Recordkeeping Requirements

Business expenses can be disallowed unless there is adequate substantiation for the expenses claimed. For travel and entertainment expenses, there are 2 main ways to prove costs: actual substantiation, or reliance on a per diem rate. First look at actual substantiation; then consider how recordkeeping can be simplified with the use of per diem rates.

There are a number of elements to substantiate for each business expense. In general, to substantiate each item you must show the amount, the time, the place, the business purpose for the travel or the business relationship with the persons you entertain or provide gifts to, and, in some cases, a description of the item. The exact type of substantiation required depends on the item of business expense.

Travel

You must show the amount of each separate expense for travel, lodging, meals, and incidental expenses. You can total these items in any reasonable category. For example, you can simply keep track of meals in a category called daily meals. You must also note the dates you left for the trip and returned, as well as the days spent on the trip for business purposes. You must list the name of the city or other designation of the place of the travel, along with the reason for the travel or the business benefit gained or expected to be gained from it.

While this may sound like a great deal of recordkeeping, as a practical matter hotel receipts may provide you with much of the information necessary. For example, a hotel receipt typically shows the dates you arrived and departed; the name and location of the hotel; and separate charges for lodging, meals, telephone calls, and other items. The IRS says that a charge slip for hotel costs is no substitute for the hotel receipt itself. You must have documentary evidence for the cost of lodging. You do not need documentary evidence if the item (other than lodging) is less than $75 or, in the case of transportation costs, if a receipt is not readily available. Thus, if a cab ride is $9 and the driver does not provide you with a receipt, you are not required to show documentary evidence of this expense.

Meals and Entertainment

List expenses separately. Incidental expenses, such as taxis and telephone, may be totaled on a daily basis. List each date of the meal or entertainment. For meals or entertainment directly before or after a business discussion, list the date and duration of the business discussion. Include the name and address or location of the place for the entertainment and the type of entertainment if not apparent from the name of the place. Also list the place where a business discussion was held if entertainment was directly before or after the discussion. State the business reason or the business benefit gained or expected to be gained and the nature of the business discussion. Include the names of the persons entertained, including their occupations or other identifying information, and indicate who took part in the business discussion.

If the deduction is for a business meal, you must note that you or your employer was present at the meal. Again, a restaurant receipt typically will supply much of the information required. It will show the name and location of the restaurant, the number of people served, and the date and amount of the expense. Be sure to jot down the business aspect of the meal or entertainment, such as asking a client for a referral or trying to sell your services.

Gifts

Show the cost of the gift, the date given, and a description. Also show the business reason for the gift or the business benefit gained or expected to be gained from providing it. Indicate the name of the person receiving the gift, his or her occupation or other identifying information, and his or her business relationship to you.

A canceled check, along with a bill, generally establishes the cost of a business item. A canceled check alone does not prove a business expense without other evidence to show its business purpose.

TABLE 8.2 Sample Expense Diary

Table NaN-2

Using a Diary or Log

Enter your expenses in a diary (see Table 8.2) or log at or near the time of the event giving rise to the expenses. Computer-generated records are acceptable. Be sure to include all the elements required for the expense (especially the business reason for it).

It is a good idea to total expenses on a monthly basis and then use a recap form to put annual figures together.

Other Substantiation Methods

The IRS has recognized we are in the computer age and has endorsed various computer-based substantiation methods. For example, if each employee has a company credit card, electronic reports from the credit card company can be used to substantiate charged expenses (paper receipts of expenses in excess of $75 are still required).

Missing, Lost, or Inadequate Records

If you do not have adequate records, you may still be able to deduct an item if you can prove by your own statement or other supporting evidence an element of substantiation. A court may even allow an estimation of expenses under the “Cohan rule,” under certain circumstances. Where receipts have been destroyed, you may be able to reconstruct your expenses. You must, of course, show how the records were destroyed (fire, storm, flood). The IRS may require additional information to prove the accuracy or reliability of the information contained in your records. Recordkeeping alternatives are discussed in more detail in Chapter 3.

