If you
filed for an extension you could still be in tax season or you might just be
preparing for the next one. Either way, boaters are using, or some are considering
using, their houseboat to conduct a business enterprise. What a great way to
claim a tax deduction for defraying some of those expenses associated with it,
right?
Navigating
the Internal Revenue Code is daunting and terms of depreciation for business
property, amortization, expensing limitations-well, it all make the eyes glaze
over, but here's an overview of selected tax regulations along with suggested ways
to keep track of expenses properly attributable to the business, red flags that
can trigger an audit, and tips on how best to avoid this unpleasant occurrence.
First,
many boaters have known for years that recreational boats could, and still may,
qualify for the second home tax deduction (tax form 1098) with interest paid on
boat loans being deductible. Boats used for business
purposes also come with deductions if meeting certain requirements which need
to be understood to decrease the chance of audit. (As an aside, experienced tax
professionals advise not claiming the well known "home office" deduction if
your residence is a target for auditors and particularly if it provides only
minimal tax savings.)
According
to the American Institute of CPAs, improved overall financial reporting and
enhanced transparency has become the norm in the business world, and the IRS
computers certainly have them on their radar. And just as large corporate yachts
operators must prove business-related expenses in a manner acceptable to the
IRS, so must individuals keep accurate records of use of their recreational boat
for business purposes.
Write Offs-Real
Company Examples
One boat
owner takes customers of his small, yet prosperous, electric company out on
fishing excursions along with doing extensive wiring jobs on docks in marinas
and resorts in the area. At tax time the cost of mooring, fuel, crew (when
used), insurance, legal fees (if any), financing costs, repairs, equipment and
other legitimate business expenses are subtracted from company earnings. Vessel
depreciation further lowers his taxable business income.
Buddies
who aren't customers that he takes for short fishing cruises pay a fee for the
angling trip (for food and fuel) which covers those expenses and makes sure
income can be shown against expenses. The tax advantage is that all expenses
are tax deductible against your other income, he explains. That includes
depreciation. It cost $23,000 just to paint the boat.
Whether a
sole proprietorship or, for instance, held as a limited liability company (and
mainly owned by individuals), U.S. Treasury Department officials advise the law
requires the `company' produce records establishing business use of the boat,
and any personal use by an individual must be reported as personal income. They
also readily admit luxury houseboats and yachts can catch the attention of
auditors the way a Rolls-Royce would draw attention versus a less luxurious
car.
Another
example of business use is a houseboater who uses his vessel to research
marinas and hidden bays for a cruising guide publisher, his vessel being the
primary tool of his business under an independent contract for services. And
yet another real estate seller utilizes his 92-footer which enables him to
deduct insurance, repairs, maintenance and other operational expenses (see IRS Pub.535
Other Business Expenses). So far both businesses have passed IRS muster with
both individuals noting that all allowable and appropriate expenses are written
off in conjunction with IRS regulations, the latter owner adding, "The boat
makes money because the boat makes money."
Business
Entertainment Expense
This
category of expense is a frequent topic of inquiry. (See IRS Pub.463.) What
expenses are deductible is not an easy question to answer as what are
deductible is often determined by the kind of business and particular
activities. Plus an expense must be "reasonable considering the facts and
circumstances." A business purpose must be served among business acquaintances.
If
entertaining for example, a combination of business and non-business persons at
the same onboard occasion, the entertaining expense must be divided pro rata
subject to the 50 percent allowable only limitation. The IRS legal tests are
the expenses must be "directly related" test and the "associated-with" test. And
an expense for hosting a client or customer with a dinner aboard must be
separated from say tickets to a dance or auction at the local yacht club.
Logging in
your designated log book, diary or notebook (along with on your computer having
backup disk regularly updated on hand), grouping certain "expenses of a similar
nature" is acceptable to the IRS. Substantiation by the best evidence possible
is the requirement. Receipts, cancelled checks, bills and invoices, showing the
amount, date, place and essential character of the expense are generally
considered adequate documentary evidence to satisfy recordkeeping rules. Think
timely and accurate.
Depreciation
Deduction On Business Property
Only
property used in a trade or profession or other income-producing activity can
be depreciated on your tax return. Depreciation can't be claimed on property
held for personal purposes such as your boat if not used for business. Some
kinds of business property that depreciate include machinery, equipment and
furniture. I write this with the caveat that `depreciation' and the rules
relating are a very complex subject in tax law.
For our
discussion, IRS Code Section 179 allows taxpayers to write-off a fixed amount
of capital expenditures on their return each year ($500,000 for 2010) rather
than depreciate them over multiple tax years. One limitation, however, is that
Section 179 expenses shouldn't be greater than the net income generated by the
business for which the property was acquired. (Goodwill, information databases,
customer lists, licenses and other intangibles can't be depreciated but could be amortizable over 15 years on
your return.)
Avoiding An
Audit
Finally,
the IRS has a standard tax auditing program. It advises that most people are
picked based on a computer analysis (that's based upon a closely-guarded
formula) to determine which returns are most likely to be in error. Most
filings singled out for audit are what they have basically always been-types of
deductions claimed, deductions that appear too high in relationship to income,
erroneous tax items, items that require proof or an explanation, or are on the
tax man's list of hot tax issues.
Recalling
our previous boat use examples, chances for audit are greater if: the business
receives cash in the ordinary course of business; there are complex business
expenses listed on the return; expenses are large in relation to the income
reported; a prior IRS audit resulted in a tax deficiency; a dockmate or other
informant has given information to the IRS; and unreported taxable income pops
up when the computers match with information gathered from banks and others
sources. (A common red flag are the traditional `self-employed.')
To learn
if your floating enterprise is listed on guides the government publishes for
auditors, call the IRS Freedom of Information Act Reading Room at 202-622-5164
or write to Box 793,
Ben Franklin Station, Washington,
D.C. 20044.
These can help pinpoint what auditors are looking for and how to best protect
yourself. As with any information, visit a tax professional for your specific
situation.
The author is a long-time East Coast boater with
a law degree. Questions or comments are welcomed at joan_writer@hotmail.com.
[Sidebar]
To order
publications mentioned go to www.irs.gov/formspubs or call 800-829-3676, or
write Internal Revenue Service, 1201 N. Mitsubishi Motorway, Bloomington, IL
61705-6613.