Deducting Travel and Entertainment Expenses with Confidence
Anna Coldwell, CPA
When owners, managers and salespeople attend trade shows, call on customers and evaluate suppliers, they may incur travel and entertainment expenses. This article explains how manufacturers and distributors can legitimately deduct and properly substantiate expenses to ward off unwanted IRS attention. A sidebar discusses the importance of keeping business expenses separate from personal expenses.
Owners, managers and salespeople often incur travel and entertainment expenses. Manufacturers and distributors need to understand how to legitimately claim these deductions and properly substantiate them to ward off unwanted IRS attention.
Your company can deduct ordinary and necessary expenses that owners, employees and other business associates, such as prospective customers, suppliers or professional advisors, incur when traveling on business. These expenses include the travel costs of getting to and from your business destination, as well as any business-related expenses at your business destination. Examples include:
- Transportation by car, bus, train, boat or plane;
- Car rental at your destination;
- Shipping and baggage fees;
- Lodging and meals;
- Dry cleaning and laundry;
- Tips; and
- Phone and Wi-Fi access charges.
You can deduct all travel expenses if your trip was entirely business related. But be careful to deduct only business-related expenses if you extend your business trip for a personal side trip. In addition, if you have an accountable plan, you can exclude any qualifying employee reimbursements for such expenses from the employee’s taxable income, which also will reduce employment taxes.
Travel expenses, along with meals and entertainment costs, are IRS hot buttons. If your business claims these expenses for tax purposes, expect the IRS to review your records at some point. So, it is important to keep track of all expenses using a log, diary, notebook or any other written record. Hold on to all of this documentation for several years in case the IRS inquires about the deductions, including the expenses:
- Time and place; and
- Business purpose.
If the expense is for meals or entertainment, you also must show the business relationship to the taxpayer of any person entertained. In general, business-related meals and entertainment costs are only 50% deductible and they can’t be lavish or extravagant.
IRS requirements can turn expense reimbursement into a tedious, time-consuming process. As the employee travels, he or she must collect paper receipts and keep a log of all business meetings. Then he or she typically submits a monthly expense report for all travel expenses. These reports usually require managerial approval. Administrative delays may occur if documentation is incomplete or a supervisor questions the business purpose or reasonableness of an expense item.
The IRS does, however, allow some recordkeeping shortcuts that may be worthwhile. For example, a sales rep who sees the same customers on a regular basis may be able to enter just the customer’s name in his or her day planner or Outlook calendar, rather than repeat all of the details for every visit. To simplify matters further, some businesses opt to use IRS-approved per diems, instead of reimbursing employees for their actual expenses for lodging, meals and incidentals while traveling.
Incidental costs do not include: 1) transportation between places of lodging or business and places where meals are taken or 2) mailing costs of filing travel vouchers and paying employer-sponsored charge card billings. These costs must be reimbursed for separately from per diems. Per diem rates vary, depending on where and when the employee travels. If your company uses per diem rates, employees do not have to meet the usual recordkeeping rules required by law. Rather, the employer simply pays the specified allowance to employees. However, they still must substantiate the time, place and business purpose of the travel. In addition, individuals who own 10% or more of the business cannot be reimbursed using per diem rates.
Planning and Training
Recordkeeping is critical when it comes to deducting travel and entertainment expenses. With proper planning and training, a tax advisor can help your company implement strong travel and entertainment expense reimbursement policies and procedures that will withstand IRS scrutiny.
Sidebar: Business vs. Personal expenses: What’s Deductible?
Family-owned manufacturers tend to toe a fine line between personal and business expenses — and the IRS knows it. For example, a business owner might try to deduct the cost of an airplane ticket for a spouse to accompany the owner to attend a business convention. But unless there is a bona fide business reason for the spouse’s presence, this expense is not deductible for business tax purposes. When a bill contains both personal and business expenses, it may seem easier to charge it all to the business. However, such shortcuts could lead the IRS to disallow the entire deduction. So, it is critical to maintain clear and detailed records of how you have split the bill to prove you are complying with the tax rules.
