BUSINESS RECORDKEEPING GUIDE
The services that Pancerella & Associates provides for your business is a key part of business recordkeeping. However, it is not the only part. As a business owner, you must keep accurate income and expense records. For income, you may receive money, property or services (bartering) from a variety of sources. Your records must identify these sources of your income. You must also keep track of expenses. You may forget an expense unless you record it when it occurs. You can use your records to identify expenses that can be claimed a deduction. Your records support the income and expense reported on your tax returns. If the IRS examines your tax return, you may be asked to explain the items reported. Good records will help you explain any item.
The IRS does not require you to keep your records in a particular way other than keeping them in a manner that allows the ability to determine the correct amount of tax.
Your checkbook should keep a record of your income and expenses. In your checkbook you should record amounts, sources of deposits, and types of expenses. That is why we provide you with a sales and cash report worksheet and an expense coding system. And while we do not need to see them, you need to keep these documents in an orderly fashion.
Keep your records by year and type of income or expense. One method is to keep all records related to a particular item in a designated envelope. We recommend a file box or electronic storage.
The basic records are documents that everybody should keep. These are the records that prove your income and expenses. They are as follows:
Canceled checks or other proof of payment
Sales and credit card slips
Credit or debit card receipts
Deducting Expenses for your Business:
Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. Meals and entertainment, travel
and automobile expenses (local transportation) require additional recordkeeping. These particulars are described below.
Meals and Entertainment Expenses:
Meals and entertainment expenses require you to jump through several extra hoops to qualify as deductible and are subject to limitations. Nevertheless, if you pay careful attention to rules outlined below, the expenses should qualify as deductible.
(1) Ordinary and necessary business expenses. As stated above, all business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carrying on the business. These terms have been fairly broadly defined to mean customary or usual, and appropriate or helpful. Thus, if it is reasonable in your business to entertain clients or other business people, you should be able to pass this general test.
(2) “Directly related” or “associated with.” A second level of tests especially applicable to meals and entertainment expenses must also be satisfied. Under them, the business meal or entertainment must be either “directly related to” or “associated with” the business.
“Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. Thus, a specific, concrete business benefit is expected to be derived, not just general goodwill from making a client or associate view you favorably. And the principal purpose for the event must be business. Also, you must have engaged actively during the event, via a meeting, discussion, etc.
The directly related test can also be met if the meal or entertainment takes place in a clear business setting directly furthering your business, i.e., where there is no meaningful personal or social relationship between you and the others involved. Meetings or discussions that take place at sporting events, night clubs, or cocktail parties—essentially social events—would not meet this test.
If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (i.e., takes place on the same day as) a substantial and bona fide business discussion.
This test is easier to satisfy. “Goodwill” type of entertainment at shows, sporting events, night clubs, etc. can qualify. The event will be considered associated with the active conduct of the business if its purpose is to get new business or encourage the continuation of a business relationship. For meals, you (or an employee of yours) must be present. That is, for example, if you simply cover the cost of a client's meal after a business meeting but don't join him at it, the expense does not qualify.
(3) Substantiation. Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. The use of reasonable estimates is not sufficient to stand up to IRS challenge. You must be able to establish the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. Obviously, you must set up careful and detailed record-keeping procedures to keep track of each business meal and entertainment event and to justify its business connection. For expenses of $75 or more, documentary proof (receipt, etc.) is required.
(4) Deduction limitations. Several additional limitations apply. First expenses that are “lavish or extravagant” are not deductible. This is generally a “reasonableness” test and does not impose any fixed limits on the cost of meals or entertainment events. Expenses incurred at first class restaurants or clubs can qualify as deductible.
More importantly, however, once the expenditure qualifies, it is only 50% deductible. Obviously, this rule severely reduces the tax benefit of business meals and entertainment. If you spend about $50 a week on qualifying business meals, or $2,500 for the year, your deduction will only be $1,250.
The actual costs of travel (e.g., plane fare, cab to airport, etc.) are deductible for out-of-town business trips. You are also allowed to deduct the cost of meals and lodging. Your meals are deductible even if they are “personal,” i.e., not connected with business, although, as with all deductible meals, only 50% of the cost is allowed (80% for long-haul truckers, certain airline, train and bus employees, and certain merchant mariners). Additionally, no deduction is allowed for meal or lodging expenses that are “lavish or extravagant,” a term that has been interpreted to mean “unreasonable.”
Personal entertainment costs on the trip aren't deductible, but business-related costs such as for dry-cleaning, phone calls, and computer rentals are.
Some allocations may be required if the trip is a combined business/pleasure trip, for example, if you fly to a location for five days of business meetings and stay on for an additional period of vacation. Only the cost of meals, lodging, etc., for the business days are deductible—not for the personal vacation days.
On the other hand, with respect to the cost of the travel itself (plane fare, etc.), if the trip is “primarily” business, the travel cost can be deducted in its entirety and no allocation is required. Conversely, if the trip is primarily personal, none of the travel costs are deductible. An important factor in determining if the trip is primarily business or personal is the amount of time spent on each, although this isn't the sole factor.
If the trip doesn't involve the actual conduct of business but is for the purpose of attending a convention, seminar, etc., IRS checks the nature of the meetings carefully to make sure they are not vacations in disguise. Be careful to save all material helpful in establishing the business or professional nature of this travel.
The rules on deducting the costs for your spouse if she accompanies you on a business trip are very restrictive. No deduction is allowed unless she's an employee of yours or your company and her travel is also for a business purpose.
Finally, note that personal expenses you incur at home as a result of taking the trip aren't deductible. For example, the cost of boarding a pet while you're away isn't deductible.
Automobile (Local Transportation) Expense:
Local transportation refers to travel in which you aren't away from your tax home (the city or general area in which your main place of business is located) long enough to require sleep or rest.
The most important feature of the local transportation rules is that your commuting costs are not deductible. That is, the fare you pay or the miles you drive simply to get to work and home again are personal and not business miles and no deduction is available. This is the case even if you work during the commute, e.g., via a cell phone, or by performing business-related tasks while on the train. An exception applies for commuting to a temporary work location that is outside of the metropolitan area in which you live and normally work. “Temporary,” for this purpose, means a location where your work is realistically expected to last (and does in fact last) for no more than a year.
On the other hand, once you get to work, the cost of any local trips you take for business purposes is a deductible business expense. So, for example, the cost of travel from your office to visit a client, pick up supplies, etc., is deductible. Similarly, if you have two business locations, the cost of travel between them is deductible.
If your deductible trip is by taxi or public transportation, save a receipt if possible or make a notation of the expense in a logbook, and record the date, amount spent, destination, and business purpose. If you use your car, note miles driven instead of amount spent. Note also any tolls paid or parking fees (with receipts).
You will need to allocate your automobile expenses between business and personal use based on miles driven during the year. Proper recordkeeping is crucial in the event of an IRS challenge. Your deduction can be computed using (1) a standard mileage rate plus tolls and parking, or (2) actual expenses (including depreciation, subject to limitations) for the portion of car use allocable to the business. For method (2), you will need to keep track of all costs for gas, repairs and maintenance, insurance, interest on a car loan, and any other car-related cost.