Travel and entertainment rules from a practice development point of view.

• Author: Federanich, Charles E.

Deductions for travel and entertainment (T&E) tend to be taken for granted by most clients--until they get audited. Although most of the current rules have been in force for five years or more, many clients do not know (or do not want to know) what they should do to ensure the deductibility of T&E expenses. Therefore, it is both the responsibility of and an opportunity for the CPA to guide clients in this area.

While clients may consider their T&E deductions to be an inalienable right, Congress and the IRS have a somewhat different view. In the committee reports to the Tax Reform Act of 1986, the House of Representatives explained that it was proposing the 20% reduction for meals and entertainment because there is an inherent element of personal living expenses in such deductions. T&E is a favorite IRS target, because ignorance of the rules leads to inadequate documentation, which makes it easy for the Service to disallow otherwise valid deductions. A look at some of the areas of confusion and the basic recordkeeping requirements should be worthwhile.

* Business travel requires an overnight stay away from the taxpayer's "tax home" (generally the taxpayer's regular place of business) and allows deductions for meals and lodging in addition to the cost of the transportation. For the costs to be deductible at all, the trip must be primarily for business, which is a facts and circumstances test based in part on the amount of time spent on business versus the time spent on personal activities. A spouse's travel costs will be personal unless there is a bona fide business reason for the spouse to go along. Since any personal travel paid by a business must be reported as compensation to the employee, it will benefit both employee and employer to provide documentation that supports the highest business-related amount possible.

* Business meals and entertainment have to meet one of two basic tests to be deductible. They must be either "directly related to" the active conduct of the taxpayer's trade or business, or they can be "associated with" the active conduct of the business. "Directly related" is a tougher test to meet and requires (among other things) that the taxpayer usually transact or discuss business during the entertainment and expect to derive some business benefit beyond just goodwill. "Associated with" means the entertainment should immediately precede or follow a "substantial and bona fide" business discussion; business does not have to...