Travel, Meals, Wheels, and Entertainment: Your Guide to How and When to Take These Write-Offs

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If you’re a business owner, it pays to stay current with the law

From advertising and promotion to travel expenses, there are a host of things businesses can classify as deductibles on their income tax return. The accepted amounts of deductibles have remained stable for many years, but since the advent of the Tax Cuts and Jobs Act of December 2017, there have been changes in what businesses can safely write off.

The Act is intended to reduce business tax rates and there are several changes with regard to deductibles. Today, we’re examining how Part 4 of the Act redefines what is considered an acceptable tax deduction and how this affects the areas of entertainment, vehicular, meal, and travel expenses.

Vehicle costs and tax deductions

There are now a few clear rules on how to ascertain the deductibility of the vehicle(s) involved in your business. You may claim a depreciation deduction based on your actual car expenses, referred to as “the basis.” Typically, an unadjusted basis is used comprising the cost of the vehicle, sales tax, dealer preparation, and destination charges.

If you make any substantial improvements to your car like a new engine or air conditioning, then you increase your deductible basis. Your basis can decrease based on Section 179 deductions, the use of clean fuel vehicles or alternative business vehicles. The depreciation period begins when that vehicle is placed into service for your business.

If your car is driven for business use more than 50% of the year, then deductibles are calculated using MACRS (Modified Accelerated Cost Recovery System). Use of less than 50% is calculated by the standard mileage rate. The former sees the vehicle cost depreciate over 5 years, while the latter allows you to take a tax deduction on things like insurance expenses, repairs, gas, and parking fees/tolls.

In both instances, the actual cash amount you can deduct may vary from tax year to tax year. Incidentally, depreciation deductibles are usually higher for trucks and vans than for cars. And these deductions do not apply to vehicles used to travel between work and home (see the section on travel expenses below).

Business entertainment expenses

Under the present tax law, a business may deduct entertainment expenses (including entertainment-related meals) with two provisions: that the expenses are both ordinary and necessary in the performance of trade or business, and that they conform to either the Directly-Related or the Associated Test:

  • The Directly-Related Test – You must be able to prove that you engaged in business during the period of the entertainment and that the active conduct of business was the main purpose of the engagement. You must at least have had a reasonable expectation of gaining business benefits/income in the future.
  • The Associated Test – The entertainment must be linked to the active conduct of your business or trade, or directly precede or follow a substantial business discussion, meeting, or negotiation intended to gain income or business benefits.

Business owners must be wary of a few IRS classifying terms, some of which can be nebulous. For example, if an entertainment expense is deemed “lavish or extravagant,” it won’t be deductible. Likewise, if the entertainment doesn’t take place in a” clear business setting,” it won’t classify. Be very careful about deducting too many of these expenses, as well as ones that are very large.

Records detailing cost, time, place, and business relationship to the entertained must be kept that prove the expenses meet the test conditions. A general limit of 50% of entertainment expenses are deductible, but this also comes with exceptions. For further clarification, consult IRS Publication 463.

Tax-deductible travel expenses

Under the fourth section of the Tax Cuts and Jobs Act, expenses incurred for providing transportation for commuting between the employee’s residence and place of employment are denied as deductibles – except as necessary for ensuring the safety of the employee.

Business travel expenses that take you away from your usual place of work can be deductible, however, but must first be considered based on your tax home. Your tax home is generally defined as the entire city or general area in which your regular place of business is located. If you’re traveling away from there to conduct business, then your expenses may still qualify as deductibles. Here’s what qualifies:

  • If you travel by plane, bus, car or train between your tax home and your destination. Note that travel by ocean liner, cruise ship, or other forms of luxury water transportation carries a daily limit on the amount you can deduct, which is twice the highest federal per diem rate allowable at the time of your travel.
  • Types of transportation which take you between airports, stations, and hotels.
  • Meals or lodging, if your trip is so long you need to stop overnight.
  • Operating and maintaining your car while away on business. An example of this is using the standard mileage rate to calculate deductible costs. In 2017, this was 53.5 cents per mile.
  • Business-related calls while traveling (faxes included).

