During the ordinary course of business, the practice of reimbursing employees for expenses, as well as deducting expenditures related to meals and entertainment, is common. A clear understanding of the rules will improve your ability to defend your expenses should they come into question with the Internal Revenue Service (“IRS”).
What Are the Rules?
Internal Revenue Code (“IRC”) §162 allows expenses to be deducted that are:
- “Ordinary and necessary” in running a trade or business, and
- “Directly related to” or “associated with” the trade or business.
IRC §274 requires recording “at or near the time” of the expense in order to be deemed timely; IRC §274(d) disallows the deduction of expenses that are not properly documented; and IRC §274(n)(1) caps the amount of the deduction to 50 percent of expenses.
What Does the IRS Consider Adequate Records?
Records need to address the following criteria to be acceptable:
- Amount and description of each expense
- Time and location of the entertainment and/or meal
- Business intent and the expected benefit from the business expense
- Description summarizing the topics discussed
- Disclosure of the business relationship to the person or people entertained
Examples of proper documentation include:
- Receipts
- Cancelled checks
- Invoices
Who Maintains the Records?
Depending on the type of arrangement, the burden of recordkeeping will rest on the employee or the employer.
There are two types of arrangements:
Accountable Plans
- Employer expected to keep records
- Contain the following characteristics:
- Business Connection – expenses made on behalf of employer for employer benefit
- Substantiation – follows documentation requirements
- Returning Excess Amounts – employees return per diem not spent on business activities
- Non-accountable Plans
- Any plan not meeting the criteria of an accountable plan
- Employer treats advances or reimbursements as compensation on Form W-2
- Employer withholds portion of the compensation for payroll purposes
- Burden shifts to employee to prove the deductibility and the deduction is subject to the two percent adjusted gross income floor
Proper documentation provides the best defense to substantiating deductions to IRS. Failure to adhere can result in disallowed expense deductions as well as penalty assessments from the IRS. Please contact us for assistance in determining the deductibility of expenses or consultation to improve your recordkeeping policies.
