Note:

Some organizations may want to claim charitable and program expenses as "promotional expenses" , which if proven to be ordinary and necessary, are fully deductible.

Lobbying and political expenses are not deductible expenses.

Fines and penalties are not deductible expenses.

Amounts paid for kickbacks, bribes, and other illegal payments are not deductible expenses.

Amounts paid by health care providers for payments in consideration of the referral of a client, patient or customer are not deductible expenses.

Amounts in excess of reasonable compensation or compensation for non-profit motivated activities are not allowable as a deduction.

Income taxes paid (including UBIT) are not deductible.

Expenses incurred in connection with a convention, seminar, or similar meeting held outside the "North American area" are limited under IRC section 274(h). Rev. Rul. 2011-26, 2011-48 IRB 803.

Substantiation of Expenses.

Generally, the burden of proving the existence of a deduction or loss falls on the organization.

Examiners should use their best judgment in balancing utilization of time on substantiating expenses and accomplishment of the overall EO examination program as directed by Management. Thus, EO Examiners are not required to substantiate all deductible expenses unless the situation demands it.

Scrutiny should be reserved for expenses that appear unreasonable, large, unusual, and questionable. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992) [92-1 USTC P 50,113].

The "Cohan rule" is often cited by taxpayers who ask to use estimates where specific proof of the amount of the claimed deduction is absent. Cohan v. Commissioner, 39 F. 2d 540, 543-544 (2d Cir. 1930) [2 USTC P 489]. However, the organization must establish the essential proof necessary to allow for an estimate. Coloman v. Commissioner, 540 F. 2d 427 (9th Cir. 1976) [76-2 USTC P 9581], affirming T. C. Memo. 1974-78; see also Vanicek v. Commissioner, 85 T.C. 731 (1985).

Expenses for travel, entertainment expenses, business gifts, computers and vehicles require record-keeping before a deduction is allowed. These expenses should be substantiated in accordance with IRC 274(d) and IRC 280F and the regulations thereunder.

Depreciation.

A depreciable asset begins to depreciate in the year it is first placed in service.

Note that the useful life or cost recovery period for certain assets may have expired before the year under examination began; thus, further depreciation of such assets would not be allowed.

Certain assets are NOT depreciable, such as certain works of art and land.

The IRC 179 deduction is only allowed if an election was made on a voluntarily filed tax return.

In general, the depreciation method depends on when tangible property was placed in service: 1. Since 1986 – Generally Use MACRS, 2. After 1980, but before 1987 – Use ACRS, 3. Before 1981 – Use straight line, DB, SYD or other consistent method.

EO examiners generally will not challenge the organization’s depreciation methods established before the revoked years, and reported on annual EO Information Returns.

Dividend Received Deduction.

Corporations are allowed a special deduction called a dividend received deduction. See IRC 243, IRC 244, IRC 245 and IRC 246. The major reason for the dividend received deduction in IRC 243 is to avoid so-called "double taxation" in corporate taxes on earnings as income is passed from one corporation to another.

Generally, examiners will not allow this deduction unless a revoked organization can establish that it is entitled to the deduction.

IRC 277, Deductions Incurred by Certain Membership Organizations in Transactions with Members.

IRC 277 provides that a membership organization not exempt from tax may deduct expenses attributable to the provision of goods or services to members only to the extent of income derived from members. The purpose of this provision is to prevent nonexempt membership organizations from effectively rendering themselves free of tax by off-setting losses from membership activities against income derived from investments or other nonmember sources to produce little or no taxable income. Were they permitted to do so, they could put themselves in a better position than exempt clubs, which are taxable on all income but "exempt function" income.

Other Income tax provisions.

IRC 263 and IRC 263A requires corporations to capitalize certain expenditures or include in inventory certain costs incurred in connection with real property and inventory.

IRC 470 provides that if a corporation leases property to a governmental or other tax-exempt entity, the corporation cannot claim deductions related to the property to the extent that they exceed the corporation’s income from the lease payments.

If an organization under examination requests a change in accounting method, follow the procedures in IRM 4.11.6. A request for change in accounting method for an organization under examination requires the consent of the Director, EO Examinations before an application on Form 3115, Application for Change in Accounting Method, can be submitted in accordance with the instructions of the form. See Rev. Proc. 2008-52, 2008-2 C.B. 587.