Archive for Travel

Thinking about Buying a Business? Your Opportunities for Tax Deductions Have Already Begun!

Are you aware of business start-up deductions? If you’re not, you should find out right away! You don’t want to miss out on these tax-deductible activities that are only valid when you’re starting a new business. In fact, you don’t have to start your own business; you can get these tax benefits from simply buying a business. Fortunately, this article deals you in on the details.

It Pays to Plan

Before you even purchase your new business, you can start keeping track of your deductible expenses. That’s right, you are eligible for deductions related to merely thinking about your soon-to-be business. Here’s an example. Let’s say you invite a friend to dinner because she purchased her business only a few years ago, and you’d like to find out more about what goes into starting a newly purchased company. That dinner is deductible because you have a business purpose for the expense—you are seeking necessary information for your venture. These expenses are called “start-up expenses”.

Whether you create or buy a business, you will by necessity go through an investigatory phase. If you don’t do this, you may want to reconsider going into business for yourself! However, the rules about how deductions work are a little different in each situation, so we’ll stay focused on the process for purchasing an existing company.

Basically, you are going to incur expenses while you analyze your options and make a decision about what kind of (and then which) business to buy. That is the extent of the investigatory phase. After that, start-up expenses stop, and you begin tracking business expenses.

Here’s a breakdown of the steps and what expenses you may be looking at:

  • Investigating Possible Businesses—First of all, let’s make clear that when we say “buy a business”, we are talking about actually purchasing an active business, not buying corporate stock. If during this period, you spend $41,000 to analyze and review your options, you can begin writing off those expenses the day the escrow closes on your purchase. You get a $5,000 write-off on the first day, and $200 each month after for the 180 months.[1]
  • Identifying Your Prospective Business—In order to take advantage of the expenses for your investigatory phase, you must identify the business you plan to purchase. If after investigating the possibilities, you do not identify a target business, you will not be eligible for any deductions. At the point when you identify your target business, your investigative expenses stop. In the event that you identify a target business but do not end up buying it, you are still eligible for acquisition and facilitative costs, but not the investigative costs.
  • Buying the Business—Once you have identified the business and move forward with purchase, any additional expenses are considered capitalization rather than start-up costs. These are costs that you cannot benefit from until you later sell or leave your business. The IRS has what is called a “bright-line rule” regarding the date your research of possible businesses ends and acquisition activities begin.[2] It is either 1) the date of your letter of intent (or similar documentation), or 2) the date that a binding written contract is executed between you and the target business (unless board approval is required, in which case it’s the date terms are approved by the board or its authorized committee). The IRS will go with whichever of these two dates is earlier.[3]

Take a look at that last bit about the bright-line rule. That means that if you hire an accounting firm, for instance, to investigate your target company, the firm may continue to provide services to you after you submit a letter of intent. The accounting firm will make a financial analysis in the investigatory phase, but it also could review the target company’s books and records after that point. Only the services provided before submission of your letter of intent count as start-up costs.[4] The additional services are capital costs.

Of course, the IRS never makes things easy, so there is an exception to the above bright-line rule. It wouldn’t be tax law if there weren’t, right? You see, some expenses are inherently facilitative, meaning they cannot be counted as investigatory expenses. What about the bright-line date, you may say. It doesn’t matter. Facilitative expenses are capital costs regardless of the date you incurred them. Here are some examples that are inherently facilitative to a purchase:[5]

  • Appraisal costs
  • The cost of a formal written evaluation of the transaction
  • The cost to have a purchase agreement prepared
  • Any costs necessary to obtain shareholder approval
  • Costs for negotiating the transaction
  • Costs for structuring the transaction
  • Any costs for conveying property, such as title registration or transfer taxes

When Corporations Are Involved

Things are always a little trickier when corporations are the entities making the transaction. You may find yourself in one or both of the following situations: you could be purchasing a corporation, and/or your corporation may be the buyer. Let’s look at a few scenarios.

  • You Only Buy Common Stock—If you take over a corporation through common stock, any investigatory expenses are not deductible. This is because you have gained an investment rather than an actual business or trade interest.[6]
  • You Buy Stock Plus Assets—If stock purchase is included in the process to fully take over a corporation, that is a different matter. When you acquire a business’s assets, even when stock is also exchanged, you are eligible for start-up deductions and amortization.
  • Your Corporation Is the AcquirerUnlike the sole proprietor, who claims start-up expenses on the Schedule C, an S or C corporation will claim these expenses on the corporate tax return. Always keep in mind that your corporation is a separate entity from you. Do not pay any of the costs incurred by your corporation. If you do, make sure the corporation reimburses you. Doing otherwise will cause headaches with your taxes.
  • You Form the New Business as CorporationWhen you do this, you incur organization expenses for setting up your company’s entity structure. This can include fees paid to incorporate, legal services required to set up the corporation, accounting services, and expenses related to organizational meetings for directors or stockholders. These costs are separate from investigatory costs and capitalization costs.[7] The good news is that they can be amortized just like start-up expenses. You claim up to $5,000 in the first year and amortize the remainder over 180 months.[8]

Now you know what to do as far as acquiring your business, but what if the business fails or is sold before you finish seeing the full benefits of amortization? No worries. For sole proprietors, you deduct the remaining (unamortized) costs as a business loss.[9] For corporations, both the unamortized start-up and organization costs are deducted on the corporation’s final tax return.[10]

Tax law is not written to slow down businesses, despite the fact that it can get complicated. On the contrary, legislators know that the opening of new businesses benefits the whole economy. That’s why your able to write-off expenses like the ones discussed here. Take advantage of it! The benefits are available so that you and your business can succeed.

  1. IRC Section 195(b).
  2. TD 9107.
  3. Reg. Section 1.263(a)-5(e).
  4. Reg. Section 1.263(a)-5(e)
  5. Reg. Section 1.263(a)-4(e)(2).
  6. H. R. Rep. No. 1278, 96th Cong., 2d Sess. 3, 9-13 (1980).
  7. Reg. Section 1.248-1(b)(2).
  8. Reg. Section 1.248-1T(a).
  9. IRC Section 195(b)(2).
  10. Liquidating Co., 33 BTA 1173.

