Proving Business Expenses
Everyone in business must keep records. Among other things, good records will help a business prepare the business tax returns, and will support items reported on tax returns. Taxpayers also must keep their business records available for inspection by the IRS.
In order to claim any deduction, a business owner, like any taxpayer, must prove two things: what expenses were for and that the expense was in fact paid or incurred. Supporting documents may include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. The documents should show the amount paid and the reason for the expense. Businesses must keep their records as long as needed to qualify under the Tax Code. Generally, this means until the period of limitations for auditing the return expires.
There are special recordkeeping requirements and strict documentation rules for certain expenses. These expenses include:
- expenses for travel away from home (including meals and lodging while traveling),
- meal and entertainment expenses,
- business gifts, and
- cars and other means of transportation.
For these expenses, taxpayers must keep receipts and must also substantiate each individual expense as to (1) the amount, (2) time and place, and (3) business purpose. For entertainment and gift expenses, taxpayers must also provide the business relationship of the person(s) being entertained or receiving a gift. For vehicle expenses, taxpayers must keep a mileage log.
Businesses that give reimbursements and allowances to their employees for employment-related travel and entertainment expenses must generally treat these amounts as income to the employees. However, there is no income inclusion if: (1) the employee is required to account for the expenses to the employer; (2) the employee does not deduct the expenses; and (3) the total expenses equal the total reimbursements and allowances.
Accounting for expenses means giving the employer documentary evidence and an account book or statement to verify each expense’s amount, time, place and business purpose. An employee is treated as having accounted for expenses if the employer provided a fixed allowance, and the employee verifies the time, place, and business purpose of each expense. A fixed allowance includes the standard mileage rate for cars and the federal per diem rate for travel away from home.
A reimbursement arrangement is considered an accountable plan if it meets the following three requirements:
- It provides advances, allowances or reimbursements for business expenses paid or incurred by an employee;
- Each business expense must be substantiated to the employer within a reasonable period of time; and
- The employee must return any excess reimbursement within a reasonable period of time.
If the arrangement is an accountable plan, the reimbursements are excluded from the employee's wages and exempt from employment taxes. Any excess reimbursement that is not returned within a reasonable period is treated as paid under a nonaccountable plan.
If you have any questions about proving business expenses, please contact your tax advisor or Ira Bergman, Partner, Entrepreneurial Services Group, at 314.687.2323 or firstname.lastname@example.org.