Tuesday, December 17, 2013

Are Advisor Management Fees Deductible?

Tiffany C. Wright, Demand Media & AZ Central writes:  Small Business Owners often do not have the revenue or profitability to hire an executive management team during the earlier stages of their business. Therefore, they may rely on an advisory board or an external business advisor to assist them in managing their business. If these individuals or firms are compensated, the advisor management fees are fully tax deductible as long as these arrangements are treated as arm's length engagements. "Arm's length" means both parties act independently, in their own interests, as if they have no relationship.

External Consultants and Coaches

A business can deduct 100 percent of any monies it pays to external consultants for professional services, business assistance or management advice. For example, a company may engage a strategic advisory firm to help it determine the best strategy to enter into a new market or sell more products. Alternatively, a business owner who needs ongoing help working through various issues may hire a business coach. She may meet with that coach weekly to identify the source of the problems and come up with solutions. Both of these scenarios have a real business purpose and are therefore deductible as a business expense.

Legal and Professional Fees

Most small business owners claim the amounts they pay to business coaches, business advisors, strategy consultants and other advisor management professionals under "legal and professional fees" on their income statements. Owners must obtain an invoice for the services provided. The invoice must clearly state the name of the service provider, the description of the service provided and the cost of the service. Owners must retain these invoices as proof of services in case of an audit by the Internal Revenue Service.

Disallowed Deductions

There have been several legal cases where the Internal Revenue Service disallowed the tax deductions for advisor management services. In two cases reviewed for this article, the owner formed a separate company to provide management or advisory services to another company he owned. In these cases, neither company maintained accurate records of the services provided or the reasons behind the services. Invoices either did not exist or were irregular and lacked critical information. The IRS subsequently saw that one owner owned both companies and disallowed the tax deduction for the payments.

Related Entity Deduction Requirements

If a business pays a business advisory fee to a related party, that business advisory must be an arm's-length, traceable transaction. To avoid having the IRS disallow the tax deduction, owners must treat transactions between companies they own as they would treat transactions with a third party. A legitimate, provable business reason for obtaining the business advice must exist, and the person providing the advice must not work for both entities. A contract or proposal for services must exist, and the providing entity must invoice the other on a periodic basis.


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