._. ________ .__ .H8
In..... ra""~ for Your Pract ic ~ _______ .________ .___________ .301 8
Inter. st on Bu,in... Loan' _ _ _ _ _ _ __ .______ ,w
l ega l and Prof..,"'",,1 ~"ic.' __._____._ _ _ _ _ _ _ _ _ 353
T..... _ .______.____ '"
Domestic Production A<t ivit ie .... ____________ .__ .__ .______ .______ . 3S8

15 Hiring Employt'e5 and Independent Contractors___ ___.361

Em ploY"'" Wrsu, Ir.de""nden, Con"ac,o" ___ .__ ._. ____________ . 362
T.. Deduction, for Pay and B.nefit' _ _ _ _ _ _ _ _ _ ~
Em~~

R.oimbursi ng Employn'< __ ._________ .__________________ .____ .372

Employing Your Fa mily____________________ 375

T.. Deductions When You Hire Inde""nd..,t Comractor, ___ .__ .__ .__ .384
16 Professionals Who Incorporate __.__________________.__.__ ._ 3-89

Autom.,,", Employ..e Statu'.____ ~ _ ____.____ ~ _ __ __ ___ ___ __ __ 390

Paying Yourself • ______ • __ .__ • ____._.____ __ .. _ ._ . ______ 391
Employee Fringe Sendi,, __ ~~ _ ___ ___ .____ ___ __ __ ___ ~ ____ .~
Sf»,..,hold ... loan. ______________________ .__________ .___ A 13

17 How You Pay Business Expenses______________ 417

Your p,;oc,ice Pay. ________________ ._______ .__ .__ ._______ .__ .__ ._.• 18

Using P... >on~1 Fund. 10 P~y for Bu,ine» Expense. _______ • _ _ _ .10
Vour Client Re imbu,se, You ___________ ._________________ .__ .__ ._ 418
Accou n",ble Plan, _ __ ___ _____ ~ _ ____.____ ~ _ __ __ ___ ~ ____ 'W

18 AmendingTaxReturns _ _ _ _ _ _ _ _ _ ."
R~ .>on. for A~nding Vour Ta. R~lurn _. __________ '~
Time limits for Filing Amended Return • .___________________437
How to Amend Vour Relum __________ .__________ .______ .__ .__ ._ 439
How the IRS Processe, Refund Claim. __ ._________ .__ .___________ .___ 440

19 Staying Out of Trouble With the IRS______.__.______.__.__._441

Anatomy of an Audit _____________ _ _ _ 442
The iRS; Clear and Pr...,nt Dangero , Phantom Menace! ___________ 444
How Tax R<>turn. Are Sele<:,td for Aud its.___._ _ __
--'"
Ta. Shelte.., Scam,. and Schemes ____________ ._____ ._______ ._____ ._ 448
T~ n Til" for Avoidingon Audi' _ _ _ _ _ _ _ _ _ _ _ _ _ . S2

20 Record Keeping and Accounting ______________.____.455

RKording Vour Expense. ____ _ ________ 458
Documen ling Your Otduction. ____________ ._____ ._______ ._____ ._ 460
Accounting Method. _ _ __ _ _ _ _ _ _ _ 479

Tax Vea.. ______ __ _ _ _ _ _ . 86

21 Help Beyond This Book _ _.~_~ _ __ ~ __ . _ _~ ___ ___. _ __ 487
S. conda,~ Sourc~. of Tax Info,ma{ion ,_. __ ~ ______ .___ ~ __ ~~. __ .4S11
Th ~ T. x Law ____ ___ _
.~ ____ ______._ _ ~ ___ ._ _
~_~ ___ .__ ~ •. 494
Con<u I{;ng a Tax P,of... ,ionlo l~ __ ~ __ .__ ~ __ ~ __ .___ ~ __ ~~. __ . SOl

Index ________________ ~ _ ___ ___________ ~ _ ___ _____ ~ %

Your Tax Deduction Companion

f you'". prof.ssio" . I, <\0 0'" " " d , '0 ,.II you ,h., ,"ns.rt 0'"

I of your large" "p, ns<., Th . b. .. way to minimi", YOUT tax" and

m.. imi7~ )'OUr tah-hom. incom. i, to take ,dv.ntag. of .v.ry tax
dNuetion ov. il.bl, 10 you,
TI .. IRS will n.ver compl.i" if you do,,', .. k••11 , he dedue'io",
you're entitl. d to - a nd it .. na i nly do •• n't mak., po int of ,dven i, ing
woy' '0 low.r your 'ox.., In f.et, m.ny prof.ssionol, mi', OUt on . ll
ki"d, of d.due, ion, "''')' yeor ' imply bee.use they . rtn', . "', ,, of
them- or b"au •• t h. y neglect to h,p the record, no< ,ssary 10 back
them up.
TI,o, ', wh ..e ,h i, book COm" in, Speciolly .. ilored for , he unique
"",d, of prof.ssional" i, ,how, you how )'DU e. n d. due,.11 or most
of yOUT bu,in", .~ p. n ..' from )'DU r f,deral "~._.'.. rything fTOm
.d .. rr i,ing to w h ide deprtcior ion.
TI,is book. ,he first of its k ind. i, .bour ,ax d.due, ions for.1I 'YP"
of profession.I., indud ing:
• Jc<;ountoots
• ",ch ireelS
• ehiropr.e,ors
• consu lr.nts
• dentistS
• doerors
• , ngtn.."
• I.wy."
• m.rriage . nd f.mily ,h.rapists
• op,ome"istS
• pharm.cistS
• psychologists, .nd
• ,.. ,..in.. i. ns.
1 I T"" OEDUCTIONS FOR PRO F(SIIONAl S

It On be Llscd by professionals who wor!< b)' ,h.mselv.s, or b)' , hose

invoh,.d in group pntc, ic ... You C' n us< ,h is book nO ",'11 <r how your
pract ice i. legall y organizrd-whet h.. you a .. a sole proprieto r, or ..~
invoh'.d in a profession al co rporo' ion, p. rtn<fsh ip, or LLC.
This is nO' a ,a x p .. p~ntl ion guide-w. do nOt show you how '0
fi ll om your [ax fo rms. (By th~ ti m. you do your tax ... it olay b. too
I. t. to t. k~ d~duction. you ~ou ld have taken if you h.d planned t h~
prior yea r's busi n.ss spend ing wisely ~ n d kept proper r«Oords.) I nste , d,
, h;' book gi\'~s you all [h~ inform ation you n..d [0 max imi .. your
deduct ible ~xp~ns ..-.nd avoid common deduc[ion m i,u k ~s. You <an
(~ n d should) use t his book all yelt long, '0 make April 15 ~s p~ in less os
possibl<.
Ev.n if you work wi[h", a<couman! or . norh .. tax prof~ssio nal .
you need 10 I.. rn about tax deduct ion s. No tax profess ional will ~vrr
know os nHlch abou' you r business as you do ; ~nd you ca n', expec'
• h ir~d profe ssional [0 st arch high . nd low for ~very deducrion you
migh[ be abl. to t.k~. <speci.lly d uring ,h. busy tax prepdmion
se.son . The i n form~tion in , h is book will help )'OU provide you r to'
professional wi, h b."" r«Oords, ,sk bette r qLJC$, ions, obuin be' tet
.dvic~-an d . juS! as imf>Ortamly, .v.lu at. th~ advice you g~[ fro m tax
prof~"iona l •. w~b,it." .nd other ,ourc...
If you do you r ta ..s yourulf (as more ond mOre sm~ ll busine"
OW " .... are doing. " p.cia lly wi,h ,h. hdp of [ax p" p..", ion "'[[-
wa ..), you r n~ed for kn owledge is e\·.n greal<r. NO[ e"en t he mo.t
soph;'tic.,ed t.. prtpH;ttion ptogrlm ca n dec ide wh ich t.x de,luctions
you should t~ ke or 'ell yo" w1,. t h.. you·v. o\'erlooked. v~h"bl.
d.duC[ ion . This oo ok c. n b. you r I.gal compan ion, prov id ing p ractic. 1
. dvice a nd informat ion so t hat you can re. t . .. u red , hat you a .. not
p.ying mOrt ' 0 the I RS ,ha n you neN to.

•
 C HAPTER

Tax Deduction Basics

How h. D ~du ctiom WorL"__ "_"_"_""""_" __ "_"_"_"_"_" __ "_"_"___ "_'

Typt'. of T.x Deductioo>-_____________________________ .4

YouPay T..... On l~onyourProfl!< 5

You Must H. v~. Legal 60.;, for Your Deduction' ______________________ ~,
The Valu e of a Tax Deduction _____________ ._________________________________ .____7
rffi.ral and SUle Income T..... _______________________ 7

Soc;,,1Securit y . nd MMic ... T. ",,,"_"_"_" __ "_""."_""."_" __ "_"_"_"._.". 8

Tat.1 Ta. Sa vingo __ .___ ..._. __ .__ .__ ._._. __ ._ ..._. __ .____ ._ ...__ ._ ..._. __ .____ ._. ____ ._ .._. 9
What Profe .. ;" nal. Can DM uct _ _ _ _ _ _.____ ~__ .. ___ "
'>u r<_Up Ex pt'n',,, ."_____ "__ "___ "_____ "__ "___ "_ ____ "____ "_" ____11

Opt' r. t ;ng Ex p<'n'." ___________________________________________________________ 12

CapOul E xpt' n~.' ____________________"
• I T"" DEDUCTIONS FOR PROF(SIIONAl S

he tOX code is full of ded" o;ons for profes:;;on.l$--from outo·

T mob ile expe ns,,!O w'g" for employees. Before you CO n " on
laki ng advantage of lhe~ deduc{ ion.. howevef. you need a bas ic
u ndemanding of how busin e" .. pay { n . . and how { n d. du<!io ns
work. Th is chop«r gi,.. s )·ou all the in fo'm., ion yo u nerd '0 get s" ned.
I{ eo,.. ",
• how {ax d.du<!ions work
• how to calc ulate the value of. ," x deduction •• nd
• wh.l' profession, l, COn deduo .

How Tax Deductions Work

A ,"x deduct ion (also c. lled ~ ,"x write-off) is ~n 'mO Unt of money
)·o u .re ent itled !O sub,ract from your gross income (all ,he money you
m,kc) to de{erm ine your !3uble income ({he amO" n{ On which yo"
m" SI p.y tox). The more deduc, ions yo u h,,·c. t he lower yo"r ta•• ble
income will be . nd the Ie.. tU yo u will h.ve to p. y.

Types of Tax Deductions

Th.re are {h reo b.s ic {yp. s of (ax deductio n.: p. rso nal deduction"
invest ment deduct ions, .nd business deductio ns. Th is t>o<>k cove" only
businr« deduoions-the large or,"y of write-olf, av. il,ble to busi"e«
oWners, includ ing professionals.

Personal Deduc ti ons

For the nlO" p,n. )'our p"",nal. living. and fan!il), "'pe nse, ore not
lOX deduct ible. For exa mple. ),ou ca ,,'[ deduct the food [h., )'ou buy
fOT yo"rsd f .od yo"r f.m ily. Th . re are, howeveT, ,ped.1 " legori. s of
person.1 ~xp e n s" {h" m,y be ded"cteJ, s"bjc" {O S{f ict limitat ion$.
11",. ind ud. i,."" , uch os home mortgage in,. .... , ""e , nd local
la •• s, ch3Ti,.bl~ contribution " med ic.1 ~.pe n ... , bov. " th r.shold
.mount , i n{~rest on . duc,,{ ion loans. a nd .I imony. 'Ih is book Jo~s nOt
eo,... ,he.. pe rson,1 deducrion,.
 (H"PUR 1 I TAX DEDUC TIO N 8.-llCl I ~

Investment Deductions
M. ny profe.. ion.l. "y 10 ma ke monry by invrs,; "g money. For
e.. mp le, they might in"..t in real eState or play the stock m"ht. 'Jhey
incur .11 kind. of expense$, such .. fees p.id to money nlana ge... or
fin. nci. 1 plan ners, leg.land .cco uming fers, " nd im..rs[ on money
borrowed to buy invest me nt property. These and ot her invest ment
expenses (.Iso coiled ex penses for the p roduct ion of in come) ~re 'ax
deduc,ible, subje" to Sir "" li mi,alion s. Invest men l deduct ion' . ~ n01
covered in [h i, book .

Business Dedunions
Beeou.. a professio n, l pr. ctice i, . profit· making entetpriS(, it is
a busine .. for taX purpose,. reople in busi"e.. usually must spend
money on thei, business---for examp le. fo r offic. space. supplirs, a nd
equipment_ Mos t bm i nel.$ expenses art deduct ible, SOon er Or bltr, Ont
w.)· or . nmh... And ,h." what <ids boo k i, .bom : How profess ion . l,
may deduct their busi "e.. expense,.

You Pay Taxes Only on Your Profits

Th e federal incom . tax b w r«ognizo. t h" you muSt spend money
to m.ke money. Virm.lly .... y profess io n.l. how" .. sm . 1I h is or
h.. pract ke. incu rs some "'P"'''s, Even. professio" .1 wil h • low
o"erhead practice (such as a PSJIchologist) must pay for office space and
insu tJ nce. or course, nla ny profess io n.ls in cu r subst .ntial expe nscs,
" 'en exceed ing ' heir income.
If you art a ,ole pro pri etor (or ow ner of a one-person LLC tax.d as
a sol e proprieto rsh ip), you are not legally requ ired to pay tax on every
doll .. you r practice lakes in (yoH r gross business income). I nste . d,
you ow. laX on l)" on Ihe ' mOUm lefl 0'·" arter yom practice', deduc, -
ibl. expenses.re , ubt racted fwm your g'o.. incom. (t h i' re",ain in g
a nlOunl is cal led your net p rofit). Although some tax deductio n cal-
cul.,ion, can ger . bit complic.ted . ,he b... ic math is ' imple: , he mO~
d.duction, you tak• . [h. lower you r net profit will be, and ,h. l. ss [Ox
you w ill have to pay.
• I T"" OEDUCTIONS FOR PRO F(SIIONAl S

EXAMPLE: K, ,,", 0 ,ole prop'i«or, e.. ,,,d $100,000 th i~ yel r

from her ch ild psychology proctice. Fortu n.tely, ,he doesn', h.,'e
to pay inoome IdX on the <nl ir. $IOO,OOO-her gross busi ne..
income . Instead, she can deduct from hor gross income various
busine.. expen"'" includ ing, S 10,000 officr "n.. 1 deducdon
(..e Chapter 3) a"d. 55,000 deduction for insu rance (..e
Chapter 14), The.. and her other expen..s amount to $20,000,
She "n deduct the $20, 000 from her $100,000 g!o$$ income to
arr i.-", h" net profit: $80,000, She p'y' income .. x on ly On
Ih i> net profit .mou nt,

The prit\ciple i, ,h. sam. if your pracrke is a parme"h ip, LLC

LLP, or S corporariot\: bu,i"e" n p' ''''' are deducted from ,h•• milY',
profit, to determine the ent ity', net profi t for the yelt, which is p'sscd
th rough the entity to the ow ners' in dividu.1 tax rtt llrns.

EXAMPLE: A$$u me th .. K.rt n is. member of. three_ow ner

LLC, and is entitled to one-, hi rd of ,he LLC, income. She
doesn', P'Y (JX on ,he gross income ,he LLC r",e iv.. , only on
her portion of its net income .ft...xpensC$ 3rt deducted, 'Ihi,
ye .., the LLC cor ned $400,000 . nd h.d S100,000 in expen,'s,
She P'Y" tax on one -th ird of ,he LLCs $300,000 nCl profi"

If your practice is otpni7.Cd as, C corporation, it tOO pays ta x onl y

on its net profits.

You Must Have a l egal Basis for Your Deductions

All tax deduct ion, are a matt .. ofleg i,l.tive grace, which mea n, t hat
you C.n take a ded uction only if it is spccific~lIy , Howed by One or
more provi,ions of the ,"x law. YOLl Ll$uolly do not hove to indic.te On
your 'H remrn wh ich tax law provi>io n giv .. you Ihr ' ight to take.
particular ded uction, lf you are audi"d by ,he IRS, howrvcr, you'll
hove to provide, legal b~sis for every ded uction the IRS questions. If
,he I RS co ncludes 1hOI you r deduct iOIl wasn', juS! ified , it will deny
 (H"PUR, I TAX DEDUCTIO N 8.-llC l I 1

,he ded"C1 ion , nd chorge yOH b.ck " ' '', inICr ... , . nd, in SOme cosc',
pen.h i...

The Value of a Tax Deduction

MoS[ '»paye", even sophislic' lCd profess ion.I •. don', fully apprrd."
ju", how much money Ihey "n SlVe wi, h tax deduc' io n,. A deduction
repre,e n,s income On wh ich you don', h,velO p.y 'lX . So t he v.luc of
. ny ded"ction is t he 'mOu n' of ta' yo" would h,,'C h.d ro p.y o n t hot
inco",e had you " 0[ deduc<ed il. A deduclion of $1.000 won ', save you
$I,OOO - i' wi ll saw )'o u wha"vrr you would OIhcrwi.. have had '0 pay
" to' On th31 $1,000 of income.

Federal and State Income Taxes

To dcrcrmi ne how mLlch income ,a a droHction will save you . you
must first figure out your marginal incom.'ox b' dCk.,. Th. Unit.d
State. h.. a progressive i nCO nl< tax SYSl< n' fo r i ndividual".p.y. " ,
with si, differtn"u rates (ofICn c,lI.d lOx brackets) ""ging from
10% of , ..,ble incorne '0 35% (sc. Ihe ch,n below). 1he higher your
income, ,he high., your '" rate.
You move from on. b,acket ro ,h. n"" on ly wh.n YaH' taub l.
inco",e exceeds ,he bracket . mOUI\!. For eunople, if you a rt a si ngle
,axpay" in 2009, you p.y 10% incom. t.xo n all yourtdXable incom.
up to $8,350. If your taxable inco Ol ' exce.ds that a nlOunt, the n• ., t..
rotc (15%) appli .. '0,11 )'Ou r income over $8,350 - b", , he 10% ratc
still.pplirs '0 ,he lirst $8 ,350. If your income ..ceeds the 15% brocket
,moum, ,he n.. '13x we (25%) applies '0 the ..cess amount, and w
On until the tOp bracket of35% i$ rr.Ichro.
1he tax bracket in wh ich ,he last dollar you e, rn for ,he ycar fall .
is called yoU! margin.1 .. x brd~k ... For ex. mpl. , if you h.v. $150,000
in .... bl. income, your m.rgin al tax bracket i. 28%. Todet.,mine
how mnch fede .. 1 inco",e t~. a deduction will soye )'ou, multiply the
amOUm of ,he ded uctioI' by your marginal u. br>.ck... For example, if
yOU! n"rgin al t.. bracht is 28%, you wil l say. 28e in f.dera l in com.
I I T"" OEDUCTIONS FOR PRO F(SIIONAl S

l>X~S for eV"r dollar you Ht able 10 dl im ~s 0 dtduClible bu,in",

tXp~l\sr (28% x $1 • 28 4),

Th . fol lowi ng I.bl~ lists Ih. 2009 f.d.r.1 incom. tax bradm for
. ingle and ma rried ind ividual laxpaye".

2009 Federal Perronallncome Tax Brackeu

Tao Brock .. Inco",," If Siop 10>«>""" If M."i .... Fi ~ o,Joiotl~

,~ Up to $8,)50 Up to $16 ,700

'" From $8,351 t o $33,950 $16,70 1 t o $67,900

,'".. Sll,5/S1 [0 S81 ,ISO

S81 ,lSI 10 S171,I50

\17 1.55 1 t o $372.950

S6',9(l l [0 Sll',O';O

sm,051 [0 $lOM50

$108,85 1 t o $372.950
'" All ""'" $37l,9S0 All 0,,",' $)72.950
'"
I n conl~ , n bl':lck~1S ..~ adju"ed each yea, for i" Aal io" , Fo, currrnr
brlckrrs,,~ IRS Publicarion 505, Tax Withholding and Eltimawi Tax,
You Ca n .Iso deduct you, business expenses f,om a ny sllte incom e
tax you mll St p'r. 'Ihe average State incomt tax ",e is abollt 6%,
.11 hough st ve" ,u.. , (AI""ko , Florid., Nevada, SOUlII DJkor., Tn."
Washi ngton, , nd W)'Oming) don't h."e. n in co me tlX . You eJn find.
list of. 1I SWe income \Jx " .. s " the Ftdtr:uion of T .. Admi nis",lO rs
wtb.i .... www.,axadm in,org,

Social Security and Medicare Taxes

Evtryont who work.-whethtr a business OWntr O f an employee-"
requ ired 10 pay Social Security. nd M.d ica .. tn. s, Th. Wlal laX paid
is t he s;> me , but the tax is poid d ifferendy dep(nding On whether )'OU
are' n e"'plo)'" of a n incorpora .. d pnlcl ice or 0 . . [f-.employed OWner
of . partnorsn ip, LLc' 0' LLP, Emplo)..., pay ono·h. lf of ,hest tax ..
th rough poyroll deductions; emplo)'(!$ muS1 pony up th( other h,lf .nd
" ltd the ent ire p. yment to t he IRS. Self·employed proft$Sionals m"SI P' ),
 (H"PUR, I TAX DEDUCTIO N BAIICI I 9

. 11 of ,h"S' " xcs , h"mS'h"C$. 1h"se diff"rtnces don', m... n much when
you'rt .n employee of. busine.. you ow n, sinc< , he nlOn<y is ~oming au'
of your pock., ",helh" il is paid by Ihe employ« or employer.
Theso laxes arol"'ied on Ih o omploymem in.ome of employees, a nd
On Ihe sdf-employmen' in~om" of business Ow nerS. They ~'m,i" of .
12.4% Soci.1 Srcur i,y tax on incomr up 10 an annualli mil; in 2009,
Ihe limil wos $106,800. Modi .... laxes a.. not subjen to any incomr
limi, . nd are levied at a 2.9% ""e. This combines to. '0101 15.3% lax
On employment or sdf.etIlploy me nt income up to ,he Soci,1 Secu ri, y
lax «il in g. Howrv", Ihe . ff. cI iv~ sel f-. mploym. nt lax rJ1r is som~wha,
lower than 15.3% be,""se (l) you arc allowed to deduct h~ lf of you,
self.employ n"nt '"'''S from yO il r n'" incom" fo' income lOx pu rposcs,
.nd (2) you pay srl f-. mploym~m lax on only 92.35% of your n~1
sdf·employm<nl in<omr. Th~ following chart shows Ihe df rnivr sdf·
~mp loymen ' lax ",,,S.

I""om~ Tox Brach.

,,.
,,. 12.3~

11.15%

'" l' .B3%

like i n~omc ,".es, srlf·employmcnt taxes .re paid On the nel profil
you corn from. business. 'Ih"s, deductibk business e.penS's rcJuce .he
amoum of sclf-rmployme m lOX you hav. 10 pay by lowering ~'our n"
profit.

Total Ta)! Savings

Whe n you add up you r ,"vi ngs in Feder:! I, Slate. ,nd se lf·employme nl
!axes, you C.n see the, ru. v. lu. of • business laX d.duclion. For
.~ . "'p le. if you'" single . nd you r t:IX.ble busine .. income (wh"h.. os
an employe. of an in<orporated praclice or a selr-e mployed ow ner of
I. I TAX OEDUCTK:>NS FOR PROHSSK:>N", S

• partnersh ip, LLC, or LLP) is below ,he Soci.1 Security lOx ceiling, a
businrss deduction co.n be worth " much", 28% (in fede,,1 , axes) +
12,)% (in sd f-. mployment taxes) • 6% (in ,We Ia.es), That add , up to
• whopping 4),3% SJvings, (1 f you item i.. your pe.,ona l d. duction"
your act ual 'ox Slving from ' business deduct ion is. bit less because
i, ..duces your state income tax and th ... f01e reduces the fedrr.l
in~om. tax sav ings from thi. it.nlizrd deduction.) If you buy a $1,000
compute' for yOLl' praCtice ,nd yOLl ded"c, , he expense, you $:lve 'OOu,
$433 in ,aes. In elf"'t, ,he govemmern is paying for . Irnost h, lf of
your business npcn''',
Add it ion. l busi neSS ded .. c,ionl ore wort h less if rou' income is
,bo,'e the Soci,1 S",urity 10x ailing, becault yOll don', h,,'t '0 par ,he
12.4% Social Security tax. For .. ampl., if you're in ,h. 33% incom.
ta~ bracket, an add i,ion.1 d.du~,ion will be wonh 33% (in f.der, l
"xeS) t 6% (in mle laxes). 1.9% in ,'ledic..e lax's. 1hisaddsllp to
41.9% . S, ill llO' bad ,
Th is is why it's w importa", to k now .11 'he bu,i"e" d.ductions you
.re entitled to ,a k, and '0 ,a ke adv.n,agt of everyone.

fQ'1 CAUTION
\..V Don~ buy I~in,. juot '0 ,., • tax deduction. Akhough U"
Mductio", C~n ~ worth> "". ~ d"",,'t rna"" =~ to buy ",moth ing you
don', need juot '0 get a <kduction. Ahe< all. you "ill """e '0 pay fo, doe
i'om. and ,he 'a. okductioo you 8'" in ,,",urn wil l only co"", a portion oft ....
con, For ex.amplr, if )'OU buy a $3,000 compu,...- )'O~ don', really nei"d, )'Ou'.
p<obably "" .1* to d<'d"", ~" 'lun lu lf the c<»t. Tha' ""'.'" )'Ou 're \lill o~,
ov...- $l.S00 - money )'Ou 've """'" lor wmeth ing you don't need. On ,he ot""r
hand, d)'O~ ",.lIy do need • compu''''-. ,.... deduc.ion you'", .n,~led '0 ;,Ii""
found monry- .nd ~ may help )'Ou buy a brner compu, .. , than you could
othe<w;'" atf<>rd,

What Professionals Can Deduct

Profess ion.l, or. busin." own • ." and., such th.y can d. duc{ four
broad cotegor ies of business "'penSe$;
 • StO rHlp cxpe nl><$
• op"., ing .xp.nses
• capit.l .. p~ n ..., and
• inv.ntory costo,
1his ..ction provid.s, n introduc'ion '0 .ach of , h... c'''gori.s
(thq"~ coyt"d in gI~.!tr druil in lalt r chapttrs).

CD o
CAUTION
You mu'! keep <rock of your "penH" You can ~uc! onfy 'hOH
~~p"n"" tr.;" you octualfy incur. You nNd ro k..,p re<;onh of the<e up"n""
to (1) know for ,ur~ how much you ac,ually 'p"nt; ..,d (2) prn ~ to ,he IRS ,hat
you r~ally .pent ,he mo~ you d.-d"",N on your ,ax '~' ur n. in ca", you .. ~
a udited. Accounting and bookk..,ping ar~ dis<u.>ed in detoil in Ch.1pter 20.

Start-Up Expenses
1h. firS! mon.y you will hove ro .h.1I ou[ will b. for your pr. e,ki,
S!.n-up tlpt""s, Tht .. i"dud. moS! of ,ht COSIS of g~"ing your
pr.ctict up a nd run n ing, likt Iict o.. f •• s, adv"tisin g costs, .Horn.y
~ ncl ."ou nti ng fIXS, t,,!Vel expenses, ma rktt rcSe, reh, a nd office
suppli~, .. p." .... Ston-up com orr <lO' curr."tly d~duetibl.-tl,..
i" you Cdnnm clrclu<! thr m all in thr )'rar in wh ich you incur thr m,
Howe-'cr, you c. n d.duct up to 55,000 in St .. t-up coSts in th~ fi rst year
you or, in busin~'o, You must d.duc, ,mOU nlS o"~r $5,000 Oytt ,h.
"tI, IS y,a rs. (S •• Chap"r 10 for . d.,. il.d discussion of d.duc,ing
sun·up e.pen ..,,)

EXAMPLE, Cary, an op,om~trisr who has rtc<ntly gr.duattd

from optometry school. d.cid.s to optn his own pract ict. B.for.
0>ry's optom.tr y offict op.ns for bl1sin~ss, h. hos to .. nt spac.,
hirt ond ,r.iTl .mplor~", 'Tl d obtain .11 n.e' '''H)· op,om.. ric
.quip mt nt. Thtst "an·up •• p. n... coS! 0>ry $50,000. Cary
may d.duct $5,000 of th i. anlOunt tht first yoa r he. in bu,iness .
1h. rtm,ind.r moy b. d. ducttd ovtr , h. fir" 180 months tho,
hl, in busint5S-S3,000 ptr r t ar for 15 )'t ars,
" I TAX D£DlKTKl NS FOR PROF£SSKl NMS

Operating Expenses
Operat ing exp~nsC$ 3 re the ongoing d3Y-to.,J.y COS{S , busin.ss incu r$
to stay in b\lsin~'. 11..)' i"dud. such .h ings a, .. n., urili.b, sa lari ...
,uppli.., IT",,,,I np~n"s, cor np.n'~', . nd .. pairs and maim.none • .
Thes. exp. n... (unl iko ,{, Tt-UP up. n,es} ar. curr.ntly de<iuc{ibl~­
.hOl is, you C.n d~duc. ,h~m,1I in .h~ sam. )'~' r in which you p.y
.h.",. (S.. Ch.p.~r 3.)

EXAMPLE: Af.. r Cary', op'om'''r offie~ 0p' ''~' h. b'gin' paying

$5.000 a nlOll.h for .. n•• nd u.il i.i... Thi' isan op~r.ti ng
. xpen .. (h., i, cu r", mly deduct ibl. , Wh~n Cal)' doc. h i' {axes.
he C.n d.d uo from h i' income th •• nt i.. amOun' h~ paid for
"nl .nd ut il il i.. forlh. }'u r.

Capital Expenses
Cap it.I .... t. 3'" t hing' you buy for YOUT prJ<ti<~ {h.t h" " . u..fu l
lir. of mO'" t ha n On' )·~.r, ,uch ,sland, buildings. ~l1 ipm."t. "hid...
books, fu rn ilUT~. a nd p.,.n" )'OU buy from Dl h. rs, 11,.,. co,,~. c.lI.d
,"p;t.1 "p r n..s, arr con.id... d to b~ p.rt of your ;nve,{mr m in your
bu,; n.". not day-to·day opewi ng expoo..,.
Lug. btJ,in.", ___ ,ho.. ,hal buy at I~as, ,.,..al htJndre<i thou,and
dolla" of capital a",{S in . y.ar-must d. duc{ tn . .. com by using
d' prr,ia{ion, To d' proci.[e an it~m. you d~duct a portion of {h~ co.{ ;n
uch y." of ,h" i.. m's u..f"l lik D.p.ndi ng On Ih" 0< . .1, ,his could b.
on)·wh~ .. from .hr~ • •o 39 y.ar. (th.IRS d«id .. rl,. a",,', u"fullife).
Sma ll bu.;n.sse.; can also u.. d.pr~ci.tion. but .hoy hay. ano{h ..
option aVJ il abl. for d~duct i ng many capitd I rxp.n .." Th. y can
c"rr' nriy d.dLlc, a sub"a n"ol amoulll of long,"'m os,., pl1rch.scs i" 0
singl. y. ar-$250,000 for 2009 (sch.du l.d to go down ro $133,000 in
2010, plu,.n infia{io n .djustmr nt)-u n d~r a p rovi.ion of t he {ax cod.
c.lied S.oion 179. Section 179 is di,cu, ..d in d",ai l in Ch.p '" 9.
 CHA PTER 1 I TAX DEDUCTION !ASk:S I u

EXAMPLE: Cary ,pent $5,000 On exam in ing ch.irs for h is olliee.