How You Can Deduct Your S Corporation Board Meeting with Your Spouse

When it comes time to deduct business expenses on a tax return, most corporation include expenses for board meetings. After all, that’s undeniably a business expense, right? Well, sometimes it’s not so clear, like when the only two board members are a wife and husband. If you and your spouse jointly hold stock in your S corporation, how do you prove your right to a deduction? Can you go to a restaurant or take a business trip and still deduct the meeting?

Proving Your Business Purpose

When your board meeting consists of just your spouse and yourself, you have to be careful that the IRS has sufficient evidence documenting the business activities of the meeting. How do they know the event was a board meeting, and not just a pleasant lunch date? Husbands and wives have been conducting business together since before the birth of US tax law. You can study precedent cases to find out how the IRS is likely to view your situation.

Unfortunately, not many cases exist regarding this particular scenario, so you have to look at similar situations regarding deductible business expenses. In the case of Ben Heineman, the IRS questioned him for building an office at his vacation property, costing $1.4 million in today’s dollars (the office was built in 1969). Heineman stated that he could perform certain work (such as making business plans) better with his family and away from the distractions of the Chicago offices. Not exactly the same situation as a board meeting, but the same requirements for determining whether an expense is business or personal.

Heineman was the president and CEO of Northwest Industries, Inc., which had its principal offices in Chicago, IL. Not wanting to spend his summers in Chicago, he built the office at his vacation home in a resort area, Sister Bay, Wisconsin. During the period of the year when Mr. Heineman used this office (from about August until Labor Day), he worked at least 5 hours per day, six to seven days per week. He used this time to perform duties essential to the Chicago offices, including long-term business planning.

In the end, the courts ruled in favor of Mr. Heineman, stating it didn’t matter if it would have been less expensive for him to get a second office in Chicago. He had a necessary and ordinary business reason for the trip—he could concentrate better on his work at that location. Therefore, he was entitled to his deduction.

What the Heineman Case Means for You

Why is this case important for your board meeting scenario? The only deductions that Mr. Heineman claimed were depreciation on his office building and maintenance expenses for it. He did not claim traveling expenses for the trip between Chicago and Wisconsin. However, he did travel—to his vacation property. According to tax law travel regulations, you are able to deduct business expenses incurred on a trip that is otherwise personal, and that is why Mr. Heineman was able to deduct his second office expenses.

The same travel regulations would apply to you if you take your spouses-only board meeting to an out-of-town location. So, what you need to show the IRS (with accepted documentation) is:

  1. Business was the primary purpose of the trip, and
  2. Business actually took place during the trip.

All you have to do to establish business as the trip’s primary purpose is to ensure that you conduct business on more days than you partake in personal activities. Fulfilling the requirement that the trip was necessary for business is tougher. How do you show that it was necessary to go out of town? Again, look at Heineman. You could have some very good reasons for going out of town to conduct business: get away from ringing phones, find peace and quiet to concentrate, or not to be distracted by email or employees.

As for proving that you conducted business, you simply keep records of evidence that you did work. These could include:

  • Documents generated on this trip (such as a business plan)
  • A recording of business conversations that took place
  • Evidence that you were in a business setting
  • A print log showing you physically printed business documents to be discussed and reviewed

The out-of-town board meeting can be a bit of hassle to document, so if you’re banking on the deductions making the cost of the trip worthwhile, you’d better make sure you plan efficiently and can back up your claim to the business purpose of the trip. The funny thing, however, is that an in-town board of directors meeting for a wife and husband is even more difficult to prove.

You see, tax law specifies that you cannot deduct personal, family, or living expenses. That means deducting a meal at a restaurant as a business expense is going to be awfully difficult to justify to the IRS, particularly when no one else is participating other than you and your spouse. You’ll see why with an example of a couple who was not allowed to deduct their board meeting expenses.

Mr. and Mrs. Duquette were the sole board members of Norman E. Duquette, Inc. and attempted to deduct expensive meals at two separate restaurants on January 1 and February 1. At the meals, they discussed items such as approval of payment for trips and determining whether to move the business to Naples, Florida. Unfortunately for the Duquettes, the court decided that the couple had no evidence that the issues required significant discussion.

The Duquettes had no employees, and the couple both lived and worked together. The court found no proof that could justify a husband and wife having an expensive dinner in this situation, when they could have just as easily had the discussions elsewhere without the expense. Here is the IRS’s standard stance on the matter (from the Internal Revenue Manual): “Board meetings between husband and wife are not ordinary and necessary business expenses, but personal entertainment expenses, and are therefore not deductible” (Treas. Reg. Section 1.162).[1]

The takeaway from this is that fine dining expenses are not deductible as a wife-and-husband board meeting under official IRS policy. That does not necessarily mean you cannot deduct such expenses, but you’d better be prepared to have a rock-solid justification for it (i.e. a well-documented business reason). Unlike the Heineman case, the Duquette case does not set a precedent (and neither does the IRS audit manual).

Applying the Cases to Your Situation

If your spouse-only board meeting needs to be away from home, either in-town or out, you need to be able to answer the question “Why?” Heineman had something concrete to show the IRS and the court—a business plan that he developed because he was able to concentrate and focus better at the second office. The Duquettes, in contrast, failed to produce any evidence of work effort during the meetings.

To take advantage of deductions for a spouses-only board meeting for your S corporation, you should be confident that you have at least a 50-50 shot at your reasons being accepted, and whoever prepares your taxes has to back up that assertion. Your tax preparer is at risk of severe penalties for filing a return that doesn’t have a justifiable 50-50 chance. When using this strategy, show the Heineman case to whoever prepares your taxes. But, remember that you are highly unlikely to be able to deduct the in-town, husband-and-wife meeting at a restaurant.

Still want to conduct a meeting during a meal? If it’s an issue that requires a third party, such as your attorney, then go ahead! It’s only when spouses dine together exclusively that the deduction becomes difficult. But, when the two of you are meeting to discuss business matters with someone else who is necessary to the discussion, it makes sense that you must find a location to meet (just be sure to document the business purpose!).

  1. Internal Revenue Manual 4.10.10, Paragraph 9707.

Make Your Records Rock Solid to Avoid Audit

This article isn’t about any particular way to save money on your taxes. However, it will make a huge difference in your taxes no matter what strategy you use for your tax return. Even the absolute best tax methods can leave you at the mercy of an auditor when you don’t properly document and keep records. Sure, you may think it’s a hassle, but is putting in a few hours up-front on an organized record-keeping system worth thousands, even tens of thousands, of dollars in tax savings? You bet!

