First Choice Accounting, Inc.

Tread carefully when deducting "luxury" business expenses

Many people are surprised to learn that some "luxury" items can be deductible business expenses. Of course, moderation is key. Excessive spending is sure to attract the IRS's attention. As some recent high-profile court cases have shown, the government isn't timid in its crackdown on business owners using company funds for personal travel and entertainment.

First class travel

The IRS doesn't require that your business travel be the cheapest mode of transportation. If it did, businesspeople would be traveling across the country by bus instead of by plane. However, the expense as it is relative to the business purpose must be reasonable. Taking the Queen Mary II across the Atlantic to a business meeting in the U.K. could raise a red flag at the IRS.

As long as your business is turning a profit and is operated legitimately as a business and not a hobby, traveling first class generally is permissible. Even though a coach airline seat will get you to your business appointment just as quickly and an inexpensive hotel room is a place to sleep, the IRS generally won't try to reduce your deduction.

However, if your trip lacks a business purpose, the IRS will deny your travel-related deductions. Don't try to disguise a family vacation as a business trip. Many people are tempted; it's not worth the consequences, especially in today's environment where the IRS is aggressively looking for business abuses.

Conventions

Convention expenses are deductible if a sufficient relationship exists to your profession or business and the convention is in North America. No deduction is allowed for attending conventions or seminars about managing your personal investments.

Overseas conventions definitely get the IRS's attention. If you want to deduct the costs of attending a foreign convention, you have to show that the convention is directly related to your business and it is as reasonable to hold the convention outside North America as within North America.

Country clubs expenses

Country club dues are not deductible. In fact, no part of your dues for clubs organized for business, pleasure, recreation, or social purposes is deductible.

Some country club costs may be partially deductible if you can show a direct business purpose and you meet some tough written substantiation requirements. These include greens fees as well as food and beverage expenses. They may be deductible up to 50 percent.

Meals and entertainment

Younger colleagues don't remember when business meals were 100 percent deductible and deals were brokered at "three martini lunches." Meals haven't been 100 percent deductible for a long time and, like other entertainment expenses, the IRS combs them carefully for abuses.

Expenditures for meals, entertainment, amusement, and recreation are not deductible unless they are directly related to, or associated with, the active conduct of your business. The IRS also requires you to keep a written or electronic log, made at the time you make the expenditure, recording the time, place, amount and business purpose of each expense.

Even if you pass the two tests, only 50 percent of meal and entertainment expenses are deductible.  If you write-off business meals through your company and there is a proper reimbursement arrangement in place, you won't be charged with any imputed income for the half that is not deductible, but your company will be limited to a 50 percent write-off.

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Tax Tips

• If you have self-employment income from a schedule C or you were issued a form 1099, you should strongly consider making a SEP contribution rather than an IRA contribution. A SEP contribution (Simplified Employee Pension) is fully tax deductible and can usually be larger in amount than an IRA. Further, the SEP gives you other options an IRA doesn't.

• If you are self-employed or have self-employment income, you may be eligible to deduct part of your health insurance premiums directly against your income. This could be a big tax saver.

• If you receive a 1099 in one year for money you physically receive in the following year, you do not have to pick it up until that following year. You should be sure to note this properly on your return.

• You can deduct a credit charge in the year it was charged, rather than when you pay the bill. So if you charge a deductible expense on December 20th, but don't pay the credit card bill until January 17th, you should take the deduction for the prior year.

• If you have a child, you must have his/her social security number in order to claim an exemption. This is true regardless of your child's age. You can contact Social Security at 1-800-772-1213. Make your life easy and just fill out the forms in the hospital when the baby is born.

• If you owe money on your return and you can't afford to pay it, enclose what you can afford now and file the return with a balance due. Many taxpayers do not realize that the penalty for "Failure to File" is 10 times greater than "Failure to Pay."

• If you buy a mutual fund shortly before a capital gains distribution, part of your investment will almost immediately be handed back to you. The result: you'll owe tax on the distribution and have less money to reinvest. Ask the fund company the date of the next scheduled distribution and purchase shares after this date.

• You may think that selling one bond fund to buy another is just a way of rebalancing your portfolio, but the IRS will view the sale as a capital gains transaction. You can postpone the tax by transferring between funds after Dec. 31st, but if you're committed to making the transfer this year, be sure to withhold part of the sale proceeds to pay taxes on the gain.

• When calculating cost basis, most people remember to factor in commissions on trades or mutual fund transaction fees, but many overlook money that has automatically been reinvested. Reinvested capital gains and dividends can add quite a bit to cost basis so your gains may be much smaller than you believe.