By Michael D. Koppel, CPA, PFS, CITP, MBA
Retired Partner at Gray, Gray & Gray
January 2015
The title of this article is taken from the 1943 Broadway musical, Oklahoma. But it may also be applied to a very important tax concept that also originated with a musical great from an earlier decade.
In 1930, songwriter George M. Cohan went to tax court to dispute the denial of deductions for business entertainment and travel expenses. The IRS had denied the deduction because Cohan had kept no records of his spending. The resulting decision has been a benchmark for such cases in which taxpayers who are unable to produce records of actual expenditures may rely on reasonable estimates provided there is some factual basis for it. The decision read, in part, “Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.”
It is important to remember that unless the tax rules require a certain level of documentation a taxpayer is allowed to substantiate the deduction through other methods. But that does not absolve the taxpayer from complying with the rules when there are specific requirements. This was demonstrated very clearly in the 2014 case of David H. Garza v. Commissioner U.S. Tax Court. David Garza claimed business travel expenses in relation to his employment, but was unable to produce detailed, written logs of the expenses with specific business reasons for each expenditure.
The decision in this case demonstrates that certain expenses require very detailed documentation in order to be deducted, even if the court believes they are legitimate deductions. As the court said “Nevertheless, while we believe that petitioner had business travel expenses in relation to his employment, the Court must heed the strict substantiation requirements of section 274(d). See, e.g., DeLima v. Commissioner, at *16 (finding with no doubt that the taxpayer used a vehicle for business purposes, yet having no choice but to deny the vehicle expense deduction because she failed to follow the requirements of section 274(d) and its related regulations).”
This is where “all er nothing” comes into play. You can’t keep a partial record and guess at the rest. Unless you can document in detail all of your business-related expenses (as outlined in the strict substantiation requirements of IRC section 274(d)), the IRS is very likely going to deny all of the deductions.
IRC 274(d) identifies four different classes of expenses:
- 274(d)(1) – traveling expense (including meals and lodging while away from home)
- 274(d)(2) – any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity
- 274(d)(3) – business gifts (still limited to $25)
- 274(d)(4) – any listed property (as defined in section 280F(d)(4))
The last class – Sec. 280F(d)(4) &ndash covers assets that are used by the vast majority of closely held businesses. This includes any passenger car or other vehicle used for transportation, property of a type generally used for purposes of entertainment, recreation or amusement, any computer or peripheral equipment, and any other property of a type specified by the Secretary by regulations.
Please note that certain vehicles that cannot be used for personal use, other than a de minimus amount, are exempted from the substantiation requirements. However, it is important for businesses to discuss vehicles such as trucks, vans and SUVs with a qualified tax professional to determine if they are exempt.
So what qualifies as “substantiation” of business travel and entertainment expenses?
The regulations require “adequate records or by sufficient evidence corroborating the taxpayer’s own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation or use of the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.”
Please don’t get the impression from the above paragraph that “a taxpayer’s own statement” is going to carry much weight. As we have seen in Garza and other cases, the IRS and the courts want to see contemporaneous records with the details listed above before they will allow a deduction.
Other cases leading up to and following the 2014 Garza case have also demonstrated the importance of keeping detailed contemporaneous records for business vehicles that can be used for personal use. While these cases do not create new tax law, they provide the IRS with more than enough ammunition for disallowing all of this type of expense if any deduction is not fully documented.
Taxpayers and their tax advisors need to understand that this documentation is required to take a deduction on a tax return. The courts and the IRS will not allow any deduction without this documentation.
For more information on keeping business records for taxation purposes, or questions about other tax issues, please Contact Gray, Gray & Gray’s Tax Department.
This article was originally published as “Substantiating Expenses: All or Nothing” in the AICPA “Tax Adviser” on December 1, 2014.