The Rules of Record Keeping

Here’s the fact—the IRS is never just going to take your word for it that you spent X number of dollars on justifiable and legal business expenses that are now tax-deductible on your return. Sorry, no documentation, no deduction.

So, with that in mind, here’s the first rule you need to know.

Rule #1 Always keep your accounts separate. In fact, you should have separate checking accounts for:

  • Each spouse,
  • Each corporation,
  • Each Schedule C business you report, and
  • Your rental properties (you may even want a few separate accounts for these if they are very different kinds of rentals).

How about an example of why this is so important. Let’s say you own a sole proprietorship, and you cover your spouse under a Section 105 medical reimbursement plan. If you’re using one checking account jointly for your household and your business, you would have to write the reimbursement check to yourself—and that negates your Section 105 plan.

That’s exactly how Darwin Albers lost out on deductions for his 105 plan.[1] Keep your business and personal accounts separate—just do it.

Rule #2 Earnings go to the account belonging to the business that earns the money. Do not take payments in your personal name. If you do, they cannot be assigned to your corporation. The person or entity that earns any given income is taxed for said income.[2] If you follow the rule above, then it’s easy not to mix personal receipts into your business account and vice versa. Although it’s possible to argue with the IRS that some receipts in a given account are not taxable, it’s not worth the frustration and wasted time.

Rule #3 Keep track of your deductible expenses each day. Don’t wait until two weeks from the purchase to write down your expenses (or save them in your file). For one thing, it increases the chance that you may miss something. For another, the IRS requires that deductible expenses are recorded within one week. The idea of doing daily record keeping may make you want to just toss your files over your shoulder (don’t—you’ll hate reorganizing them up later), but it really is good practice. After all, how hard is it to save a receipt and make a note about why you spent the amount?

Rule #4 Keep a log for each set of expenses. For most deductions, you need evidence that proves your business use or business purpose for the expense. Want to deduct vehicle expenses? Keep a log to track daily mileage. Want to deductions on your rental properties? You’d better keep track of how you materially participate in your real estate or how you qualify for status as a real estate professional. Planning to make deductions for your home office? Again, you need a log, this time to keep track of how many hours you spend working in that office. You’ll have to consistently spend more than 10 hours per week working from your home office in order to claim it on your tax return.[3] By keeping track on a daily basis, you can take advantage of the sampling method of calculating your deductions in some cases (such as vehicle mileage); this method allows you to take a sample from a three month period rather than calculating the exact sums.[4]

Rule #5 Keep track of travel and entertainment costs. For travel expenses, you have to prove (with documentation) where you were each day and why. Your business entertainment costs also need proper documentation, including what you spent money on, how much, when, and where the expense occurred. Your receipt will cover all of those, but you’ll additionally need to note who you entertained and why (i.e. the benefit to your business).

In the case that you operate your business as a corporation, you’ll have to turn the expenses in to your company. You can do this by paying with a corporate credit card, or you can have the corporation reimburse you for the expenses. Making sure the company pays is important; otherwise you’ll only get employee-business deductions for those expenses.

What to Remember

No matter what kind of business costs you incur, you need to remember these two primary pieces of information: 1) prove what you bought and 2) prove that you, in fact, paid for it. As mentioned above, a receipt or paid invoice covers the first part of this. In order to prove payment, you can use a credit card receipt or statement, canceled check, or bank statement (for electronic transfers). Note: An item is considered paid for when you charge it to your credit card, regardless of when you pay the amount to your card.[5]

Don’t pay with cash. It makes things more difficult for you. If you pay with cash, an auditor will want to know where the cash came from, how you can show cash trail and tie it to the payment, whether you can prove an ATM withdrawal, and most importantly, did you really pay for something in cash or are you just making up a deduction? Paying with pretty much any other method is much less of a hassle.

A Note on Petty Cash

Petty cash works for some small businesses. If it’s what you’re accustomed to and you haven’t had any problems, then by all means continue using the system. However, many small business owners end up kicking themselves in the pants with a petty cash system. You’ll likely find it easier to use a reimbursement system.

With the reimbursement system, your company simply writes you a check for the expense when you provide documentation for it (a receipt or expense report, for instance). Because you have to present documentation for reimbursement, you’re less likely to get caught without evidence for your spending, as you could with petty cash.

Statutes of Limitations and How Long to Keep Records

The IRS has statutes of limitations on when either you or it can make changes to a tax return (this is not just the period during which they can audit you). Here are the time frames given in IRS publications:[6]

  • No limit if you did not file a return
  • No limit if you filed a fraudulent return
  • Three years after filing if you filed on time (or with extensions), you did not understate your income by 25 percent or greater, and you did not file fraudulently
  • Six years after filing if you filed on time (or with extensions) but you understated your income by greater than 25 percent
  • If you filed an amended return or already made changes to the original return (like a quick refund claim), either three years after filing or two years after paying the tax
  • Seven years from filing for a claim filed for a bad-debt deduction or loss from worthless securities

If you have employees, you need to save your employment tax records for four years after whichever date comes later, the date payroll taxes were paid or the date they were due.

Because these statutes of limitations also indicate how long the IRS can audit your return, you need to ensure that you hang on to all of your records until the risk of audit has passed. This could mean keeping records for a period of multiple years. In the case of assets, like office equipment and office buildings, the records are relevant throughout the asset’s entire depreciable class life. As long as you are still depreciating an asset, it will be in that year’s tax return. When using Section 179 to expense an asset, you also have a potential recapture throughout the depreciable class life.

Here’s an example. You buy a desk for $1,500 and depreciate it over the MACRS life of seven years. This depreciation actually takes eight years, so you need the original purchase receipt in year eight in order to prove your deduction. Additionally, you will need to retain that purchase record for three years after that when the statute of limitations expires (for a total of eleven years). It works the same with Section 179, except that you also have recapture exposure during those eight years of depreciation.

Would you like an easy way to keep track of this? Just make a permanent file for any assets with a life greater than one year. This way, you don’t need to keep track of class lives or time frames on the statutes of limitations.

And, here’s another quick tip for keeping those records organized:

Simplify your file system by devoting separate drawers for each tax year. In those drawers, you’ll put any information on assets, income, and other information applicable to your return. This method is for assets other than those you keep in your permanent file. The first drawer will be where you put all documents as you acquire them throughout the year. The next drawer is last year’s tax documents. The drawer after that contains documents from three years ago, and so on until you reach the year at which your statute of limitations expires. Each year, you move the drawers down one level and dump the one at the bottom of the line. You can also use this method for any employee tax files.