Bec,u", the ch. irs have . u",ful life of mOre ,han On e )·e, r. 'hq
ore c.pital .,,,,t, that h. w il l . ith. r h .... to d'pT.ciat. ov<r srv.ral
years OT deduct in on. y.ar und., Section 179.

C.rtain c.p i" I . ... " , suc h as I.nd and co rpora,. stOCK. n.ver wear
om . up". 1expenst$ reh «<! to these COStSarc nOt deducti ble; the Owner
mLlSt w,i, u nt il ,he '''e' is <o ld ' 0 recOver the CDSt . (See Chapter 9 for
OlD" on this topic.)

Invenrory
Tnv.ntory is m<rch . nd is<: that. bu,iness m. kes or bu)·s to res<:11 to
CuStomers. It docs n·t m, "er whet her you m, nuf.ctu rc the mercha ndise
yourself or buy fi n ishro "'Cfch. nd ise fronl som<D <le el", and "",II ,he
i,.ms [Q cus[Qmers. I nvemory doem·, includ. rools. equ ipm.m . Dr other
items,h ", you uSe in your pr""i,e; it refe rs on ly [Q items that you buy
Dr make '0 ",II.
Wh .. her profe .. ion. ls ,el l i",·.mory for ux purposes can be a Iricky
quest ion. M.teri.l, that are an in d ispensable a nd in ",porab le p. rt of
the rendering of. s<:rvice ,rc nOt im"(ntory_ for ... mple, gold that.
de",i« pl.ce, in pati.n,,· .... h i, n01 inv.mory.
You must deduct inventory cost. separately from all other bu.ine ..
expe n..s-you deduct inventory cost!: .5 you s<:11 the im"(ntory. I nvcntory
,hat renlO ins unsold " ,he end of , he )·.ar is a bus;',... a=t. [10' •
d.duclibl. expense. (S.., C hap'" 13 fo, more on dro uc, ing in ... mo ry.)

EXAMPLE: In . dd i, ion to providing optometric ",,·ices. Cary

stoch • nd ••11, .y. gl.sscs to his p"i.,m. In h is Ii "t year in
practice. Co ry .p.nt $15,000 on hi' invento,y of oyogl.s",., but
sold only $10,000 worth of them. He C:l. n deduct only $10,000
of the il1>e n' ory COSIS for ,he )·.ar.

•
 CHAPTER

Choice of Business Entity

Typ ... of Bu.i"",. Entitie . __________________________ . 17

So!. Prop,;.. o"hip .______ .__ ._____ ._______ .__ .____________ .__ ._____ .____ .18
Limited L",bility Com Pi' ny (l LC) __ .__ .__ ._.______ .__ .___ .__ ._.____ .__ ._.______ .. 19
Limited l",bility Pan ner""i p (ll P) .._______ .__ .______________ ._________ .20
Co,por3.ion _____ ._____________________________________________ .21

Partn ... ship. _____________________________ ._____________ .____ .__ .2 3

lim iting Your liability _ 24

What I'li.bility? _ _ _ _ _ _ _ _ _ _ _ _ _ _ 25
L.. bil it y for P,of.... ion. 1 Malpro,! ice .. __._. ______._ ___.___ .____ .__._. ___ .__ .26
Lia bilit y for Bu sine.. Debt •.__ .____ .__ ._..._. __.____.__ .__._..._. __.____ ._.___ ._....23
O.her T~. of liability ___ .__ .____ ._______ .______ ._______.__________ 30
Th. Ro!. <i In .u, a"" • ._______ ______________ ._ ____________ ._. __ _.__ .31

The Fou, Way. Bu.inn. {nli.i ... Are Taxed ._________________ .__ ._. ___ .__ .32
Tax Treatmen. Cho"" •. __________________________ .33
So!. Prop, ;.. 0' '''' ip Tnation .___ .__ ._______ .__ .__ .__ ._______ .__ .____ .____ 34
Partn ership Ta •• tion. __ ._._____ .____ .__ .__ ._._________ .__ .__ ._.____ .__ ._._. __ .__ .. 35
S Corporation Taxation ___ ._______ ._______ .__ .__ .__ ._________ .____ .____ 36
C Co ' pom io n Tan. ion .______________________________________ .37

Co m pa, in 1\ Tax T,ea' men ... ______ .___ .______________ ._______ .__ .____ .__ .38
Tax De<hx tiom _ _ _ _ _ _ __
Tax Rate .. ____________________________ 39
- - - -"
Ow,,",,' Employment St a, u._
.______.__._. ___________.___.______._.___.__48
Fringe S. nefi ... ___.__ ._ ..._. __.___ .____ .__ ._..._. __._______ .__._..._. __.____ ._._. __._....52
AIIoc •• ;ng P,ofl •• and los ~ •. _____ ._______ ._______ ._______.______ .____ .53
Deducting Busin ' " l"' ~ .. __ ._____________________________ ._. ___ .__ 54
Retaining Earning' in Your Busi ne" ______________ "
" I TA>< DEDUCTIONS fOR PROHSSION", I

St;o'e THe. ____________________________________________________ 61

IRS Audit ______________________________________ .62
Rat~ s..

Should You Change Your Bu.in .... Entity or Tax Treatmenll _ _ _ _ _ '"
The Cost of COn ..... ting to Another Bu,ine .. Form _________________________ 6S
Changing Your T.~ Treat ment .. __ .__ .__ .__ .__ .___ .__ ._._. __ ._. __ .____ .__ .___ ._ ..67
Automatic Con""rsion of You, 8usine.. Ent ~y._. ____ .__ .____ .___ .______ .69
 CHAPTER> I COO'::(Of6~' N( SHN Tt TY I "

his ch,p'" is ,bout how )'OU' lOx lif~ is .ffeCted by ,he fo'm of

T busine.. em it)' you us< 00 conduct rou r p,ofe .. ion.1 procdce.

If you'« al« ady; n practice, you w;lIl.. rn the pro. Jnd cons
of t ho bus;n .... for m you hov. cho.. n- :lnd you may d<cido 00 con"on
to .noth.. type of en' ity or tax ,reatm en t, If you're jus, ." rting your
praCI;c., you w;1l n..d to ligur. out which busi ne.. ent;ty " nd tax " .. t·
me nt i. bost for you.

Types of Business Entities

r;"",J' bU$iness has , I"gal form, includ ing a p,of.ssion, 1 practice, If
you',. in proct"e tigh t now, you , bm iness .Imost c"'toi n Iy f. lls into
one of ,he following ""gorie"
• ""Ie propriew"hip
• pa'tn e"hip
• cO' pO"t io n
• limi"d li,bil i! )' company (LLq. or
• limit.d liability pm n."hip (L LP).
·Ih. ""k proprietorship and partnership ar. ,he defau l, business
'nlil ies-Ih.y come imo exi"'n,e ,ulomadcolly un le.. , b u,i"e ,,',
own." lake Ih. '''I''
"cc..sa,), 'a form on. of Ih. OIher em id...
'Jh. fo llowing chart g ives you . n id.. of ,h. b'e~kdown for the 'ypes
of business ' Mit i.. profess;onal, me, (It doe, nO, i ndud. profession.l,
who provide he,lIh s",ke<----doclors, de", i",• • nd "" on ,)

Tax Retums Filed by professionals-20 06

T)'I>" of Entil~ Number of Ta. Returns Fi~d in 2006
So~ ProprielQ"

Par'nef.hip. ("",fud ing LL P.) 185.879

LLC. 116.621

C Corporat ion. 813,266

S Corpora. ion. S8S,940

I. I fA)( DE DUCTIONS fOR PROFEISIONA.lS

Sole Proprietorship
'Ihe majority of profelSion , ls who practice by themselves >Te sole
proprieto rs. M. ny h ... e a,,~ined [his legal s,",us wi[hoU[ e .. e" re . lizi ng
it. Qui" simply. if you "a" ru tl" itlg a pmfessio n, 1 pranice by yours<:lf
and do not ineo rpOTate Or form , n LLC or LLP, )'ou ore Jutomat k ,lIy.
sole prop rietor.
A so le proprieto rsh ip is , o"e -own" busin.,s. Unlike , co[pow ion.
LLc' general portnefShip, or LLP. i[ i, not. s<:parate leg. 1entity.
'Ihe business ow ner (proprietor) personally owns . 11 the ,lSetS of the
bu,iness ."d is in sole charge of irs ope""ion. Mo" ,ole pmp,ierors
run ,,,,.11 opew io tl" bUl a sole prop,ietor can h ire e"'ploye., .nd
no nemp loyees, too.lndud, some sole proprietors havc I.rge opero tio n,
with many employees.
You don', have '0 do . n)·[h ing ' ped.l or file "')' pape rs [0 sc, up
• sole pro prietorsh ip, ot h.. than the usua l license, pem , it , .nd oth.,
regu latory requ i reme ntS your St,te andlor loc.l ity impo.es On • ny
business. O f ro ll "". if you're in • profession ,h .. requires .Ikens<: [0
ptaC"" , yo u m ust comply with [he .pplicable requiremems or ,he ,Ia,.
nlay fo",e you to clos<: you r proprietorsh ip .
Sa le proprietors), ips arc the mO$l Co mmo n form of busi ness entity
us<:d by profess ion.ls. O ne big ..., on for [heir popul.,;[y is ,h .. , hey
.rr by f., the simple" a nd cheapest way to o rgan ize a one"owne,
busi nelS.
If you p",,, ice by yoursdf, . $Ole proprietorship nu)' wel l be you r
be" btl. A, f.. . s , •• ., . re conee",ffl. i, ·s. " ..edler" choke bee.us<:
it provides pass·through tax. t ion , wh ich moSt professional, prefer. You
.1$0 won', h..·c '0 fi le. "'p . ... e!Ox re[um for your pta" ict , which
..,v., [in" .nd ",o"ey.
So le proprielOrsh ip' do h.v. on. big d [Jwb.ck : Thoy offer no Ii mit. d
liab ility. Corporations, LLCs, . nd LLl', provide li mited liability, wh ich
i, ,he m.in ,.,so" why m. " y profe ssion.ls usc ,hem. How,,·cr. when
yo u proclicr b)' you rsel f. , heli n,iICd liabili,y you'll obta in by form ing.
corporat ion, LLc' or LLP is oflCn more illusory th.o r., I,
lhu<. stick ing wi,h 11" u nA..],y, ' imple, . nd cheap $Ole proprielOr.
,hip i,. perfrc!ly ration. l choke. Remember. however. ,h at if you SlOp
 ( HA'TEI , I CHQK:E O f! lJS'NlII WT ,TV I "

p", cticing by you'sdf . nd form . group p..",ic., yOll C. n nO long.. b•

• sol. propr i" or, You'll ' UlOn1O' iallly b.com•• p.''''' ' in , p. tIr"rildp
unless you form an LLc' LLP, or corporation-whi<h is highly advisabl•.

@ RESOURCE
For d~,"il~d l uH:l a nc~ about ""'" to ro,m and run a .., 1<
propri ... o ..... ip, m." to Wo,kjngjof ¥ou'''/f Law & r"" .. for InJ<p<nd<nt
COnt,a<IOr<. " •• Ian<"" & Consultant>. by St,"p~n Fi,hm.n (Nolo~

Limited Liability Company (LLC)

Th o lim ited liobi lity co mpany, or LLc' is the newest typ e of busin~ss
form in th e United StaltS. 'Ihe LtC is a u niqu e h)'brid: ~ CrOSS bet ween
• p. rt nersh ip .nd corpo""ion. It pro vides t he Hex ibili, y. inform. li,)·.
• "d ,u attr ibute. of. partnersh ip and ,heli mi .. d liabili,y of.
corporation. H ow~ver, a f~w ~t. t<S (C.l ifo rn i" Oregon.• nd R h od~
1,I, nd) b. , rnost ' yp~' of professional, fro m usi tlg , hem. In ,h..e SUte,.
profession . l. ",ek ing ,he d..i",ble . 11 rib", .. of . " LLC will u,u. II)·
choos • • ithor an LLP or on S co rporat ion in. t<ad .
In mOSt Statts, prof.ssion, ls who form LLCs muSt . d h.ro to
'~SI ric,;on, ,imil .. [0 [ho", for pro f. ssioll . 1corponuion ,. All ,h.
own~rs must b.lic. n",d to po rform {ho prof~"iond] ", rvice. " " i. d
on by the Lt C .nd ownersh ip Cl nnot be t ransferr.d {o u n] i",n",d
ind " ·idu. l, . Thus, for ~x .mpl.,.11 {he Own'" of. d. ntal LLC Jl\USI
b~ licr" ",d d. ",iSls.• nd no d~", is ,-owner Jl\ay , .. "sf.. h is or h.. LLC
own~rship (o a nond. nti ...
To form an LLC, On~ or mOre poopk muSt fi k , ,,ide. of orga n i... t io n
st".,
wi, j, d\~i r bu.i". ,. fi ling oflicr. Alt ho ugh not ~ui rrd b)' . 11Slate ..
it i, h ighly de.ira ble {o adopt a writt<n LLC o p~rat i n g agro. ment laying
OUI how {ho LLC will be govorn. d.lfyou don't prep"" an operat ing
' grr cmen'. l h~ d. r.ul , pro visions of you r , u ,e', LLC I. w, will .pply.
LLC. pro,id~ li mited liabili,y .. "d p. l'l n. rsl, ip .... { rra{II'~m-'"
idea l co mbina tion for many profession als. Jf you 'r~ in • grou p pract i«,
the LLC shou ld bo on {he top of your lis{ wh~ n choosin g you r businoss
~mi' y.
,. I T"" OlDUCTIONHOR P~or(I\IONAll

On the other h~nd, if )"Ou,,, in $010 pnlcticc, you won't g, in much

by forming.n lLC. A, far a, t>xe, go, you'll "ill be "e,,,d lik.. solc
propricto "h ip by th.1RS. Morr importa", I)", th.l im iIrd liab ility a solo
pr.ct it ion,r obta in' by u,ing an Ll C may pro", 10 be morr mythical
,h. n rc.J.

RESOURCE
For. "Om pie •• di«u .. ion On how .0 form limn.d liabil ity
companie •. _ Form Yo u, Own t",,~ed tiability (omP<'''Y. by An.hony
Moncmo {Nolo~

Limited Liability Partnership (LLP)

Prof"sion.ls in all st ...s now h.v. , hc oP' ion offonni ng • sp<'Ci.1 ' yp'
of part n. "h ip called a lim ited liability partnersh ip, or l LP (also cal l.d
• ' ''giStcrcd li mit.d liabil ity partn.rsh ip") . lLl's are mu ch tho SJ m.
OS rrgular gtn,,,1 p.rt n..ship' ,xc'p' for OnC cru d .1 adv.n"g.-,h.y
li mi' ,h. p. rt n. rs· I.. bil i,)· for m. lprac, ic. d.im, .nd. in so",. >!a,c,.
d.b .. incurr.d by tho pa rtnersh ip.
Profession. ls in $O m C stat<s- Ca liforn ia, for CX3 mplc- use lXI's
b.cause >!a .. l.w proh ibits ' h.n, from form ing LLCs. annth .. popul ..
• m ity that prov ides li mited liability. LL P, orr limit.d to prof... ion.l,
in cert. in occupations- typic. lly prople who work in the medical.
l.g.l. a nd .ccounting (, cld, .• nd a f.w ot h.. prof.ssion' in which
• p rof.ssion . l·elic", "Ia, ionship exists. I " som. st 01". '''gin ...s.
v .... in " ia n. , a nd . cupu nctu , i,t. a '" . 1'0 a ll ow.d to form llP,. Not
.11 , ...gori.! of Iiccns.d profession , Is Can for m an LLP- it dep.nds On
your sta ...
At l.." two pHlne .. are n..d. d to form . n LlP, and the p.rtne"
muSt us ually be licensed in tho Sam. or rel ,ted profess ions. llPs don·t
romc in'o .. is,enc, .u, omatic.lly lik. gcncr.1 partncrship,. l n mOst
" ' leS. cr ... ing an lLP requir .. "gis,r. , ion wi,h ,h. s.... go .... nm.<\!.
an nual fili ngs, and ad ministrative fee ..
 C H ~ ' TE l> I CHOtC (OfSUSIN(SHNT ITY I "

Form. n LL P if you w. nt 10 h"" ' n LLC, bUI )'oll r SUI< doesn'l

. llow p.ople in your prof. .. ion 10 "'" II..m . If you r SI .I< .llows you 10
u.. . ith" an LLC or LLP, dO n'1 choo.. an LLP wit houl fi", ~ar.flllly
chrck ing }'our n at •• lawo 10 ... if LL P, provi<le the sa me dq;ree of
li mil<d li.bilily prOl.clion . s LLC!. If thq don't . form.n LLC.

Corporation
A corporation is ~ I. gal form in wh ich yOIl c. n org. ni... nd conduCl
a business and share in the profits or losses. In the P'lS{, most Stat.S
proh ibi,cd many typ.s of p rof.ssion als- for exampk . doclors and
lawy.rs- from form ing a corponuion !>.caus. th.y f" ..d Ih. y would
b. ",. d 10 li mit ,h. ir liabil ,,}' for malpractic. , Now. all 'w" p<rmit
professionals 10 form 3 spcc ial kind of corporat ion "lled a p rof~ssion3 1
COrpor.tion Or profession ol ",rvice corponl{ion. Th. pro fession~1 co rpo'
rat ion has th. basic amibm., of ...gu lar corporation wilh cr nain
rest rictio ns . bom owne rsh ip a nd the type of work it C. n do. (All
fu rther refe rences to corponot ions i ncl" de professional corporatio ns and
prof. ssion.1",.. ic. corpora!ions,)
The lisl of prof.ssion . ls who muS[ form p rof.ssion~1 corpowions
,., ries from state to st. te, but " su ~ lIy in d "des:
• .ccoum. l\1s
• .nginu!1
• !Jwyers
• psychologislS
• soci. 1workers
• veler'n.. i~ ns, .nd
• hc.lt h care professio nals such .s doctors. dentists. nurses, physical
the"'piS[s. op <o merrim , opticians, . nd spe. ch pathologislS.
Mo" ""''' impo'" rrsrric!ions on who mor own 0 profess ional cor·
porat ion , nd t he work it c.n do. Trpic. llr,' profe.. ion , 1co rporat ion
mll St be org> n iud for the sole pu rpose of p~rfo rm in g profession , l
",,,ices, .rld ~ll sh" .!wld.,. nlUS! b.licen,.d 10 render ,h., ... vie •.
For . um pl•• ' n 0 m.d ie.1 corpo"'''on . ~11 til< sha .. hold.rs IllUS! b.
lice nsed phys icians.
11 I T"" OWUCTIONI FOR PRO FElllONAll

rr
\lJ
CAUTION
A prof~.<ional .orpor •• ion i• • " •• ~ I.w .Io"ifi.a.ion_i. lias
no.hins .0 do wi.h ,he IRS Or 'axe •. A ~ol",sio"'l co'lX'ra."'" .an I>e ti,h ...
• C or S ,0'lX'ra. ion 1<>< .ax P'J'IX'''''. as d..."ibed below. A p,olessional
corl"',~ion ;,.100 not the ... ~ ., • p..-"" ru.1"".ice cOfI"'",'ion (PSC~ A PSC

;, an IRS cLo .. iIlc. tion 'M' N. nothing to do with th< pr<>I~ .. ion.ol cOfI"''"tion
rult-s of )OUr Slat'" (_ '~SO<1al s.....ic. Corpora'ions: b.k>w. f<>< mo.. "" PSCs~

All hough Ill< word corponnio!, .. nd , 10 co"jur~ up inllgt. of

hug. busin . .. corpor. ,ion , (lih 18 :>'1 or M icro""f,). in ... Ii, ~.. moS!
corporatio ns-especially lho,. own. d by pr<>fessional,- a r•• n,,11
operat ion•. In fact, in m,ny profe"iona l <o' l"' rat ion•. t here is only one
,hordlO ld " who i, . Iso of"n Ih~ sol•• mplor~'-' hat is •• si ngl. p. rson
dir~" .nd ru n, Ill. co rporation ."d owns.1I ,he corporo" stock.
A to'porat ion h... I.gal .~i5lenc. tompl... ly s<:p..ato fron> it'
ow". rs- ind..d, it is con.id".d to b~ . p"'on for l.g. 1purpo,u . It
ca n hold ,id~ 10 prop." ).. ,u~ and b • •u. d. h. v. ba nk .ccou m,. borrow
money. hi,. . ", ploy • ." . nd do . nyt hin g .I •• in . he busin... world . hal
• hu m, n being c." do. If you ;n <orpo rot. your prJct ice , the torpor. -
'ion b~om .. th . Own~r of Ih~ busi " . .... nd you Own th. corpo rntio n
in Ih. form of Slock ow"~,,h ip . nd ordinuily work a. ilS ~mploy.e.
You <" a" a corpo w ion by fil ing tho nO<.""I}· forms wit h a nd
p.ying th~ r~qui"d f.., ' 0 yo ur .ppropri... " , ...g.ncy-usu .lIy th.
offi ce of ,h. '~"' a ry of " ... or corporation' com mission" . E.ch SlO..
'p. cili . s ,h. form , to u,e a nd th. li lin g cost. You will n.~d to ch .~k
you r 5Iat. IJW to d. t",m in . ", hethor you muSt for n, a prof. .. ion , 1
corpo ..,ion and 10 m. k~ sur< yo u m'" .ny ' pre",-l "qu i"m'nt$ for
prof~ssiona l corporation•. You' ll .lso n •• d to choo,," a n. m. for your
corporation, . dop' <or po rate bylaws, .. t up yOUT corporat~ ,"cords,
.nd "co.piul itt' you r corporot ion-issu e stock in ' .. Urn for money.
prop.flY. ~ nd lo r .. rvic .. provid.d 10 Ih. corporation.
M. nr prof.s.siona l•. part icula rly tho.. in tho h •• hh ca rr Ii . ld,
hav. incorporated th. ir p ra~' i < ... Many of ,h . .. corpo rations were
form.d b.fo,. L LC~ b" . m. widdy . v. il . bl• • nd corpo rat ion' w~r~
th. only game in town if a prof.s.sional w. m.d lim iIrd l",-bility Ev.n
if they want <0, th. shar.hold. " of many of th . .. corpordlion, con·,
 CHA'TEk 1 I CIfOICE OF Bu SINESHNT,TY I u

convert ,hem '0 'nOlh" 'YP( of (n,i,y be",,,,, , he ' ''x '051\ would be
p roh ib i, i,'e,
Although their popul. rity has d i min i,hed somewhat ,ince the
Jdvent of th. LLc' profo.. ion.l. n.v."hel= continuo to form
corpOla,ion', S corpor., ion' ..e e'pecially pop" l.. brcau" ,her C'n
provid~ s.aving. on Soci,1 Securi,y and M ~d icar~ tox .., C corporat ion •
• r. oft.n cho.. n b<cau" they provide the beM dedu. tio n. for fr inge
b<ndil$-~ ,'rry imponon' con,idenllion for many high.income
profe"ion,I" How ev.., YOIl COn obta in ,h..e ""me benefi" by fo rming
.n LLC and <iecting to h.w it IJxed a, an S or C corporat ion,
l'erh~pslhe mOS' imporran' "'son corpO~,lIions con, inlle '0 be
u"d i, hobi,. l'(opl<like whOl ,hey're u"d ' 0, ond eyeryone is u"d '0
corpora, ion" Thq hav~ b~en around for ovor 100 yea" .nd a .. wd
understood by bu'in .,,~ople, courts, I.wyers, a nd t.x profe"ion.I.,
LLCs ore milch n<wrr ,nd hoye mOrt ]eg. l unccruin, ies,

~ RESOURCE
\!!!!!J For more i~fo'm.,;'>n on <o'po,",iom . nd how '0 in<o,po,"'~,
,ef... '0 IrI,o,p"'~I$ You, Bu,irl$<I. by Anthony Mar>eu"" (Nolo~ ~ a", al""
incOl'poro'ion _vice, ,r.., will inco'po,.'e you, bu,ine" fu, you. Among ,he
b,,,, k,..,wn i, n... Company CQfpm~t io n.' www.cmpo... 'e.com.

Partnersh ip
In , he 1'>8,. aImoSl . 11 profe"ion.ls who p","clic(d wi,h OIhe" w~"
pa rtners; n . gene'l l partnersh ip. Howe,.. r, most p, of."ion.l,
.b, ndoncd thc gc ncra] p' nn.rsh ip fo rm whcn othc, typ.' of bus; nC$$
cmil its (lik( profession , 1corpor.,ion'. LLCs.• tld LLP,) w~rc c[("cd
th.t Ii m it.d th.i r porso n.1 liabil ity for malpract icc cI.im, and d~bt,­
so n1ct hi ng. p.nn.,-sh ip doO! nOt do.
A p.",,~rsh ip is. form of s1,.rtd oWn(rsh ip .nd m.nag(m<n' of
• business , A gene",1 pan nersh ip outon,.,icolly con .., i",o exisunce
wh.n.,.. , two or mOTo poopl •• nt.r into a ,·.ntu r~ tog.thor to eJrn •
proM' and don"t choo,"" '0 form SOme Olh(r b" ,in<" em i,)". As will, so],
proprietorsh ip,. i, i, nO' n~c("ory '0 fil( Oll)' popers to form. ge"e",I
.. I TAX OEDUCTK)NI fOR PROH"K)N""

part n"'s h ip. 1h~ p' rtn~rs contribute mon~y. prop~rty, ,ndlor ~rvic~s to
the p,rt nership .nd in retu rn r""eive . ,h.re of th e profit< i, ~arn'. 11.e
partnr "h ip form is .. t .. mdy fl rxible b~causr t hr pa rtn. " may agr• •
to spl it th. profit. and ma nage tho bu,in . " in v irt ually any way they
w' nt. (\'(Ie ref.. to gtn~r, 1 p'rtn~r,hip, ' imply OS p.rtnersh ip")
Unl ikr • sol. proprirtorsh ip. a parmersh ip has a kg.1 u i't.nc~
diSIinct from its own." (t h. partn.rs). It can hold titl~ to prop.rty.
, ue .nd b~ ,uN. h,,·~ bank ",count,. borrow mOMy. h ire employus.
,nd do . ny,hing d se in 11" bu,in'" world ,II" . hum. n being C. n
do. Becau,r a p.rt n.rsh ip i, a .. parat. kg.1 ~ntit y. proprrty acquirrd
by. portne"h ip is property of ,he portnership ,nd nOt of ,he p'rtner,
individu,lIy. This diff... from a sol~ proprielOrship where th~
propri.tor-ownrr individu.l ly own, . 11 t he .ok propri.to"h ip prop"'Y.
Breausr parr nersh ip' prov id. no lim i,ed I iabi lity to ,h.ir own~rs.
profcssiona l$ .b. ndoned them in d ro,'e, when professionol corporO! ion,
,nd LLC, bec.m e .v.il.b le . Ind~ed, as t he eh,,, at th e beginn ing of
th is chaptrr shows. th~ partMrship has becom. n ...ly . xtinCl amo ng
profcssion, I$.
If you,re in . p.rtnership right nOw. you shou ld seriou,ly th in k
. l>out fo rming >It LLC. LLP. or corpora, ion '0 dw you can limit your
pr rson.lliabil i,y for acts by the othrr pwplr in you r group pract ice,
How ... er. ifl imited li.bil ity i$ nOt importa nt to )'Ou-for example.
bee.u.. you h,,·, plenty of in,u rnnce-' partnersh ip i, jUst U good for
"group pract ice a, an LLC or LLP.

@ RESOURCE
'0
For a d~t.i l ~d di«u .. ion of pa" ..... hip. inciudinl how write
p~rtn e"hi p ~5r«me n", >= Form " PQrtnm~JP. by O..,i, Clifford and Ralph

W.rner(Nolo~

Limiting Your liability

Th~ mOSt import. nt co n,id"otion in choo'ing yo ,,, b\Jsin~" ,truCture
(or deciding whOl hrr or not to Sl ick wi,h whO! you haw) i, usually
Ii.b il ity-that i" th . .... m • busi n. ,,·s own.." arr p. rso n.lly
 CHAPTERl I CHOIC£Of8 u SIN£lHNTlTY I '~

r~'pOI\$ible for pay ing for th'i r b"si n~S"$ d,b" . nd b",in~$~;.rd oted
I.wsu its . ind'N, ,h i, iss", is Sten os '" imporu m t hot ,h, corpo,,",ion,
LLc' • nd LLP w..~ cr~'Ird for th~ ' XP"'''' purpo", of lim i, i ng th . ir
own~r" liab ility.
It', likely ,hot you'" 0$ concr",rd abo", your Ii~bili,y OS an),body
d sr, For rhis Irawn, you migh' Ihi nk ,h.t you shou ld fOIm a corpo r~­
,ion or lim it. d liability com pa ny. Af,., all, , h.", bus i n~'" forms ar<
supposrd to prov ide limi"d liob ilit y-prou"ion from drbu ond law_
suits. I"d"d, many p ro pl~ S"m to bel i~,'~ th ~t forming. corporatioll,
LL P, or LLC is Iik. h.ving a m.gic sh irld againS! liabi lity. How. v..,
the sad truth is th .. thrre ~ re m.ny holes in the limited liab ility , hield
oiferrd b)' the co rp om ion , LLP, ond LLC.

What Is Liability?
Liabiliry ",~a ns b~ing l~gJlly r~'pon'ibk for a d~b, or for doing
", mot hi ng th. t inj" "'s so moOn~, such ,$ COmm itt i ng profession" I
malp/':lct ice or in jur ing someOne in • '/':Iffie ~ccid ent, If you ~re
pw"",ally Ii.bl~ for a d~b, or wrong . nd a porron su~ you and ob ,. ins
a j udgm~m ag. in " you. you' ll haY< '0 pay ,h~ judgm~m youmlf. If
you don', p'y, t he person who obt.i ned the judg ment Ca n t. ke you r
pw>onai proP'''y '0 P' )' i, (subjec, to cerrai" li ndrs), Thus. you could
~nd up losing your p.""nal ba"k .ccoums, p~r"'na l proP' ''y (lik~
you r car), .nd e,'cn your housr,
On the other h.nd, if only you r businen isli.b le for. debt or
wrongdoing, you hav. no 1q;.1 oblig.!ion to u,"" p~rson . l funds '0 pa)'
a p~fSo n who ob,ains a judgm~m 'gainS[ your bus in=. BUI , of cou,,",
you r business "SSetS can by t.ken to sat isfy a judgment aga in st your
busin~ss .
Obvious ly, b usin~" ow "e.., incl ud ing prof~ssional s, don', W'r\! '0
put thei r po""nal a""{S ,, risk if th ey g~t suod for "" lpT<ct ico Or ot her
. lleged wrongdoin g, Or if thei' pr;lctice incurs debt$, h w.s to help
a,-aid p..",na l li.bili,y .nd ."cou .. g~ p<opl~ 10 i ",'~SI in busi ne"",
,har ,he corporarion was c.. a,~d . Much Ia.. r, , he li mi .. d liabili,y
~omp. ny w.s <Stabl ishod to provide ,he $J n l~ dq;ree of Ii mitod 1iab ility
wi,ho ut th~ e. p"'''' a rid bot h.. of forming and ru " ning' corporation.
" I TAA OWUCTION! FO~ PRO FE!!IONAl!

LLP, w"," , Iso es"blished to gi .. pro fession ,l , lim i1<d lilbility.

