How To Prove Certain Business Expenses

When discussing business expenses I often get asked "Do I have to keep my receipts or can I just use my credit card bill?" IRS Publication 463 addresses the substantiation and record keeping requirements for business expenses. IRS says you must have documentary evidence to prove a business expense. However there are some exceptions to the documentary evidence requirement.

The following is from Pub 463.
Documentary evidence. You generally must have documentary evidence, such as receipts,
canceled checks, or bills, to support your expenses.

Exception. Documentary evidence is not needed if any of the following conditions apply.

• You have meals or lodging expenses while traveling away from home for which
  you account to your employer under an accountable plan, and you use a
  per diem allowance method that includes meals and/or lodging.
  (Accountable plans and per diem allowances are discussed in chapter 6.)
  
  



• Your expense, other than lodging, is less than $75.
  
  



• You have a transportation expense for which a receipt is not readily available.
  
  

For most people the $75 rule is really useful. However, even if you are not required to provide documentary evidence you still have to prove the expense by providing information about the amount, time, place and business purpose of the expense. IRS provides a table available here that to be honest is more confusing than helpful.

For expenses under $75 a businesses general ledger or an individual's financial records (Quicken, MS Money, or paper ledgers) will generally suffice as long as they provide amount, time, place and purpose descriptions. If the expense is over $75 you need documentation. IRS also has something to say about what constitutes adequate documentation. For example a charge card receipt is not adequate for a restaurant bill because it does not show the number of people served. You can read some other examples contained in the publication.

The best solution is to setup a record keeping system that automatically tracks everything IRS needs. Here's the suggestion we give to clients.

1. Get a seperate debit or charge card for business expenses and use it religiously.



2. Keep all receipts and record a quick note on the face of the receipt that includes who was with you and what was discussed (John Smith and Joey, 2006 tax planning).



3. When you get back to the office put all receipts in an envelope.



4. Once per month reconcile your credit card bill to your financial records, refer to the month's receipts as needed to record your expenses, then seal the receipts in the envelope and staple it to the month's credit card statement. The whole package goes into the credit card vendor file and will be archived at the end of the year with the rest of your financial records.



5. Try to minimize the expenses you pay with petty cash.



6. DON'T WAIT UNTIL YEAR END. We've compared clients who reconcile expenses once per year with those who reconcile monthly and on average clients who reconcile monthly are able to claim TWICE the amount of business deductions as those who procrastinate.

If you need help setting up a system now is the time ask for it. Give us a call if you don't know where to start.

Axiom Professional Group is a public accounting and consulting firm started by Joey Brannon, CPA. For more information you can view the Axiom Professional Group, P.A. home page   or visit the Axiom web site articles page (both links will exit the blog site).

New Hire Reporting Requirements

The following article was originally printed in the March issue
of Axiom's newsletter. To view the newsletter in its original format
visit the Axiom web site.

In the last month we have had several clients
express surprise regarding the new hire reporting
law in Florida. This has nothing to do with taxes or
accounting but it affects small business so we are
often asked for clarification or direction when
clients have questions.

Since 1996 every employer in Florida has been
required to report new hires to the state. This
information is used to track down dead beat parents
who are not paying their court mandated child
support payments. It is possible that if one of your
employees is in this situation you will be contacted
by the Department of Children and Families to
initiate garnishment of the employee's wages for
child support.

While reporting is mandatory it is not enforced very
well and the New Hire Reporting Center’s efforts are
not publicized or coordinated with other agencies
that have more teeth (Florida Department of Revenue
for instance). This isn’t necessarily bad because it
allows the Center to take a more collaborative role
with businesses and encourage them to ‘do the right
thing’ for kids who may be dependent on a child
support check that never comes.

Employers are required to report new hires within 20
days of hire. The information that must be included
is the employers name, address and FEIN and the
employee’s name, address, social security number and
date of hire. This information can be filed
electronically through the Center’s web site or it can be
filed in paper with the office in Tallahassee.

