Automobile Expenses

Article on: Business Travel Expenses
Article on: Travel from a Home Office

Meals and entertainment
Younger traders probably do not remember the good-old-days when business meals were 100% deductible and business deals were hashed out over "three martini lunches." Meals haven't been 100 percent deductible for a long time and, like other entertainment expenses, the IRS combs them carefully for abuses.

Expenditures for meals, entertainment, amusement, and recreation are not deductible unless they are directly related to, or associated with, the active conduct of your business. The IRS also requires you to keep a written or electronic log, made near the time that you make the expenditure, recording the time, place, amount and business purpose of each expense.

Even if you pass those two tests, only 50 percent of meal and entertainment expenses are deductible. If you write-off business meals through your company and there is a proper reimbursement arrangement in place, you won't be charged with any imputed income for the half that is not deductible, but your company will be limited to a 50 percent write-off.

For meal and entertainment deductions, on each credit card receipt, make sure the following are clearly written:

• Who was present (their names and their business relationship)?
• What business was discussed (immediately before, during or immediately after the meal/entertainment)?
• How was this related to your business?  What was the purpose?
• Where was the business discussion held and the meal consumed (name and location of restaurant)?
• When was the meal/entertainment and business discussed (exactly on what date)?
• Exact cost of the meal/entertainment?

Meals Deductible Percentage Under 274(n)(3)
55% for years beginning in 1998, 1999
60% for years beginning in 2000, 2001
65% for years beginning in 2002, 2003
70% for years beginning in 2004, 2005
75% for years beginning in 2006, 2007
80% for years beginning in 2008, 2009
Section 274(n)(3) provides a special rule that increases the percentage that can be deducted for meals of persons, such as truck drivers, who are subject to the hours of service limitations established by the Department of Transportation.

Article on: Meal and Entertainment Expenses

Article on: Business Deductions: Cars, Food & Entertainment

Meals for the convenience of the employer
IRS Code §119 allows for 100% deductible meals when they are for the convenience of the employer and they are furnished on the business premises of the employer.  The business premises must pass one of two tests: a "spatial" definition, which focuses on the physical extent of the employer's property or a "functional" definition, which focuses on the performance of services by the employee.

The meals should not be given as a form of extra compensation or as perquisites (perks).  Examples of why meals would be 100% deductible and also fully excludable from the employee's income:

• Very short meal period allowed
• No available eating facilities outside the business premises
• Employee must remain on site for business reasons (to meet customers or to trade securities, for example)
• To attend mandatory business meetings

The meals must be just that: meals.  Cash allowances or reimbursements for meals (and lodging for that matter) must be included in gross income by the employee.

The family may join the employee for the meals.  §119(a) specifically states that your spouse and other dependents may partake in the free meals.

There are some misunderstandings as to if only c-corporations are allowed this as a deduction or if other entities and self-employed businesses qualify.  Also whether "employees" includes owners, partners (§703(a)(2)(E) &  §707(a)) , LLC members, managers, shareholders (§1372) and officers can also be subject to debate.  Non-employees are not covered (Weeldreyer v. Commissioner; Schmidt v. Commissioner; Tschetter v. Commissioner; Waterfall Farms, Inc. v. Commissioner; Armstrong v. Phinney, 5th Cir., 1968.)

On February 16, 2006 the IRS identified §119 as an emerging issue to be addressed.

Headliner Volume 148
The Internal Revenue Service has identified an emerging issue regarding individuals who receive free or reduced rent in exchange for providing security or other services at apartment or residential housing complexes. The value of the free or reduced rent is not being reported as income when required.

In general, the fair market value of the reduced or free rent should be recognized and reported as income under Internal Revenue Code § 61 which defines gross income. This means the apartment or housing complex owner (employer) should include the value of the free or reduced rent in the employee’s gross wages on Form W-2, Wage and Tax Statement, at the end of each year.

For the value of free or reduced rent to be excluded from income the conditions outlined in Internal Revenue Code § 119, Meals or Lodging Furnished for the Convenience of the Employer, must be met. IRC § 119 states:
(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment.

There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if —
(1) in the case of meals, the meals are furnished on the business premises of the employer, or
(2) in the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment.

