Recordkeeping

If you deduct travel, entertainment, gift, or transportation expenses, you must be able to prove (substantiate) certain elements of the expense. This section discusses the records you need to keep to prove these expenses.

If you keep timely and accurate records, you will have support to show the IRS if your tax return is ever examined. You will also have proof of expenses that your employer may require if you are reimbursed under an accountable plan. These plans are discussed later under Reimbursements.

How To Prove Expenses

Table 28-2 is a summary of records you need to prove each expense discussed in this chapter. You must be able to prove the elements listed across the top portion of the chart. You prove them by having the information and receipts (where needed) for the expenses listed in the first column.

You cannot deduct amounts that you approximate or estimate.

You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You must generally prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if you prepare a record in a computer memory device with the aid of a logging program, it is considered an adequate record.

What Are Adequate Records?

You should keep the proof you need in an account book, diary, statement of expense, or similar record. You should also keep documentary evidence that, together with your records, will support each element of an expense.

Documentary evidence.   You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.

Exception.   Documentary evidence is not needed if any of the following conditions apply.

1. You have meals or lodging expenses while traveling away from home for which you account to your employer under an accountable plan and you use a per diem allowance method that includes meals and/or lodging. (Accountable plans and per diem allowances are discussed later under Reimbursements.)
2. Your expense, other than lodging, is less than $75.
3. You have a transportation expense for which a receipt is not readily available.

Adequate evidence.   Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense.

For example, a hotel receipt is enough to support expenses for business travel if it has all of the following information.

1. The name and location of the hotel.
2. The dates you stayed there.
3. Separate amounts for charges such as lodging, meals, and telephone calls.

A restaurant receipt is enough to prove an expense for a business meal if it has all of the following information.

1. The name and location of the restaurant.
2. The number of people served.
3. The date and amount of the expense.

If a charge is made for items other than food and beverages, the receipt must show that this is the case.

Canceled check.   A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose.

Duplicate information.   You do not have to record information in your account book or other record that duplicates information shown on a receipt as long as your records and receipts complement each other in an orderly manner.

You do not have to record amounts your employer pays directly for any ticket or other travel item. However, if you charge these items to your employer, through a credit card or otherwise, you must keep a record of the amounts you spend.

Timely-kept records.   You should record the elements of an expense or of a business use at or near the time of the expense or use and support it with sufficient documentary evidence. A timely-kept record has more value than a statement prepared later when generally there is a lack of accurate recall.

You do not need to write down the elements of every expense on the day of the expense. If you maintain a log on a weekly basis which accounts for use during the week, the log is considered a timely-kept record.

If you give your employer, client, or customer an expense account statement, it can also be considered a timely-kept record. This is true if you copy it from your account book, diary, statement of expense, or similar record.

Proving business purpose.   You must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, then you do not need to give a written explanation.

Confidential information.   You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the expense and have it available to fully prove that element of the expense.

What If I Have Incomplete Records?

If you do not have complete records to prove an element of an expense, then you must prove the element with:

1. Your own written or oral statement, containing specific information about the element, and
2. Other supporting evidence that is sufficient to establish the element.

Destroyed records.   If you cannot produce a receipt because of reasons beyond your control, you can prove a deduction by reconstructing your records or expenses. Reasons beyond your control include fire, flood, and other casualty.

Separating and Combining Expenses

This section explains when expenses must be kept separate and when expenses can be combined.

Separating expenses.   Each separate payment is generally considered a separate expense. For example, if you entertain a customer or client at dinner and then go to the theater, the dinner expense and the cost of the theater tickets are two separate expenses. You must record them separately in your records.

Combining items.   You can make one daily entry in your record for reasonable categories of expenses. Examples are taxi fares, telephone calls, or other incidental travel costs. Meals should be in a separate category. You can include tips for meal-related services with the costs of the meals.

Expenses of a similar nature occurring during the course of a single event are considered a single expense. For example, if during entertainment at a cocktail lounge, you pay separately for each serving of refreshments, the total expense for the refreshments is treated as a single expense.

Allocating total cost.   If you can prove the total cost of travel or entertainment but you cannot prove how much it cost for each person who participated in the event, you may have to allocate the total cost among you and your guests on a pro rata basis. An allocation would be needed, for example, if you did not have a business relationship with all of your guests.

