UNDERSTANDING THE TAX CODE:EARNING MORE FROM YOUR BUSINESS

EXPENSES

Memphis Consulting Group, LLC.

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Agenda1. Why is this Important?

2. Everyday Business Expenses

3. Qualifying Business Expenses

4. Business Entertainment Expenses

5. Employee Expense Reimbursement

6. Insurance Deductions

7. Business Travel and Transportation Expenses

8. Domestic Travel v Foreign Travel

9. The Importance of Adequate Record Keeping

10.Conclusion 2

1. Why is this Important?

■ This session is to help business owners “Start with the end

in mind.”

■ All business owners want to be successful and generate

income from their businesses.

– Business owners also want to build wealth, manage the

wealth, and transfer wealth

– Business owners cannot work forever. They need to plan

for retirement.

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a. What the Big Boys Are Doing?Companies Net Income Tax Rate

CBS $1.8 Billion -13.1%

GE $5.8 Billion 0.9%

Prudential Financial $3.5 Billion -3.0%

Time Warner $4.3 Billion -0.6%

PG&E Corp $1.8 Billion -4.6%

4Source: Center for Tax Justice

In business terms, it is called tax avoidance. These companies are using

perfectly legal means to pay less tax. So why don’t you, the small

business owner?

b. Income

Income is money that an individual

or business receives for providing a

good or service or through investing

capital.

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c. Types of Income

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■ There are four types of income:

– Taxable – Taxable income is wages, salary, commissions, sales,

rents, interest, dividends, and royalties.

– Tax-free – Tax free municipal bonds are the most popularly

thought or example of tax free income. However, fringe benefits

can be even better. With fringe benefits the employer gets a

deduction and the employee has no taxable income upon receipt.

– Tax-deferred – Taxes should always be deferred as long as

possible. Examples of tax deferral strategies include: IRAs,

401(k)s, Health Savings Account, and Deferred Annuities.

– Tax-sheltered – Tax sheltered income is where you escape the

system and never pay the tax. We would all like this, but not

everyone can arrange to deposit income in tax shelters and avoid

probing by the tax authorities.

d. Fringe Benefits■ Certain fringe benefits can provide an unusually tax favored

manner of supplementing the compensation of key

executives.

■ The employer may be able to take a depreciation deduction

and deduct any cost incurred to provide the benefit.

■ Examples of fringe benefits:

– Use of Company Car

– Meals

– Employee Discounts

– Vacation Pay and Sick Pay7

2. Everyday Business Expenses■ What are everyday business expenses?

– An everyday business expense is any expense incurred in the

ordinary course of business. Business expenses are deductible and

are always netted against business income. According to the IRS,

business expenses are the cost of carrying on a trade or business.

These expenses are usually deductible if the business operates to

make a profit.

■ Examples of business expenses:

– Fringe benefits

– Rent

– Utilities

– Advertising

■ Business owners have every right to use these expenses as a deduction

to hold on to more of their business income. 8

a. Commissioner v Soliman

■ Soliman was an anesthesiologist who traveled to three

different hospitals for work, but neither hospital offered

him an office. Soliman had a home office, and he did not

see any patients in his office. However, he conducted a

variety of tasks that were related to his medical practice.

The Commissioner did not allow the deductions for his

home office because he did not believe that the office was

Soliman’s primary place of business.

■ The tax court did not agree with the Commissioner and

ruled in favor of Soliman stating that his home office was

his primary place of business and the expenses were

ordinary and necessary for his practice.

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3. Qualifying Business Expenses■ Even though a business owner may deduct their business

expenses, not all expenses of a business would qualify as a

deduction.

■ Qualifying expenses are expenses that are ordinary and

necessary for your business to function efficiently.

■ Here are some example of expenses that would not qualify

as a deduction:

– Lobbying expenses

– Clothing expenses

– Vacation expenses

– Some membership dues (with the exception of

Professional Organizations and Chambers of

Commerce) 10

a. Ordinary and Necessary according to the IRS

■ To be deductible, the IRS states the business expenses have to be

ordinary and necessary. Do your expenses qualify as ordinary and

necessary for the function of your business?

■ An ordinary expense is one that is common and accepted in your

trade or business.

■ A necessary expense is one that is helpful and appropriate for your

trade or business.

■ Examples of ordinary and necessary expenses:

– Rent

– Interest from loans

– Taxes 11

b. Hamper v Commissioner

■ Hamper was a news anchor in the mornings and

afternoons. As an anchor, she had to wear business suits in

order to conduct her daily job requirements. She then

decided to deduct her expenses for the clothes she

purchased for her job. The Commissioner did not allow the

deduction stating that all of her expenses were not ordinary

and necessary for her job.

■ The court found in favor of the Commissioner stating that

all of her expenses were not clothing for her job. Most of

her expenses included other items that were deemed to be

personal purchases.12

4. Business Entertainment Expenses

■ Paying for entertainment expenses incurred on behalf of

the company due to business responsibilities is a

traditional benefit.

■ Taxpayers may deduct entertainment expenses incurred for

business purposes.

■ To be deductible, the expenses must be ordinary and

necessary and incurred in the operation of a business

regularly carried on by the taxpayer.

■ Lavish or extravagant entertainment expenses are not

deductible.

