Motsch CPA Newsletter    

Are you keeping adequate records to substantiate your business deductions for meals, entertainment, travel and listed property (vehicles, boats, computers, airplanes and cellular phones) deductions claimed on your tax returns?

Meal and Entertainment Expense Deduction: Business Connection Necessary

What is the best way to establish a business purpose when claiming business-related meal and entertainment expense deductions?

Expenses of an activity that is generally considered to be entertainment, amusement, or recreation, in addition to being ordinary and necessary business expenses, must also be directly related to the active conduct of the taxpayer's trade or business in order to be deductible. To meet the directly related-to requirement, consider whether the entertainment can take place in a clear business setting, such as a hospitality room at a convention where goodwill is created through the discussion or display of products. However, entertainment expenses directly preceding or following a substantial and bona fide business discussion, including business meetings at a convention, need only be associated with the active conduct of the trade or business, in addition to being ordinary and necessary.

A business meal expense is generally not deductible unless there is a substantial and bona fide business discussion during, directly preceding, or directly following the meal. However, the “business discussion” rule does not apply to the situation where a taxpayer who is away from home on business has a meal alone or with persons who are not related to his or her business. In that situation, the taxpayer may claim a deduction only for 50 percent of his or her own meal expense.

Entertainment expenses allocable to the spouse of a taxpayer or of a business customer are also deductible, but only if it is established that the taxpayer had a clear business purpose, rather than a personal or social purpose, in incurring such an expense. In addition, when a taxpayer entertains a customer and a deduction is allowable under the general rules, a deduction is also permitted for expenses pertaining to the customer's spouse if it is impractical under the circumstances to entertain the customer without the spouse.

The following chart form IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, summarizes requirements for determining when entertainment expenses are deductible:

Tax Planning: Combining Business and Personal Trips: Primary Purpose Test


What are the benefits of combining business and personal travel?

Expenses incurred in traveling away from home on business are fully deductible only when the primary purpose of the trip is business. The amount of time spent on business as compared to personal activities is important when determining if the trip is primarily for business or personal reasons. And, when the primary purpose of the trip is business, but the trip is extended for vacation or a nonbusiness side trip occurs, the business-related travel expenses are deductible.

Example (2): Jane Arthur took her husband, Ken, on a 10-day buying trip to Chicago in 2003. While in Chicago, Ken occasionally typed business notes for Jane and accompanied her at luncheon and dinner. Arthur spent $250 for travel, one-half of which was allocable to Ken, $200 for meals, of which one-half was for Ken, and $750 for hotel rooms. The hotel rate was $75 per day for a double room, while a single room would have cost $40 per day. Because Ken's presence on the trip served no bona fide business purpose and he was not a bona fide employee, of the $1,200 total cost of the trip, the taxpayer is entitled to deduct only $575 ($125 travel, $50 food (50% of cost), $400 lodging) as an ordinary and necessary business expense.

Substantiation requirements

(a) In general. — no deduction or credit shall be allowed with respect to —

(1) Traveling away from home (including meals and lodging),

(2) Any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity,

(3) Gifts, or

(4) Any listed property such as vehicles, boats, airplanes, computers and cellular phones,

unless the taxpayer substantiates each element of the expenditure or use (as described in paragraph (b) of this section) in the manner provided in paragraph (c) of this section.

(b) Elements of an expenditure or use

(1) In general. — no deduction or credit shall be allowed for travel, entertainment, a gift, or with respect to listed property unless the taxpayer substantiates the requisite elements of each expenditure or use as set forth in this paragraph (b).

(2) Travel away from home. —The elements to be proved with respect to an expenditure for travel away from home are —

(i) Amount. —Amount of each separate expenditure for traveling away from home, such as cost of transportation or lodging, except that the daily cost of the traveler's own breakfast, lunch, and dinner and of expenditures incidental to such travel may be aggregated, if set forth in reasonable categories, such as for meals, for gasoline and oil, and for taxi fares;

(ii) Time. —Dates of departure and return for each trip away from home, and number of days away from home spent on business;

(iii) Place. —Destinations or locality of travel, described by name of city or town or other similar designation; and

(iv) Business purpose. —Business reason for travel or nature of the business benefit derived or expected to be derived as a result of travel.

