The Labour candidate is accused of diverting public money – intended for parliamentary duties – during his campaign to become West Midlands Mayor.
It has led to the Independent Parliamentary Standards Authority (IPSA) launching an investigation into the Birmingham MP's staff and office costs.
But the claims have been dismissed by members of Mr Byrne's team who claimed they are "purely politically fabricated" as they welcomed the inquiry.
A spokesman for IPSA, which confirmed the investigation, said: "The Compliance Officer for the Independent Parliamentary Standards Authority has opened an investigation to determine whether Mr Liam Byrne MP has been paid an amount under the MPs’ Scheme of Business Costs and Expenses (‘the Scheme’) that should not have been allowed.
An investigation will be conducted into claims submitted under the following areas of the scheme: Staffing and Office Costs in 2019/20.
"In accordance with the legislation and the procedures for investigation made thereunder, no further information will be published until the investigation has been concluded."
The move comes after Tory MP Andrew Bridgen wrote to the authority, which monitors the expenses scheme for MPs, demanding an investigation into an "alleged gross misuse of parliamentary expenses" by the Birmingham Hodge Hill MP.
The letter sent to IPSA by Mr Bridgen includes a reference to a claim from an unnamed local election candidate who reportedly said Mr Byrne's parliamentary staff were being made to "work full-time on the mayoral election".
It also includes an allegation said to be from a former staff member of Mr Byrne's, who complained to Labour's ruling National Executive Committee that he was "using his publicly funded parliamentary staff to run his mayoral campaign".
According to the letter, the staff member claimed their own wages were paid from Mr Byrne's parliamentary budget, despite doing work that was "100 per cent non-parliamentary".
A further allegation says Mr Byrne employed a "constituency assistant" through the House of Commons, who described his role primarily as "managing" his "campaigns". He is also said to have employed a parliamentary head of research who "developed local policy" for his Mayoral campaign.
Leicester MP Mr Bridgen's letter also says Mr Byrne has spent more than £31,000 on Facebook advertising since the end of 2018, but has only registered donations of £23,583.20 during that time.
A spokesman for Liam Byrne's office said: "These complaints are purely politically fabricated by Liam's opponents and were made up to throw mud at Liam in the high stakes West Midlands Metro-mayor election. That's politics. There is no truth to them and so it is quite right IPSA investigate them quickly and efficiently in order to put everyone's mind to rest."
West Midlands Mayor Andy Street won a second term in the election in May after comfortably holding off the challenge of Labour, with the former John Lewis boss winning on second preference ballots after falling just short of the 50 per cent vote required to claim a first round victory.
The Conservative politician received 314,669 votes over the two rounds, which put him 47,043 ahead of Labour's Liam Byrne after the run-off and saw him increase his vote share from 50.4 per cent in 2017 to 54 per cent this year.
Steve Caudwell of the Green Party came third with 35,559 votes, while Lib Dem Jenny Wilkinson was fourth on 21,836 and Reform UK's Pete Durnell brought up the rear on 13,568.