Professional Fees Can Be Scary… But Deductible

Most people hate paying taxes but not far behind is their dislike of paying for tax and other professional financial services. However, value propositions for clients can be increased when they understand how professional fees are being claimed to their advantage on their tax returns.

By paying close attention to this pain point for your clients, you may be able not only to reduce their annual tax bill, but increase referral opportunities, too, especially since the rules for deducting various professional fees can be complicated. For example, accounting fees are deductible to the extent they are incurred for bookkeeping and/or recordkeeping for an investment or investment portfolio. Use Schedule 4 for these purposes: the Statement of Investment Income.

The cost of preparing a tax return is also deductible but only if the individual is reporting income from a business or rental. In the former instance,  deduct these expenses as accounting fees on Form T2125 Statement of Business or Professional Activities; in the latter use Form T776 Statement of Real Estate Rentals as opposed to Schedule 4 Statement of Investment Income. Commission sales employees may also deduct tax preparation costs in some cases.

Legal fees are deductible if they were incurred:

• in the ordinary course of a business. This would include legal fees paid for annual filings and regular business matters
• in the course of appealing, or objecting to, an income tax assessment from CRA
• to obtain financing for an investment. Twenty percent of such fees are deductible annually over five years
• to make representation in relation to a business carried on by the taxpayer. This could include various activities, from lobbying government to obtaining licensing, permits, franchises or trademarks
• in the course of collecting money owed to a taxpayer as a severance, pension benefit, or retiring allowance. The amount deductible is limited to the amount of the payment actually received by the taxpayer, less any amount transferred to a Registered Retirement Savings Plan (RRSP). Legal fees in excess of this limit may be carried forward up to seven years if additional payments are received

Here are some true-to-life examples, to help you and your clients understand some of these rules better:

First, let’s take a look at Bob’s situation.  He has accumulated several rental properties that earn a nice investment income each year. He paid his accountant $1,750 this year to do the bookkeeping for his properties, and to prepare his tax return. Can Bob deduct the accounting fees? The answer is yes. Since the accounting fees were paid for bookkeeping and tax preparation for purposes of earning income from a rental property, Bob may deduct these fees on his tax return for the year in which they are paid using the rental income statement.

Frank’s Pizza Business is our next example. Frank is the proprietor and he pays an annual fee to his lawyer to keep his business-name registration up to date. In the current year, he also paid a fee to his lawyer for preparing security documents for a mortgage Frank took out to allow the business to purchase a new building. How are these fees treated? In this case, the fees for the annual filing are deductible in determining the profit from the pizza business. The fees for assisting with the mortgage financing are deductible, but not all at once; special rules require they are deducted over five consecutive years—one fifth in each.

In our third example, Alexandra is in the process of a heated and expensive argument with the CRA. She earns income each year by buying homes, fixing them up, and renting them out for upscale rentals. Two years ago, she was reassessed by CRA. She incurred total legal fees of $5,000 in the course of objecting to the reassessment. Can she deduct these fees? The answer is, again, yes. Because these legal fees were paid in the course of objecting to a CRA assessment or re-assessment, they are fully deductible.

Advisor Alert: Staying current on what business and investment expenses are deductible for your clients can make a significant difference to their tax bill. Especially if you are in the financial services industry, consider embellishing on your credentials with an MFA – Business or Retirement Income Specialist Designation.

Client Alert: There are tax rules in place that allow you to offset some of the costs you incur for professional advice. Be sure to ask your accountant or financial advisor whether you can get a break on the fees you are paying him or her, as well as on your legal fees. Jacks on Tax by Evelyn Jacks is also a handy reference on the tax treatment of these and other expenses. You can order it at www.knowledgebureau.com or by calling toll free 1-866-953-4769.