If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.
Facts of the case
In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.
The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.
The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.
When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)
Best practices for business expenses
This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:
DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.
DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.
DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.
DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.
With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster.
In 2020, there was record-breaking new business growth in the United States. The sheer number of new businesses was 24 percent higher than the prior year, with new employee identification number (EIN) applications breaking records in Quarter 3. This all took place despite the pandemic that has swept around the world. In the 1930s, an Austrian economist described this phenomenon of new business growth in times of uncertainty as “creative destruction.” In short, this creative destruction happens as people come up with new ways to overcome challenges – like the inability to shop in person due to lockdowns or health concerns.
However exciting or successful your new business may be at marketing and sales, it’s hard to know what you don’t know about the finance functions and find the time to manage the books and your other priorities. Brushing important accounting and record-keeping tasks to the side can hurt your bottom line and create stress when tax payments are due. So how do you tackle this problem? Keep reading to find out.
Your business will thrive when the finance functions are in working order. Business owners quickly realize they will either need to carve out the necessary time to manage their organization’s finances or hire someone else to do it.
Hiring a CFO is one option. However, most new businesses do not have forty hours of work for a qualified individual. This is when outsourcing CFO services can be a practical solution.
The benefits of working with an outsourced CFO:
- Lower Operating Costs – Any change that will reduce costs without otherwise endangering operations will generally be positive. Many businesses are just too small to justify hiring a full-time, in-house CFO.
- Increased Efficiency – Inefficient operations harm your organization. A real advantage of outsourcing is that behind your outsourced financial planning expert stands an entire team of accountants, partners, consultants, and bookkeepers. When financial activities are outsourced and analyzed by an independent party specializing in that activity, efficiencies will result.
- More Flexibility – When a business owner wears too many hats, one is bound to fall off. Outsourcing CFO functions will allow your organization to become more flexible in dealing with its environment and core activities. Changes that make an organization more agile will make it better able to excel.
- Reduced Risk – Outsourcing a function may reduce the risk an organization faces. Outsourcing payroll, for example, is likely to reduce risk, as experts will now do the job.
- New Ideas – Outsourcing CFO duties will bring new ideas to the table. Small businesses need to recognize that outsourcing an expert will give them a clear advantage with complex financial activities.
- High Growth Potential – Many organizations are limited in taking on more activities because their current staff is spread too thin. Outsourcing financial activities can allow business owners and other staff to engage in better-targeted tasks.
Outsourcing services from your organization can help you operate more effectively. With our requisite knowledge of different organizational structures, we can help you create innovative changes in your organization. If you would like to learn more, please call our office to speak with one of our professionals and learn how our outsourced CFO services can help enhance the success of your business.
The last few years have afforded quite a few changes in how the IRS allows businesses to handle meal and entertainment costs in relation to their taxes. The 2018 Tax Cuts and Jobs Act (TCJA) eliminated deductions for most business-related entertainment expenses. Since the pandemic, the IRS has temporarily changed the tax-deductible amount allowed for some business meals to encourage increased sales at restaurants. With the easing of restrictions, businesses may be considering company picnics for employee appreciation or starting up business lunches with clients again.
With all of these changes, putting a system in place to accurately track business food and entertainment expenses becomes essential. Best practices should include requesting detailed receipts and separately tracking which costs fall under the 50 percent deduction, 100 percent deduction, or not deductible categories.
In addition to keeping excellent records, below are some additional things to keep in mind about the business meal and entertainment deduction rules, including a helpful chart highlighting the deduction category particular meal and entertainment expenses fall under.
Meal and entertainment expense changes
Under the TCJA, the IRS no longer allows businesses to deduct most entertainment expenses even if they were a cost of doing business. Food and beverage related to entertainment venues are only covered with detailed receipts separately stating the cost of the meal.
Another change from the TCJA is that spouse or guest meals are not covered from travel unless the business employs the person. So, if your spouse accompanies you on a work trip, their meals are not deductible for the business.
The Consolidated Appropriations Act of 2021 (CAA) has temporarily increased the deduction for business meals provided by restaurants to 100 percent for tax years 2021 and 2022. Not all meals are created equal, however. The 100 percent deduction is only available for meals provided by restaurants, which the IRS defines as: “A business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises.” Prepackaged food from a grocery, specialty, or convenience store is not eligible for the 100% deduction and would be limited to a 50% deduction.
Also, note that the expenses must be considered ordinary (common and accepted for your business) or necessary (helpful and appropriate) and cannot be considered lavish or extravagant. An employee of the business or the taxpayer must be present during the meal, as well.
