Business deduction documentary evidence – IRS Publication 463
Many people are under the impression that a credit card statement and/or a bank statement showing purchases made by credit or debit card would qualify as allowed evidence to support the viability of a deduction. However, this is not the case. You would be required to show the receipt for each item deducted on your tax return if your return is selected for audit.
Under the tax law change of 2018, entertainment expenses are no longer deductible. Business meals and travel are still allowed if you have adequate documentation. In order to deduct travel and meal expenses you need to document the following items:
- Name and location of the hotel or restaurant.
- Dates of stay at hotel or meal at restaurant and amount paid for meals separated from lodging.
- Number of people served at restaurant.
- Business purposes described for the meal and/or travel.
Substantiation for business auto deductions – IRS Publication 463
Taxpayers have two options for deducting automobile expenses. You can deduct either the actual costs of operating your vehicle or you can take the standard mileage deduction. If you choose the standard mileage deduction method in year one, you must continue using that method throughout the life of that vehicle. Regardless of the deduction method you choose to employ, you are required to maintain a mileage log for each year of claimed business usage. If you elect to deduct the actual costs of the vehicle usage, you would also be required to produce receipts showing proof of deducted costs for fuel, insurance, tires, repairs, etc. The following items are required to be included in your mileage log:
- The beginning odometer reading for the year (or the first date the vehicle is used for business purposes).
- The date of the travel (you must document all miles driven if using the actual expense method but you are only required to document the business miles driven if using the standard mileage rate method).
- The destination of your travel.
- The number of miles driven to arrive at your destination.
- The business purpose of your travel for any miles you are claiming as a deduction.
Your mileage log can be a calendar, a notebook, or some other type of log book (office supply stores carry them).
If your return is ever selected for audit, the IRS and the Department of Revenue would require that you provide your auto mileage log records to substantiate the auto deduction that is taken on your return. Without the log, all auto related expenses will be disallowed.
Hobby Loss Versus For Profit Business or Farm
Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule”. In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business for profit.
An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year. If an activity is not for profit, losses from that activity may not be used to offset other income and if so determined, the IRS could change prior years’ returns disallowing prior losses.
The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you have the knowledge needed to carry on with the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
New Business Formation Items to Consider
- You need to determine what type of taxing entity the business should elect along with the legal entity choice. The available options are sole proprietor (LLC or no LLC) for tax purposes, partnership (as an LLC or no LLC), C Corporation or S Corporation. We recommend you talk with your accountant and attorney to determine the best choice for you.
- Will you have employees? If so, additional requirements will exist.
- If it is a Washington based business it will need to be registered with the State of WA for excise filing purposes (and payroll if you have employees). If an Oregon based business, you will need to register with the Oregon Department of Revenue.
- Most counties in the State of WA and Oregon have a personal property tax that is levied on assets used for business purposes. Is the business registered with the County?
- Some cities require you to have a business license to perform business inside their city limits so you should make sure you are in compliance.
- Do you have a separate bank account set up for business use? You should do this.
- What system do you use for invoicing?
- From a standpoint of bookkeeping software, we generally recommend considering QuickBooks. It is fairly user friendly and will track all activity of the business.
- If you don’t feel confident of you bookkeeping skills, we encourage you to find a local bookkeeper to help with your week to week or month to month needs.
Existing Business Items to Consider
If you are a corporation (either C or S) you are required to have annual business meetings and keep a written record of the minutes of these meetings. At a minimum you should be outlining who the officers are for the year. Any other significant items that are planned for the year from a business standpoint should be documented in the minutes. If you are ever audited, you would be required to produce your corporate minutes.
You are required to file annual renewal of your business registration with the Secretary of State (applies to both Oregon and Washington) if you are registered as an LLC, C Corporation or S Corporation.