What expense category is Audit and Tax Preparation Fees?

For any business, ensuring financial accuracy and tax compliance is paramount. This often involves two distinct professional services: a formal financial audit conducted by a CPA firm and the annual preparation of your business tax return. The fees paid for both of these services are a necessary cost of doing business.

While both are professional fees, the IRS has specific rules about their deductibility, particularly when it comes to separating business from personal tax preparation costs. This guide will clarify how to categorize these fees per IRS rules to ensure your company remains compliant.

Audit and Tax Preparation Fees Category

The fees you pay for a financial audit of your business and the preparation of your business tax return are ordinary and necessary business expense. These costs fall under the general category of Legal and Professional Fees.

IRS Publication 334 allows for the deduction of fees charged by accountants that are directly related to operating your business. This includes both auditing and tax preparation services.

Important Considerations While Classifying Audit and Tax Preparation Fees

The most critical factor is distinguishing between fees that are 100% for the business and those that may be partially for personal matters.

Financial Audit Fees

The cost of a formal financial audit of your business's books and records is a deductible business expense. This service is performed directly for the benefit of the business entity.

Tax Preparation Fees (Business vs. Personal)

This is where allocation is key. IRS Publication 334 states that you can deduct on Schedule C the cost of preparing the part of your tax return that relates to your business.

• Deductible Portion: The fee for preparing your Schedule C, Schedule SE, and related business forms (like Form 4562 for depreciation) is a deductible business expense.
• Non-Deductible Portion: The fee for preparing the personal parts of your Form 1040 (such as itemized deductions on Schedule A or reporting personal investment income) is a personal expense and is not deductible as a business expense. Your accountant's invoice should ideally break down the fee between business and individual preparation.

Fees for Resolving Tax Issues

Publication 334 also clarifies that you can deduct the amount you pay or incur in resolving asserted tax deficiencies for your business.

Tax Implications and Recordkeeping

To deduct these professional fees, you must report them correctly and maintain proper documentation.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), the deductible portion of audit and tax preparation fees is reported on Part II, Line 17, Legal and professional services.

What Records to Keep

You must have documentary evidence to substantiate the fees. Your records should include:

• The engagement letter from your CPA or tax preparer.
• Invoices that detail the services provided. For tax preparation, the invoice should ideally separate the fee for the business return from the fee for the personal return.
• Proof of payment, such as a canceled check or credit card statement.

How Fyle Can Automate Tracking for Audit and Tax Preparation Fees

Fyle helps you manage and document payments to your accounting and tax professionals, ensuring every invoice is captured and ready for tax time.

• Centralized Invoices: Have your CPA firm email invoices forwarded so they can be sent to Fyle for automatic and accurate data capture.
• Separate Business vs. Personal: If an invoice includes both, you can easily split the expense in Fyle to ensure only the business portion is coded for deduction.
• Create a Clear Audit Trail: Fyle keeps the engagement letter, invoices, and proof of payment together in one easily accessible digital record.
• Automate Your Accounting: Sync the categorized professional fee directly to the correct GL account in QuickBooks, Xero, NetSuite, or Sage Intacct.