Travel and Entertainment Expense Deductions: What SMBOs Need to KnowWant to save on taxes but worried about getting audited by the IRS? Find out from a CPA which deductions fly.
Are you saving as much on your taxes as you can? Do you want to deduct business entertaining and travel expenses but worry about what may happen if you make a mistake or try to deduct too much?
CPA and CPSM Bryan Eaves of Sourcing Business Solutions shared his insights about the rules on business entertainment and travel deductions and how to understand — and follow — them.
Here are answers to the most frequently asked questions.
Does claiming entertainment expenses increase the chances I’ll get audited?
No one can predict which tax returns will be audited. But Eaves noted the IRS uses many ratios to determine if business deductions are reasonable. “For example, if you have total revenue of $50,000 for the year but your entertainment expenses deducted for the year are $25,000, that is clearly a red flag,” he said.
Eaves said your deductions should be at justifiable levels or ratios for the type of business you’re in. “The IRS computers calculate reasonableness levels using these ratios. Be honest with your taxes and everything will likely be fine,” he said.
How can I tell which entertainment expenses are tax deductible?
According to IRS.gov, you may deduct entertainment expenses that are “both ordinary and necessary” in carrying on your trade or business as long as they meet one of these two tests: the directly-related test or the associated test.
To meet the directly-related test for entertainment expenses (including entertainment-related meals — read more on these further below), you must show all of these:
- The main purpose of the combined business and entertainment was the active conduct of business.
- You did engage in business with the person during the entertainment period.
- You had more than a general expectation of getting income or some other specific business benefit at some future time.
Even if your expenses do not meet the directly-related test, they may meet the associated test. To meet this test, you must show the entertainment is both:
- Associated with the active conduct of your trade or business
- Directly before or after a substantial business discussion.
“The purpose of the entertainment should be to conduct business, and business should actually be discussed,” Eaves said. “People present should be documented and the specific business discussion should be outlined as part of your documentation.”
What documentation do I need if I deduct entertainment expenses?
You need to keep the following records:
- A description of the person/people being entertained and their relationship to you.
- The purpose of the entertainment.
- The amount of the entertainment expense.
- A written record of the date and place of the entertainment and any other relevant information, such as the contacts received from your meeting.
Can I deduct meals if I conduct business during the meal?
There are strict rules surrounding the deduction of business meals. Only meals in which you conduct business are deductible. Eaves said meals fall into two categories: Meals while traveling and entertainment meals.
“Entertainment meals, meals with prospective customers for example, are only 50 percent deductible, but If it’s your own meals while on travel then they are 100 percent deductible,” Eaves said. “If eating with customers or potential customers while traveling, then it is a 50 percent deduction and considered entertainment.”
Eaves said when in doubt, you should consult your accountant for advice specific to your situation.
Can I deduct meeting and conference expenses?
According to Eaves, meeting and conference expenses are deductible if the purpose of the trip is the conference. “If you are traveling somewhere on personal time and decide to conduct business after you are already on the trip, those expenses are not deductible,” he said.
“Business meetings should be planned and confirmed in advance of the actual traveling in order to be deductible.”
How do I know what travel expenses I can deduct?
According to the IRS, in order to claim business travel expenses, you must first determine where your “tax home” is, which the IRS defines as the location used in your tax filing.
The IRS considers you to be traveling away from home if both:
- Your duties require you to be away from the general area of your tax home substantially longer than an ordinary day’s work
- You need to sleep or rest to meet the demands of your work while away from home. (The rest requirement is not satisfied by merely napping in your car; however, you don’t have to be away from your tax home for a 24 hour period – just long enough to necessitate sleeping or rest.)
The following expenses are considered deductible business travel expenses:
- Transportation, such as taxis, car rentals, airport limousine or shuttles
- Dry cleaning
- Computer rental or fees for necessary professional assistance
If you have extensive travel expenses to claim, Eaves recommended you use an accountant or accounting firm you trust, one that has experience with small business tax returns. “If you do it yourself, you should use well-known tax software like TurboTax, which asks you detailed questions and also has IRS audit insurance that you can buy,” he said.
Are there entertainment expenses I should avoid deducting?
Eaves said the key to knowing which entertainment expenses you may deduct is making sure the cost is reasonable for the business you’re seeking or clients you’re entertaining.
“If you take an existing client to the NCAA Final Four that you profited $100,000 from last year, those tickets, hotel, and food costs are probably worth it and considered reasonable. However, if you spend $5,000 on great tickets to the NCAA finals for a prospective client that would only generate $2,000 per year in revenue for your company, you better have some other reasons documented why this prospective client is worth the business deduction,” Eaves said.