If your return is examined.   If your return is examined, you may have to provide additional information to the IRS. This information could be needed to clarify or to establish the accuracy or reliability of information contained in your records, statements, testimony, or documentary evidence before a deduction is allowed.

How Long To Keep Records and Receipts

You must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep your records that support your deduction (or an item of income) for 3 years from the date you file the income tax return on which the deduction is claimed. A return filed early is considered filed on the due date. For a more complete explanation, get Publication 583, Starting a Business and Keeping Records.

Reimbursed for expenses.   Employees who give their records and documentation to their employers and are reimbursed for their expenses generally do not have to keep copies of this information. However, you may have to prove your expenses if any of the following conditions apply.

1. You claim deductions for expenses that are more than reimbursements.
2. Your expenses are reimbursed under a nonaccountable plan.
3. Your employer does not use adequate accounting procedures to verify expense accounts.
4. You are related to your employer, as defined earlier under Who cannot use the standard meal allowance.

See the next section, How To Report, for a discussion of reimbursements, adequate accounting, and nonaccountable plans.

Additional information.   Chapter 5 of Publication 463 has more information on recordkeeping, including examples.

How To Report

This section explains where and how to report the expenses discussed in this chapter. It discusses reimbursements and how to treat them under accountable and nonaccountable plans. It also explains rules for fee-basis officials, certain performing artists, and certain disabled employees. This section ends with an illustration of how to report travel, entertainment, gift, and car expenses on Form 2106-EZ.

Self-employed.   You must report your income and expenses on Schedule C or C-EZ (Form 1040) if you are a sole proprietor, or on Schedule F (Form 1040) if you are a farmer. You do not use Form 2106 or 2106-EZ. See your form instructions for information on how to complete your tax return. You can also find information in Publication 535 if you are a sole proprietor, or in Publication 225, Farmer's Tax Guide, if you are a farmer.

Both self-employed and an employee.   If you are both self-employed and an employee, you must keep separate records for each business activity. Report your business expenses for self-employment on Schedule C, C-EZ, or F (Form 1040), as discussed earlier. Report your business expenses for your work as an employee on Form 2106 or 2106-EZ, as discussed next.

Employees.   If you are an employee, you generally must complete Form 2106 to deduct your travel, transportation, and entertainment expenses. However, you can use the shorter Form 2106-EZ instead of Form 2106 if you meet all of the following conditions.

1. You are an employee deducting expenses attributable to your job.
2. You were not reimbursed by your employer for your expenses (amounts included in box 1 of your Form W-2 are not considered reimbursements).
3. If you are claiming car expenses, you use the standard mileage rate.

For more information on how to report your expenses on Forms 2106 and 2106-EZ, see Completing Forms 2106 and 2106-EZ, later.

Gifts.   If you did not receive any reimbursements (or the reimbursements were all included in box 1 of your Form W-2), the only business expense you are claiming is for gifts, and the rules for certain individuals (such as performing artists), discussed later under Special Rules, do not apply to you, do not complete Form 2106 or 2106-EZ. Instead, claim the amount of your deductible gifts directly on line 20 of Schedule A (Form 1040).

Statutory employees.   If you received a Form W-2 and the Statutory employee box in box 13 was checked, you report your income and expenses related to that income on Schedule C or C-EZ (Form 1040). Do not complete Form 2106 or 2106-EZ.

Statutory employees include full-time life insurance salespersons, certain agent or commission drivers, traveling salespersons, and certain homeworkers.

If you are entitled to a reimbursement from your employer but you do not claim it, you cannot claim a deduction for the expenses to which that unclaimed reimbursement applies.

Reimbursement for personal expenses.   If your employer reimburses you for nondeductible personal expenses, such as for vacation trips, your employer must report the reimbursement as wage income in box 1 of your Form W-2. You cannot deduct personal expenses.

Reimbursements

This section explains what to do when you receive an advance or are reimbursed for any of the employee business expenses discussed in this chapter.

