Deductible Costs

Local transportation costs include the cost of driving and maintaining your car (including tolls and parking) or the cost of taxis, bus fare, train fare, or airfare. Computing the cost of driving and maintaining your car is discussed in Chapter 9.

Commuting Costs

As a general rule, the costs of commuting between your home and workplace are not deductible. Thus, your bus or train fare, gas for your car, bridge and highway tolls, and parking fees are nondeductible. This rule does not change merely because the commute is unusually long or you do work on the way (e.g., reading reports on the train, talking to clients on your car phone, or displaying advertising on your car). Commuting costs are considered nondeductible personal expenses. This is so despite the distance or time it takes to commute. Even if there is no public transportation to the worksite or any lodging nearby, commuting costs remain nondeductible personal expenses.

However, there are a few exceptions that make certain commuting expenses deductible:

1. If you have one or more regular places of business but work at different locations on a temporary basis (as defined under the following exception), you can deduct the daily cost of travel between your home and the other work site.

2. If you travel from your home to a temporary work site outside the metropolitan area where you live and normally work, you can deduct the daily cost of travel between your home and the temporary work site, regardless of the distance. Temporary means that work is realistically expected to last for one year or less. If it turns out to last longer, the period up until the realistic expectation change is treated as temporary.

If you travel outside your metropolitan area, both the IRS and courts agree that the costs of traveling between your home and a temporary work site outside your area are deductible.

3. If you have a home office that is the principal place of business for the activity conducted there (see Chapter 18), the cost of traveling from your home to your clients or customers or to other business locations is deductible.

4. If you must haul tools or equipment to your jobsite and you use a trailer or have to make other special arrangements, the additional cost of commuting with the tools is deductible. The basic transportation costs are still treated as nondeductible commuting expenses.

Local Overnight Stays

The IRS has liberalized the rules for deducting the cost of local overnight stays. As long as this is not a compensatory benefit, but done for a business purpose, the employee is not taxed on the overnight stay(s), and the employer can deduct the cost. For example, an employer may require its employees to stay at a local hotel for the bona fide purpose of facilitating training or team building directly connected with the employer's trade or business.

Deductible Costs

Travel costs include transportation costs, lodging, meals, and other related expenses.

Travel with Another Person

If you take your spouse, child, or another person on a business trip, the costs related to that person are generally not deductible. The only way in which the costs are deductible is if that person works for you, there is a bona fide business reason for the travel, and the costs would have been deductible had they been incurred by someone who was not accompanying you. If the person provides only incidental services (such as typing notes or acting as assistant), his or her travel expenses are not deductible.

How do you distinguish between expenses that are yours (and deductible) from those of your companion (not deductible)? Clearly, the full cost of the other person's travel fare and meals is not deductible. In the case of lodging costs, if you are sharing a room, you must determine what you would have paid for a single, rather than a double, accommodation. For the most part, this is not simply half the cost. You may be able to deduct two-thirds or more of the cost of lodging.

There is a way for a business to turn nondeductible spousal travel costs into deductible costs. If your corporation treats spousal travel costs as additional compensation to you as an employee, then the corporation can claim a deduction for the costs as compensation rather than as travel and entertainment costs. In most cases, this alternative does not make much sense from your perspective, since it only shifts the tax burden from your corporation to you. However, if your personal tax picture is such that additional compensation will not result in additional tax, consider this alternative.

Major and Minor Job Locations

Some individuals work in more than one location. They may, for example, have a major job in one city and conduct some minor business in another. The cost of travel between the 2 jobs is deductible.

Part Business–Part Pleasure

If you combine business with pleasure, only part of your costs may be deductible. If your trip was primarily for business, then the portion of the travel costs related to business are deductible. This means that the full amount of airfare may be deductible. Meals and lodging for the days spent on business are also deductible.

Whether the time spent is primarily for business is determined by the facts and circumstances. There is no hard-and-fast rule.