Per Diem Rates

If you receive reimbursement using one of the per diem rates discussed earlier, you need not retain documentary evidence of the amount of an expense. The per diem rate is deemed to satisfy the proof of the amount of the expense. However, use of the per diem rate does not prove any of the other elements of substantiation. For example, if an employee is reimbursed for business travel using the high-low method, he or she still must show the time, the place, and the business purpose for business travel.

Where to Deduct Travel and Entertainment Expenses
Employees
You calculate your travel and entertainment expenses on Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. You can use the EZ form, which is a simplified version of Form 2106, if you do not get reimbursed by your employer for any expenses and, if you are claiming expenses for a car, you own the car, and are using the standard mileage rate (as explained in Chapter 9). You enter your total from Form 2106 or 2106-EZ on Schedule A, Itemized Deductions, as a miscellaneous itemized expense. These deductions are then limited to the amount they exceed; 2% of adjusted gross income.
DISABLED EMPLOYEES
If you have a physical or mental disability, your impairment-related work expenses are deductible as an itemized deduction, but the 2% floor does not apply. Impairment-related work expenses include expenses for attendant care at your place of work as well as other expenses that are necessary to enable you to work. General medical expenses, however, are not impairment-related work expenses; they are simply personal medical expenses and are deductible as such.
SPECIAL RULE FOR PERFORMING ARTISTS
If you meet certain requirements, you can deduct all of your car expenses as an adjustment to gross income on page 1 of Form 1040 instead of claiming them as miscellaneous itemized deductions on Schedule A. You are treated as a qualified performing artist (QPA) if you meet all of the following tests:
1. You perform services in the performing arts for at least 2 employers in the year.
2. You receive at least $200 each from any 2 of these employers.
3. Your related performing arts business expenses are more than 10% of your adjusted gross income from the performance of such services.
4. Your adjusted gross income from all sources does not exceed $16,000 (before deducting business expenses from your performing arts).
5. If you are married and you file a joint return (unless you lived apart from your spouse for the entire year).
You figure tests 1, 2, and 3 based on your separate experience. However, the adjusted gross income in test 4 is based on the combined adjusted gross income of you and your spouse.
If you meet these criteria, you deduct your performing arts business expenses as an adjustment to gross income on page 1 of Form 1040. Enter these expenses on the line used for totaling adjustments to gross income. Write “QPA” next to your expenses.
Self-Employed (Including Independent Contractor and Statutory Employee)
You enter your travel, meals, and entertainment expenses on Schedule C, Profit and Loss from Business, or Schedule C-EZ, Net Profit from Business. On Schedule C there are separate lines for travel, for meals and entertainment, and for determining the 50% limit on meals and entertainment. Business gifts are reported as other expenses, which are explained on page 2 of Schedule C. Schedule C-EZ can be used only if total business expenses are no more than $5,000. You simply add your travel and entertainment expenses to your other deductible business expenses and enter the total on the appropriate line of Schedule C-EZ. You need not attach an itemized statement explaining the deduction. Be sure that when you total your expenses, you apply the 50% limit on meals and entertainment.
Self-employed farmers deduct travel, meals, and entertainment expenses on Schedule F.
Partnerships and LLCs
Travel, meals, and entertainment expenses are reported on Form 1065 and are taken into account in arriving at the business’s ordinary income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit to meals and entertainment. Travel, meals, and entertainment expenses are not separately stated items. An owner’s share of these expenses is reported on Schedule K-1.
S Corporations
Travel, meals, and entertainment expenses are reported on Form 1120S and are taken into account in arriving at the corporation’s ordinary income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit to meals and entertainment. Travel, meals, and entertainment expenses are not separately stated items. A shareholder’s share of these expenses is reported on Schedule K-1.
C Corporations
Travel, meals, and entertainment expenses are reported on Form 1120 and are taken into account in arriving at the corporation’s taxable income (or loss). They are entered in the category of Other Deductions on the form. A schedule is attached to the return explaining the deductions claimed in this category. Be sure to apply the 50% limit on meals and entertainment.
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