Table 28-2. How To Prove Certain Business Expenses

IF you have expenses for:	THEN you must keep records that show details of the following elements.
	Amount	Time	Place or Description	Business Purpose and Business Relationship
Travel	Cost of each separate expense for travel, lodging, and meals. Incidental expenses may be totaled in reasonable categories such as taxis, daily meals for traveler, etc.	Dates you left and returned for each trip and number of days spent on business.	Destination or area of your travel (name of city, town, or other designation).	Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. Relationship: N/A
Entertainment	Cost of each separate expense. Incidental expenses such as taxis, telephones, etc., may be totaled on a daily basis.	Date of entertainment. (Also see Business Purpose.)	Name and address or location of place of entertainment. Type of entertainment if not otherwise apparent. (Also see Business Purpose.)	Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. For entertainment, the nature of the business discussion or activity. If the entertainment was directly before or after a business discussion: the date, place, nature, and duration of the business discussion, and the identities of the persons who took part in both the business discussion and the entertainment activity. Relationship: Occupations or other information (such as names, titles, or other designations) about the recipients that shows their business relationship to you. For entertainment, you must also prove that you or your employee was present if the entertainment was a business meal.
Gifts	Cost of the gift.	Date of the gift.	Description of the gift.
Transportation	Cost of each separate expense. For car expenses, the cost of the car and any improvements, the date you started using it for business, the mileage for each business use, and the total miles for the year.	Date of the expense. For car expenses, the date of the use of the car.	Your business destination.	Purpose: Business purpose for the expense. Relationship: N/A

If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a nonaccountable plan.

This section explains the two types of plans, how per diem and car allowances simplify proving the amount of your expenses, and the tax treatment of your reimbursements and expenses.

No reimbursement.   You are not reimbursed or given an allowance for your expenses if you are paid a salary or commission with the understanding that you will pay your own expenses. In this situation, you have no reimbursement or allowance arrangement, and you do not have to read this section on reimbursements. Instead, see Completing Forms 2106 and 2106-EZ, later, for information on completing your tax return.

Reimbursement, allowance, or advance.   A reimbursement or other expense allowance arrangement is a system or plan that an employer uses to pay, substantiate, and recover the expenses, advances, reimbursements, and amounts charged to the employer for employee business expenses. Arrangements include per diem and car allowances.

A per diem allowance is a fixed amount of daily reimbursement your employer gives you for your lodging, meal, and incidental expenses when you are away from home on business. (The term incidental expenses is defined earlier under Meals.) A car allowance is an amount your employer gives you for the business use of your car.

Your employer should tell you what method of reimbursement is used and what records you must provide.

Accountable Plans

To be an accountable plan, your employer's reimbursement or allowance arrangement must include all three of the following rules.

1. Your expenses must have a business connection - that is, you must have paid or incurred deductible expenses while performing services as an employee of your employer.
2. You must adequately account to your employer for these expenses within a reasonable period of time.
3. You must return any excess reimbursement or allowance within a reasonable period of time.

See Adequate Accounting and Returning Excess Reimbursements, later.

An excess reimbursement or allowance is any amount you are paid that is more than the business-related expenses that you adequately accounted for to your employer.

The definition of reasonable period of time depends on the facts and circumstances of your situation. However, regardless of the facts and circumstances of your situation, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time.

1. You receive an advance within 30 days of the time you have an expense.
2. You adequately account for your expenses within 60 days after they were paid or incurred.
3. You return any excess reimbursement within 120 days after the expense was paid or incurred.
4. You are given a periodic statement (at least quarterly) that asks you to either return or adequately account for outstanding advances and you comply within 120 days of the statement.

Employee meets accountable plan rules.   If you meet the three rules for accountable plans, your employer should not include any reimbursements in your income in box 1 of your Form W-2. If your expenses equal your reimbursement, you do not complete Form 2106. You have no deduction since your expenses and reimbursement are equal.

If your employer included reimbursements in box 1 of your Form W-2 and you meet all three rules for accountable plans, ask your employer for a corrected Form W-2.

Accountable plan rules not met.   Even though you are reimbursed under an accountable plan, some of your expenses may not meet all three rules. Those expenses that fail to meet all three rules for accountable plans are treated as having been reimbursed under a nonaccountable plan (discussed later).

Reimbursement of nondeductible expenses.   You may be reimbursed under your employer's accountable plan for expenses related to that employer's business, some of which are deductible as employee business expenses and some of which are not deductible. The reimbursements you receive for the nondeductible expenses do not meet rule (1) for accountable plans, and they are treated as paid under a nonaccountable plan.

Example.   Your employer's plan reimburses you for travel expenses while away from home on business and also for meals when you work late at the office, even though you are not away from home. The part of the arrangement that reimburses you for the nondeductible meals when you work late at the office is treated as paid under a nonaccountable plan.