You see? It really isn’t all that difficult to keep your records straight. You’ll be thankful you did when it comes time to prepare your return.

  1. Darwin J. Albers v Commr., TC Memo 2007-144.
  2. United States v Basye, 410 U.S. 441, 449, 451 (1973); Lucas v Earl, 281 U.S. 111 (1930).
  3. John W. and Regina R. Z. Green v Commr., 78 TC 428 (1982), reversed on other grounds, 707 F2d 404 (CA9, 1983).
  4. IRS Reg. Section 1.274-5T(c)(3)(ii)(C), Example 1.
  5. E.g., Rev. Rul. 78-38; Rev. Rul. 78-39.
  6. IRS Pub., 583, Starting a Business and Keeping Records (Rev. January 2007), Record Keeping.

You Can Deduct Your Vacation—Just Learn the Tax Rules!

Get ahead and get packed because you’re about to get advice on how to deduct your vacation expenses. We’re not talking about a lame, business conference vacation here. This is bona fide advice for getting legal tax advantages for even a luxury vacation. And, you can count the steps on one hand! It’s true. You only need to understand these five tax rules to legally deduct items like your plane ticket and hotel suite:

  • Business Motive—By a business motive, the IRS means a plan for how this trip will contribute to your ability to make a profit. The profit does not have to be immediate, but you should be able to show that you had a reasonable expectation of monetary gain from the trip.
  • Overnight Stay—As with any business travel, you can only deduct expenses for trips that last, at least, overnight.[1]
  • Importance of the Trip—Ask yourself this: are the business activities you will engage in during your trip important enough that you would take the trip purely for business reasons? If it would not make sense to take the trip, except for the personal pleasure of it, then you’ll have difficulty deducting the expenses.
  • Pass the Primary Purpose Test—This test applies to any business travel in the United States. Basically, you need to make sure that the majority of your days on vacation count as business days. To do this, you need to conduct business on more than 50 percent of the days you are away. Additionally, for any single day to count as a business day, your business activities must take up at least four hours of that day (half of a standard workday).
  • Keep Records—Most importantly, record everything about the trip, including notes about the other four rules above.

If you meet these five requirements, then you can justify the business purpose of your trip.

Doing Business in Luxury

It turns out that your business trips can be as luxurious as you desire. With the right planning, you can both accomplish important business tasks and take a well-deserved break. Consider some of the expenses that can be deducted when you follow the five rules:

  • Rental car expenses (even a Rolls-Royce, if you want!)
  • The best suite at your choice of hotel
  • Airfare (even first-class)
  • Boat tickets (cruise travel, too[2])

As you can see, there’s no need to skimp on luxury, relaxation, or adventure when you turn your vacation into a business trip. Plus, you get huge tax savings that are not available for a personal vacation.

Types of Deductions

Business travel allows for to primary types of deductions, transportation expenses and life expenses. The cost to actually travel to and from a location is always a full-expense deduction or no deduction at all. You cannot pare out part of the deduction for personal and part for business. Remember the rule about primary purpose? If you pass those requirements, then you’re clear to deduct all your transportation costs. However, if most of the days on your trip are personal days, then you cannot deduct any of those expenses, even if you conducted business on some days.

The second set of deductions, life expenses, refers to the costs associated with sustaining your life while you’re away from home. That includes your hotel stay (or other lodging) and your meals. Unlike the transportation deduction, however, life expenses can only be deducted on business days. So, if you take a whole day to visit a historic downtown district, any meals for that day and the hotel stay for that night are not deductible, even if the day before and after are devoted to business.

You can see why good record keeping is so important. The IRS is not just going to believe that you spent every day of a vacation in Maui taking care of business.

Getting Business Travel Right

The tax code is unhelpfully vague when it comes to what constitutes business travel. The language states that you can deduct expenses that are “ordinary and necessary” for conducting business.[3] Unfortunately for those of us trying to get the most from legal deductions without incurring the wrath of the IRS auditor, the courts don’t do much to narrow down these broad terms. To support the reasons for your travel deductions, the best you can do is check out the rulings in previous tax cases.

Let’s start with the kind of scenarios that succeed with deductions:

  • Meeting at a Resort—Charles Hinton III solely owned United Title Company, a North Carolina-based C corporation. Every year, he held an out-of-state board meeting in locations such as New Orleans, Las Vegas, and Puerto Rico. He only invited his corporate board members and certain business guests (e.g. bankers, real estate developers, real estate attorneys), as well as their spouse or guest. In addition to the meeting, attendees also discussed business topics, like underwriting policy.

All travel costs were deemed deductible, excluding those for the spouses and non-business guests. Otherwise, the trip was considered for business purposes because the interesting locations ensured that business guests chose to attend. Mr. Hinton’s corporation benefited from the business conversations and from the strengthening of relationships within the field.[4]

  • Expanding BusinessAlthough Raymond Jackson regularly traveled in his business’s sales territory, he was able to deduct travel expenses from outside his normal territory. The additional trips were intended to find new clients and expand his business, thus they were deductible as business travel.[5] Tip: If you are traveling to find initial clients for a new business, those must be considered start-up expenses.
  • The Seminar or ConventionConventions do provide an excellent excuse to travel, and most take place in areas that lend themselves to vacation activities. Because conventions are set up to be business activities, it is easy to justify your expenses as business-related. Just remember these guidelines: 1) the travel expenses to North American conventions are deductible as long as they advance the interests of your business; 2) any convention that consist of video lectures can only be deducted if the videos could only be viewed at the convention (they could not be streamed or downloaded from home); and 3) travel expenses cannot be deducted for seminars relating to your investment interests rather than your business or trade.[6]

Now, this next set of cases shows you what kinds of scenarios fail at qualifying for deductions (hint: you must have a substantial business reason for your trip):

  • Lack of Business Importance—A custom plywood manufacturer took customers on a trip to New Orleans for four days. The trip included attending the Super Bowl, going on a Mississippi River cruise, and hotel accommodations in the French Quarter. The court deemed the trip merely entertainment, stating that the sporadic business discussions were incidental.[7] The trip did not pass the rule about being important enough to take (and justify the expenses) without the personal element.
  • Lack of Business Motive—A minister took a tour group to Europe; however, no profit motive for the trip was evident.[8] Remember, a business trip must demonstrate the potential increase your company’s profit.
  • Lack of DocumentationA real estate salesperson lost out on deductions for five different trips because she did not keep records to sufficiently prove the business purpose of any of her travel costs.[9]

How can you avoid these scenarios? Just keep proper documentation of your trip and the expenses. It’s not difficult at all. Be sure to include 1) how much each expense cost; 2) when you departed and returned; 3) how many days you spent on business; 4) where you went; and 5) why your trip was business related or expected to generate profit. The IRS requires all of this information in order for your business travel deduction to qualify.[10] Most of this information can be found on your receipts, so keep those in a file. As far as defining your business purpose, you can simply put a note in the file or use some other dated note-keeping system.

