- April 15, 2024
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“T&E and home by 3.” The IRS audit mantra. Grab the low-hanging fruit and call it a day. Easy-peasy.
What does this mean?
An IRS agent just needs to audit the travel and entertainment accounts to obtain an adjustment and go home. Not much work with a large pay-off because business travel and entertainment expenses have special documentation requirements, and if these requirements are not met, the business will be unable to take a deduction. Many businesses do not maintain adequate documentation for these items.
The increased documentation requirements apply to more than just travel and entertainment. Four classes of expenses are covered by the rules:
• Travel (including meals while away from home);
• Entertainment, amusement, recreation, or expenses related to any facility used for such activities;
• Business gifts; and
• Expenses of listed property (automobiles and computers).
To be deductible, these expenses must have sufficient written evidence to justify the deduction. To be complete, the written evidence must include:
• The time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift,
• Business purpose, and
• Business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.
Without this written documentation, it doesn't matter that the expense is a legitimate business expense and generated a multimillion dollar business deal, the expense is not deductible.
If you want to deduct travel and entertainment expenses on your tax return, you need to beef up your documentation and comply with IRS requirements. Here are a few pointers on what is deductible:
• All expenses must have a valid business purpose. A trip to Napa Valley to negotiate a deal with wine suppliers for your wine stores would be a valid deduction. A trip to Napa Valley for your honeymoon, where you happen to say hello to your wine supplier, would not be a valid deduction. The primary purpose of your honeymoon trip is not business, and you can't deduct your new spouse's travel costs either.
• Local business travel must be documented through a mileage log. In every IRS audit where auto expense is deducted, the IRS will want to see the mileage log. The deduction will not be allowed without written support of time, place, and business purpose. The IRS will accept a sampling approach for mileage. A taxpayer can keep a mileage log for two representative months and apply the business use percentage to total mileage for the year. Documentation establishing beginning of the year and end of the year odometer readings are needed to support total mileage.
• Business meals have special rules and can be fully deductible, partially deductible, or nondeductible. Food and beverages provided to employees at work are fully deductible. Food and beverages provided to the public are fully deductible. A meal with an employee, customer, or business prospect where business is discussed is partially deductible. Fifty percent of the business meal is nondeductible. A meal where no business is discussed is nondeductible. The IRS has discretion and can disallow deductions if they deem them to be lavish and unreasonable. (But we needed to celebrate with that $12,000 bottle of wine. It was a necessary expense!)
• Only $25 of a business gift is deductible. This amount was set in 1962 and has not changed. In 1962, a $25 gift was probably quite generous. Not so today. The amount of the gift in excess of $25 is a nondeductible expense.
• Tickets to sporting events can be partially deductible or nondeductible. If you take an employee, customer, vendor, or prospect to a sporting event and discuss business, the tickets are partially deductible. Fifty percent will be a nondeductible expense. If you give your tickets away and do not attend the event, those tickets are nondeductible. They could be deductible as gifts, if there is a business purpose, but the deduction will be limited to $25 per person.
• Entertainment facilities and country club dues are nondeductible. It doesn't matter if you belong to the country club for the sole purpose of creating business contacts, the dues are nondeductible. Operating expenses for entertainment facilities (boats, yachts, hunting clubs, etc.) are nondeductible. These expenses include any acquisition costs, depreciation, insurance, and maintenance of the property. A boat used to entertain clients and customers is an entertainment facility, and costs to purchase and maintain the boat are non-deductible. Costs such as fuel, food, and beverages used to entertain clients would be deductible as long as business is discussed.
