Acuity Advisors

Can you deduct business travel when it’s combined with a vacation?

At this time of year, a summer vacation is on many people’s minds. If you travel for business, combining a business trip with a vacation to offset some of the cost with a tax deduction can sound appealing. But tread carefully, or you might not be eligible for the deduction you’re expecting.

General rules

Business travel expenses are potentially deductible if the travel is within the United States and the expenses are “ordinary and necessary” and directly related to the business. (Foreign travel expenses may also be deductible, but stricter rules apply than are discussed here.)

Currently, business owners and the self-employed are potentially eligible to deduct business travel expenses. Under the Tax Cuts and Jobs Act, employees can no longer deduct such expenses. The potential deductions discussed below assume that you’re a business owner or self-employed.

Business vs. pleasure

Transportation costs to and from the location of your business activity may be 100% deductible if the primary reason for the trip is business rather than pleasure. But if vacation is the primary reason for your travel, generally none of those costs are deductible.

The number of days spent on business vs. pleasure is the key factor in determining whether the primary reason for domestic travel is business:

Your travel days count as business days, as do weekends and holidays — if they fall between days devoted to business and it would be impractical to return home.
Standby days (days when your physical presence is required) also count as business days, even if you aren’t called upon to work those days.
Any other day principally devoted to business activities during normal business hours also counts as a business day.

You should be able to claim business was the primary reason for a domestic trip if business days exceed personal days.

Deductible expenses

What transportation costs can you deduct? Travel to and from your departure airport, airfare, baggage fees, tips, cabs, etc. Costs for rail travel or driving your personal car are also eligible.

Once at the destination, your out-of-pocket expenses for business days are fully deductible. Examples of these expenses include lodging, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days aren’t deductible.

Keep in mind that only expenses for yourself are deductible. You can’t deduct expenses for family members traveling with you — unless they’re employees of your business and traveling for a bona fide business purpose.

Substantiation is critical

Be sure to accumulate proof of the business nature of your trip and keep it with your tax records. For example, if your trip is made to attend client meetings, log everything on your daily planner and copy the pages for your tax file. If you attend a convention or seminar, keep the program and take notes to show you attended the sessions. You also must properly substantiate all of the expenses you’re deducting.

Additional rules and limits apply to the travel expense deduction. Please contact us if you have questions.

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IRS Audit Techniques Guides provide clues to what may come up if your business is audited

IRS examiners use Audit Techniques Guides (ATGs) to prepare for audits — and so can small business owners. Many ATGs target specific industries, such as construction. Others address issues that frequently arise in audits, such as executive compensation and fringe benefits. These publications can provide valuable insights into issues that might surface if your business is audited.

What do ATGs cover?

The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:

The nature of the industry or issue,
Accounting methods commonly used in an industry,
Relevant audit examination techniques,
Common and industry-specific compliance issues,
Business practices,
Industry terminology, and
Sample interview questions.

By using a specific ATG, an examiner may, for example, be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides.

What do ATGs advise?

ATGs cover the types of documentation IRS examiners should request from taxpayers and what relevant information might be uncovered during a tour of the business premises. These guides are intended in part to help examiners identify potential sources of income that could otherwise slip through the cracks.

Other issues that ATGs might instruct examiners to inquire about include:

Internal controls (or lack of controls),
The sources of funds used to start the business,
A list of suppliers and vendors,
The availability of business records,
Names of individual(s) responsible for maintaining business records,
Nature of business operations (for example, hours and days open),
Names and responsibilities of employees,
Names of individual(s) with control over inventory, and
Personal expenses paid with business funds.

For example, one ATG focuses specifically on cash-intensive businesses, such as auto repair shops, check-cashing operations, gas stations, liquor stores, restaurants and bars, and salons. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.

Cash-intensive businesses may be tempted to underreport their cash receipts, but franchised operations may have internal controls in place to deter such “skimming.” For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.

Likewise, for gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.

Avoiding red flags

Although ATGs were created to enhance IRS examiner proficiency, they also can help small businesses ensure they aren’t engaging in practices that could raise red flags with the IRS. To access the complete list of ATGs, visit the IRS website. And for more information on the IRS red flags that may be relevant to your business, contact us.

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How to set up an accountable plan.

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Profits: How low can you go?

If your profits are falling compared to revenue and assets, your financial statements may provide insight into what’s happening and how to improve your performance.

Watch for red flags

As you sell more and invest in additional assets, profits should, in theory, increase by a proportionate amount. However, that’s not always the case. Ratios to watch for a decline include:

Gross profit [(revenue – cost of sales) / revenue],
Net profit margin (net income / revenue), and
Return on assets (earnings before tax / total assets).

For all three profitability ratios, look at two key elements: changes between accounting periods and differences from industry averages.

Identify possible causes

If these ratios are declining, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of an external trend. If the industry is healthy, yet a company’s margins are falling, perhaps management has lost its control of costs — or maybe vendor or receivables fraud is to blame. To find the root cause, it’s often helpful to study the main components of the income statement.

Revenue. If the top line (gross sales or revenue) has declined, your overall profit margin will fall because there is less revenue to spread fixed costs over. To determine if this trend is company-specific or industrywide, look at revenue trends of public companies in the same industry. Also, monitor trade publications, trade associations and relevant online sources for information.

Cost of goods sold. This category of expenses is a function of raw materials, labor and overhead elements. Direct materials and labor should be controllable and historically represent a consistent percentage of revenue.

Overhead is mostly fixed and shouldn’t significantly increase unless the company has made changes (for example, purchased new equipment, changed its depreciation policy, or relocated its production facility). Examine those elements to determine whether overhead is increasing or decreasing and how the ebb and flow applies to the gross margin, which is simply revenue minus cost of goods sold.

Selling and administrative costs. Check whether selling and administrative cost items increased significantly. This section of the income statement can also be revealing if you’re trying to determine whether a profit margin decline arose from deteriorating industry conditions or weak management.

Find clues in your financials

Need help solving the mystery of your disappearing profits? Our auditors can use your financial statements to help compute financial statement ratios, identify problem areas and find solutions to get your performance back on track.

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A review of significant TCJA provisions affecting small businesses

Now that small businesses and their owners have filed their 2017 income tax returns (or filed for an extension), it’s a good time to review some of the provisions of the Tax Cuts and Jobs Act (TCJA) that may significantly impact their taxes for 2018 and beyond. Generally, the changes apply to tax years beginning after December 31, 2017, and are permanent, unless otherwise noted.

Corporate taxation

Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
Replacement of the flat personal service corporation (PSC) rate of 35% with a flat rate of 21%
Repeal of the 20% corporate alternative minimum tax (AMT)

Pass-through taxation

Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37% — through 2025
New 20% qualified business income deduction for owners — through 2025
Changes to many other tax breaks for individuals — generally through 2025

New or expanded tax breaks

Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023
Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million (these amounts will be indexed for inflation after 2018)
New tax credit for employer-paid family and medical leave — through 2019

Reduced or eliminated tax breaks

New disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
New limits on net operating loss (NOL) deductions
Elimination of the Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction — effective for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers
New rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
New limitations on excessive employee compensation
New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

Don’t wait to start 2018 tax planning

This is only a sampling of some of the most significant TCJA changes that will affect small businesses and their owners beginning this year, and additional rules and limits apply. The combined impact of these changes should inform which tax strategies you and your business implement in 2018, such as how to time income and expenses to your tax advantage. The sooner you begin the tax planning process, the more tax-saving opportunities will be open to you. So don’t wait to start; contact us today.

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