If you stay over on a Saturday at a business location in order to obtain a reduced airfare, the stay is treated as business, and the cost of lodging for that stay is fully deductible. This is so even though you spend the time on personal matters. If the trip is primarily for personal reasons but you do conduct some business, you can deduct the direct costs of the business activities but no part of the travel costs.

Entirely for Business

If you travel abroad entirely on business, all of your travel costs are deductible. (Meal and entertainment costs are still subject to the 50% limit.) If your trip is considered to be entirely business, then even if some time is spent sightseeing or on other personal activities, all of your transportation expenses are still deductible. There are special rules for determining whether your trip is considered to be entirely for business. You are treated as having spent your entire trip on business if you meet any of the following 4 rules.

1. You do not have substantial control over arranging your trip; travel is presumed to be entirely for business. You do not have control if you are an employee who is reimbursed for travel and are not related to your employer nor a managing executive (someone whose actions are not subject to veto by another). As a small business owner, it is virtually impossible to satisfy this rule. However, you can still fall within one of the other rules.

2. You are outside the United States for a week or less (7 or fewer consecutive days). In counting days, do not count the day you leave the United States, but do count the day of your return.

3. You spend less than 25% of the time outside the United States on personal activities, regardless of the length of the stay abroad. In counting days for this rule, count both the day you leave and the day you return.

4. You can show that a personal vacation or another personal reason was not the major consideration in arranging the trip. You can use this rule even though you do have substantial control over arranging the trip.

Primarily for Business

If your travel abroad is not treated as entirely business (because you do not meet any of the 4 rules), you may still deduct some business expenses if the trip is primarily business. There is no mechanical rule to establish that the trip is primarily business. However, if you can show a valid business reason for the trip, you can deduct the portion of business expenses allocable to the business part of the trip, including the allocable portion of transportation costs.

Primarily for Vacation

If you travel abroad primarily for vacation but attend some business or professional seminar, you may not deduct any portion of the trip as a business expense. You may, however, deduct the cost of the seminar (registration fees and other related expenses) as a business expense.

Foreign Conventions

The expenses of attending a convention outside the North American area (see Table 8.1) are not deductible unless the meeting is directly related to your business and it is reasonable to hold it outside the North American area.

A number of facts and circumstances are taken into account in showing that it is reasonable to hold the convention outside the North American area. They are:

• The purpose of the meeting and the activities taking place at the meeting

• The purposes and activities of the sponsoring organizations or groups

• The residences of the active members of the sponsoring organization and the places at which the meetings of the sponsoring organizations or groups have been held or will be held

• Other relevant factors

Cruise Ships

The cost of business conventions or meetings held on a cruise ship is limited. The maximum deduction per year is $2,000 per employee for each individual attending the convention on the cruise ship. In order to get this deduction, a number of requirements must be met:

1. The meeting must be directly related to your business.

2. The cruise ship must be a vessel registered in the United States. (All ships that sail are considered cruise ships.)

3. All of the ship's ports of call must be located in the United States or in U.S. possessions.

4. You must attach a written statement to your return showing the days of the cruise, the number of hours devoted to business, and a program of scheduled business activities.

5. You must also attach a written statement to your return signed by an officer of the organization or group sponsoring the meeting that shows the schedule of the business activities of each day of the meeting and the number of hours you attended.

As a practical matter, the only cruises that qualify for this $2,000 limit for business conventions or meetings while cruising are those in Hawaii and some on the Mississippi River. However, the cost of business travel by sea that is not for a convention or meeting is deductible at twice the highest federal per diem rate (the daily living rate paid to a federal employee) at the time of the travel.

Change in Job Assignments

Suppose your assignment gets extended or shortened. How does this affect whether the assignment is treated as temporary or indefinite?

What Expenses Are Deductible?

If a job assignment is temporary, then personal living expenses—rent, utilities, food, and other expenses—are deductible. The reason for this rule: Congress recognized that if you are required to be away from home on a temporary basis, you will have to incur duplicative living expenses, since it would be unreasonable to expect you to relocate for that short period of time.

However, if the job assignment is indefinite, it would be reasonable to expect you to relocate, and there would be no need for duplicative living expenses. If you do move to a new location, the cost of moving expenses may be deductible (see Chapter 22).

