Tax and Business Alert - October 2003

Have you ever had an expense report returned unpaid along with a request for more supporting information on a travel and entertainment (T&E) expense item? This is a common occurrence because of stringent IRS documentation requirements to support T&E expenses. Even though there may be no question as to the deductibility of an expense, it may be disallowed by the IRS for lack of substantiating documentation. The information in this article should help you and your employees adequately substantiate your T&E expenses and avoid future documentation requests from the accounting department or, worse yet, the IRS.

Substantiation Requirements.
Substantiation rules apply to expenses incurred for either business or investment purposes such as: (1) overnight travel, including meals and lodging; (2) meals, entertainment, and recreational activities; (3) local transportation expenses; (4) gifts; and (5) the use of property such as an automobile, cell phone, or computer for a business purpose. IRS rules disallow a deduction for these expenses unless you maintain adequate records to substantiate the:

· Expense amount.
· Time and place the expense was incurred.
· Business purpose of the expense.
· For gifts, a description of the item given and the business relationship you maintain with
  the person receiving the gift.
· For entertainment expenses, your relationship to the person or persons entertained.

Documentary evidence (paid bill, written receipt, or similar evidence) is required to substantiate all T&E expenses of $75 or more. However, a written receipt is always required for lodging while traveling away from  home, regardless of the amount. A credit card statement is not sufficient documentary evidence of a lodging expense. Instead, a hotel bill showing the components of the hotel charge is required. For transportation charges, documentary evidence is not required if not readily available (e.g., cab fare). Although the IRS requires documentation of T&E expenses only when they are at least $75, many businesses set a lower threshold for their own internal reimbursement purposes.

The Per Diem Method.
Rather than pay for actual expenses, an employer can use a per diem allowance to reimburse employees for business travel expenses incurred while away from home. The per diem amount can be at or below the applicable federal per diem rate, a flat rate or stated schedule, or in accordance with an IRS specified rate or schedule. The amount deemed substantiated by the IRS for each calendar day (or partial day) is the lesser of the employer's per diem allowance or the amount computed at the federal per diem rate for the locality of travel.

The maximum per diem amounts deemed substantiated under the IRS guidelines are those that apply to federal employees. There are two separate rates for each locality: a rate for lodging and a rate for meals and incidental expenses.

Tax Calendar

October 15 --Deadline for filing 2002 Form 1040 if an extension was filed in August,
                   --Forms 5500 that were automatically extended in July are also due today.
                   --The same is true for calendar-year partnership returns (Form 1065) and
                     trust returns (Form 1041) on an extension.

Funding College Expenses with IRA Distributions

The cost of a college education is increasing more rapidly than wages or inflation. As you search for the financial resources to pay the ever-increasing cost of a post-secondary education, your IRAs may provide a potential source for that funding. Taxable IRA distributions in an amount up to your qualified higher education expenses for the year are not subject to the 10% early distribution penalty for taxpayers under age 59. However, your entire distribution, or a portion thereof, may be subject to regular taxation even though the penalty is avoided.

Qualified higher education expenses include education expenses incurred by you, your spouse, children, stepchildren, or grandchildren (including your spouse's grandchildren). The expenses must be for tuition, fees, books, supplies, or required equipment at an eligible educational institution. Expenses for room and board also qualify, up to the minimum amount included in the institution's cost of attendance. However, your qualified education expenses are reduced by any scholarship, education assistance allowance, or other payment (but not by a gift, bequest, devise, or inheritance) for your education expense that is excluded from your gross income.

Example: John is age 48 and has a traditional IRA with a balance of $ 100,000 (no basis). His daughter Taylor attends an eligible educational institution while living at home. Her 2003 tuition, books, and supplies cost $20,000. John may withdraw up to $20,000 from his IRA in 2003 to pay Taylor's eligible higher education expenses without incurring the 10% penalty. (However, the $20,000 would be included in John's taxable income.)

If Taylor receives a $10,000 scholarship in 2003, John may only withdraw up to $10,000 from his IRA for Taylor's eligible education expenses without incurring the 10% penalty.

Eligible educational institutions include accredited postsecondary educational institutions offering credit toward a bachelor's, associate's, graduate, or professional degree, or other recognized post-secondary credential. Certain post-secondary vocational institutions are also included.

Note: See page four for information on penalty-free IRA withdrawals for first-time homeowners.

Interesting Websites

Do you own or are you thinking of starting a business? The Kauffman Foundation's Entreworld website at www.entreworld.org features "A World of Resources for Entrepreneurs." The website is a public service provided by the Kauffman Foundation designed to provide entrepreneurs with essential information as quickly and easily as possible. This website centralizes important business resources from the best external sites, combines that information with their own content which is added daily, and makes all the information easy to find.

Thinking of starting a home-based business? Barbara Brabec at www.barbarabrabec.com offers information and inspiration for home-business owners who are striving for financial success and happiness in both their professional and personal lives. Brabec is the author of several books on how to profit from a home-based business built around one's life/work experiences, special interests, or natural creativity. The website reflects her professional and personal interests, activities, philosophy, and beliefs.

