If you’re claiming a deduction for meals, entertainment, auto or travel expenses, expect the IRS to closely review it. Too often, taxpayers have incomplete documentation or try to re-create records months (or years) later. In doing so, they often fail to meet the strict substantiation requirements set forth under tax law and by the IRS. Tax auditors are adept are rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by a recent U.S. Tax Court case. (Crawford v. Commissioner, T.C. Memo 2014-156)
IRS Substantiation Requirements
When it comes to meals, entertainment, auto and travel expenses, a taxpayer must generally show:
- The amount of the expense,
- The time and place of the expense,
- The business purpose of the expense, and
- The business relationship to the taxpayer of any person entertained (if the expense is for meals or entertainment).
For listed property, such as cars and trucks, a taxpayer must establish the amount of business use and the amount of total use.
Shortcuts are allowed under certain circumstances. For example, a taxpayer may opt to use the standard mileage rate, as established by the IRS for a given tax year, in lieu of substantiating actual auto expenses. In 2014, the standard mileage rate is 56 cents per mile for business travel.
In addition, if you drive the same route consistently, you may be able to use an accurate record for part of the year to show your mileage for the whole year. Be prepared to show the time picked was representative of the whole year. You may not have to show the business purpose if it’s obvious from the destination. For example, a sales rep who sees the same customers on a regular basis may be able to enter just a name. Consult with your tax adviser for guidelines in your situation.
Case in Point
In 2009, Marcus Octavious Crawford worked as an engineer for AFL Telecommunications. His employer fully reimbursed travel expenses incurred as part of his job. As a side business, Crawford also sold nutritional supplements and recruited new salespeople for a company called Vemma. He reported wage and salary income of $52,659 from AFL Telecommunications on his 2009 personal tax return, as well as gross receipts of $1,183, and business expenses of $38,123 from Vemma on his Schedule C.
The Tax Court disallowed $27,759 of his meals, entertainment, auto and travel expenses from Vemma because they weren’t adequately substantiated. Crawford committed numerous faux pas when documenting expenses incurred from his side business, including:
- The daily calendar used to substantiate his business expenses contained vague, inconsistent entries, such as a person’s first name or a location.
- Some of the days on his calendar were simply annotated with numbers meant to represent miles, but the Tax Court couldn’t ascertain whether these miles were related to his work at AFL Telecommunications or Vemma.
- The locations Crawford listed on his calendar didn’t consistently match receipts he submitted to support his meals and entertainment expenses.
- The description Crawford provided for all of his meals and entertainment expenses was “interview/team training,” but he ate most of these meals alone — and admitted that some of the receipts he submitted were for personal meals.
- His travel expenses were documented by invoices and printouts of travel reservation confirmations, but he never showed that these amounts were actually paid by anyone.
- Many of the receipts he entered into evidence were paid with a credit card ending with “1904.” Crawford later admitted that AFL Telecommunications reimbursed him for all payments made with that credit card.
Best Practices for Business Expenses
The Crawford case is a classic example of why it’s critical to maintain meticulous records to support business expenses for meals, entertainment, auto and travel. Whether you operate a separate business or report business income on Schedule C of your personal return, these expenses are IRS hot buttons.
The following is a list of “DOs and DON’Ts” for meeting the strict IRS and tax law substantiation requirements for these items:
DO keep detailed, accurate records. Documentation is critical when it comes to deducting meals, entertainment, auto and travel expenses. There is no “right” way to keep records. In fact, the IRS website states: “You may choose any recordkeeping system suited to your business that clearly shows your income and expenses.” However, the law requires strict recordkeeping for deducting these particular expenses (see “IRS Substantiation Requirements” at right). If you have employees who you reimburse for meals, entertainment, auto and travel expenses, make sure they’re complying with all the rules. The dollars can add up very quickly.
DON’T try to re-create expense logs at year end or wait until you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. Require employees to submit monthly expense reports.
DO respect the fine line between personal and business expenses. Be particularly careful about trying to combine business and pleasure. For example, if you’re taking clients to a ball game on your husband’s birthday, use extra care. Don’t be surprised if the IRS or court asks if you had relatives at the business destination. Also ,remember that you can’t deduct expenses for a spouse on a business trip unless he or she is employed by the business and there’s a bona fide business reason for his or her presence.
DON’T be surprised when the IRS asks you to prove your deductions. Meals, entertainment, auto and travel expenses are always a magnet for attention. Therefore, be prepared for a challenge.
With organization and guidance from your tax adviser, you can maintain tax return records that will stand up to close scrutiny from the IRS. For more information about tax recordkeeping, consult with your tax adviser. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions, if your records are lost due to, say, a fire, theft or flood.