If you are not in compliance with the new hire
reporting law you should report any employees hired
within the last 180 days and then continue to report
new hires within the 20 day deadline. The Center’s
web site mentioned above provides a lot of helpful
information including frequently asked questions
that cover most of the situations we have run into
with clients.
       

Deducting Vehicle Expenses

The following article was originally printed in the March issue
of Axiom's newsletter. To view the newsletter in its original format
visit the Axiom web site.

Last month I talked a little about the difference
between leasing and buying business vehicles.
This month I’ll cover the two options IRS gives you
to take tax deductions on business vehicles and what
happens when you or your employees use personal
vehicles for business use.

As it turns out buying or leasing is not the only
decision you need to make. You also need to decide
whether to deduct the actual expenses or take a
deduction based on a mileage rate provide by IRS.
For instance, if you choose to use the actual
expenses method you will get tax deductions for
depreciation, fuel, registration fees, maintenance,
tolls, insurance, parking fees, garage rent, tires,
etc. If you choose the standard mileage rate you
will get a deduction equal to the number of business
miles driven times 44.5 cents per mile (the rate for
2006).

It is easy enough to sit down with your CPA and run
the numbers to estimate which method will provide
the greatest deduction. When doing this it is
important to consider deductions over the total life
of the vehicle, not just the first year. For
instance, a section 179 election (writing off a
large portion of the vehicle’s cost in the first
year) might be very attractive but it also
eliminates the possibility of taking future
deductions based on the mileage rate. As another
example, it is possible to write off many times the
original cost of the vehicle by using the standard
mileage rate in high mileage situations.

Another consideration is the administrative work
involved with tracking your deductions. To most
people the standard rate seems much simpler,
provided they keep track of their business and
personal mileage. If you use this method you will
not be able to deduct any actual expenses such as
fuel, maintenance, registration, insurance, etc.
This means you will need to record these expenses in
such a way that they are easily identifiable. Your
CPA will have to strip these expenses out and report
them as non-deductible on your tax return.

All of the above is directed toward businesses that
own vehicles within the business entity. The same
rules apply if you use your personal vehicle for
work and are not reimbursed by your employer. The
one downside is that your expenses will be reported
as unreimbursed employee business expenses on Form
2106 and will be subject to a 2.7% AGI floor. In
layman’s terms this means the expenses will get
lumped into a class of deductions that do you no
good until they exceed 2.7% of your adjusted gross
income.

If your employer does reimburse you
then you will need to determine if it is under an
accountable plan or a
non-accountable plan. Accountable plans require
employees to submit substantiation of expenses and
return to the employer any advance in excess of the
expenses incurred.  Under an accountable plan the
employee does not have to recognize the
reimbursement as income (and therefore does not
have
to pay any tax on the amount).

Non-accountable plans are those that either do not
require the employee to substantiate the expenses or
do not require the employee to return any excess.
Under these plans the entire amount of the payment
to the employee is included in wages and the
employee must pay tax on the amount. Employees
then
file Form 2106 to claim a deduction for their
expenses and must substantiate them with adequate
records as outlined by IRS. Under these plans
employees are subject to the aforementioned AGI
limit of 2.7%.

Developing a vehicle use strategy is important to
both you and your employees. It is another one of
those areas in which a little planning can not only
simplify your life but also yield more favorable tax
deductions.
       

Lessons from Subway Founder Fred DeLuca

The following article was originally printed in the March issue
of Axiom's newsletter. To view the newsletter in its original format
visit the Axiom web site.

        Fred DeLuca is one of the two founders of Subway,
the international sandwich chain that has seen
phenomenal growth in the last two decades. This
easy to read book chronicles some of the company's
startup activities and is filled with anecdotes and
case studies of other famous and not so well known
entrepreneurs.

