If you run a business, you know that you need to support expenses with detailed records.
To be deductible, every expense on your tax return might have to be defended if your company is subject to an audit. Plus, failing to operate in a businesslike manner, complete with good records, might lead the IRS to deem the activity a hobby rather than a business, in which case your deductions may be limited or disallowed.
While there’s no one right way to keep business records, some types of expenses do require more details. For example, records relating to automobile, travel, meal and home-office costs are subject to special requirements or limitations.
An activity must be engaged in for profit
For a business expense to be deductible, the taxpayer must establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an “ordinary and necessary” business expense. In one court case (Gaston v. IRS, 2021), a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.
She engaged in various activities that included acting in the entertainment industry and selling jewelry. The IRS found her activities were more like hobbies than businesses engaged in for profit, and it disallowed her deductions.
The taxpayer did, however, have some success when she took her case to the U.S. Tax Court. The court found that she was engaged in the business of acting for profit during the years at issue, though not all of the claimed expenses were ordinary and necessary business expenses. The court allowed deductions for expenses including headshots, casting agency fees and lessons to enhance the taxpayer’s acting skills. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.
In addition, the court found that that taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed.
Proper records are required
In another case (Elbasha v. IRS, 2022), a taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold and interest. The IRS disallowed most of the deductions.
n court, the doctor used charts to illustrate his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity.
The U.S. Tax Court disallowed the deductions, stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business.
Can You Deduct The Costs Of A Spouse On A Business Trip?
If you own a company and travel for business, you may wonder whether you can deduct all the costs of having your spouse accompany you on trips. It may be possible, but the rules are restrictive. In general, your spouse must be your employee. And even then, strict rules apply. But there is some good news: Bringing your spouse on a business trip generally doesn’t reduce deductions for your own travel costs.
If your spouse is your employee and his or her presence on the trip serves a bona fide business purpose, then you can deduct travel costs. But it isn’t enough for your spouse to merely be “helpful” in incidental ways, such as by typing your meeting notes. Your spouse’s presence must serve a necessary business purpose.
In most cases, a spouse’s participation in social functions, for example as a host or hostess, isn’t enough to establish a business purpose. That is, if his or her purpose is to establish general goodwill for customers or associates, this is usually insufficient. Further, if there’s a vacation element to the trip (for example, if your spouse spends time sightseeing), it will be more difficult to establish a business purpose for his or her presence on the trip. On the other hand, a bona fide business purpose exists if your spouse’s presence is necessary to care for a serious medical condition that you have.
If these tests are satisfied in relation to your spouse, the normal deductions for your spouse’s business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidentals such as dry cleaning and phone calls.
A nonemployee spouse
Suppose your spouse’s travel doesn’t satisfy these requirements. You may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse, but only any additional costs you incur for him or her.
For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. In other words, you can write off the cost of what you would have paid traveling alone. To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you’re staying.
If you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse won’t be deductible.