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Travel Agent Denied Travel Expenses

andyroed

As a travel advisor and business owner you are entitled to deduct ordinary and necessary business expenses related to your work. This includes travel so long as it is ordinary, necessary, and related to your business. Sometimes, the IRS will question those expenses, and it is up to you to prove that they are indeed ordinary and necessary to your business as an advisor. 


We are going through a court case in which a travel advisor was audited by the IRS and had all of her travel deductions disallowed. Once I take you through the case, we will discuss what she could have done differently and the lessons we can learn. 


The first thing I want to make clear is just because you are audited by the IRS does not mean you have done anything wrong. Individuals and businesses are audited for a number of reasons. Sometimes it's random, sometimes it is triggered by the IRS computer system and sometimes it is based on what you have put on your tax return. You don't have much control on if you get audited or not, but you do have control once the process is initiated. 


Typically, an IRS audit starts with a letter from the IRS. The letter usually explains the reason for the audit and may request additional documentation from you. Normally, you have around 30 days to respond to the letter. After you respond, the IRS usually takes its time reviewing your documents. They may just accept your documentation or the correspondence may go back and forth for a while. If it isn't resolved by mail, you may need to meet with an IRS agent to discuss the issue in person. During this face to face meeting you can go it alone or you can involve a tax attorney, enrolled agent or other representative to help you navigate the process. If and only if an agreement can not be reached during those meetings, the next step is to take the issue to tax court where a judge will decide if the taxpayer is correct or the IRS is correct. That is where this case picks up, in tax court. If you want to read the court document yourself, you can click on the link in the description.  


This case was heard in 2015 and is in relation to a tax return filed in 2010. You will see throughout the court documents they refer to the “respondent” which is the IRS, and the “petitioner” which is the Person involved. I will just say the IRS and Priscilla,  moving forward.


The IRS determined that Priscilla owed $5,642 in taxes and also that she should pay a penalty of around $1,100 dollars. The taxes that were owed by her are mainly a result of the IRS saying that many of her business expenses are not deductible business expenses. Priscilla feels they are, so now we find ourselves in tax court. 


Background


In 2010, Pricilla was retired from her educator position but continued to consult with teachers and high school students. During 2010, she was paid $4,881.00 for these services. 


In addition, in 2010, Pricilla also acted as a travel agent. Her goal was to focus on travel for older people needing more accessible travel solutions. In 2010, most of her clients were friends and friends of friends, but she did make $3,143 in commission from her bookings. 


During 2010, Priscilla and a friend took a cruise from New York to Los Angeles by way of the Panama Canal. They stopped in Florida, Costa Rican and other destinations along the way. 


She also made an advance payment on a 40-day cruise from India to Africa to be taken in 2011. She also visited universities and museums in California and paid expenses in 2010 for a variety of other items, including decorative items, subscriptions, local transportation, storage, telephone and Internet, supplies, and postage. 


She did maintain receipts for such expenses but did not segregate them among expenses relating to her UCLA activities, her travel agent activities, and personal expenses. On a Schedule C for her Travel Agency which was attached to her U.S. Individual Income Tax Return, she deducted $27,744 in expenses from the $3,143 gross income from the travel agent activity. This resulted in a $24,601 net loss to be deducted against her other reported income totaling $76,207. The largest item claimed as a deduction was "research travel” of $15,288.


The IRS states that " Taxpayers may deduct expenses incurred while traveling away from home if the trip is primarily to obtain education that has the requisite relation to the taxpayer's business. If as an incident of such a trip the taxpayer engages in some personal activity such as "sightseeing, social visiting, or entertaining, or other recreation", the portion of the expenses attributable to such personal activities is not deductible.


To deduct expenses incurred for travel, meals, and lodging while away from home on job-related education, a taxpayer must satisfy the strict substantiation requirements of section 274(d). Section 274(d) disallows deductions for traveling expenses, including meals and lodging, unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement: 


1) the amounts of such expenses

2) the time and place such expenses were incurred

3 the business purpose for which such expenses were incurred.


Those records generally must be written and must be prepared or maintained at or near the time of the expenditure when the taxpayer has full present knowledge of each expense. In addition, each expense must be supported by the taxpayer's own written or oral statement "containing specific information in detail as to such element".

      

Patricia did provide receipts for the cruises, shipboard purchases, and other expenses. However, the receipts do not show any business purpose for the expenses, and her testimony was not in line with her documents. 


The IRS said: Her rationale for deductibility is unpersuasive, and we need not accept it. The shifting explanations and the failure to allocate among expenses related to UCLA activities involving high school students and teachers, travel agent activities involving older travelers, and personal expenses of traveling with her companion undermine the reliability of her testimony. 


The IRS concluded that she has not satisfied the strict substantiation requirements. We cannot conclude that petitioner has satisfied her burden of proof. Many of the expenses are inherently personal, and her explanation is improbable and not persuasive. Patricia is not entitled to deduct the business expenses on her schedule C.


In the end, she lost the court case and had to pay $5,642 in taxes due from the denied expenses and also an accuracy related penalty of around $1,100 dollars. 


Lessons Learned 


I think the first thing we can look at is why she was audited in the first place. While we don't always know the reason and it can be completely random, reporting a 24k loss from your travel agency business which in turn reduced her other income was likely a reason the IRS took a look at her return. 


The second thing we can see from this case is that the travel expenses were very high in relation to her income and it is very likely that NOT all of her travel was 100% business related. She took a cruise from LA to New York and also made a deposit on a 40 day cruise from India to Africa. While some of it may be business related, it is very unlikely in my opinion that it was entirely business related. When it comes to travel expenses, the IRS has very specific rules for travel inside and outside the United states. If you don't know these rules, be sure to take a look at IRS Publication 463 or join the Taxes for Travel Agents Digital Course that goes over all the specifics with regard to travel.

The third issue this agent faced was record keeping. The burden of proof is on you to prove each and every expense. It seems to me that she was not separating her personal and business expenses, nor was she documenting what she was doing that made these trip business related. You need to be able to prove the amount of the expense, the time and place of the expense and the business purpose of the expense. Just producing receipts is not enough. You need to have a dedicated system for tracking your income and expenses. If she would have had a better accounting or tracking system, she may have had a better chance proving at least some of her expenses. 


It can be tempting as a Travel Agent to try and justify all of our travel as a business expense. But the IRS clearly says that the scheduling of incidental business activities wont change what is really a vacation into a business trip. You need to understand what makes a trip business related and you also need to ensure you document


(1) the amounts of such expenses, 

(2) the time and place such expenses were incurred and 

(3) the business purpose for which such expenses were incurred


Remember, when it comes to proving business expenses, you are guilty until you prove your innocence. The Burden of proof is on YOU!


Hopefully she learned from these mistakes and was able to be successful moving forward. I hope that at least you can take something away from this court case. It is very important to educate yourself on the IRS regulations as they relate to your business. There are a ton of great resources out there. The IRS website is a great resource, the small business administration also has a ton of great information, and IRS publication 463 provides some guidelines as they relate to travel. If you are looking for a one stop shop for everything tax and finance related for travel agents, check out taxes for travel agents.com where I have some free resources as well as a comprehensive course covering all the basics and fundamental knowledge needed to operate your business. 


Andrew Roed, EA

Taxes For Travel Agents, LLC


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