Documentation of Travel and Entertainment Expenses

The Internal Revenue Service (“IRS”) guidelines for deducting travel and entertainment expenses are complex. The following discussion will assist your firm in properly documenting these expenses and avoiding a potential tax authority audit.

There are specific rules regarding the deductibility of travel and entertainment expenses. These guidelines must be followed or you will not secure deductions for your legitimate business expenses.

Documentation Substantiation of Business-Related Expenses

In order for travel and business expenses to be deductible, you must demonstrate the following:

• That you had more than a general expectation of gaining some business benefits other than good will;
• That business was conducted during the entertainment;
• That your main purpose at the event was the active conduct of business.

Documentation of the above requirements must be contemporaneous.

The IRS presumes that events that take place in environments that are not conducive to business (nightclubs, theaters, sporting events, country clubs or cocktail parties) are not directly related to business. To overcome the IRS presumption, you need to demonstrate that you were engaged in a business discussion or conducted business during the event.

The individual entertained must be a business associate, prospect and/or client; someone who could reasonably be expected to conduct business with you.

Note: When you entertain a business associate with his/her spouse and your spouse attends, the entertainment of both spouses is deductible.

Substantiation

The tax law requires you to prove the business purpose and amounts incurred in business travel and entertainment.

IRC Sec. 274(d) specifies that no deduction is allowable for travel and entertainment under IRC Sec. 162 or 212 unless you substantiate, by adequate records or sufficient evidence corroborating your own statement, all of the following:

1. The amount of the travel and entertainment expense;
2. The time and place of the travel or entertainment (or date and description of the gift);
3. The business purpose; and
4. The business relationship to the taxpayer of the persons entertained (or receiving a gift).

This information should be written on each receipt with respect to entertainment or included on expense reports submitted by the employee.

The above rule applies to travel, local transportation, entertainment, business gifts, and all listed property, including autos. This does not apply to qualified non-personal use vehicles (basically a vehicle not suitable for personal use) [IRC Sec. 274(d) and (i)].

You are required to maintain a contemporaneous log: a record of the elements of an expenditure made at or near the times of the expenditure that is supported by sufficient documentary evidence (diary, credit card, Outlook) and has a higher degree of credibility than a statement prepared later when there could be a lack of accurate recall [Temp. Reg. 1.274-5T(c)(1); see also Reg. 1.274-5A(c)(1)]. A statement record that is not made at or near the time of the expenditure must have a “high degree of probative value” to be credible. The term “at or near the time” means that the elements of the expenditure are recorded at a time when, in relation to the expenditure, the taxpayer has full present knowledge of each element of the expenditure and business relationship [Temp. Reg. 1.274-5T(c)(2)(ii)(A)].

In order to meet the “contemporaneous adequate records” requirement, a taxpayer must maintain an account book, log, statement of expense, trip sheet, or similar record along with documentary evidence (i.e., expense report). You are not required to record information in a diary, log, statement of expense, etc., that is already reflected on a receipt. The account book, log, statement of expense, etc., must be prepared so that each record of an element of an expenditure is made at or near the time of the expenditure [Temp. Reg. 1.274-5T(c)(2)(ii)].

The general substantiation rule requires that corporations must maintain documentary evidence, such as a written receipt, for any lodging expense and for other travel and entertainment expenses of $75 or more [Reg. 1.274-5(c)(2)(iii)]. A hotel receipt is adequate to support expenditures for business travel if it contains the name, location, date, and separate amounts for charges such as for lodging, meals, and telephone. A restaurant receipt is adequate to support an expenditure for a business meal if it contains the name and location of the restaurant, the date and amount of the expenditure, the number of people served, the purpose of the meal and, if a charge is made for an item other than meals and beverages, an indication that such is the case [Reg. 1.274-5(c)(2)(iii)(B)].

Substantiation Summary

Records are required to substantiate (who, what, where, when, and why) travel expenses away from home, including meals and lodging, entertainment, recreational activities and business gifts, and must include the following:

• Amount
• Time, place, and date;
• Description;
• Business purpose; and
• Business relationship.

