Travel, Meals and Entertainment Expenses
Commuting Expenses. To open this section I want to be sure we understand that, in general, the costs of commuting between a taxpayers home and work location are nondeductible commuting expenses. But under certain circumstances these commuting expenses can be deductible if:
1) The expense is for going between the taxpayers home and a temporary work location outside the metropolitan area where the taxpayer lives and normally works.
2) The taxpayer has one or more regular work locations away from home and the expenses are for going between home and a temporary work location in the same trade or business, regardless or distance or
3) The taxpayers home is the taxpayers principal place of business, and the expenses are for going between home and another work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance.
A temporary work location means a job or contract that is expected to last, and actually does last for one year or less.
What we strive for is to make as much vehicle mileage deductible as possible. Learn the commuting rules above. Mileage around town in the course of your business is generally deductible. Having a home office really helps as your business miles are determined as you drive away from your home.
If you do not qualify for a home office, your miles to your business are nondeductible commuting miles, but all the rest of the miles you drive for business are deductible. If you do not go into the office, the miles to your first client or job is commuting, then miles from job 1 to job 2 to job 3 and back and so on are deductible, and the miles from the last job or client is nondeductible commuting. These are very important concepts as by knowing them you can design your day to optimize deductible miles.
Tax Commandment – Keep A Mileage Log!!! More on this later.
Travel Away From Home. Expenses for transportation, meals and lodging are deductible for business travel away from the taxpayer’s tax home. The term ‘tax home’ includes the entire city or general area where the taxpayer regularly conducts business. The tax home is determined without regard to where the taxpayer’s family home is located. Actually, a husband and wife can have different tax homes if each works in a different area. The ‘tax home’ concept is important to understand.
I recall a client who lived in Solvang who took a job in Los Angeles, so he had to drive there every week. Many times he’d get a motel and stay and drive back on weekends. This was a permanent position (not temporary). He wanted to deduct his miles back and forth as well as his lodging. No dice. He doesn’t qualify for any of the commuting exceptions above. The IRS says it is his choice to work so far away from his job. His tax home is in LA where he works, therefore, no deduction.
There are a number of special rules on tax home such as for; transients, airline pilots, military, etc.
To deduct travel expenses one must meet the ‘overnight rule.’ You must be away from your tax home longer than an ordinary work day, and must be away long enough that you cannot reasonably expect to complete the trip without sufficient sleep or rest. And the rest period must be of sufficient duration that is necessary to secure lodging. A cat nap at a rest stop is not sufficient rest for this purpose.
Once you meet the requirements, you can deduct ordinary and necessary reasonable costs of; transportation, bus, taxi, baggage, vehicle, lodging and meals, dry cleaning, telephone, tips, internet access, computer rental fees, etc.
Special rules apply when business travel is mixed with personal travel. When a trip is made:
- Entirely for business – all travel expenses are deductible.
- Primarily for business – facts and circumstances must be looked at but usually the transportation is deductible for taxpayers cost (not spouse or children unless they are employees and an integral part of the business). Same with meals, hotel, etc.
- Primarily for personal reasons – The entire cost of the trip is nondeductible however, any direct business related expenses incurred at the location are deductible.
Special rules are there for luxury water travel, conventions in North America, conventions outside of North America, cruise ship conventions, travel outside of the United States and the like.
Meals and entertainment. The cost of entertaining a client, customer or employee can qualify as an ordinary and necessary business expense. Entertainment activities can include the cost of meals (food, beverage, tax, tip). Entertainment can be provided at facilities such as nightclubs, social clubs, sports facilities or theaters, or on hunting, fishing, vacation and similar trips. However, a deduction is generally not allowed for the cost of renting or owning an entertainment facility such as for country club dues.
To qualify for a deduction, the entertainment expenses must be directly related to or associated with the active conduct of a trade or business, or for the production or collection of income.
Directly related: The taxpayer must show that the main purpose of the event was business, engaged in business with a person or persons during a meal or entertainment activity and have more than a general expectation of receiving income or some other specific business benefit in the future.
Associated with: The taxpayer provides entertainment or a meal directly before or after a substantial business discussion. The taxpayer must actively engage in a meeting, discussion or other business transaction to obtain income or some other specific business benefit. It is not necessary that the taxpayer devote more time to business than to entertainment.
Note: Meals with business associates and coworkers are generally not deductible unless that taxpayer can establish a clear business purpose.
Lavish or extravagant: Expenses are not allowed for entertainment that is lavish or extravagant (remember the ordinary and necessary discussion). Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs or resorts. However, the expenses must be reasonable considering the facts and circumstances.