(3) Entertainment in general. —The elements to be proved with respect to an expenditure for entertainment are —

(i) Amount. —Amount of each separate expenditure for entertainment, except that such incidental items as taxi fares or telephone calls may be aggregated on a daily basis;

(ii) Time. —Date of entertainment;

(iii) Place. —Name, if any, address or location, and designation of type of entertainment, such as dinner or theater, if such information is not apparent from the designation of the place;

(iv) Business purpose. —Business reason for the entertainment or nature of business benefit derived or expected to be derived as a result of the entertainment and, the nature of any business discussion or activity;

(v) Business relationship. —Occupation or other information relating to the person or persons entertained, including name, title, or other designation, sufficient to establish business relationship to the taxpayer.

(4) Entertainment directly preceding or following a substantial and bona fide business discussion. —If a taxpayer claims a deduction for entertainment directly preceding or following a substantial and bona fide business discussion on the ground that such entertainment was associated with the active conduct of the taxpayer's trade or business, the elements to be proved with respect to such expenditure, in addition to those enumerated in paragraph (b)(3)(i), (ii), (iii), and (v) of this section are —

(i) Time. —Date and duration of business discussion;

(ii) Place. —Place of business discussion;

(iii) Business purpose. —Nature of business discussion, and business reason for the entertainment or nature of business benefit derived or expected to be derived as the result of the entertainment;

(iv) Business relationship. —Identification of those persons entertained who participated in the business discussion.

(5) Gifts. —The elements to be proved with respect to an expenditure for a gift are —

(i) Amount. —Cost of the gift to the taxpayer;

(ii) Time. —Date of the gift;

(iii) Description. —Description of the gift;

(iv) Business purpose. —Business reason for the gift or nature of business benefit derived or expected to be derived as a result of the gift; and

(v) Business relationship. —Occupation or other information relating to the recipient of the gift, including name, title, or other designation, sufficient to establish business relationship to the taxpayer.

(6) Listed property including vehicles, boats, airplanes, computers and cellular phones. —The elements to be proved with respect to any listed property are —

(i) Amount

(A) Expenditures. —The amount of each separate expenditure with respect to an item of listed property, such as the cost of acquisition, the cost of capital improvements, lease payments, the cost of maintenance and repairs, or other expenditures, and

(B) Uses. —The amount of each business/investment, based on the appropriate measure (i.e., mileage for automobiles and other means of transportation and time for other listed property, and the total use of the listed property for the taxable period.

(ii) Time. —Date of the expenditure or use with respect to listed property, and

(iii) Business or investment purpose. —The business purpose for an expenditure or use with respect to any listed property.

(c) Rules of substantiation

(1) In general. —a taxpayer must substantiate each element of an expenditure or use  by adequate records or by sufficient evidence corroborating his own statement. A taxpayer must maintain and produce such substantiation as proof of each expenditure or use of listed property. Written evidence has considerably more probative value than oral evidence alone. In addition, the probative value of written evidence is greater the closer in time it relates to the expenditure or use. A contemporaneous log is not required, but a record of the elements of an expenditure or of a business use of listed property made at or near the time of the expenditure or use, supported by sufficient documentary evidence, has a high degree of credibility not present with respect to a statement prepared subsequent thereto when generally there is a lack of accurate recall. Thus, the corroborative evidence required to support a statement not made at or near the time of the expenditure or use must have a high degree of probative value to elevate such statement and evidence to the level of credibility reflected by a record made at or near the time of the expenditure or use supported by sufficient documentary evidence. The substantiation requirements are designed to encourage taxpayers to maintain the records, together with documentary evidence.

(2) Substantiation by adequate records

(i) In general. —To meet the “adequate records” requirements, a taxpayer shall maintain an account book, diary, log, statement of expense, trip sheets, or similar record, and documentary evidence which, in combination, are sufficient to establish each element of an expenditure or use. It is not necessary to record information in an account book, diary, log, statement of expense, trip sheet, or similar record which duplicates information reflected on a receipt so long as the account book, etc., and receipt complement each other in an orderly manner.