The employer makes the decision whether to reimburse employees under an accountable plan or a nonaccountable plan. If you are an employee who receives payments under a nonaccountable plan, you cannot convert these amounts to payments under an accountable plan by voluntarily accounting to your employer for the expenses and voluntarily returning excess reimbursements to the employer.

Adequate Accounting

One of the three rules for an accountable plan is that you must adequately account to your employer for your expenses. You adequately account by giving your employer a statement of expense, an account book, a diary, or a similar record in which you entered each expense at or near the time you had it, along with documentary evidence (such as receipts) of your travel, mileage, and other employee business expenses. (See Table 28-2, earlier, for details you need to enter in your record and documents you need to prove certain expenses.)

You must account for all amounts you received from your employer during the year as advances, reimbursements, or allowances. This includes amounts you charged to your employer by credit card or other method. You must give your employer the same type of records and supporting information that you would have to give to the IRS if the IRS questioned a deduction on your return. You must pay back the amount of any reimbursement or other expense allowance for which you do not adequately account or that is more than the amount for which you accounted.

Per Diem and Car Allowances

If your employer reimburses you for your expenses using a per diem or car allowance, you can generally use the allowance as proof of the amount of your expenses. A per diem or car allowance satisfies the adequate accounting requirements for the amount of your expenses only if all four of the following conditions apply.

1. Your employer reasonably limits payments of your expenses to those that are ordinary and necessary in the conduct of the trade or business.
2. The allowance is similar in form to and not more than the federal rate (discussed later).
3. You prove the time (dates), place, and business purpose of your expenses to your employer (as explained in Table 28-2) within a reasonable period of time.
4. You are not related to your employer (as defined earlier under Who cannot use the standard meal allowance). If you are related to your employer, you must be able to prove your expenses to the IRS even if you have already adequately accounted to your employer and returned any excess reimbursement.

If the IRS finds that an employer's travel allowance practices are not based on reasonably accurate estimates of travel costs (including recognition of cost differences in different areas for per diem amounts), you will not be considered to have accounted to your employer. In this case, you must be able to prove your expenses to the IRS.

The federal rate.   The federal rate can be figured using any one of the following methods.

1. For per diem amounts:
   1. The regular federal per diem rate.
   2. The standard meal allowance.
   3. The high-low rate.
2. For car expenses:
   1. The standard mileage rate.
   2. A fixed and variable rate (FAVR).

Regular federal per diem rate.   The regular federal per diem rate is the highest amount that the federal government will pay to its employees for lodging, meal, and incidental expenses (or meal and incidental expenses only) while they are traveling away from home in a particular area. The rates are different for different locations. Your employer should have these rates available. (Employers can get Publication 1542, which gives the rates in the continental United States for the current year.)

The standard meal allowance.   The standard meal allowance (discussed earlier) is the federal rate for meals and incidental expenses (M&IE). The rate for most small localities in the United States is $30. Most major cities and many other localities qualify for higher rates. The rates for all localities within the continental United States are listed in Publication 1542.

You receive an allowance only for meals and incidental expenses when your employer does one of the following.

1. Provides you with lodging (furnishes it in kind).
2. Reimburses you, based on your receipts, for the actual cost of your lodging.
3. Pays the hotel, motel, etc., directly for your lodging.
4. Does not have a reasonable belief that you had (or will have) lodging expenses, such as when you stay with friends or relatives or sleep in the cab of your truck.
5. Computes the allowance on a basis similar to that used in computing your compensation, such as number of hours worked or miles traveled.

High-low rate.   This is a simplified method of computing the federal per diem rate for travel within the continental United States. It eliminates the need to keep a current list of the per diem rate for each city.

Under the high-low method, the per diem amount for travel during January through September of 2002 is $204 (including $42 for M&IE) for certain high-cost locations. All other areas have a per diem amount of $125 (including $34 for M&IE). (Employers can get Publication 1542 (Revised February 2002), which gives the areas eligible for the $204 per diem amount under the high-low method for all or part of this period.)

Effective October 1, 2002, the per diem rate under this method for certain high-cost locations is $204 (including $45 for M&IE). The rate for all other locations is $125 (including $35 for M&IE). However, an employer can continue to use the rates described in the preceding paragraph for the remainder of 2002 if those rates and locations are used consistently during October, November, and December for all employees. Employers who did not use the high-low method during the first 9 months of 2002 cannot begin to use it before 2003. See Revenue Procedure 2002-63 for more information.

