The IRS has uncovered a number of schemes that claim to allow deductions for personal living expenses. Taxpayers should consider these points before investing in a possible abusive scheme:

• Any investment scheme or promotion that claims to allow a federal income tax deduction for normal personal expenses should be considered highly suspect

• A business must truly exist prior to claiming expenses

• In order to be deductible, the expenses must be ordinary and necessary expenses paid or incurred in carrying on a trade or business

• Personal, family and living expenses are not deductible business expenses

• Forming an S corporation, partnership, or any other pass-through entity does not cause personal, living and family expenses to become deductible; nor do incorporation, the existence of board minutes, and partnership agreements authorizing personal, living or family expenses cause these expenses to become deductible

Examples of misuse of the law:

• TRAVEL – Deducting travel, meals, and entertainment under the guise that everyone is a potential client.

• AUTO – Excessive car and truck expenses when the asset has been used for both business and personal use.

• PAYMENTS TO FAMILY MEMBERS – Deducting payments to family members for routine household tasks that are not ordinary and necessary to the operation of the business, such as taking out the trash, mowing the lawn, washing the car, answering the telephone, etc. Also payments to family members that are excessive in relation to the services performed.

• BUSINESS USE OF HOME – Abusive promoters often advise taxpayers to deduct excessive costs associated with the operation of the home. The promoters claim that the “exclusive use” restriction can be avoided by placing business-related items in each room of the house. A deduction for the business use of a home is limited to that area of the home that is used regularly and exclusively for business purposes (Internal Revenue Code Section 280A). For example, merely placing a calendar or file cabinet in a room does not satisfy the “regular and exclusive business use” requirement.

• EDUCATION EXPENSES – Some schemes advise taxpayers that they may claim up to $5,250 per year in educational expenses for each family member. There are specific requirements that preclude virtually all investors in this scheme from qualifying for this deduction (Internal Revenue Code Section 127).

• MEDICAL REIMBURSEMENT PLANS – Abusive promoters assert that taxpayers can make their family’s medical expenses 100 percent deductible merely by employing their family member(s). In order for the medical expenses to be deductible under a self-insured medical reimbursement plan, a bona fide employer-employee relationship must exist. In addition, the plan has to meet other requirements (Treasury Regulation Section 1.105-11).

• RECORD KEEPING – Taxpayers in these schemes are advised to maintain detailed records of all expenses incurred. The existence of such records does not negate the requirement that expenses be “ordinary and necessary” in relation to a legitimate business activity. The expenses must also satisfy any other deductibility requirements (Internal Revenue Code Section 274).

Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.