Yellow Light Orchestra
Brad and his wife run a preschool, so we often wind up using a lot of metaphors around here that would appeal to school-age children. Case in point? The Green Light, Yellow Light, Red Light framework we use for helping clients understand what’s definsible, what’s risky, and what’ s an absolute no-go from a tax deduction standpoint.
Green Light Deductions are expenses that are 100% business use, directly correlated to business activity, and would pass any audit with flying colors. These are easy.
Red Light Deductions are expenses that don't have business use, can't be tied to producing income, or have specific case-law prohibiting their deduction. These are also easy. Some clients try to make these complicated, but they’re easy.
That leaves us with Yellow Light Deductions, and where we see the most confusion. Here are some guidelines to help you figure out if that expense truly is a deduction:
Is it used by you outside the business? If it has both business & personal use, can you allocated and support a percentage to business use? (similar to what we do with home office & auto expenses)
Can you tie the use of it DIRECTLY to making income? e.g. if you didn't incur this expense, you couldn't make income
Is there any case law specifically prohibiting it? (such as with personal-care expenses)
A good Yellow Light Deduction question we got asked recently was on the deductibility of Botox. Normally - this would be hard-no because of the personal benefit the taxpayer derives from this.
In this example though, the engagement was specifically with a company wanting to pay for a review of the product, and as part of that, the taxpayer had to purchase the product to do the review. Because there is a clear tie between making the income and the expense (the review cannot be done and money will not be made unless the product is purchased), this deduction now becomes a Green Light Deduction.
With Yellow Light Deductions - document, document, document! Remember, these are deductions that aren't as black-and-white as a Red or Green Light Deduction, so it would be beneficial to have more support for the deduction that normal.