If you are on a temporary assignment and return home on weekends, holidays, or visits, the time at home is not treated as away from home, and the cost of your lodging at home is not deductible. The cost of your lodging at the temporary work site, however, continues to be deductible. Thus, for example, if you are living away from home in a motel and return home on a weekend but must pay for the motel room anyway, that cost is deductible. The cost of meals on a return trip home is deductible only to the extent that the cost of meals away would have been deductible. The cost of travel from the temporary assignment home and the return trip is also deductible.

General Rules on Deducting Meal and Entertainment Expenses

In order to be deductible as a meal and entertainment expense, an expense must be:

1. An ordinary and necessary business expense, and

2. Able to qualify under a directly related test or an associated test.

The Directly Related Test

You satisfy the directly related test if you can show that the main purpose of the entertainment activity was the active conduct of business and that you did, in fact, engage in business during the entertainment period. Entertainment in a clear business setting is presumed to meet the directly related test. You must have more than a general expectation of deriving income or some other business benefit from the activity at some future time. You need not devote more time to business than entertainment in order to satisfy this test. You simply have to demonstrate that all the facts, including the nature of the business transacted and the reasons for conducting business during an entertainment event, support a business purpose. Nor do you need to show that business income or some other business benefit actually resulted from a specific entertainment event.

You will be presumed to have failed the directly related test if you are on a hunting, skiing, or fishing trip or on yachts or other pleasure boats unless you can show otherwise. Other locations that are presumed to have failed the directly related test include nightclubs, golf courses, theaters, and sporting events.

You bear a heavy burden of proof when the entertainment is held in a place where there are substantial distractions that prevent the possibility of actively conducting any business. This kind of entertainment is presumed to fail the directly related test. Substantial distractions are present at nightclubs, theaters, sporting events, and social gatherings (cocktail parties or meetings that include persons other than business associates). You can, however, overcome the presumption by showing that you engaged in a substantial business discussion during the entertainment despite the distractions.

Associated Test

If you cannot meet the higher standard of directly related, you may still be able to show that the entertainment is associated with the conduct of your business. This test requires showing that the expense is associated with your business and directly precedes or follows a substantial business discussion. You must have a clear business purpose for having the entertainment expense. This includes entertainment to get new business or encourage continued business with existing clients or customers.

How do you know if a business discussion is substantial? There is no quantitative way to show this. There is no prescribed amount of time you must spend meeting or discussing business, and you do not have to devote more time to business than to entertainment. You do not even have to discuss business during the entertainment itself. Whether the entertainment meets the associated test depends on the facts and circumstances of the situation. You must be able to show that you actually held a business discussion to get income or other business benefit. Goodwill entertainment satisfies the associated test.

If the entertainment is held on the same day as a business discussion, it is treated as held preceding or following a substantial business discussion.

When the business discussion is not held on the same day as the entertainment, all the facts are taken into account in determining whether the associated test is met. Factors considered are the place, the date, and the duration of the business discussion. For example, if you or your customers are out of town, the dates of arrival and departure may affect entertainment expenses.

Other Requirements

In addition to meeting the directly related or associated test, you must show that the cost of the entertainment was not lavish or extravagant. There are no dollar figures used in making this determination; rather, it is based on the facts and circumstances. However, no deduction is allowed for fees paid to scalpers, ticket agents, or ticket brokers for tickets to theater, sporting, or other events. Only the face value of the ticket is deductible. Also, the cost of skyboxes and other private luxury boxes at a sports arena is limited. These boxes generally are rented for a season or a series of events, such as playoff games or a World Series. Where the cost covers more than one event, you cannot deduct more than the total of the face values of nonluxury box seats times the number of seats in the box. Then the 50% limit applies.

Food, beverages, and other separately stated charges related to the skyboxes are separately deductible (subject to the 50% limit).

