Mark Pestronk
Q: In a column five years ago ("Tough to meet IRS requirements on travel-related deductions," Aug. 6, 2012), you wrote that there were no court precedents, regulations or IRS guidance on the deductibility of travel agents' familiarization trips and other travel expenses incurred to learn about suppliers' products and destinations. Any update? Also, what are the odds of getting caught if I deduct something I shouldn't?
A: There is now one relevant court case. Unfortunately, it disqualified all of the travel agent's claimed travel deductions.
This issue is a recurring one. At least once a year, prospective clients ask me for help because they are being audited by the IRS, and they are concerned whether they have properly deducted travel expenses on their tax returns.
Travel agency owners and independent contractors often view most of their travel, and certainly cruises and trips to other countries, as deductible. Their justification is that such activities help them be better travel agents by becoming more knowledgeable about destinations and suppliers' products.
In the 2015 case of Lee v. Commissioner, the tax court ruled against Lee, after she claimed that "expenses for cruise travel with her companion enabled her to advise prospective travel agency clients. ... She claimed that any information obtained through her travel was useful in broadening the knowledge that she would convey to others."
I would have no problem defending such a position as an expert witness, and I would welcome the chance to try. You probably don't get to be a cruise expert unless you have been on cruises, and the same would apply to all modes of travel and all destinations. However, the devil is in the details: the record-keeping requirements are extremely stringent.
You need to keep records of the amounts of each such expense, the time and place the expenses were incurred and the business purpose for each expense. "Each element ... must be substantiated ... at or near the time of the expenditure." In the alternative, each expense must be established by the taxpayer's own detailed written or oral statement combined with corroborative evidence. Even stricter rules apply to foreign travel of more than one week, cruises departing from foreign countries and meetings on cruise ships, so you should consult your certified public accountant or tax attorney if you have questions.
I realize that, notwithstanding the stringent regulations, agency owners and independent contractors have probably gotten away with these deductions. I strongly suspect that their success has more to do with the low percentage of tax returns that get audited these days than with their compliance.
If, like most agency owners, you own an S corporation or limited liability company that chooses to be taxed as an S corporation, the latest figures released by the IRS show that just 0.3% of those tax returns get audited, and a third of those cases are closed with no changes. So your odds of getting any deduction disallowed are about two in a thousand.
However, if, like many independent contractors, you operate as a sole proprietor and put all your business expenses on Schedule C of your Form 1040, your odds increase at least sixfold, and they increase further if you do not show a profit. So if you want to lower your chances of getting audited, convert from being a Schedule C filer to an S corporation filer.