To be deductible, a business expense must be:
1. Directly connected with your trade or business; 2. "ordinary" (customary or accepted in the business), and 3. "necessary" (appropriate and helpful to the business; it doesn't have to be indispensable or essential).
It cannot be lavish or extravagant.
In addition to these basic rules, there are strict limits on the deductibility of business-related meals, entertainment, auto, gifts and home office deductions.
Home Office expenses were liberalized in 1999. Until then, they are deductible only to the extent of net income, only for a portion of the home used exclusively on a regular basis as:
1. Your principal place of business. (The question here is: Where do you earn your money. It might be his only office in the whole world, where he takes care of all his business, but even if he meets all of the rules, a surgeon who operates in the hospital, not his home office, does NOT qualify. So, real estate salespeople, who earn their money showing houses, probably do not qualify under this test, even if it's their only office in the world.)
2. A place of business that is used for meeting with clients or customers in the normal course of business.
Go to www.wwlaw.com/icdeuct.htm for complete Home Office rules
MEALS & ENTERTAINMENT
Entertainment expenses (including business meals) must be either:
1. "Directly related" to the active conduct of business, which business is the primary purpose of the entertainment (i.e. you have to talk business during the entertainment).
Generally, this test is not met if the entertainment occurs in a setting where there is little or no possibility of conducting business, such as night clubs, theaters, or sporting events.
The "active conduct of business" requirement means more than a general expectation of a specific business benefit at an indefinite future time.
2. "Associated" with business [i.e. entertainment directly precedes or follows a substantial business discussion (which business discussion is part of an active effort to obtain a specific business benefit), and the business discussion is the principal purpose (of the combined business and entertainment)]. It is not necessary that more time be devoted to business than entertainment.
No deductions are allowed for entertainment facilities (yachts, hunting lodges, swimming pools, tennis courts, or bowling alleys).
If you meet all of these tests, generally, only 50 percent of business entertainment is deductible.
Business gifts of up to $25 a year per recipient are deductible. If it cost no more than $4 and your name is embossed (for example, a pen) it does not count as a gift.
That's why many people call their gifts "promotion" or "advertising." Will calling a gift "promotion" avoid the $25 limit if you are audited? If you give a client a $35 gift without your name printed on the gift, clearly only $25 is deductible. But if your name is prominently engraved on the gift, more should be deductible. In real life, it depends on the auditor and, the reasonableness of the gift, and the advertising potential thereof.
In real life, it depends on the auditor and, the reasonableness of the gift, and the advertising potential thereof.
Clothing is not deductible, unless it has a permanently affixed logo.
Automobile Expenses directly attributable to the conduct of business are deductible.
Exception: commuting expenses (between your home and regular business location) are not deductible. (If your home office is your principal place of business, there are no miles disallowed for commuting.)
Holding a business meeting in the car while commuting does not turn the commute into a business deduction. However, going to a business meeting on the way to the office allows a deduction for the additional mileage over that required to get to work.
Exceptions to exception (deductions are allowed for commuting):
1. If you need your car to carry large items for work. 2. If you work at two or more places in a day you can deduct the cost of getting from one place to the other, or 3. If you are on temporary assignment out of town.
There's a case out of Marin, California. The Director of the County Health Facility was required to have her car at work. [Her duties included emergency delivery of medical specimens.] The IRS agreed that she needed her car at work, but driving the car from her home to work was commuting. She could have left the car at work; her decision to take it home at night was personal.
If you have one car, you must allocate something to personal use. There is no possibility that an IRS agent will ever believe that you did no personal driving.
If you have more than 1 car, other than commuting to and from work, it is possible to justify 100% business use.
Once an auto is determined to qualify for business, the deduction must be calculated. There are two methods:
1.Actual expenses (gas, repairs, insurance, etc.) plus depreciation, or alternatively,
2. The standard mileage allowance may be used:
50¢ per mile for 2010
51¢ per mile for Jan - June 30, 2011
55.5¢ per mile for July - Dec 31, 2011
55.5¢ per mile for 2012
56.5¢ per mile for 2013
56¢ per mile for 2014
57.5¢ per mile for 2015
DEPRECIATION is already built into the standard rate; no depreciation is allowed for cars for which the standard rate is chosen.
Only the business percentage may be depreciated. If the car is used 75% for business use, only 75% of the cost may be depreciated.
"Luxury" Auto Limitation
In order to prevent abuse on "luxurious" cars depreciation is limited (to about $1,600 - $3,000 per year), even if the car is used 100% for business. If it is used only 75% for business, only 75% x $3,000 may be deducted. If a car costs $25,000, it will take many years to depreciate.
LEASED CARS are deductible, subject to rules to prohibit large deductions for luxury cars. Leasing is not a way to avoid the luxury car depreciation limitations. There is an annual ceiling on deductible lease expenses, corresponding to the depreciation limitations.
INTEREST on a car used for business purposes is subject to different rules:
1.The portion attributable to personal use or employment use by an employee is not deductible. 2. The portion of interest attributable to business use is fully deductible.
All of the above rules are pointless if you cannot prove that you complied. Proper record keeping is vital to substantiate auto deductions. Remember - the IRS auditor has a car and cannot deduct it. You must be ready to prove to a non-believer that you comply with the rules.
You must have evidence of business use. The IRS auditor will try hard to deny any proof if you don't have a contemporaneous diary showing each expenditure, the time, date, and amount, and the business purpose.
ALSO DEDUCTIBLE ARE:
- Dues and Publications;
- Repairs to business property (repairs are designed to keep property in an ordinarily efficient operating condition, but do not add to its value or appreciably prolong its useful life);
- Extra 1st year depreciation for business assets (but not cars) ($18,000 for 1997; and $18,500 in 1998). This means that if you buy business equipment for up to $18,000, you can write it all off in the first year, rather than depreciating it over 5 years.
"Listed property" has additional requirements for first year depreciation. These are fun assets, like home computers, cars, and cameras. These are not eligible for extra 1st year depreciation unless used at least 50% for business; then only the business proportion is depreciable.