Home Entertainment

If you entertain business associates, customers, or employees at your home, can you deduct your expenses? The answer depends on whether you discuss specific business during the course of the dinner or other entertainment event. Business dinners may be conducive to business discussions. Other types of social gatherings, such as pool parties, may not be as conducive to business discussions and may raise questions with the IRS. It may be helpful to keep the guest list to a minimum (no more than 12) in order to be able to hold discussions with all guests. If you have a larger group, it may be difficult to show that you had business discussions with each guest.

If you do entertain at home, do not combine business with pleasure. The presence of nonbusiness guests may support the conclusion that the gathering was not for business reasons and that business was not discussed. Taxpayers have not fared well in proving that parties for personal events, such as a child's wedding, birthday, or bar mitzvah, were held for business even though business guests attended.

Limit

There is no dollar limit on what you can spend for meal and entertainment expenses. (Remember, though, that there is a lavish or extravagant limit.) However, only a portion of your costs is deductible. Meals and entertainment expenses are generally deductible only to the extent of 50% of cost. The 50% limit applies to meals eaten while traveling away from home even if they are paid with a per diem reimbursement rate.

The 50% limit does not necessarily apply to all business meals or entertainment. There are some important exceptions:

• Promotional activities.

• Meals paid for recreational, social, or similar activities primarily for the benefit of employees. This exception would apply, for example, to your cost of providing food at a company picnic.

• Food and beverages provided to employees as a tax-free de minimis fringe benefit. This exception would apply to your expenses of providing an employee cafeteria on your premises. This de minimis exception has also been applied to meals furnished in “meal rooms” by the Boston Bruins on away games because they were available to all employees (not just highly compensated ones like the players) and the meal rooms were treated as the employer's premises.

• Workers in the transportation industry who are subject to the Department of Transportation's hours of service limitations are subject to an increased meal deduction for food and beverages consumed while away from home. They can deduct 80% of their meal costs.

Impact of the 50% Limit on Employees

The fact that the company cannot deduct 50% of its costs for meals and entertainment does not affect employees. Employees are not taxed on the nondeductible portion of meal and entertainment costs even though they receive a full reimbursement or an advance for these expenses.

Club Dues

You cannot deduct the cost of dues, including initiation fees, to clubs organized for pleasure, recreation, or other social purposes. For example, the cost of airline clubs is not deductible. However, dues to certain business, professional, and civic organizations continue to be deductible. These include:

• Business organizations—business leagues, trade associations, chambers of commerce, boards of trade and real estate boards, business lunch clubs

• Professional organizations—bar associations, medical associations

• Civic organizations—Kiwanis, Lions, Rotary, Civitan

If you pay club dues for an employee, you can turn what would otherwise be a nondeductible expense into a deductible one. You can treat the payment of club dues on behalf of an employee as additional compensation. In this way, the business can claim a deduction for club dues as compensation, not as travel and entertainment costs.

This option applies only to club dues that would otherwise be deductible but for the ban on deductibility. Thus, it applies only if the club is used for business. For example, suppose a corporation pays the country club dues of an employee. The employee uses the club 100% for entertaining clients for business purposes. The corporation can elect to treat these dues as additional compensation to the employee. Of course, the employee cannot claim any offsetting deduction on his or her individual income tax return. If the country club is used solely for personal purposes, then the cost of dues is not subject to this election rule.

The election to treat club dues as additional compensation can be made on an employee-by-employee basis. Thus, if you own a corporation that pays club dues on behalf of yourself and other employees, the corporation can elect to treat the club dues as additional compensation to your other employees but not to yourself. If the corporation pays your club dues and elects to treat this as compensation to you, all you are really doing is shifting the tax burden from the corporation to yourself, something that may not have any net advantage. The corporation should weigh this election carefully before making it.

Spouse's Expenses

If you take your spouse or a friend with you on business entertainment or take a client's or customer's spouse along, are the spouse's expenses deductible? In general, the answer is no. However, if you can show that the purpose for including the spouse was clearly for business and not some social or personal purpose, the spouse's costs are deductible.

