This is one installment in our series of articles for business owners. To access the other articles in the series, please click on the following links:
Tax Issues for Business Owners – Travel and Transportation
Tax Issues for Business Owners – Depreciation of Fixed Assets
Marc Johnson has spent the last eight years of his life as a Master Watchmaker. The first seven years were spent in Boston as an employee of a watch repair company, but a year ago he set out to start his own business. He was a highly skilled and educated watchmaker that spent most of the day repairing and restoring wristwatches, pocket watches, and timepieces. Unfortunately, like all new business owners he now had to dedicate some time to learning how to manage the finances of the business, keep appropriate accounting records, and eventually determine the proper tax treatment of various items when filing season rolled around.
Marc had a few issues he ran into in that first year, not unlike many other new business owners, which included:
In this article we will discuss the first issue – travel and transportation. Stay tuned for future articles that will discuss the other items noted above. And keep in mind that the following discussion applies to sole proprietors; so if you are a partnership or corporation, the regulations will differ in certain circumstances.
The first concept that needs to be addressed when evaluating travel and transportation expenses is the term tax home. While exceptions exist, in general your tax home is going to be your regular place of business. So in the case of the master watchmaker, that would almost always be wherever the watch workshop is located. For Marc that would be Ellicott City, Maryland, located outside of Baltimore. This concept is important because the deductibility of expenses varies based on whether Marc is traveling inside or outside his tax home. For example, there is different treatment if he is driving to meet a potential customer or business partner for lunch in Baltimore compared to when he drives to New York for a two-day trade show and has to stay overnight.
Once your tax home is established, that leads to the next important concept; the distinction between travel expenses and transportation expenses.
Points to Remember:
When Marc goes to New York for the trade show, he is considered to be traveling away from his tax home, and many of the expenses he incurs are therefore deductible as travel expenses. Deductible travel expenses include the cost of airfare, train tickets, or mileage depending on the mode of transportation. It also includes taxi fares to get from the airport to the hotel, the cost to ship his displays from home to the trade-show, the cost of the hotel, and the cost of meals. Of course the deduction for those meals is limited to 50%, and the meals must not be lavish or extravagant. Those are the most common travel expenses, however there are various other ordinary and necessary travel expenses that you should check to see if they are deductible.
One important part of planning and accounting for a trip is determining the primary reason for the trip. If the primary reason is personal, then the entire cost is a nondeductible personal expense. So if Marc decided to visit his brother in California for five days, and spends the entire trip with his brother with the exception of a three-hour seminar on watchmaking that happened to be taking place at the time he was visiting, then the primary reason for the trip would be personal. The actual cost of the seminar can be deducted, as it is a business expense, but he would not be allowed to deduct any portion of the airfare or other travel expenses just because he attended the seminar. The more taxpayer friendly aspect of the regulations comes in to play when the primary purpose of a trip is for business, but the taxpayer extends the trip for personal reasons. For example, Marc has a three-day trade show in Boston and decides to drive to the show. The drive to Boston is 800 miles round-trip, which is deductible. After Marc finished in Boston he decides to stop in New Hampshire to stay one night with a friend, adding 200 miles to his trip. While each situation is different, it is likely that the primary purpose of Marc’s trip will be considered business related in this case. With the extra stop in New Hampshire, Marc ends up driving 1,000 miles total for the trip, and has an extra night at a hotel for $100. He can’t deduct the $100 for the hotel and he can’t deduct the extra 200 miles he drove to go to New Hampshire. But he still gets to deduct the 800 miles it would have taken to go to and from Boston, and he has essentially reduced the cost of visiting his friend.
When Marc drives to downtown Baltimore to meet a customer, he is not considered to be traveling away from his tax home. In this case the expenses he incurs are transportation costs, and are subject to different rules for deductibility. If Marc takes a bus or a taxi, the treatment is straight-forward. He is allowed to deduct the cost of the bus or taxi fare. However, it’s more likely business owners will be using a car to drive from one place to another, in which case the treatment becomes slightly more complicated.
A taxpayer using a car can deduct the expenses by using either the standard mileage rate method or the actual expenses method. The standard mileage rate method is the simplest in terms of record-keeping, as it only requires you to take the number of business miles driven multiplied by a certain rate, which usually fluctuates around 55 cents. There are however certain conditions that prevent you from using this method, such as using five or more cars in your business at the same time. This method may also not be advantageous when comparing the deduction to the other method. If you use the actual expenses method, you must keep track of all costs associated with operating the car, such as depreciation, registration fees, gas, repairs, etc. The actual expenses are then divided between personal and business use, which is typically determined by tracking mileage. Clearly this method creates more record-keeping, but it can also lead to a larger deduction, so it may be a good idea to calculate or at least estimate your deductions under both methods.
Once you have fully grasped what is deductible and how the expenses are reported, the last issue to be addressed is what many business owners consider to be the biggest hassle – record-keeping. You must be able to substantiate your expenses for travel and transportation. When you fly to a destination and stay in a hotel, you will need your receipts for the hotel and airfare, but you also need records of when you traveled and an explanation of the business purpose for the trip. You also may need a log for when you are driving within your tax home to determine the mileage for business versus the personal use mileage. You can reference Publication 463 – Chapter 6 to see the requirements for record-keeping and a more detailed listing of examples for documentation.