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Don't overpay your income taxes by overlooking expenses which you are entitled to deduct. Use this Financial Guide to ensure you are handling your business travel and entertainment costs in a tax-wise manner.
Table of Contents
This Financial Guide shows you how to take advantage of all of the travel and entertainment expenses you're legally entitled to and offers guidance on which expenses are deductible and what percentage of them you can deduct. It also discusses the importance of following IRS rules for keeping records and substantiating your expenses in order to avoid an audit.
Tax law allows you to deduct two types of travel expenses related to your business, local and what the IRS calls "away from home."
Local Transportation Costs
The cost of local business transportation includes rail fare and bus fare, as well as the costs of using and maintaining an automobile used for business purposes. For those whose main place of business is their personal residence, business trips from the home office and back are considered deductible transportation and not non-deductible commuting.
You generally cannot deduct lodging and meals unless you stay away overnight. Meals may be partially deductible as an entertainment expense as discussed below.
Away From-Home Travel Expenses
You can deduct one-half of the cost of meals (50 percent) and all of the expenses of lodging incurred while traveling away from home. The IRS also allows you to deduct 100 percent of your transportation expenses--as long as business is the primary reason for your trip.
To be deductible, travel expenses must be "ordinary and necessary", although "necessary" is liberally defined as "helpful and appropriate," not "indispensable." Deduction is also denied for that part of any travel expense that is "lavish or extravagant," though this rule does not bar deducting the cost of first class travel or deluxe accommodations or (subject to percentage limitations below) deluxe meals.
What does "away from home" mean?
Where is your "home" for tax purposes?
There are some rules in the tax law concerning where a taxpayer's "home" is for purposes of deducting travel expenses that are less clear such as when a taxpayer works at a temporary site or works in two different places.
We'll cover these rules briefly in these two examples:
Here's a list of some deductible away-from-home travel expenses:
However, many away-from-home travel expenses are not deductible or are restricted in some way. These include:
There are limits and restrictions on deducting meal and entertainment expenses. Most are deductible at 50 percent, there are a few exceptions. Meals and entertainment must be "ordinary and necessary" and not "lavish or extravagant" and directly related to or associated with your business. They must also be substantiated (see below). For employees who are "fully reimbursed" (see below), the limits are imposed on the employer, not the employee.
Your home is considered a place conducive to business. As such, entertaining at home may be deductible providing there was business intent and business was discussed. The amount of time that business was discussed does not matter. Likewise, if you hold a small party (less than 12 people) at your home and discuss business with your guests it may be deductible as well.
Reasonable costs for food and refreshments for year-end parties for employees, as well as sales seminars and presentations held at your home, are 100 percent deductible.
If you rent a skybox or other private luxury box for more than one event, say for the season, at the same sports arena, you generally cannot deduct more than the price of a non-luxury box seat ticket. Count each game or other performance as one event. Deduction for those seats is then subject to the 50 percent entertainment expense limit.
If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. The amounts separately stated for food and beverages must be reasonable.
Deductions are disallowed for depreciation and upkeep of "entertainment facilities"-yachts, hunting lodges, fishing camps, swimming pools, and tennis courts. Costs of entertainment provided at such facilities are deductible subject to entertainment expense limitations.
Dues paid to country clubs or to social or golf and athletic clubs are not deductible. Dues that you pay to professional and civic organizations are deductible as long as your membership has a business purpose. Such organizations include business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards.
Entertainment costs, taxes, tips, cover charges, room rentals, maids, and waiters are all subject to the 50 percent limit on entertainment deductions.
Expenses are directly related if you can show:
There is a presumption (in the eyes of the IRS) that events that take place in what it considers places non-conducive to doing business are not directly related to your business. These places include nightclubs, theaters, sporting events or cocktail parties. It also includes meetings with a group of people who are not business associates, at cocktail lounges, country clubs, or athletic clubs. However, you can overcome the presumption by showing that you engaged in a business discussion or otherwise conducted business during the event.
Even if you can't show that the entertainment was "directly related" as discussed above, you can still deduct the expenses as long as you can prove the entertainment was "associated" with your business. To meet this test, the entertainment must directly precede or come after a substantial business discussion. Further, you must have had a clear business purpose when you took on the expense.
The person entertained must be a business associate. That is, someone who could reasonably be expected to be a customer or conduct business with you, including an employee or professional advisor.
In circumstances where it's customary to entertain a business associate with his or her spouse, and your spouse also attends, entertainment of both spouses is deductible, thanks to the "closely connected rule."
