IRS allows deduction to AGI for certain tax-related payments.

Individuals whose business activities require the preparation of Schedule C, Profit or Loss from Business; Schedule E, Supplemental Income or Loss; and Schedule F, Farm Income and Expenses, for their individual returns, and those that incur expenses to resolve asserted tax deficiencies relative to these activities, have scored a major victory. In Rev. Rul. 92-29, the IRS made it clear that "above the line" deductions for allocated portions of return preparation fees are now permitted, as long as the return preparation bill states clearly a reasonable allocation for these three schedules. The Service also allowed similar treatment for fees paid to resolve asserted tax deficiencies. The ruling does not address the subject of "tax advice" as it relates to sole proprietors, farmers or persons with supplemental income.

Last year the {RS held in Letter Ruling 9126014 that tax advice and return preparation fees relative to Schedules C and E would only be allowed as a miscellaneous itemized deduction pursuant to Sec. 212[3}, subject to the 2% floor.

In the letter ruling, the Service placed a great deal of weight on Temp. Regs. Sees. 1.67- 1T(a)(1)(iii) and 1.62-IT(d). Temp. Regs. Sec. 1.67-IT{a)(2){iii) provides, as an example of a miscellaneous itemized deduction, the "[e]xpense for the determination of any tax for which a deduction is otherwise allowable under section 212(3L such as tax counsel fees .... "But it is not clear whether this example was intended to apply to returns that did not include Schedules C, E and F.

Temp. Regs. Sec. 1.62-IT{d) provides that to be deductible for the purpose of determining adjusted gross income [AGI], expenses must be those directly connected with the conduct of the trade or business. The temporary regulations provide an example of taxes as they relate to rental real estate. State income taxes attributable to the income generated from the property are indirect and would not be deductible "above the line." Property taxes, on the other hand, are direct, and would therefore be deductible "above the line." The above language and examples actually may be traced back to the Senate Finance Committee Report as it relates to the predecessor to Sec. 62 {Section 22[n][l]) [AGI computation). Of greater significance from this Committee Report is the following.

Fundamentally, the deductions thus permitted to be made from gross income in arriving at adjusted gross income are those which are necessary to make as nearly equivalent as practicable the concept of adjusted gross income, when that concept is applied to different types of taxpayers deriving their income from varying sources .... Such equivalence is necessary for equitable application of a mechanical tax table or a standard deduction which does not depend upon the source of income.

When fees for preparation, resolution or advice relating to taxes are incurred by an entity such as a corporation or partnership, they are always deductible in arriving 'at the entity's income. To be fair to nonentity types of business activities, it seems only logical that the deductions for preparation, resolution or advice should be deductible in arriving at AGI. In Letter Ruling 9126014, the IRS chose not to place emphasis on this section of the committee report and also probably relied on Rev. Rul. 70-40, which allowed a deduction "below the line" for tax litigation expenses. Rev. Rul. 70-40 has, of course, been modified as it relates to tax-related resolution expenses.

In Rev. Rul. 92-29, the Service restated the intent of the above cited 1944 Senate Report regarding AGI. The ruling provides specifically for deductions in arriving at AGI for expenses incurred by an individual taxpayer in preparing that portion of his return that relates to his business as a sole proprietor, and expenses incurred in resolving asserted tax deficiencies relating to his business as a sole proprietor. Finally, expenses incurred in preparing schedules or resolving asserted tax deficiencies relating to profit or loss from business (Schedule C), income or loss from rentals or royalties (Part I of Schedule E)or farm income and expense (Schedule F)were deductible under Sec. 69,(a) in arriving at AGI.

The IRS was very clear about tax preparation and tax resolution fees being apportioned. However, the tax advice items that had been disallowed in Letter Ruling 9126014 were not addressed in Rev. Rul. 92-29. It seems that fees for tax advice attributable to the aforementioned activities should be treated comparably. However, a definitive answer on those fees cannot be given without further explanation by the IRS. From Charles E. Price, Ph.D., CPA, Associate Professor of Accountancy, School of Accountancy, Auburn University (not affiliated with DFK), Auburn, Ala.