You may not be able to include deductible expenses in every vacation, but now that you know the rules, you may start looking at your travels a little differently. If you can reasonably fit in business activities while enjoying yourself, it makes sense to take advantage of the tax savings. Review these five easy rules the next time a travel opportunity arises.

  1. Barry v Commr., 54 TC 1210, aff’d 435 F.2d 1290.
  2. Subject to luxury water travel limits, between $678 and $810 (varies by time of year) per day for 2015.
  3. IRC Section 162(a)(2).
  4. United Title Insurance Co., TC Memo 1988-38.
  5. Jackson v Commr., TC Memo 1975-301.
  6. IRC Section 274(h)(7).
  7. Danville Plywood Corp. v U.S., 899 F.2d 3.
  8. Blackshear v Commr., T.C. Memo 1977-231.
  9. Robinson v Commr., T.C. Memo 1963-209.
  10. Reg. Section 1.274-5T(b)(2).

Knowing the Rules Can Boost Your Travel Deductions

Traveling for business can be a tricky situation when it comes to taxes. How do you know what can be deducted? And, what counts as a tax-deductible business day? The IRS actually has some fairly easy rules, so once you know how to define “business days”, it becomes much easier to understand your deductions and get the most from them.

Personal Days vs Business Days

Why is it so important to understand the difference between personal days and business days? For starters, any travel done on business days (by the IRS definition of the term) allows for deductions on gas, lodging, and food. That can mean significant savings for you when documented correctly.

Let’s lay out the business day rules and what they mean for your deductions (you only need to meet one of these requirements):

  • You Work More Than Half a DayIf you work for more than four hours on any particular day of your trip, that day counts as a business day. Typically, a full work day is eight hours, so that means doing business for more than four hours constitutes the majority of your possible work day[1].
  • You Spend the Day TravelingLet’s be clear about this. You must spend the majority of your day traveling for business. Even if you perform no other business activities that day, your business travel day is counted as a business day[2]. Just make sure the majority of you trip qualifies as business.
  • Your Presence is RequiredIf one of your business associates must have you present for necessary business reasons, your travel and expenses for that day are deductible, even if you did not spend four hours working[3]. Associates include your partner, employer, customers, or clients.
  • You Were Prevented from WorkingThings happen, and your day does not always go as planned. Luckily, the IRS plays fair on this. If you tried to conduct business but were prevented by circumstances beyond your control, you can still deduct your business travel expenses[4].
  • Holidays, Weekends, and Other Necessary Standby DaysSometimes your travel may stretch over a period that includes non-business days. When it’s not practical to return home and travel back again, your expenses for these days are deductible. To prove the necessity, keep records indicating that travel time would have been unreasonable or the expense would have been greater to travel back and forth than simply to stay over[5].
  • Days that Save MoneySometimes you score a travel discount for traveling a day or two earlier or later than needed. As long as you can show that the amount you saved outweighs what you spent on staying an extra day or two, your costs count as business day travel expenses[6].

As you can see, it’s fairly easy to create a business day out of what would have been a personal day. Knowing the difference between the two is the key to boosting your deductions. Just be sure to keep accurate records that indicate how you spent your time, how much money you spent, and why the activities were for business purposes.

Primary Travel Expenses

Now that you know which days are business days, you need to understand what expenses are covered on those days. Certain expenses are pretty much a given on business trips, so we’ll take a look at how those common expenditures figure into your deductions:

  • Food and Lodging—Anything you need to sustain yourself during travel is called a life expense. Your meals and hotel stay are life expenses. However, be careful that you only deduct these expenses for business days, not personal days.
  • Transportation—Unlike life expenses, transportation cannot be partially deducted (i.e., divided between personal days and business days). If the majority of your trip was for business purposes, you deduct all of your transportation expenses. If the majority of the trip was for personal reasons, you cannot deduct travel[7].
  • Business Expenses—Business expenses are the exception to the business day vs personal day rule. These are expenditures that can be deducted regardless of whether the day was primarily spent doing business. Some examples are shipping costs, communication costs, and printing costs.

Now you know the rules for what constitutes a business day and which expenses are considered tax deductible for business travel. Before making these deductions, you should always check that the trip qualifies. That means the majority of days on your trip should be business days, and some expenses (such as food and lodging) can only be deducted for days that are actual business days. When you’re mixing business and leisure, you cannot deduct these expenses on days where the majority of your time was spent in non-business related activities.

Sample Itinerary

It really doesn’t make sense to avoid fun and experiences just because you’re on a business trip. By planning ahead and documenting your time, you can spend plenty of time enjoying yourself wherever you may be conducting work activities. Look at this example to see how the deductions add up:

  • Days 1 and 2—You rent a car to drive from Maryland to Orlando, stopping overnight at Georgia in between. Both of these days are deductible for business travel.
  • Days 3 through 5 (Friday, Saturday, Sunday)You are staying in Orlando. Normally, these would be considered personal days, but if you set up a meeting with colleagues or potential clients on Friday, you can turn all three days into business days.
  • Days 6 through 9—This is the week of the business conference, and you are staying at a Disney Resort. You can deduct the price of the resort stay and your meals for these days.
  • Days 10 and 11You leave Florida to drive back home, and you stop over at Georgia again. Like the trip to Florida, these days are business travel days.

With an itinerary like this, you have eight business days if you do not conduct business on the first Friday. Even with eight of the eleven days, your trip is primarily business and you can deduct all transportation expenses. You can deduct the resort stay and meals (life expenses) for the eight business days. Or, if you make that first Friday a business day (thereby converting the weekend to standby days), you can deduct life expenses for all eleven days! The next time you’re planning a trip (whether business or personal), ask yourself what you can do to make it a business trip and still have fun.

