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...