Exceptions

Certain gifts are not subject to the $25 limit. These include gifts of nominal value ($4 or less) with your company name imprinted on them that you distribute to a number of clients or customers. These gifts would include, for example, pens, plastic bags, kitchen magnets, and calendars. Thus, if you give a customer a $25 gift and also send a calendar, the value of the calendar (assuming it is below $4) is not taken into account. Both gifts are deductible. Another exception to the $25 rule includes signs, display racks, or other promotional material used on

In one case, the Tax Court recognized another exception to the $25 limit for gifts to employees—gifts designated as an employee relations expense rather than as a gift or compensation. The court allowed a deduction in this case of almost $1,500 (the cost of a set of golf clubs) given as incentive for continued good performance by a top salesperson.

When Is an Item an Entertainment Expense?

If you give an item that could be treated as either an entertainment expense or a business gift, how do you know how to classify it? The choice is yours. In making it, take into consideration the fact that an entertainment expense is subject to a 50% limit, while a business gift is subject to the $25 limit. Thus, if you give tickets to the theater or a ball game and you do not go with the client or customer to the performance or event, you can choose to treat the cost as either an entertainment expense or a business gift.

If you treat an item as a business gift but want to change the treatment, you may do so within 3 years of the filing of your return by filing an amended return.

If you go with the client to the theater or sporting event, you must treat the cost of the tickets as an entertainment expense; you cannot treat it as a business gift. However, if the gift is one of food or beverage intended to be consumed by the client or customer at a later time, you must treat it as a business gift. Thus, if you give bottles of wine or liquor, they constitute business gifts.

No Reimbursement Arrangement

If an employee on salary has no reimbursement arrangement and is expected or required to pay for travel and entertainment costs by himself or herself, the employee can deduct the expenses on his or her individual income tax return. The business expenses are deductible as miscellaneous itemized deductions. This means that after applying all the limits discussed above, such as the 50% limit on meals and entertainment, costs are deductible only to the extent they exceed 2% of the employee's adjusted gross income. In this instance, the employee is responsible for recordkeeping of business expenses.

Accountable Plans

If an employer maintains an accountable plan, the employee does not deduct any expenses. Instead, the employer pays for and deducts all costs. No reimbursements are reported as income to the employee, and the reimbursements are not subject to payroll taxes. Thus, an accountable plan is a tax saver for both the employer and employee. Typically, accountable plans are used for travel and entertainment expenses, but can be used for any purpose (e.g., reimbursing Internet access fees for employees required to work at home).

A reimbursement arrangement is treated as an accountable plan if:

• The expenses have a business connection. This means the expenses must have been incurred while performing services as an employee for an employer.

• The employee must adequately account to the employer for expenses within a reasonable time. Accounting within 60 days after paying or incurring the expenses is considered a reasonable time. The employee must supply the employer with documentary evidence (canceled checks, receipts, or bills) of mileage, travel, and other business expenses unless reimbursement is made at a per diem rate. All employees must provide the employer with a statement of expense, an account book or diary, or a similar record (including computer logs) in which expenses are entered at or near the time at which they were incurred. All amounts received from an employer must be documented. This includes not only cash advances but also amounts charged to an employer by credit card or other method.

• The employee must return to the employer within a reasonable period of time any excess reimbursements. Thus, for example, if an employer advances an employee $400 for a business trip and expenses totaled only $350, the employee must return the excess $50 within a reasonable period of time. A reasonable period of time depends on the facts and circumstances. However, it is automatically treated as reasonable if an advance is made within 30 days of the expense, adequate accounting of the expense is made to the employer within 60 days after it was paid or incurred, and any excess reimbursement is refunded to the employer within 120 days after the expense was paid or incurred. It is also automatically treated as reasonable if an employer furnishes an employee with a periodic (at least quarterly) statement requesting reimbursement of excess amounts and reimbursement is in fact made within 120 days after receipt of the statement.

If the employer maintains an accountable plan but an employee does not meet all the rules (for example, the employee fails to return excess amounts or is reimbursed for nonbusiness expenses), then those expenses are treated as paid under a nonaccountable plan. The remaining expenses are treated as paid under an accountable plan.

