The purpose of this letter is to advise you of the rules for deducting the cost of your out-of-town business travel within the U.S. These rules only apply if the business conducted out of town reasonably requires an overnight stay.
The actual costs of travel (e.g., plane fare, cab to airport, etc.) are deductible for out-of-town business trips. You are also allowed to deduct the cost of meals and lodging. Your meals are deductible even if they are “personal,” i.e., not connected with business, although, as with all deductible meals, only 50% of the cost is allowed (80% for long-haul truckers, certain airline, train and bus employees, and certain merchant mariners). Additionally, no deduction is allowed for meal or lodging expenses that are “lavish or extravagant,” a term that has been interpreted to mean “unreasonable.”
Personal entertainment costs on the trip aren’t deductible, but business-related costs such as for dry-cleaning, phone calls, and computer rentals are.
Some allocations may be required if the trip is a combined business/pleasure trip, for example, if you fly to a location for five days of business meetings and stay on for an additional period of vacation. Only the cost of meals, lodging, etc., for the business days are deductible—not for the personal vacation days.
On the other hand, with respect to the cost of the travel itself (plane fare, etc.), if the trip is “primarily” business, the travel cost can be deducted in its entirety and no allocation is required.
Conversely, if the trip is primarily personal, none of the travel costs are deductible. An important factor in deter- mining if the trip is primarily business or personal is the amount of time spent on each, although this isn’t the sole factor.
If the trip doesn’t involve the actual conduct of business but is for the purpose of attending a convention, seminar, etc., IRS checks the nature of the meetings carefully to make sure they are not vacations in disguise. Be careful to save all material helpful in establishing the business or professional nature of this travel.
The rules on deducting the costs for your spouse if she accompanies you on a business trip are very restrictive. No deduction is allowed unless she’s an employee of yours or your company and her travel is also for a business purpose.
Finally, note that personal expenses you incur at home as a result of taking the trip aren’t deductible. For example, the cost of boarding a pet while you’re away isn’t deductible.
Click here to view the pdf version of this section
The purpose of this letter is to advise you of the rules for deducting business meals and entertainment expenses. This type of expense requires you to jump through several extra hoops to qualify as deductible and is subject to limitations. Nevertheless, if you pay careful attention to rules outlined below, the expenses should qualify as deduct- ible. Four levels of tests must be satisfied.
(1) Ordinary and necessary business expenses
All business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carry- ing on the business. These terms have been fairly broadly defined to mean customary or usual, and appropriate or helpful. Thus, if it is reasonable in your business to entertain clients or other business people you should be able to pass this general test.
(2) “Directly related” or “associated with”
The business meal or entertainment must be either “directly related to” or “associated with” the business. “Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. Thus, a specific, concrete business benefit is expected to be derived, not just general goodwill from making a client or associate view you favorably. And the principal purpose for the event must be business. Also, you must have engaged actively during the event, via a meeting, discussion, etc. The directly related test can also be met if the meal or entertainment takes place in a clear business setting directly furthering your business, i.e., where there is no meaningful personal or social relationship between you and the others involved. Meetings or discussions that take place at sporting events, night clubs, or cocktail parties—essentially social events—would not meet this test.
If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (i.e., takes place on the same day as) a substantial and bona fide business discussion. This test is easier to satisfy. “Goodwill” type of entertainment at shows, sporting events, night clubs, etc. can qualify. The event will be considered associated with the active conduct of the business if its purpose is to get new business or encourage the continuation of a business relationship. For meals, you (or an employee of yours) must be present. That is, for example, if you simply cover the cost of a client’s meal after a business meeting but don’t join him at it, the expense does not qualify.
Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. The use of reasonable estimates is not sufficient to stand up to IRS challenge. You must be able to establish the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. Obviously, you must set up careful and detailed record-keeping procedures to keep track of each business meal and entertainment event and to justify its business connection. For expenses of $75 or more, documentary proof (receipt, etc.) is required.
(4) Deduction limitations
Several additional limitations apply. First expenses that are “lavish or extravagant” are not deductible. This is gener- ally a “reasonableness” test and does not impose any fixed limits on the cost of meals or entertainment events. Expenses incurred at first class restaurants or clubs can qualify as deductible. More importantly, however, once the expenditure qualifies, it is only 50% deductible. Obviously, this rule severely reduces the tax benefit of business meals and entertainment. If you spend about $50 a week on qualifying business meals, or $2,500 for the year, your deduction will only be $1,250, for tax savings of around $300 to $400.
Click here to view the pdf version of this section
This is how to claim deductions for expenses you incur in connection with your employment. The expenses include those for local transportation (other than commuting), business meals and entertainment (at 50% of cost), travel away from home, supplies, educations, etc. The tax treatment of these items depends on the arrangement you have with your employer. In particular it depends on whether you are reimbursed for your costs and, if so, under what type of arrange- ment.