In addition, Regulations § 1.119 (b) Lodging state:
The value of lodging furnished to an employee by the employer shall be excluded from the employee’s income if three tests are met:
(1) The lodging is furnished on the business premises of the employer
(2) The lodging is furnished for the convenience of the employer, and
(3) The employee is required to accept such lodging as a condition of his employment.
Only under the provisions outlined in IRC § 119 may the value of the free or reduced rent be excluded from income.
When preparing the tax returns of individuals who receive free or reduced rent for providing security or other services, the issue of income must be addressed and reported as appropriate.

Tread carefully when deducting "luxury" business expenses   Many people are surprised to learn that some "luxury" items can be deductible business expenses. Of course, moderation is key. Excessive spending is sure to attract the IRS's attention. As some recent high-profile court cases have shown, the government isn't timid in its crackdown on business owners using company funds for personal travel and entertainment.

First class travel
The IRS doesn't require that your business travel be the cheapest mode of transportation. If it did, businesspeople would be traveling across the country by bus instead of by plane. However, the expense as it is relative to the business purpose must be reasonable. Taking the Queen Mary II across the Atlantic to a business meeting in the U.K. could raise a red flag at the IRS.

As long as your business is turning a profit and is operated legitimately as a business and not a hobby, traveling first class generally is permissible. Even though a coach airline seat will get you to your business appointment just as quickly and an inexpensive hotel room is a place to sleep, the IRS generally won't try to reduce your deduction.

However, if your trip lacks a business purpose, the IRS will deny your travel-related deductions. Don't try to disguise a family vacation as a business trip. Many people are tempted; it's not worth the consequences, especially in today's environment where the IRS is aggressively looking for business abuses. To get around consider making your spouse an bona-fide active owner/officer of your corporation or LLC.  Ditto for the kids or other family members.  By doing this correctly the trip is not a family trip for pleasure, rather it is an owners' trip for business, and the owners just happy to be related family members.  The distinction is an important one.

Conventions
Convention expenses are deductible if a sufficient relationship exists to your profession or business and the convention is in North America. No deduction is allowed for attending conventions or seminars about managing your personal investments.

Overseas conventions definitely get the IRS's attention. If you want to deduct the costs of attending a foreign convention, you have to show that the convention is directly related to your business and it is as reasonable to hold the convention outside North America as within North America.

Cruise
http://www.bradfordtaxinstitute.com/Free_Resources/DeductCruise.aspx

 Country club expenses
Country club dues are not deductible. In fact, no part of your dues for clubs organized for business, pleasure, recreation, or social purposes is deductible.

Some country club costs may be partially deductible if you can show a direct business purpose and you meet some tough written substantiation requirements. These include greens fees as well as food and beverage expenses. They may be deductible up to 50 percent.

Business Use of a Car
If you use your car, SUV, or some other vehicle in your business, you are entitled to certain tax deductions for expenses incurred in connection with the vehicles.

If the vehicle is used exclusively for business purposes, you may generally deduct the full cost of operating the vehicle. If you use a vehicle for business on a part-time basis, you will need to allocate your expenses based on your business and personal usage.

But what, exactly, is "business use of a car?" Generally, the IRS classifies all car usage into three categories: business, commuting, and personal. "Business use" generally means travel between two business destinations, one of which may include your regular place of business. Typical travel expenses that are deductible include expenses for:

• travel from one job to another
• travel from one customer or client to another
• travel from your office or business location in order to perform business tasks, such as to pick up supplies and inventory, to check your business post office box, or to make a bank deposit

In addition, if you have a regular place of business, the cost of traveling between your home and a temporary work site that is not the regular place of business is deductible, regardless of the distance traveled. A temporary work site is a place where an individual is realistically expected to perform, and does perform, services for less than a year.

Also, if you do not have a regular place of business and you travel outside of the metropolitan area in which you work to a temporary work site, you are allowed a deduction for your travel costs. Travel within your metropolitan area is not deductible.

Commuting expenses
Vehicle expenses incurred in commuting between your home and your main or regular place of business are nondeductible expenses. This is true even if you have an advertising display on your car, or you use the commute to listen to business books on tape or to phone your clients, unless you have a valid business/tax purpose for the car being parked at your home to begin with.  For example: driving your car 100 miles from a business location back to your hometown, parking it by the side of a busy highway where the advertising display on the car is seen by thousands of daily commuters, and then walking two blocks to your home, may be a valid business trip.