Corpomions . LLCs, .nd LLPs , r< .11 li m ited li.bility emil i..,
Th . d.fau lt bu,in." ent ities-the sol< proprirtorsh ip and PUIn..•
ship- provide no limited li.b il ity at .II- you .... personall y li able
for you r business', deb" . nd wro ngdoing by you or .nyone eI.. who
worb in your prJctic. , If you want lim itrd liability, you must takr
th e necessa ry >!ep' to form. co rporation. LLC , or LLP under your
,,,,, I.w,

CAUTION
Li~b1 lily ho> nothinllo do with uution or Ih. w~y ~ hoin ...

entity i, .....<1. For a>rn,"~. tM ow","" of • I"""..,.,hip will hav~ unli rn~N
liability """n il they d,oo .. to haw: their p""""rohip toxe<l as a corpomion.
You mu," <K'u.tty form a limit"" liability b",i~< ""t ity u~ the ..,pliuble
'" .. ~ law to M.....tit frorn~; limit"" I",bility .«ributt<.

Liability for Professional Malpractice

'Ih. single g"OIesl li .bil it), "po,,,,, mOSt profession . ls fa" is for
m.l proCti", A single medicol m. lp",,,i,, I, w,u il, fo r eumple, Can
... , ult in a judgment for millio ns, Even if you're in nocent. defend ing.
m.l praCt"e lawsu it can COSt h" nd reds of tho" ", nds of dol lars. C.n •
I imired I i~bilily enl ily hdp you ovoid person,1 Ii.bility for m,lp ~.CI ice ?
Yes. but not as much a, you migh t lh in k.

Your Own Malpractice

No li m ited IilbililY enlity-wh.,her. corporOlion, LLC. or LLl'-
proteCts you .gain" perso ", 1 li.bil ilY for you r own m. lpr>Cl ice, or
ot h.. perso nal wro ngdoing. If your busine.. does n't have enough a","
to pay. jud gment obta; n.d against you , you r personal assets can be
to ken. Thus. yOll r p.rsonal.sse" will .Iw.)'s be On lhe line if yO Ll , re
sued for malpractice. This i, why professional, ,hould always have
malproctice ins urance .
 CH .. ,nR, I C""!Cl OF !lJSINEII HWTY I 11

EXAMPLE: Jan ... 0 civil eng ine.., forms 0 p rofession al corpo!':lt ion
of wh ich she is ,he sole sh ..ehold.., She helps d..ign , bridge
Ihal collapses. k illing do"ns of com muters. Eve n though Janel is
incorporaled , she could be hold pmo naliy li able (.Iong with h..
corpO!':llion) fo r a lly d.mages ","used by h...lIeged malprac,ice
in designing the bridge. BOlh Jan .. ·s personal OSselS and t hose of
h.r corporation are at risk.

Malpractice by Others
Whal if somebody rise in your pract ice gets sued for malprac,ice, If
}'Ou r p..ctice is a pa rt nersh ip, e.ch part ner is person.lIy liable for any
wrongful oCtS committed by .nolher p, rt ner in t he ord i n~ry co urse of
pannersh ip business. Thus. you will b. p..,mn.lly liabl. for malp,"cl ic.
,bims ag.ins! you r part ners, " 'cn if you wcre nOI per$()nall)' im"(llved.
This makes Ihe p~"nersh ip 0 bad choice for professionals who practice
IOg .. hrr. II i. by for , he mos, impona", reason II,., mo .. profession.ls
don', practice as regu la, parm..,;hips.
In co nt .. SI, if your proctice is. corporation. llC, Or LLP, )"(l"
won'l be person olly li ,ble for m. lptOctice by your fellow CO-Ow ners (or
employees) .. long as you w"en', pe rson.lly involved ill ,h. alleged
wrongdoi ng. ,I,hny S"t.s roq u i'" t h"l , .. t. in IYP'S of prof.ssion, ls
have malp ... ' tice insu '" nee 10 obtain Ih is Iim i" d liabi lity. ·Ih. rules
va ' r from ... te .o ... .. - you .hould learn )·OUr1.

EXAMPLE: Lou is is" doctor im'olved in a n incorporated medic.I

prac,ice wi. h Susan . nd Florence. O ne of Loui" pa.ie"lS ciai",s
h~ conlnlin.d m.lpT3ctic~ and sues Lou is perso nally .nd .Iso
SueS Ih. group. Whi l~ bolh Ih. group . nd Lou is con b~ held
liable. , he other doctors ill ,he group. Susan and Florence. can·
lIot be held person.ll y liable for Loui" nu lpr.Clice . Th i. mea ns
Ihei r po""n . l aSselS ore nOI J{ risk.

Thus. if you'" involved in • group pracl ice wi. h 01 her profession. I"
it', hit hty advi",bl~ to form a Ii mi..d Iiab il ilY ~ n l i,y. You don 'I w.m to
be held pe""n. lly li.ble for someOne else's m.lp!':le.ia .
11 I TAA DWUCTOONS FO~ PROFESSOONALS

On the Ot h" ha nd, if you practice .Ione, • li mited Ii.bil ity entity
won't help you 01.11 wi"" it COme, to malpractice li,bilit)', bcc.u..
th " . is no co-own.r whose malpract ice you need to be insulated from,

Liability for Business Debts

In add ition to liab ility for malpractice, you could be perSo:m. lly liable
for debts incu rred by yo ." practice.

Sole Propri eto rs and Pa rtn erships

When you'", a sole proprietor, you a", persona lly 1i.ble for . lI t h.
debts of you r busi neS$. Th i, me.nS thot a bllsiness creditor-. person
or comp. ny to whom )'OU owe money for i[ent< you usc in you r
busi"",,-can go .fter .11 your a""t<, both bu,in." a nd person.1. Th i,
may indude, for example, your person,l ba nk 'cco" n's, stocks, you r
cor, . nd even your hous • . Si milHly, . porson.l cred ito.-a pe"on or
company to whom you owe money fa. pe.sonal i[em, -can go after
you r bu,ine,. a"",,, such a, bu,in." ba nk account, • nd equ ip ment ,
I'art ncrs .re personally liable for .11 p.rt ncr,h ip dcbts . nd bwsll its,
Lh... me as sol. prop.i.rors, Howeye., pannership crediro rs are
required to proce.d fi '" .ga i os< th. partn."hip property. If th.",
i,n', enollgh 10 !;atisf)' the Jebts, the)' COn then go .fre r ,he p.rtners'
persona l property.
In . dd it ion, .aeh pan ncr is deemed to b. th•• g.", of Lh. panner-
ship when co nducting p..-t nership business in , he uSllal w.y. 'lh is
meanS you']] be personally liJble for part nership debts your partners
incur while ""ying on partnership busine .... wh"hcr you knew about
, h.m or not,

Li mi t ed Liability En t ities
Corporation, . nd LLC, were c".ted to en.ble people to i"..-", in
bu,i"","",. without risking allthoi, personal as .. " if th. busin." fail.d
or b.ca n,. unabl. to pay it' dob.., (In someotates, LLP. prov id. no
 CH."TER, I Cf1OlC t O f !l1SrNElSENTlTY I >9

prot«:tion at . Il.g. inst partnership debts; in others, t h.y p ro~ide th.

sam. prote ct ion a"n LLC or corporation.)
If you'" talk ing about a largo ~o r porat ion O f LLc' th.n li mited
liabili,y for debt< reall y doe. e. i, t, For exampl., if you buy .tock in
Micro sof" )'Ou don't h,ve '0 worry ,bout M ierosof,'. c"d ito" suing
you , But it usually d.,."n't work t hO! w'y for 5mall corporation, or
sm,lI LLCs--" pecially n.wly establi,h.d one. without a track r~cord
of profit$ .nd good cred it h istory.
M,jor er<d ilOrs, ,uch a, b,nk" don', want to b~ Iclt holding th~
bag if your bu.i n." go", undn To h. lp .nsur~ paym.nt, thq will
want ' 0 be .ble to go .f,,, yo ." pcrson. l .sset$ a, wel l os you r b"s in<$S
,s:;cts. As, fts"lt, if you've formed, corpon>,ion or LtC, they will
d~mand ,h at you p...onally guara nt .. bu. inr" loan., c" dit cards, or
oth. r rxtr n,ion, of cr. d it-that i" sig n a I. gall y . nforc~abl~ do~um . n t
pledging you r person,l ' ssct! to p. y the debt if your b"sin<$S o~t! f, ll
short. 1h i, m.an' thO! you will b. p.rson,lIy ljab l. for the d.bt, jUst as
if yo u w~r~ a sol. pro prirtor or p.,tnn
No, only do ba nks ~ nd ot h.. lenders un ive .... lly rcq"irc person , 1
gu , r.nt ..., other c"d ito" do,s well. For ~x ~mp le, yOll m,y b.
r~quir.d to prrson.ll y guaramr~ paym. "t of your offic. I.... ,nd ~v~n
I. a... for up.ns i\'~ ~qu ipmrnt , Sta ndard form, u5td by supp li~rs oft~n
,ont, in person,1 g",r;>nt.c provisions m.king )'0" person.lly l i~ble
wh en you r company buy, equ ipm ent , " d sim il., items.
You ca n ayoid haYi ng to plrdg. a p.rsonal guaran!r~ for somr
bU$incss debt$. The.. wi ll mOSt likely be romincand smo ll debu. But,
of co " r$C, Once SOmeOne getS wise to the f.Ct t hat you r busi ness is nOt
paying ilS bil l" 'hry won't . x« nd you .ny mor< cr~d i,. If yo u don',
pay your bills and obtain. b. d cr~dit rating, no on. may b~ willing to
b you b"y th ings for your businc&S On "cd it. Only" ftless "cd itors
might not "quift. per<onl i g"l"'ntee in the~ c;reu mSta ne.,.
30 I TAA DWUCTIONI FO R PROFElllONALI

Piercing the Corporate Veil

Another w.y you can ~ poeroonally liable even toough you'"" Iorm..:!
• corporation i, through. legal doctrine called ' piercing the corporate
veil,· Under th<. legal ,ule. cou'" d"'og.>n:I the corporate entity and
ooid ~. own,,, poe=nally liable lor any harm done by the co,poration
and for corporate debt~ Corporate ownen .,. in danger of h.ving tll<ir
corporation pierc..:! d they treat til< corpor.tion ., their ak .... ego, rather
than ••• >epa," ' . legal entity-for "".mple, they f.il to c"",,ibut.
money to the corporation or i'5Ue stock, they t.ke corpor.te lunch or
••"", fo r poeroo,..1 m e, they commingle corporate.nd p"roonal lund"
at they fail .0 ob\.erv. co'porate formal itie> .uch a. keoping minute. and
ooiding board meeting>. The ..me type of piercing can probably be u>ed
.galnst llC owner5.

Other Types of Liability

Malpractice and busin. "" debts a,.n 't t h. only type of liabil ity you n•• d
to be worried about. Other forms of liab il ity include :
• Prem ist, li.bili,y: respon, ibili'r fo r inju,ies or d.m.ges ti,.,
occu, at your office or other plJce of bu, ine..,
• Infr ingement lilbilitr: whe n SOmCOne cI .im, that you h. ve
infri " gN On' p.tc nt, copy right, tr.d em. rk, or trode secre,.
• Emp loycr liability: liabil ity for inju ries o r damagrs cau",d by an
emp loy.. wh il e h. or she was wo rki ng for you ,
If you're . sole propriet or or p.rt ner in a p.rtne"hip, yOLl' ll be
p.""n. lly liable for , he", types of lawsuits, Thco rrt i<;ally, you're not
p.""n. lly liable if you form. corpor"ion o r LLC. (I n oom. stalOs,
LLl'. arc . lso SUppOsM to provide protC<;t ion from these typc. of
li.bil ity; in others, {hey proteCt on ly .go illst m.lpnlctice liabili, y by
ot h.rs in your pr,Clicd
However, rem ember t h.{ you're .Iw.ys peroon.lly liAbl. for your
Ow n negligence or intention.1 wrongdoi ng. You ..An be person. ll y lioble
 C H ~ ' TE l> I CHOtC (OfSUS IN(SHNT ITY I "

und.. . negligen ce ' heory for . ll lhe difr"en l lype, of b wsuilS OUl lin ed
. bove. He",.", ,ome ex. mpb of how you collid be ,ued p"<on. lly
even though you've for med. co rporat ion . LLc' or LLP:
• An e m p loy~ accident. lly injure, ",meo ne wh ile ru nn ing on
ernlnd for you. The injllred pe""n 'ues you perso ". lIy for d.m ' ge,
cl.iming YOIl n.g] igent ly hired. tr. ined , andlo r '"p.rvi..d the
e"'ploye •.
• Someone ,u" yO Il, cl. iming )'oll've infri nged upon . p.. en " lnlde
"crel, or copy rigill. Even if you'v e formed . corponllion or LLC,
you can b. personal ly li able for , uc h d . im ,.
• '[he perso n in charge of yOll r payroll fails to properly wi,h hold
. nd p. y inco me . nd Social Secur ily " '" for )'ou r employe.,.
You co n be p..",nall y liabl, even if you w... n·{ p. ""n.lly
invol v. d.
In . ll , h... C;LIes, form ing. corf>Or" ion, LLC, or LLJ' will prove
u,dc" \0 prol~1 you from pe..o n.llilbili,y.

The Role of Insurance

If incorponl <i ng or form ing.n LLC or LL P won'l rdi"'e you of all
you r personal liobil ity, what a re you supposed to do to protect yOIl rsclf
fronl bu,in. ss -,.Iated I.w, ui,,? 11,.,.', a ,'ery ' imple .n,we " get
in ,"r.. """. YOllr in , u,.r will d.f,nd you in ,"ch law.ui" a nd p. y .ny
sett lements or dam . ge . w",ds up to you r po licy lim its, 'Ih i, i, what . 11
wise business Own erS do, whether they ",e sok proprietors, p. rt ner"
LL P own.". LLC m,,,,be,,. or corponl ,ion OW",,, , Li.bi!i[y a nd n" "y
orh.. form. of bu,in . .. i", urance.,. avail abl. to pro[~[ you fro m [he
types of lawsu its desc ribed above, Liabi lity insu ", nCC prem ium, .re
deducrible OS a busi"'" .. pense.
Nore c. .. fully. however. [ha, insu ",nee won', prorrC! you f ronl
liabi lity for busin.ss deb ,,- for .. ampl., if )'OU fa il to p.y back . Ioan
Or def."l t On • lea,., 'rh i, i, where b. nkruptcy COmes in ,
12 I TAX OEDUCTK:>NS FOR PROHSSK:>N", !

Limited Li. bilit, Limited Li . bihy

Typo or Entity ",. in" L.w.ui,,! Apin .. O.b,,!

Sole Prop'''to,;hip ~ ~

P." ..... hip ~ "0

'" '" '"
~,.,.

'" '"
Corporation
'" '"
The Four Ways Business Entities Are Taxed
Busin.ss.. are not .lIt...d alik. , Th . ....... four diff.,e nl typ .. of tax
1reat men, ",' ilobk
• role proprietO!1ihip tOX treot m.nt
• partnership lax " .a,mem
• S corporal ion tax tr • .,mem, .nd
• C curpO"t ion tax treatment,
You get to , hoo", wh ich type of tax t reatm.nt you w'nt, Th i, i, on.
of Ih. most impoHanl bu.in." d. cisions you'll ,,'., make beeaus. Ih.,.
are big differences among the .va ilable choices, For eumple, if you
choose Sore ''''poralion trealment, you'll be your praCtices . mplo)'",
.nd have to have you, incom. and Social S.curi,y tax .. withheld from
your ",lal}", In contra.t, you' ... nol.n . mploy .. if you , praclie. rre. iv.,
sole proprietorsh ip Or p.rt ne!1ih ip tax t rellmtnl, NOlh ing is wilh held
from you r poy, SO you'll h",t to p.y est imated t"es four time, a year,
Th.,. a,. alro important diff... ne.. as to how profits can b. alloc."d
among a group p,.clicc', ownt' S, how losses can be deduCl«[, a nd
eve n the likelihood of an IRS .uci il, lhe.. a nd olher differenCeS are
comp arrd below, BUlli,,,, )'OU ne.d to und.",at\d how ,hediffer.nt
form. of tax 1,..,.lment wolk,
 CH ..,UR,
. I CHOIC[On u SIN£lH NTlTY I u

Tax Treatment Choices

Wh. n.vet. business . nt ity is creatN Of Com.S into exist.nc<, it
aUlonlldcally "c~h'.. 0 form of,.."~,, m'n ' by d.fault. How.v.,.
~~C<P' for ",I~ propri~rorship'. bu,in.". .n d, i.. hav. ",m. I.. woy to
chang. from their d.fault treat m.nt to anot h.r type of tax tr.at m.nt.
A muhiow n.. LLC, LLP. or I"r""rsh ip is automatically .. " d as 0
pann~rsh ip b~' d.fouh. but may choose ro b. tand a, 0 C corporation
or 5 corporat ion. Thi, i, ... ily acco nlplish.d by lili ng. docum.m
calkd ", n dcct io n" with the IRS. O ne< this is do n.,.s fa r .s th.
IRS i, conc~rn.d. ,h~ LLC. LLP, or p.<tn."h ip is now ,h. sam~" a
corporation . nd it fi l.s t he tax forms for t hat typ. of e"t ity. How.,.''''
the great ",ajof ity of LLCs , LLPs , and pJrmmh ips stick with th. ir
ddoul, pon n..ship tax ... a'm.llt .
Corpo!':" ion, or. ta .. d a, C corpomions by d~faul,. bur may
change to S cOfpomion tox t,.. tmem by libng an S co'porat ion
dcct ion . 'Ih is i. extTOm.!y common. A one'OWMr LLC i. tax.d ..
a sol. propr i<1 orsh ip by d~fauh bu, c.n ricc, '0 b. 'n~d as 0 C or
5 corporat ion by fi li ng an . Iect ion. Th is is not ,omOlon. The ",Ie
proprietorsh ip i, tho only emity that <an't ,hang. its tax treat m.nt- it
mUSt " .. in ,h. sol. propri<1orship uxa,ion tr'.'m~llt ,ha, i, r<c~i",$ by
d~foul,.

Th. tabl. ~Iow SI1OW' all the ,ho;';e, aVJilabl. fo, ea.h typo of . ntity.

T1P~ of [ n'ity Tn Trn'm ~ nt Choic ...

Sole pcopr;"w,n;p Sole propr;"'o,,nip ,,,,,.,,.. (def. ul, " ..,me"')

p. rt n, ,,hip. ll P, P. rt n~"hi p , ... ,"'" (d<f.ul, " ..'m,n'). or

mul,;own<r LLC C w <por .. ion , ... ,.".., or
S CO'l"'''''''''' , ,,,,.,,..

Sinlle-ow""r llC Sole proprie'or'nip '''''''''' (def. ul, ,,,,,,,,,en,). or

C w <por.'ion , . . ...".., or
S corper .. "'" ....,."..

C <orpor" ion '''''''''' (d,f. ul, ''''.. m.n'~ or

S wrpe"'''''' ,...,."..
'" I TAX DWUCTIONS FO R PROFESSIONALS

Sole Proprietorship Ta)(ation

When )'OU 're a sole proprietor (or ,ingle_member LLC with so le pro-
pritwr tOX " eatme",). )'o u ond your busi"e"" H. one .nd the "me for
lOX purposts. Sale proprietorsh ip, don't p.)' toxe, or file taX return,.
Inste.d. you nmst report tho incom. you earn or losses )'OU incur o n
),our OWn person.1tn return (IRS Form 1040). If you tarn. pro fit . the
monty is .dded to ony ot hrr incom. you ha".- for tx. mplr . in"ust
in co mo or you r ,pou ...·s incom. ifyou're marriod a nd fi l•• joint tax
",t urn - a nd th at total is taxed,
Although you ou t ...d On your lOt, l incomr ugardl."" of it< souret.
th .I RS st ill wants to know about th. profi,.bil ity of your busi n."", To
,flOW wh.th .r you h,,'e 3 profit or loss from your sole proprietorsh ip.
you mU<1 IilelRS S"hedulr C. Profit ur Los< From B",;nffl. with lOur lO x
rrt urn. A" [his form. you list "ll your bu,ine"" incom. ond deductibl.
expenso., If you have more than OM bu,;n .... you must lile a .. parat.
Schedule C for •• ch one .

EXAMPLE; Ir ina is a sol. prop ri.tor d. m i't with no on . tlso in

her p"'''''e. Th i, ye. r, ,h e hod $250.000 in dtnt. l incomt ond
$150.000 iI, rxptn"". giving htr 0 $100,000 pro fit . Sht lilt,
Sch. dul. C with h" perllO na l tax .. lUm (I RS Form 1040) list ing
th. oxpens... nd incom. from h.. pract ice. Sh ... ports h"
$100.000 profit On hrr Form 1040 . nd p.ys ptrsonal incom. t>x
on i[. as well as Soc ial Security . nd M.dica .. lax... To figure h..
t ...., sh. add, h.. dem.1 incom. to any oth" ta.. blt income
she has for Ihr yeor-for ex~ mplc, i"''ts'ment income-a nd p.ys
taxtS On il ., perso n.1 lOX rott •.

Sole proprietors muSl u'" I he ,ole p roprittor form of ta x"' ton. If.
sol. proprit lor w' n'S' different Ifpe of t>x Ife.tm"n" he or sh" mLlSI
form a bu,iness .nt ity such as a corporat ion or LLC.
In add it ion. LLCs will. ant Owntr 3 re .utOm,1 ic. ll y trcatt d Iike
sole pro prittorsh ips for ,.. purpo"'S' Howt\'tr, thty have , he option of
sw ilch ing to a C or S corpor.,ion laulion .
 CH."TER , I Cf1OlC t O f !l1SrN£lSE NTlTY I n

Partnership Taxation
l h. next b.sic form of business t .. atio n is pa rtnership taxat ion. 'Ih is
forn , of lna,;on .pplies 10 I"" ne rsh ips. LLPs . and multimember
LLCs. When lhey are firsl formed . lhese emilies . 1I.uwnmic. lly
use part nersh ip taxat ion; a nd the great m.jo rity w nti nues to uS<' it
,h rougholll t heir existence. H ow"'er, , hey have , he Opt ion to .witch to
",her forms of taxation.
Undo< partn ersh ip tn treat"" nt, the busi ness ent ity is. P'''-
th rough .ntity for t.x purposes- th.t is. it ord inaril y p,ys no t ....
i" df. Instead . ,he prohrs, 10"". deduc';o "s. and "x cred i" of ,he
busi ness are p."ed through the busi"e" to ,he owners individual t ..
ret u rn •. If the bu,;ne" has , profit. tneowne,. pay in w nl< tax on th.i r
ownership .h are On thei r iI,d ividu. 1 re,urns at their ind i"idu.l income
,a.< "lies. If t he busi ness incurs • loss. i, i, li kewise .... red . mong ,he
owners who may deduct it from oth., income on thei r individual
returns, subject to ,.rtain lim itat ion•.
Unl ike a sole proprietorsh ip, a p' '' nersh ip is conside red 10 be
separate from the partn ers for the purpooes of computin g incom •
• nd d.du<t;ons. Th. partnersh ip fi le, its own tax return on IRS Form
1065, US. Rnurn "iParmmhip Inc"m~. Form 1065 i, not used '0 p. y
,axes, ra,her, i, i,a n informatio" rel urn ,hat info r",' , he i RS of , he
pa rr nersh ip', income . deductions, pron t', lo"",s, and tax cred it' for the
ye". Form 1065 , 1,0 includes a "'pH.te part c,lIed Schedule K-! in
which ,he pan n~r<h ip lislS e,ch p.n nds .h ..e of ,he items listed On
Form 1065. A S<'parat~ Schedul~ K· I mus< b. provided to ..ch part ner.
Each partne, reports on his o r her ind ividual to> r.. urn (Form 1040)
,he pann d . <hare of the pann~rsh ip'. net profi' or loss 0$ <hown
On Schedule K-L Ord in .. y busi" ess income or loss is reponed on
Schedule E, Supplmlmtalln('()m~ or fA". However, cert.in i.. m, must l>e
reported on ot h., "h. du le.- for eump le , c. pitai gain •• nd lo,oes muSt
b~ reponed on Schedule D . nd charitab le w mribut ion. on Schedu le A.

EXAMPLE, Irina decides 10 joi n her de nta l ptolc( ice wi,h h~r fri~n d
Leo', d~n .. l ptole, ice, Th~y proc,ice 109.. h.. as gen~rol p'n ners.
The parm~rsh ip ~arns S500.000 in inw me in one y.. r and has
l~ I TAA DWUCTIONI FO R PROFEll lONALI

$200.000 in d""uctibl. expenS's.lhe $300.000 .n nH.I profit

the part nersh ip e,rnS is p..... d th rough the part nersh ip '0 Leo
.nd Irini. individu al tax return.-each grl> 50% of the proli t,
or $150.000. They each must pay perso nal incom . t.. on th.ir
sh, ,, of ,he profi,~ Their profi' is ,dded ' 0 any o,her income
th.y ha.'. ,nd is ta ..d at thei r individual rox r. rr"

S Corp orati on Ta:ll:ation

S corpor:uion' or. tOX"" much like partnership" Like 0 p.rt nership •• n
S corpof:uio)l is , pHs-,h rough em iry-income .nd 10.... ' 1'." through
the co rporation IO th" owner, perso n.1 tax retu rn"
S corpow ion, also repon thei r incom. and deductions much Iik.
p, rtnership" An S co'pOnlt ion filt$ On informotion trtu'n (Form 1120S)
"port ing ,he COrponlrjon', incollle. deduc,ions, profi,s, 10...." and 'ox
".d i.. for rhe yr ar. Like pan ne", ,hareholde" musl b. provid.d a
Sch.d ule K_l listing , h.i •• hart$ of the item. On , h. corporation'. Form
1120S. Th e sh, reholders fi le Sched"le E wi,h , heir pe rson,1 ta re,um,
(For m 1040) showing ,heir ,hare of corporation incom. or 10....,
No busin." emity , tart. our with the S corporat ion form of
.ax a, ion.lnste,d, you muSt obtain it by fi ling.n elec' ion with the IRS .
Th" most com mon war to obtain S cor poration taxat ion i, to form
• rq;u lar C corpora,ion and t h"n iii. an elect ion to b" tax<d .s an S
corpor., ion with the IRS. 'Ih is si mply i",'OI,-., filing IRS Fo.m 2253
wi, h rh. IRS . However, S corpowion st.ws is , llowed on ly if:
• t he corpomion has no more than 100 ,hareholders
• non. of the corporation's sharehold . .. 0 re nonr..id.nt al ien,-
t hat is, noncit iz.ns who don't Ii.,. in ,he Un it"" S"le$
• Ihe corporaIion has only on. d", of stock-foI example, Ih..e
can', b" pr.f.,red stock giving some shareholde" 'p.c i.1 righ .., and
• nOne of the corpo.ation's sh~rehold.rs~" other COrpOI'::u ions or
partnership'.
Th.~ restrierio", apply whether you form a C coq}Qration and
change it to an S corpowion , or form.n LLc' LLP, or partnership and
elect S corporat ion la, "e'l m,nt. 'Ihey do nO' pose, problem for the
Vast majorit y of professio nals,
 -uOj1",odJOl >iF 01 !jOl ol''l ~UO! l"'P'P ""'11. ~UJnlOJ I "UO~u~d
J! ' Y' 110 , ,,,u,dn ,,,,,!snq ',' OJ l",odJO, ''11 Dnp'p 01 "~ ' y oP <>SIP
"~'!l ~P"'P! " ! P '0 's",n"oq '''''I~' JO "'JOJ '''ji ll! ('mo~ll! IPnp!A!p"!
'") m~'l' 01 p'lnq!Jl$!p ' ! 1! 1!)Un SOl ,"' ss,u!snq !»,",odJO'u! ''1'
'HlOl Ol ! UO '"l ,mOlOl! le "osJOd Aed ',uOP <1'P loy" ey' u"l,.,JOdJO, J
'(Mol'q uop'''' .'~IP'll H.1. ~Y' u!
."op'''.1 ~ Iqnoa. = -1l0!'HP' ~Iqnop 01 P'~I ""~ '.\JW'11 U! ' '1~!'IM)
'lq!l"'P'P lOu OJ. ~"P I0'l''" 'l' ''1' 01 p~lt'q!JlS! P IP U ~P !A! P 'J~_U1M H
'lUOJ "YJo , >]][ ",u, dx> ~upc"do pu~ 's>snuoq 'Sly~u~q ~~U !lJ "om
'"!HI''' ~'.{0l d,u~ ~"! pnp"! ',,,,u,dx> ,,~u!.nq ""'''~>1' P'" ,,"U! pJO
Sl! , 0 II" ~m o,u! Sl! '"O'J l)t\ r~ r 01 11'~ 11 -SJ~ u",O II! JO ~~)rJ xU
l'Ol OSJ;d ~'1 l lou '''l"' %" ,,",odJo, UMO Sl! 1t '!'1l d.d I! pOl' '''',,(
HI ~Y' JOJ 'goJd ,~u " ! 110 " 101o n, ''''o~u! ,,,~d uopf~odlO~ J V

'S'~~l"MP"!I'
pOl e J~~ClU"AP" 'l,oq J"'l " ! lU~r! xU ' l"J"d,s J! 'lt 'u~Plo'1~'"'1s ''1'
"'AI"'m~'l' POl" uo!,cJodJo~ ''ll- u,.{.dul ~mcd", >Jom '0 OM1 """~
.(><1' '"op",JOdJ<Y.> J ~ m,oJ 'lpuO!"'JoJd ~JO'" 10 ~uo U''lM "~1J~ " I
' V-Ol l l WJo~ ,0 Olll lUJO~ !ju!sn Slil ' 'l l 'l 1! "' ~Uj tU~'
x", u,"o J!~'1 l '101 put >cuo'U! ,~u J!''ll 01 0 J~"j >iUO'U! ,.d lSmu SUO!'

-rJodJ<Y.> J 'Pf,,,ul 'UOj In", JO ."'JoJ uopr,JOdJO~ S pu~ 'd! 'lSl~UlJcd

'd!'1SJ01,! ,do,d ' 10$ ''11 '1'!-" op .{''l1 n su,nl~J xell~"p!A!rU! ,11)UMO
''11 01 'l~I ")j '11 ".d 1001 01' ~"'$Ol Pol" $l90J<I -"Ipu, ~u!'{"dx"1 '1" ,d",
"c pOl.,,, '! ",u!,nq ' 'l' 'uoP"" JO 'UJoJ U,,!IC,lOdJO~ J ''1' J ~pUn

uOP\'X\'.l uopeJodJo:>:>

("Mol'q .iHl~," '"".1 ".1 '0 Al!1113 ""'! '"a

mo,\ ~~U"'lJ 11 0,\ PI"oys. ~'S) ' UO!S!"P ,u~"odw! S! 'f' !jU!>] "'" ~JOpq
l"uol<'>'JOJd xrj " '''' ma 'uoll"I' uopClOdJO~ S ue :l uqy J .p'SUO~
Plno'lS no" ' no" 01 ' AIU'W " ,po no. ' u;," l'''j H' uoueJOdJo, S
PU" 'd!'1SJ,lIlJ.d JO',,111 ':)1 1 u. ~''''1 "P'~J I" no.{ J! 'J~'~"'OH
', u. ",,.;,, ""1 dl'l<J,ulJcd ' lnepp J "Y1 "J"d Allfn," sdIY<J , ulJrd JO
'''Jl1 ''':)11 "'"'l 0'1'" ' I"UO",s'JoJd ><ne';q .uop '(lIen,n ',uS! S!'{l
'S'lll ~'P 'P!'" UO! lJ~I' UO! l",od10~ S " " 'I ~ P" " 2111 10 '<Ill 'd!,!,
',~u'nd • ,"lOJ OJ I! In,"" uO!" JodJOJ S "!~lqO 0 , A"'" l''l'O ~'!l

l( I AlII NHIlNlY1i J01:>lOH) I 'n14Y~)

31 I TAA DWUCTOONS FO~ PROFESSOONALS

EXAMPLE: Bill form' a C corporatiOIl- Bill, Inc.-to Ow n and

op~r',. hi. m~d ic,1 proc,ice. He Own' all the <lock in ,h~ corpo"
ration. The co rpordlion uk., in $)()O,OOO in incom~. It P' Y' out
iJOO,OOO in op~rating npom. s and .. Iari.. for Bil j"s <mplo)"'"
ond p.y$ Bill . 5100,000 .. lory. Bill, Inc. had 0 ,'" profit for
th~ r . a r of SIOO.OOO (S500,000 incomo - $400,000 np~n .. ' _
$100,000 n. t profit). It must pay taR' on it< profit at tho appli-
cable corpon te ,ax ratc. Bill, Inc. fi les irs Own lOx re,,,rn . nd P'Y~
th~ ,ax from it. Own fund .. Bill, ,h~ individuol and ~mploy .. of
Bill, Inc. must fil. h i' own p.,,,,nal in"'m~ t.,. "tum and pay in-
COme tox" On h is $100,000 :i;ll" y 0' indivi du~1 inrom~ lox ~Jtes.

