One thing you can always count on during an audit is a request for documentation supporting meals and entertainment expenses. The IRS has found that these expenses are heavily abused and are an easy way to generate additional tax revenue, not to mention additional revenue from penalties and interest.
You don't have to spend a lot of time reading tax cases to find one where meals and entertainment expenses were disallowed specifically because of improper documentation.
*Here are a few examples from recent cases:
The taxpayer's business meal expenses did not satisfy the substantiation requirements because they did not include the taxpayer's relationship to the parties involved or specify the business purposes of the meals.
The taxpayer's meals and entertainment deductions were disallowed because the taxpayer couldn't provide anything to tie the deductions to specific copies of receipts, checks, or other documents. Plus, in the few records the taxpayer did provide, there were duplications and other irregularities in the records making them unreliable altogether.
A spreadsheet listing the numbers the taxpayer put on his return was insufficient to substantiate or use to reconstruct business expenses for meals and entertainment.
This means that even if a meal or entertainment expense is perfectly legitimate, it can be disallowed if the documentation is not proper!
How to Protect Your Meals and Entertainment Expenses:
In my teachings, I dedicate an entire session to Travel, Meals and Entertainment. One of the strategies I share is how to use the IRS rules to make money on your meals and entertainment by turning your current non-deductible expenses into legal tax deductions. One of the key parts to making this strategy work is protecting your meals and entertainment deductions by keeping proper documentation.
Use this short checklist for all of your meals and entertainment expenses and your deductions will be well protected:
_ Amount of each separate expense
_ Date of expense
_ Location of expense
_ Business purpose of expense
_ Names and business relationship of the people involved
It may seem like quite a bit for each and every meal and entertainment expense, but here are a few ways to make this process very simple:
Get a receipt! The first 3 items - amount, date and location - are usually printed on the receipt. Then simply write the remaining 2 items - business purpose, names and business relationship on the receipt.
I always recommend scanning your receipts so you have an electronic copy. Many receipts tend to fade in just a year so your documentation could disappear! A scanned copy won't fade and can help reduce the clutter of receipts.
If you don't get a receipt, then document all of the items listed above (either write them down or type them up) and then attach support for the payment. Here are a few examples:
If you paid by check, attach a copy of the check and your bank statement showing it cleared your bank account.
If you paid by debit or credit card, attach a copy of your bank or credit card statement showing the debit or charge.
If you paid by cash, try your best to get a receipt! Otherwise, make sure your documentation is precise and make sure a very small percentage of your expenses fall into this category of paid by cash and no receipt.
Don't force it! If a meal or entertainment expense doesn't meet the business purpose requirement because it was a personal expense, then don't deduct it. If the IRS finds personal expenses being deducted, then all of your other expenses will be heavily scrutinized, putting your legitimate deductions at risk for the slightest reason.
Tom Wheelwright is not only the founder and CEO of Provision, but he is the creative force behind Provision Wealth Strategists. In addition to his management responsibilities, Tom likes to coach clients on wealth, business, and tax strategies. Along with his frequent seminars on these strategies, Tom is an adjunct professor in the Masters of Tax program at Arizona State University. For more information please visit http://www.provisionwealth.com.