Your takeaway on tax deductibles

Tax law is like anything else on the legal landscape; its details are subject to change without a whole lot of public fanfare. Many business owners with the best intentions have found themselves on the wrong side of the IRS due to changes they didn’t know had taken place. You may find this list of possible tax deductions helpful to learning which deductibles could help your business.

For further information and future developments on this tax reform, visit the IRS website and learn more about Publication 463. If you’re an entrepreneur, professional, or investor, Provident CPA & Business Advisors can help you navigate complex tax law. Our clients typically reduce their taxes by as much as 20% or more, allowing them to generate tax-free wealth for the future.

Get in touch with us for expert advice on tax etiquette, and learn how we help businesses thrive across 12 fundamental areas.

Avoid That Dreaded Letter from the IRS

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6 ways to lower the chances of an audit of your business tax return

Business owners dread getting an audit notice from the IRS. It causes immense stress that investigators will find something that results in you having to pay a penalty – or worse. However, are you aware of the things you can do to help avoid an audit in the first place?

Here are 6 tips you can use to help audit-proof your business tax return

1.  Lower your DIF score

The IRS selects tax returns for audit based on a computerized scoring system called the Discriminant Index Function (DIF). This system assigns a score to individual and corporate tax returns.

“[F]ormulas are developed … to classify returns by assigning weights to certain basic return characteristics. These weights are added together to obtain a composite score for each return processed. This score is used to rank the returns … highest to lowest,” according to the IRS.

If you receive a high score on your return, there is a much better chance that the IRS will choose to audit you.

Items and deductions that can result in a higher DIF score may include:

  • Income other than basic wages, such as contract payments
  • Unreported income, such as investments
  • Home-based business or high home-office deductions
  • Noncash charitable donations
  • Large business meals, entertainment, or travel deductions
  • Excessive business auto usage
  • Losses from an activity that could be viewed as a hobby rather than a business
  • Large casualty losses
  • Claiming deductions on personal returns rather than through the business entity

Any tax return that is flagged by the DIF system goes through a manual screening for further evaluation. If the IRS determines there is a cause, you may become subject to an audit.

2.  Avoid writing off too many deductions on your personal tax return

A lot of business owners make the mistake of writing off too many things on their personal returns rather than the business entity’s return. This can result in a high DIF score, as the relative weight of a scored deduction on a personal return is higher.

You can lower your score by having deductions flow through from the business entity to your personal return as one number.

3.  Cross check all numbers on tax forms

If a vendor or client issues you a tax form (such as 1099), they will also file that form with the IRS. You must be sure that you report the correct amount on your business taxes.

The IRS may screen the figures on your return to make sure they sync up to the returns they get from other parties. Any discrepancy can result in a notice to correct the return – or an audit.

4.  Be careful when reporting business losses

If a net loss is reported on your businesses taxes for too many years, it can lead to a higher score. The IRS may decide to label your business a “hobby,” meaning you won’t be able to claim business deductions for that activity. To learn more about the “Hobby Loss Rules” and how to navigate them, check out our recent blog.

5.  Be aware that what you pay certain employees, and the type of employees can raise your score

C corporations that pay an unusually high salary to executives can result in a higher DIF score, as this is a common tactic used to minimize profits and lower taxes. Make sure you don’t exceed a reasonable salary range for your industry to avoid triggering an audit.

Another red flag can be having a high ratio of “independent contractors” versus employees. Using independent contractors allows a business to avoid payroll taxes and other benefits that must be paid to full-time or eligible employees.

6.  Have thorough documentation for all of your deductions

This may be the most important thing you can do, especially if you ever do get audited. Be sure to keep careful, accurate records regarding all of your income as well as documentation to back up any expenses or deductions that you claim on your taxes.

Receipts, payment slips, canceled checks, and any tax forms from vendors or customers are some essential components. Anything that provides specific, verified information can help; for example, auto expenses can be backed up using Google maps to prove an estimate of miles.

You must provide enough detail to explain deductions rather than simply file them as “miscellaneous” expenses. You also want to collect and save this supporting documentation in case you ever do get audited.

Remember, the key to surviving an audit is “documentation, documentation, documentation.”

The way you structure business taxes and claim deductions can result in a higher score from the IRS, which may result in a dreaded audit. Follow these 6 tips to help lower your score.