All corporations oro in iti.lly und as C corpo rJ[ions and suy [h at

W:ly unless they file an dec( ion to be t.xed oS on S co rpor:"io n wit h
the I RS. In oddi( ion, p.rt nership$. LLl's, ond LLC$ Can dect (0 be
tJRd lik. C corporarion,. This i, nO! commonly dono, bur i, an op[ion
you should co ns id o[ if you a lr~ady havo an LLc' LLP, or par m~"hip
.nd would like (0 obt.in the benefits ofC corpor", ion tox {reatmCn{
wi,hoU[ going [0 [ho troubl~ of ", molly forming a corporarion . s~ ••
tax prof. .. ion.1 fi " ' , how~\'~r, b~cau .. one. you choo.. C corporAl ion
t re.{ mt n( it may be proh ibi{i,.. ly expensive (0 switch back.

Comparing Tax Treatments

No sing). {yp~ of tax n •• tment is b.s{ for 0"<'" professiona l. To h. lp
yo u i", ell ig. "tly clwo .. t h. ,ax ""'mem for your practice, ,h i, .. « ion
comp. re, how ,h. ""as:
four IlX ".lI m."I< dilf.. in " in< crucil l
o t n d. duction,

o t"x r.u.s

o own ..... ntploym.n , <l,t US

o fring. bon. fits

o alloc.t ing prohl< ,nd IOMes

o d.d uct ing business 10""

o r~lli" i"g .. m ings in ,h~ b usin~"

o SW~ {ax." a nd
o 1RS audit ralOS.
 CH.VTER, I Cf1OlC[On u SIN£lSE NTlTY 1 )9

Tax Deductions
Does )'OUf fOfm of t• .,tion ch.nge the type of tax d.duaions you m"y
,ake for your proc[ic.! Mo,dy. 110. T•• d.ductio<1 •• r< ll rgtly [I>< sanl<
no m." .. how . busi<1'" is [aM , Any bu,in ... nlay dNluCI [h. ordi<1ary
"nd n.cess,ry op.n",. it incu ... ,. wdl as t.k. d~p",ci.tio " for long-
["m busin... O=IS. 1hi, co",,, .lmoS!.1I [h. dMucrion' in ,his book.
How ..'''. "'",. d.duc';o<1s diff.. for C . <1d S corpor,uions. os
comp .... d with ",I~ propr i.tor and pJrm."hip lax", ion:
• C .nd S cOfpor,u io n, n.~d nor pay tax on a ll Of P" f\ of tho
divid.nd, th.y rrc.iv. ftorn st ock th.y own in O1h.. corpor,tio ns
• C and S corporat io n. g~ { much b. ,,", tr~J{m~ nt fO f chari{Jbl~
d~duction' of in". ntory Of ",i~ ntific prop~f\y (... Chapt"' 13).
,"d
• , h...... m.jor d iff... ncrs in ,h. w.y c. pi.. 1g. in, . nd 10,"",,""
{.. ~d (.~. IR S PublicJ[ion 544. Sal.. ~nJ Otb" Disp.,iriom of
A....I>, for d~{.iJ.) ,
1<1 addi,ion . C coq>or,t ion ~mploy.~s ll . .d nO! p'y ,a 0 <1 m.<1Y
typo. of fring" b"ndi ts. i ndud ing hoa!th i nsuranco and o{h .. mod ic.1
b"ne/i ts (s' " Chapter 16).

Tax Rates
Wou ld n·t it b~ nice if you cOllld lower yo" r {Jx !";lIe by ch, nging yo."
[ax u .a[ m.n{? M.ny busin... own~rs can do [h i, (a[ I.a" in part) by
usi ng C corporation {ax tr".,m. nt. Unfonuna[tly. prof.ss ional. . ..
ord in. ri ly nOt ~ mong {hem. I n$t(.d, mO$t profe$$ion~l, (nd up p~ying
inwm~ tax On th.i r profit~,t person,1 tax "' .. , nO m",,~r ",h,. form of
[ax " . a[ m.n{ [hey choo"" For {his rr ..on . [ax mrs arr usually nOl an
impor1Jnt considct>t ion wh~n pfofe$$ ionals ,hoo", {h~i r t.. {reat m(nt,
If yo" r pr,Ct ice h" ,ole proprietorsh ip, p~ " nersh ip, or S corporot ion
[ax " . a"".", . you " .. [ax~d on "ny pron" you rrcri," from [h. busi".,.
a[ your per",n al incom. tax r.,..
-Ih~ 2009 perron.1 incom( nx r~{($ lr( lis{~d in the following chart
([hey ..~ . dju".d ~.ch Y'" fO accou", for inflat ion).
.., I TAX OEOUCT K)NS fO R PROfESSK)NALS

2009 Federal Perronallncome Tax Brackets

b. Brock.. Income II li"Pc I"""'me II Monied Fi~"KJ";ndy
,~ Up to $a')lo Upto$ 16,700

From $a,JS 1 t o $JJ.9S0 $16,701 to $67.900

'"
,,. Sll,9S 1 to s a l ,lSO S67,9Q I to $ 1l7,OSO

sa l ,lS I t o $171 .110 $ 1l7.01 1 to '108.8SO

'",,. $17l.%1 to$J72.9S0 $108,8S 1 to Sl72.9S0
,,. All 0,",,' Sl n,9S0 All 0 .. ' SJ72.9S0

C corpor.t ions h.ve thei r Own income u x rat e$ (shown in the ch art
bdow) , At , e"ain incomelevds. the"" !':I t" a.. low" th. n , hos< for
individual, -fo r nample. a si ngl e ind ividual must pay a 28% tax on
income from $82,25 1 to $100.000 . wh ile • C corrow ion p.y$ on ly a
25% .. , on th is ~ mOLJn" C corrorat io n$ h " .. ,h-se lower fates to help
,hem keep money in the bu,;ness for expansion purposes , If you can
u.. th. "" low.. corpo r.,. ra ..,. it can b. ad""ntag'ou, 10 k•• p pIOn"
in the corpora, ion rot her th an p~ying the m to yo ." .. lf in the form of
""Iar)', bonu" or fringe b. ".fi ts ,

Regular C Corporation Income Tax Rates

Ta .. bw Income Tax Rat.
Up to $50,000

$SO.OOI to $100,000
'"
, 100,001 to SH I,OOO
'"
$JJS,OOI [0 510.000,000
'"
510,000,001 [0 SIS,OOO,OOO
'"
511,000,00 1 t o SIS, H }.H}
'"
All SIS.H},}}}
'"
0,",'
'"
 CHAPTE R1 I COOO:EOf SU<; IN EIS[NTITY I .,

Few profmio nal,." .ble to take adv, ntage of t he~ C corporat ion
,ax ""... In,,,. d . professionals with C corpo .... tio '" ord inarily lll. h
,ure that their corpor.t ions pay lill i. or no tax at all and in"ead pay
income t .. only o n th. ir employ.e co mpensation at their personal ta.
r..c,. Th,,,.re twO ""ons for this:
• the 35% flat tox ra .. for personal ~rvic. co rporations. and
• double ,..at ion.
Bot h i<5u,$ are discusscd in dorail below.

Personal Service Corporation s

Specia l tax m l.. apply to C corporations (or LLG, LL l\, or parm' Mips
th,t elect to b... xed ,$ C corporot ion.) owned by people engaged in
occup.tions involving p rofession . 1~"ic... 1hc I RS calls .uch corpo .... -
tions prr",nal ~rvice corporatio ns, or rsc•. Th e.., corporations pay
corporate t .. at a flat rate of 35% on al l their net inconl<. The reaSOn -
ing behind th is rul. is that prof.ssionals "'ho form C corporation'
should n't hav •• ta . dv.ntag. over prof. ssion . ls ,,·ho h,." other 'yp"
of bus in . .. entit i... Thrrefore, they must pay tax on all th.i r income at
the h ighe" individual tax We.

Personal Service Cor poration Inco me Tax RaIl'S

r. .. blolncom. Tao Rot.

so
A ll 0 ..'
'"
EXAMPlE, l h e Waher Marvin Profession,l Corporat ion is 3 C
corpo.. tion owned by M .. vin. H is comp'ny h.5. $ 100,000
profi, for ,he )..... I, mus, pay corpora.. income ,ax on the
whole $100.000 a, ,he flat 35% we bec.ust his co rporation isa
person, I strvice corporat ion.

A C co rporJt ion w ill be dJ" ined :IS a p.,50n,1 •.,vi ce co rporJt ion if
substa nt i,lIy .1 1tne stock is owned by corpo",te employees eng.ged In
,h. following .ct ivi, i.. or prof.ssions;
u I TAX DEDUCTK:>NS FDRPROHSSK:>N", S

• h.. lt h services
• low
• ac<ou nt ing {indud i ng OOokkreping ond tax "tum preparation;
Rainbow Tax S'Tviu ". Ccmm'r, 128 T.c. 5 (2007))
• engineerin g
• uchit<ctu"
• co n,uhing
• a"uarial .science, Of
• performing arts.
Heahh service, indude medical .. rvicr, provided by physi cian"
nil fSeS, dentiSts. physica l t hetOtpim, a nd ot her si m ilar hellth care
professionals. VeterinHi.> ns are incl uded", well. (Rev. RLlI. 91-30.)
Con,ulling mea ns gening paid to give a cl ie", your advice or coun .. l.
You're not a consu l,ant if )'ou get pa id only if the elient buyosometh ing
from you or from SOmeOne else th rough you. lhLlS, consulting does not
indude ", I.. or brokrntge .. rvic ...
These caregori.. include the gr.at majori ty of C w'pom ion, fm med
by profession.ls_ Fortunately, the "lSt m.jot it)· of PSG make su re their
corporation has no net profit for the year by " k ing out any profitS in
,h e fo rm of MJ.ry or bonuses (on which ,hey pay taX on their personal
" t ur n. at individual rat.,). O r, t her have thei , corporat ion prov ide
them with fringe benefits wh ich are nOt ","hle at all. ·Ihus. few I'SCs
actu . lly pay income [aro a, the 35% ra te. In fact . ,hry usually don',
pay any [ars a, al l.
lhe IRS can d isregard yOLlr PSC mt<tS altogether if it determi nes
th. t yo ur pri ncip. l purpose fOf form in g the I'SC was to obta in corpo-
m. tax benefits. (lRC § 269A{o).) If t hi' occurs, the IRS can "rar you
as if you never incorporated for lax purf>Ose •• nd mar " .lloca" income
to yOLl. You co uld also lose tox benefits J'OU obta ined by form ing the
PSc. ,uch a, taX sovings from h.. I,!> ond .cdde", in,ur. ncr pions,
med ical reimburstme", pl.n " .nd employer pension pla ns.
lh is 1RS rule is intendetl to prevent profession ' Is from fotm ing
PSCs solely to obt. in lOx benefitS and it ~pp l ies o nly to PSCs that
perform servic.. for juS[ one client or patient. Thus, i,', usuall y not
an issue because mOSt l'SCs.rc for med to provide services to • large
nil mber of patients Or cl ientS_
 CHAPTU, I C><OK:l Qf ! l1SINEIIE HTITY I OJ

EXAMPLE: So lly i, . n" d i.,1 doctor employed by Acme HO'pi,,1.

5.11 )' WOnlS 10 oblOin Ihe bendi, of. medicol r< imb ursement
pl. n. but Acme does n'l h.ve on • . So, , he fo rms J prof. ssionJI
corpowion , hal . h. wholly own. a nd has it provid. hor, ilS only
employ"', wi, h . pl. n. S.lIy has Ac me hir< her corpor"ioll.
Sally. Inc.. 10 work for iI, [n" ..d of hiring h.. a. an ind ividu.1.
Acme pay. S. lIy, I n~. , which ,h.n p.y. S. lIy, ilS employ••. Sally
works onl)· for Acme Hospil . l.lfS.lly is .ud il<d, the IRS co uld
disrrg.rd h" carpe r""" ' lI d tr<al her as . ,al< prop,i<lar.
,h..eby d<nying h.. ,he lax b",. fi" ,h. ab lJ in. d ,hwugh h..
corpo",ian's medic. 1 rei mbursement pl. n.

Avoiding PSC Status

To b., d ....m.d ..... PSC for IRS pufJ'O""." C corJ>Or... ion must hoove:
• emploY"'" who spend 95% or more 0/ their t ime on he.. hh,
law. e ngineering. a rch ~e< IU re.... cou nting. ... , ",,, .. I '" Oence.
~form ing "'''. or con.u Iting serv"' .... .or.d
• stod thoot i. at le.st 95% (by y.. I",,) owned by e mploY"'" who
poet form • ...:h professional _ vic ... 10' ,he corJ>O,"Iion. (Temp.
Reg. ~ H48'1T(eX~MSn
0 .... w~ to .ovoid h•• ing your C corJ>Oration d .... if>ed .I, " PSC i.
10 ""gage in mo", lhoon 0"" line 0/ bu,i ....... The corpor.otion won'l b..
a PSC il 'he """,nd bu" ne .. r"'luir ... at 1... <1 S% 0/ ,he corporalion',
empj"Y"'" time .. nd d""",'t i""o"'" 0"" 0/ the J>SC sery",,,, listed alKwe.
For ... mple, one CPA ~rm ..voided PSC statu. by purch .. ,ing i.. office
build ing.or.d cartfully docume n,ing ,ha, more ,han S'lO 0/ i" emplo""",'
, ime was spen' ma""ging ,he building.
Anolher str.,egy (th.ot i. Ie.. likely to work) i, 10 h;o"" 5'11. or mo",
0/ ,r., <lock ownod by ~ple who .... no< corpora,. e mplo)'O"<'i. For
~xample, Ir., ow ...... mig'" Iransfer ""me <lock '0 , heir re lali .... '0 avoid
Ir., % "" thremold. Ho""""". in most ".II", the stock in prof",.ioru l
corJ>Or.'ion. m.y b., owned only by tf>. proi'<-.,ional. who worle for the
corP'Or .. ion.
.. I TAX DEOUCT>ONS fOR PRDfElS>ONAL\

The rLlle m' f , Iso ,ppl)' '0' prof"sion,1 who is, member of
, p,rtn"sh ip. LLC. LLP. or corpor;r, ion ,nd who form" PSC '0
,ubstiturt: for him in thr r nt ity.

EXAMPLE, And .. is . drm is[ who pract icrs in.n LLC, with Tom
.nd Mikr. And .. wants IO obta in rax·adn ntagrd brnd]" th.,
he C~n get on l)' as. n employee of a profession~ 1 corpOf;ltion _H e
forms. profession. 1corporat ion . nd becomes it< only employee.
He [hen "ansfers h i' in,."" in the LLC 10 h is corporAtion. The
w [porat ion is now part·owner of the LLc' nOl Andrr prrsonally.
As And re's employer. the corpor;tt ion has A nd rt: prO"ide dent.1
,,,v ices [0 [hr LLC, a nd p.ys him a salary .nd benefilS . • uch as a
medic.1 ..i",bur.. ment plan. Breau.. And .. i•• n e",ploy.r . hr
need nOt P')' income '"x On the .. fringe benefilS, and they mly
be ded \lcted as . business upen .. by his corporation-m.k ing
,hem [ax f ..e. Th i•• 11 sound.g...,. bUl [hr iRS could disregard
Andri. corpofalion becau .. (I) it's a PSC, (2) i[ porform •• 11 ilS
.. rv ices for one enl ity (t he LLq, . nd 0) its princ ip,1 P" rpose
was 10 givr And .. !aX benefilS he couldn'[ g" OIh"wise (such os
• med ical .. imbu =mrm pl.n).

You con . void . ny risk ofhoving [he i RS disregard your PSCStatUS

if you prrfor nt your ,..rvicrs for mo .. ,ha n on. dirm or pat irnt. For
ex, nlpk. Sal ly from th e fir" .. ,mpie .bove wo"ld have bee n safe h~d
her PSC performed services for twO or mOre hospitals ~1 the s.me
time. You c.n .Iso avoid [hr ru le if you can show [hr iRS you had
a significant non,., re.SOn for forming your PSC-for ... mpl., 10
obtain li nlited li.b il ity.

fQ\ CAUTIO N
\.l) For PSC •. dan~ JO i•• Ion~. ~ .u"' to con", l. your tax .d. ~.,.
b.-fu,e farming' profe-s""". 1corporation if it will be a PSC .nd you11 perfOl'm
",b<t.ntially. 1I your <e.-it... for ane client ar ""tity.
 CH..,TER
• , I CHOIC[Of8 u SIN£lH NTlTY I .~

Double Taxation
If you'r~ ,h~ own~r of. C corpor:uion (or choo .. dw nl~,hod of
'au,ion fOTyour LLC, lLP, o r partnership), .ny direct paynl~m of
your corporadon·. profi .. !O you will b. con.id.rod a d i, id' nd by ,h .
IRS . nd ..... d ' wic~. Fi ... ,. II,. corpol':llion will pay corpol':l " inco ",.
tax on t he profit at co rporat. We. o n its own T. tu m, and th. n you'lI
pay personal inCOOle tax on what you receive from the co rpor.lt ion . l h i,
is c.lI~d "do ubl . ' .... io<l."
I <lcom. fro m di,·id. nd. (pay m«"s of ~a", ing. from corpor., ions
to thei, .h.,oho lde,,) usod to bo t ..ed at ord inory in come ta. rat •• ,
which currtntly ra ng. from IO%!O 35% (... , h. chan . , , h. b.gin <l ing
of , hi ...c,ion). Und~r ,"x ch.ng.. , h .. look df<c' ill 2003, how,,·~r.
qual died d ividend, ore ,"x.d at a maxi mu m of 15% for th~ years 2003
th rough 2010. Un less Congr~ .. acts .g. in, t he tax on dividends will
rist ' 0 20% in 2011. (For , ho.. in lh. 10% or 15% ,ax brach,. , h. , ..
rate on qualili . d d ividr nd, in 2008 th rough 2010 i. .. ro, but will go
back up to 10% in 2011.)
Wh~n you .dd ,h~ 15% p~r<onal ,,. On divid.nds ' 0 ,h. 35%
corpora .. incom~ ,ax moS! p rof. ssion. 1C cor pol':l' ion, mU<1 Pl )·. you
have, tot , l 50% tax. Ouch! In p racticr , how.v .., Ih. rffrcti". tax , aIr
i, sligh!!y lowe' Ihan 50%.

EXAMPLE, A I has incorporaled his consu lling bus ino", wh ich

is ,ax.<I ~$ ~ C corporat ion, H~ owns . 1I t h~ stock and i' th.
com p, ny'$ p"$id~n' , nd w i•• mployu. I n On~ r<c~n' y. ar. tho
corporJ!ion .arn. d S150,000 in gross incom •. Th~ corpor.uion
pa id Al a n 580,000 salary .nd had $20.000 in d.dun ibl~
or.rati ng cxp.nse" reSLllt ing in 0 550.000 profil for tho ycar.
Al had h i. corpomion pay h im , he $50.000 in ,h. form of a
d ivid~nd. Th. $50 ,000 i, land twice: Firs!. ,he co rpo raIion

Pl)'$ $1 7,500 lox on;t ~t th c corporotc I':lt. (35% b.c.me

AI's corpo ratio n is " per<onai , .. vi" corpor. tion). This 1""'$
$32.500 of ,h. $50.000 10 dimibU!. '0 AI. Al pay' pmonal
income lax on Ih. $32 .500 al Ih~ 15% di"id",ds taX w e- ,
$4,875 t~x. ' rho total tax i$ $ 12,375. ' Ih is 'mOunts to an
.ff."iv. lox ra,. of 48% .
<6 I TAX OEOlX:TK)NSlORPROIESSK)NALS

In reallif~. how,"". double " .. tio n is rard y. probl~m for prof.~_

,iotl. l, who hay. C corporation. (or LLC •. LLP•. or plrtn .r.h ip' t,.~d
th., w ay). O rd inari ly, you'll b• • n .mploy~~ of your ~orpOf.t ion and
tn . ,.Iary. b.noli ts, and bonu .., you re~. iv. will b. d. duCl;bl... p. nses
for corporat~ income .. , pLlrpo .... If you h.nd l. thi ng' right, yo ur
.mploy•• comp. n"'tion will~., up .11 or moS{ t h. corporat. profir.
so th ..... linl. or no t.ub!. incom.l.ft on wn i<h your co' porat ion
will hove to poy income to . , In ",counti ng p. rl.nce. the corporation',
itlcome is 'l~roed 01" ," You' ll on ly pay incom~ ta once-p..."o nal
in~om. tax on your ~mployo. comp~ns.t ion.

EXAMPLE: Assum. ,hal AI, from (ho abov. rxamp lo . has hi'
co rporation p.y h im $80,000 in ",lary . nd a 550,000 yoar-
ond ompl oyer bonus. He is paid no dividend . The co rpor.don·s
lOl~ 1 deduCt ible expenses ore now $150.000 ($80.000 s;Ilary.
520,000 op" "ting rxpon .., ~ 550,000 bon u, _ 5150,000). Th.
co rporat ion', d. duc tibl. oxp. n.., a r~ ~qualto it' S 150.000 gross
income fot the ye~r, le~ving zero ,.x.ble income, As a tesul'. the
corpor.,ion p.y. no incom. t .... , Al must only p.)' p<Ison.l
incom. tn on his .. luy . nd bonus, just as a ny mh .. ~mploy.~
would . t he 550,000 di stributed to Al as.n employ_e bonus is
taxed as ord inary income (nOl a d ividend) ~t his m~rgin. 1 {tOp}
incom. ux ralr, which is 28% . Thus, Al on ly has to p.y S14.000
in personal in come t.. On the bonus. Obv iously, t~ is isf.. kss
th~ n t he $22,375 in to,. 1corpOfote ~ nd ind i"idual income la.
lha( would hav~ h.d fa b.~n p. id if (h~ $50,000 dimibut io tl wa,
a d ivid.nd ,

Wh." yo u OW" yo ur C corporAt ion, wh~(hrr .lon. or with on.

or mor< co -own..', you gO! (0 d.dd. how nluch (0 pl)' you ... lf. and
what form you r p'ym_n(S will t.kc. Obviousl)·, you'l l w. nt to pay
you rsrlf .nough to »'Did doubl. , ...!ion. Howe...., yo ur d.d sion
.bout how much '0 p. y youtself is ,ubj~C! '0 r.. i.... by ,h~ IRS in (h.
event of an audit . 'lhe IRS .1I0w. on Iy ~o'por:u~ owner-.mploye..
to pay themselv.. a ,e.so n,b1c s. lary for work they actual I)· perform.
 'OS!J" lOu S)op IUO!'''G!J,I!P lm" )O '''\'$! ~~1 01 '"m" $I~u!~nq
mOA II" UMO '(II" uO<J,d AP"'J I" no.' 'J01~!JdOJd '10<" ",noA JI
" "'P ,~.'o 'nl~~ U! " ~p,,dd. ' f'l' .,m. "MO lr~' "'s)"lsnq ,oJ
Jop,dns JfJ s"".u 'f'" u' "''l' S>~ .. U'I'll 'Uol'.Plnl>!1 "odn ~;Uj-H'
S)" p~,u''l' 01 11m" p, ,,!,,,dd. >lnql" l!p AI!'"" !PJO u", uO!,"JodJo,
S JO d!'-!"'UlHd ~ •• p,nl Alllu, ur )0 ,,~u,"o ,~, ·"'.llU oo U[

'UO!I' Jod Jo, ~! Y PU" ~~I'"'I:) 01- '", ~I q"op

"I) '''y, 'smU ' (u)r~ ooo'ooa - '''''1 ~u)Plmq OOO<O~S - ~n l '~
~uIPllnq OOO 'O~U) "0 H 1 ''''O~U ) A~d " nu' ') U) '~ OOO'OOU"
I~'I u",,",od,o, S!H ,(U!~~ OOO"Ll$ · ~! S~q ~"JodJo, OOO'~L$
- "'I"A ~u!PI!nq OOO'O~lS) uO"" ~lUO'U! ICUOSJ,d Acd ,Imu ~~
U'"~ Iflld~J OOO'~Ll$ ~ .e4'H 'OOO' ~Lf I) VOl< "fJo,hoo ')4 U)
~!S~q sp[J e ~:) 'lU!'I 0, SU! I' I! "q Jy' jOd! 'I$.J~u"",o '~JSU"" '! ~. ~
pu~ uO!I"odJo, S! 'I Imr, "i>!1~~I"'I:) -S)I"G 000'0,; t " luO S"~
mq 'OOO'O~U 4uo ..... II ~UlPlmq ~'ll 'm,,, U~ll_~O JOJ SUlPlmq
,~!tI0 1I"'u, ~ P'UMO '"4 UO!'"I<>dlO~ ''ll 'lSrJl~lpod ~ '''1'''0
Aq pJUMO"PIO$ uO!lr~odJo,:) ~ I! ",u I '~Jln'fJ 'lldW'I'Xl

'SJ'pIO~" "'fS
Jyl 0, ~)1lq! m! p AJUO'u Jljl puc PIO$ S"! Awdwd J~' j! J" Jl ~plo~ J,un
~'ll '1~'"4< JI ' 'I1 }0 ""'I n , ~'I' 'p, n., , nl"" "~J"'U JI "j 1..(u,doJd
'4""4' )U nOl'" ~4' uo xn Ard 0, ~~~4 II'M A_4' 'uonrpmb'l uo
$J'plo~~,"'ls "]1 0) p"nq!"S"!p S! Am doJd ,~, Jl 'lOA(»JOW '(lSO~) S!$~q
U! SpJJ"J J1\I"A 1Jl' "'U J ! ~J I<Au~dwd J'l ll u"OlU ~ ' '1) UO 'I! "~1
-UlrS ' 'I' uo I~X", >luoJwAed "mu uOIl"Jo dJO,,'ll ', nl"" "~J" 'U
'!"J <I! J01 u O!I.~od lO~"]1 Aq Plo. ~,~,,, 'TJ!"' p''"''' ' '1 lSnlU All,dwd
''1' '(I~,u Tsn'l JO H'O ..oll) SJ'" PT"b!1 S"SI" 'IJ1\' 'Il!M Uo!,~,odJO'
:) "Jl ·'lu~,.d JO ""ll~ I"~J '" y,n< '"uI) J,-,O , nl"A '" , ,",:»,ddr
ley , " .... UMO "4' ("eN> "4' pox", I dnl<J~u l1rd JO <'d11 '$:)11
'0) suo),.,JOdJoo:) JOJ I'" 001 ll~ ~,uO~''1 u~, 1I0!,","' 'l'Inoa
(" "Ao ld,u~-lruo!'I'J01d p".,odJOJu! " ~~H no.(
u''IMJ I><moA A"d u~, no.. 'l,n,u MO'I JO UOlSsn:>s, P P' IIrl'P " lOJ 91
l>ld"'jJ "S) 'UO!,ex", ' Iqnop OJ u>/'1nl J," 1"" SlI["{l Aq 'pu'pI'!p
p>s! nllS")p SC PJ,"~' ) ,,~ '1'I"uO$n lU1\ p"u,Jp J," l"'l' 5IUnO'U" AUV

n I AlllNHIlN'5niJ01J<OH) I "ll~V~)
•• I TAX DWUCTIONS FO R PROFESSIONALS

Owners' Employment Status

Shou ld you be an employee of your p""ice or" self-emplo)'ed busi ness
OW ",,? The . nswer [0 [h i, queSlion ha, i",!",rum co"sequenc..
because employe.. and ",If-employed people a .. [.."cd d iffe .. mly for
m. ny tox purpo", •. Each [ype of employment ,t.m, h" its pro, and
con' , neid,.r is be" for e"ery profession,1. You choo'" your employ-
men[ SlOI us whe" you choose your lOX ! re.unel\[ . If you choose S or
C corpowion t .. !reat men[, you' ll be Jn employoe . If you choo", Jny
ot her!3x tre3lment, you'll be ",If-e mploye<!. You shou ld undeCS!and the
",m iliealion' of [his ded'ion before you make i[.

Solt' Proprietor and Partnt'uhip Tax Trt'atment

If your pr.l"ice is "xed .. ~ sole proprLctorsh ip Or p.. t nersh ip, you .rc
<w[ . n employee of )'our business emil y, inSle.d. you ore. busi"ess
ow".,-.Iso called ,elf-employed. Your busi"ess doe,n'[ h" 'e [0 p.y
p.yroll !JxeS On your inco nle Or withhold income !ax from you r pay. It
noed nOt lile employmenr t,x rtturns, or p.)' ""e Or fede,.,1 u nemploy-
men ! ,. xes. You need nOl be covered by worker, compensolion insur-
.nce, All [his C<ln ,a,'e hund .. ds of dollars per ye ...
H owe"cr, you do h.ve to p.y ", If_employme nt !axes- {h" is
Social Secmi,y .nd Med ic. re , ..es-on your business i"corne. called
'''If-employmem income by ,he IRS. This cons;'!S of a \2 ,4% Sod.1
Secur ity !ax on the Ii rS! S I06,800 in se lf-e mployme nt income in
2009, .nd a 2.9% ,' ledic3!e t .. On .1 1self_emp loyment income, nO
mmer how much . Thus •• ,01 . 1 15.3% [ax muS! be p, id up w the
«il in g amount. The S""ial S"urity tox ceili ng i, .djusted .n oually
for inA,tion. lh.se taxeS must be p.id four ti mes. year (,long wit]'
i"come ,"xes) in [he forn l of eS!i",,,ed ,ues. Self-employ me", , .....
ore equiv.le", '0 , he ,01.1 S""i.1 Securit~' . nd Medic~", [ax (F ICA [ax)
p.id fora n enlploy«.