  1. Reg. Section 1.274-4(d)(2)(iii).
  2. Reg. Section 1.274-4(d)(2)(i).
  3. Reg. Section 1.274-4(d)(2)(ii).
  4. Reg. Section 1.274-4(d)(2)(iv).
  5. Reg. Section 1.274-4(d)(2)(v).
  6. PLR 9237014.
  7. The technical rule is “primary purpose,” which does not necessarily mean the majority of days.

Understanding Travel Deductions for Educational Seminars

If you’re considering going out of town for an educational seminar, you may want to ask yourself a few questions to determine whether the expense is justified[1]. First, is the trip primarily for the purpose of continuing education? If so, how many hours of each day there will actually be spent in educated-related activities? If not, then is the trip part of a vacation or leisure trip?

To deduct your travel for a business-related education seminar or event, you have to show that obtaining business education is the primary reason behind your travel[2]. Not only that, you must also keep in mind that for tax law purposes, the term “travel” refers only to trips that take you out of town long enough to require a stop for sleep[3].

Is the Trip Business or Personal?

Of course, sometimes you combine business and personal time on a trip out-of-town. It would be silly not to take advantage of new sights if you have the opportunity. But, what do you do about deducting expenses in these situations? It’s actually not that difficult.

If your trip otherwise qualifies as a tax deductible business trip, and you take, for example, a three-hour hike through the mountains while you’re there, you can just handle any hiking costs as personal expenses. This does not cancel the validity of your business trip[4]. All you need to do is document which expenditures went towards business events and which were for personal activities.

Matters aren’t much more difficult for personal travel that includes business. If you take a vacation or other personal trip and end up spending a day working on business matters, you treat the travel expenses and the majority of the trip as personal for tax purposes[5]. Then, you keep track of any expenses for the business day and note them as business expenditures. Note: This does not mean you can deduct food and lodging for a day of your vacation because you took a one-hour conference call. But, if you spend a full seven hours of one day trying to work out business issues during your vacation, then you can count that day as business.

If your trip is fairly evenly mixed between business education and personal activities, it may be more difficult to determine whether travel and lodging expenses are deductible. IRS regulations state that the important thing is to weigh the relative amount of time spent to each in order to determine the primary purpose of the trip (in particular, you can look at regulation 1.162-5(e)(1)). Now, look at that last sentence. You will see that time is the determining factor, not importance of the educational activities. The division of time is what the IRS will consider.

Another example may help to clear up how this works. In revenue ruling 84-55, a taxpayer took a trip for educational classes sponsored by his alumni association. The educational meetings only lasted about two hours per day, and the rest of the time he spent with his family. The IRS ruled the trip a family vacation. However, he was allowed to deduct expenses for the cost of the classes. Nothing of the hotel stays, meals, or back and forth travel was allowed to be deducted.

Other cases have been ruled in much the same way (see Holswade[6]). You should understand that if the number of hours spent on business education is minimal, the trip will be considered personal. In this case, you will likely only be able to deduct the costs of the educational course itself. It is only when more than half the day is spent on business that you can consider it so[7].

Time is easy to measure. When you’re going on a mixed-purpose trip, be sure to track your time consistently. This is the only way you have an argument for deducting expenses for lodging, meals, and travel.

How to Document Your Trip

Be aware that the IRS is not going to just take your word for it that you spent more than half your time conducting business. You may be asked to provide documentary evidence of your business activities during the trip. In that case, each of the following items is useful:

  • Receipts—Obviously, you will file all the receipts from your trip. This shows both the business-related expenses and how you paid for them. Tax law absolutely requires that you save receipts and document the business reason for each day (e.g., attending a specific seminar) if expenses exceed $75. Be sure to note what each receipt is for—breakfast, gas, etc.
  • Brochures—Most education seminars will provide an event brochure. Hang on to this, and put it in a folder with other information regarding your travel. This is especially useful if the brochure outlines how the seminar is useful for your business purposes and has a clear outline of benefits.
  • Notes—You may not remember every detail of your outing. This is where taking timely notes comes in handy. Once you are back from your trip, or even better, during the trip, take time to note which activities you took part in for business and how long they lasted. You can also jot notes down on your brochure if it’s not clear how the seminar benefits your business.
  • Travel LogWhat format you use for your log does not matter. What is important is that you have somewhere (a notebook, calendar, or app) that allows you to your activities during your stay. This should include all events that you attend, contacts you meet, and how you otherwise spend your time. You can find several good software applications for this.
  • Summary of Benefits—If you haven’t noted this in any other journal, you may want to outline the benefits you received from the seminar after the trip ends. This allows you to state clearly what you got from the trip and how you will apply it to your business. This works as a supportive document that explains why the travel was business related.

With the proper documentation, you should be able to prove that your trip is eligible for business tax deductions. Just remember the half-day rule and to keep thorough records. A business trip does not have to be “all business,” so relax—figuring out eligible expenses is not all that difficult.

  1. Rev. Rul. 84-55.
  2. Reg. Section 1.162-5(e)(1).
  3. Rev. Rul. 75-168; U.S. v Homer O.Correll (1967, S Ct) 389 US 299; IRS Pub. 463 Travel, Entertainment, Gift, and Car Expenses (2005), p. 3.
  4. Reg. Section 1.162-5(e)(1).
  5. Ibid.
  6. Holswade v Commr., 82 T.C. 686 (1984).
  7. Reg. Section 1.274-4(d)(2)((iii).

Don’t Be a Target for the IRS

If there’s one thing the IRS is most known and feared for, it’s the audit. It’s well-known by now that the IRS has had its eye on tax-exempt conservative groups, but what you may not realize is that they’ve now expanded that extra attention to entrepreneurs, owners of small businesses, and high income earners. This is atypical of their past trends, since they had previously focused efforts on watching large corporations. However, the number of revenue agents in the IRS has risen by more than 5,000 people in the last few years.

Who’s at Risk?

This expansion in auditing-capability primarily hits the upper-middle class and affluent individuals. Without raising taxes, this move has allowed the IRS to greatly increase total tax collections because more audits are performed and more revenue officers are available to collect unpaid taxes from citizens. Grumble if you will, but the decision-makers are probably pretty happy with their investment in extra workers. Estimates show that the IRS has an 18 to 1 return rate on each dollar invested in audits and collections.