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a. Wounded Warrior Project Scandal

■ Since January 2016, the media and public have been up in arms against the Wounded Warrior Project.

– The Wounded Warrior Project is a non-profit organization that raises awareness for injured veterans and assists them and their families with finding programs and services to meet their needs.

■ According CBS, only 60% of the company’s donations went to the assistance of veterans. Everyone wondered where did the rest of the money go?

■ Former employees of the Wounded Warrior Project stated that the company would take lavish trips and host expensive parties.

■ According to the CEO, the trips were conferences and the parties were fundraisers for the injured veterans. However, the Wounded Warrior Project spent $26 million on “conferences” and $34 million on fund raisers in 2014. The CEO and COO were released in March 2016 due to lavish spending.

Source: CBS News and New York Post14

5. Employee Expense Reimbursement■ Employers can receive a tax deduction if they reimburse their

employees for any money spent towards the functions of the

business. This is called employee expense reimbursement.

■ This is a method for paying employees back when they spend their

own money on business-related expenses. Examples include:

– Business travel

– Supplies

– Education (related to current career)

■ The employee expense reimbursement falls under the accountable

plan for tax purposes.

■ To be an accountable plan, the reimbursement has to follow certain

rules and guidelines in order to qualify.

■ The expenses have to be reimbursed before they can be considered.15

a. Rules for the Accountable Plan

■ To be an accountable plan, the reimbursement or

allowance must include all of the following rules:

1. The expenses must have a business connection.

2. The employee must adequately account for the

expenses within a reasonable time period.

3. Any excess reimbursement or allowance must be

returned within a reasonable time period.

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6. Insurance Deductions

■ If a business owner pays insurance premiums for their

employees, this could count as a deduction for the

business.

■ This includes medical, dental, and long-term care

insurance.

■ Employers can deduct premiums paid and incurred for

health insurance.

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7. Business Travel and Transportation Expenses

■ Travel, meals, and lodging expenses incurred by a taxpayer while

away from home in connection with his services as an employee are

deductible.

■ The expenses are only deductible if the purpose of the trip is

primarily for business.

■ Examples of deductible travel expenses undertaken for business

include:

– Meals and lodging

– Air, rail, ship, bus, and baggage charges

– Telephone and telegraph expenses

– Taxi

– Laundry, cleaning, and clothes18

a. Commissioner v Flowers■ Flowers was an attorney in Jackson, Mississippi who also worked as

counsel for a railroad company. The railroad company offered

Flowers a new position which would require him to work in their

corporate office in Mobile, Alabama. He elected to take the position,

but refused to move to Mobile permanently. The company allowed

Flowers to stay in Jackson and fly back and forth to Mobile. The

company would not reimburse him for traveling since Flowers

elected to pay for the cost himself and refused to move to Mobile, so

he decided to use his travel expenses as a deduction towards his own

taxes. The Commissioner did not allow the deduction stating that

these are considered personal expenses.

■ The court found in favor of the Commissioner stating that the

expenses are not considered business-related. Flowers decided to

remain in Jackson instead of moving to Mobile where his new

position is located which makes the expenses his own personal

costs. 19

8. Domestic Travel vs. Foreign Travel

■ If a trip within the United States is primarily for business, the

taxpayer may deduct the entire travel cost to and from the

destination as a business expense.

■ Foreign business travel has more restrictive requirements.

– Expenses for primarily personal pleasure or for vacation costs

are not allowed, but business expenses at the destination are

allowed.

– Trips outside the US primarily for business but there were some

nonbusiness activities, not all travel cost from home to the

business destination and back may be deductible.

– To be fully deductible, foreign travel must be primarily for

business.

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9. The Importance of Adequate Record Keeping

■ To receive deductions for business expenses, a business owner has

to keep adequate record of those charges. According to the IRS, you

should keep the proof you need in an account book, diary, log,

statement of expenses, trip sheets, or similar record. You should also

keep documentary evidence that, together with your records, will

support each element of an expense.

■ Record keeping is the process of recording transactions and events

in an accounting system. In addition to keeping books of accounts,

you must be able to support the transactions.

■ Any purchases, sales, payments, or other transactions have to be

recorded accurately. Here are some examples of different accounting

systems:

– QuickBooks

– Sage 21

a. Lysford v Commissioner

■ Lysford was a mortgage broker and a trained pilot who

would fly to different areas to conduct business for his

company. To keep track of his flight and transportation

expenses, Lysford would write the information in a spiral

notebook that he kept on his plane for tax purposes. The

Commissioner did not allow his expenses to qualify as a

deduction because there was not enough evidence to

substantiate as proof of his claim for business expenses.

■ The court found in favor of the Commissioner stating that

the spiral notebook was not adequate for accurate record

keeping for business expenses incurred.22

10. Conclusion■ Business transactions can be beneficial to taxpayers in

more ways than one.

■ Think about the income you can keep and not just the

income your business earns.

■ To receive those benefits, a business owner has to make

sure they are meeting the guidelines set forth by the IRS.

■ It may be helpful to consider meeting with a trained

professional to help you keep more of what you make and

grow more of what you keep.

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Memphis Consulting Group,

LLC.5118 Park Avenue, Suite 212

Memphis, TN, 38117

P: (901) 791-4643

F: (901) 791-4653

www.memphisconsultinggroup.com

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