Earlier this year I had to go to Norway for work. My girlfriend wanted to come too, so we combined business with pleasure, staying an extra week to visit Paris and Scotland. Great. But when the trip was over, I realized my finances were a mess. Despite good intentions, I'd mixed personal and business expenses, something I'd vowed never to do.
I'm sure you've done the same thing: made a quick judgment call about the deductibility of an expense, only to end up in a gray area fraught with doubt and the threat of an IRS audit looming over your head. On paper the IRS's Publication 535 lays out its guidelines succinctly, stating that a business expense must be both ordinary and necessary in order to be deducted. But in practice, we all know it's never that simple. In fact, Stephen Fishman's book Deduct It! devotes 500 pages to the subject.
It's my belief that things go wrong with deductions when folks make purchases that might be used for business, but aren't. Costco memberships, office furniture or that slick big-screen TV for the home office are some examples that come to mind. I have a friend who deducts every round of golf he plays, whether he's entertaining clients or not. He rationalizes that those client-free rounds are necessary to maintain his skills for client-related games; therefore, they qualify as write-offs. I have my doubts.
But according to attorney Frederick W. Daily, author of Tax Savvy for Small Business, my friend's wishful thinking isn't completely unfounded. "Money you spend in a reasonable way, with an expectation of bringing business revenue, is a deductible expense," Daily says. It's that expectation of revenue that drives many a business owner to concoct a tenuous link between a personal expense and a tax deduction. Personally, I'd rather bank on certainties, not assumptions, when it comes to the IRS. So come January I'm going to be spending a lot of time and money with my accountant sorting out receipts from my trip to Europe.
IRS Audit Traps
Business debit/credit card used for personal expenses. I know, you tell yourself you'll pay the business back soon. But do you? You should have one card for business and one for yourself at all times, and never misuse them.
Business trips with family or friends. Good in theory--until your colleague accompanies your family to dinner. Now you're in a gray area. Avoid this mashup by carving out separate schedules for company business and personal time, with no overlap.
The home office. I know a guy whose father, a widower, worked from home and kept a file cabinet in every room of the house--including the bathrooms--so he could write off his entire house.
He was never audited. (But he never remarried, either--gee, I wonder why?) Don't be like this guy. Concentrate all your work papers and equipment in one room and keep personal stuff (the TV, game consoles, collectibles) out of it.
Toys or apparel disguised as office equipment. It's tempting for small-business owners to claim new toys as business deductions. But that Xbox isn't a business expense unless you're reviewing games with the intention to make a profit. The $6,000 Hermes laptop bag is also iffy, especially if you're claiming four other fashionable carryalls as well.