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I issued a 1099M to my kids for work performed under the guidelines

of Federal Publication 15 Employer's...
I issued a 1099M to my kids for work performed under the guidelines of Federal Publication 15 Employer's Tax Guide (Family Employees) for domestic work perform in the parent's private home. The federal IRS has not questioned this write off, but the state of Alabama has.

The Alabama State Revenue has cited CFR 1.262-1 (Personal, living, and family) as stating "Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses". Based on this statement the state is disallowing my my deduction for the 1099 filed by me and on my child's Federal and State tax return.

My main question is which publication has priority of ruling over the other? I believe that my deduction claimed is justified based on Federal Publication 15 Employer's Tax Guide language. How do I address this issue?
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Answered in 15 minutes by:
10/18/2013
Lev
Lev, Tax Advisor
Category: Tax
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Lev :

Hi and welcome to our site!
There is NO contradictions - just because that payment was reported - doesn't mean expenses are deductible.
Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit.
Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.
The statement above is based on the federal law - see here - http://www.law.cornell.edu/uscode/text/26/262
a) General rule
Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.

Lev :

Thus, the fact the IRS has not questioned your deduction doesn't mean much - they have three years to audit the tax return - and assess additional tax liability.
However - if these are not personal - but business related expenses - such expenses indeed may be deducted - and you may address the issue by providing supporting documents and explanation for business purpose of these expenses.

Customer: If you read pub 15, it states that wok performed does not have to linked to a business. What is your view on this? The state tax person told me even if I hired a house keeper and issued a 1099 which is filed, I can not claim as an exemption.
Customer: I am looking for a position to hing my hat on.
Lev :

You are correct - if you hire a house keeper and pay for services - that is income to that house keeper and you as a payer might be required to report that payment.
However - that doesn't mean you may deduct such payment.
Reporting requirements for payments and deducting such payments are two different issues.
Publication 15 that you referenced addresses reporting requirements - but it says nothing about deducting such expenses.
Still the federal law we mentioned above states that personal expenses are not deductible - and that statement is valid for both federal and state levels.
If these are personal expenses - we may not deduct them unless such deduction specifically allowed by the law. For instance - the law allows to deduct personal mortgage interest expenses - but there is no statute which allows to deduct a housekeeping expenses.

Customer: So the botXXXXX XXXXXne is, I am screwed? Is there' no other leverage point for me to use. Just need to offset the impact if the federal Gov't decides to audit after closure with the state. The funny part is I am receiving a refund from the state for 2010', 2011, and 2012.
Customer: how do I prep for the Federal if they audit?
Customer: Are you still there?
Customer: I am still awaiting a final answer. Should I expect a final response?
Lev :

Sorry - I am here

Lev :

Unfortunately - your situation doesn't leek good...
In general - you may amend your past tax return - and there would be additional tax liability, penalties and interest charges.

Lev :

That is true for both - federal and state tax returns,
What you might want to consider - the statute of limitation for 2010 tax return would generally run out on Apr 15, 2014 - three years after the tax return was due.
So - if the IRS would not send you an assessment letter before that date - they will not be able to assess additional liability for that tax year after that.

Lev :

The best path forward might be to ask the IRS to abate penalties, however it would be very unlikely that interest charges are abated. File a form 843 -http://www.irs.gov/pub/irs-pdf/f843.pdf
to request the "accuracy related penalty" be abate based on reasonable cause. If you provide the reason like "I forgot" - I do not think it will be considered as reasonable - so be careful when prepare an abatement request. If you have a health reasons - most likely it would be accepted.
Here are instructions - http://www.irs.gov/pub/irs-pdf/i843.pdf
If the IRS accepts your reasons as reasonable - and agrees to abate penalties - at least part of the issue would be resolved.

Lev :

States are usually more more reluctant for abatement requests...
But if the amount of additional tax liability is substantial - you might consider having someone representing you with taxing authorities.
Unfortunately - there is no simple and easy resolution.
You might expected a different answer... please do not shoot the messenger.

Customer: The state is refunding me approx. $4500 as soon as I agree to the audit conducted. I will take your advice reference the Federal. I guess I will just need to wait and see if they audit. They did a review in 2010 and ruled in my favor. I will pray that they don't have time to bark up my tree.
Lev :

That would be your choice. Please be aware that state audit will be available for the IRS as soon as it is completed - so they may follow.

Lev
Lev, Tax Advisor
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Satisfied Customers: 30,162
Experience: Taxes, Immigration, Labor Relations
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