The US Internal Revenue Service (IRS) allows certain discretionary business expenses to qualify as ‘tax deductions’. Some expenses are incurred to meet and please clients or attract their business, but due to the nature of these expenses, many taxpayers are uncertain whether such an expense, from a tax perspective, is deductible or not.
Unfortunately, due to this reason many clients are caught off-guard when they are questioned about this deduction during the preparation of their year-end income tax return, as they have no documents or records, such as receipts, bills, or any kind of invoice to support their claim for these expenses.
Given the frequency of occurrence of our clients inquiring about whether certain expenses are deductible for tax purposes, in this article, our analysts have summarized some of these discretionary tax deductible expenses claimable by businesses or individuals on their annual income tax return which may have a non-deductible component.
Is it a Deductible Discretionary Business Expense?
Travel Expenses
As per the IRS, tax deductible travel expenses are those which have been incurred during travel away from home for work (business or job) purposes. The expense has to be ordinary and necessary, i.e. common and required to the particular type of business. Additionally, when considering the home, for tax purposes it has to be the tax home; the home where one stays while working for a job or business. The tax home could be different from their family home or personal residence. If you do not have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you regularly live.
Any meal, lodging, or travelling expense, such as: taxi, laundry, fees, and tips qualify as deductible travel expenses during the taxpayer’s stay away from home for work reasons.
To validate the travel expenses deduction, the taxpayer should keep records of all the expenses incurred and any advance or allowance received from their employer. The amounts for each expense should be categorized along with the start and end date of the trip as well as the purpose of the business trip.
Entertainment Expenses
Business-related entertainment expenses are those incurred to please a client, customer, or even an employee. Like travel expenses, these also have to be ordinary and necessary. Expenses incurred at any event qualify for deduction, if along with being ordinary and necessary, they satisfy either the ‘Directly-related test‘, i.e. main purpose of the combined business and entertainment was the active conduct of business, intent to earn income or profit, and proof that business was the subject of the entertainment; or the ‘Associated test’. For this, one must show that the entertainment is associated with the active conduct of trade or business, having a clear business purpose for the expense, either to obtain new business or enhance existing business relations. The expense does not need to fulfill any time limit, but a taxpayer should be able to justify the expense with any benefits obtained through the particular entertainment expense.
However, one is only allowed to deduct the expense incurred on the client or potential client only and not on anybody else such as the client’s spouse who is not part of the business, and in addition, only 50% of the unreimbursed entertainment expense amount spent on the client is deductible.
Gifts to Clients or Business Partners
Giving gifts in the course of business is a common practice to promote business, and therefore many clients feel it should be an allowable tax deduction. Unfortunately, one can only deduct up to $25 for business gifts given to each person directly or indirectly in the course of business during the particular tax year.
In case both the taxpayer and their spouse happen to distribute gifts, only one can claim the deduction, irrelevant of the fact that there are two separate businesses or both of them are separately employed. This rule applies for partnerships as well, all partners are treated as one taxpayer.
Transportation Expenses
Transportation expenses are not the same as the travel expenses mentioned above. In the case of transportation expense, one can deduct expenses incurred on travelling within the city for work purpose, such as: cost of transportation by air, rail, bus, taxi, etc., or the cost of driving and maintaining a car. Again (like all the other business expenses) it has to be ordinary and necessary.
Transportation expenses include those incurred in going from one workplace to another for business or professional reasons, such as: visiting clients or customers, a project location, or temporary office. Please note this does not include the daily commuting expense that is incurred while going from home to a particular office on an everyday basis, such as: a monthly transit pass expense, except when it happens for a short-term or temporary basis.
That being said, these are simply a few of the business-related discretionary expenses that a taxpayer may deduct. Depending on the taxpayer’s business type, many other expenses could qualify as ‘ordinary’ and ‘necessary’ business expense, and thus qualify for deduction.
It is highly recommended that individuals, freelancers, or businesses incurring such expenses consult their tax practitioner and obtain guidance and recommendations based on their tax situation.
AG TAX LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax associates are dedicated to assist you with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
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