Substantiation of Away-from-Home Travel Expenses

For each trip, the following must be documented:

• Amount of the expenses;
• Dates of departure and return, demonstrating the number of days spent on business;
• Destination;
• Business reason and benefit expectation; and
• Name, title (business relation) of the people met.

Substantiation of Entertainment Expenses

For each entertainment expense the following must be documented:

• Amount;
• Date of the entertainment;
• Name, address, and type of entertainment (the labeling of “dinner” and/or “show” is not adequate);
• Business purpose;
• Nature of the business discussion that took place; and
• Name, title (business relation) of the people entertained.

Note: For season tickets, each game needs to be documented (who, what, where, when, and why).

Business Gifts

To substantiate the business gift deduction, the following must be documented:

• Cost of gift;
• Date of gift;
• Name, title and occupation of the gift recipient; and
• Gift description.

The IRS has prescribed limitations to deductibility of no more than $25 per person.

Employee Reimbursements

Employees who are fully reimbursed by their employers are not subject to the deduction limits. The record-keeping and reporting rules do apply and should document the following:

• Credit card slips;
• Diary;
• Outlook; and
• Statements.

Charitable Contributions As Business Expenses

From time to time, law firms are asked to make donations to various charitable or civic organizations. In some situations, the intention is strictly charitable. In others, the firm feels pressured because of a business relationship with the organization, a business relationship with a board member, or a business relationship with another important contributor to the organization. Again, this needs to be documented in accordance with the above criteria in order to be considered a legitimate business deduction.

Deductible Travel Expense Example

1. Lodging;
2. Cost of cleaning clothes;
3. Telephone, fax, modem;
4. Secretarial services;
5. Transportation between job/client sites or to and from hotel and terminals;
6. Airfare, and fares and charges related to shipping baggage;
7. Costs of bringing or sending documents;
8. Keeping and operating a car, and garaging a car, airplane (including hanger costs);
9. Transportation between temporary sites, hotels, and restaurants;
10. Computer rentals;
11. Tips;
12. Costs incurred traveling abroad for existing clients; and
13. Travel costs incurred to acquire a new client, even if unsuccessful.

Non-deductible/restricted away-from- home expenses:

1. Commuting between your home and job;
2. Travel to improve one's knowledge of a certain field that is not part of your job; and
3. Travel costs incurred while looking for a new place of business; must be capitalized; and
4. Luxury travel is subject to a per-day limit.

Meal and Entertainment Expense Examples

In the case of rentals of skyboxes and other luxury boxes, where the rental covers more than one event, the deduction is subject to the 50% entertainment expense limit.

The deductions for the costs of entertainment facilities (yachts, lodges, camps, pools, tennis courts) are subject to the entertainment expense limitations.

Country club, athletic club, and social club dues are not deductible.

Entertainment expenses are deductible as follows:

1. Business leagues, trade associations, chambers of commerce, boards of trade functions ' 100%;
2. Firm parties and functions ' 100%;
3. Charity dinners ' 100%
4. Golf outings ' 50%; and
5. Meals ' 50%.

Note: Entertainment costs, including taxes, tips, cover charges, room rental, maids, and waiters are subject to the 50% limit on entertainment deductions.

The bottom line is that the record-keeping and documentation for travel and entertainment expenses must be complied with contemporaneously to preserve the deductions. The “who, what, when, where and why” must be listed on the invoices to be in compliance. Becoming familiar with the record-keeping and expense limitations discussed above is prudent business and may help your firm avoid a potential tax authority audit in the future.

Scott B. Ehrenpreis is a principal at Friedman LLP, Accountants and Advisors, based in New York City. He has more than 30 years of experience as a tax specialist, helping middle-market companies, entrepreneurial owners and high-net-worth individuals mitigate controversial tax issues and preserve wealth. Web site: www.friedmanllp.com. He can be reached at: [email protected] or 212-842-7669. Phillip A. Bottari, CPA ([email protected]), a member of this newsletter's Board of Editors, is partner in charge of the Friedman LLP Law Firm Services Group, which provides accounting, audit, tax, and practice management services to law firms.