Prorating the standard meal allowance on partial days of travel.   The standard meal allowance is for a full 24-hour day of travel. If you travel for part of a day, such as on the days you depart and return, you must prorate the full-day M&IE rate. This rule also applies if your employer uses the regular federal per diem rate or the high-low rate.

You can use either of the following methods to figure the federal M&IE for that day.

1. Method 1:
   1. For the day you depart, add ¾ of the standard meal allowance amount for that day.
   2. For the day you return, add ¾ of the standard meal allowance amount for the preceding day.
2. Method 2: Prorate the standard meal allowance using any method that you consistently apply and that is in accordance with reasonable business practice.

The standard mileage rate.   This is a set rate per mile that you can use to compute your deductible car expenses. For 2002, the standard mileage rate is 361/2 cents a mile for all business miles. This rate is adjusted periodically.

Fixed and variable rate (FAVR).   This is an allowance your employer may use to reimburse your car expenses. Under this method, your employer pays an allowance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your variable operating costs (such as gas, oil, etc.) plus a flat amount to cover your fixed costs (such as depreciation (or lease payments), insurance, etc.). If your employer chooses to use this method, your employer will request the necessary records from you.

Reporting your expenses with a per diem or car allowance.   If your reimbursement is in the form of an allowance received under an accountable plan, the following two facts affect your reporting.

1. The federal rate.
2. Whether the allowance or your actual expenses were more than the federal rate.

The following discussions explain where to report your expenses depending upon how the amount of your allowance compares to the federal rate.

Allowance LESS than or EQUAL to the federal rate.   If your allowance is less than or equal to the federal rate, the allowance will not be included in box 1 of your Form W-2. You do not need to report the related expenses or the allowance on your return if your expenses are equal to or less than the allowance.

However, if your actual expenses are more than your allowance, you can complete Form 2106 and deduct the excess amount on Schedule A (Form 1040). If you are using actual expenses, you must be able to prove to the IRS the total amount of your expenses and reimbursements for the entire year. If you are using the standard meal allowance or the standard mileage rate, you do not have to prove that amount.

Example.   Nicole drives 10,000 miles a year for business. Under her employer's accountable plan, she accounts for the time (dates), place, and business purpose of each trip. Her employer pays her a mileage allowance of 20 cents a mile.

Since Nicole's $3,650 expenses computed under the standard mileage rate (10,000 miles × 36½ cents) are more than her $2,000 reimbursement (10,000 miles × 20 cents), she itemizes her deductions to claim the excess expenses. Nicole completes Form 2106 (showing all of her expenses and reimbursements) and enters $1,650 ($3,650 - $2,000) as an itemized deduction.

Allowance MORE than the federal rate.   If your allowance is more than the federal rate, your employer must include the allowance amount up to the federal rate in box 12 of your Form W-2. This amount is not taxable. However, the excess allowance will be included in box 1 of your Form W-2. You must report this part of your allowance as if it were wage income.

If your actual expenses are less than or equal to the federal rate, you do not complete Form 2106 or claim any of your expenses on your return.

However, if your actual expenses are more than the federal rate, you can complete Form 2106 and, generally, deduct those excess expenses. You must report on Form 2106 your reimbursements up to the federal rate (as shown in box 12 of your Form W-2) and all your expenses. You should be able to prove these amounts to the IRS.

Example.   Joe lives and works in Austin. His employer sent him to San Diego for 4 days and paid the hotel directly for Joe's hotel bill. The employer reimbursed Joe $50 a day for his meals and incidental expenses. The federal rate for San Diego is $46 a day.

Joe can prove that his actual meal expenses totaled $290. His employer's accountable plan will not pay more than $50 a day for travel to San Diego, so Joe does not give his employer the records that prove that he actually spent $290. However, he does account for the time, place, and business purpose of the trip. This is Joe's only business trip this year.

Joe was reimbursed $200 ($50 × 4 days), which is $16 more than the federal rate of $184 ($46 × 4 days). The employer includes the $16 as income on Joe's Form W-2 in box 1. The employer also enters $184 in box 12 of Joe's Form W-2, along with a code L.

Joe completes Form 2106 to figure his deductible expenses. He enters the total of his actual expenses for the year ($290) on Form 2106. He also enters the reimbursements that were not included in his income ($184). His total deductible expense, before the 50% limit, is $106. After he figures the 50% limit on his unreimbursed meals and entertainment, he will include the balance, $53, as an itemized deduction.

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