Are you feeling confident that your business is too small to come under scrutiny? Think again. The IRS conducted a study involving 46,000 taxpayers, and the results indicate a $345 billion tax gap. Guess what else the study revealed—about two-thirds of that gap came from entrepreneurs, small business owners, professionals, and investors. The IRS has grown its means to act on suspicious tax returns, and it’s looking straight at you. That’s right; it’s moving about 30 percent of its auditors away from large corporations and using that workforce to scout out smaller prey.

What IRS Expansion Means for Your Tax Return

An audit can cost you a lot of money in professional fees, back taxes, interest, and penalties, so it makes sense to audit-proof your return now. Don’t assume that you make too little for the IRS to be concerned with you. Although the top earners have the highest audit risk (those earning more than $1 million have seen a dramatic increase in audit rates recently), even individuals making $200,000 are experiencing the effects of increased tax surveillance. Your risk of audit may not be as high as the 1 in 8 chance that millionaires now face, but it is trickling down to businesspeople with more modest incomes.

In order to understand why you may be audited, it helps to understand the process used by the IRS. It has several different methods for selecting returns for audit, and one that has been in use for decades is called the discriminant index factor (DIF). Basically, a mathematical formula is used to score a return, often based on the ratio of income to deductions. The process breaks down like this:

  • You send in your tax return, and the systems at Martinsburg West Virginia National Computer Center run the numbers.
  • Your return gets a DIF score. The higher the score, the bigger the chance that additional taxes may be able to be collected from you.
  • IRS employees audit the returns with the highest score first (i.e. the returns that will bring in the most additional revenue).

The formula for DIF scores is regularly updated using an analysis of intensive audits, the Taxpayer Compliance Measurement Program (TCMP). It’s conducted every few years. For a TCMP audit, every single piece of information on the return is analyzed. For people reporting business receipts on their personal income tax return (Schedule C and Schedule F), gross business income is used to determine DIF score, not net business income. Red flags that generate a high DIF result may lead to your receiving a letter of inquiry, or even the dreaded examination of your tax return.

Avoiding the Audit

After computer DIF scores are assigned to the returns, IRS employees then select which returns will be audited. This process usually starts later than June. A computer formula may assign you a high DIF, but in the end it is up to classifiers working in the district offices to determine whether your return raises red flags. So, even if a high DIF result brings your return under scrutiny, you can follow some simple rules to keep down your chances of being selected for audit.

Take a look at some basic tips for making your return less likely to be audited:

  • Balance Your Deductions—Risk of being scrutinized increases with the more deductions you take compared to the size of your income. Time your deductible expenses right so that they are fairly even on a year to year basis.
  • Always Respond to Inquiries—If the IRS sends you a letter regarding missing schedules, send a response! Failing to answer makes you much more likely to be examined.
  • Remember Form 8283—When you make a non-cash charitable contribution, you must include this form.
  • File Your AMT—The alternative minimum tax is separate from regular taxes. You’ll need to use Form 6251 and send it in with your 1040.
  • Document Your Casualty Losses—Casualty losses are already a red flag for the IRS. You definitely deserve any deductions you are entitled to for such losses, but be sure to document all information about the date of loss, cost, and any insurance payments you received. And, include this information with the return, not when they’ve flagged you for auditing.
  • Report Any 1099 IncomeIf a client of yours reports a 1099 to the IRS, you’d better make sure you report it on your tax return. When you don’t, it’s considered a matching issue, and you will be contacted about it. In the case that you are contacted about a mismatch issue, respond to the IRS immediately to prevent an escalation of the situation.
  • Use an Entity Structure—Filing a high number of gross receipts for your small business drastically increases your return’s chance of being examined. However, when you switch from reporting these on a Schedule C to reporting them as a corporation, partnership, or LLC, you significantly reduce that risk. Not only does using an entity structure lower your chance of being audited, it also decreases your taxes. It’s an excellent option to consider if you are functioning as a proprietorship or independent contractor.
  • File On Time—This one should go without saying, but turning in your tax return by deadline (including extensions) can help you to avoid examination.
  • File a Paper Return—Filing electronically may seem easy, but there’s a reason the IRS encourages taxpayers to use this method. An electronic return can go right into their DIF scoring system and be ready for analysis immediately. Rumor has it that only about half of all paper returns even get scored in the DIF system. Most taxpayers are required to use the electronic filing system. However, you can opt out by attaching IRS Form 8948 to your paper return.
  • Watch Out for the Big Three—IRS agents are coming down hard on deductions for travel, automobiles, and entertainment expenses. The secret to having these deductions approved is documentation, documentation, documentation. Quick and dirty tip: The IRS requires 5 pieces of documented evidence, but all you really need is your receipt! It covers 1) date of the expense, 2) where the expense occurred, and 3) amount of the expense. Then, you simply write on the back of the receipt 4) the business purpose for the expense and 5) your relationship to the person or group you entertained. Simple! Just don’t forget the receipt—the IRS does not count credit card statements as receipts. For automobile deductions, you’ll also need to keep a mileage log.

Electronic filing has made auditing easier (and a bigger priority) for the IRS. Now that they need fewer employees sifting through paper files, they have allocated a larger portion of their workforce towards audits and collections. With this increased strength, they have turned their eyes toward smaller entities, but you can audit-proof your return by providing accurate documentation and following these tips. Don’t let the IRS intimidate you into forgoing deductions you have a right to!

How Commissioned Employees Have Vanquished the AMT and You Can, Too

When it comes time to prepare your taxes, you may have an unpleasant surprise waiting in the alternative minimum tax (AMT). Despite its intention of ensuring that top earners pay their fair share of taxes, the AMT really can be a kick in the pants for employees, who cannot deduct their business expenses. Particularly in the case of commissioned employees, this creates a huge difference in the amount of taxes they pay.

What You Need to Know about the AMT

The AMT was created during the 1986 tax reform, and it basically taxes income that is deductible under the regular tax, such as employee business expenses. Here are just a few of the types of employees who pay their own work expenses:

  • Mortgage brokers and bankers,
  • Insurance sales professionals,
  • Traveling sales professionals,
  • Real estate sales professionals, and
  • Emergency room physicians.

Why are commissioned employees particularly burdened by this tax? It’s because they often have a slew of business-related expenses that they pay out of pocket. Then, here comes the AMT to tell them they are not allowed to deduct any of those expenses. However, independent contractors performing the exact same duties as those commissioned employees can deduct many of their expenses.

