New Higher Business Expense Deduction May Decrease IRS Audits

The IRS often audits small business tax returns with the aim of denying deductions for business expenses, including lodging, meals, and other incidential expenses.

The IRS pursues these audits becuase taxpayers often do not keep adequate recrods to substantiate the deductions that they claimed on their tax returns. This allows the IRS to open audits to look for other issues, with the assurance that the audit will at least uncover “improper” business expense deductions. This is why many taxpayers may benefit from new Revenue Procedure 2006-41 without even knowing about it.

Revenue Procedure 2006-41 raises the per diem rates and it eases the documentation requirements for expenses incurred while a taxpayer travels away from their home.

Generally self-employed taxpayers and employees (whose expenses are not reimbursed) can deduct expenses incurred while traveling away from home for business purposes. However, the deductions for food, beverages and entertainmenet is limited to 50% of the otherwise deductible expense for most taxpayers. These expense deductions are only allowable to the extent that the taxpayer retains sufficient records to prove the amount of the expense.

There are a number of exceptions from these substantiation requirements. For example, employers can offer a per diem allowance rather than reimbursing employees for actual expenses. Taxpayers generally do not have to substantiate payments that meet the per diem rules in order to be entitled to the expense deduction.

The per diem amount has to be equal to or less than the federal per diem rate or a flat rate that does not exceed the actual expenses or the anticipated actual expenses.

If the taxpayer elects to us a flat per diem rate, pursuant to Revenue Procedure 2006-41 (and starting on Ocotober 2006) employers can deduct up to $246 for high-cost localities and $148 for low-cost localities for lodging, meals and incidental expenses (the Revenue Procedure details what localities are high and low-cost localities).

While these rates are still not adequate to cover the reasonable and actual expenses incurred by most taxpayers, it does get a little closer. As such, the IRS might not be as confident about opening IRS audits with the aim of denying business expenses and the hope of finding other issues….

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