EXAMPLE: Mel is. sole propriewr de", iSl. In 2009. hi' net ", If-
employment income W", 520 0,000. He must pay. 15.3% self-
employmen' !Ox On , he firSt $106.800 of h is self-employment
income, . nd. 2.9% Medic.", , ... On [he rem.inder. H is ,oul
 CH.VTER, I Cf1O lC [ On u SIN£lSE NTlTY 1 09

sdf_employm.n t ,,. is (15.3% . $106 ,800) • (2.9% x $93 ,200) ~

$19,043,

S Corporat ion Tax Treatment

As f~r ", employ ",ell! s,",u, go ," , , hing' wo", v<ry di/fer<ntly for
profe... ion.l. who ~hoo" S corporatio n ,{.tu" Alt nou gn an S <o rpora-
{ion i, taxed mucn like a partne rsh ip, i{ i, , t il l a corpowion - . "'pa -
rol< l'g, l.n, i, y. An 5 corpo rotion ,ha"hold<r who pe rform' more thall
minor .. rvi~, fo r the co rporation will be ilS . mployee for {O> purpo... ,
a, well a,. sha r< holder. In e/fe<;t, on active , hor. hold. r in 3 corpor. t ion
w' . " ' I I•• st 'wo hats:~" $h. .. hold.. (own.,) of the corpo rat ion, ,nd
OS ' n ","ploy~. of , hot corpo ration . If , he corpo ..d on is 'null, OS mOst
prof. ... iona l ~orporatio n . ,r<, {h • • har.holdor-emp loyee nOTma lly .. rv~'
'S ' n offi e.. . nd di .. C!or of the corporat ion os well. So, One person Can
b. ,,·. ..ing four IlOts.
A , n. r<holder-employe. mu" b. com p . n,"{~d for hi' or her .. rvic~,
to {h. pra"ic. with 3 r~a"'n .bl . sa bry and , ny otn., employ .. com-
p.n:;;.>t ion th . corpo""ion w. ntS to prov id •. Th. shor.hold.._employ~e
mUst r<porr h is 5 corporat io n's .,rning. On h is p~rsonal i"com' 'ox
retu rn, 3nd pay ni , ,h ... of Social Security a nd M.dicare {ax.. on any
~mp loy<c s.IHy hes p~id. The corporatio n nHISt withhold fed".l in·
~Om' a nd . mploym.n t tOX from ,he sh, ,,hold.,... mploy. ", p'y, ,nd
pay s!ate and fed... 1 un. mploym. n{ {an , . nd Soc", l Secur ity . nd
M~d ica re tue, on {he ~m p loyee's ben. lf.
1h~ 50ci,I 5c<:n rity , nd M.dic..~ tax r:lt< for, n employee is
th . " m~ os fo r , ..If-. mployed busi ne" Ow n" : however, it', p,id
d ilfrr. ntly. Half th. IOtal {ax i. ded ucted by {h •• mploy~T from t h.
~mp loy<c'$ p. y, :lnd holf is p~ id by the empIOj'~r il .. lf. W hen you Own
th . busin«s , hot is p.ying the" la es, it m,k'S nQ proct ic,1d iff""lC~
(h at half i, pa id b)" {h • • mploy~r-you ... {h• • mploy...

EXAMPLE: As.sum~ that M rI (from th~ ~bov. n , mple) ha, form.d

. n S corpo r,,\ion of wh ich he', th. ""I~ sh..~hold.r. B. cau ,. II<
ptrforms dtn{a l scrviccs for {ht corpo .. {ion, ht is its em ployet
for {ax pu rposes. In One r",en' ytar, {h~ corpora'ion p ~ id Mel
so I TAA DWUCr.::>N' FO~ PROFEI.IONAL'

$200,000 in cmplo}-." $:l lory. Th. corporat ion wi,hhold, half

of M.rs Soci. l S.curi,)' .nd M"dic, ,, ,,. .. from h i< wag .. ,nd
pays Ihe olh" half imlf. Th. tolallax is 519,043, jusl like wh.n
11.1 .1 WJS a sole proprietor.

Also, mosl 'Ial.... ~ui re Ihar ..eh employ.e be provided wirh

work.",' comp.nSltion in$ur.nce co'·Ctog". H owcvcr, SOme $t.te,
disp.nse with t hi, requirement if ,h" corpoto'ion h.s on ly 0 few
. mploy .... Unemployment insu rancr and work.",' comp.nsarion
""verage co,,,, at I.." sewral hu nd red dolla", per .mplo)·...
Cle. ~y, being dal$ified ;t5 an S corporot ion emp loyer has m.ny
diSldv.t\lagrs for a professiona l. Bu! ir also has one pot. t\ti.1 big
advantage: S corporation tax trearmenl can provide a way to take
SOmC money out of your corporation wi, hout po)· ing employment
"xe,. l h is is brc'"" yo" do no' h.ve '0 p.). employmen' (Ox On
dimibur ion, (dividends) from you r S corporarion-th.r i,. on rarn ings
and profits that pass through the corpor.r io n to you., a shareholder,
nOt,S an cmplo}-ec in compensation for )"0'" servicrs. The I, rger your
di,rribur iotl. rh.le" .mployment lOX you' ll P')'. l1>e S corporal ion
i, Ih. only busin.., form rh., ma kes iT possibl. for irs owne", to ,,,'e
On Soci.l Src"rily . nd ,\l edicarc t.xes. 'Ihis iS l hc m.in ...son S
corporat ions h,,"t bern, .nd remain, pop"lar with profession.ls.

EXAMPLE: Al$ume th" M"l's S co rporat ion pays hi m only.

$90,000 " lary. 1he re",a in ing $110,000 of ,he corpora,ion',
pra 6" are p.".d rh rough !h. S corporarion .nd reponed as
an S corpor.lIion d istributio n on Mel', perso n.1 income tox
"'llt rn , nOt as cmplo}"t. ",IJ r}·. llee.",e it is nOt viewN "
.mployee wages, nei,h .. Mel nor hi' ""'por., ion need '0 pl y
Soci.1 Seemiry or Medicare lAX on rh is amoum. Mel. tld his
co rpo .. t ion on Iy pay 3 to,,1 of $1),770 in employ n,,,nt I.xes
(15.3% .t 590.000 • $13,770) in.,ead of $19,043- 0 ,.x s.aving.
of55,273.

If you took nO salary., .11. you would nOl ow, . n)' Soci~1 Seeuri! y
.nd Med ic,re !nes. A, you ndgh! expect, however. ,hi< is nOl .1I0wed.
 CHAPTER 1 I Coo':E OF 1U5 IN ESS ENTITY I "

Th. IRS I'«[ui"s S corporotion sh"d>oId""'mploy'" to pay tl,.m""I... ,

• " ..o n.bl .... Iory- a, I•• " wh., orl,,, bu,i n'=' p. y for ,i", ilor
,.. vier" (5 •• "P.yi ng Youmlf" in Ch.p'" 16 for 0 d.,.ilrd d iscu",ion
of what const itute. a "a.onabi. ,a iary.)

C Corporation Tax Treatment

When you form 0 C corporarion (or choo"" that "wh od of taxation for
yom LLc' LLP, or p, rtnorship) a nd . "ivciy work in the bus ine .., you
b..,om. your corpor.,ion's ''''ploy''' w i,1, rI" sa ", ... x conscqu.nc.,
os d.scrib.d for.n S corporation . mploy.. . bov• . How,,'''' C corpo ·
rat ion sha"holder-employ..s con't sa", on ... es by paying th.msch.. s
corporate d istr ibut ion. inste.d of employ.. sal.. ie!. 'Ih is is boc.u"" , C
corpora, ion i, • , .. p. ying 'n' i,), .nd C.n no , d.duc, d i" rib ution, m.d.
to sha"hoid.". Thus, it mu st pay corpo rat. incom. tJx on th. distribu-
tion!- ordin.rily a{, 35% r.te. Mo,"o""r, t he .h, ,, hold.,, must pay a
15% incom. tax On such d iStlibution'.

EXAM PLE , A""u m. {hat M.i (from {h • • bo'" exa mp!.s} h...
C carpo"'tion , !t p.y' h im $90,000 in ''''plo),,,, w.g.s . nd •
$1 10,000 sh . r"h ol d" di" ribution. Md .nd hi' corpor.tion
must pay $13 ,770 in .mp loym.nt , ..., on Md', wag .. (15.3%
• $90,000 . $13,770), j"sl1ikc wh.n Mel h. d an S corporat ion
in tl,. pr"vio us ... mpl. , How.vet, b.c. usc i,'•• C corpo""ion
(and a p.rso na l .. rvie .. corpowion ), M.r, co rporatK'" mU>I
pay $38,500 in corpora.. incom. {.xe, on tho $110,000 Mel
I.f, in hi' corpora .. b. nk . CCOunt to b. d istribu..d to h im . s
a divid.nd (35%. SI IO,OOO _ 538500). Th. d ivid.nd is no,
d.duc{ ibi. by ,h. co rpordtion a, a bu,in~ss rxP""'" and M<I
"'LIlt P'ra 15% incom. {ax On il. Only $71,500 w'$ I. rr to b.
distribtltM to Md'$' d iv id.nd .ft" his corporatio n p. id itS
{an" so M.I must pay an $1 1,725 ,n on ,b. amou nt (15% x
$71,500 _ $1 1.725). Th. total {JX on {h. $110,000 d istribution i,
$50,275 ,
H ad Mr!, a si ngl . uxp a)'rr, paid h im", lf {h. $1 10,000 as
.mploy~. salary in 2009 in".ad (for a 5200,000 (0{.1 ",Iary),
it wo"ld h,,·. bun !ubjm {O a 53, 190 M.d ie.,. tax, $2,083
51 I TAX DEDUCTK)NS FOR PROHSSK)N", S

Sa,i.1 Security to, • • nd $3 2.72 3 in p<rson. l inmme <o xes, No

m rpara" inmme toX would be due bec. ust <I" ,.I.ry muld be
d. duct. d by Md', mrporatia" as a bu,in ... "'pen ... The tota l
I.. on the SI10,OOO wou ld be $38,716.

How.ver. bring. C mrporation employ.. , instead of a ..If-em ployed

busine .. OwnCr or S corpo"uian emplo)'ee, h. s sig n ifican t t ~x .dv.n.
'"ges when it COmeS to fringe benefi",

Fringe Benefits
Fring. b.n.fi" ... ,hings like h.. l, h. disabiliry, .nd lif. insurance; paid
vacat ion,;. com p. ny car ; .nd reimbursement of medi,. 1e.pen ... not
cO"crod by insu rance. 'Ih is is t he one m.jot arC, where C corporation
.. x " • ., "''''' i, f. r superior ,a ,h. mher !Ox regi", ...

C Corporation TaK Treatment

When )'0" for m ~ C cor por.tion (ar eleo to h.ve yo" r LLC , 1.1.1',
or pann.rship !Oxed a•• C corpor.,ion) and ac,iv.ly work in ,h.
business. you b. come your mrporation', employ... B.ing. corpora ..
employee, inste . d of, sel f.~mp loyed b"$ine" owner, h.s sig n ifica nt
t ~ •• d,·,ntages when it Comes to [r inge benefit s,l he tax I.w . Ilows. C
corpora, ion 10 provide i" . mploy... wi,h m.ny 'yp" of fr i ng~ b~n~fi"
which i, can deduct f,om the corporation', inmme a, a bus in.ss
expcnse. 8m the emp loyecs need nOt indude the v.lue of the fr inge
b.". fi " in , h.i r , uabl. inco", • . df",iv.ly ",. king , h.m tn f.... l hi'
can sav. many ,housands of doll.rs in tax ... No mher bmin." .mi,y
ca n do this.
Possible t.. ·free emplayee fr inge benefi tS incl" de:
• h.. l, h. • cride"" .nd de",,,1 insur. nc. for you and you r f,m ily
• disability insura nc.
• reimbursemcnt of medical «penses not cove.. d by inSUr;lnce
• def. rr.d con'pet15.tion plans
• worki ng cond i,iOlI fringe ben.li" such os con'pany-own.d cars,
, "d
• gro"p term life in s""n".
 CH,VTER, I CHOIC[On u SIN£lH NTlTY I u

EXAMPLE: M,rilyn incorpor.tes h" optonw ric p!':lCtic-, of

wh ich sl,. is ,h~ on l), enlploy~e. M,rilyn's corpor" ion pro,id«
h~r wit h hea lt h insu rance and a m~dical rrimburs.m . nt plan
for uninsurrd med ical ~.p~nses for her and hor fa m il y at a cost
of $10,000 p" )'e. r. Th, ,,,, i ... co .. C~" b. d.dwct,d from th.
corporAtion's incom. fo r corpo rat~ inco",. ta. pu rposes, but
is not includ.d .. income on Marilyn's person.l tax mum, In
effect, nO ax h~, to be poid On ,h. $10 ,000.

So le Proprietorship, Partnership, and

S Corporation TaK Treatment
Pfof."ionJI, ,axed as sol. proprietors, S corporat ion own ers, • nd
p~rtn~rs, may d.duct 100% of , heir health in sUfOnce pr~m iu ms from
,h.ir p.rson.1 incom. ,ax , Thi' inc!ud" ,h. ir own h•• llh insurance
prrm iu n" a, w.ll as those for th~ i f 'pou= .nd d. p. nd~ nt,. But th is is
o speci~1 p~"ono l d,duc,ion, nO' 0 busi n"ss deduCtion. Thus, i, doesn',
r~duce , heir incom~ for Sod,l S<'Curi,y ,nd Medico" ,ax pu rpo",,,,

The.. professional, g~ t no othrr ta.·advJntag<d fring. b. n.fit" If

th. entity provid.. the ownrr with a noth " typ. of fri nge benefit, its
.... Iu. mUS' b" indud.d in ,he owner's p"so llol ,ax rewrn ond incom.
,ax m Ust be p.id On it. For "xo"'p l. , if.n e",i,y ,"xed os a partn ersh ip
provid...n own" with d iSJbil ity insuranc., rh. own~r mu,t indude t~
val ue of th" inS\".nce in his or h.. t~xlble incom" for th. yeor. But th,,,
is Oil' wa), ~rou "d ,h is: 1h~ busin<S$ Ow n" C.n h i" his or h" spou se as
an .mplo),,,, and provide t~ 'pause with b.n. fit" (S .. Chapt" II,)

~ RELATED TOPIC
~ ~ Chap'er 16 for a d""ailed diKU""'n of fringe t>erwrli" lor
I"Okss.,,,,,I, who art t~ . , C <orpor.,""'''-

Allocating Profits and Losses

P• .,,,.rsh ip' , LLPs, and LLCs ,ax.d lik. pa.,,,.,sl, ips (~s moS! ,rt) hay.
a ta~ adv" ntage when it co",eS 10 allocati ng prol1 t' and losse,. Unl ih
corpOfation', tney h.ve g" , t A., ibility on how to . Ilocat' pfofits . nd
S4 I TAX DWUCTIONS FO R PROFESSIONALS

losu' ,mo ng Ihe Ow n",. For n.mple. One Own" cou ld get 75% of
the proll" , nd the oth.. 25%, "en though they,re each equ,1 owners
of Ihe LLC or partnersh ip. Professiona ls invoh.. d in group practice,
fi nd thi' AnibililY '''ry altr'Cl ive because il allow, Ihem to be cr<at ive
in f.,h ion ing Iheir compen~lion. For e.. mple, p." nenhip or LLC
profit. can be di<tr ibuted ,ccord ing to rach owner's col leCiions or
r<ce iplS, .ha r<d equally, .hared according 10 e.ch owne rs percentage
of ownership, based On complex form ul,s involving pointS or u nitS, or
b,sed On , combinOlioll of method,-for ex' mpl., dis!t ibut ion' cou ld
be ba..d partly on ownership percentag.. and part ly o n collect ions.
Or, Ihey co n uSC" less r.t ion.1 opproach: ]>~rtn.rs or LLC me mbers
COil simply get loget her a, the end of the year ,nd decide how mLlch
each person shou ld g.t of Ihe Ii rm', net profits for Ihe yea r. Howeyer.
there ar< limits o n how creat ive LLCs. LLP., a nd part nership. can get.
Complex IRS " ,1es (",,,bsr.n, i,1 economic effect rules") permit the IRS
to di,regord a p.rtnersh ip ,I loc", iOIl of profi" or 10''', if i,·, don. on ly
to avoid taxes.
You don·t have Ihe S.me flexibili'y with ~n 5 or C corpo,...,ion . Any
profits ,.ken Out of. corpor::uion '$ di,·idend, must be distributed (0
The ,hareho ld.rs in proportion 10 Ih.ir ownersh ip ,hare. For exa mple. if
there ar< two shareho lders and edCh own. 50% of ,he stock, Ihey must
e~ch recei,·e, and p~y income t., on, • 50% sh.re of , ny corror.".
dividend. The on ly w'y '0 provide dispropo"ion.te d i<1 ribu'ion' i.
to pay ,ome shareholder-employees mor< sa lary or other employee
compens;rl ion , h~ n others. 8 ", t here is a limit On how much employee
compens;r,ion • C corporat ion ,ha"hold"~mploy.. m.y re.sonably
be paid. And. it·, prefCI.bl~ 10 pay S corpomion ,hareholdm .. little
employee <omp en"lion as possible to ",'Oid employment tax ... (See
Ch.pt" 16.)

Deducting Business Losses

50m. prof.ssio"al p"'cti", 10.. rnortey.1hough this is ,,01 conrrnon, i,
<an o<cu r. How you can deduct Ihes. losse, wi ll depend on what Iypo
of lax trcat nlCnt you nave for you r bus iness. And Ihough Ihe prob lem
ofh , ving loss .. doe,n·, occur often wi,h prof.ssional bu.in...... t h.
 CH"'TER, I CfjOlCtO f !lJSINtISE NTOTY I ~~

d ifference. bet w~n the tOX "eOt men'$ ond how you cOn deduCt the
loss.. is .ign ificon1.

So le Proprietorship and Partnership Ta~ Treatm ent

JUSt as income passes th rough. sole proprietorsh ip Or p.rt nership to
,he OWner, pe rsonol IO. rerUrn', SO do losse .. 1hus, subjec, 10 some
import.", lim i,o,ion., lo.ses from on em i,y ,ned 0" sole proprielO r-
ship (sol. proprietorship or single-m'Olb.r LLC) or a n ent ity .. xed as
a part nership (lLC, LLP, or part nership) co!, I>e deduc!ed from ony
mh., income the ow"e" h,,'e, 1hey can even be deduc!ed from income
ea rned in prior years that h", alr.ady b.e n t . ..d, or saved up to be
used in futu n: ye.rs, 'lh i, makes sol. proprietorsh ip or p. rt nersh ip
!a' "e.,me", ideol for , bu.iness ,h at expeclS '0 lose money, which
profe.. ionals ju,t staning out sometim .. do .

EXAMPLE 1: U ... holds a ful l_t ime job os an e"gine .., She decides
to establish. pa ' Hime consulti ng bu.i"... she oper.", .. a sok
proprietor, DUT ing hot fiTSt year as a sole propr ieto r, sh e incurs
$1 1,000 in expenses . "d e"nS $1 ,000 in consu lt ing f~" giving
her a $10,00 0 loss from h.. co ll, uit ing bu, iness, She "po,", th is
loss on IR S Sch edu le C, which ,he fi le, wi,h h.. personal income
..
ta " t urn (Form 1040), aec~ " Lis:> is ~ sole proprietor, she Ca n
deduc, ,hi. $10,0 00 10$< from any income ,h e has, indud ing her
$100,000 .nnual "lory from h., engineering job, This MY'" her
.bout $4,000 in !axe. for the ye.r,

EXAMPLE 1: Jack and Joh ann •• ". marr ied couple who ti le .
joint income t.x "turn. Johann. elmS $80,000 a)'" .. fro n, hcr
job, J~,k is a bwycr rmployed by an in su r~ ncc company. He
qui" h i' job and Slam hi' own legal proct ice . Hr form, a onc-
owner LLc' wh ich i. taxed as a sole propr ietm.hip, In h is fi m
)'t>f in bu,iness, h i, co mpany Carns $20,000 and has $40,000
in rxpense •. '0" entire $20,000 b".incs, loss p..ses th rough
the LLC 10 Jack a nd Johanni. personal joint tax return, They
subt "" t the 520,000 loss from thei r IOtal taxable income fOt
the year, which consistS of Joh.n nis $80,000 .. lory. '[h is lea,'e,
s~ I TAA DWUCTIONI FO R PROFEll lONALI

the", with 560,000 in inco",e fo r the yur, S"'us- they.r. in

, he 25% income tOX b",ck", thq\ 'e ..,,,,d $5,000 in fede",1
incom. lax (25% x $20,000 _ 55,000).

How..'''' th ...... som. limitatio ns on tho .mount of loss", .n

ow n.. of.n .ntity ta.d .. a partn. rship can d.duct o n his or h..
person, l nx ,etu'n. l he mO$t important lim it i$ t hot the deduCt io n
for 105S<"S COnnOt exce(d t he ownds b,sis in , portn(lsh ip, LLI', or
LLC [ax.d Iik. , paltn. rsh ip. Bas i, mran5 you r tota l inv.s[m.nt in [h.
busin . ss for [ax pu rf'O .... In g.n ...I,. busi n.", ownrr cannol d.dun
a loss that (xccrds th e ow nds c~sh contribution 10 t h( entily, plus
incom. prrviously rrcogn iud from ,h•• "ti[y, rrducrd by any loss",
or d. ductions ,ha< w... prrv iously d.duct.d , I mporta ntly, ow n.." of
(nt ities , ..«I ' $ part nersh ips may .Iso .dd to Ihei' b'li$ their shore of
all the (nt ily's liab il it i($--Io.ns ,nd othor debl$--wh ich COn g!(~tly
incrra .. [h.i, basis a"d .1I0w , h.m 10 d.duct morr lo,""s ,

EXAMPLE: Ralph . nd Norton, both ch iropracto rs. dodd.

thoy want [0 jo in th.i, pranic.s. Thry form.n LLC [a.d
lik•• p.rtnersh ip. ·Ih.y .a,h own a 50% in ter.st in the LLC
. nd equ.lly sharr .11partnership profirs a nd lo,""s. l hey each
com ' iburr S 10,000 to [h. LLC. Tho LLC .1"" oruainrd a 550.000
ba nk lo a" to co~r i15 firs[-)"" op.rating np.n .... Ralph and
Norton each have a 535,000 basis in th e LtC ($10,000 Clsh
co""ibutiort + 50% of ,h. $50.000 loan _ $35.000). lit. LLC
lo..s $50,000 ,h. first y.... Ralph .nd Norton may .ach deduct
$25,000 of th. loss on th.ir personJ I f.tu rnS. 'Ihis lcav.s th.m
e.eh wit h. $10 ,000 b•• is. If the LLC 10$<s $50,000 the ne' t
y.ar. they willo.ch. b•• bl. [0 deduct on ly $10.000 of ,ho los<,
and will end up wi,h. uro basis.

S Corporation Tax Treatment

S ,orpOfJtion shar.hold.rs (or own.rs of LLG. LLPs, Of p'''' n.rships
,",ed that w'Y) may .1"" deduct thei' $hare of b"$iness lossrs fro m thei r
po rso!t . 1 i!tcom .. , How.v.,. unlikr ow"rrs of p. " no rsh ip taX .",i[i..,
 CHAPTU, I CfiOOC[ Of !l1SINEIIE HTITY I S1

S corporot ions shar~holders may nOI odd S corporal ion Ii.b il i, ies to
Iheir basis. Th e only Ii.bil iti .. thaI m.y b~ .dded 10' n S corpon>lioll
sharehold.r. basis arc .hareholder 10.". that the .h. ",holder maKe. to
{he corpowien. Thu>, if Ro lph and Nono n from t he above nampl.
h.d formed an S corporal ion , Ih.y ~.ch wo uld ha,-e only . $JO,OOO
"ar{i ng b"is and could deduct only {hat amount of {heir fi", )'ear
loss. As. r.sult, p.nn. "h ip ,ax trr.{m. n{ has a big advantagr o..er
S corporat ion ta trea'menl wh~n it cOmes to dMLlCli ng losses.

C Corporation Tax Treatment

If a C corporation has a loss fOTthe ta. y." , it is {rapp. d in {he
corporation - it st.ys in {he corporation .nd c.n only b. deducted
On Ihe corporado n·s .... trturn. Losses do nOl p, ,,, h rough to ,h.
,hJtehold. ,,' pr rsonal r.turn. as is {h. ca .. wit h pass-through r nt il;".
Thu>, the ,ha T. hold. " don't g .. to deduct {he los"" from th. ir p.rso n.1
incom~ from oth~r <ourc~ .. 1his mahs the C corporatio n form of
laUlioll Ihe worst po"ibl~ for a money-losing busirtCss. However. few
prof. ssion. l. incur loss.., <0 {h i, f.ctOT is u>ually not <0 imponant
when choo'ing {hei, ... treotnlOnt.

Retaining Earnings in Your Business

If yOLl w.nt 10 keep earnings in your busi ness wilhoul payin g person.1
income taX on {hose earn ings. you will not want {o <hoo .. pann."hip
{ax tre.. menc Each Own.r of a pr'Clice ,hat is ,"xed as. p.rtnership
mLlSt pay I. xes On his or her entire share of profitS, even if {he enlity
choos.. 10 reinveSt {he profils in ,he busi ness .. ther ,h~n d istr ibute
{h.m {o , h. OW"",,. This resuit, in phantom income-income )"ou
n" ,., pay lOx On C,'Cn {ho"gh yo" n, ,'cr received it.

EXAMPlE, Mario, r.uiJ, .nd R.lph jointly own. group opto -

metric proc(ice org. n iud as.n LLC . nd (axed li kca par( ne,-
ship . 11,is YCAr, Ih')" had $300.000 in pronts. wh ich [hey share
.qua ll)". l1,.y wo uld lih 10 kerp $100.000 of ,he ir prollts in the
business 10 help purchase new C<!" ipmen, • nd a b" il d ing for their
p"'Clice. lheya re fre. to do (his. bm (hey will st ill.11 be {a'M
SI I TAA DWUCr.::>N' FO~ PROFElIIONAL'

On ,h"ir fu ll , h, rc of , he LLC's $300,000 profi', e..en ,hough i,

i, nO' d istributed '0 ,hem. Thu " ' h")' e, eh h,ye ' 0 P'y 'ox on
S100,000-thoi r ind ividuol sha ... of tho $3 00,000 profi,-ovon
tho ugh they actually r"". ive only $67,000 from t h. ir LLC .nd
l.. ve ,he rcm.ining $100,000 in , he ir LLC ba nk ,eCOUllI,

The sa me th ing h'pp eM to sole proprieto!'$. 'Ih"y poy tax On all , heir
bu.i ness profi,s, even ,hoSt: ,h"y leave in ,heir bu,iness.
C corporat ion ,ax " ..,mem is the on ly form of taxation , hat al low,
bu,i ne", owners to .. ta in . am i ngs in ,h. bu.iness without h.ving to
p.y person,l income taxes On , hem. 'Ih is al lows you to spli' the income
)'o ur busine ss .. ,," wi,h your corporat ion, Unfort unat<iy, income
spl;u ing i, nO{ nearly as advant ageous fo, professio nals as i, i, for most
other busine •• Ow ners, 'Ih is is bec.use a prof" •• ional corpo", ion , .. ed
;1.$ l C corpo~.uion u,,,.lly qual ifi"s 0$ " personol St:rvice corpOM ion

, h., must pay a fta, 35% income tax o n all its incom •. This is .qual
ro ,he rop income , ax raIC fo r ind ividu.I ,. (Of COUlSt: . , hi , rule also
.ppl"'. to LLCs, LLI's, ond p.rtnersh ips,h " chooSt: to be ,.xed •• C
corpor., ion,.)

Tax Savings Thro ugh Income Split ting

It is sril l possible '0 ,.ve sOme money th rough incom" spli" ing bee""St:
you don', h. veto pay Soci.1 Securi,y .nd Med ic, .. lOX'" On profitS
you .. tai n in 0 C corporJtion . The", con.; 't of a 12.4% Social Security
tax on •• Iari.. paid ro employ.." includ in g yourself, up to an annua l
ceiling 'mO "n ' ($106 ,800 in 2009), . nd. 2.9% Medic .... tax on.1l
. mployee income. Whether you' ll ,"v~ money, and how much. depends
on your personal incom. !Ox bracket. If you are ; n one of the lOp two
individual". br,ck",s 0 5% or 33%), yOll h,,·e. combined 37.9% tax
rate On you r employee compe ns.:nion (35% income tax + 2.9% Medic ...
tax _ 37.9% combined tax). If you hep money in you r corporation
in"..d of taking it out as .mploy.. componsa tion , ,he co rporation wil l
JUSt hov" '0 poy. 35% corporarc income ta, SO you save 2.9% in 'oxes.
Bu!, if your top brach, i, 33%. ~'ou'li saw on ly 0.9%.
 CH."TER, I Cf1OlC t O f !l1SrN£lSENTlTY I ~9

EXAMPLE: Se"y, a singk dOClOr, Owns a nd opera,,, On incor_

po!':ned mNk.1 prac,ke ,axed as a C corporation. In One ye.r.
{he corpor:uion pays Seny. 5350,000 salary, whic h pl.c<, h<r
in {he top 35% income (ax bracket. Afm paying a ll its ann ual
" pen''S, Be"y's corpora! ion is lef, wi! h a n<l profi' of $ 100,000.
R. t h.. [han p.y h.... lf [he $100.000.,. n emp loyee bo nu"
Betty decides to Ie.,.. th e money in h<r ""' poration . nd use i{ for
fU' Ll re e'pansion, The corpo!':"ion PO)" 35% corpo,"" income
lOx On the .. reui ned e.,n ing<. Had Bwl' u ken ,h e $10 0,000 a,
, bonu" she would have had to pay ' 35% persona l inco me ta,
On i" pi", she and her corpomion would h~vt had {O split {he
2.9'% Medicare tax , Not having '0 pay ,he M.d icare!a ,"w d
$2.900 (2.9% x SIOO,OOO _ $2.900).

i'tofC$$ionol corpor:>!ion, in the fid ds of h" l,h . law, aecou n'i ng,
archil<c{uI<. or consuhing may keep up [0 $150,000 of their C corpo-
ration earn in gs in {hei r COIpOra{e bank .ccount wi{hom penalty, Pro-
fessionol, who don't p~4Ct icc in ,hese fidds mol' keep up 10 $250,000 in
a C corpo!,:I[ion . You can u.. [hi, money [0 exp.nd you r procrice, buy
equi pment , or pay you =lf emp loyee benefits, ouch as health in,ur.nee
and pe nsion benefi ts.
If you keep mOre than the $150,000 Of $250,000 lim it, you' ll
become SUbjecI to an ex". 15% tax c. lled [he "accumula,.d .. ",ings
tax ,' This tax is intended to d iscourage you from shelt ..ing too much
of your corporJ{ ion's earn ings. Howe,'Ct, you c.n avoid {he 15% if you
can show Ihe IR S [hat the exc~" occu mul., io ns are held for re.sonably
.t\{;cipa{ed needs of t he business, no, juS! [0 avoid [ax.., In practice,
{h""gh, few sm, ll corporations ncod 10, or "e . bk to, accu m" l.te mOT<
{han {he $1 50,000 or $250,0 00 li m i,.

Personal Holdi ng Company Penalty Ta~

If five or fewer profess iona ls own 50% Or mOre of a C corpor" io n's

s'ock. the corpo~.uion C~n become subject '0 , he perronol hold ing
compa ny {ax. Th is is an ex"a 15% penal, y tax on , he corpor.,ion's
income. Th e tax C3n be imposed if .{ least 60% of {he corpowion's
und ist ribu{ed income fo' {he {ax ye~ r is person.1 hold ing company
60 I TAX DWUCTIONS fO R PROfESSIONALS

income. Th is is income derived from p.ssive 'OLlrees such ~s interest.

ror~ltiC5. di,·idend ••• nd "nrs. Unfortun .tely for p rof.ssion, ls. inco""
from prof.ssion.l .. rvic .. can also b. p.,...,nJi hold ing comp.ny incom •.
A mou nt. rcccived for profcss ional soIVic.. a re pc,..., nal hold ing
comp.ny incom. if:
• t hey Ofe p~id und" . wriuc" or oral contIdCt in which th.
di. nt (rat her th.n thc corporat ion) can d« ign.,c (by nanlC
or de:seription) the p,rricu l.. employer who is to perform t he
.. rvice., .nd
• t he d«ign.,.d employer own. 25% or morc of the co rporat ion's
stock. (IRe § 543(a)(7).}

EXAMPLE, Sally i. the ..,Ie owner of her C corpoIdIion. Her rom-

p.n)' is hi red by Acme, [n c., to perform consult in g serv iccs_The
COn""Ct $p" ifics th~t Sa lly•• nd Solly alone, may perform the
."vices. Al l the incom. Sal ly's company .arns from th. comraCl
i. pe,...,n.1 holdin g company income, If all her corpor.u io n',
pe""'n~1 hold ing comp;ny inco me for the year ~ mOunt$ to 60%
or mo" ofh.r comp.n)" , 101.1 inrome. ,he 15% per..,nal hold-
ing comp. nY!ax will be tr iggered.