What Employees Can Do about It

If your income level boxes you into the AMT, you don’t have to give up and lose thousands of dollars to additional taxes. And yes, it is potentially thousands. Take, for instance, the case of Dan Butts, an Allstate insurance agent. In one year, he paid about $10,000 more in federal income taxes than agents at State Farm.

What did Butts do wrong? Nothing—the difference lay in how he was designated by his employer. Butts was considered a W-2 employee, but the State Farm agents were independent contractors with 1099’s. Look at that scenario again. Butts did the same job, at the same pay, and with the same deductions as the agents at another company, but because of his designation, he paid $10,000 more in taxes.

That is a ridiculous situation for an employee to be in simply because the AMT does not permit deductions for business expenses! Fortunately, if you’re in a commissioned position, like Butts, you can do something about this unfair situation. He simply amended his tax return to put his W-2 employee commission earnings on the Schedule C form that self-employed individuals (including contractors) use. He deducted his expenses and saved that $10,000.

Of course, the IRS noticed that he used the wrong form, and he ended up going to court over the issue. . . and winning! Of note in this case is that the court granted Butts independent contractor status even though he had been employed as an employee with Allstate for years and enjoyed employee benefits[1]. The ruling went his way because he carried a “risk of loss”, just like the agents who were independent contractors.

However, you should keep in mind that using the Schedule C to avoid the AMT may work differently in various fields. For instance, a mortgage loan officer named Dan Cibotti worked for Liberty Trust Mortgage, Inc. as a commission-only W-2 employee. More and more commissioned employees are filing on Schedule C, and Cibotti was one of them. In his case, the court ruled that he was considered an independent contractor, despite having a W-2 that reported his income as an employee, because[2]:

  • He set his own hours and chose his own work location and method of finding clients;
  • His employer did not provide him an office;
  • He claimed a home-office deduction;
  • He was paid 100% on commission;
  • He had the possibility of gain or loss on his business activities; and
  • He received no employee benefits, such as a retirement plan or health insurance.

As you can see, the two situations were quite different, but each involved a commissioned employee who fought for his right to file as an independent contractor and won.

Going Forward

Now that other cases have set the precedent, it is becoming easier for insurance agents and other commissioned employees to avoid the AMT. In fact, the IRS, in chief counsel notice N(35)000-141(a), ordered its lawyers not to challenge individuals who claimed independent contractor status under the Butts precedent, but the IRS can be a stubborn entity. The notice that allowed independent contractor status also instructed the lawyers to:

  • Calculate self-employment tax on the agent’s net income and allow a credit just for the employee share of FICA and Medicare (i.e., employer payments are not included);
  • Calculate taxes on employee benefits, like employer-paid medical insurance and Section 125 contributions;
  • Calculate taxes on 401(k) contributions and make the taxpayer aware that they may not fall back on the Lozon decision, which concluded that such contributions were not taxable until withdrawn[3].

This notice has since expired, but if you plan to pursue independent contractor status, it would be wise to compare AMT savings with the potential tax disbursement outlined in the above IRS strategy.

Other Cases

Several other cases for independent contractor status have gone to court with varying results. Wesley Wickum, a district manager for Combined Insurance Co. of America, amended three years of tax returns and reclaimed $27,000. His salary included commission from his sales, bonuses, and override commissions based on the salespeople he recruited and supervised. In a funny twist, his company had previously considered the salespeople and managers to be independent contractors, but had changed the status out of fear of IRS penalties for wrongly classifying employees as contractors!

You can see the repercussions on business. The AMT hurts a company’s best salespeople—those who make the most commissions. When such a worker is classified as employee instead of contractor, the AMT comes into play, and may cause the best salespeople to leave the company.

A sales agent named Paul Hathaway also amended three years of tax returns after learning of the Butts case[4]. He was a commissioned employee, and although his company provided a W-2 each year and gave him benefits, he paid his own expenses for food, samples, travel, telephone, stationary, and business cards.

William Johnson and Barbara Lewis, on the other hand, lost each of their cases for independent contractor status. Johnson was a full-time hospital equipment salesperson who worked on commission, but the court ruled that he was an employee because his employer 1) restricted him from hiring employees and 2) required that he file daily call reports[5]. Lewis sold hair care products to salons and also made commissions. The court ruled her an employee by status because 1) her employer required her to file daily sales activity reports, 2) her employer supplied her with leads, which she was expected to follow up on, and 3) she had a negligible “risk of loss”[6].

AMT Tax Savings

If you’re going to claim independent contractor status for your commissioned income, take these cases as examples what kind of evidence you need. Remember, your savings could be thousands of dollars. Need an example? Let’s say you’re a mortgage loan officer, like Wickum in the case above. If you made $200,000 and spent $125,000 in business expenses, you have a net income of $75,000.

With regular taxes, those business expenses are reduced by 2 percent, leaving a regular taxable income of $79,000 (.02 x $200,000 = $4,000; $125,000 – $4,000 = $121,000; $200,000 – $121,000 = $79,000). But, for AMT purposes, this employee gets no deductions on those expenses. That means the taxable income is the full $200,000. That’s a huge difference!

So, if the employee files taxes on Schedule A, the amount owed is $45,000. On Schedule C (as an independent contractor), it would only be $15,000. You can see why commissioned employees argue for their contractor status.

If your work situation involves unreimbursed business expenses and a status as employee, you have options to establish your status as an independent contractor for tax purposes. Since the IRS has established a position on this issue, you can start by discussing your status with the local IRS district director. If necessary, you can escalate the situation by requesting a private letter ruling from the IRS. This route does cost money, but it will likely be less costly than going to court. Litigation like the Butts case has not happened in years, so you have a good chance of a ruling in your favor if your circumstances and evidence are sufficient. The AMT seems to be here to stay for the present, so don’t let thousands of dollars slip away from you every year.

  1. Butts v. Commissioner, TC Memo 1993 478, affd. per curiam 49 F.3d 713 (11th Cir. 1995).
  2. Dean Cibotti v Commr., TC Summary Opinion 2012-21.
  3. Lozon v. Commr., TC Memo 1997-250.
  4. Paul E. Hathaway v. Commr., TC Memo 1996-389.
  5. William O. Johnson v. Commr., TC Memo 1993-530.
  6. Donald J. Lewis, Jr., v. Commr., TC Memo 1993-635.