Friday, May 23, 2008

Business deductions

I was meeting with a prospective client yesterday and they were talking about deductions. This person owned an upscale retail clothing store and a friend of theirs had told them they could write off almost everything as a small business owner.

Drive to work - write it off.
Laptop computer - write it off.
Cell phone - write it off.
Daily lunch with his business partner - write it off.
Fancy clothes - write it off.
Haircut - write if off.

The list was actually longer but I think you get the picture.

While all of these have some connection to the business activity, that doesn't necessarily make them deductible. While there are many specific rules regarding business deductions, the items noted above generally have a high degree of personal benefit, i.e. non-business, to them. Everyone has to eat, wear clothes, get their haircut and drive to work. These are generally personal expenses and therefore not deductible as business expenses.

Haircuts and clothing are almost never deductible. As a general rule, clothing is deductible only if it is a requirement of the job AND, cannot be worn as street clothes. My friend and his employees who dress nicely in their upscale clothing store cannot deduct their clothing as a business expense. It may be a requirement of the job but the clothes can also be worn outside of work and therefore can't be deducted. If it is any consolation, I can't deduct my suits, shoes and ties either.

Cell phones and laptops are considered listed property and an allocation between business and personal use is required. The business use portion is deductible while the personal portion isn't.

There are a number of ways to handle cell phone accounting and I recommend you do it right with professional help to review the tax implications of your plan. I see too many companies who don't handle this correctly and expose themselves to potential liabilities. The biggest mistake I see is where a company simply provides cell phones to employees and pays the monthly bill without any accounting by the cell phone user. This type of arrangement is allowed but the payment is considered W-2 compensation and should be handled accordingly.

Business meals have a their own set of specific rules but generally, the meal must be ordinary and necessary for your business and directly related to or associated with it as well. Having lunch with a co-worker will not pass the necessary test and is therefore not deductible. Most meals are considered personal unless, you are meeting with a client or perspective client AND discussing business.

The IRS has strict rules for substantiating meal and entertainment expenses. For each expense, you must show the date, place, amount, business purpose of the expense, and the business relationship of the person you entertained. Receipts are required for expenses of $75 or more.

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