Barred from a Tax Break? Lawyer Fees and Employers

Q:  Tax Playa, I'm an attorney pending admission (I'll be officially admitted next month), and my employer has just reimbursed me for my bar dues.  Is that reimbursement taxable income?  Also, if my employer reimburses me for my notary public dues, is that also taxable income?  If one's taxable and the other isn't, what's the distinction?  In my Federal Income Tax course in law school, this same question regarding reimbursement of professional fees was posed because most firms reimburse their attorney's bar dues, but the query was never resolved by our professor.
Ellis, Canandaigua, NY

A: This depends on the relationship with your employer at the time the expenses were incurred, as well as whether the payments were made as part of an "accountable plan..."

Business Expenses in General

As a general rule, businesses are allowed to pay for the ordinary (usual in that line of business) and necessary (convenient to execute business strategy) expenses of running a business.  If a business directly pays for an ordinary and necessary business expense incurred by an employee in the course of conducting business for the firm, this is normally allowed without question.

Accountable and Unaccountable Plans

This does include reimbursing employees for ordinary and necessary business expenses.  Where those expenses are deducted depends on whether the business maintains an "accountable" or "unaccountable" reimbursement plan.

If the business maintains an accountable plan (one in which the employee turns in receipts and gets reimbursed), the business deducts the payments as if it had made them directly.  If, however, the business gives an employee an "expense account" or some other mechanism, it must include this value in wages.  The employee is then responsible for documenting expenses on his 1040 as an unreimbursed employee business expense.

Given, however, the hurdles to this deduction (need to itemize, 50% meals limitation, 2% of AGI floor, AMT disallowance, Pease phaseout, etc.), it is usually much easier to get a deduction on the business level under an accountable plan or by the business paying the expense directly (like with a company card).

Lawyers Fees

Lawyers are required to maintain good standing (including payment of fees) in a bar association.  In addition, it may be useful for them to maintain other credentials (such as the notary public fee you mention).  I would argue that if there is a ordinary and necessary business purpose for your employer to want to keep you in good stead professionally, he can certainly deduct the cost of doing so, and would not have to add it to your wages.  Alternatively, you could turn the receipt into your employer, have him reimburse you, and he deducts the cost on his business return.

If, however, your employer simply made cash available to you in an unaccountable way for expenses that include bar association dues, that is a different matter.  You would have that money added to your income as wages, and you would be responsible for trying to take an unreimbursed employee business expense.

Even worse, when that money is added to your wages, you will have to pay FICA tax on them, as will your employer.

Therefore, in this situation, I would recommend the following:

1. Properly-account for the cost of such fees;
2. Your employer should justify for his own purposes that these fees are an ordinary and necessary expense of having a lawyer as an employee;
3. Your employer should then either pay the fees outright, or reimburse you under an accountable plan.

One final caveat: notice how I keep using the word "employer."  If you don't have an employer-employee relationship with a firm, you must account for these expenses differently:

1. Partners of a firm can either have the partnership claim the deduction, or can claim an expense deduction on the Schedule E;
2. Freelance lawyers on retainer to a client should deduct these expenses as a business expense on their Schedule C (if unincorporated), or their 1120/1120-A/1120-S Form (if incorporated).  In the latter case, there may be an employer-employee relationship between the lawyer's corporation and the lawyer.  In that case, the accountable plan rules described above apply.

Comments

[Ellis]

Great answer, thanks!