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.