A quick guide to business meal deductions
||Tax Code Reference
|Company social events and facilities for employees (e.g., holiday parties, team-building events)
||IRC Secs. 274(e)(4) and 274(n)(2)(A)
|Meals and entertainment included in employee or non-employee compensation
||IRC Secs. 274(e)(2) and (9)
|Reimbursed expenses under an accountable plan
||IRC Sec. 274(e)(3)
|Meals and entertainment made available to the public
||IRC Sec. 274(e)(7)
|Meals and entertainment sold to customers
||IRC Sec. 274(e)(8)
|Business travel meals
100% (1/1/2021 to 12/31/2022)*
|IRC Secs. 274(e)(3) and 274(e)(9)
|Client/customer business meals
100% (1/1/2021 to 12/31/2022)*
|Business meeting meals
100% (1/1/2021 to 12/31/2022)*
|IRC Secs 274(e)(5), 274(k)(1), and 274(e)(6)
|De minimis food and beverages provided in the workplace (e.g., bottled water, coffee, snacks)
|IRC Sec 274(e)(1)
|Meals provided for the convenience of the employer
||50% (through 12/31/2025)
0% (on or after 1/1/2026)
|IRC Sec. 274(n) and 274(o)
|Employer-operated eating facilities
||50% (through 12/31/2025)
0% (on or after 1/1/2026)
|IRC Sec. 274(n) and 274(o)
|Meals/beverages associated with entertainment activities when not separated stated on the receipt
|Personal, lavish, or extravagant meals/beverages in relation to the activity
||IRC Secs. 274(k)(1) and 274(k)(2)
|Entertainment without exception
||IRC Secs. 274(a)(1) and 274(e)
*Meals are only deductible in the 2021 and 2022 tax years if provided by a restaurant, as defined by the IRS in the above article.
If you need help establishing a system to better track expenses or seek clarification on whether certain expenses are tax-deductible, give our team of CPAs a call today.
Winning Tax & Financial Advice for Professional Athletes & Entertainers
Professional athletes and entertainers often come into wealth quickly, at a young age and without the financial resources and support they need to put themselves in the best long-term financial position. Regardless of their age or stage in their careers, these high-net-worth individuals can benefit greatly from the help of a trusted tax and financial advisor.
Hamilton Tharp has served professional athletes, entertainers and their agents and coaches since our founding in 1981. We realized right away that our services are ideally suited for these individuals and related businesses. We help them achieve their financial objectives through the following services:
- Tax planning and return preparation, including international and multi-state considerations
- Financial planning, including budgeting, cash flow projections and investment decisions
- Contract offer evaluation and negotiation assistance
- Legal entity, retirement account and charitable foundation set-up
- Accounting services
- Estate and trust services
By working with us, athletes and entertainers realize the following benefits:
Lifestyle Maintenance During Career Transitions –
We have developed budgeting and cash flow projection models for professional athletes that demonstrate the importance of investments given their relatively short period of high-income earnings. We help athletes accumulate wealth so that they can transition into a second career while maintaining the lifestyle they’ve become accustomed to.
Financial Security –
Highly compensated individuals may enjoy luxurious lifestyles, but they also bear increased financial risks. In many unfortunate cases, athletes and entertainers have lost significant wealth because they failed to comply with applicable tax laws, made hasty or ill-advised financial decisions or let their money fall into the wrong hands. Our clients count on us to provide an expert opinion and unbiased perspective for their unique financial opportunities and challenges.
Tax Savings –
Through nearly 40 years of providing services to professional athletes and entertainers, we have developed unparalleled expertise in the tax laws applicable to this group of individuals, as well as the most tax-advantageous strategies for their specific circumstances. For example:
- Residency: As experts in choice of residency, we know what steps are required to ensure residency in the chosen state, and we have helped clients achieve significant tax savings by successfully establishing their residency in tax-free states. After developing an overall plan in our residency analysis, we follow up on an annual basis to ensure compliance with residence requirements.
- Multi-State and International Considerations: Hamilton Tharp prepares state taxes in almost every state and offers experience in multi-state tax planning and compliance that is virtually unmatched. We help athletes and entertainers understand where and when they will owe taxes to avoid surprises and penalties. Many of our sports clients have saved hundreds of thousands of state-tax dollars by following our recommendations. Although this is not possible in every case, we help professional athletes minimize the ever-growing tax burdens that stem from having to file wherever they play. We also serve clients who play internationally and are well equipped to evaluate the impact of foreign taxes and credits.
- Business Entities & Retirement Plans: Working with agents and sports marketing companies, we have developed tax-advantaged techniques that allow athletes and entertainers to defer taxes by establishing business entities and retirement programs for their extra earnings, and paying fees to family members when appropriate.
- Charitable Foundations: In 1985, we were one of the first firms to set up and receive exempt status for the foundation of one of our professional athlete clients. Although now a popular technique with many athletes and entertainers, our pioneer efforts in this area have resulted in the development of informative models and 100% favorable determinations from tax authorities.
Comprehensive Contract Evaluation & Negotiation Assistance –
During critical contract negotiations, Hamilton Tharp provides an important perspective on the tax and cash flow considerations of contract offers. Very few agents have the training in financial and tax analysis that we offer. We are regularly asked to evaluate contract packages for our clients, and we have developed a computer model that provides a comprehensive comparison of alternative contract scenarios. With Hamilton Tharp rounding out their contract negotiation teams, our clients are confident that they’re evaluating offers from all angles and securing the best deal for their future.
Sound Investment Advice –
Hamilton Tharp has worked with many of the best investment advisors in the country, so we are in an ideal position to help athletes and entertainers interview, evaluate and select advisors who are experienced, respected and best suited for them. Our firm then stays involved to track and monitor investment performance and hold advisors accountable.
The Teammate that will Command Financial Victory
Athletes and entertainers need an independent professional they can call upon for advice, not just so they can stay focused on using their talents to make the most of their careers, but also to optimally respond to the host of unfamiliar opportunities and challenges that accompany newfound wealth. With the help of a trusted advisor, they can retain and grow their wealth for years and generations to come.
Contact us to learn more about our tax and financial planning services can help professional athletes and entertainers meet their financial goals.