The fact that you have a receipt or can otherwise prove that you incurred an expense does not by itself establish that it is deductible. Only business expenses that are ordinary, necessary and reasonable in amount are deductible.
Small-business owners most frequently lose deductions for expenses such as meals and travels not because they lack receipts, but because they are unable to show that the expense was for their business, not their personal pleasure.
Thus, you must be able to show the IRS that the expense relates to your business.
Case in point: Stephen Wallach, an airline pilot who also worked as a real estate broker in California who dealt primarily in commercial properties. Unfortunately, Wallach’s real estate business didn’t do very well, reporting a $23,124 loss in 2007. One reason his brokerage business lost so much money that year was that he claimed business expenses of more than $14,000 for travel, meals and entertainment. The IRS disallowed all of these expenses. Wallach appealed to the U.S. Tax Court and lost.
To substantiate a deduction for travel, meals or entertainment, a taxpayer must maintain adequate records or present corroborative evidence to show:
- the amount of the expense;
- time and place for the expense; and
- the business purpose for the expense.
Wallach provided the Tax Court with bank records and photocopies of receipts for meals, hotels, rental vehicles and airline tickets to substantiate some of his expenses. However, he was never able to establish a believable business purpose for them. For example, he claimed deductions for hotel, rental car and meal expenses for an 11-day trip to Hawaii. He said the trip was to scout potential properties for a client.
However, Wallach’s records showed that he paid for multiple hotel rooms for the same nights and that there were multiple occupants in the rooms. Needless to say, it appeared that Wallach went to Hawaii for a vacation, not to scout for property. The Tax Court disallowed all his Hawaii expenses. (Wallach v. Comm’r, T.C. Summ. Op. 2012-94.)
Travel, entertainment and meal deductions are always a hot button for the IRS. The IRS is particularly suspicious of trips taken to "scout property." People often try to turn vacations into "business trips" by claiming they took the trip to look for property. Oddly, these scouting trips are always taken in nice resorts.
Whenever you incur an expense for business-related entertainment, meals, gifts or travel, you must document the following five facts:
- The date. The date the expense was incurred will usually be listed on a receipt or credit card slip; appointment books, day planners, and similar documents have the dates preprinted on each page, so entries on the appropriate page automatically date the expense.
- The amount. How much you spent, including tax and tip for meals.
- The place. The nature and place of the entertainment or meal will usually be shown by a receipt, or you can record it in an appointment book.
- The business purpose. Show that the expense was incurred for your business — for example, to obtain future business, encourage existing business relationships, and so on. What you need to show depends on whether the business conversation occurred before, during, or after entertainment or a meal.
- The business relationship. If entertainment or meals are involved, show the business relationship of people at the event — for example, list their names and occupations and any other information needed to establish their business relation to you.
The IRS does not require that you keep receipts, canceled checks, credit card slips, or any other supporting documents for entertainment, meal, gift or travel expenses that cost less than $75. However, you must still document the five facts listed above. This exception does not apply to lodging — that is, hotel or similar costs — when you travel for business. You do need receipts for these expenses, even if they are less than $75.
All this record keeping is not as hard as it sounds. You can record the five facts you have to document in a variety of ways. The information doesn’t have to be all in one place. Information that is shown on a receipt, canceled check, or other item need not be duplicated in a log, appointment book, calendar or account book. Thus, for example, you can record the five facts with:
- a receipt, credit card slip, or similar document alone;
- a receipt combined with an appointment book entry; or
- an appointment book entry alone (for expenses less than $75).
No matter how you document your expenses, you are supposed to do it in a timely manner. You don’t need to record the details of every expense on the day you incur it. It is sufficient to record them on a weekly basis. However, if you’re prone to forget details, it’s best to get everything you need in writing within a day or two.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.
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