Dear Diary, Today I Went to Starbucks

If you are self-employed and either eat out or drive on the job, chances are you’ll want to deduct what you spend on those things. But meals and car expenses are two of the most likely things on your tax return to get scrutinized by the IRS, and who wants to organize hundreds of receipts for small dollar amounts? An easy alternative is to keep a spending diary — or two or three. A spending diary eliminates the need for you to keep tons of receipts for tiny amounts and is also one of the only spending records the IRS will accept as legitimate.

I have two spending diaries: a small notebook that I keep in my purse for meals/entertainment/public transportation, etc., and a pad taped to the dashboard of my car for mileage and car expenses. I recommend a separate diary for your car because it will be organized slightly differently than a regular diary. Some people like to use a digital or cassette recorder in lieu of paper (Blackberry/iPhone users, I’m looking at you) but either method is fine as long as it contains the proper information.

Like all documentation prepared for the IRS, a spending diary must follow a series of somewhat complicated rules in order to be admissible. Here’s how to set up an iron-clad meals and entertainment diary, for example:

  • Include only entertainment and meals you ate out (not groceries!) that totaled $75 or less. You will need to keep a receipt for any meal or entertainment expense over $75 (no matter how many people you paid for).
  • Create the following set of columns for your diary:
    • The date
    • The amount you spent
    • Where you spent it (establishment and city)
    • The names and business relationships of anyone you entertained
    • The business you were doing or discussing
  • Fill out the information the day you spend the money

For your car diary, just follow the format from this IRS example:

mileage log

Source: http://www.irs.gov/publications/p463/11081l08.html

Tip: record the entries from your diaries into a spreadsheet every week when you do the rest of your bookkeeping. This will help you to budget future spending and will save you time when you need to prepare your taxes.

Steady at the Wheel: Car Deductions

One of the areas of your tax return at which the IRS looks most closely is the section covering car deductions. There’s a reason for this: it’s a difficult set of tax laws to navigate and many people over-deduct or use sloppy estimates, resulting in more money for the government when they catch you. You don’t need receipts for everything, since it’s difficult to get receipts for things like mileage, but you do need detailed records of everything.

Car deductions are easy if you have a company car. In this case, you can just deduct the whole shebang. What’s more complicated is if you use your personal vehicle for business purposes. If you fall into this latter category and need to itemize your deductions, here are the basic steps:

  1. Keep a mileage diary in your car at all times. Write down the date, the starting and ending mileage, tolls, and one of the following purposes for any business-related trip you make:
    • Overnight travel away from home
    • Shopping for your business (not shopping for yourself, even if you use the purchase at your business, like a suit)
    • Travel to a professional development event such as a seminar or conference
    • Sales calls
    • Deliveries
    • Travel for marketing or promotional purposes
    • Travel to a job site or meeting as an independent contractor — NOTE** if the job site you are traveling to has you on the books as an employee rather than as an independent contractor, you are now technically commuting, which is not deductible.
    • Travel between job sites
    • Any other qualifying travel during your business day.
  2. Keep all receipts and statements for tolls, maintenance and repairs, gas, auto registration, inspections, etc.
  3. At the end of the year, total up your business mileage and divide it by your total mileage for the year. This will give you the percentage of your car that was used for business. Also, look up the amount by which the value of your car has depreciated (must be $2,660 or less if your car was bought new that year or was worth more than $12,800 at the beginning of the year).
  4. Total up your car-related receipts and depreciation for the year and multiply the total by the percentage you just came up with.
  5. Multiply just your business mileage by $0.31. This is the standard automobile deduction, calculated by mile.
  6. Compare the results of steps four and five. You will use the higher of these two numbers to get your deduction.
  7. If you are 100% self-employed, stop here. Your costs are fully deductible.
  8. If you are on the books at anyone else’s business as even a temporary and/or part-time employee, your car costs are subject to the “2% floor.” In this case, total up your Adjusted Income for the year (income minus expenses) and multiply it by .02. Subtract that amount from the business-related car expenses you came up with in step 6. This is the total amount you may deduct. If you come up with a negative number, you may not claim a deduction.

See? It’s complicated. I didn’t even mention things like specific deductions for hybrid vehicles or certain trucks, driving for charitable purposes and deductions for interest on leased vehicles. For all the nitty gritty stuff, start with this page directly from the IRS.