It is advisable for the company to formally adopt an accountable plan by putting the action into corporate minutes (see Appendix B) or in other written form.

Nonaccountable Plans

If an employer maintains a reimbursement arrangement but it does not qualify as an accountable plan (for example, excess reimbursements need not be returned, or reimbursements cover nondeductible personal expenses), the plan is considered a nonaccountable plan. In this case, the employer must report the reimbursements on an employee's Form W-2. The employee then deducts the expenses on his or her individual income tax return, subject to the 2%-of-adjusted-gross-income floor.

Reimbursement at Per Diem Rates

Reimbursing employees for travel and related expenses at a per diem rate simplifies things for all concerned; employees need not keep track of every expense and retain receipts for all of them, and employers can make reimbursements at a flat rate, easing accounting procedures. If an employer pays for business expenses using a per diem rate, special rules apply. If the rate used by the employer is the same as or lower than the federal per diem rate for the area of travel, reimbursements are not reported on an employee's Form W-2. If an employee's actual expenses exceeded the reimbursement at or below the federal rate, the employee can deduct the excess expenses on his or her individual income tax return. However, if the rate used by the employer is higher than the federal rate, the amounts are reported on Form W-2. The amount of the federal rate is not included in an employee's gross income, though excess reimbursements are included in the employee's gross income. The employee can, however, claim business deductions for these excess amounts (subject to the 2% floor).

There are several acceptable federal rates that an employer can use to make reimbursements, including the federal per diem rate, high-low method, standard meal allowance, and the incidental rate.

Note: Self-employed individuals cannot use the standard rates covering lodging, meals, and incidental expenses to substantiate their travel costs. They can, however, use the standard meal allowance to substantiate meal costs during business travel.

There are several types of per diem or standard rates that can be used for substantiating travel costs. The rules and amounts for each of these rates have been discussed previously in this chapter. These rates include:

• Federal per diem rate

• High-low substantiation rate

• Standard meal allowance

You cannot use the standard meal allowance if you are related to your employer. You are considered related if your employer is your brother, sister (half or whole), spouse, parent, grandparent, child, or grandchild. You are also considered related if you own, directly or indirectly, more than 10% of the value of your employer's stock. Indirect ownership arises when you have an interest in a corporation, partnership, trust, or estate that owns stock in your employer's corporation or if family members own stock in your employer's corporation. Again, you can use the standard meal allowance if you are self-employed.

Travel

You must show the amount of each separate expense for travel, lodging, meals, and incidental expenses. You can total these items in any reasonable category. For example, you can simply keep track of meals in a category called daily meals. You must also note the dates you left for the trip and returned, as well as the days spent on the trip for business purposes. You must list the name of the city or other designation of the place of the travel, along with the reason for the travel or the business benefit gained or expected to be gained from it.

While this may sound like a great deal of recordkeeping, as a practical matter, hotel receipts may provide you with much of the information necessary. For example, a hotel receipt typically shows the dates you arrived and departed; the name and location of the hotel; and separate charges for lodging, meals, telephone calls, and other items. The IRS says that a charge slip for hotel costs is no substitute for the hotel receipt itself. You must have documentary evidence for the cost of lodging. You do not need documentary evidence if the item (other than lodging) is less than $75 or, in the case of transportation costs, if a receipt is not readily available. Thus, if a cab ride is $9 and the driver does not provide you with a receipt, you are not required to show documentary evidence of this expense.

Meals and Entertainment

List expenses separately. Incidental expenses, such as taxis and telephone, may be totaled on a daily basis. List each date of the meal or entertainment. For meals or entertainment directly before or after a business discussion, list the date and duration of the business discussion. Include the name and address or location of the place for the entertainment and the type of entertainment if not apparent from the name of the place. Also list the place where a business discussion was held if entertainment was directly before or after the discussion. State the business reason or the business benefit gained or expected to be gained and the nature of the business discussion. Include the names of the persons entertained, including their occupations or other identifying information, and indicate who took part in the business discussion.

