Tax Tips
Deductible Expenses for Small Businesses - Part II - April 2000
Richard Scrivanich - Partner
In this month's Tax Tips, let's continue on with our discussion of deductible expenses for small businesses by taking a look at bad debts and casualty losses, entertainment expenses, the home office deduction, and miscellaneous expenses.
Bad debts and casualty losses.
If a customer or vendor doesn't pay your invoice, that bad debt may or may not be deductible; it depends on what you're billing for. If your business sells goods, you typically can deduct the cost of goods you sell but don't get paid for. But before you can claim a bad debt write-off, the IRS requires that you take reasonable steps to collect payment. That can include giving the debtor written warnings or going to a collection agency or small-claims court. Since a bad debt deduction can only be taken in the year in which the debt becomes totally worthless, you should step up your collection efforts if you have some bad debts you want to write off this year.
Unfortunately, if your business provides a service such as writing or consulting, you cannot deduct an unpaid bill as a bad debt. No tax deduction is allowed for time you devoted to a client who doesn't pay. The rationale behind the rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts.
If your business property is damaged or destroyed due to some unforeseen event such as a hurricane, flood, theft, or fire, you may be entitled to deduct the loss. A special rule applies to business property that is completely destroyed as a result of a casualty loss. In such cases, your loss is your basis in the property without regard to fair market value. There are no dollar limitations on these losses as there are on personal losses, nor are there any adjusted gross income limitations. You must, however, reduce your loss by the amount of any insurance reimbursement you receive.
Entertainment expenses.
You can deduct 50% of your qualifying business meal and entertainment expenses. Entertaining guests at restaurants, nightclubs, theatres, sporting events-any activity considered to provide entertainment, amusement, or recreation-falls into this category. In the IRS's view, your meal and entertainment expenses qualify for a deduction if they meet as least one of two tests. The entertainment must be "directly related" to the active conduct of your business, which means business is the primary purpose of the meal or entertainment expense, or it must be "associated with" business, which means even if you don't discuss business at the meal, the meal or entertainment expense precedes or follows a substantial business discussion. For example, catering lunch for a business meeting would be a "directly related" expense, while meeting a client to discuss a proposal and then taking him or her to a ball game would fit the "associated with" requirement.
Note:
Holiday parties, picnics and other social events you put on for your employees and their families are an exception to the 50% rule; such events are 100% deductible.
Home office deduction.
As of January 1, 1999, the home office deduction rules became more lenient. The Taxpayer Relief Act of 1997 made the home office deduction more accessible by expanding the definition of "principal place of business." The new definition benefits those self-employed persons who manage a business from their homes, but also provide a service or meet clients at another location. An example would be a doctor who sees patients at local clinics, but conducts the administration or management activities of the business from a home office. A home office now qualifies as your principal place of business if you use it regularly and exclusively to conduct the administrative or management activities of a business, and there is no other fixed location where you conduct substantial administrative or management activities.
Miscellaneous expenses.
If you're like many small business owners, you regularly spend small amounts of cash on things like pens, taxis, and postage stamps. Over the course of a year, these outlays can add up. For example, suppose you stock your office lunchroom with coffee, soft drinks, and snacks. That $25 a month outlay translates into a $300 expense by the end of a year, and it's all deductible. One way to improve your cash expense record keeping is to reimburse yourself by check. Every few weeks, tally your cash receipts and write yourself a business check for the amount you spent. Remember, you don't necessarily need a receipt for items under $75; just be sure to keep good records. One way to do so is to put all of your small business purchases on a corporate charge card that provides you with regular management reports. This will save you time and money during tax preparation time.
IRS studies show that poor records, not dishonesty, cause most small business people to lose at audits or fail to comply with their tax reporting obligations. Keep detailed records of expenses for travel away from home, business meals and entertainment, business gifts, automobile expenses, and others. For any expense over $75 and for all lodging expenses, whatever the amount, you must have a receipt. You must substantiate each individual expense as to amount, time and place, and business purpose. For entertainment and business gift expenses, you must also note the business relationship of the person. These notations may be made on the back of the receipt or recorded in a formal expense log.
If you have any tax related questions, please feel free to call me at (562) 698-9891.
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