The Internal Revenue Service (“IRS”) guidelines for deducting travel and entertainment expenses are complex. The following discussion will assist your firm in properly documenting these expenses and avoiding a potential tax authority audit.

There are specific rules regarding the deductibility of travel and entertainment expenses. These guidelines must be followed or you will not secure deductions for your legitimate business expenses.

Documentation Substantiation of Business-Related Expenses

In order for travel and business expenses to be deductible, you must demonstrate the following:

• That you had more than a general expectation of gaining some business benefits other than good will;
• That business was conducted during the entertainment;
• That your main purpose at the event was the active conduct of business.

Documentation of the above requirements must be contemporaneous.

The IRS presumes that events that take place in environments that are not conducive to business (nightclubs, theaters, sporting events, country clubs or cocktail parties) are not directly related to business. To overcome the IRS presumption, you need to demonstrate that you were engaged in a business discussion or conducted business during the event.

The individual entertained must be a business associate, prospect and/or client; someone who could reasonably be expected to conduct business with you.

Note: When you entertain a business associate with his/her spouse and your spouse attends, the entertainment of both spouses is deductible.

Substantiation

The tax law requires you to prove the business purpose and amounts incurred in business travel and entertainment.

IRC Sec. 274(d) specifies that no deduction is allowable for travel and entertainment under IRC Sec. 162 or 212 unless you substantiate, by adequate records or sufficient evidence corroborating your own statement, all of the following:

1. The amount of the travel and entertainment expense;
2. The time and place of the travel or entertainment (or date and description of the gift);
3. The business purpose; and
4. The business relationship to the taxpayer of the persons entertained (or receiving a gift).

This information should be written on each receipt with respect to entertainment or included on expense reports submitted by the employee.

The above rule applies to travel, local transportation, entertainment, business gifts, and all listed property, including autos. This does not apply to qualified non-personal use vehicles (basically a vehicle not suitable for personal use) [IRC Sec. 274(d) and (i)].

You are required to maintain a contemporaneous log: a record of the elements of an expenditure made at or near the times of the expenditure that is supported by sufficient documentary evidence (diary, credit card, Outlook) and has a higher degree of credibility than a statement prepared later when there could be a lack of accurate recall [Temp. Reg. 1.274-5T(c)(1); see also Reg. 1.274-5A(c)(1)]. A statement record that is not made at or near the time of the expenditure must have a “high degree of probative value” to be credible. The term “at or near the time” means that the elements of the expenditure are recorded at a time when, in relation to the expenditure, the taxpayer has full present knowledge of each element of the expenditure and business relationship [Temp. Reg. 1.274-5T(c)(2)(ii)(A)].

In order to meet the “contemporaneous adequate records” requirement, a taxpayer must maintain an account book, log, statement of expense, trip sheet, or similar record along with documentary evidence (i.e., expense report). You are not required to record information in a diary, log, statement of expense, etc., that is already reflected on a receipt. The account book, log, statement of expense, etc., must be prepared so that each record of an element of an expenditure is made at or near the time of the expenditure [Temp. Reg. 1.274-5T(c)(2)(ii)].

The general substantiation rule requires that corporations must maintain documentary evidence, such as a written receipt, for any lodging expense and for other travel and entertainment expenses of $75 or more [Reg. 1.274-5(c)(2)(iii)]. A hotel receipt is adequate to support expenditures for business travel if it contains the name, location, date, and separate amounts for charges such as for lodging, meals, and telephone. A restaurant receipt is adequate to support an expenditure for a business meal if it contains the name and location of the restaurant, the date and amount of the expenditure, the number of people served, the purpose of the meal and, if a charge is made for an item other than meals and beverages, an indication that such is the case [Reg. 1.274-5(c)(2)(iii)(B)].

Substantiation Summary

Records are required to substantiate (who, what, where, when, and why) travel expenses away from home, including meals and lodging, entertainment, recreational activities and business gifts, and must include the following:

• Amount
• Time, place, and date;
• Description;
• Business purpose; and
• Business relationship.