Tax law requires you to keep records that will prove the business purpose and amounts of your business travel, entertainment, and local transportation costs.
Which Records You Must Keep
You must substantiate the following business expenses:
To substantiate these items, you must prove:
Here's how these rules apply to your record-keeping for travel expenses, entertainment expenses, and business gifts.
Away-from-home travel expenses. You must document the following for each trip:
Entertainment expenses. You must prove the following for each claimed deduction for entertainment expenses:
Business gifts. You must keep the following documentation for a business gift to substantiate the deduction:
Employees who are "fully reimbursed" by their employers are not subject to the deduction limits discussed in this Financial Guide-their employers are. "Fully reimbursed" means that all the following occur:
You adequately account to your employer by means of an expense account statement. If you are covered by (and follow) an "accountable plan," and your reimbursements don't exceed your expenses, you won't have to report the reimbursements as gross income. Some per diem arrangements (by which you receive a flat amount per day) and mileage allowances can avoid detailed expense accounting to the employer, but proof of time, place, and business purpose is still required.
However, if your employer's reimbursement plan is not "accountable," you must report the reimbursements as income, and you can then deduct the expenses you paid but you must deduct them as employee business expenses, subject to the 2 percent-of-adjusted-gross-income floor.
If you are reimbursed under an expense account for travel, transportation, entertainment, gifts, and other business expenses, here are the record-keeping and reporting rules that apply. If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a nonaccountable plan.
If you are covered by (and follow) an "accountable plan," and your reimbursements don't exceed your expenses, you won't have to report the reimbursements as gross income.
However, if your employer's reimbursement plan in not "accountable," you must report the reimbursements as income, and you can then deduct the expenses you paid. You must deduct them as employee business expenses, subject to the 2 percent-of-adjusted-gross-income floor. An accountable plan is one in which (1) your expenses are business related, (2) you adequately account for these expenses to your employer within a reasonable time and (3) you return any excess reimbursement within a reasonable time.
Self-employed individuals and employees who use their cars for business but either don't get reimbursed or are reimbursed under an employer's "non-accountable" reimbursement plan can deduct auto expenses. In the case of employees, expenses are deductible to the extent that auto expenses (together with other "miscellaneous itemized deductions") exceed 2 percent of adjusted gross income.
If you use a car for business, you have two choices as to how to claim the deductions:
For some, the standard mileage rate produces a larger deduction. Others fare better tax-wise by deducting actual expenses. After we tell you about limits on auto depreciation, we'll tell you how to determine which of these two methods is better for you tax-wise.
Expensing and depreciating vehicle costs. Deduction options and amounts depend on the percentage used for business. Also, if the car is used more than 50 percent for business, it can be included as business property and qualify for Section 179 expensing in the year of purchase. The deduction is reduced proportionately to the extent the car is used for personal purposes. If you take this deduction you can't use the actual mileage for that vehicle in any year.
Depreciation. Assuming the car cost more than the Section 179 limit, or Section 179 is not available or is not claimed, depreciation is also allowed. Several depreciation options are available, but there are limits to the amount of depreciation that can be claimed per year. Depreciation otherwise allowable is reduced by the proportion of personal use (for example, a car used 20 percent for personal use is depreciated at 80 percent of the amount otherwise allowed). Accelerated depreciation--depreciation at a rate higher than that resulting from dividing the vehicle's cost by the number of years it will be used--is not allowed where personal use is 50 percent or more.
Finally, if you claimed accelerated depreciation in a prior year and your business use then falls to 50 percent or less, you become subject to "recapture" of the excess depreciation (i.e., it's included in income).
Of course, using the standard mileage deduction allows you to avoid these limits.
Determining whether to use the standard mileage deduction. If you opt for the standard mileage rate, you simply multiply current cents-per-mile rate by the number of business miles you drive for the year.
Be aware, however, that the standard mileage deduction may understate your costs. This is especially true for taxpayers who use the car 100 percent for business, or close to that percentage.
You may use the standard mileage for leased cars if you use it for the entire lease period. Or, you can deduct actual expenses instead, including leasing costs.
Recordkeeping. This is the best thing you can do to make the most of your auto deductions, not to mention essential to have this documentation in case of an audit. You won't be able to determine which of the two options is better if you don't know the number of miles driven and the total amount you spent on the car. Furthermore, the tax law requires that you keep travel expense records and that you give information on your return showing business versus personal use. If you use the actual cost method, you'll have to keep receipts as well.
Tip: Don't forget to deduct the interest you pay to finance a business-use car if you're self-employed.