(ii) Account book, diary, etc. —An account book, diary, log, statement of expense, trip sheet, or similar record must be prepared or maintained in such manner that each recording of an element of an expenditure or use is made at or near the time of the expenditure or use.

(A) Made at or near the time of the expenditure or use. —For purposes of this section, the phrase “made at or near the time of the expenditure or use” means the elements of an expenditure or use are recorded at a time when, in relation to the use or making of an expenditure, the taxpayer has full present knowledge of each element of the expenditure or use, such as the amount, time, place, and business purpose of the expenditure and business relationship. An expense account statement which is a transcription of an account book, diary, log, or similar record shall be considered a record prepared or maintained in the manner prescribed in the preceding sentence if such expense account statement is submitted by an employee to his employer or by an independent contractor to his client or customer in the regular course of good business practice. For example, a log maintained on a weekly basis, which accounts for use during the week, shall be considered a record made at or near the time of such use.

(B) Substantiation of business purpose. —In order to constitute an adequate record of business purpose, a written statement of business purpose generally is required. However, the degree of substantiation necessary to establish business purpose will vary depending upon the facts and circumstances of each case. Where the business purpose is evident from the surrounding facts and circumstances, a written explanation of such business purpose will not be required. For example, in the case of a salesman calling on customers on an established sales route, a written explanation of the business purpose of such travel ordinarily will not be required. Similarly, in the case of a business meal, if the business purpose of such meal is evident from the business relationship to the taxpayer of the persons entertained and other surrounding circumstances, a written explanation of such business purpose will not be required.

(C) Substantiation of business use of listed property

(1) Degree of substantiation. —In order to constitute an adequate record, which substantiates business/investment use of listed property, the record must contain sufficient information as to each element of every business/investment use. However, the level of detail required in an adequate record to substantiate business/investment use may vary depending upon the facts and circumstances. For example, a taxpayer who uses a truck for both business and personal purposes and whose only business use of a truck is to make deliveries to customers on an established route may satisfy the adequate record requirement by recording the total number of miles driven during the taxable year, the length of the delivery route once, and the date of each trip at or near the time of the trips. Alternatively, the taxpayer may establish the date of each trip with a receipt, record of delivery, or other documentary evidence.

(2) Written record. —Generally, an adequate record must be written. However, a record of the business use of listed property, such as a computer or automobile, prepared in a computer memory device with the aid of a logging program will constitute an adequate record.

(3) Substantiation by other sufficient evidence

(i) In general. —If a taxpayer fails to establish that he has substantially complied with the “adequate records” requirements with respect to an element of an expenditure or use, then, except as otherwise provided in this paragraph, the taxpayer must establish such element —

(A) By his own statement, whether written or oral, containing specific information in detail as to such element; and

(B) By other corroborative evidence sufficient to establish such element.

If such element is the description of a gift, or the cost or amount, time, place, or date of an expenditure or use, the corroborative evidence shall be direct evidence, such as a statement in writing or the oral testimony of persons entertained or other witnesses setting forth detailed information about such element, or the documentary evidence. If such element is either the business relationship to the taxpayer of persons entertained, or the business purpose of an expenditure, the corroborative evidence may be circumstantial evidence.

(ii) Sampling

In general. — a taxpayer may maintain an adequate record for portions of a taxable year and use that record to substantiate the business/investment use of listed property for all or a portion of the taxable year if the taxpayer can demonstrate by other evidence that the periods for which an adequate record is maintained are representative of the use for the taxable year or a portion thereof.

(d) Disclosure on returns

   Business use of passenger automobiles and other vehicles

(i) Taxpayers that claim a deduction or credit with respect to any vehicle are required to answer certain questions providing information about the use of the vehicle. The information required on the tax return relates to mileage (total, business, commuting, and other personal mileage), percentage of business use, date placed in service, use of other vehicles, after-work use, whether the taxpayer has evidence to support the business use claimed on the return, and whether or not the evidence is written.

(ii) Any employer that provides the use of a vehicle to an employee must obtain information from the employee sufficient to complete the employer's tax return. Any employer that provides more than five vehicles to its employees need not include any information on its return.

