Is it Normal to Allocate 83% of Business Expenses to “Other Deductions” on a Tax Form?

Navigating Expense Categorization on the 1120S Form

I find myself grappling with a complex issue related to expense categorization on the 1120S tax form, and I’d appreciate some insights from a broader audience.

Business Context

I run a solo marketing and advertising agency and transitioned from a single-member LLC to an S-Corp on my CPA’s advice for tax savings. As the sole W2 employee, I frequently engage subcontractors, such as graphic designers, web developers, SEO.html" target="_blank" rel="noopener noreferrer">SEO specialists, and PR consultants, sourced from platforms like UpWork or through direct contracts with other agencies.

Current Challenge

Recently, during a deep dive into our financials with my bookkeeper, we encountered a disagreement with my CPA on expense categorization that needs clarification.

Previously, using Schedule C, subcontractor expenses were classified as “Contract Labor.” However, the 1120S form lacks this category. These expenses don’t fit under “Advertising” since they don’t pertain to promoting my business (that’s mainly for PPC campaigns), and they don’t belong under wages, considering none of these are regular employees.

Differing Opinions

My CPA proposes classifying these expenses as “Other Deductions,” supported by an attached statement clarifying their nature. He suggests indicating “Cost of Goods Sold” as zero since our business, designated by the 541800 Business Activity Code, doesn’t produce tangible goods. He recommends aligning these classifications with the 1040C and appending the statement to the 1120S form.

In contrast, my bookkeeper argues that placing 83% of our deductions under “Other Deductions” could resemble listing them as “Miscellaneous Expenses” on the 1040C, potentially triggering an Audit. He believes “Cost of Goods Sold” (CoGS) should be interpreted as “Cost of Sales” or “Cost of Revenue,” suggesting that “Goods” in this context is irrelevant.

Bookkeeper’s Perspective

He contends this expense is an operational cost tied directly to business growth (generating more revenue results in higher subcontractor expenses) and should be treated as CoGS. This categorization, he argues, offers the IRS a clearer picture of net profit (about 25% of the business, including my wages). He warns that returns where over half of the expenses fall under “Other Deductions

When it comes to categorizing business expenses on an 1120S form for an S-Corporation, it’s crucial to strike the right balance between compliance and clarity. Misclassification can lead to unwanted attention from tax authorities, including potential audits. Here’s a breakdown of your situation with some guidance on how to navigate it:

Understanding the Dilemma

Business Structure and Tax Forms:
As an S-Corp, you’ve moved from using Schedule C (for sole proprietorships and single-member LLCs) to Form 1120S.
Transitioning from Schedule C, where you previously categorized similar expenses under “Contract Labor,” might seem challenging due to form differences.
Categories on Form 1120S:
Unlike Schedule C, Form 1120S does not have a specific line for “Contract Labor.”
Common categories include compensation of officers, salaries and wages, repairs and maintenance, rents, taxes and licenses, advertising, and more.
“Other Deductions”:
It’s a catch-all option intended for expenses that don’t fit neatly into other categories.
Attaching a detailed statement explaining these deductions is commonly practiced.

Perspectives and Recommendations

CPA’s Perspective:

Usage of “Other Deductions”:
Labeling subcontractor expenses as “Other Deductions” with an attached statement is a straightforward, although somewhat unconventional, method.
It’s defensible if well-documented and clearly justified, but there’s an inherent risk of scrutiny due to the majority of expenses falling under this label.

Bookkeeper’s Perspective:

Categorization as CoGS:
This aligns expenses as directly related to earning revenue, depicting a clearer rela0tionship between income and expenses.
Although “Cost of Goods Sold” traditionally pertains to tangible goods, service-oriented businesses can reasonably interpret it as “Cost of Revenue,” especially when subcontractor work is integral to service delivery.

Recommendations:

Documentation is Key:
Whatever path you choose, meticulously document the nature of each expense. A supplementary statement should contain thorough descriptions and justifications.
Consider the Nature of the Expenses:
If subcontractor services are essentially the product your business sells (i.e., marketing services facilitated by subcontractors), aligning with CoGS might be more intuitive and transparent.
Consultation:
Since both book

One response

APAdmin

25 February 2025 at 8:17 PM
When it comes to categorizing business expenses on an 1120S form for an S-Corporation, it’s crucial to strike the right balance between compliance and clarity. Misclassification can lead to unwanted attention from tax authorities, including potential audits. Here’s a breakdown of your situation with some guidance on how to navigate it:

Understanding the Dilemma
1. Business Structure and Tax Forms:
2. As an S-Corp, you’ve moved from using Schedule C (for sole proprietorships and single-member LLCs) to Form 1120S.
3. Transitioning from Schedule C, where you previously categorized similar expenses under “Contract Labor,” might seem challenging due to form differences.
4. Categories on Form 1120S:
5. Unlike Schedule C, Form 1120S does not have a specific line for “Contract Labor.”
6. Common categories include compensation of officers, salaries and wages, repairs and maintenance, rents, taxes and licenses, advertising, and more.
7. “Other Deductions”:
8. It’s a catch-all option intended for expenses that don’t fit neatly into other categories.
9. Attaching a detailed statement explaining these deductions is commonly practiced.
Perspectives and Recommendations

CPA’s Perspective:
- Usage of “Other Deductions”:
- Labeling subcontractor expenses as “Other Deductions” with an attached statement is a straightforward, although somewhat unconventional, method.
- It’s defensible if well-documented and clearly justified, but there’s an inherent risk of scrutiny due to the majority of expenses falling under this label.
Bookkeeper’s Perspective:
- Categorization as CoGS:
- This aligns expenses as directly related to earning revenue, depicting a clearer rela0tionship between income and expenses.
- Although “Cost of Goods Sold” traditionally pertains to tangible goods, service-oriented businesses can reasonably interpret it as “Cost of Revenue,” especially when subcontractor work is integral to service delivery.
Recommendations:
1. Documentation is Key:
2. Whatever path you choose, meticulously document the nature of each expense. A supplementary statement should contain thorough descriptions and justifications.
3. Consider the Nature of the Expenses:
4. If subcontractor services are essentially the product your business sells (i.e., marketing services facilitated by subcontractors), aligning with CoGS might be more intuitive and transparent.
5. Consultation:
6. Since both book
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Is it normal to put 83% of business expenses under “Other Deductibles” in a tax form?

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