If the deduction is for a business meal, you must note that you or your employer was present at the meal. Again, a restaurant receipt typically will supply much of the information required. It will show the name and location of the restaurant, the number of people served, and the date and amount of the expense. Be sure to jot down the business aspect of the meal or entertainment, such as asking a client for a referral or trying to sell your services.

Gifts

Show the cost of the gift, the date given, and a description. Also show the business reason for the gift or the business benefit gained or expected to be gained from providing it. Indicate the name of the person receiving the gift, his or her occupation or other identifying information, and his or her business relationship to you.

A canceled check, along with a bill, generally establishes the cost of a business item. A canceled check alone does not prove a business expense without other evidence to show its business purpose.

Using a Diary or Log

Enter your expenses in a diary (see Table 8.2) or log (e.g., in writing or with an app) at or near the time of the event giving rise to the expenses. Computer-generated records are acceptable. Be sure to include all the elements required for the expense (especially the business reason for it).

It is a good idea to total expenses on a monthly basis and then use a recap form to put annual figures together.

Other Substantiation Methods

The IRS has recognized various substantiation methods. For example, if each employee has a company credit card, electronic reports from the credit card company can be used to substantiate charged expenses (paper receipts of expenses in excess of $75 are still required).

There are a growing number of apps that can be used for keeping track of travel and entertainment expenses that turn smartphones into timely recordkeepers. Some are free; some have a modest cost. Each has different features (e.g., customization, mileage tracking, links to credit cards, whether limited to iPhone/Android, whether they are stand-alone or tied into software). Some apps to consider: Certify, Expensify, webexpenses, Xpenditure, and Zoho.

Missing, Lost, or Inadequate Records

If you do not have adequate records, you may still be able to deduct an item if you can prove by your own statement or other supporting evidence an element of substantiation. A court may even allow an estimation of expenses under the “Cohan rule,” under certain circumstances (the Cohan rule is named after entertainer George M. Cohan's case in the last century). Where receipts have been destroyed, you may be able to reconstruct your expenses. You must, of course, show how the records were destroyed (fire, storm, flood). The IRS may require additional information to prove the accuracy or reliability of the information contained in your records. Recordkeeping alternatives are discussed in more detail in Chapter 3.

Per Diem Rates

If you receive reimbursement using one of the per diem rates discussed earlier, you need not retain documentary evidence of the amount of an expense. The per diem rate is deemed to satisfy the proof of the amount of the expense. However, use of the per diem rate does not prove any of the other elements of substantiation. For example, if an employee is reimbursed for business travel using the high-low method, he or she still must show the time, the place, and the business purpose for business travel.

Self-Employed (Including Independent Contractor and Statutory Employee)

You enter your travel, meals, and entertainment expenses on Schedule C, Profit and Loss from Business, or Schedule C-EZ, Net Profit from Business. On Schedule C, there are separate lines for travel, for meals and entertainment, and for determining the 50% limit on meals and entertainment. Business gifts are reported as other expenses, which are explained on page 2 of Schedule C. Schedule C-EZ can be used only if total business expenses are no more than $5,000. You simply add your travel and entertainment expenses to your other deductible business expenses and enter the total on the appropriate line of Schedule C-EZ. You need not attach an itemized statement explaining the deduction. Be sure that when you total your expenses, you apply the 50% limit on meals and entertainment.

Self-employed farmers deduct travel, meals, and entertainment expenses on Schedule F.

Partnerships and LLCs

Travel, meals, and entertainment expenses are reported on Form 1065 and are taken into account in arriving at the business's ordinary income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit to meals and entertainment. Travel, meals, and entertainment expenses are not separately stated items. An owner's share of these expenses is reported on Schedule K-1.

S Corporations

Travel, meals, and entertainment expenses are reported on Form 1120S and are taken into account in arriving at the corporation's ordinary income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit to meals and entertainment. Travel, meals, and entertainment expenses are not separately stated items. A shareholder's share of these expenses is reported on Schedule K-1.

C Corporations

Travel, meals, and entertainment expenses are reported on Form 1120 and are taken into account in arriving at the corporation's taxable income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit on meals and entertainment.