If you deduct Meals (as a form of entertainment) expenses (“M&E”) or Business Mileage on your tax return (either for a business you operate or as an un-reimbursed employee expense), you might want to pay close attention: The IRS is beefing up their audit activity of “low hanging” fruit in an effort to raise some revenue. M&E expenses and business mileage have made it to the short list of low hanging fruit. The IRS is requesting backup documentation/substantiation from taxpayers to support the deductions claimed and, unfortunately, if the support given does not meet the IRS standard, the entire deduction is often disallowed. The purpose of this article is not to say that just because you deduct these expenses, you are going to be audited and/or the expenses will be disallowed. What I want to do is alert you to the possibility of an examination or request for records so you have time to ensure your records are in order.
So, what does the IRS require in terms of documentation to claim a deduction? Let’s first discuss M&E expenses and a little background related to the expense.
M&E Expenses:
In IRS Publication 463 (“Travel, Entertainment, Gift, and Car Expenses”), the IRS discusses that you can deduct entertainment expenses as long as they are both (1). Ordinary and necessary and (2) Directly related or associated. Directly related means that the main purpose of the expense was to conduct business, you engage in business with the person you are entertaining at some point during the meal, and you have more than a general expectation of generating income from them in the future. If the expense doesn’t qualify as directly related then it may meet the “associated” definition which means it would need to be associated with the conduct of your business and take place immediately before or after a substantial business discussion. What does the IRS require you keep in order to support the expense? You must have documentary evidence such as receipts, cancelled checks, or bills (don’t think you can pull out your monthly credit card statement with a bunch of charges highlighted and expect the IRS to agree with the deduction). Documentary evidence will normally be considered adequate by IRS standards as long as it shows the amount, date, place and essential character of the expense (the IRS goes on to say that a restaurant receipt also must have the number of people served listed). This is where most people stop their recordkeeping, but please be informed that in addition to the receipt, the taxpayer must list (and I’m quoting this straight from the IRS):
- Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. For entertainment, the nature of the business discussion or activity. If the entertainment was directly before or after a business discussion: the date, place, nature, and duration of the business discussion, and the identities of the persons who took part in both the business discussion and the entertainment activity.
- Relationship: Occupations or other information (such as names, titles, or other designations) about the recipients that shows their business relationships to you. You must also show that you or your employee was present at the meal.
If you don’t normally list the purpose and relationship on your receipts, I suggest you start immediately going forward (and you may want to document this for prior receipts).
TAX TIP: I tend to do this at time of the meal when I am signing the receipt by listing the information on the back of the receipt. It takes a couple of seconds and my documentation is now complete. Generally, I also keep an envelope with me (you can keep it in your car, purse or briefcase) where I place the receipt immediately (and any other business receipts I may accumulate when running errands). This way, all of my business related receipts are together and, once I get back to my office, I can pull the envelope out to place in my files.
Business Mileage:
Let’s now discuss business mileage. In order to deduct business miles, you must be using your car for a valid business purpose (sorry – commuting to/from work doesn’t count). IRS Publication 463 goes into great detail on what qualifies as business purpose (the discussion starts on page 15 of the 463 dated 2/04/2009 if you are interested). Also worth noting, the IRS has strict guidelines on how to determine your business miles (i.e.: estimating your mileage based on a percentage of total miles driven for the year will not fly). It’s fairly simple (so to speak): you must record your mileage in some sort of “log” with the business purpose (don’t forget to capture the mileage on January 1st which will serve as your beginning mileage and the mileage on December 31st which will serve as your ending mileage). If you are ever audited or reviewed, the IRS will request your mileage logs (I would suggest that if you don’t have a log book for 2009 or any prior open tax year, you create one!).
TAX TIP: I record my mileage in the calendar function on my PDA phone (blackberry, iPhone, etc). When I get in my car, I log the odometer reading, where I’m going and, if applicable, why I’m going there (i.e.: the client name, function, store name and intended purchase, etc). Once I get to my destination, I type in the ending mileage. I have my PDA set up to automatically sync with my outlook so I can print it out each month. For those not comfortable using technology, I used to keep a calendar in my car (just one of the month-at-a-glance calendars). I would perform the same steps as listed above, but just by writing them in the day “box”. For the record, you do not need the starting and ending mileage of each trip. You could mapquest the points to determine your mileage (keep the mapquest printout for your records). This method is helpful if there is a place you drive to frequently.
In summary, I want to point out that just because you can produce the above substantiated records doesn’t mean that, if audited, the IRS will accept them. Remember: they still have to pass the reasonableness test (i.e.: the IRS may raise a flag if your business/occupation is computer programming and you are trying to deduct mileage comparable to that of a trucker). Unfortunately, there is not a concrete definition of reasonable. That will be between you and your CPA!
About the author: Shannon Pope is a CPA serving North Houston from The Woodlands, TX to Kingwood, TX. For more information on her background and services offered, please visit the website www.shannonpopecpa.com.
The information contained herein is general in nature and provided for informational purposes only. It is not intended or provided to constitute tax or legal advice or to be used for (a) avoiding any tax related penalties that may be imposed on you or any other person/entity under the Internal Revenue Code, or (b). promoting, marketing or recommending to another person any transaction or matter addressed in this communication. Please consult with your CPA and/or attorney regarding your specific legal or tax situation. Please contact us if you with to have formal written advice on this or any other matter.
