Tax deductions frequently overlooked by small business

By Todd Tyler, CPA, San Diego, California

Small-business accounting software has revolutionized bookkeeping for small businesses. It integrates all the income and expense entries into easy-to-use financial statements, registers and reports. But the results it produces are only as good as the entries that are made, and often small businesses miss out on important tax deductions by failing to categorize information correctly or not realizing the extent to which deductions can be taken. In my practice, while reviewing the financials of new clients, I’ve noticed several mistakes that occur repeatedly but, if corrected, can produce valuable tax savings.

Deducting meals and entertainment

The most pervasive misperceptions center on limits related to deductions for meals and entertainment. When hosting a customer or client, you are limited to a deduction of just 50 percent of these expenses. For meals, parties and many other situations for your employees, however, you may be able to deduct 100 percent of the expenses.

For example, when you provide meals to your employees on your work premises for your convenience, they’re fully deductible. The 100 percent deduction also applies to the less formal times you bought pizza during a late-night project to keep your employees productive and, under certain conditions, to your holiday parties and company picnics. If you take most of your employees to lunch for a celebration and you talk about work, the meal expense is 100-percent deductible. But if you take a client to lunch, you can only deduct half the cost. Moreover, if you have two holiday parties — one for highly compensated managers and the other for rank and file — the part for the managers is 50 percent deductible, while the one for other employees is fully deductible. Likewise, a dinner cruise is not limited to 50 percent, nor are company events ranging from a weekend of paintball to retreats for bonding exercises.

You can buy a ticket package to a sporting event and deduct all of your expenses associated with it if all the net proceeds benefit a tax-exempt organization and if substantially all the work carried out at the event is handled by volunteers. A special provision allows for full reimbursement for food and beverages provided to employees on certain types of vessels, as well as on oil and gas platforms and in their supporting camps.

I recommend to clients that, in their chart of accounts, they maintain a category for “meals and entertainment” expense and another one for “employee benefits” expenses so that these expenditures can be called out and assigned the correct deductibles.

Deducting gifts and awards

Another frequently misunderstood tax provision deals with the deductibility of gifts. You are permitted to give, to any one person, gifts with a total value of up to $25 each year. The way you prepare and deliver the gift, however, may enable you to deduct the cost of a far more expensive item without the $25 limitation. If you give the present to a company or a particular department — rather than to an individual — the dollar limits do not apply. So if you want to offer a gift to a representative in the purchasing department of a client company, you would be limited to the $25 deduction if you handed it to him or her as a personal present, but you could deduct the full amount of any gift if you addressed it to the department or the company as a whole when you handed it to the individual.

Likewise, you are free to deduct completely any gifts to individuals or companies that could be perceived as marketing materials. These could range from clothing with your company’s name on it to an expensive crystal set embossed with your company logo. Some business people have tried to stretch this provision by simply temporarily attaching their business card to a gift, but that likely exceeds the bounds of the regulations. If you give gifts for customer referrals, they are subject to the $25 limit unless you have a written agreement with the recipient. In that instance, the gift becomes taxable income to the recipient but enables you to take a full deduction for the business.

Awards given to an individual employee for length of service or safety achievements have no limit on their deductibility up to a value of $1,600 a year and do not need to be included in the employee’s taxable income. A length-of-service award is eligible for deductibility only if it is not received during the employee’s first five years of service or if the employee has received the same award during the previous four years or the current year. Managers and administrative staff are not eligible for fully deductible safety achievement awards.

Deducting reimbursed employee miles

Another area where confusion often exists is in the reimbursement of employee miles. Many small businesses have an employee run errands in his or her vehicle with no reimbursement or for a flat compensation (five dollars for gas, for example). Employees who use their own cars for business purposes should submit their miles for reimbursement at the current Internal Revenue Service (IRS) standard rate. They are deductible to the business owner. Small-business operators should remember that mileage for trips they make to the bank or to their post office boxes can be reimbursed as well. Travel from home to work and back is considered commuting and is not reimbursable under IRS regulations, but if you make trips from your office to a customer location and back during the work day, those miles are subject to reimbursement. I recommend that owners and employees keep a mileage log in their car and record the odometer readings for the start and end of each business-related trip. Short of a log, the IRS has accepted an appointment book (PDA, computerized calendar, etc.) as the basis on which to create the individual’s mileage records.

As final advice, it’s important to ensure you are recording all your tax-deductible charges appropriately. For example, computers can be depreciated and need to be listed on a separate IRS form when taxes are filed. Some bookkeepers simply lump computers in with office supplies. If you spend $2,000 on supplies and $1,200 of that amount is for a computer, list “$1,200 for computer” in the memo field so your accountant can pinpoint it as a depreciable item.

Another way to help avoid errors when recording expenses is to use the software’s memory option that automatically displays the amount of a recurring expense when the name of the vendor is entered. Charges such as rent, digital subscriber line service and newspaper subscriptions tend to be the same every month; and for these kinds of expenses, your software can enter the correct amount for you automatically.

Finally, as the business owner, be sure to examine the income statement before you submit it to your certified public accountant (CPA) to see if anything looks out of place. Ensure that you haven’t recorded a depreciable item under meals, for example. Work with your CPA to be certain that you are obtaining the full scope of deductions that you deserve.

About the author

Todd Tyler, a certified public accountant and certified financial planner, graduated from San Diego State University with a bachelor of science degree in finance and later returned to attain a certificate in personal financial planning. His experience includes working at the large international CPA firm Ernst & Young in tax compliance in addition to small regional accounting & financial planning firms. Todd preferred the difference he could make with smaller companies and tailored his practice accordingly.

Company Info: Todd Tyler, CPA, CFP, began in private practice in 2000 to providing accounting, tax preparation and planning, and financial planning to businesses and individuals. His goals for business owners are to organize and streamline the financial side and minimize taxes. He works on a specific need or comprehensively with business owners to implement accounting systems, assess internal control, and reduce tax liabilities both for the business and for the owners personally. Todd has appeared on local TV news programs and is frequently called upon by other accounting and tax professionals for advice. Todd continues as a sole practitioner with some assistance during the busy tax season.

Note: This information is provided to you by third parties for informational purposes only and shall not constitute tax or legal advice. Microsoft has not checked or verified any of the information provided and makes no representations or warranties as to its accuracy. Each individual’s tax situation is unique and you should check with your accountant or other tax professional for particular advice on your situation.