(3) Business use of other listed property. — taxpayers that claim a deduction or credit with respect to any listed property other than a vehicle (for example, a yacht, airplane, or certain computers) are required to provide the following information:

(i) The date that the property was placed in service,

(ii) The percentage of business use,

(iii) Whether evidence is available to support the percentage of business use claimed on the return, and

(iv) Whether the evidence is written.

(2) Employer

   Reliance on employee records. —For purposes of substantiating the business/investment use of listed property that an employer provides to an employee, the employer may rely on adequate records maintained by the employee or on the employee's own statement if corroborated by other sufficient evidence unless the employer knows or has reason to know that statement, records, or other evidence are not accurate. The employer must retain a copy of the adequate records maintained by the employee or the other sufficient evidence, if available. Alternatively, the employer may rely on a statement submitted by the employee that provides sufficient information to allow the employer to determine the business/investment use of the property unless the employer knows or has reason to know that the statement is not based on adequate records or on the employee's own statement corroborated by other sufficient evidence. If the employer relies on the employee's statement, the employer must retain only a copy of the statement. The employee must retain a copy of the adequate records or other evidence.

(f) Reporting and substantiation of expenses of certain employees for travel, entertainment, gifts, and with respect to listed property

(1) In general. —The purpose of this paragraph is to provide rules for reporting and substantiation of certain expenses paid or incurred by employees in connection with the performance of services as employees. For purposes of this paragraph, the term “business expenses” means ordinary and necessary expenses for travel, entertainment, gifts, or with respect to listed property which are deductible. Thus, the term “business expenses” does not include personal, living, or family expenses, nonbusiness travel expenses, depreciation or credits with respect to listed property  because the use of such property is not for the convenience of the employer and required as a condition of employment. Generally, advances, reimbursements, or allowances for such expenditures must be reported as income by the employee.

(2) Reporting of expenses for which the employee is required to make an adequate accounting to his employer

(i) Reimbursements equal to expenses. —For purposes of computing tax liability, an employee need not report on his tax return business expenses for travel, transportation, entertainment, gifts, or with respect to listed property, paid or incurred by him solely for the benefit of his employer for which he is required to, and does, make an adequate accounting to his employer  and which are charged directly or indirectly to the employer or for which the employee is paid through advances, reimbursements, or otherwise, provided that the total amount of such advances, reimbursements, and charges is equal to such expenses.

(ii) Reimbursements in excess of expenses. —In case the total of the amounts charged directly or indirectly to the employer or received from the employer as advances, reimbursements, or otherwise, exceeds the business expenses paid or incurred by the employee and the employee is required to, and does, make an adequate accounting to his employer for such expenses, the employee must include such excess (including amounts received for expenditures not deductible by him) in income.

(iii) Expenses in excess of reimbursement. —If an employee incurs deductible business expenses on behalf of his employer which exceed the total of the amounts charged directly or indirectly to the employer and received from the employer as advances, reimbursements, or otherwise, and the employee makes an adequate accounting to his employer, the employee must be able to substantiate any deduction for such excess with such records and supporting evidence as will substantiate each element of an expenditure.

(3) Reporting of expenses for which the employee is not required to make an adequate accounting to his employer. —If the employee is not required to make an adequate accounting to his employer for his business expenses or, though required, fails to make an adequate accounting for such expenses, he must submit, as a part of his tax return, the appropriate form issued by the Internal Revenue Service for claiming deductions for employee business expenses (e.g., Form 2106, Employee Business Expenses,) and provide the information requested on that form. In addition, the employee must maintain such records and supporting evidence as will substantiate each element of an expenditure.

(k) Exceptions for qualified nonpersonal use vehicles

(1) In general. —The substantiation requirements of section 274(d) and this section do not apply to any qualified nonpersonal use vehicle (as defined in paragraph (k)(2) of this section).

(2) Qualified nonpersonal use vehicle

(i) In general. — “qualified nonpersonal use vehicle” means any vehicle which, by reason of its nature (i.e., design), is not likely to be used more than a de minimis amount for personal purposes.