Charitable Contributions 101

As we enter the final quarter of the year, many of us will be reviewing our charitable giving strategy to ensure we meet our 2003 goals and commitments. We thought this would be an appropriate time to review some basic charitable deduction limitation and substantiation information.

Deduction Limitation.
If you contribute cash or property to a qualified charity, you can claim the contribution as an itemized deduction. (Sorry, no deduction is allowed for taxpayers who do not itemize.) The limit on your charitable contribution deduction allowed for any one year is based generally on your adjusted gross income (AGI) for that year. The maximum contribution deduction allowed is 50% of your AGI. The limit on your contribution deduction may be reduced significantly (as a percentage of your AGI) depending on the type of organization receiving your contribution and the kind of property you contributed. Excess contributions not used in the current tax year can be carried over to the five succeeding tax years.

Substantiating Contributions.
Recordkeeping requirements for charitable contribution deductions vary based on whether the contribution is made in cash or property and the amount of cash or the value of the property contributed.

Cash and property contributions of less than $250.
Cash contributions must be substantiated by one of the following: (1) a cancelled check, (2) a receipt from the charitable organization showing your name, the date, and the contribution amount, or (3) other reliable records containing the same information.

Property donations must be substantiated by (1) a written receipt or letter from the charitable organization showing its name, the date and place of contribution, and a detailed description of the property; or (2) if it is impractical to obtain a receipt, reliable written records containing the (a) organization's name, date and place of the contribution, and a detailed description of the property, (b) fair market value of the property and how it was determined, (c) property's cost or other basis, (d) terms or conditions attached to the gift, (e) deduction amount, and (f) for securities, issuer's name, type of security, and whether the security is regularly traded on a stock exchange or over-the-counter.

Property contributions of more than $5,000. If you donate an item or group of similar items valued at more than $5,000 in the aggregate during the same tax year (whether or not donated to the same charity) you must obtain a qualified written appraisal and attach to your tax return a completed "Appraisal Summary" signed by the appraiser and a representative of the charitable organization. For example, if you gave books to three schools and you deduct $2,000, $2,500, and $900, respectively, your claimed deduction is more than $5,000 for these books. You must get a qualified appraisal of the books, and for each school you must attach a fully completed appraisal summary to your tax return. These requirements do not apply to contributions of money or publicly traded securities that have market quotations readily available.

Penalty-free IRA Withdrawals for First-time Homebuyer

Are you looking for a new home, but are a little short of cash for the down payment and closing costs? A penalty-free withdrawal from your IRA may be the solution to your cash flow problem if you can qualify as a first-time homebuyer.

How to Qualify as a First-time Homebuyer. Your new home does not have to be your first to qualify as a first-time homebuyer. A first time homebuyer is an individual who has not had an ownership interest in a principal residence during the two-year period ending on the date of acquisition of the principal residence. If the individual is married, the spouse must also meet this two-year requirement. The date of acquisition is the date the individual enters into a binding contract to purchase a principal residence or begins construction of such a residence. So, for the purposes of these rules, the first time homebuyer is not necessarily someone buying a first home. Rather, the homebuyer (and spouse) must not have owned a principal residence for two years before the new home is purchased to qualify as a first-time homebuyer.

Waiver of the Early Withdrawal Penalty. IRA withdrawals used for qualified first-time homebuyer expenses are not subject to the normal 10% premature distribution penalty for taxpayers under age 59 ½. However, your entire distribution, or a portion thereof, may be subject to regular taxation even though the penalty is avoided. Qualified first time homebuyers distributions are withdrawals of up to $10,000 during the individual's lifetime that are used to pay the costs of acquiring a principal residence for a first-time homebuyer. For married taxpayers, each spouse qualifies for up to $ 10,000 in penalty-free withdrawals, but each spouse must withdraw the funds from their own individual IRA accounts.

Using the Penalty-free Funds. The penalty-free distribution must be used within 120 days of receipt to pay costs (including reasonable settlement, financing, or other closing costs) of acquiring, constructing, or reconstructing the principal residence of a first-time homebuyer who is the individual, the individual's spouse, or a child, grandchild, or ancestor of the individual or individual's spouse.

The 10% penalty tax on early withdrawal does apply to any amounts not used to acquire the home within 120 days unless the 120-day rule cannot be satisfied due to a delay in the acquisition of the residence. In that case, the individual can avoid the 10% penalty by putting all or part of the amount withdrawn into the same or a new IRA before the 120-day period expires.

Quailing Accounts. The first-time homebuyer withdrawal rules apply to traditional and Roth IRAs, but an individual's $10,000 lifetime limitation is the same regardless of the number or types of IRAs. Withdrawals from a Roth IRA will not always present a penalty problem, because Roth IRA withdrawals are considered to be tax-free distributions of contributions first (on which no penalty would apply). In addition, they are not taxable or subject to the 10% early withdrawal penalty if made more than five years after the individual's first tax year for which a Roth IRA contribution was made.