Deducting Meals, Entertainment, and Travel Expenses Part 2

Now that we know the qualifications for these deductions, let's talk substantiation and record keeping...

Substantiation Requirements

Detailed records documenting the amount paid, time and place of the expense, people attending, business purpose, and nature of the meeting are always required.  For travel related meals you can either maintain your receipts or use a standard meal allowance, or per diem for the destination.

Documentation is critical, but there is no “right” way to keep your business records.  The IRS says there is no particular method of bookkeeping you must use in your business, but the method you choose must clearly and accurately reflect income and expenses.  When you are at the mercy of the opinion of an individual IRS auditor, it is always best to be as detailed as possible.  IRS agents look for personal meals or other deductions that don’t satisfy their substantiation rules. 

Best Practices

  • Keep your receipts!  This may seem obvious, but keeping your receipts organized can require a little work.  However, it is worth the effort because it is the most critical thing you can do to support a deduction. If you have trouble keeping all your receipts in order, we suggest scanning them to a folder or taking pictures of receipts.  Your deduction will likely be thrown out without a receipt.
  • Keep records of any reimbursements you receive to cover your out of pocket. Only your net out of pocket cost is deductible.   
  • If you are an employee (not self-employed), and your unreimbursed business expenses are fairly small in total for the year, you may not be able to utilize the deduction.  Only deductions in excess of 2% of your adjusted gross income can be deducted if you itemize.  If you take the standard deduction, you would need a very large amount of out of pocket expenses to see any benefit. 
  • Maintain bank or credit card statements showing the charges being charged to you and being paid as well as the original vendor’s receipt. 
  • Separately track marketing expenses and entertainment expenses as marketing is fully deductible while entertainment is only 50% deductible. 
  • Don’t try to re-create records at the end of the year or later.  Stay on top of your records throughout the year.  These expenses attract a lot of attention from auditors, and you need to be prepared to defend the deductions when challenged.
  • If an expense is both personal and business related, be sure to only deduct the business-related portion. 
  • When in doubt, give us a call!  If you have questions, give us a call!  If you need clarification or more information on anything, give us a call!  Seriously, we like talking to you and want to help you get the maximum benefit of every deduction available.  We enjoy having informed clients and staying off the IRS’s radar, so please never hesitate to reach out to us. 

Deducting Meals, Entertainment, and Travel Expenses Part 1

 We have many clients, both self-employed and employees, that can deduct business expenses for meals, entertainment, and travel.  Because big deductions for these items are always ripe for audit, it’s important to understand what types of expenses are deductible and what you will need to support the deduction should you ever find yourself on an IRS auditor’s radar.  Those auditors are adept at finding inconsistencies and errors in taxpayers’ records leading to the loss of those deductions, therefore its best to stay on top of your record-keeping. 

First, let’s review what business expenses can be deducted.  The standard the IRS uses is “ordinary and necessary.”  For an expense to be deductible, it must meet both requirements.  Ordinary expenses are common to your business, and necessary expenses are helpful and appropriate to your business.  Even with proper documentation to support the cost of an expense, if the IRS determines it does not meet both requirements they will throw out that deduction.

What Qualifies and What Does Not

Meals are deductible when traveling away from home (whether eating alone or with others) on business and during business-related entertainment.  For travel meals to qualify, you typically need to be away from your general area of work for longer than a day.  Business related entertainment meals could be with a client, customer, or employee so long as business was conducted and a future benefit to your business is expected.  You need another person eating with you for this type of meal, so meals you eat alone whether it’s your lunch break or a quick stop as you drive between client appointments are not deductible.   Typically, you can only deduct 50% of the cost in either of those situations.  Because the IRS assumes you eat whether you are at home or away on business, they do not allow 100% of the cost to be deducted. 

Entertainment expenses, including entertainment-related meals, must be the result of a more than general expectation of a specific business benefit.  The expenses could be the result of entertaining a client, customer, or employee so long as business was conducted. Dues for membership to country clubs, golf clubs, airline clubs, or hotel clubs are not deductible.   Costs of entertainment for your spouse or spouse of a customer are typically not deductible unless there is a clear business purpose for a spouse to attend.  Expenses for the use and operation of an entertainment facility, such as a yacht, hunting lodge, vacation home, or airplane, are not deductible whether you own or rent the property. 

Travel expenses are deductible if you are required to be away from your tax home for longer than one day but less than a year.  Typically, your tax home is your city or the general area of your main place of business.  Deductible travel expenses include airfare, rental cars, taxis, baggage fees, lodging, and any tips paid for these services. Expenses that are lavish or extravagant are not allowed, and expenses for a spouse on a business trip are not allowed unless there is a bona fide business reason for his or her presence.

In my next blog post, we'll discuss substantiation requirements for deducting these expenses...

Should I add up my medical expenses?

Medical expenses are not like charitable contributions. Your deduction is not equal to every dollar you spent on medical expenses like it is when you give money away to charitable organizations. Medical expenses only start counting towards your itemized deductions when they exceed 10% of your adjusted gross income (7.5% for age 65 or older).

Here’s an example… say your adjusted gross income (AGI) is $100,000 and you had $10,500 in medical expenses. The first $10,000 in medical expenses (10% of $100,000 AGI) would go nowhere and only $500 would come through as a deduction. Basically, the first $10,000 would only get you to the starting point and anything beyond that would count as a deduction. If you had less than $10,000 in medical expenses, that would mean no medical deduction at all.

Because of the high threshold, many people are unable to take a deduction for their out-of-pocket medical expenses. So, if you know you definitely did not have more than 10% of your adjusted gross income in medical expenses, you should save yourself the time and forget adding them up. And if you know you take the standard deduction rather than itemizing, that’s another reason not to add them up.