(ii) List of vehicles. —Vehicles which are qualified nonpersonal use vehicles include the following —

(A) Clearly marked police and fire vehicles,

(B) Ambulances used as such or hearses used as such,

(C) Any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds,

(D) Bucket trucks (“cherry pickers”),

(E) Cement mixers,

(F) Combines,

(G) Cranes and derricks,

(H) Delivery trucks with seating only for the driver, or only for the driver plus a folding jump seat,

(I) Dump trucks (including garbage trucks),

(J) Flatbed trucks,

(K) Forklifts,

(L) Passenger buses used as such with a capacity of at least 20 passengers,

(M) Qualified moving vans,

(N) Qualified specialized utility repair trucks,

(O) Refrigerated trucks,

(P) School buses,

(Q) Tractors and other special purpose farm vehicles,

(R) Unmarked vehicles used by law enforcement officers if the use is officially authorized, and

(3) Clearly marked police or fire vehicles. —A police or fire vehicle is a vehicle, owned or leased by a governmental unit, or any agency or instrumentality thereof, that is required to be used for commuting by a police officer or fire fighter who, when not on a regular shift, is on call at all times, provided that any personal use (other than commuting) of the vehicle outside the limit of the police officer's arrest powers or the fire fighter's obligation to respond to an emergency is prohibited by such governmental unit. A police or fire vehicle is clearly marked if, through painted insignia or words, it is readily apparent that the vehicle is a police or fire vehicle. A marking on a license plate is not a clear marking for purposes of this paragraph (k).

(4) Qualified moving van. —The term “qualified moving van” means any truck or van used by a professional moving company in the trade or business of moving household or business goods if —

(i) No personal use of the van is allowed other than for travel to and from a move site (or for de minimis personal use, such as a stop for lunch on the way between two move sites),

(ii) Personal use for travel to and from a move site is an irregular practice (i.e., not more than five times a month on average), and

(iii) Personal use is limited to situations in which it is more convenient to the employer, because of the location of the employee's residence in relation to the location of the move site, for the van not to be returned to the employer's business location.

(5) Qualified specialized utility repair truck. —The term “qualified specialized utility repair truck” means any truck (not including a van or pickup truck) specifically designed and used to carry heavy tools, testing equipment, or parts if —

(i) The shelves, racks, or other permanent interior construction which has been installed to carry and store such heavy items is such that it is unlikely that the truck will be used more than a de minimis amount for personal purposes, and

(ii) The employer requires the employee to drive the truck home in order to be able to respond in emergency situations for purposes of restoring or maintaining electricity, gas, telephone, water, sewer, or steam utility services.

(6) Unmarked law enforcement vehicles

(i) In general. —The substantiation requirements do not apply to officially authorized uses of an unmarked vehicle by a “law enforcement officer”. To qualify for this exception, any personal use must be authorized by the Federal, State, county, or local governmental agency or department that owns or leases the vehicle and employs the officer, and must be incident to law-enforcement functions, such as being able to report directly from home to a stakeout or surveillance site, or to an emergency situation. Use of an unmarked vehicle for vacation or recreation trips cannot qualify as an authorized use.

(ii) Law enforcement officer. —The term “law enforcement officer” means an individual who is employed on a full-time basis by a governmental unit that is responsible for the prevention or investigation of crime involving injury to persons or property (including apprehension or detention of persons for such crimes), who is authorized by law to carry firearms, execute search warrants, and to make arrests (other than merely a citizen's arrest), and who regularly carries firearms (except when it is not possible to do so because of the requirements of undercover work). The term “law enforcement officer” may include an arson investigator if the investigator otherwise meets the requirements of this paragraph (k)(6)(ii), but does not include Internal Revenue Service special agents.

(7) Trucks and vans. —The substantiation requirements of section 274(d) and this section apply generally to any pickup truck or van, unless the truck or van has been specially modified with the result than it is not likely to be used more than a de minimis amount for personal purposes. For example, a van that has only a front bench for seating, in which permanent shelving that fills most of the cargo area has been installed, that constantly carries merchandise or equipment, and that has been specially painted with advertising or the company's name, is a vehicle not likely to be used more than a de minimis amount for personal purposes.

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