Our bonus tip is to consult with a tax professional who is trained to protect your assets and minimize your tax burden. Contact Provident CPA & Business Advisors today at 855.693.7829 or  info@providentcpas.com for all of your business tax needs.

Defining Your Business’s Marketing Strategy

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You know where you want to go – but what determines the steps to get there?

The first two questions on the Vision Traction Organizer (VTO) are exercises that help you think of the future state of your organization. You define core values and look at the common purpose, cause, or passion that aligns everyone in your company.

Then you start to bring time definition into the picture. You’re tasked to select a 10-year target. It’s a goal that everybody in the organization can stand behind, and which becomes the one big thing that gets fixed in the minds of the leadership team. It’s the long-range objective which gives meaning to the day-to-day activities. So, now you know where you want to go – but what determines the steps to get there? You need a marketing strategy.

Perfectly clear

Markets change. Customer needs want, and desires do, as well. Nevertheless, too few organizations invest enough time and effort required to clearly define their market or their customers.

And you can’t plan your future or realize your company’s goals when you don’t have this level of detail. It’s why the most successful companies in the business are literally obsessed with understanding who they’re selling to. Only then do they embark on creating a strategy to market to customers.

The VTO approach to a marketing strategy has four major parts:

  1. “The List”
  2. The Three Uniques
  3. The Proven Process
  4. The Guarantee

The List

Think about your spouse or significant other for a moment. Because of the closeness of your relationship, you’re able to describe how they act in great detail. You’d be able to create a series of lists that gave insight into who they are, what they believe, and why they act the way they do.

These are the same things you should know about your customers, to a lesser degree. You should be able to create what’s known as customer or buyer personas for each type. They’re based on your best customers – those with whom you have the deepest relationships.

This exercise is about listing as much as you know about the people who find your product or service valuable. They represent your market. There are three important areas to explore as you make these lists:

1.  Demographics

  • Age
  • Gender
  • Marital/relationship status
  • Number and age of children
  • Occupation
  • Job title
  • Income
  • Level of education

2.  Psychographics

  • What are their goals and values?
  • What are their pain points or challenges?
  • What objections did they raise during the sales process?
  • What information sources do they value?
  • Who are their heroes?

3.  Geographic Information

  • Where are they located?
  • Why are they located there?
  • What is unique about this area and how does it relate to their lifestyle and business?

Your Three Uniques

By the time you’ve completed the creation of your list and started breathing life into the customer personas, it’s likely that you’ll also have gained deeper insight into your organization. You may discover, for example, that you share certain values or pain points with your best customers. It’s time to put those insights to work.

Your marketing strategy must revolve around your unique selling proposition. What three things that make you, unlike any other company? It’s only when you are clear on the intent and context of your customer that you can be clear on how to provide them with your solution. Your “three uniques” may come easily to you by asking:

  1. What unique experience or process does our organization provide our customers?
  2. What words do our best customers use to describe us?
  3. Why are we different from our competitors?

The answers to these questions arm your marketing department with communication touchpoints. These unique selling propositions must be found throughout your sales and marketing materials. You and your existing customers may know this information, but your prospects may not.

What is your proven process?

Have you ever documented the path your customer takes when they use your product or service? Think about how much easier it would be to show this documented path to prospects. Being able to show your proven process helps you build trust and authority. Above all, you’re demonstrating consistency. This documentation also shows customers how you are partners in the process of serving them.

Your guarantee

What can you promise to customers that reduce the up-front risk of using your product or service?

The default thinking is that a guarantee offers you your money back if you’re not satisfied. You can start there, but the challenge is to do a deeper search. What’s the proactive thing you can provide that reduces concern or risk? That’s your guarantee. The key to creating an effective one is making it powerful but achievable.

Answers to these questions create the foundation of your marketing strategy. They help you understand who your customers are and what they want from you – and why. These answers also help you communicate the reasons your company is the best solution. And when combined with other processes and tactics, the marketing strategy enables you to reach that 10-year target.

Discover how we can help you strategize business growth while we minimize your taxes.

How to Get Around the Limitations of The Hobby Loss Rules

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The new tax code makes it more important than ever to ensure your business can’t be called a hobby

Running a side business is trickier than ever when it comes to paying taxes, thanks to the new Tax Cuts and Jobs Act (TCJA) of 2017. For years, taxpayers and the IRS have argued over the definition of a “trade or business” versus a “hobby.”

