There are generally accepted accounting principles that are used for bookkeeping purposes and there are tax laws that are used for completing and filing a tax return. These two things are not always the same. Because there are differences between accounting principles and tax law, the amount you can deduct for tax purposes may not always be the same as the amount that you can deduct for accounting purposes.
One of the best examples of this difference involves travel expenses – which usually includes expenses for meals. And as a small business owner, if you’re going to attempt to handle your accounting and/or tax activities on your own, you need to know the difference.
Accounting Expense Recognition
For accounting purposes, business expenses are the costs incurred in carrying on a trade or business for profit. That means that pretty much any expense incurred that is directly related to the activities of your business, or furthering your business purposes, can be recognized as an expense in your accounting records. So, if you decide to sponsor a NASCAR team to advertise your company, you could expense the costs in your profit and loss statement.
However, be careful that you’re not mixing personal expenses with business expenses. For example, if you personally own a vehicle (meaning that the vehicle is titled in your name) and you use it sometimes for personal trips and sometimes for business purposes, you cannot attribute 100% of the cost of ownership and operating that vehicle to your business. You must allocate the costs between business and personal use based upon some reasonable method; such as miles driven. But if the vehicle is owned by the business, then 100% of the cost of its ownership and operation can be expensed to the business.
Travel Defined
When it comes to expenses for traveling, the small business owner should be aware of the difference between what constitutes traveling and what are really personal expenses. Traveling for business means that you leave the general area in which your business is located for longer than an ordinary work day. The IRS has a similar definition but adds a requirement that you need to sleep or rest to meet the demands of your work while traveling.
Example 1: You are a contractor. You leave the city where your business is located and travel 350 miles to a neighboring city where you attend a seminar. The seminar ends at 7:00 pm so you decide to eat a meal then rent a hotel room for the night. The next morning, you drive the 350 miles back to your home city. You are considered to be traveling for business and your expenses would be considered travel expenses.
Example 2: You are a consultant. You leave your office and drive ninety minutes to attend a meeting with a customer. After the meeting, you stop for a meal then return to your office later the same day. Because you were not away from your business for longer than an ordinary work day, you would not be considered to be traveling. The expense for your meal would be considered a personal expense.
What Expenses Are Deductible?
Once you establish that you are traveling for business purposes, you can then determine what travel expenses are deductible for tax purposes. To be considered a business expense and therefore deductible for tax purposes, an expense must be both ordinary and necessary. The IRS defines an ordinary expense as, “one that is common and accepted in your industry.” A necessary expense is, “one that is helpful and appropriate for your trade or business.” Therefore, in our previous NASCAR example, if your business is a beauty salon or a pet grooming service, the IRS might conclude that that type of advertising is neither ordinary nor necessary and disallow a deduction.
So what travel expenses are deductible:
Transportation – the cost of traveling by plane, train, bus or car is 100% deductible for tax purposes. When traveling in a vehicle that you own personally, you can deduct actual expenses incurred or use the standard mileage rate. If you need to take a bus or taxi from an airport to a hotel and/or from the hotel to the business location of your client or a similar meeting place, fares for these types of transportation are also 100% deductible.
Baggage and Shipping – fees for checked baggage or sending samples or display materials by common carrier in advance separate from the transportation that you take are 100% deductible.
Lodging – the cost of lodging in hotels or motels if your trip includes an overnight stay or is long enough that you need to stop for sleep or rest to properly perform your duties is 100% deductible for tax purposes.
Meals – the cost of meals if your business trip involves an overnight stay or is long enough that you need to stop for sleep or rest is deductible for tax purposes. The cost of meals includes food, beverages, taxes and related tips. However, the IRS places a limitation on how much you can deduct.
Telephone/Internet – business calls (this includes business communications by fax) and access to internet service so that you can conduct business while away from the office are 100% deductible.
Other – These expenses might include transportation to or from a business meal with clients, computer rental fees, notary fees or other tips, such as for baggage handlers and taxi drivers. Remember though, that any other expenses must be considered ordinary and necessary to be deductible.
50% Limit on Meals
As I mentioned above, the IRS places a limit on how much of your meal expenses can be deducted for tax purposes. First, the IRS will not let you deduct expenses for meals that might be considered lavish or extravagant. This does not mean that the expense will be disallowed just because it is over a fixed dollar amount or takes place at a nice restaurant or night club. If the expense is reasonable based on the facts and circumstances, the deduction will be allowed.
A $50 tab (for one person including tip) for dinner at a nice restaurant in Chicago or Miami probably would not be considered lavish or extravagant. However, a $100 tab under the same circumstances in Des Moines or Dallas might be. Again, it will depend upon the facts and circumstances. Therefore, keeping proper receipts and notes could be very important.
Second, and most importantly, in general, the IRS allows you to deduct only 50% of your business-related meal expenses. This limit applies to employees, employers and self-employed people (including independent contractors). The 50% limit applies to business meals while traveling but also to meals for entertaining customers at your office, a restaurant, or other location and to a meal expense incurred when attending a business convention, meeting or luncheon.
Helpful IRS Publications
I always recommend that small business owners consult qualified tax individuals and CPAs when they have business related questions. However, if you prefer to do it yourself or are looking for more information prior to consulting a professional, the IRS has a couple of great publications relating to this topic; Publication 463 for employees and sole proprietors and Publication 535 for other business entities.
I encourage you to post questions if you have them. Thanks.