Commingling business and personal expenses may extend beyond travel. Owners may be tempted to deduct salary expense for family members who do not render services to the company, personal legal fees or home renovation costs as business expenses. There are also some gray areas, such as home office renovations and family birthday parties that are attended by key customers. It is important for business owners to understand what qualifies as a business expense and to always keep business accounts separate from personal accounts. If you have expenses which you are not certain how to treat, you should consult with your tax advisor or call us.
Close-Up on Forensic Accounting Investigations
Max Grebenschikov, CPA
If an employee is suspected of stealing assets or cooking the books, it may be time for a forensic accounting investigation. This article discusses how business owners and senior managers can handle fraud suspicions to minimize disruptions, preserve evidence and mitigate losses.
What should you do if you suspect an employee is stealing assets or cooking the books?
How to Investigate Fraud
Managing the Business Risk of Fraud: A Practical Guide, a joint publication of the Association of Certified Fraud Examiners (ACFE), the American Institute of Certified Public Accountants and the Institute of Internal Auditors, outlines the approach a qualified expert will take to execute an effective, coordinated fraud investigation. According to the guide, fraud investigations generally follow a basic 10-step process:
- Categorize issues.
- Confirm the validity of the allegation.
- Define the severity of the allegation.
- Identify types of information that should be kept confidential.
- Define how the investigation will be documented.
- Manage and retain documents and information.
- Escalate the issue or investigation when appropriate.
- Refer issues outside the scope of the program when appropriate.
- Conduct the investigation and fact-finding.
- Resolve or close the investigation.
Work with legal counsel and your forensic accounting expert to determine the appropriate process for the particular matter at hand. You will need to give the expert authority to conduct the investigation and work with internal departments, including human resources, in-house counsel, senior management, IT and internal audit or accounting.
How Investigations Work
A forensic expert typically starts by interviewing third-party witnesses, corroborative witnesses, the alleged perpetrator and any co-conspirators. The expert will also gather relevant evidence from internal documents, such as personnel files, internal phone records, emails, financial records, security camera tapes, and physical and IT system access records. External sources of evidence could include public records, customer and vendor information, media reports and private detective reports.
Then, the expert will review and categorize the information collected, conduct computer-assisted data analysis and test various hypotheses. He or she will document and track every step in the investigation. Appropriate documentation covers:
- Privileged or confidential items;
- Requests for documents;
- Electronic data and other information;
- Memoranda of interviews; and
- Analysis of documents, data, interviews and conclusions drawn.
Finally, the expert will deliver a report of his or her findings. Discuss with your attorney the appropriate format for the report and how distribution will be affected by the need to protect legal privileges and avoid defamation.
How to Prevent Future Losses
To minimize its legal liability, a company must take some corrective action in response to an expert’s fraud findings. The company may even consider taking action before the investigation is complete, when necessary, to maintain confidentiality, preserve evidence or mitigate losses. Management could, for example, suspend or reassign an employee or commence legal action to restrain specific assets.
After the expert has completed the investigation, the company can make a criminal referral and may even be required to do so by law. Alternatively, the company might pursue civil litigation, impose disciplinary action, file an insurance claim, extend the investigation, or revise business processes or internal controls.
Why Pursue Prosecution
More than 40% of fraud victims choose not to formally refer perpetrators to law enforcement authorities for prosecution, according to the 2016 Report to the Nations on Occupational Fraud and Abuse published by the ACFE. Why? Many victims fear negative publicity. Others feel internal discipline, usually termination of employment, is sufficient or they settle the case privately. However, failing to pursue prosecution of white collar crime sends an undesirable message to other employees. That is, if you commit fraud against this employer, management is unlikely to report it to the police. Without fear of prosecution, other employees may feel emboldened to test the waters.
Moreover, when management does not refer fraud cases to law enforcement, there is no criminal record created for the perpetrator, allowing him or her to commit similar crimes against future employers. Fraudsters tend to be habitual offenders — and they become craftier and bolder with each new scam.
If fraud strikes, a formal investigation can protect your company and others from future scams. By understanding how your expert will conduct the investigation, you can ensure that you are providing the information and assistance necessary for it to be successful.