Taking Care of Business: Making Sure Those Expenses Are Deductible
By Stephen Parezo
September 2004 Did you hear the one about the traveling salesman who incurred a ton of travel and entertainment expenses on his last business trip? Well, he assumed that all his outlays, whether they were paid in cash or with the corporate credit card, were deductible expenses. It wasn't until he tried to deduct all these charges that he learned a good deal of the expenses were not able to be fully written off.
Before the Internal Revenue Service started tightening its deduction limits and qualifying items as legitimate business expenses, those incurring costs reportedly for business purposes had a lot more leeway.
"That's one area that the IRS has always been diligent because of the potential for abuse," said Brent D. Rose, a Fiducial Tax Advisor at the company's Technical and Administrative Service Center (TASC) in Columbia, MD.
Keeping it strictly business
"If these expenses are business-related, travel and entertainment expenses need to be related to getting clients or trying to increase the business and for referrals," he said.
The key to deducting these types of expenses is making sure it's business related according to IRS statutes, which are very detailed requirements.
One such example of a company trying to take advantage of these expenses includes buying a boat and looking into depreciating it as a business asset. But this ploy just doesn't tread water with the IRS, said Rose.
"What most people don't understand is that a boat, especially if you buy it to entertain clients, is considered an entertainment facility and you're not allowed deductions for an entertainment facility other than mortgage interest or taxes," he said.
If the boat was purchased for a valid business purpose, such as providing sightseeing tours or fishing trips, then it would be considered a legitimate business deduction. Boat owners are either going to use it for business purposes or it's an entertainment facility for which all they can deduct is out of pocket expenses.
Meals are never on the house
In case the tab wasn't put on a credit card -- a credit slip where the signed receipt would serve as documentation -- the businessperson should write on the back of a piece of paper and record details such as date, time, who they met with, what they talked about and the general purpose of the meal. That way, they can fully substantiate the deduction in case the need arises.
There's a lot of misrepresentation that takes place under the guise of meals being a legitimate business gathering. "Taking a fellow employee out to lunch isn't good enough," Rose noted.
One area where the percentage of meals that can be deducted has increased is for transportation workers like interstate truckers who are allowed to write off around 65 percent to 70 percent of their meal expenses, up from the 50 percent level.
But there are some companies that aren't able to separate travel and entertainment expenses, said Mary Jane Rhoades, Fiducial Tax Accountant for corporations and partnerships at TASC.
"They still don't know the difference between these two types of accounts," she said. "It takes better recordkeeping."
Yet gray areas remain. Consider this example: A company holds an open house event for both clients and employees, with the event including a buffet and a deejay providing entertainment. Are all these business expenses 100 percent deductible?
Despite this being a business setting, only 50 percent of the meals and entertainment expenses in this scenario are deductible, according to IRS guidelines. On the other hand, if this was a company-sponsored holiday party then these expenses would be 100 percent deductible because they are traditional expenditures.
The following three-prong test is used to determine the validity of an expense:
Per diem rates are biggest abuse area
Many people want to use the per diem rate more than what they pay out of pocket, but the biggest abuse in this area concerns sole proprietors who cannot use the per diem rates. As a general rule, the small business person has to use actual lodging accounts.
Once again, Rose reminds that because they're statutory submissions, it's very important to keep good records and documents of travel and entertainment expenses.
"You ought to have a contemporaneous receipt, sign and date it on the same day," he said. "It will hold more weight than creating documents a while later."
For expenses paid by cash, the per diem can help a little bit for meals and incidentals but tips may not be included as part of a meal. The same rule applies to tipping a bellhop or concierge so be sure to keep track of those expenses too.
Support deductions with proper documentation
Here, Rose relates that if you're putting in for this deduction, make sure you take the product with you on vacation. Just be careful on trying to deduct the whole business trip. "If you can justify that the primary purpose was business, you're in good shape," he said, especially when the audit rate is low for these types of deductions.
For Schedule C sole proprietors, the biggest problem is they don't have documentation to support their expenses, which is more important that any other tax deduction since the documentation is required by Congress.
This further demonstrates the pivotal role that a tax professional plays in wading through the mire of paperwork from a small business and classifying receipts in the proper categories.
"It's important to have a good advisor who will point out what the requirements are for documentation to support these expenses," Rose added. "They will point out what the requirements are for documentation and usually will find additional deductions that the small business owner hadn't thought about."
STEPHEN PAREZO is the Writer/Editor for Fiducial.2004 Fiducial, Inc. Reprinted courtesy of international small business services provider Fiducial. For more information, tips and resources, log on to www.fiducial.com. All Rights Reserved.