50% Deduction Limitation: Per the IRS Code, expenses for meals and entertainment are only allowed at 50% (unless subject to Department of Transportation rules, then they’re 80% deductible). So if you entertain a client or deduct meals while on business travel and spend $500, your deduction is only $250.
Record Keeping Requirements
Most of us do not like the record keeping part of the tax system, but it is critical to your tax health. It’s also important to your business health, as good records help you monitor and improve your business. You can only control what you measure and, without good records, it’s hard to measure.
You simply cannot depend on the begging the IRS for mercy when it comes to your records. Getting your tax records right is not difficult when you know what to do, set up a system to do it, and form the habit of doing what the system requires.
What do you think is the unpardonable sin in an IRS audit? If you said, lousy records you win the prize. I’ve been in IRS audits with good records and bad, and believe me, good records saved the client taxes and, it saved the client fees for me to represent them in the audit. Of course, bad records did just the opposite, but you already knew that.
Here are some guidelines to follow:
Set up separate business checking accounts. Do not comingle with personal funds, or funds of separate businesses. Deposit receipts only in the account that earns the money.
Record deductible expenses daily. Okay, weekly is fine. The longer things sit, the harder it is it seems to get it in, and the harder it might be to remember what it is for.
Keep mileage logs. To deduct your vehicle expenses, you need proof of business use. This is true whether you operate as a sole proprietor, partnership, corporation, LLC or anything else. If you are an employee of your corporation, you must submit business use substantiation to your corporation. Partners reimbursements should be set up the same.
A great way to track your business mileage is in your appointment book so it reflects your business activity each day. Further, the appointment book facilitates the use of a sampling method that allows you use a three month log to prove business use for the year if your mileage is fairly repetitive.
Use a separate log for each vehicle and for each business or rental property if applicable.
If you don’t use an appointment book, there are special auto mileage logs you can buy at staples or office depot that fit in your pocket, software, or you can design your own.
You also need to show how many miles your business vehicle(s) went for the whole year, as well as how many business miles. I suggest having an oil change as close to January 1st of each year as possible. This gives you the beginning and ending miles for each year.
Again, remember that information, expenditures, and mileage logs must be kept separately for each business vehicle. Unless you plan to just take the standard mileage rate where you figure business miles and apply an IRS rate to it, you need to know how much was spent for vehicle #1, #2, etc separately along with their respective logs.
There is just no really fun way to do all this. But if you want the maximum deduction, bullet-proof audit protection, and peace of mind, you must develop the habit of keeping up auto and all business records.
Records for travel and entertainment. You need to prove, for each day of travel, where you were and why you were there.
For meals and entertainment, you need to record who, what, when, where, why, and how much. A tip is to add a short note to each receipt with the name of the person you entertained, why you entertained this person, what relation this person has to your business, and what the meeting did for your business (the future benefit). The receipt itself contains the remaining documentation; what, when, where, how much. Be sure to write the tip on the receipt as well.
Important: If you operate a corporation (C or S), you need to turn the documentation in to the corporation, and the corporation needs to either pay for the entertainment and travel expenses directly (with a corporate credit card) or reimburse you dollar for dollar for the amounts spent. Do not neglect this step or you will lose deductions.
Proof for other business expenses. For all expenses, from the purchase of your desk and computer to pens and staples, you need to:
- Prove what you bought. Get receipts and save all your receipts!
- You need to prove you paid for what you bought. Cancelled check, credit card receipt or other proof of payment.
- You need to show that what you bought is an ordinary and necessary business expense for your business. Be able to prove they are not personal use items.
As a general rule, don’t pay in cash. It’s like putting fresh meat in front of a bear. The radar flips to high and all sorts of questions fly out of the auditors mouth:
- Where did the cash come from?
- How can you track the cash to the payment?
- Was an ATM withdrawl evident before the cash payment?
- Did you really spend the cash or just make up this deduction?
By using checks or credit cards, you don’t endure this line of questioning. If you have to pay in cash, get a receipt and jot the answers to the above questions on it and save it.
When I walk into an IRS audit with receipts, documentation, and perfect logs, I blow away the auditor right off the bat, and the rest of the audit slides like a sled on snow.
When I walk into an audit with bad records, the auditor takes a more aggressive stance. “If this record is bad, maybe there’s more to go after.” As the old saying goes, “you never get a second chance to make a first impression.” It’s as true here as anywhere.
Call me with any questions you may have. (805) 264-3305