No reimbursements. If your employment-related expenses aren’t reimbursed by your employer they are deductible, but only as a “miscellaneous itemized deduction.” This means they are lumped together with other miscellaneous items (e.g., investment expenses, tax return preparation costs) and are only deductible as an itemized deduction to the extent the total exceeds 2% of your adjusted gross income (AGI). This is known as the “2% floor.” Thus, depending on your AGI and your other miscellaneous deductions, you may lose all or part of your employee expense deduction.
“Accountable” reimbursement plans. An accountable plan is one under which your employer reimburses you for your employment-related expenses (or pays you an expense allowance) but requires you to “adequately account” for the expenses. This means you must submit to the employer an expense record (account book, diary, expense statement, etc.) along with receipts and other documentation indicating the expense amount, time and place, business purpose, and business relationship to anyone else involved (e.g., a client, supplier, etc.). For the plan to qualify as an accountable plan, it must also require you to pay back any excess payments you receive. For example, say you receive $1,000 under an expense account arrangement and only incur $800 in expenses. In order for the plan to qualify as accountable, it would have to require you to return the $200 not spent.
If you are reimbursed (or receive an allowance) for expense under an accountable plan, the tax treatment is simple: do nothing. The transaction is treated as a wash. The reimbursement or allowance should not be included in your income on the W-2 form you receive from your employer and you don’t take a deduction for the expense. If your employer only reimburses (or gives you an allowance for) part of your costs, you can claim a deduction for the excess expenses that actually came out of your pocket. In this case, however, the expenses are only deductible as a miscellaneous itemized deduction, as discussed above.
Non-accountable reimbursement plans. If your employer doesn’t maintain an accountable plan, any expense reimbursements or allowances you receive from your employer will be included in your wages on the W-2 form you receive from the employer. You then separately deduct your expense as a miscellaneous itemized deduction, again subject to the 2% floor described above. This system may operate unfairly from your perspective.
Example: Ellen is paid $50,000 in wages. Her adjusted gross income is $60,000 and her employee expense is her only miscellaneous itemized deduction. She incurred $1,000 in employment-related expenses and was reimbursed the full amount by her employer but not under an accountable plan. Her W-2 form will show $51,000 in total wages received, including the reimbursement. Since her miscellaneous total was less than 2% of her AGI ($1,020), she gets no deduction.
Planning approaches. If you are in a situation in which the 2% floor is denying you your expense deductions, it may be possible to change your situation to take care of the problem. If you receive reimbursements or allowances, your employer might be willing to put an accountable plan in place. Alternatively, the employer may be willing to cover the costs directly, rather than having you pay the expenses.
Click here to view the pdf version of this section
Many people are now working out of their homes. This may be a good time to review the criteria for claiming a deduction for the business use of part of a person’s residence.
Your home office must be used in a trade or business activity. You cannot take a deduction if you use your home for a profit-seeking activity that is not a trade or business. For example, if you use part of your home to manage your personal investments, you cannot take a home office deduction.
The home office must be used regularly and exclusively for business. You must regularly use a room or other separately identifiable area of your home only for your business. You do not meet this requirement if you use the area for both business and personal purposes. For example, an attorney who writes legal briefs at the kitchen table cannot claim a home office deduction for the kitchen. You do not have to meet the exclusive-use test if you use part of your home to store inventory or product samples or as a day care facility.
Your home office must be one of the following:
If you are an employee, you must use your home office for the convenience of your employer. If the employer does not require the employee to work from home and provides an office or work space elsewhere, a home office is likely to be considered a matter of the employee’s convenience and therefore not deductible.
Even if the taxpayer’s home office meets the above rules, the deduction may be limited. Expenses attributable to business use that you could deduct even if the home were not used for business, such as home mortgage interest and real estate taxes, are fully deductible. Otherwise, home office expenses are deductible only to the extent of gross business income, reduced by other allowable business expenses unrelated to the home; any expenses that are not deductible due to the income limitation may be carried forward. ”Direct expenses” of the home office include the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office are completely deductible. The “indirect” expenses of maintaining the home office are the allocable share of utility costs, depreciation, insurance, etc., for your home, as well as an allocable share of mortgage interest and real estate taxes.
Sales of homes with home offices. If you sell at a profit, a home that contains, or contained, a home office, the otherwise available $250,000/$500,000 exclusion for gain on the sale of a principal residence won’t apply to the portion of your profit equal to the amount of depreciation you claimed on the home office. In addition, the exclusion won’t apply to the portion of your profit allocable to a home office that’s separate from the dwelling unit. Otherwise, the home office won’t affect your eligibility for the exclusion.