M . ny professiona l corpor.tions n,er , the nve-own"'50% own.r,], ip

test .nd , hu, can be subj." 10 ,he person al hold ing comp~ny pen.l ,y if
th ey ~rc nOt "reruL (You ,>n't get arou nd theowncrship teSt by giving
rorpor." ,lOck to mher business .ntiti.. or rdOl iv«.)
F01<un ately. it 's rda,;vdy .a,y to avoid Ii,. prrson,l holding
comp, ny pcn,lty ta>. First, )"OU shoul d make 5u ,. th . t no 'gr«mcnt
you m," e with . n)' d ien( requires th.t t he :service< be pe rformed by .n)'
.",ploy•• of your rorpor~'ion who owns 25% or mo" of t il. romp"'y
.wck. It', al.., .dvi.. ble '0 indude in your d i.m ag"em.m a prov i,ion
th. t your corpo"'tion. not the die nt. h.s t he right to designate the
p. ,...,n who will p..forrn th. servicrs.
If you ort con,idrring incorponuing your pr:lcdce (or changing your
LLc' LLP, or p.rtoCfship to C cor poration la. (,..t lllent), you .hou ld
be carcfulabom .ssign in g your person.1s.. vice cO nn" tS to your new
rorpor.tion , h could, riggrr , h. p. ,...,rt,1 holding rompa ny tox. For-
 C H ~ P TE l> I CHO >C (OfSUS'N(SSWT ,TY I"

,un"ely. the IRS p"m i,. newly incorporOied bLJ.ines$e$ in , his fix to
",'Oid til< tax i<l many c.s" by p.ying OUi. de ficiency di,·idend. How-
ever, Ihe w . por.1 ion wil l 51 ill be sub;,cI 10 imerest .nd olh .. penallY
payme nts. It', wise for any profession.1 who inw. po ..... an existing
puctiee to check wilh, ta profess ion. l lo m.ke ""e the corpoution
will not run afoul of Ihe personal holding COmpJny penalty tax ,

State Taxes
Depe nd ing on wh ere you P"''' icc, SIal< I3X<$ m ighl be ~ n impOtl,nl
f.Clor in your choice of bu.iness en,ily. Some " .... impose h igher (Oxes
on bu,inesse, ,h,n othe ...
All stJI" excep' Nebrasb . nd Somh Dakot a impose corporal<
income based on Ihe .mO"nl of I~x,b l . income •• rned in , h. , .. I. by
Ihe COrpOlOllion _l he rot., V1ry from Sl,,, 10 " .... 50me $lOIel .150
charge fr.nchioe taxes- for .xampl•. C,liforni. ex,ctS • h.f,y S800
minimu m f.a nch ise lax per y., r .fter Ih. fi r$1 y.a r • carpor.lIion i, ; n
b" ,inC5S,
10.10" """ [ax sole propri.lO"h ips. p"n ne"h ip" LLCs. and LLP,
[h. ",m. w'y the 1RS do... The ow ne" p.y tax" 10 [he "al< on [h.i r
persona l r<turns, .nd Ihe enl ily ilse lf docs nO, pay" .lal< tax. a m
some "ot" impost sped,l [axes OIl ~ass-I hrough .",il ies. For ins ,.,,, • .
C"liforni. levies" lOX on LLC, [h., n"ke o,'er $250.000 per y. ..: Ih.
lax range. from .oom 5900 10 $1 1,000. A simi lar tax i. imposed on
California 5 carpor., ions. Ill inois. M.,$;lch",ctt ••• nd l'e nn5ylvJ nia
charge LLG 5200. $500, , nd $360. rt'peClivel),. as ,nnu,l rtpen
fi li ng fe ..,
In addilion. SO me ",te. (inclu d ing Ca l ifom i" Delaware, Ill inois,
"". ss.eh u.."" New H'rIlpshirt. Pennsylvania, ond W),oming) impose
.., , nnual LLC fcc tim is nO! incom.-rtlalCd. 1his m,y be called a
franch;st ,a>. a n an nual regi.trJt ion fee, ora re new, l fe•. In mo.1
""cs, Ihe f« is .bolll 5100; blll Cal ifornia C'"ctS an $800 min imum
funeh ist .ax per y... from LLCs .nd LLP. as well , B.fort formi"g
allY business emi.y, fi lld OUi wha[ IOXcs or f." your ,,.1< eh ..g... Yo u
sho"ld b. able to find Ih i$ al Ih. website of your slali"« .. ,, ry of
" .... dep.nmem of corper" io ns. or dep.rt menl of r,,'en\1e or tax ,
n i T"" OlDUCTION! FOR PRO FE!!IONAl!

IRS A udit Rat es

D~. how you r bllSi neU i. 13 x.d , ffect your ~h, n~.s of being ,,,d iled
by , he IRS? 11.e sl,ort 'n'Wer is, ye.! Th e following chart ,h ow, ,he
maS! recemly reported IRS .ud ;, r:a,., for a ll ' ypes of bus; " .."".

IRS Audit Rates

2007 Audit h tr 2008 Audi' R•• r

Sol. Propei<ton
I ""om~ und., $2S.000 1.l~ 1.2~

I l5.000 to S100,000 ,~ ,~

$ 100.000'0 $100.000 6 .1 ~ ,~

0 .., $~OO.OOO ,~ ) . 14~

P... n~nhip. 0.4" 0.• ""

SCarpa r .. ion. os~ 0.4""

C Co epo"' ;""'
A, ... , u nd ~ r $1S0.000

Il50,000 '0 SI mill ion

0.8~

1.l,.
..
1.4"
~

$ 1 million '0 $S mill ion ,.~ ,~

SS million w S10 mill ion ,~ ) .1"

1his chart ShOWSlh., sole propr ietors h.,·. 3 much gre... , ch. nce
of being audi"d by Ihe IR S th. n businems Opetatffl Ih rough p.ttner.
,hip' or corpora tions. In 200S. 3.S% of sole proprietors earni ng morr
th. n S 100.000 from th. ir bu.in." were aud itod. In contra't, only 0.5%
of S corpor:alions ond 0.8% of C COrpO'" ions with less 1ha n $250,000
ill a,,,,1S were . udi,.d. Thus. sole propr;ewlS earn;"g S 100.000 [0
S200,000 were almo't h"e lime. mo trlikrly 10 b~ aud i[ed [han mo"
corporations! A si mil. r d isp"ily holds "". for pan nc,sh ips.
NOl C"Cn corporation. wilh ~SSt{$ wotth mOre Ihon $10 mill ion were
.uditrd more often [h,n sole propr ictolS. The", "ali"ies undoubtedly
 CHAPTER, I CHOIC£OF 8uSIN£lHN TlTV I 6 )

,die" th~ IR S's belief that $OI~ prop,ierO!1i habitually underreport th~ir
in(om~. IOke dedllct ion' to wh ich 'hq ..~ not en,it led. or other wi~
ch~", on their {a .... Also, the IRS beli~v~s sol ~ proprietors hav~
greator opportu nity to ch.at on {a~ ... t ur n, b. c:m ", th~y a ... of{~n ",I f-
pr<pared. In (ont roSl, to. r~turns for COrponltion" p.. tne!1ihip.. and
LLC. orr usua lly p.. p..~d by {ax profe.. ionals who know {hey can b~
pu nish~d by t h~ IRS if 'hq pr~ par~ a fal .. ... t urn.
1h~ IRS promises that ~ud itS for corpor.t ions .nd partn~"h ip$ wiJl
inc,.,,, in th~ n~x' few )'e .... Nevert heless. ~ud it r.,,, for aJl t rp~s
of busine.".. a rr re la{ively low; so {h i. facror .Ion~ probably shouldn '{
,Iic,ate yOll' choice of business ~n{ily.

Should You Change Your Business

Entity or Tax Treatment?
Neilh. r your ohoic. of bu.in~" .nti{y und., . t. t. l.w, no r th o {a>
(rcat m~nl fo r )'Ollr business u nder f~donll ta~ 1.w, is engr,,,.. d in $ton~_
You e,n ,Iw,)" swi.eh .0 ,TlO1h" forn, of ,a "e."n~m . another
busin~ss em i,y form. or both. Ind~d. m,ny professionals ".rt 011' as
sol~ propr i~tors a nd {ho n sw itch to 0 co rpor:U ion. LtC, Or LLl' when
{hey {, ke On partn~'s and want limited liabi li,y_
Wh.,h~r )'OU shou ld mak~. change dep~nds on wi,.. your go.l.
are a nd what type of .n{ity and {ax !reJ{m~nt YOIl na ... now. Th.",
is nO busin ess ~ntity Or form of {ax tr~atment {hat is right fo r .v~ ry
profession . !.
The foJlowing eh . " can help you decide if you .hould conVert !O'
di ff.,. n{ entity, Or .imply ch, nge you r tax {reatn lent (wh ich is ."i. r to
do), For exa nlpk, if you wa nt li m ited li,bility, {h~ chart shows {hat you
muS! h"", a C or S eorponl , iotl or an LLC or LLP (wi.h ' ''y type of
{ax tr. a{m. nt}, If you want to combine your lim i{. d liability wit h lower
Social S~cu rity a nd Medic:He {n"" you c.n choose an S corpOr.ltion ,
or " , LLC or LLP with S corpo"uion !a' ,reatmen1. lf, i "S!~.d.you
w.m li mi .. d liability . nd maimunl deduCl ions for fringe benefi.s,
you' II wo nt a C corporation , o r an LLC or LLP with C corpor,,{ion
.. ~ t re.{ ment. Hut nO on{i{y will give you limited !i.bil i{y, lower Social
Security .tld Med iCHe taxe ... nd ma imun, dMuc,;ons for benefilS,
.. I TAX OEOlX:T K)NS l O R PROIESSK)NAL S

Choicr of Business Entity Drcision Matrix

~-.
M.. i",um Social
~- S«uri.y R..... Rod", •

""".... """.... '"

tion.1o< •M 0«1"« .."ni.I' Si",pl;';i.y
Limi.od

,
liability
frin~
~.

, .....Mod;'; ...
~
;.

, ,
.udi, .M
,hane .. ~,-
C <O'l'O .. tion

S <o'l'O"'tion , ,
Multiown<r
LLC.,..LLPw i'h
, ,
,....,......
p.. ,n • .wp ...

L.C.,.. llP wrth

C <O'l'O .. tion
'a ...... m..,'
LlC.,.. LLP wrth
S <0'l'O"tion
' ' ' ' ... 'm..,'
P...."_ip
with

,.........,
P''''_pwe

Pa,,_ip
with C C<KJI'O'1'-
,;.,., we ......-
-,
P."n_ip
with S COfpora-
'""'we ......
-,
~
p"'fl~_ip

O"~ · _n<r ,
LL( with ..,1.
p"'pri ...,.. ... ip
"x ","m • • '
 CHAPTER, I CHOIC£OF 8uSIN£lHNTlTY I 6~

The Cost of Converting to Another Business Form

As a gene,.! rul. , uninco rporated professio n.ls wil l h,ve lint.!3x cos{ in
cOIlven ing to • <o1~ ptopri~torship, p." " ..ship, LLC, or LLP. How~v~r,
{h..~ c." b. rxc'ption" 11m.. b.for~ doing ,uch a com.. rsion, you
should con,u l{. {'x prof.ssion, 1.
Conv.ning to . corpor.,ion c.n b~ {ax fu. if IRS rul... rr follow, d.
(S~. IRC § 351,) How,v." ill sor,,, casts, rh..~ c.n b, str iou, ,.x

constquenc"" pan icubrly fOf profess ion,l, who," OI ,; n bmin= asso{

i, {h.i f accou n{, fec.i",bt.. T "X wi ll bo duo if {h. bmin.ss liabil i{ies
Ir.osf..., d 10 (0' .ssu",.d by) d" co'po,"tion ~%c~,d 11.. own.., , a
bas is in th. tran,f. ... d bu,iness a=t,.

EXAMPLE, Fdix i,. ",I. proprir tor ",chi"C! who d.cid" 10

incorpora{. hi s prau",., By rOf his larg. s{ busi noss . ss<{ is his
p,"ctice', account. Tec. i",ble- {h. money owed to him by his
cli'nos-wh ich '0I0lln" '0 $100,000, How"'''' u nd" 'tondord
.... rul~,. h~ hlS a 2' <0 basi' in .uch accou nts rrc,iv.bl~. Hi,
only oth.. busi n. ...ss<{ is $10 ,000 in clSh , H. tran,f.rs t h.
uceiv~ bl,s ~ n d c~ sh '0,I., corpor~' ion along with $100.000 in
liabiliti.., 11" ' mO Un' of ,ransf""d li abili,i.. ~xc ..ds ,h~ basi,
in his bu,in. ss . ss<{S by 590,000, Fd ix will h.v. {o pay {ax on
{h. $90,000 .xco..,

This ,<suit ca n b. avoid. d wi, h car.ful plann ing. For .xampl• . Frl ix
(from (hc , bove exa mpk) could rc{ain h is aCCOu ntS recciv.bk ~nd
pay p'f'SOnal incom' t~x On th,", as they ore paid. O r, h. co"ld kn d
mon.y TO his Hch i«cm r< pra n i", prior {o incorporat ion", thaI 110.
ba,is in the tran, r. ... d a... t, nc •• ds {h. amount of liabi]i{ir., Thus,
it '$ css'nt ial {hat your t~ x advis", 3pp rov' yo"r incorporatio n plan$
befo.. you file .rt icle, of incorporot ion to COnvert an existing sok
propri.{orsh ip, paI!n~fShip. LLc' or LLP {o a co'poraI ion .
'lhcrc are often signi fic.n{ t. x com if yOll want to COnvert out of,
C corponu ion.l nde,d, if yOIl al"ody hove 3 C corpomion, you m~y be
stuck wi,h iI, To conv. " a cofpor., ion 10 a sol. proprirtorship, LLC,
66 I TAX DEOUCTONS fO R PROf[ISONA'S

LLl', or partnersh ip, it muSt be dissoh'ed and its .»,uliquid.ted. Both

the C corporat ion . nd its shueholders m.y end up OWhlg ,ubstanti. 1
t.us when t ho corpowion is d issoh.. d. For exa mpl. , Ih. corporation
may ow. ta.es if it own •• ss. t. t hat appreciat .d over its nist. n«, such
... ,,~I propert y. Th e sh."holders may . Iso have to p. y income tax if
Ih •• moum or cash value of th. proP' '' y they re«iv< on liquidation
n«eds Ih. ir ind ividual basi> in thei r sh..."
Dissolution isn't ne«!s.r)' wh.n a C corporntion is com,.rted to . n
S corporntion. But th." could still b. substanti al tax probl.ms-f"
. .. mple, coll. ction of accoum, ree. ivd bl . could b. ,ubjret to dou ble
ta.. t ion.ln addit ion, ,he S corpor.tion may have to pay U, On "b"ilt-
in gains if it sells ~s,," wi,hin ten ye~rs .ft" clre'i ng S ,ta'us. Built_in
gain, ar< t ho amoum Ihat Ih. f. ir market n lu. of the corporation's
us. t, nee.d. d th. ir tax basi> wh.n th. S ekct ion w", mad • .

EXAMPLE, J.ck and J~n., bot h chiropractors. organ ized th.ir

practice ~s" C corpor>! ion in 1997, In 2009. they had their
corporat ion dcct S St. t us. The cor po~.tion owned a smal l office
build itlg. Th. building's b.sis was $200.000, bm its f.ir math,
valu. J[ Ih. t im. th.y cI." . d S stams was 5300.000. If the
buildi ng i, sold 3nyt im. wit hin 10 years of decting S mUll, , he
corporat ion wijj h.ve to p.y ~ ' prei.1 35% corpO~Jt. b .. 1t.. On
its $100,000 buil,-in gain . Assum. the build ing is sold in 2012
fo r $400.000, 'lh" corpo"tio n must pay" 535,000 tax on the
bu il t_i n gai n, Jock .nd Jill wi ll then h,,'c to poy person31 income
In on , h... ",ain ittg $165,000 of ,h. $200.000 gain on the sal •.

Ag. in. co nsult . tax profcssiona l before com.. " i ng a corpor.l!ion,

@ RESOURCE
Rd~. to HC or (orpo",tio"!, by Anthony M~ncu", (Nolo). for a
good o""" iew of the tax .nd Other consequence, of con_ting to • diff....,'
b<o~ne" ent ity.
 CHA'TER, I CHOICE OF BuSINESHNTITY I 61

Changing Your Tax Treatment

As d is,u~d .bo,'., i( 's poss ible to ,h.ng. (h. w.y your business is
rr ••"d for (OX purpo.., without changi ng your bu,i" .... form, 1h i, can
b. much d,.,p" and • .,i.. ,h"" con\'~ning [0 .nOlh~r busin~" ~"'i(y,

LLCs, Partllerships, LLPs

I'~ r(nersh ips,mult iowner LLC" ~nd LLPs ~mom.ticJlly reee i,'e p~"ner_
ship [ax rrea[me", wh~n thry aIr Cf~J[ed. How..... r, [h<y can ch.ng~ 10
S Or C CorpOr.lt ion (ax (.... (m~nt, LLCs with only On. Ow n.. r..:eiv.
sok propr ietorship tax (r~a(men ( when they ar< crea(ed, 'Ihey c. n .Iso
switch 10 S or C corporot ion rr~",met\[, You do [hi, by mak ing an
~kction 10 r~c.iw corpora,iotl taX IIra"\I~n! wi[h (hrIRS .

,\\ OS( om inesscs don '( m, ke th is elcction OCc.usc mOS! LLCs, L LPs,
" "d p. n " ..sh ips w.u[ 10 b. uxrd lik. p"",rrsh ip' (or sol. propri"or-
ship. in (h~ c . .. of o".-own~r LLCs), How.", r, you miglll ,hoo.. 10
b~ (.x.d.s.n S <oq>orat ion if you w. n( !O S.W~ On .mploym.ntt ...s,
Or, you might w.ntlO b~ (,xN like. C corporat ion b..:.uS( you wan!
max imum d.duclioll< for fri"g~ b."dilS,
If you W'n! 10 m.k. an drclion [0 chatlg< your tAX rr~J1m~m, you
si mp ly chcck the ,ppropri, (c box On IRS Form 88.32, Enlif] Cwssifica-
lion El"lion, ,nd li lr i[ wi[h [h~ IRS. lh~ d..:t io n c." b~ m,d. a[ all)'
[imr, O"c~ you filr [h~ form, your LLC , LLP, or p.n". rsh ip will br
mat.d .xactly lih , C corpor.nion by t h. IRS (mo't S(at •• also r~<og­
ni,c t he eI..:tion fo r It,(e tax purposcs), You'll h,,'e to fi le corpor'(t ( n
r~lUrns .. nd will have. 1I III< b."rfilS .nd burd,,1S ofC corpo .. lio n ,,.
rr""t m. ", drscrib~d abov • . If you wan! your LLC, LLP, or pan"e"h ip
to be (... d like.n S corporation , you may do SO by fi ling , n S co rpora-
[ion dec,ion ,,' ill, [h. IRS , IRS Forn t 2553, SUI you mUSl mr" . lIlh~
conditions for S corporat ion .,,[US [0 br Ir• • ,.d" on. ("'. "S Corpo",-
(ion TJ XJt ion" under "The Four Ways Bus iness En( iti.s A ... Tax.d:
~ bov<),
Your bu.ine" will still b~.n LLC, LLP, or p.rtn. rsltip for all od,.r
no ntax purpo",., Thu" fO T example, a pJTtn.,sh ip will not provide
lim i(.d liabil i(y to its OwnerS .v. n if it', (ax.d lik. a co rporotion by
II,. IRS .
6. I TAX DWUCTIONS FO R PROFESSIONALS

EXAMPLE: Tony ond Mitch. ~th Mich igan orthodontists. co·

O"'n On LLC ,axed like a partnersh ip. They ~t h decide they
want to take adn ntage of ,he tax·f. .. fringe benefi ts available
to C w rporations. The re are two ways they can do ,h is: (1) they
COn dissolve their LLC and form a new corporOlion in Michigan;
or (2) [hey can simply Ii!. an d.ction with th. IRS to hay. thrir
LLC tax. d like a C corporat ion. Th.y d .. id. to do it tll • •• sy
way and file ,hr dret ion. As far [he IRS is w ncerned. [he Tony
and Mi[ch LLC is nOw' C corporation. It i. ascparate [upaying
. ntity and must file i"own ~orporatr tax returns. Tony a nd
MitCh are now employee. of .he ir pr:letke for tox purpose •. 'Ihry
m11St have income and employment taxes withhdd from ,heir
pay and [hey will be qualified to recrivt tax·fre •• mploy.. fr inge
b. n. Ii".

ff1 CAUTION
\l.J elect ing . MW t.x trutrn~nt huthe <.Orne t.oxcon .. q u~n<esu
<on .. "inl to • different '~pe of buoin ... e n t it~. f o, .. amfd ... > part~'''' ip.
UP. Or muk;.,,,,,,,,", llC [hal ......,,, corpor;,,;"n [ax [,..,a",,~n[i. detom<'<l '0
ha .... l;quidat<'<l lor tax PU'PO"" a nd cont'ibut<'<l . 11 its • ...-t•• nd liobi lit;". to
the c"'poratio n in ..change for >lock. (tRS Reg. lOU701.3(g)(1)(i}) Thi. can
ha.... conI)' tax C<>o""lu~r>t~ ., d....: rib<'d .bove. Th~ moral: s.. ... ,.., to con.uk
wit h )IOt.lrta, advi"" beforc making on elK,,,,n to h",~ )'DU' LLC. LLP. Of
pa,t~"" i p .. , <'<I lik •• corpofation.

If it turn, OUI you don't lik. YOUT corporalion tax "raIm.nt, you
can chango bock to partn e"hip tax tttatmont by making anorh ..
election; bu., you m"st ordinarily wait five )'"'' to do $0. (T".!. Rog.
301.7701·3(c)(l)(iv).) MortD\'cr, electing 10 chango back '0 p'!1nmhip
tax tr.at mrm could romlt in added tax .. btcau .. it will b. trra,.d as
o cOn$tr"" ive corporareliqu id~l ion for fed ..al income t~x purpose<
and so Can beuxablo 10 both tho liquidaringcorpol':nion .nd ilS
,h.rthold.". Ag.in, co nm lt a tax .dv;str befm. making a chang• .
 CHAPTER , I CHOIC [ Of8 u SIN(I!(NTlTY 1 69

Corporat ions
Coq>or .. ions . Iso h. v. , h• • bil i,y '0 ch ong. how , h.y .rr , ...d. All
corpora' ions JUlo 01a,ic. lly rr,. iv. C corpora!ion 'ax t «.tOl.nt wh.n
,hc y ,rc 'reatcd. BUI , C corpo,",ion thai O1Cets t!,e r. qu irC01entS
Ill ' )' choo.., S corpo..,ion"'[U' by fili ng," d~,ion wi,h , h. IRS os
describ. d above . It', also pos.si ble for.n S cOfpora! ion to revoke it'
S cor poration $tatuS . nd rctum to C co rporat ion tox n .,tm. n!.

Automatic Conversion of Your Business Entity

In '001' C~"$, yO Ll r bll$incs.s will ol1!omOl ically COm" " '0 On' of th.
two d.f,uh . nt it i~" th~ sol. propri.to"h ip or pan nr" hip. This can
h app~ n without you .v.n k now ing it. For <X l mpl., if a sol . prop fi. to r
$1""$ '0 proelice wi, h One or more Ot her professlon,ls inste.d of On his

OWn, he will ' lllOmalic. lly become a p.. ,n., in. p~ " n.,sh ip unl.ss , he
pa Tl n~ .. . Iret to form 0 corporat io n, LLc' Of LLP. Th . n. w partn . " h ip
will autom1!i,a lly receive part nersh ip tax treltment.
Similarly, if . p,n ne"h ip, LLC, LLP, or corpora, ion brc. k$ up .nd
all tn. fo rmer own . .. sta rt to practic. on ,h~i r own, th.y will ~ach
autom at ically b~com . sol. pIO p ri~ IOrs a nd «c. iv~ sol . propri.tor t.x
tfeatm<n,.
If you don't wan! w b~ a sol. pwpri.wr or paTl nr! in a pann~"h ip ,
you n~.d to tak~ . .. p.to form anoth ., . mity. I d~a llr, you shou ld do
th is before an ou,omat Lc convers ion 0<,,, rs.

•
 C HAPTER

Operating Expenses

Rrqu irrmrn • • for Drdu~.ing O p r r~ . i ng Ex prn.r • ._""_"_"_" __ "_"_" ____72

Ordin.r~ and Necessary. ________________________________ .n

Cur~n{ EXp"n~ 74
Bu.ine... ReI.ted ___________________________________________________________ 7S
Reason.ble __ .___ .__ .__ ._. __ .__ .__ .__ .___ .__ ._. __ .__ .____ .__ .___ .__ ._. __ .__ .__ ._. __ .____ . n

Operatinghp enses That Are Not Deduc{;ble _________________ 77

Tax Reporting.". __ "__ ."_"_"_". __ ." ___ ."_"_"_". __ "_" __ "_"_" __ .__ "_"_" __ "_.78
" I TAA DWUCTIONS FO R PROFESSIONALS

his choptcr CO>'1'$ ,hc ba'ic rules for dcduCting bu,iMSS

T opcr,t ing .. pensr<---the brtld·, nd-buu .. cxpcnsrs virtu, ll y

..ery professional incu l'$ for th in gs like rem, suppli" , .nd
",lari.. , If you don', ma inta in an in" entory or buy expensi.. equ ip-
ment, theSt day.to_doy COSt, will prob.bly bc your l,rgest c",cgory of
businr.. upe"",. (and your largest sourc. of deductions).

Requirements for Deducting Operating Expenses

Th.re .re so many d iff... nt k ind. of bu,i "e.. op..ating exp.n.." thot
the , .. code couldn't pouibly list them " II, In".,d , if you w"nt to
deduct. n item 3$ a ousi neu operating expense, )'0" m"St m.ke $" . . the
expendit ure m.e" erru in req uirem.nts. If it does, it will qu.lify os.
deduCIible bu,iness operating expense. To qua lify. the "p.nSt must be:
• ord i n~'}'3nd nec,,,,,,y
• a " " rent "penSt
• directly rel.,.d [Q )'our bu,in..... nd
• .."""n.ble in .mOunt. (IRe § 162.)

Your Pra cti ce Must Have Begun

You mu" be<a"ying on > bu.in .... [Q havededuct i b"o~tit'S

e ' l"'n",._ eom )'OU ir.cur before )'Our practice i. up and running ~'" not
cu"..,tly d.-duc,ibJoo ol"',a'ing ~xl"'n"", ~ ... n il 'My;1(~ o,dinary'oo
_~""Y_ Howeve,. up [0 %.000 in "Of'-Up ex~ .... "",y be deduc,ed
tf>e fi,,, ye~' )'Ou're in bu.ine ss, with the ,e"",inde, deducted over the
ne," 15 Y".n, <s.", (Mpt"r 10/0, 3 d isc"""'n 01 "3rt-up ""1'''[11''<,)

Ordinary and Ne<:essary

Th. Ii", requirem.nt i. <1,., the .xp.n", mUst be ordin ary .nd
n«."",y. lhi. mean< that the co<l i. common .nd ' helpfu l3nd
'pp'opri.te" for you r business (W,kI; v. Hr/<'!,ing, 290 U.S. 111 (1933)),
Th •• xp.n", does,,', ),,,.. 10 be ind i'pe n",ble ' 0 be necessa,y' i, need
 CHAPTER J I OPERAT ING EXPE NSES I 1J

only help yOLl r business in SOme way-even ifi" s minor. A one·,i n'"
e~ p "nd i1U rr can be ord inary and necessary.

EXAMPLE: Con nie. a den' is' . buys ~ tel"vision S"t and instolls
it in h", d"n,.1 office wai,ing roOm"" pl1 ients Can watch TV
wh il. w.it in g for th. ir appoi ntme nts. Although having a TV set
in her w~ i'i n g rOOm is nOt ~ n indisp"ns.Ok item fo' Conn ie's
dental business. it is helpful; SOm" patients might chooSt Conni"
in'te.d of anoth", demiSI bre au,. they C>n wa{ch T V whil. [hey
wait . Therefore, {he TV is an ord inary and n.ce,.. rr "pen,. for
Con nie's d" nt al praCTic• .

h', usua lly fairly easy to fig"" out wh",h", an .. pen .. p'"''
th" ord inory and n"',,$$3 ry teSt. Som" of ,he mOSI cOmmOn types of
operating expense, include:
• rent for . n outsid. office
• employ"" sabries .nd benefits
• equ ipm"nt rental
• leg.1 and .ccou", ing fe.,
• car and {ruck np' ''se,
• {,"v"l "xp"nses
• ",e.l and e",.".in ",.", expense,
• suppli., and ",.",ria l,
• puhlic.{ions
• sll bscrip,ions
• repa ir and ",.i",.n.ncr exp.n",s
• busi ness t .. es
• in,erest On Ollsin"ssloans
• liern..,
• banking fe.,
• .dvcrtising cOSts
• hom" office upenses
• business·rrl.",d . duc ", ion .~pen ..s
• post'g<
• profenion. l .ssociltion dllcs
• business liabilir y . nd prop.rty i"iIl,""cc
" I TAX O£DUCTKl ~\ FOR PROH\SKl ~ "lS

• h.. lt h insuronce for employees

• oflice utilities. a nd
• wftware used for busin.ss,
C enerally. the IRS won't second-gue" yom da im that a n ."pense
i, ordinary and necess"y, unless the il<m or ..,vice de . ,ly ha, nO
leg itima .. busin. ss purpose.

EXAMPLE: An in'Il '.ne< .gent claimed a business deduct ion fo'

p.rt of h is handgun collect ion because h. had to go Ie "unsafe
job sit.." to settl. in.uranc. daim •• and t her. w",.n unsolved
murder in h is neighborhood. The t ~ x cOlt n d iSl ilow«] the
deduClion nplaining. "A handgun simply does not qu.lify as an
ord inary and necessary bus ine" expe nse for an in.u tanee agent.
even , bold lnd brave Wym E3rp lype wilh l faSt draw who is
willing to ' isk injury 0' death in the service of h is dients:' (So",p
v. Com",·r. T.C. Memo 1981 ·1986.)

Current Expense
Only CUrren' expense, ore deduct ible :IS business 0P"ot ing "pen"s,
Cu".", expenses Oct for il<II1' thot will b.nent you, proctice for Ie"
lh. n one year. These .re the costs of keeping you r busi ne" goi ng on
o day-to-day ba,i" including money you spend On items 0' serv i.e"
,hot ger used up, wear Out. 0' beeome obsolete in Ie" ,h.n One Y''''
A good ex.mple of a current expense is your practi,<, monthly phone
bill, wh ich be nefi" your bu,iness for one mo nth. In co nt raSt, buying
o ,elephone for yOll ' pract ice wou ld be. capi,.1 expense (not 0 current
expense) bee.ll.. the phone will beneli, you, business for more th.n
one ye ar. Other commo n capital oxpen... include caTS. bus ine" equip-
ment, comp ute,s, ond ,,~leSt . te.
Cllrrent '~pen ..s a re curren tly d edu~, ible-.hO! i,. they ore fu ll )'
deductible in the )'ear in which you incur tn. m. Becau.. a ll busine"
operat ing e' pense, .... ~mrem expenses, they.re alw. 1I cu rre ntly
ded!!c, ible. How".. ,. the ,"nu.1 deduction, for SOme op.roting
oxp. ns", (notably home ofFic..) are lim ited to the amoum of prollts
 CH..,TERl
• l OP( R AT I NG(XP( ~I (I I 'S

you corn fro m t he business in that year. (Sec C hapter 7 for mOre On the
home office ded uClion.) hems )'ou buy for your practice th . t I.., for
mo re t ha n one year (cap ital expense items) must b. d' prec iat.d ove r
several y..... Of d. duct. d in one Y"1f u nder S.ction 179. (S.. Chapt.. 9
for mOre on dedue,ing long-term =IS.)