Travel from a Home Office
If you work out of your home and your home is your principal place of business, you can generally deduct the cost of traveling from home to any business destination. This is true whether the destination is another regular place of business, a temporary place of business (such as a client or project location), or a destination such as a bank, post office, supplier, etc.   See Rev. Rul. 99-7 Holding (3).

If you are a real estate agent and you maintain your principal place of business in your home, you can deduct the expenses that you incur in traveling between your home and the houses you're trying to sell.

Whether your home is your principal place of business is determined under the same standards that apply to home office deductions. If your home doesn't qualify as your principal place of business, you must follow the general rules in determining whether a particular car trip is sufficiently business-related to be deductible.

Click here for information on depreciation of the vehicle's cost or the optional mileage method

Article on: Business Use of a Car

Excel templates: Mileage log     Mileage log    Mileage log B   Mileage log C   Mileage log D   Mileage logger equipment 

The tax law limits most deductions for entertainment expenses to 50% of the original cost. In order to qualify as a deduction, all business entertainment need to meet six elements of substantiation. It makes no difference what other types of support you have for your business entertainment; failure to meet the six elements can result in a disallowance.

Substantiation Requirements for All Business Entertainment Expenses
The entertainment must be incurred in the “ordinary and necessary” course of your business and then documented to meet IRS substantiation requirements.  Failure to meet the requirements will cause a loss of valid deductions.

• Cost: The cost of each entertainment expenditure must be recorded someplace. When the cost is $75 or more, documentary evidence such as a receipt, voucher, or credit card charge copy must be retained to support expenditures.  No receipts are required for entertainment expenses under $75 per expense.
• Time: The definition of time is usually the date when the entertainment takes place. When entries are made in a diary-type document, the date on the diary page is adequate support for time.
• Description: The nature and place of the entertainment (“business meal at The Dirty Nail”) must be described. When a charge slip or receipt is obtained, the nature and place are usually self-evident.
• Business purpose: Of the six elements, this is the most important. A specific advanced purpose for the entertainment is required. You must have a specific business purpose to meet with your prospect in order to deduct any entertainment with them. The following examples will illustrate this:

Example: Bill goes to a local steakhouse alone for dinner. He strikes up a conversation with the waitress about his real estate business. His dinner would not be deductible since he didn’t have a prearranged appointment to meet with her.
Example: Bill is talking with his next door neighbor, Sally. She mentions that she is considering selling her house but doesn’t have time to talk about it at that moment. Instead she suggests that Bill come to the restaurant where she works for lunch as a waitress and talk about listing her home over lunch. This meal would be deductible.

• Business relationship: The IRS wants you to identify the person or persons entertained. The names, occupations, official titles, and other corroborative information to establish the business relationship should be identified. In many cases, the person’s name with the word “prospect” would be sufficient to establish both business purpose and business relationship for a business meal.
• Timely Recording: The recording must be contemporaneous with the activity. For all practical purposes, that means you must record the elements of substantiation on a timely basis, preferably on the day the entertainment takes place.

Deducting Business Meals
Applying the substantiation rules to a business meal means the following are required in order to deduct it.

1. You must discuss business before, during, or after a business meal to qualify for a business meal deduction.
2. The business meal must be arranged for the purpose of conducting specific business before the fact.
3. The business meal must take place in surroundings conducive to a business discussion.  IRS presumes that the “active business discussion” test is not met if the business meal occurs under circumstances where there is little or no possibility of engaging in a business discussion. Eating dinner at a nightclub with a continuous floorshow is an example of a non-business setting.  Similarly, a large cocktail party is not a business setting.

Documentation of a Business Meal: Answering the questions “Who?”, “Where?”, “When?” and “Why?” and recording the cost as shown will give you proper documentation for business meals.

