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Q: I frequently advance expenses to clients that total as much as 25 to 50 percent of their final invoice. These fees are reimbursable, but are there tax considerations I should be aware of?

Kenneth Kunkle, attorney/principal
Kunkle Trademark & Legal

A: It depends on the type of expense. Let's start with the more complicated, and in my opinion, least desirable, of the situations. If it is an advance for costs that have to be made specifically for this client, then the advance might be considered a "loan." Examples could be things such as payments to service vendors or contractors that have a special skill or access that only this client needs, or equipment that you will use only once for this client. In those cases, the IRS might not want you to expense it as an immediate business expense. In that situation, then you would book those expenditures that you paid as a loan to your customer (an asset on your books) that is to be recovered when your client pays their invoice. In this situation, you should be charging your customer interest on the loan. Of course, a simple remedy for this complicated "loan" situation would be for your client to pay their own expenses directly.

If, on the other hand, you can make the argument that the expenses are not unusual, and are the kind of costs that you would have generally paid for any client, then the reimbursement is not included in your income (and, of course, you do not get a deduction for the costs because you have been reimbursed).

A third situation would arise if the expenses being advanced on behalf of your clients were the type of meal and entertainment expenses that would be subject to the 50 percent tax disallowance. In this situation, it is important to be clear in your contractual arrangement with your clients about which party (you or them) will be subject to the 50 percent tax disallowance. Your preference would likely be to provide your clients with adequate documentation of any meal and entertainment expenses incurred such that you are fully reimbursed on a nontaxable basis, and they are subject to the 50 percent disallowance based on bearing the ultimate economic cost for these meal and entertainment expenses.

David Vang is a professor of finance at the University of St. Thomas Opus College of Business.