What if I told you that Corey deducted less than $5000 a year for these expenses? And what if I told you that Corey averaged less than $10,000 a year in income from his professional bodybuilding career? Okay so, no rich guy to make an example of here. Just the IRS calling buffalo meat and body oil personal expenses, not business deductions.
If you know any bodybuilders, you know that they understand the long game and have no problem spending as much time as necessary to accomplish their goals. So it may be no surprise that Corey disputed the audit and filed a petition in tax court to get his deductions deducted.
Care to wager a guess as to the outcome of Corey's case?
The IRS standard for deducting a business expense is that it must be “ordinary and necessary” for the business. Generally this means it's common in that line of work, and it directly relates to producing income or operating the business.
When it comes to things like vitamins and supplements, gym memberships, and hair cuts the IRS considers these personal expenses regardless of how much you argue that they matter for your business. [The Netflix subscription (because you watch movies while you work); the highlights and hair cut (because you're an influencer and your image is part of your brand); the dog sitter (because it was a business trip you went on), none of these are deductible expenses for your business.]
In the end, the court allowed Corey to deduct the body oil expenses only. The rest were deemed personal expenses and not deductible against his business/bodybuilding income*. (There are some fun explanations in this case about when and why a personal expense might qualify for a business deduction. If you want to know more about that, invite me for coffee and I will go on for hours about all kinds of obscure tax mumbojumbo).
So the lesson for self-employed folks and small business owners is if you try to deduct questionable expenses and your return gets examined by the IRS, it is likely you will not be allowed to deduct those things and will have to pay back taxes and related penalties and interest.
What's more, the deductions that are allowable must have documentation to back them up or they can be disallowed in an audit, even though they were legitimate.
So, for those expenses that are necessary for your business, you’ll need to keep records that include more than just the credit card statement line item with the vendor and the total amount. “Office Depot, $84” is not enough, "Printer paper and toner for client reports” is more like what we're looking for.
For expenses like meals and travel (including mileage) the IRS is extra picky about documentation. Meals, buffalo meat included, require the business purpose of the meal/meeting and a list of attendees (and most meals, whether they are local or while traveling are only 50% deductible. Some aren't deductible at all).
Mileage deductions require a log that includes the date, starting location, destination, total mileage, and the business reason for each and every trip.
If you travel for your business, you’ll need a description of the business purpose for the travel, and daily logs documenting the amount of time you spent working vs personal time. The percentage of the total time you were working is the percentage of the trip expenses you can deduct.
Developing habits of tracking these things early on will serve you well as your business grows. Some things to try:
first and foremost, set up and use separate business bank and credit/debit card accounts
write down purpose and descriptive info on receipts, snap a picture of the receipt, and upload to your accounting software
use a GPS-based app to track your mileage and add business purpose info as you go (or for the analog among us, keep a small notebook in the car and write down all the relevant info for every trip each time you drive)
And remember to keep all this documentation for at least 3 years from the date you filed your taxes.
Finally, let me remind you that there are ways to reduce the taxable income from your business without claiming unallowable deductions. If you’d like to learn more about that, let’s setup some tax planning time.
Disclaimers
Corey's case (Wheir v. Commissioner, T.C. Summary Opinion 2004-117) is for illustrative and educational purposes only and does not constitute formal tax or legal advice. Because the Wheir case was decided as a U.S. Tax Court Small Tax Case, it is only legally binding for the specific parties in the exact dispute and cannot be cited as precedent for other tax returns.
This information is provided to assist in understanding information relevant to the determination of whether an activity may be treated as a for-profit business for federal tax purposes. Conforming with the information provided does not guarantee that the Internal Revenue Service (IRS) will agree with the classification of the activity as a business.
Final determination is based on all facts and circumstances, and the IRS may reach a different conclusion upon examination. The taxpayer remains responsible for the accuracy and completeness of all information provided and for maintaining adequate records to support their position.
Now Corey believed, and perhaps rightly so, that all of these things were directly related to his ability to produce income (by placing in bodybuilding competitions) and therefore part of the operating costs of his bodybuilding profession. Seems reasonable, yes?
Well, maybe the frumpy accountant types at the IRS were unusually bothered by Corey's incredible physique, but for whatever reason, they audited his return and denied his deductions for the buffalo meat, vitamins, supplement-filled smoothies, and bodyoil.
You might be thinking, ok so how MUCH body oil are we talking here? Maybe Corey was one these celebrity-type multimillionaire guys deducting hundreds of thousands of dollars in questionable expenses, and the IRS was all like "we may be frumpy but we have rules about deductions for these entitled rich buff dudes."
There once was a bodybuilder name Corey. In order to compete at the highest professional level and earn a living by placing in top bodybuilding competitions, he required a considerable amount of the following: buffalo meat, vitamins, supplement-filled smoothies, and lots and lots of body oil.
