Taking Tax Deductions on Red Flag Items


Tax deductions aren’t just a fun perk of being a business owner, they’re important for helping your business to make the most of its income. In order to score the maximum refund, it’s necessary to identify and submit all possible deductions. This means that you can’t shy away from deductions that may be considered red flags by the IRS, like meals and entertainment (M&E).

“Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business,” according to Joy Taylor from Kiplinger. “Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation rules.”

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While the IRS may heavily scrutinize deductions for meals and entertainment, especially at certain income levels, that doesn’t mean that taking them results in an automatic audit. As long as you’re careful about how you file your deductions, there’s no reason to avoid taking all of the deductions you’re owed.

The goal of the IRS is to make sure that businesses aren’t claiming personal costs as business expenses. This is why it’s important to maintain very clear documentation and make sure you know all the rules about the deductions you wish to take. Working with a tax professional makes this much more feasible for a business owner who has many more types of taxes to deal with than an individual.

“First of all, with only a few exceptions, you are limited to deducting 50 percent of your M&E expenses. No doubt, this is another indication of the IRS’s ingrained skepticism,” states Tom Taulli, contributor to Entrepreneur.com.

Deducting meals is not very complicated. To start with, your meals must have a business purpose, such as a business discussion to them. It’s not necessary, however, that you write up a contract or strike a business deal during the meal. If you are on an overnight business trip, you may also deduct meals where you ate by yourself.

Deducting entertainment is more complicated because you must discuss business prior to or after the entertainment. This is due to the fact that the IRS doesn’t think it’s likely that significant business will be discussed during entertainment activities.

“To deal with this, you will need to have the discussion during the same day for the entertainment. There is an exception if the person you are meeting with is from out-of-town,” states Taulli.

tax-2There are some details to keep in mind when deducting entertainment in order to help your deductions look legitimate to the IRS. For one thing, if you’re deducting entertainment that occurs at your home, you should stick with less than 12 guests to be on the safe side.

Taulli notes that “if the entertainment is for your birthday or some other type of social event, then expect the IRS to get antsy. The agency will likely deem this to be personal and not deductible.”

The most important thing to keep in mind when you’re taking a deduction for a meal or entertainment is to keep diligent records and save all receipts, even if it is not required by the IRS to save the receipt. 

Joy Taylor notes that, “You must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.”

In your records, be sure to include the reason for the expense and the nature of the meal or entertainment. This includes where you went, the type of entertainment and the nature of the discussion you had. Also keep track of the people involved, the location, time and date and the cost.

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