Deducting Associated Entertainment Expenses
According to tax law, with siome exceptions, you generally may not discuss business in places and at events that are not business settings.  Examples of non-business settings include, but are not limited to:

• Nightclubs
• Golf courses
• Theaters
• Sports events
• Hunting trips
• Fishing trips
• Ski trips

By themselves, entertainment expenses for activities like those above are not deductible.  However, they can be deducted under the “associated entertainment” rule.  Associated entertainment, also called goodwill entertainment, takes place in a non-business setting.  No business discussion occurs during the entertainment. The entertainment precedes or follows a substantial and bona fide business discussion, usually the same day as
the entertainment. The key to deducting associated entertainment is linking it to a related business discussion and recording the link. There must be a link between the business discussion and the entertainment.

Documentation of a Business Meal Followed by a Theater Performance
Note how the theater event is linked to the meal with the word Followed. Also note that the business discussion occurred in a proper business setting and was followed by entertainment “associated” with the dinner discussion.

Season Tickets to Events: Season tickets and box seats to theaters and sports events are treated according to the individual events.  For example, you hold season theater tickets to attend 10 specific performances during the year. You treat each of the 10 performances separately. The deduction is limited to the printed face value of the ticket.

Business Gifts:  Tax law limits your maximum deduction to $25 for business gifts to any one person during a tax year. This limitation applies to gifts of tangible personal property. Husband and wife are treated as one taxpayer for purposes of the $25 limit. However, gifts made to business where there is no single person designated to receive or benefit from the gift, have no limit.  There is an alternate rule for gifts of entertainment tickets. You have the choice of treating the gift of a theater ticket either as entertainment or as a business gift. There’s no $25 limit on the entertainment gift. Moreover, when giving tickets as gifts, you need not go along to the entertainment event.

Meals are not entertainment: Gifts of entertainment meals are not allowed. You are entitled to a tax deduction for a business meal only if you are present during the consumption process.

Feed and entertain your spouse:  The IRS has a “closely connected” rule. Most spouses qualify as closely connected. The closely connected rule permits deducting the expenses of entertaining your spouse as well as the spouse of a business guest. In other words, if your business guest brings a spouse, you are entitled to bring yours. Of course, you must be entertaining the business guest during the ordinary and necessary course of your business and you must meet the business discussion and documentation requirements.

Deducting Dutch-treat MealsWhen you go to a meal with a business guest, pay your own way and spend more than what you would normally spend, the Dutch-treat rule comes into play. For example, you attend a Chamber of Commerce luncheon meeting and the lunch costs more than you would normally spend for lunch; you may claim the excess as a Dutch-treat business lunch.

Example: You spend $22 at a Chamber luncheon. Had you not gone to the luncheon, you would have spent $2. Your deduction is $10, the excess business cost over your personal cost (times 50%).

The “Sutter Rule”
IRS may, at its discretion, invoke the “Sutter Rule”. The “Sutter Rule” allows IRS to disallow a portion of your business meals when such meals absorb substantial amounts of your typical living expenses.

Document personal meal costs to support your Dutch-treat meals and avoid the “Suffer Rule.”

• Written evidence: Your personal meal evidence must be in writing.  Entries in your diary or account book are strong evidence.
• 30-Day test: Record the cost of personal meals in your diary. Do this for at least 30 days during the year.
• Meals at home: When you eat meals at home, the task of developing your personal meal costs is somewhat more complicated. There are basically two ways to compute the cost of personal meals consumed at home.

Method 1: Write down the actual items consumed and determine the cost of each item. Two eggs for breakfast, when a dozen eggs cost $1.20, would cost $0.20. If you need to determine actual costs only a few times during the year, it’s easy to simply write down the actual items consumed.

Method 2 Use actual grocery bills to make an allocation by members of the family. If, for example, the grocery bill for a week amounts to $150, you can estimate the cost for breakfast, lunch, and dinner. If the dinner groceries cost $70, you could divide the $70 by seven days in a week to arrive at $10 for the average dinner. If there are two people in your family, the average cost per person is $5. That would be your cost for purposes of determining your Dutch-treat deductions and maximum disallowance under the Sutter Rule.

Deducting Home Entertainment
Your home is already a setting conducive to a business discussion. If you invite a couple to your home for dinner, it’s easy to have a one-on-one business conversation. You do not need to spend more time trying to conduct business than you spend entertaining your guest.

Example: You invite the Jones to your home to ask for a referral. You ask for and receive the referral. Even though 90% of the evening is spent on non-business activities, the cost is deductible. If you asked for and failed to get a referral, the cost of entertainment is still deductible.