There are two audiences that I think can get a lot
from this book. The first is people considering
opening their own business. There is a tendency to
think businesses require tens or hundreds of
thousands of dollars in
financing and thick business plans to get
started. This book should put those misconceptions
to rest if you have them.

I don't want to give the wrong impression. One of
the biggest mistakes we see is undercapitalized
businesses, and DeLuca himself devotes a whole
chapter
to the maxim "Never Run Out of Money." Still, there's
more to a successful business than financing and,
you'll have to understand that before you start out
on your own.

The second group that should read this book is
business owners envious of competitors who
somehow, someway manage to be
more successful with less financing, smaller product
lines, inferior locations, etc. If you find yourself
asking "how
did they do that?" then this book will get you back to
the basic ingredients of success that are often
forgotten after expansion, relocation or a period of
fast growth.

DeLuca outlines 15 lessons he thinks are essential to
small business success. They are...

1. Earn a Few Pennies


2. Begin with an Idea


3. Think Like a Visionary


4. Keep the Faith


5. Ready, Fire, Aim!


6. Profit or Perish


7. Be Positive


8. Continuously Improve Your Business


9. Believe in Your People


10. Never Run out of Money


11. Attract New Customers Every Day


12. Be Persistent


13. Build a Brand Name


14. Opportunity Waits for No One


15. Take the First Bold Step

I have given this book to a few people that are
starting or are thinking about starting their own
business. I read it before I struck out on my own and
it helped give me some peace of mind that I was
thinking about the right things. There is something
about DeLuca's story telling style that proves both
instructive and inspirational.

Interestingly DeLuca's personality and
the story of Subway are not exactly the best
examples of sound business planning. The fifth rule in
particular seems to apply to DeLuca and those who
usually leap before they look probably won't stop
long
enough to read his book. In that sense there may be
some disconnect between DeLuca's personality and
that of his audience.

However, the book provides a great alternative
framework
for developing a business plan
that I've used with a few people who don't relate
well to
the traditional analytical business planning approach.
In that sense DeLuca's 15 lessons provide a great
outline for turning someone's passion into a viable
business that both customers and bankers can relate
to.
       

Choose Your Measures Wisely

The following article was originally printed in the March issue of Axiom's newsletter. To view the newsletter in its original format visit the Axiom web site.

We talk about goals with every new client, but just as important we talk about what kinds of measures we will use to mark our progress toward achieving those goals. Often the same goal will result in entirely different measures for two different clients. Let me give you an example.

I recently met with two new clients on the same day who each expressed their long term goal as financial independence. However, one of them was willing to put everything else in life aside for a period of 24 months in order to jump start a new business. If successful the business will sell for enough money to provide a modest retirement at age 40. Once that is accomplished my client will have the freedom to go back to school and train for an entirely different career in which she has always had an interest.

The other client is purchasing a series of business investments that will yield supplemental income and provide modest capital gains. This client will continue a successful professional career while trying to diversify his earnings stream to the point where his financial future will not entirely depend on selling his professional practice.

In the first case all of our efforts will be focused on achieving a maximum valuation of the business for eventual sale. In the second case our due diligence in vetting potential investment opportunities will focus on not jeopardizing the current professional practice and guaranteeing at least a minimal amount of income yield. The metrics we will use to measure success in each case are vastly different.

Like so much of what we do this seems like common sense, but over and over again we hear clients taken aback by our approach. The bottom line is that focusing on profitability, or free cash flow, or net assets or any other measure can be misguided depending on what the client wants to accomplish. A focus on short term profitability could erode the liquidity and eventual sales price of a business looking for an exit strategy. A focus on capital appreciation could result in a short term cash crunch that puts pressure on an existing professional career.

So the point is this: when you talk about goals with your CPA make sure you also talk about how you will measure your progress toward achieving those goals. The measures you choose will direct daily decisions and your ultimate success depends on what you do today.

View the Axiom Professional Group, P.A. home page   or visit the Axiom web site articles page (both links will exit the blog site).