Welcome back. Now that we've talked about trade or
business expenses in general and when they are deductible,
let's talk about some types of business expenses that,
even if ordinary and necessary, may be non-deductible.
In this video, we'll look at trade or
business expenses related to political contributions,
lobbying expenses, and executive compensation.
First, political contributions are non-deductible.
This would be giving money to a politician's campaign,
whether that is a campaign for president of the United States,
United States Congress, a state governor's race,
or just a local city council race.
Of course, a business is still free to make these contributions, but they will not
receive a tax benefit, via a deduction, because of it.
Along similar, but somewhat different lines, are lobbying expenditures.
Lobbying is an effort to influence a politician or public official on a particular issue.
So, for example, if there was a law that a business wanted changed,
they might pay a lobbyist,
that is, someone who is a professional lobbyer, a fee to spend time
trying to convince congressmen to change the law the way they want it changed.
Or they may have an employee conduct the lobbying themselves.
Lobbying can occur on both elected officials, like congressmen and congresswomen,
and the president, or you could lobby a non-elected public official.
For example, a business lobbying on tax issues may lobby the Secretary
of Treasury or other officials in the Department of Treasury and of the IRS.
And, like political contributions to a politician's campaign,
lobbying expenses are non-deductible.
This is true regardless of whether those lobbying expenditures occur at the local,
state, or federal level.
Interestingly, the non-deductible lobbying expense rule was slightly
changed by the Tax Cuts and Jobs Act at the end of 2017.
Prior to 2018, local lobbying expenditures were actually deductible,
such as trying to influence a mayor or city council on a particular issue.
But this is no longer the case.
So now, no matter whether the lobbying is local,
state, or federal, it is non-deductible.
Moving on, one type of business expense that is generally deductible is
membership dues paid to a trade association or a professional organization.
But trade associations, like the National Association of Manufacturers,
and national professional organizations, like the AICPA for
accountants, are also generally involved in at least some amount of lobbying.
When this occurs, the portion of your membership dues
that supported the lobbying efforts will not be deductible.
But any membership dues related to
the other non-lobbying activities of these organizations, like education,
professional development, positive branding for an industry,
those will generally remain deductible.
Basically, we have a pro-rata approach to allocate
the membership dues between the deductible and the non-deductible lobbying.
But remember, lobbying is an effort to influence decisions.
Just monitoring and following legislation without an effort to influence is not lobbying.
And there is one exception to lobbying expenses being non-deductible.
It's a pretty small one.
It's the exception for de minimis in-house lobbying.
De minimis is a Latin phrase meaning too trivial to merit consideration.
So here, if a business spends $2,000 or
less for one of its employees or officers to lobby,
then the costs are deductible because they're considered too small to matter.
In other words, they are de minimis.
However, once the lobbying expenditure exceeds $2,000,
then none of the expenses related to lobbying are deductible.
Next, we're going to talk about some limitations on deductions for compensation.
In general, compensation such as wages paid to
officers and employees is a deductible business expense.
However, there are some limits we need to know about.
First, compensation paid to shareholder employees, and
their relatives, of closely held corporations must be reasonable to be deductible.
So, if a person both owns a business and works in the business as an employee,
that individual's salary for being an employee must be reasonable.
That means not too low, but not too high.
Think Goldilocks here.
For example, an employee owner may want a low salary so they pay less in payroll taxes.
And with lower wages,
they'll have more business income,
which, in turn, could qualify them for a larger qualified business income deduction.
That's the 20% deduction for certain pass through and sole proprietorship income.
Or they may want to pay themselves
a higher salary to get a bigger deduction for the business.
Or they may want to pay a relative that happens to be in
a lower tax bracket an unreasonably high salary to shift income.
Each taxpayer may have a different motive, depending on their own tax considerations.
But ultimately, the compensation must be reasonable.
One way to demonstrate reasonableness is to compare the wages you pay
for a certain job to what is the going rate in the market outside of your company.
So you can compare an owner employee's salary to what
other non owner employees receive at similar firms,
maybe in the same industry.
And, as it relates to compensation,
there is also a disallowance provision that applies only to
compensation paid to executives of publicly traded companies.
Here, the deduction for compensation of
the chief executive officer, chief financial officer,
and the three other highest-paid corporate officers
is limited to $1 million each year.
This is known as the section 162(m) limitation,
since that's where it's found in the Internal Revenue Code.
Note, this limitation only limits the ability of
that publicly traded company to deduct the compensation.
They can still pay their executives whatever salary they will like,
but they can only deduct the first $1 million payment per covered executive.
Any salary paid over $1 million would be non-deductible.
Now, prior to the Tax Cuts and Jobs Act,
there was a pretty easy way to get around this limit.
That's because prior to the TCJA,
this one-million-dollar limit did not apply to incentive-based pay.
That is, pay which is based on meeting
certain performance incentives, as opposed to being some guaranteed amount.
So for example, it was not uncommon for executives to have
a $1 million base salary, which was entirely deductible,
and then also have performance incentives to earn many millions more in compensation,
all of which would have been deductible as well.
But starting in 2018,
that planning opportunity has been eliminated.
So no matter whether the compensation is base salary or incentive based,
this $1 million deduction limitation will apply.
But again, it's just for certain key executives at publicly traded companies.
Private companies can still deduct compensation in excess of
$1 million, subject to that reasonableness requirement we talked about earlier.
Matthew HutchensLecturer of Accountancy
Petro Lisowsky, PhD, CPAAssociate Professor of Accountancy