And now, if the IRS slaps a designation of “hobby” onto your operation, it will eliminate any tax benefits from the activity.

For tax purposes, a hobby is an activity where your prime motivation is having fun instead of making a profit – even if you occasionally do. The IRS requires you to report hobby income on your tax return.

But while a loss from a trade or business is usually deducted in full, the TCJA wiped out any deduction for hobby-related expenses until 2026. Previously, the IRS allowed hobbyists to deduct expenses up to the amount of the activity’s income but did not allow for net losses.

These changes make it critical to establish a money-losing side business as a for-profit operation that has simply not yet crossed into the black. A trade or business, according to the IRS, is an activity you may enjoy, but engage in primarily to make a profit.

Tax court cases abound where the IRS has challenged taxpayers under Internal Revenue Code Section 183 – referred to as the hobby loss rules – in an effort to prevent loss deduction abuses by hobbyists. The rules apply to individuals, S corporations, trusts, estates, and partnerships – but do not impact C corporations.

The IRS warns that it will invoke the hobby loss rules to eliminate loss deductions from operations that it believes do not fit its criteria for a trade or business. It commonly classifies inherently “fun” activities like creating art, photography, writing, jewelry-making, antique collecting, horse breeding, or training dogs as hobbies.

Fortunately, history shows that the IRS loses as many cases as it wins on this issue in court – as long as taxpayers have followed the proper steps to establish a profit motive for their actions.

So, what’s the difference between a business and a hobby?

The easiest way for an activity to avoid getting caught in the hobby loss rules is by turning a profit. The IRS won’t dispute that an activity is for-profit if it earned a profit in three out of the last five years – ending with the last taxable year. For actions involving horses like showing or racing, the rule changes to two of the past seven years.

If the activity is losing money, however, the regulations consider nine factors to determine if your activity is a business or a hobby. If they are all or mostly answered “yes,” the activity is a business. If the answers are all or mostly “no” – it’s a hobby, according to the IRS.

In a nutshell, here’s what taxpayers must consider to avoid being pigeonholed as a hobby:

  • Your expertise. Did you study the business practices of your operation? Do you consult with experts to improve your knowledge?
  • The manner in which you conduct your activity. Do you keep complete, accurate books? Are records used to improve performance?
  • Your time and effort. Is a big chunk of your personal time and effort devoted to the operation?
  • An expectation that the assets you use could appreciate in value. And more important, do you have a plan to generate profits if they do?
  • The activity’s success. What is your history of profits and losses for this operation? Are profits coming in a reasonable amount of time?
  • The number of occasional profits. Even a single year of success can be used as a strong indication that an activity is more than a hobby.
  • Your overall track records. How successful have you been conducting other activities? Did you make any of them profitable?
  • Your financial status. Do you have other income sources that are being offset by losses from your side activity? Are you rich enough to absorb ongoing losses, which may indicate that your activity is really a hobby?
  • The elements of personal pleasure or recreation. If there are substantial personal elements, the IRS is likely to label your activity as a hobby.

Many of these factors are out of your control – but for sure the first three are not. Running your activity in a businesslike manner, talking to experts, creating a business plan – these seemingly obvious steps go a long way toward helping your business escape the hobby zone.

What if the IRS labels my hobby as a business?

Put simply, it’s your lucky day – go ahead and deduct your losses. As an added benefit, an experienced certified public accountant can help you roll losses backward or forward and claim them against profits in another year.

What can I do if the IRS labels my business as a hobby?

To make the case that your hobby is a business, you must be able to prove that you are treating it that way. Besides working to generate profits, make sure you are performing such actions as keeping organized and detailed records, working regularly, invoicing clients, advertising, and writing a business plan that outlines your profitable intentions.

The IRS can be quick to claim that money-losing side businesses are hobbies – and the new tax code tilts the hobby loss rules even less in a taxpayer’s favor. An experienced CPA can help you create a strategy that ensures that your activity falls within the IRS’ definition of a trade or business – and reaps the tax benefits that go along with it.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact in their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on the new tax code, and to find out how we can help your business exceed your expectations.