- Discover tax recordkeeping tips.
- Find out how to keep records through receipts.
- Discover the two methods for deducting business use of a vehicle.
- Learn more about gift deductions.
- Find out how to properly report business equipment.
- Learn how to define “ordinary” and “necessary” in terms of expenses.
- Discover tips for recording meals & lodging.
- Learn how to document entertainment expenses.
- Learn the two methods for claiming home office deductions.
With the ever-increasing complexity of our tax system, it is commonplace for many small businesses to make mistakes with bookkeeping and filing. Want to avoid making errors in your recordkeeping? Then, you need to know the most commonly encountered pitfalls. Here are Fiducial’s tips to help keep the proper records.
Recordkeeping through receipts
Even though the IRS does not require receipts for business meal expenses of less than $75, it is nevertheless wise to hang onto them. There is no better documentation than a credit card receipt since it has all the expense information required. All you need to do is write on the slip the purpose of the event, the individual(s) you were with, and your business relationship with that person or people.
Generally, small businesses use either the actual expense method or the optional mileage method of deducting the business use of a vehicle. Both must account for any personal use of the vehicle, including commuting. When using the actual expenses method, you can determine the deducible business portion of the expenses by multiplying the total expenses by the percentage of business use. You can find this by dividing the business miles driven by the total miles driven. When using the optional mileage method, you must multiply the business miles by the IRS published standard mileage rate. This rate is 56 cents per mile for 2021 (down from 57.5 cents per mile for 2020). So, regardless of the method used, make sure you keep track of the total and business use miles for the year since this is required recordkeeping for either option.
Do not overspend on gifts to clients and business associates. The IRS will allow a deduction of only up to $25 worth of gifts to any individual per year. Being too generous will cost you. With only that first $25 per recipient considered a deductible business expense, the rest will be nondeductible. For deductible gifts, be sure to keep a copy of the purchase receipt and note on it the business purpose for making the gift or the benefit you expect to receive. Also include the name of the person to whom you gave the gift, his/her occupation or title, or some other designation that will establish your business relationship to the individual.
Business equipment recordkeeping
Since the IRS considers equipment a capital expenditure, it has to be depreciated. That is why lumping equipment together with supplies is not a good idea. This is true even when you elect to expense equipment purchases under Sec. 179 or claim bonus depreciation. If you do not report the purchases properly, the IRS could rule that the expense was improperly characterized. If that is the case, you would not be entitled to the deduction claimed on your return. There could be other repercussions, leaving you with no current deduction at all.
Ordinary and necessary expenses
To be deductible, an expense must be ordinary and necessary. An expense is “ordinary” if it is customary and conventional for the taxpayer’s line of business. A “necessary” expense is helpful in the taxpayer’s business; but it need not be indispensable.
Meals and lodging
When traveling for business, lodging is 100% deductible. However, the away-from-home meals deduction limits the deduction to 50% of the cost. So, if you charge meals to a hotel room, you must account for them separately. We advise you to keep a copy of the statement from the hotel that shows the charges, as well as a credit card receipt or other payment receipt.
Entertainment at Sports Events and Theaters
Entertaining customers at sporting events and theaters is commonplace. But, as a result of the Tax Cuts & Jobs Act, which became effective in 2018, a tax deduction is no longer allowed for entertainment expenses. The Act did retain a deduction for business meals, however, that is directly related to or associated with the active conduct of your business.
The term “directly related” means that actual business discussions were conducted during the meal and you anticipated a specific business benefit from the meal. The term “associated with” is more liberal and includes meals either preceding or following a bona fide business discussion. In either case, the business deduction continues to be 50%* of the actual expense. Also remember that business meals must be documented. Documentation includes the amount, business purpose, date, time, place and names of the guests as well as their business relationship with you. * However, for 2021 and 2022, the cost of food and beverages provided by a restaurant as a business meal is fully deductible.
Recordkeeping for home office deductions
There are two methods for deducting the business use of a home. One is the conventional method of prorating the expenses (with some limitations) of the home. You do this by multiplying the allowable expenses times the business use square footage divided by the total square footage of the home. The other method, referred to as the simplified method, allows a $5 per square foot deduction (maximum 300 square feet) without having to keep records of expenses. Both methods have the same eligibility requirements; the second decreases your need for recordkeeping.
Every business is unique, so if you need assistance in setting up your recordkeeping system or need further clarification on any of the topics discussed, call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.
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