The question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. It is intensely factual, and the stakes can be very high. If a worker is an employee, the company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages plus FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well.
Employee (Common-Law Employee)
Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed
People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax. A Form 1099-MISC is to be filed showing the amount paid if it is $600 or more.
If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes. ). These individuals are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Social Security and Medicare taxes are to be withheld from the wages of statutory employees if all three of the following conditions apply.
There are generally two categories of statutory nonemployees: direct sellers and licensed real estate agents. They are treated as self-employed for all Federal tax purposes, including income and employment taxes, if substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes
Some categories of individuals are subject to special rules because of their occupations or identities. For example, corporate directors aren’t employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons.
Under certain circumstances, you can ask IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee.
There is an increased need to substantiate your charitable contributions. While all contributions must be substantiated, contributions of $250 or more require a written receipt from the charity. If you donate property valued at more than $500, additional requirements apply.
For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the charitable organization showing its name, plus the date and amount of the contribution.
The acknowledgement must include the amount of cash, whether the charity provided any goods or services in consideration for the contribution, and a good faith estimate of the value of any such goods or services. If you received only “intangible religious benefits,” such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn’t reduce the charitable deduction available
For a contribution of property other than money, you generally must maintain a receipt from the charitable organization showing its name, the date and location of the contribution, and a detailed description and an estimated value of the property. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution by a contemporaneous written acknowledgement of the contribution by the charitable organization. You must have the receipt in hand by the time you file your return (or by the due date, if earlier) or you won’t be able to claim the deduction. IRS may require a photograph.
Additional documentation is required: If the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction is not allowed. You are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return. A qualified appraisal isn’t required for publicly-traded securities for which market quotations are readily available. Additional documentation rules apply for donations over $20,000 and $50,000.
If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70. But your contribution is fully deductible if:
Cash contribution made through payroll deductions: A contribution that you make by withholding from your wages may be substantiated by a pay stub, Form W-2, or other document furnished by your employer that shows the amount withheld for the purpose of a payment to a charity.
Contributions of services substantiation: Although you can’t deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses. For contributions of $250 or more get a statement from the charity that contains a description of the services you provided and the date the services were provided.
Once the tax filing deadline passes, you may be in the mood to throw out some tax records. But be careful not to discard essential receipts that could help you fend off an IRS audit – or toss out important documents that could enable you to collect a future refund by filing an amended tax return. Here are some guidelines on what you need to keep for federal tax purposes and what you can safely get rid of (individual states may have their own regulations):
Completed Tax Returns
Many tax advisers recommend that you hold onto copies of your finished tax returns forever. Why? So you can prove to the IRS that you actually filed. But even if you don’t keep the returns indefinitely, you should hang onto them for at least three years after they are due or filed, whichever is later. That means you can now throw away some paperwork from your 2007 tax return, which was filed in April of 2008.
Retain all receipts, cancelled checks, and other records that backup the items on your tax return for the same three-year period. The reason you must keep these items has to do with the “statute of limitations.” In most cases, the IRS can audit your return for three years. You can also file an amended return of Form 1040X during this time period if you missed a deduction, overlooked a credit or misreported your income.
Exceptions to the Rule
In some cases, the statute of limitations is longer than three years. The IRS has up to six years to conduct an audit if you understate your income by more than 25 percent. And the tax agency can come after you anytime if fraud is involved or you don’t file a tax return at all. But there are also cases when taxpayers get more than the usual three years. You have up to seven years to amend a return and take deductions for bad debts or worthless securities, so don’t toss out any records that could result in refund claims from those items.
Save information about stocks, bonds and other investments for as long as you own them. In order to calculate capital gains or losses, you need figures from these statements that show the purchase date, price, commission and dividend reinvestment. If you invest in limited partnerships or “passive” activities, you should also retain related records until you sell.
Individual Retirement Accounts
The IRS requires you to keep copies of Forms 8606, 5498 and 1099-R until all the money is withdrawn from your IRAs. With the introduction of Roth IRAs, it’s more important than ever to hold onto all IRA records pertaining to contributions and withdrawals in case you’re ever questioned.
Save records that enable you to compute the basis or adjusted basis of your home. You’ll need this information to determine depreciation for home office or rental purposes, as well as any taxable gain if you sell. Also, keep records related to your purchase price, refinancing a mortgage, settlement or closing costs, the cost of improvements, casualty loss deductions and insurance reimbursements for casualty losses. Generally, you should retain this information for as long as you own the property and, after you sell it, for the statute of limitations period that applies.
Save proof of deductions that are taken over more than one year. When you “carryover” excess write-offs because they can’t be deducted right away, you need to hold onto the related records longer.