Business-Related
An n pense must be directly relared '0 your pr>c,ic. [Q be d.d ucrible
as. b"si ness operati ng ex pense. This means th.t you C.nnOt deduct
personal expenses. Fot ua mple, t he COS t of l personal co mp"t,r is l
deducrible ope rar ing n pe",. only if you use ,he compUler for business
pu rpose s; iT is nm d.ducr ible if you uSC i[ to p.y p.rson.1 bills or play
computeT games. If yo" buy sometll ing for both personal. nd busi ness
use, yo" C~ n ded UCT only the b"si ness pottion of the expe nse. For
example. if you buy. cellular phone and use i[ h. lf of ,he [i n1< for
business c.lls • nd half of t h. Iime for person. I c. ll s, yo" can deduct
only half of the COSt of the phone.s a business expe nse.
Many np.nses h. ve borh a pe rsonal . nd business compon.llI .
which c.n n,.k. it difficulr [Q ,ell if.n expensc is busi ness-rela,.d .
Bee""se of this, the business-related '«Iu irement is usually the mOSt
eh . llenging f. e,or in de"rn,; ni"g whet her an npensc quali fies .. a
deducribl. busin.ss oper>t ing np.nse .
Even the moSt St ra ightfo rw,Hd coSts ca n prosent difficult ies. For
enmple, it's usu" ll y eosy to tell whether post.ge is • personal Ot business
expense, If you n"it sonwh ing for your prae,ice. i,·,. business expe"se,
if you mail son,«hing un rel~ted [Q you r busi " .... i,', a person al upe"se.
But ovon nOTe, t here Cln be questions. f.or examp le. shou ld. doctof be
allowed '0 dedu c, ,he pOSlage for ro<le.rd, he se"ds 10 h is p.,iem,
while he is on ""cadon in Europe? (Yes- , h. ,ax COUrt said [he po<l'ge
was ded uct ibl. as. n advertisin g expense; Duncan v, Comm'" 30 T.c.
Memo 386 (195S),)
The IRS h", created rules and regul., ions for some of ,he more
eommon operAting "p.ns" ,h at of,.n invo!>·e . diffie ulr crossover
of person.1 "nd bus iness. Some of tn.se rules help by laying om
guidelines for when . n expense is a nd isn', deductible. O , he .. impose
" I TAX OEDUCTK:>NI FOR PROH"K:>N", '

rtcord_k«cping .nd Oth.. rcqu irt n"nts to p .. vent ob",es by dishonest

t.xplyers. Most of the comple xity in determin ing whether. n expense
i, d. ductible as a bu. ine... op.rat ing n pc",e involves undem. nd ing
.nd app lying t he .. sp .cial rules and regu lations.
The expe".., th .. p.... nt the mOSt COmmOn problems (.nd ...
mbject to the rna", rom p"h.n,ivr IRS rules . nd tegul at ion,) indude:
• home office r. pcn ... (..e Chaptct 7)
• me,l, . nd entertainment (see Ch'pter 4)
• tr,,·cI (see Ch'pters 5 ond 6)
• car and truck npense. (sec Choptcr 5)
• business g iftS (see Chopter 14)
• bod debts (..., Ch'pter 14)
• emp loye. benefit, (se. Chapter 12)
• interest payme nts (sec Chapter 14)
• hea lt h in'Llr.nee (see Ch.pt .. II)
• CUU llty losses (..., Chopter 14)
• taxes (..e Chop,er 141, and
• edLl"t ion expenses (see Ch'pter 14).
Through the.. rut ... nd .. guilt ions. the IR S provides gu id. nce On
Ihe follow ing t)·pe, of questions:
• If you rent an apartment and usc p.rt of one room as a busin....
°
office, ,hould )·ou be .1I0wed to deduct 011 or ronion of the
rent os. busine" openlting expense? How much of the roOm has
to be u.ed as a n offic. (a nd for wh at period of time) for it to be
co n,idered used for busi ness "'th .. ,ha n personal purpose" (5..
Ch'pter 7 for inform.. ion On the home office deduction.)
• Ca n you deducI Ihe monq you 'pe nd on a nice ,uit to wear to
YOut officr ? (Se. Chapte' 14 for information about deducti ng
business d oth ing.)
• C. " yOLl dedLlCt the COSt of driving from home to you r office?
(See Chap,er 5 for ru l... bom deducti ng commu, ing expens ... )
• Can you deduct the cOSt of • lunch wit h. former dien t'
Docs it m'"'' whether yon oCI\'ol ly t.lk .bout bu,i ness ot t he
lunch? (See Chap«r 4 for ru les about deduc' ing meal, and
entertainment.)
 CHA,n.) I QptRAT ING [)(P(NS(S I 11

Reasonable
Subje<:t to SOme impo rt3 nt exceptions, there is nO lim it on how much
you ca" deducI, .. Io"g a. Ihe arnOUn ' i. relson,ble .nd )'OU do,,'t
dffluct more than you 'pend . A, a ru le of thumb, an expe.,.e i. rr>son -
able unle" there 3re mo re «onomical3nd pract ical way. to achieve t he
same r« ult. If I he IR S find. th .. , lOU r deducI ion' were unrea,onably
la'g• . it will d is. llow Ihem or., Ie." dis. llow the pordon i[ find,
unrr,son .ble .
Whether , deduction i, reasonabl. depe nds on the cin;u nW3nCd,
but certain arr as are hOI buttons for [h. IRS-esp.d,lIy cor, ente"ain-
me nt, tra"d, .nd meale.pe n, ... There a re >!t ict ru l., requiri ng you to
fulll document these deduct ion,. (Se. Chapt.,., 4. 5, .nd 6 for nlO .. on
car, " "wi, a nd meal and .rne"ainmenl expense,.) Th e reHonablene"
issue . Iso com.. up when " busi"... p.y...ce .. ive .. IHies [0 emplo),,,,
to Obtoin , large tax deduction. For example, a professional might hire
hi, 12-y.ar-old son to ,n,w., phones ,nd pay him 550 3n hour-
d .. rly all exce.,;", w.ge for ,his type of work.
For som e type, of op..ati ng . xponse., tho 1RS lim its how much you
can doduct. Th= in clude:
• the home ollice deduct ion, which i, lirni!<d [0 [he profil from
yo ur busin.., (although )·ou Cln c, ,,y o,.. r .nd deduC! ""Y excess
. mount in futu re yoa",) (s« Ch'pt.. 7)
• bu,ine" mea l. and .nterta in n,. nt, which.", oo ly 50% deductible
(st e Ch'p«r 4)
• trd'..1 expc",o., wh ich .r.limited d~pond i ng on tho kngt h of
you r trip and tho tim. you 'pcnt on bu,;nc" whi lc 3way (,~e
Chop", 6), ond
• bu,i"e.. gifts, which are sub;.cl 10 , 525 maximum per i"dividual
per yoar (stO Ch.pter 14).

Operating Expenses That Are Not Deductible

Ewn ,hough tnoy m ight b. ordinary and nocr",ry, some typ .. of
ope"'ting upe nses ar. nOt d.duc( ible under 3 nr circu m$(O nee$. 1n
SOme cases, ,h i$ i$ beeaust Cong..n h. s declared th o( i, would be
11 I T"" OEDUCTION5 FOR PRO FE55ION", 5

mor.lly wrong or ot h"wi$c contror)' to 50 und pu blic pol icy to ~llow

peo ple to drdtlct the .. com. In oth.. c~" •. Cong''''' simply dorsn·t
wJnl 10 .llow Ihe deduction , Th.", nond.ducl ibl• .xp.ns", indud.:
• fin., and p.n.lli.. paid 10 Ih . govern",.nl for violalion of any
low-for exomple. lOx penoltirs. porki ng tickrts. or fi neS for
violaling (ily hou,ing cod~s (IRC § 162(f})
• ilkg.1 brib., Of kickbacks to p riv ... part i., or gov.rnm~m
offici.l, (lRC § 161{c))
• lobby ing "pen'" or politicol COnt ribm ion.; how",,,•• busi"e ..
mJY d~ducI up to $2,000 p. t y•• t in <xp.n", to in fiu.n"," local
legislation (s,a,~. counly, or ci,y), nOt includ ing the expen.. of
hiring a profeS5ionoilobbyist (~uch lobbyiSt exp~I\"'1 or. nOt
d. ductibJ.)
• two -third, of .ny damJg"' pJ id fOf violat ion of th. f.d.r.1 .mi-
, r\lSI lows (lRC § t62(g))
• p rofe .. io,,,1 .ccr~d itot Lon fees, induding bar ~"m fers.
m.d ical and demal licen", f... p.id to g.. in it iallic. nsing. and
~ ccount i ng cenificote fees p~ id for Ihe ini,i.1 righ, to ptoclice
accou n, ing
• ch ..ilabl. donal ion, by any bu,in' " ol her Ihan a C coq)Orarion
(Ih ... donJlion. a TO d.ductibk on ly as pw;onaJ <Xp. n....; ...
Ch'pter 14)
• coun,ry dub, 50d,1 dub, or .. h bic dub dues (..e Ch'p'" 4)
• f.d. raJ inoom. I.. ~, you pay on your buoin~ss incom. (...
Chlpter 14), ~nd
• "rrain inte'rs' pa)'menlS (see Ch.pter 14).

Tax Reporting
h·. v"Y "'y to d~duc, op.nHing .xpe""s from your incom~ ,axes.
You .imply ke~p !rock of "·"r,hing you buy (or 'p<nd mon.y on) for
you r pract ice during Ihe ye .., including Ih~ JnlOunl 'P~"I on ~ach
ilem . l h en you record Ihe e.pcns« On your I3x ret urn. If you are a sole
proprietor. you do ,his on IRS Schedu le C. Profit or Lou From Bwinffl.
To m.ke ,h is ,,,sk .osy. Sch~dul~ C liSls commott eurr,,,, expe"..
cJtcgories- you jusl need to fill in Ihe JmOunt for each category, For
 CHAP TER J I OPERAT ING EXPE NSES I '"

e~ a mp le,if you spend $1,000 for ad,,"t ising d uring th" )'''"'' )'OU
would fill in ,h is amOU nt in , h" ho~ for , h" advcrtising a" "gory. You
add up all of you r <u rr. nt nponses on Scn. du l. C .nd d.du<t tn.
tota l from your gross busi n.ss in<om. '0 d.... min. you r n.. bu,i n.ss
in~ome-1h. amOUnt On whi~h you ar< 1axed.
If you or. a limitrd li. bil ity company own." parmer in a part n.,·
,nip, or S oorf>Ow ion own." In. proo . .. i, vrry 'imilar, rxc. pl you
don't Use Sch.dule C LLC, and partnersh ips fi le IRS Form 1065, US.
R,/urn of /'arm~r"';p Inrorn~, .nd ,heir Own"" .h.", of " P""" i.
repon. d on Schrdul. K·l. S <orf>Oration. u.. Form 1120S, U. S. Incorn~
Tax Rnum for an S C~Tp~T~ricn. Each p~ rtn"', LLC m.mber, . nd
S corporat ion sharthold",', shar< of th",. dcciuction, pass", 1h rough th.
emity and is drductrd on tn. ownds ind ividu.1 tax "[u In on Scnedule
E. R. gu l.. C corpowio", ii i. th oir own corpow. tax .. tu rn"
•
 C HAPTER

Meal and Entertainment Expenses

Activitie. Th.t Aren', Entertainment_______________________ ,82

Meal' Can s.. Tra ~1 or Entortainment _ _ _ _ _ _ _ _ _ _ _ _ "
Who C~n s.. Ent~.uined l __________________________________________ 83
Oed uet ing Entertai n men t Ex pe n.... _____________________________________________ 84

Su.iness Oi",,,,ssion, s..fore o r After En,ertainm",,{ _ _ _ _ _ _ _ "

Bu.iness Oi",,,,ssion, During Meal'. ____ ___ .______________ .___________ 86
En {ert a ini ng at Home .. __ .__ .__ .___ _.__ ._. __ .__ .____ ._ .•. __ .__ ._. __ .__ .__ ._. ___ .__ . S8
Enterta inment in Clear Busi ....... s,,{ting. _______________ S8
C~Ic u I.,i ng You. Oed u <I ion .____________________________________ S8

Expen "'. Mu" Be Re. ",,,,,ble ______________________________________ 89

Going -Outch- .______________________________________ .89
Expen",. You Can', DedUCI... __ .__ ._______ .__ .____ ._______ .__ ._____ .___ 90
En 'ert a inme n{ Ti<;ket, __ .__________ .__ ._. ______ ._. _ __ ._. __ .______ ._. ___ ._._.92
M •• I, for Em pIoyee •. _. ___ ._. __ ._ .•. __ ._______ .__ ._ ... _.•. _______ .__ ._ ... ___._ .. __ .93
Expen.... Reim bu ned by C lien ,, ____ ._______ .______ ._______ .__________ .93
11 I T"" OlDUCTION! FOR PRO FE!!IONAl!

prof"~ion.1 p",,, ice i~n', conducted sold y in.n olfice , YOLlr

A mOst import.n, business m"' ings. diem com . clS.• nd

marketi ng dfo rts can ..h place a, restau rants, go lf courses, or
sport i ng events. The tn I.w recog n ius th is a nd permits you to deduct
pa rt of ,he co,, of bu~i ne ... -rd .. ed en tert.i n ment. Howe...., taxp.y"s
havr . bused th is deduct ion in the past, so the IR S has imposed stricr
ru les lim it ing t he typos of entertainment •• pen ..s you c.n deduct .nd
,he ' mOLln' of , he deduCt ion you COn take ,

What Is Business Entertainment?

You moy deduct only h.lf of , he total .mO<1 n, you spend On busi n....
• nrert. i" mem . crivities. B.c."se ordin .. y .nd n.e ...... y business
octivities are usually fully d.duct ible, you want to b•• bl, to d iSlinguish
betwccn reg" I" business activitLeS and entert ain m. nt.
lh. b.sic ,,,le is th .. 'nte",inment involves someth ing fun, such as:
• d iningoUl
• goi ng to. nightdub
• .".nd i ng • spo rti ng " " nt
• going ' 0' concert , movi. , or ,he the. te r
• visiting. vacation ' rot (. ski .rea or beach resort, for .. ample), or
• "king a hunti ng, yachting, Or fishing {T ip,
Alt hough .. ting Out m ight f.11 into other C~tcgor ics of bm in....
op..ot i"g .xp.n .., d.pend ing 0" rh. eireu n","n crs, i, is by f.. ,he
nu n,b .. 0110 busin." entena inmen t expense,

Activities That Aren't Entertainment

En"" . in n"n' doe. nOt indLlde .ct ivi,ies ,h., .re for b u,in"~ purpose,
only . nd don', i"voh~ .ny fun or .musement. such .s:
• providing , upp" money to an .mploy.. work ing o'~ ni mr
• paying fO f a ho,,1 room used whil. t raveling on busin ess. Of
• tr.nspoft.,ion exp.nse~ incu rred whil. tr.,·di ng On business.
In .dd i, ion , m •• I, or other . ntert.inm elll exp'n'rs related to
. dvr rt ising or pro mot ions .re not considr red ent. rt . in mr nt. As •
,ule. an "pense for . meal or other entert.in ment ite m will qLl.lifr's
 CH~'TE • • I MEM ~N O ENTE RTAINMENT (J<PE NSES I AJ

.dve" i'ing if )'Oll m. ke it ... ilable to the genc",1 public-for cxa mple,
if . dc nt ist provid cs frec colfcc .nd soft drin ks to p.ticnt< in hi' w.iting
room , the co>! wou ld not be cons idered an entertai nment "pen",.
The", ki nds of .dvert i,ing and promotion cost< are fu ll y deductible
business operat ing cxpense< ("'c Ch' pter 14).

Meals Can Be Travel or Entertainment

A ",ca l can be. trO\·eI <xpen .. 0' an eme ... in",ent expense. or bo th .
' o,e disti nction won't affect how much )"Ou ,> n deduct- both t",vel
(overn ight) .nd entert.in men, expenses ore on ly 50% deductible. But
differcnt ru l... pply to the tWO ,.tego,i...
A meal is a trAvel expen", if rating our is ne"" sary wh ile you >Ie
'W'y from your ,ax hom e On 3 b" siness trip (see Ch,p,er 6 for mOre
On your ,ax home). For e"'mple, . ny me.1 you eat . lone while On ,he
road for business i, a , ,,,vel ex pe n ... On the OIher h. nd. a meal is an
e nte r"inment expen ", if you !reO{ , cl ie nt. CUStomer, or other busi ness
ossoci.te , and ,he pu rpose of ,he meal is TO benen, your pract ice . A
me. 1 is bo,h • ,ravel"nd an ente ... in me", .. pen .. if yo u trea, a die",
or orher busine ss associate '0 a meal while o n , he ro ad . How ..·... you
may deduct ,h is COSt only once- whether you choose TO do it as a n
eme ... irll"em or" tr.vel e~pense . on ly 50% of ,he COst is deductible .

Who Can Be Entertained?

You mUst be "'i, h One or more people who can benen, you r busincss
in SOme w'y '0 claim an cntert" in men' expense.1his could include
curr~nt or potr n,ial:
• cl ient<
• cu<tom ers
• suppliers
• employe.. (,e. ChapteT 15 fo r speci, l tax rule, for emplo)'e..}
• independe nt "Ontr."tors
• agents
• partn . ,., or
• professional "dv iscrs.
u I TAX OEDUCTIONS fO R PROfESSIONALS

This Ii" indude, ~l mo,' .nyone )"Ou're likely 10 meet for bu,ines,
reasOn'. Although you C.n i",·ire [,m ily membe" or friend, .Iong, )·ou
<on·t deduct the co.t. of <nterta ining them, <xcept in <ert.i n I imi,.d
, ituations.

Deducting Entertainment Expenses

Entert. inment <xpen«" like . 11 bu,i neS! oper.oting e.penses, 3 r(
deductible only if they 3rt ordinary and nec.S!~ ry. 1his me.n, that ,he
,,,,,,,ai,,mem ,xp."se mu" be common. helpful. and 'pprop,ial< fo r
your practice. Taxp.y." used to hayt TO .how only tha, [he eme rtai n-
ment wasn·1 purely for fun, "nd , h.. it benefired thei r bu,iness in
some w.y. l],i, "."dard w., "" t.,)· '0 ,a[isfy ,h., ,he IRS imposed
.ddiIional re'luiremtms for deduct i"g ,h,,,, uptn,.,.
Hefor( the I RS made the mndard TOugher, yOll could deduct
ordi n.. y and ne"" .. y enrem inme n' upense, even if b", iness w.,
n..·.. discu ... d. For ,umple, you could d,duC! ,he co., of ,.king
• diem to a restauram, eve n if )·ou spent Ihe whole time drinking
martin is . nd t.. lking .l>out 'pO,ts (the i nfamau, Ihrcc_m. rtin i lu nch).
Thi' i, no long.. ,he case-now you muS! discuss busi"." with one or
more busin." ..,ocia,.s ei, h.. before . duri ng. or af", , he ,me"ai,,-
mem if you wam to eI, im .n emert,inme nt deductio n "ubjecI TO One
excep,ion; see "Emert . ; n mem in eteH Ilu,iness Sett ings: below).

'f'
\l)
CAUTION
Who·, soinS'o kJ>Ow! Th. IRS ~·t f,;,,<,, ",it. lu,king .bout
in .... tau .. nt .. ,heoters. o r o,her plac ... 01 ....,ertainm .... '. '" iI has no way 01
know"" ",hethe, you 'eally discu .. bu.i ...... wil h • client o. other bu .........
• ' <o<"'te. You'", p'~u y much on ,he "",nor .ystem her •. 1-10_" be aw"",
,ha, if )'0".", .udi,ed. 'he IRS do~y ""utini"" 'hi' doduction becau", many
'''pa)'Off chea, when ,hey toke it. You'll al'" ha.e 10 comply with mingen,
'Kof(H"'ping 'equ irement>. (s... Chapt~, 20.)
 CH~'TE • • I M("'- ~N D (NH RTAlNM (NT (J<P( NS(I I I~

Business Discussions Before or After Entertainment

l h ••• ,i ••t WO)' to get 0 deduction fo r .nt.rt. in",. nt is to d iscuss
busin." b.fo" or afur tI,. aclivity. To m.., ,h is r.quir.m.nt . th.
discussion muS[ b. "associated " with your practice- th., is. it nmS[
hove 0 cI.ar busin." purpOI< . ,uch as devdop ing n.w busi n." or
. ncou raging existi ng d ien' rd., ionships. You don',. how ... r. have
to expect to g.t a specific bus in.ss benefi t from ,he discussio". Your
business discusston can invol... plan n ing, . dvic<, or .imp ly excha nging
u,.ful informat ion with. bus in.ss . sw<i,te ,
You .utonmic. lly ..Iisfy the bu siness d iscussion "qu iwn.n, if
you attend a bu'in ..... ,,'. t. d co nv.ntion 0' me.t ing to fu n h., your
business. Business act iviti. , - not 50eia li l i ng- mUSt b. th. mai n
pu rpo~ for the cOlwendon. S" 'e a copy of <1" program or .gend. 10
pro,'e ,his.
C.ner.l ly. th •• nt. rt.inm . nt .hould occur on th ... m. day as th.
busi ness discuss",n, However. if your busi ness guests arc from Out of
toW " , ,he e"ur,. inn .. n, co n occur ,he day befor. or , he day afur , he
buoiness talk.

EXAMPLE, M.ry and Jack . r. a ",..l,hy co uple ~eki ng to build

• fancy vac.,ion hom •. They travd from th. ir hom. in Bosto n
to New York C i,y to mc. t with AI,. well -known arch i«ct. Th .
couple .rr i,'.' On T"e:;d.y " .. ning ond AI tre.ts Ihem to dinn. r
a, a n ice ..sTaurant tha< night. Th. following morni ng. Mary
. nd Jad go to AI". office to d iscuss th e bu il din g pro;CCt and look
at $Ome prel iminary designs. Al ca n dMUct l he d inner 1hey h.d
,he night befo" . s an enun . inmen, exp.n$< .

You c. n get a deduction e,,,n if t he enten .in ment occurs in. pl."
like 0 nightclub, IhutCr, or loud <portS Oren' whe.. i,'$ d ifficult or
imposs ible to talk bus in'''' Th is is b.caus. your bus; ness discussion.
OCCUr before Or .fte r the enten, inmen" so the IRS wo n', be scrut ini zi ng
whether or nOl yOll .ctu.lIy cOll ld h,ve ta lked bll, iness ' hlfing your
.m.". inmem activity.
u I TAX DWUCTIONS FO R PROFESSIONALS

EXAMPLE: Following I.ngthy n'go, iltion$ or , di.n, '$ office, you

uk. ,h. d i.m 10. bastb, 1I ga m. '0 u nwind. 11.. COst of ,h.
t ichts is a d. ductibl< busin.ss . xp.n,.,

Th ••",.nainme", c.n laS[ lon g.. [han ~'our busin.ss d iscussion s,

as lon g as you don't 'p.nd jUM a ,ma ll fraction of your [ota l t im. o n
business.1hus, it's Mt $Ilffiden( simply to ~$k ~ n ~1$0,;"t., "H ow's
business?" YOl! mUSt h,.'e 0 SLl b",n,i.1 discussion. Also, yOllr busin.ss-
rrla"d discussion, don '[ haw to b. f.«-[o-fac.-[hq can occur ov..
the t.l.phon. or .v.n by .mail, If you hav •• n em. il d iocuss ion. b. su r<
to I~vt t he individllal emails.

Business Discussions During Meals

A"mh .. way you c. n drouc[ en" n.in",.m expe"s" is [0 diocuss
bu,in ess dll ring . me.1 at. reSt.ura nt. To get the deduction, you nmM
show th at:
• , h. nra in purposr of [he combined b u.in.ss diocussion and ",eal
was [he ac[iv. conduct of bus in.ss- you don', haw 10 sp.nd ,h.
entire ti nle tal k ing bus iness, bllt the mai n character of the me, I
muSt be bu siness
• you d id in fac, h"'e , busin.ss ", ..ling, n<gmia , ion, discussion ,
O T oth" bon. fide business t"nsaction wit h rour gue" OT gu est.

during the m.a l, .nd

• you "pee, ' 0 g., incom. Dr <om. mh., 'pfdji, bu;;m<J Wntfil
in [he fmu" from yo ur discussions du ring [he mral - [hus, fo,
e.,mple, a ClsUJI co n,·.rsat ion whOTe the ",bje<;t of bus in.ss
cOme< up won ', do; you have to h.w a spec ific bus iness go. l in
mind.

EXAMPLE: Iv, n, a sole proprietor cons"I"n ' , hos hod ongoing

.m.il d iocussion s wi,h , p rospective d ie", who i, i",,,e,,.d in
hiring him. In n thi nks h.1I b• • bl. to dost t h. d • • ! . nd got a
co ntract .ign.d in a faco-to-fac. m•• t in g. He choo"". lunch
m." iI, g bec",,, i[ '. mOr< inform,1 a"d , he pro'pec, ive elie",
will lik< getting a f ... lu nch. H. treats th. el i.nt to . 540 lu nch
 CHA,n • • I M(AlANO (NH RTAlNM(NT (J<P( NS(I I 11

at l nic~ r~"" u "n t, D u ring the lunch, th~y fi n . liu th~ termS of
l COntr.C' for I".n', con,uiring .. rvic .. and COme ' 0 • ha ndshake

ag .. em . nt, This m~al clearly led to. 'pec ific bu. i" . .. benent for
Ivan, so h. con deduct half of the cost of both hi. and hi. cl ient"
ILlneh a$ . n en,ertai nment ~x p en".

You don't n«:e"orily h3'"( to dost l de. l, sign. contro c!, or other-
wist obta in a specific b llsin~" benefit to get • deduction . But you do
h av~ 10 have a u",onab/~~xp,aal;on t hat you can g~' some specine
bmin~ss benent through your diseu"ion. at the m. al-fo , exa mpk
obtain i ng . new dient o r im'cst ment in you r pflcricc.

No DeductioA§ for Business Discus5ions

During Other Kinds of Entertainment

A •• ~~a1 ru~, bu........

you can', g<'I • ~nt ..ruinm'"nt d.d"",ion t,.,.
,laim ing thot you d;":u.",d bu.inen du, ing.n enwto inm ""t .("i"ity
at ...... than a meal. In the IRS'. "N:w, it', uwally not po,~b", to ~nga~
in ",riou, 00 ..""" di><u"jom at entertainm... , ",""ue, other than
","au"n" bee""", of troe di"".:tio"" h.mple, of pl",e. lhe IRS ",ou",
probably ~nd not <ondudve to ""iou, talk indud~
• nightclub<, theater" or "",ning """""
• cod.. il p.;Inie. Or other ~rge "",ial g;>thering>
• hunling or rnh ing Irip.
- y",ht"'g or Other plea.u", boot outing~ or
• group gat ...... 'ng> at a cocktail lounge, g<>lf club, athle,ic dub,
0' "aca,ion reoo" ,hal indud ... people who ore nol bu.,,,,,,,
a."",i ......
Thi' mean~ for ~".mple, that you Y",.II~ can't claim that you
di<cY,..,d bu,i""" during. go lf g;>me, e""n if your four<om~ co",i«. of
you and Ih''''' bu~"", . .."",ial"" In troe IRS'. VIew, go~er. ore unable to
play and .. Ik bu"""" at the >am~ tim ~, On th~ other hand, you could
have. busine" di<cu"ion before or after. golf game-for ..amp"', in the
dubhou.e, Thi' might seem ridic:ulou~ bu, il;' the rule.
.1 I TAX DWUCTIONS FO R PROFESSIONALS

Entertaining at Home
'Ih~ COSt of entert,ini ng at your home is deductibl, if it meets either
of ,h. ab",'. ,wo .."s. How" ... ,he I RS will be more likely '0 b. li ....
,ha, you discuss<d busine.. du ring home .",e". inme", if only.
,m,l1 nu n,b.. of people are involved - for .. ample, if you have. qu iet
dinner pa"y. A Ilrgtr gll hering-a cock" il pan y, for .xample-will
prob.bly qualify as an e",.."inn"", .xp.nse only if you h"'e bu,ine"
di.,;;ussions befo,e or ,fter the event. (For exanl ple, you .ign a w ntract
wit h, cl ient duri ng the afternoon .nd invite him to you r house for
• I.rg. pa" r wi, h your busin ... associ .... a nd f. mil)·.) Yo u Cln ",
however, deduct the costs of i nvi'ing nonbus in. .. guost, to your hou ...

Entertainm ent in Clear Business Settings

An ..c.pt;o n to th. general ru le th.t you nmS! d i.,;;uss busi ne.. before,
during, or .f'er en.. n,inm,n! is when ,he ento ... inment occur. in 1
d.ar busine" s.uing. For ... mple. this excep,ion applies to:
• t he price of renting. hospita l;,}' room at a cony.ntion wh.r. you
discuss )'Ou r services or products, or
• en{e"ain m' n' ,hot OCC"ts under circum,"nc" whe" ,h..e i. nO
mean ingful p,,,onal relalionship between you and the p.ople
you en tem ined- for e.. mpIe, you emem in loc. I business or
ci vic Ie"ders at the open ing of. new hotd '0 get pub lici'y for
your practic •• ralh .. ,h.n !O form busin ess relalionships wi,h
t hem .

Calculating Your Deduction

Most e.pen ... you incur for bu,ine... ntert.in ment or. d.duct ib le,
indud ing meals (wit h b"verages, tn, and t ips), you r t r;{ nsport>tion
expen.es (i"eludi ng parking). ,icke" !O eruertJi !! ",en' or 'POrt ing
eve", •• c... ritlg COstS of pIrt ies. CO,'" chorges for Idmission to
nightclubs, a nd ... nt paid for. room wh .... you ho ld, dinner or
coc ktail party.
 CH~'TE •• I MEM.AND ENTERTAINMENT (J<PENSES I A9

You , r. .lIowed ,0 deduCi only 50% of )'OU' ente nain ment expenl>'S,
includ ing tu .. . nd tip'. For ... mple, if you spend $50 for , ",,,I in
a festaurant, you c.n ded u« $25. You must, howev.., ke<p ,rack of
ev .. yth ing you spend a nd roport th •• nti .. amount on your tax ,eturn ,
The only except ion, to the 50% rule . .. tr'"spon .. ion expens,e,. which
a .. 100% deduCIibl ••• nd ('Hain m.. ls for employtes.
If you hav•• ' ingle bill or .. ceipt ,hat includes some bus iness . nt..-
tainment as well .. other expenses (.uch "lodging or t ra nspo'to,ion),
you mUst . lloe... tI,. "pens< b"we<n tI,. co<, of the .nt ertain ment
and the cost of th. olh.... rv ic ... Fo, • • ampl •. if your hot.l bill co .... "
meals .. well .. lodging, yo,,·11 have to m.ke" ...son.ble est im ... of
the portion thot eo,'..s meal,. It·, b." to t'Y • nd ,void thi, h, ssie by
getti ng' .. paw. bill fOf your ded u(tibl•• nl<rta in ment ,

Expenses Must Be Reas onable

You r ent.n. inm. nt "penses muSt be reaso nabl. - the 1RS won·t let
you deduct en,emin menl expe nl>'S that it co nsiders l.vish o r extra-
vJgant . 1h... i, no dollor lim i' on whot is re.,onable; nor,re you barred
fmm ent.rtaini ng at dduxe ""aur.",.. hOld,. nigh [cIubs. or ..sortS.
Whethef yo" r expenses will be considered r •• son,ble depends on
,h. particular f.cts . nd d rcum'w\ces-for .xampl•. a $250 "pense
for dinn .. wi,h • cIiem .nd [ 1"0 bu<in.ss .s.wci ....... f.ncy restourom
wou ld probably b• .:ansid.red reJsonabl. if you dosed a b".iness doal
du ri ng the mea l, Bc.:.use there. re no COnCrele gIl idelines, you h,,'e to
us< COIllmOn .. n ...