Substantiation of Away-from-Home Travel Expenses

For each trip, the following must be documented:

• Amount of the expenses;
• Dates of departure and return, demonstrating the number of days spent on business;
• Destination;
• Business reason and benefit expectation; and
• Name, title (business relation) of the people met.

Substantiation of Entertainment Expenses

For each entertainment expense the following must be documented:

• Amount;
• Date of the entertainment;
• Name, address, and type of entertainment (the labeling of “dinner” and/or “show” is not adequate);
• Business purpose;
• Nature of the business discussion that took place; and
• Name, title (business relation) of the people entertained.

Note: For season tickets, each game needs to be documented (who, what, where, when, and why).

Business Gifts

To substantiate the business gift deduction, the following must be documented:

• Cost of gift;
• Date of gift;
• Name, title and occupation of the gift recipient; and
• Gift description.

The IRS has prescribed limitations to deductibility of no more than $25 per person.

Employee Reimbursements

Employees who are fully reimbursed by their employers are not subject to the deduction limits. The record-keeping and reporting rules do apply and should document the following:

• Credit card slips;
• Diary;
• Outlook; and
• Statements.

Charitable Contributions As Business Expenses

From time to time, law firms are asked to make donations to various charitable or civic organizations. In some situations, the intention is strictly charitable. In others, the firm feels pressured because of a business relationship with the organization, a business relationship with a board member, or a business relationship with another important contributor to the organization. Again, this needs to be documented in accordance with the above criteria in order to be considered a legitimate business deduction.

Deductible Travel Expense Example

1. Lodging;
2. Cost of cleaning clothes;
3. Telephone, fax, modem;
4. Secretarial services;
5. Transportation between job/client sites or to and from hotel and terminals;
6. Airfare, and fares and charges related to shipping baggage;
7. Costs of bringing or sending documents;
8. Keeping and operating a car, and garaging a car, airplane (including hanger costs);
9. Transportation between temporary sites, hotels, and restaurants;
10. Computer rentals;
11. Tips;
12. Costs incurred traveling abroad for existing clients; and
13. Travel costs incurred to acquire a new client, even if unsuccessful.

Non-deductible/restricted away-from- home expenses:

1. Commuting between your home and job;
2. Travel to improve one's knowledge of a certain field that is not part of your job; and
3. Travel costs incurred while looking for a new place of business; must be capitalized; and
4. Luxury travel is subject to a per-day limit.

Meal and Entertainment Expense Examples

In the case of rentals of skyboxes and other luxury boxes, where the rental covers more than one event, the deduction is subject to the 50% entertainment expense limit.

The deductions for the costs of entertainment facilities (yachts, lodges, camps, pools, tennis courts) are subject to the entertainment expense limitations.

Country club, athletic club, and social club dues are not deductible.

Entertainment expenses are deductible as follows:

1. Business leagues, trade associations, chambers of commerce, boards of trade functions ' 100%;
2. Firm parties and functions ' 100%;
3. Charity dinners ' 100%
4. Golf outings ' 50%; and
5. Meals ' 50%.

Note: Entertainment costs, including taxes, tips, cover charges, room rental, maids, and waiters are subject to the 50% limit on entertainment deductions.

The bottom line is that the record-keeping and documentation for travel and entertainment expenses must be complied with contemporaneously to preserve the deductions. The “who, what, when, where and why” must be listed on the invoices to be in compliance. Becoming familiar with the record-keeping and expense limitations discussed above is prudent business and may help your firm avoid a potential tax authority audit in the future.

Scott B. Ehrenpreis is a principal at Friedman LLP, Accountants and Advisors, based in New York City. He has more than 30 years of experience as a tax specialist, helping middle-market companies, entrepreneurial owners and high-net-worth individuals mitigate controversial tax issues and preserve wealth. Web site: www.friedmanllp.com. He can be reached at: [email protected] or 212-842-7669. Phillip A. Bottari, CPA ([email protected]), a member of this newsletter's Board of Editors, is partner in charge of the Friedman LLP Law Firm Services Group, which provides accounting, audit, tax, and practice management services to law firms.