Your home entertainment deductions are secure when you discuss specific business with your guests.  Keep your guest list small; fewer than 12 people. That way you can talk to everyone with whom you need to discuss business.

When you invite more than 12 people to your home, you will be hard pressed to prove to IRS that you had specific business discussions with everyone in attendance. Therefore, you must establish some other type of commercial motivation.

If you entertain a group for the purpose of showing a display of your business products or services, commercial motivation is generally clearly established. When you combine the display of products with an invitation that invites the guests for a specific business reason, you strengthen your case for deductibility.

Example: Tex built his own office building and is looking for tenants. He throws a party for friends that would be desirable tenants.  This party would qualify as a deductible business entertainment expense if it meets both of two tests:

• Clear showing of commercial motivation.

Tex’s invitation established the introduction of the new office building as the reason for the party. In the room where the party was held, Tex had photographs of the new building posted on a bulletin board. Although none of the individuals attending the party rented space in the new building, Tex clearly established a clear business motivation for the party.

• Meet five elements of substantiation.

1. Cost: Tex has receipts and cancelled checks.
2. Time: Date at top of diary page.
3. Description: Entry in diary.
4. Business purpose: Entry in diary plus invitations and photographs of people around the bulletin board.
5. Business relationships: Names of individuals who own their own businesses and are prospective tenants.

The expenses are deductible because Tex passes both tests.

Personal Celebrations:  Never, never  combine a personal event with a business entertainment event.  A birthday party for your 10-year-old with business guests in attendance will not fly with IRS. Home entertainment, especially when large groups are involved, is deductible only when you can firmly establish a business purpose. If you have no personal or social relationships with the guests, other than business, your chances for a deduction are improved.

Deducting Employee Meals and Entertainment
You may deduct the costs to provide lunches to employees on a tax-free basis if you provide lunch for over one-half of the employees, and

1. there is a short lunch period (generally no more than 45 minutes) or
2. they are available for emergencies (such as an ambulance service) or
3. there are insufficient eating facilities nearby.

Also, meals must be furnished on normal business days.

The reasonable cost of a year-end holiday party or a summer outing for employees and their families is 100% deductible.

Business Club Dues and Lunches: You can deduct dues paid to business clubs when such payment is in the ordinary and necessary course of business. The terms “ordinary” and “necessary” mean that the expenses are customary, usual or normal, and helpful or appropriate. Dues to your local Chamber of Commerce would almost always be appropriate and normal. Dues paid to professional societies are deductible. Trade association dues are deductible if the association’s purpose is the furthering of the business interests of its members. Dues for community clubs organized to attract tourists and new members to your locality give rise to deductible dues.

Note: Meals incurred and “paid for” while talking business at the club are deductible. This limitation only applies to the dues.

Give sales seminars and presentations at home:  The tax court has ruled that all food and refreshments served to prospects are 100% deductible if provided at home during a sales seminar or sales presentation.

Business Expense vs. Business Promotion: IRS uses an objective test to determine whether an activity is of a type to constitute entertainment (which is 50% deductible) or more like business promotion (which is 100% deductible). Thus, attending a movie or theatrical performance would normally be considered entertainment. However, it would be deemed promotional, if done so by professional theater critics or movie critics. Similarly, a golf club salesman who plays golf and demonstrates his clubs and other golfing equipment should be able to deduct 100% of his green fees and costs of his golf balls, caddie expense, etc.

Business Entertainment Summary

• Discuss business when you eat.
• Link “associated entertainment” expenses to a business meal.
• Treat season tickets on an individual event basis.
• Use entertainment tickets as business gifts to avoid $25 ceiling.
• Feed and entertain your spouse.
• Deduct Dutch-treat meals.
  • By sure to document personal meal costs to support your Dutch-treat meals and avoid the “Sutter Rule.”
• Deduct home entertainment.
• Give small parties at home.
• Properly set up and document large group entertainment to solidify deductions.
• Entertain and feed your employees.
• Deduct business club dues and lunches.
• Give sales seminars and presentations at home.
• Deduct all food at sales presentations.

Colin M. Cody, CPA, CMA
TraderStatus.com LLC
6004 Main Street
Trumbull, Connecticut 06611-2400

(203) 268-7000