Going HDutch H
You ca n deduct . nl< tlainn"nt . xpens.. only if you pay fo[ tn. act ivity.
If a d iont pich up the tab, you obviously g" no ded"Clion, If you
split the expon .. , you muSt ,ubtr.c, whol it would hove Ilorm . lly COst
you for the m .. 1 from th. amount you actually pa id. and th.n deduc,
50% oftna< difj"erenco, Foroxample, if you pay $20 fOf lunch and you
usu.lly p.y only $5, )'OU Can d. duc, 50% of $15, or $7.50.
90 I TAX OEOUCTK)NS fO R PROfESSK)N ALS

If you go D""h 0 lot , nd au worried that the IRS might chall,ng,

),our dffi uc,ions , )'o u aln U,.., your groary bills or r.c'ipts from , .ting
out for a month to show what you usually ,p. nd _You don't n•• d to
h.p ! rJck of which g rocery items you eat for each m.al. Instead, !h~
IRS 'S<Um'$ tha, 50% of you r IOt,1 groc"y r~c<ip!S ..~ for din n<r,
30% for lunch, and 20% for b... kfast.

Expenses You Can't Dedun

'Ihc....c ccrtain c'pe nsU that you arc prohibitcd from dcducting.s
,ntetlJ in men' _

En lertai nmen l Facili lies

An . m. rtainmen! facil ity is any prop~rtr you own, '~ n!' or us< for
'nt en~ in ment-for example, a yoeht , h,m!ing lodg" fish in g camp,
sw immi ng pool, car, airplane. 'p.rt n",lt , hotel su i,. , or hom' in
a vacat ion r~sort, You may not d.duct any op~n'" for th~ us< of
an . n"rta i n m~nt faci lity, indud ing "p.ns<s for d~pr~ci at ion and
opcr~ti ng COSt$ $"ch .s t<nt , 'I( il i!i.s, maint<n.nce, or ",cu rit )-,
How~"~r, you can d.duct ou!-of-pocket " p. ns., tha, )'OU incur
whil~ provid i ng .nt.rta i nm~m a, an . nt.rta inm.", facilit y-ro<
,xa mple, 'os's for food and bcver.>ges, ca"ri ng, gas, , nd fish ing
b,it-b«au", the", "pen"s at< not for th. us, of.n enLertoin m'nt
faciliTY it,df, How. v~r, !n.s< .xp~ns" au , ubj<ct!o !h. rt,!ui .. m~m'
disc",;s.d in "Who You C. n Entem in" .nd "Ded"ct ing Entertain m,nt
Exp.nsel," above.

EXAMPLE: Hill,.n . n orne)-, ta kcs a v.luffi d ien! On an "ft'rnoon

fish in g' rip, He rentS 0 fishi ng bOI' • nd fishing equ ipm.nt,
and has a c. .... r provid~ a nit:. lunch for ,h~ trip. Bill ma)'
nOl d. duct th. COST of .. n!ing Ih. fish in g boa, b. cau", iT i•• n
, n,cm inmc n! f.cil i!)'_ Hit! , if hc has a busincss d iK..s.sion with
,he eli.", before, during, or af,~r , he trip, he m.)' d~duc, his
oU1-of-pock~, exp. n",,, inel uding !h~ coS! of II,. ca"red lunch,
li,hi ng C,!" ipmcn!, a nd bl it_
 CHAPTER< I M(Al ANO[NTE RTA,NM(NHXP( NI(I I "

Nonbusin~ss Gu~sts' Exp~nSl"s

You m,y nO[ deduct [he coS[ of eme .. ,ining prople who'r(: nO! busi-
neS. ,ss<xiar." If you .ntefta;n bus iness and nonbus iness guest, at a n
,,'en', you ",uS[ divide your en ..... in me", expen.., b.,w ..n ,he ,wo
a<td dedue, only the busine.. pan ,

EXAMPLE, You IOke th"e elien', , nd ,ix friend, 10 din ner.

Bee.u.. ,here ",ere !en prop Ie., d in ner, including you, .nd
only fou l were busin . .. r.la .. d , 40% of this "pen,e ~uJlifi •• as
bllsine .. en'eruinmen', If yO Il 'pend $200 for , he dinner, only
$80 would be dedue,ible . And be",u.. e"""J in",e", .. pe"'"" . ...
on ly 50% deduct ibl ., you r total deduction for th. eYen! is 540.

Ordinarily, yOLl C' nnQt deduct ,he ro" of en[e .. ,ining yO Ll r 'pou'"'
Of th. spou.. of " busi"." .,soci.". How.Ye [, there i, . n exc'p,ion:
You c~n d.duct th ... co .., if you can .how th., you had. d •• [
busine" purpo,", (r .. h" , han " perso nal or socul purpo,",) in h.ving
,he 'pou'"' or ' pouse , join in.

EXAMPLE, Yo" ,okc ad ient vi,i,i ng ftom 0 '" of tOw n to dinner

wi,h hi' wife. The clie",', wife jo in. you becau.. i,', impr. e,ic.1
(not to memion impoli..) to have d; n ner w;,h the d i.nt .nd nO[
indude hi, wife. You, 'po",e join, th c p.rty bee,,,,", the dient',
'pouse is p..... m. You nlly dedue, ,he coS! of dinner for bo,h
'pouse,.

Club Dues and Membership Ffi'S

In th. gOM old day. , you could d.duct dues fOf belonging [0 a country
du o Or othe r cl"b whc,. b",inc" aSSllei ..., g,l.( hcred, 'Ihis i, nO longer
possible, l hc I RS say, you CO n nOt dcd uct d"cs (i ncl" ding in;t iJtion
fees) for membersh ip in .ny dub if one of the princip. l purpo ... of [he
dub is to:
• cond"" entenain mcn' OClivi( ies for members, Or
• provide .men.inme", f.cili"., for n.. mbers fa u...
u I TAAOWUCTION! FOR PRO FE!!IONAl!

Thus, you C~n nOt d~duct dues paid to cou ntry dub" gol f . nd
,. h leric du b" . irli "e d ubs, hotel dubs, or dubs opcr. " d to pro vide
memb..,; wit h meals. How""r, you can deduct ot her expen... you
in cur to onten a in a busine.. as.sociate at a dub .

EXAMPLE, Jack, a doclOr, i, a TIlemb .. of t he Golden Bear

Golf O ub in Col" mb" s, Oh io. H is a nn ,u l membersh ip dues
ore $ 10,000. On~ night Jack im·it($ , nother doctor in the
commun ity to d inn .. at the dub', d in ing room where they
d iKu .. Jack buying h is practice. Jack pay' SIOO for the d inn ...
Jack ', $10 ,000 • nn" , 1 du~s are nOt dedu" ible , bu t h is com for
[he di nner ....

You C. n deduct dues to join business-related ta x_exempt orp niz,_

,ions or civ ic organization, as long as [hr organ ization 's pri",oty
pu '!", .. i, n'[ to providr r ntr.,ainmr n!. Exampl.. indudr p[ofrssional
assoc;, t ions such •• 3 mcd ic. I or ba r "SO';ot ion, as wel l as orga niu_
tio ns l ik~ the Kiw, nis or Rotary Ch,b, busi ness k . g ues. ch . mbers of
com m..er, ,nd It. dr associat ion ,.

Entertainment Tickets
You con deduct on ly the face va lue of an emrrtdi nment ticket, rv. n if
you p.id . higher pr ier fo r it. For ~ .. mple. you CO nnot dM u" .... ier
fees th,. you pay to ticket agencies or brok. rs, or any . mOu m 0"<[
th r fa .. value of tickets th at you buy fro m ..:,Ipers. Howrvcr, you ca n
deduct th. ent ire a mount you pay fo r a tic ket ifit's for a n a mateur
sporting ' "<Ill ru n by volu",,,,,,, '0 bene fit . ch otit y.
Ordi"arily, you or. " r mployer mUst be pre..,,,, at an em~".in"'~nt
act ivity to da im it as a bu , in. .. ~nte " a in me m . xp. n..,. This is no'
the ca... however. wi,h en t.".in m.nt t kk~". You COn giw ticketS
to di~,,1S or olh.. bu, i", .. as.socia,~, 1":It h.. ,h . n mending th, '''nt
you rstlf, and sti ll g~t • d~duct j on . If you do n't go to thr . vr nt, you
h" " the opt ion of tr..t ing t he t k ket' as. gi ft . You can get J bigger
deduct ion th i' w. y SOmet im($. G if« of LIp '0 $ 2~ ar< 100% d,ductibl~
""r Cha pm 14), SO with [ick", [hat cost Ir .. [han $50, you gtl , bigg"
 CHA PTE R ' I M(Al ANO(NH RTAlNM(NT(XP( NS£I 19)

dNuCtion if you tre" , hem" 0 gift. If they co", mo re, t re " ,hem O$.n
emen . inment expe,,~.
You may 3]'0 deduct the coM of ~.w n t icket, or a spons arena or
3 th •• t." BU!, if you ront a skybox or other pr i"J" luxury box, your
dNue,ion is limi .. d to ,h. CO" of 0 rtgulor nonl u. ury ~x se ... The
coS! of ..awn tiCKets mu,t be .Iloc,.. d IO each sepawe ,,'en!.

Meals for Employees

Ord in. rily, n,ea l and entert.in ment e.pens<s for )'OU r employees .re
only 50% dNuCtible, JUSt like your Own meal ~nd entertainme nt
e~pen'''''. How".. r. )'OU or your prac,ice may T.ke a 100% deduelion
for employ" meals:
• provided .s p.rt of. co n'pany recreatio nal Or soci.13Ct ivity- fo r
exa mple,,, picnic for your employees
• provided at) bu,ine .. pren, i.., for )'om convenience-f"
ex. mple. you provide 1" nch bec.u~ you r employees muSt re m.i n
in the office to be lVllibb le to work. Ot
• if ,he coS! is included as p.n of ,he emplo)',,'s compen..lion and
repo rted .. such on h is or her W-2,

Expenses Reimbursed by Clients

If. cl ient reimburses you for entert.inment expenses, you don't ne. d !O
coun! the re imbursem ent that you rece ive JS income as lo ng as you g i,"
the d iem a n odequate 'CCOunt ing of your ex pens<s .nd comply with
,he acco unroble pia " ru les. Basicoll)·. ,h is requ ire. ,hat )·ou , ubm i' all
your docu mentation '0 the client in a t imely m.nner, and return .ny
e~"eS$ payment<. Accoun"bl~ pl, n, ore eo,.. red in detail in Ch'pt~r 17.
If you comply wi, h the rul .., th e cl ient get< to deduct 50% of the
e~pens<s .nd you g. t 100% of your expenses pa id for by somebody
eI,e. This i. a lot bon.r th.n gening only . 50% .m~rtainm~m .~pe nse
dNuCtion . Th~ r~i mbursement ,hould nOt be listed by the clie nt On ,ny
Form 1099-M1SC. client i, requ ired to send to , he IRS showing ,he
amount paid to you fo r you r servicv; du ring t he year.
•.. I TAX DWUCT IONS FO R PRO FESSIONALS

EXAMPLE: Ph ilip, a sol. propri"or mJrht ing consulton t, tohS

"" ...... 1pwpl. OUt 10 IUllch 10 d isc uss w. ys 10 obtoin publici tr for
a d i~m , H~ bil ls his d iont $5{l0 fo, th~ lunch.. a nd providos all
th. prop~r doc u m~nt at i o n. Th~ d i. nt r~i mbu rsos Ph il ip $500,
Phil ip g", nO d. duction fo' ,h.l unch.s, but ho , I,D doe,n't
ha,'~ to indudr th~ $500 "imbu r""mont in h is ineom~ for , h~
yoar, his di~m m. y d~duC! 50% of 'ho ox pon"" as . business
. n"".inmont . xpen"" ,

On th~ ot h.. hand, if you don't ptoporly documonr your ox pr n",,',

.n)' rei mb,ll'""m'n t you obt. in from you r eli. nt must be reported
:lS incom. on yo ur ,u r<ru m and should bo indud.d in any 1099-

M ISC fo , m ,h.d i. nr pro"id" th. IRS rr rorti ng how much you w...
paid (I.. Ch.pt., 15), 'Ihe el i. nt CO n st ill d.duct tho rrimbu r""m. nt
;1$ comp.nS<>t ion p. id to )'0 \1. 1 he d i. nt·, deduction is nOt ,ubject

to tho 50% li mit bceau "" lh. paym.nt is dassifi.d as compo.,salion.

nor rrimbu r""mont of .m.rtain m.nt n pr n"",. You may d.duCl , h.
expen,es on you r Own ,.wrn, but you r deduction will be su bject to the
50% limi, .

EXAMPLE: Assu me that I'h ilip ftom the above exa mp le !':tils to
mah an ad.qu." .ccoum ing of h is mul np' ''''' 10 h is d i. m.
bur lh. di.nt $I ill .. imburst, h im for tho full S500. Tho elkm
may deduct t he entire $500, a nd muSt include this amOu nt in
,h. 1099-MI SC form i, provid.. ,h. IR S .. port ing how much
i, paid Ph ilip during ,h. )'.... Philip mU$I indud. ,h. $500 .s
ineo m. on h is tax return .n d p. y tax On it, H. may list the S5{lO
.s an entert ain ment expense On ), i, perso n. 1 tax re", rn, but ), i,
d.d ucrion is limi"d '0 $250 ,

I f you ob13 in nO re imbu rS<ment from you r client , you C. n deduct

lh. COSI , . a busi"ess c<"."ai" m.m " p.n "" on your own 10'< "'U"".
but your d~duetion will b~ ,ubi« t to ,he 50% limit. You mu" keep
. d.qUJlO records of your entertain ment . xpense. e"en if you r d ient
dO<csn', rc imbu rsr you for ,hem.

•
 C H APT E R

Car and Local Travel Expenses

loul Tr~mpo,,~. lo n Expem e. _"__ "_"_""_"_"_" __ "_"_" ___ 96

D e du~. ; bl e

Tra ... 1MU>l 8elor Busi.,.." _______________________________ 96

Commuting I. NO! Deductib~ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _"

The Standard Mileagr Rate __________________________________________101

How the St.ndord Mi leage Rate Works _____________________________________101
Requ;",men" to Use the Standard M i ~age Ra ... _____________ .l02

Th. Act ual Ex.,.,n •• Met hod.. __ ."_" __ ."_"_"_". __ "_"_" __ "_" __ .__ "_"_" ___ . 103
How the Actua l Expense Method Worh.__ .____ .__ .___ .__ ._. __ .__ .__ ._. _____ . 1O ~
Record·K«ping Requ i",ment.__ lOS
Veh Depreeia. >on Deduaion. __ "_____ "__ "___ "______ "____ "_" ___lOS
i<~

Lu sin g • C.'-__________________________________________________________________116
Other l ocal Tran .porlat io n Expense' __________________________ . 118

R.porting Tra n'po' tal;on Expen,., on s.:hed ul. C_ _ _ _ _ _ 119

When CI;"nt> Reimbu rse You ____________________________________________120
Profe .. iona" W;th Bu.inn. Ent;tiel. _____________________________________ 120
Usi ng Your Own C.r. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 121

Using a Co mp>ny Car ._"_".""." __ "."_"_"_"."_"_"._."_" ... "_"."_"_"_"_". 12 3

 l>~J " UJ,dns >II' 01 " jdlUu, Jo)----'SdlJ I j"uoSJ,,/ '1IOP"'Oj "" 1I!'nq "
0, P",""'$! '"~' _$$' U !$nq 10, ".'.1.jl $d!Jl j",Oj "np'p AIUO u", no},

ssau!sng JOJ ag lSnw W,eJl

·'''OJ ' q pxsn""p SlU 'IU >1mb,J "4lO '4'

,"lU pur AJ . ""O>U pur AJrUI PJO , , . A'~l ' " ~U Oj " '''0'
>S'4' Dnp'p
u., IloA ·P:W"j JO P,UMo S! :lSn no., 'P! 4'"' ,~, " 4 "~M JO-U! !\I , JO
'mq 'In, " ['A"O,OIU '," "notUI [ 'AOS 'u "" 'J.,----'Sdu , I.~ [ "41 '~"IU 01
,m nOA uOll"lJod," "")O , ciA1l"4." ""'''lJ1 P ou ''''I"'" 1] (·lU'lU , n nb>1
,(nssn,u pue ",HU!\'.I0 ' 4' JO UO!,sn)$!P P'j!'''P" ,oJ f m d' 4:) "S)
·",u!snq ,IlO,( 'OJ ,,"! ,dOJdd~ pu. ' j"Jdp4 'UOIU 1.Uoo'q ,$l1tu ISO' ''lL
·u ols"JOJd '0 "P"J) ·..,u .. nq mOA ,oJ .(,,,,,,,,u pur AI"U11"0 ". JI ""'I'
,>su,dx> ~ up",do ..,"!,nq 'f ' N",np'p >If .''0' uOllf"od' Uf" 1"~1

sasuadx3 UOpelJodsueJ.lleJOl alq!lJnpao

'S~ I "'I' y ~M ~", n o.J, ) O

,no '"" 0' AllnJ4" "J ""'4' ""'1IOf PU" ""1"4 juKl...:ll-p.lO,"" pool! doJ;oJ\~p )\nw
nool_ nM "':I op ur , lu.,uno".. OIJ Hu!4 ' ...... '" ' ! ' !YJ. ~U"!l,.,P"'P l nM d n ~"""I
0 1 , p,,,,,,,, poo8 d»~ 01 '! ~pn. Uf l'U!.-ll. "'u~p jO au!ll"~ m o).. ..,..nJ '"'I'
8ul~ 'OU >1,no.( '"'I'
;0>"" ~1~'" 01 ~lnJ;lJr, , _ 1""'111''''' S~ I '"'I' "'- "'"'I'
~I~''';'''O 0, "., '! ~ 1"'.- I""ur15qn, .., u., ,,..-l~, ~ =S5au!'!lG II"""

,," !ure. ' ~l U'"'lM I~ ~""I "O'!pn~ S~ I '"'0 »q w nu "'I I ~j. <01u><l..
I",, ' ""'~

UOll.U""'U~11 ·~HI ~4' 10J hy p~J ~ "'~ <01u ><l .~ uo!, . u odouOJ.l

NOI.l/lV) 0
CD
·91»do,0
U! p'llAO"n ',U ",lU " 4 '0 10 H' Aq "4"4'" 'sd!11 '4 g!U,,",O
V"'"" ...' "ISnq l"lOl ,oJ uo,,~np'p JO ,ciA,
UOW lUO~ "otU ' 4' '"," , dx, If' uo .(llJrlU lld .",n~J I"d"~, " 4' mq
' UO! ,""ods" ", ) JO su",m A" f ~U !1n ,d! " ",U!lnq l"lOj 0' Aldd, "In,
"'''ll .' t(.i ' Ul'.,O >lu04 mOlJ ,k,," A.,. 01 no., "mb" ',uop "'F ,dU l
" , uISnq '" '·'ll-UO"",,od,Ufll 1"~I, oJ ",u, dx> "np'p 01
M04 no.< S"'O'l' ,, )d"'1' S!'lL 'UO!Dnp'p HI ""g" ' q "'I' Plno.:>
1.
" -,,,,3 ' '1001 AjUO IOU ,3,,,g 111 0A U! 1"'I',d , " >Al,u,dx, If '1

SW"OISSl;O~d ~ Oj 5"011:>110] 0 XVl In

 CHAPTER! I CAR AND LOCAL TRAV(L EXP( NS(I I n

Of the gym-~re nOt dffil1ctibl".s bu.inCS$ tr.,.d expe nse., A bu,inCS$

locotion i, . ny pl.c. where you perform bu,i".ss·rdlt.d !O, k" , uch.s:
• the pl .ce where you h" .. you r principal place of bu,in ess,
i ndud ing a ho me office
• other pl.ce, where you work, in d uding tempo rary work sites
• plac.. whert you meet with diem, or pa[ien"
• the b.nk whe,e you do bu, iness bank ing
• • loc, 1college where )-on toke profession,l cont inuing "d"", ion
d os,..
• the sto te whe,e you buy bu ,;ne" ,uppl;.., or
• the pl"e wh ere yon keep busi ne" inventor)-,

Commuting Is Not Deductible

Most professionals h.ve an outside offi ce where [he), work on a regular
basis, Unfonu notely, you can't deduct [he COst of "a"eli ng ftom you r
home to your regul.r phce of business, l hesc ore commut ing e'pens.s,
which are ~ nondeduct ible perronol upe nse.
Commuting occurs when you go from ho me 10 a permane", work
locO[ion - ei [her your:
• offic. or oth . r princip. l place of busi ness, or
• .nm her pl lce where you have worked Dr rxpecI 10 wOlk for mort
[hon o"e yea"

EXAMPLE, Kim, . consulton[, rU n' he r bu,i"ess from on office

in . dow mown office build ing. hery d. )" ,he dr,,'e, 20 ", iles
from h.. suburban ho me to h.. office and ba<k. None of th i,
com mm ing mile.gc is deductible. Bm she may deduct trips from
her office 10 0 dieHl" office, or a"y ol her b usiness-rel .. ed rrip
that starts from her office,

E"n if a rrip from home h" . busine" purposc - for .xo mple,
to del iver imponan! pap e" to your office-it is .till w nside"d
commuting Jnd is not deductibk (You may, how".. " deduct the wst
of ,enting. tnt iler or an)' ot her extr,ordinory .. penst. you incur 10
haul in"emo,y 0' suppl ie, fro m your homd
9. I TAA DWUCTIONI FO R PROFElllONALI

Nor "~ n yOll deduct a commuting trip b«:olli<' )'Ou m,ke bll,in",
coil, On your cdl pho" e, Ii'''n to work-rd 'tN t.p", or h"",. bu,in'"
di.cussion with . n .,soci"e or . ",ploye. during the commu" , Alw,
placing an ad,'<n i, ing display on your veh icle won't conven a commute
to 0 busine" trip .
B.cau~ commuting is not deductible, wh ..e your office or oth ..
principal workpl ace ;.Iocated has a big effect on the .mount you can
deduCt for loco.l bu'iness trips. You will get the fewe" deduCt io n, if
)'OU work so ld y in , n outSide office, You 10.. Ollt 01, m. n)' pote nti. 1
busin e.. m il rs th is way because you can't d.duct any trips betw.. n you r
home .nd you r office.
As explainN bdow, you C. n get the mOSt deduct ions fo r 10c,1
busine.. trips if you h" ", . hom. office,

You Have a Home Office

If you have. home office that qu.lifi .. as your princip. l pl.ce of
business, ~'ou co" d.duct the COst of , ny trips you nuke frorn )'Our
hom. to . noth .. bus;n ... location, For exam ple, )'Ou CJn d.duct the
m" of d riv ing from home to your om,ide office,. dient's office, or to
attend a business-rel.ted "minor, 11.. conmluting ru le dorsn't apply if
you work" hom. bec.us<, wit h . hom. offier, you never com mu .. to
work (you'" the" .lready),
You r home office will qual ify as your principal place of business
ifit is the pl.c. where yo u earn mOst of )'o ur income or perfo rm the
. d ministrativ. or man agement tasks for your pr.ctice , (S.e Gapt .. 7
for mar< On the home office deduct ion.) If your home office ql1,l ifi"
as your principal pl, ce of business, you COn ,"" I)' incre,,, you r
deductions for bu,in." trip',

EXAMPLE: Kim (from the abow example) maim.ins a home

offie< wh ... she dors the adm in ;'trJli," work for her consu lti ng
pract ice; she . Iso h... n out, ide office whe .. sh. da.s h.r ot her
work. She C" n deduct 011 her busin'" trips from her home offier,
including the 20 -mil e daily trip In h.. oU[sid. offic., Tha nks
to h.. home office, she can now deduct 100 m il .. per we. k
" 0 I TAA OWUCTIONI FO R PRO FHIIONAL'

EXAMPLE 2: Doug spends $2,000 On • brond·Mw engine fo r h is

cor. 1h is is a c.p ito l e"pen.. because ,he IlC W engine incre~",s
th. oa r's v.lu • • nd u",fu ll if. ,

This m i. c~n b. difficulI '0 .pply brc.u", virlU.lly " II r.pairs

incre... {h. v:liu. of {h. prop.!!y being rep.ir.d. Just rem. mb" (hat
.n improvement m~ kes )'O\lr vehicle more v.lu~ble th. n i{ w,s before it
w.s work.d on , wh ile ' ,""p. ir simpl)" reSlOr($ {he,,,'s value '0 wha, it
was worth b.fo,"" it broke down .
Improv.m . nts arc d'prec i. t. d "p, .. ,.ly from t he , .. h id . it..lf-
th., is, they are trear.d .s a "p.""e item of depreci.b l. property. '[he
", m. rul"" howey", . pply {o d.p .. d~ling impro ... m",,,, as for regular
.uto d'procia,ion . Depreciation of {h. origin~ 1 .utomobil• • nd ,h. la,,,
improve ments. re combined for pu rposes of , he .n n,,.1 depreci.t ion
IimilS. 1he recovery period beg ins wh.n the improv.ment is placed in
serv ice .

Leasing a Car
If you I"" •• ca r t hat you u,;c in your pract ic". you c.n u'" t he actual
.xpense method lO deduct {h" portio n of each Ie.", payment {h"
",H. e,. ,h. busin .... prre.n .. g. us< of ,h. cor. You c.""m d.due, any
part of a le.se p.ym . n{ (h.t i, fOTcommuting or person.1 use of t h. car.

EXAMPLE: Joh rl p')" $400 • moo, h (Q I• .,•• L. xus. H. us .. i,

50% for h is d. nta l ",I., pr.c{"" .nd 50% for p. rllOna l purv0stS,
H. may deduct halfofhis I• .,. payments (SlOO. mo nth) as.
",,:.1 tr.nsport.lion .xp.n .. for his ",I", busin.ss.

Leasing compa n;". ,ypically require you to ma ke an advanc. or

dow n p. ym.nt to I..."", a car. Yo u Cln deduct ,h is COst . bt1t you mUst
spread t h. d. duc,ion ou! .qually o... r ,h•• ntir. I. a", period .
 CHA'TEU 1 CAR ANDlOCAL TRAVE l EXPEN\E\ 1 "1

i\f'
W '" With the$l~nd"rd mileage method, you don~ deduct "ny
portio n of you, 'ease p.~ment .. InSlnd, 'his cost i. co'e",d by ,he ot.r>dard
m;l<~ r. ...ot by the IRS.

Is It Really a Lease?
Some trans,lCtKl n, thot Ht coiled autO leaS!'! ore re,l ly nOt ItaSl'$ at .11.
Instrad , ,h~"e install menl purchaser-Ihal is. you pay for ,h. c>r
o.tr lime, .nd by Ihe end of Ihel,,,,e trrnl you ow n al l or p.II of Ihe
Car. You Cannot deduct any plyments yOll make 10 buy a car, e.en if Ihe
pay mentS or. ai led Ita ... paymentS. I nste.d, you have to depreciate the
coS! of Ihe car as deocribed above .

Leasi ng Luxury Cars

If you lease what theiRS considers to be a lu. ury c. r for mOre tha n 30
day'. you may have <0 reduce )'Ou r ltasc deduc tion, lile pu rposc of this
ru le is to pT" .. nt people fro m leasin g vrfy ap,ns;" , cars to get around
the lim i.., ions On depreci"ion deduct ions for cors that are pu rchased.
(Sec "Veh icle Depredation Deductio<l': . bo .... ) A luxury cor is
currently defined", on, with. fair market nlut of mo re than $ 18500,
The ,nlOu ,,1 by which you must r.duc< your deduclion (called a n
inclu'ion . motmt) is b,sed On ,he f.ir mark" v.lue of )'ou r cor .nd the
ptrcentage of ,ime thar you use iTfor bu,ine". TheiRS reca!cula,., it
tach yeJt. You can find Ihe inclusion amount fo r the current )'cJt in Ih •
.. bles p"blished in IRS I'"bli<; .. ion 463, Tra",/, Entmainment, Gif"
and Car Expm~, For tumple. if you I.,sed a $40.000 car in 2009 .nd
used i, solely for bus i"".. ,hot ytJt, you would h.... to reduct your car
open .. deduction by $58 for Ih. )'eJt, If )'OU used t hc car on ly 50%
for busin,,', ,h. reduction wou ld be $29. The inclusion amOLlnt for , he
fi ", ycar is promed based on t he mo nth wh. n you ,Uri u,ing Ih. c~r
for busin .....
11 1 I TAA OWUCTIONS FO R PRO F£SSIONAlS

Should You Lease or Buy Your Car?

WMn )'Ou ~a", a car. )'Ou are p.ying ,.nt 100' it-. _ I.., e",,~ month
/or tM u'" of the C.... At tM.nd 01 tM Ie.", term. )'Oil give the e ... ,,",ck
to tM Ie'''ng company.nd own nothing A.. gr oe.-.I rule, Ie•• ing H.r
in"eod 01 buying it makH KOnomic <en ... only if )'Ou .blOlu.ely mu"
ha"" • n_ car ' -1 (w<> or th,.., ye'" and drive "" more than 11.000 to
15.000 mile. per year. 1/ you dri"" mo ,e than 15.000 mile. 0 ye .... Ie ••ing
b.>comro an ",onomic di"m", l>e<3u<e it p"""li'ro)'Ou /0, higOO mil"'8l'.
The,e are numemu' ~nancial cakulato" .,.ilable on the Intern .. th.,
om help you d<:'ermine t..,w much i, will cost '0 I""", a carcompared to
buying on •. ~ ca,e/ul wMn you u'" ,he •• cakula,o,,_ tMy arr d.~gned
ba""'<l on certain a.<umption •. and diff• ..,n, cakul.,o" can S"'" diff...,n,
,n.wer .. I'<>r • deta iled con .... m. r guide '0 '"'0 Ie •• ing created by , he
Federal Rrse<,r brd. go to tM board '. _bsi,••, wwwJed. ,aI,..."."".
govlp ub.llr .. ing.

Other Local Transportation Expenses

You don"t hay. to dri" e a car or olh., ,·.hid. to g., a taX d. duct ion
for loca l bu.in ... trips. You c.n d. duct the "".t of travd by bu, or
ot her pu blic tran, i,. l. xi. trotin. fetry, motorcycle, bicycle. or .n)' other
mean$. How"", .lIl he ru le, li miting ded,," ion$ for travel by L. r
discu ,,,,d in "Commuting Is Not Deduct ible: abo,.., .Iso apply 10
oth., Iran'po tw ion met hod .. Th i. ",.. ns, for eu mp l., that you can',
ded uct , he COl' of com nuu ing fro m yo ,,, home to yOtlr ollice or o, hcr
p. rm anent work local ion. Th. sam. I<eo rd -k.. ping requiI<me nts . pply
as 1'1.11.