Substantiating Your Business Tax Deductions
Let’s say you travel to a neighboring state and spend three days looking over some construction equipment you’re thinking of buying. The following month, you fly to a construction industry convention where you attend several daily workshops dealing with industry best practices. At tax time, you deduct as business expenses all the expenses you incurred on both trips. Are you correct?
You are, if you have receipts that substantiate your deductions. If not, the IRS may reject your deductions. Failure to properly document business-related expenses can easily trip up the unwary. Unfortunately, if the IRS rejects one of your business expense deductions, you’ll not only incur a tax liability on the income resulting from the disallowed expense, but you may be liable for penalties and interest. The following overview of business expenses may help clarify what is required.
General Rules
Under the federal tax law, a trade or business expense won’t qualify for deduction unless you are able to substantiate it. To substantiate a business deduction, you must possess proof of the amount of the payment and provide evidence establishing the character of the expense.
Proof of Payment
The IRS says that it will accept a canceled check as proof of payment. Also acceptable are account statements prepared by a financial institution that show:
- A check clearance if the statement also indicates the check number, the amount of the check, the date the check amount was posted to the account, and the name of the payee.
- An electronic funds transfer if the statement also indicates the amount of the transfer, the date the transfer was posted to the account, and the payee.
- A credit card charge if the statement also shows the amount of the charge, the date of the charge, and the payee.
In cases when you are unable to prove payment by providing a canceled check or an account statement, the IRS will generally require other evidence of payment of an amount, such as the combination of an invoice marked “paid,” a check register or carbon copy of the check, and an account statement showing the date, check number, and amount of the expense.
Additional Requirements
You’ll need more than proof of payment to establish that you’re entitled to a deduction for a business expense. Receipts, charge slips, sales slips, signed invoices, payment acknowledgments, check registers, and carbon copies of checks are all examples of items to retain to help substantiate the character and deductibility of the business expense.
The IRS has stricter substantiation requirements for travel expenses, entertainment expenses, and business gifts than for most other expenses. The IRS will allow a deduction for these expenses only if you can establish certain information (in addition to the other requirements for deductibility) by adequate records or sufficient evidence that corroborates your statement. To meet the “adequate records” requirement, you must keep records and other documents that establish each of the following elements of an expenditure:
- Amount
- Time and place
- Business purpose
- Business relationship (for an entertainment item)
Keeping a diary, account book, trip sheet, log, or similar record of these expenses is recommended.
Please don’t hesitate to consult with us if you need clarification regarding the substantiation requirements or any other issue related to your contracting firm’s tax and financial operations.
Per Diem Rates
You can potentially simplify your bookkeeping and have more control over expenses if you use per diem rates to figure reimbursement amounts. Per diem is an allowance paid to your employees for lodging, meals, and incidental expenses incurred when traveling. This allowance is in lieu of paying their actual travel expenses.
There is a federal per diem rate for combined lodging and meal costs and a per diem rate for meal costs alone. Since the cost of living varies from state to state and from city to city, the per diem rates also vary for different parts of the country. The IRS won’t require your business to substantiate the expenses if your business uses per diem rates that are less than or equal to the federal rates. However, employees will still have to substantiate the time, place, and business purpose of their trips.
Let’s say you travel to a neighboring state and spend three days looking over some construction equipment you’re thinking of buying. The following month, you fly to a construction industry convention where you attend several daily workshops dealing with industry best practices. At tax time, you deduct as business expenses all the expenses you incurred on both trips. Are you correct?
You are, if you have receipts that substantiate your deductions. If not, the IRS may reject your deductions. Failure to properly document business-related expenses can easily trip up the unwary. Unfortunately, if the IRS rejects one of your business expense deductions, you’ll not only incur a tax liability on the income resulting from the disallowed expense, but you may be liable for penalties and interest. The following overview of business expenses may help clarify what is required.
General Rules
Under the federal tax law, a trade or business expense won’t qualify for deduction unless you are able to substantiate it. To substantiate a business deduction, you must possess proof of the amount of the payment and provide evidence establishing the character of the expense.
Proof of Payment
The IRS says that it will accept a canceled check as proof of payment. Also acceptable are account statements prepared by a financial institution that show:
- A check clearance if the statement also indicates the check number, the amount of the check, the date the check amount was posted to the account, and the name of the payee.
- An electronic funds transfer if the statement also indicates the amount of the transfer, the date the transfer was posted to the account, and the payee.
- A credit card charge if the statement also shows the amount of the charge, the date of the charge, and the payee.
In cases when you are unable to prove payment by providing a canceled check or an account statement, the IRS will generally require other evidence of payment of an amount, such as the combination of an invoice marked “paid,” a check register or carbon copy of the check, and an account statement showing the date, check number, and amount of the expense.
Additional Requirements
You’ll need more than proof of payment to establish that you’re entitled to a deduction for a business expense. Receipts, charge slips, sales slips, signed invoices, payment acknowledgments, check registers, and carbon copies of checks are all examples of items to retain to help substantiate the character and deductibility of the business expense.
The IRS has stricter substantiation requirements for travel expenses, entertainment expenses, and business gifts than for most other expenses. The IRS will allow a deduction for these expenses only if you can establish certain information (in addition to the other requirements for deductibility) by adequate records or sufficient evidence that corroborates your statement. To meet the “adequate records” requirement, you must keep records and other documents that establish each of the following elements of an expenditure:
- Amount
- Time and place
- Business purpose
- Business relationship (for an entertainment item)
Keeping a diary, account book, trip sheet, log, or similar record of these expenses is recommended.
Please don’t hesitate to consult with us if you need clarification regarding the substantiation requirements or any other issue related to your contracting firm’s tax and financial operations.
Per Diem Rates
You can potentially simplify your bookkeeping and have more control over expenses if you use per diem rates to figure reimbursement amounts. Per diem is an allowance paid to your employees for lodging, meals, and incidental expenses incurred when traveling. This allowance is in lieu of paying their actual travel expenses.
There is a federal per diem rate for combined lodging and meal costs and a per diem rate for meal costs alone. Since the cost of living varies from state to state and from city to city, the per diem rates also vary for different parts of the country. The IRS won’t require your business to substantiate the expenses if your business uses per diem rates that are less than or equal to the federal rates. However, employees will still have to substantiate the time, place, and business purpose of their trips.