Tax Terms You Need to Know
Here are a some tax terms related to the transportation and entertainment deduction that you should be familiar with:
- Ordinary and necessary expenses
- Tax home
- Away from home
Ordinary and Necessary Expenses
An ordinary expense is an expense that is common and accepted in your type of business.
A necessary expense is an expense that is helpful and appropriate in your business. To be considered a necessary expense it does not have to be required.
When the IRS says you must be away from home to deduct business-related travel expenses, they are referring to your so-called tax home. This may or may not be where you maintain your permanent residence.
Your tax home is your regular (fixed) place of business, employment, or post of duty, including the entire city or general area of your regular (fixed) place of business.
For travel expense purposes the IRS says:
- You must be away from your tax home, regardless of where you maintain your family residence.
- If you run your business out of your home, then your home, including the metropolitan area within which your home is located, is your tax home.
- If you operate your business outside of your residence, say at a retail store or office building, your store or office is your tax home.
- If your regular place of business is San Diego, California and you maintain your residence in Phoenix, Arizona, San Diego is your tax home even though your permanent residence is in Phoenix.
Your residence may be your tax home if...
- you see clients/customers/patients there regularly and exclusively, or
- you maintain a home office that qualifies as your principal place of business. This is possible if you satisfy the administrative and management test:
- Under the administrative and management rule, if you use your home office regularly and exclusively to perform administrative and management activities for your business (e.g., bookkeeping, appointment setting, follow-up calls to clients/customers, preparing financial reports) your home office will qualify as your principal place of business.
Your residence may not be your tax home.
- You live in Phoenix, AZ but don't work there.
- You have a regular (fixed) place of employment in San Diego, CA where you work Monday through Friday.
- You return home on week-ends.
Your tax home is San Diego because it is your regular place of business.
This means your costs for traveling between Phoenix and San Diego, lodging, and meals while there, are not deductible because they are considered personal expenses.
More than One Place of Business:
Your main business location is generally where you spend most of your time and earn most of your income and is generally considered your tax home. To determine your main business location, compare the time and income associated with each business location where you work.
- You live and work in Phoenix, AZ nine months of the year.
- You work in San Diego three months of the year.
- You earn most of your income in Phoenix.
- This arrangement has been going on for several years.
Phoenix is your tax home because it is your main place of business. Consequently, when you are in San Diego you are away from home. This means your round-trip travel costs between Phoenix and San Diego and lodging in San Diego are fully (100%) deductible.
However, your meal costs while in San Diego are only 50% deductible (including taxes and tips).
If you have no permanent residence and move from city to city to work, your tax home is wherever you are working at the time; you are considered an itinerant. This would apply to someone who travels around in a motor home or trailer for example, and lives in it while in the work area.
In addition, you can never be considered away from home since you have no permanent location to be away from.
Away From Home Test
To be away from home you must be away from the general area of your tax home substantially longer than a regular day's work and require sufficient time off to get necessary sleep before returning home.
Taking a one-hour nap in the car is not sufficient time off. You don't necessarily have to be away from home 24 hours, you just have to have enough time off to get necessary rest to function properly.
Overnight sleep rule:
This rule, which requires that you get sufficient time off to get the property rest before returning home, prevents you from being able to deduct the cost of your meals on one-day business trips.
Example: Sufficient time off to rest:
- You own your truck.
- You use your truck to deliver produce throughout the state.
- You make a run between two cities.
- You leave your home base terminal at 2 a.m. and return to it at 6 p.m. (16 hours).
- Before returning, you take 4 hours off at your turnaround point.
- You eat and rent a hotel room to sleep before returning.
You meet the away from home test. Your transportation and lodging expenses are 100% deductible. However, only 50% of your meal costs are deductible.
Example: Not sufficient time off to rest:
- Same facts as above, except you only take one hour off to eat and rest in your truck before returning.
You do not meet the rest test since there was insufficient time to get the proper rest. You are not considered away from home. Your trip is a one-day business trip which means your meal expenses are not deductible.