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Got the Documents? Tax Court May Allow What the IRS Won't

In January, Seattle-based general contractor Steve Cramer had a lovely break from the Pacific Northwest's winter floods. He and his wife Celia, vice-president of Steven D. Cramer & Associates Inc., spent a few days in Las Vegas. They stayed at the MGM Grand Hotel, saw Bette Midler and the Four Tops, and played a little blackjack. Because the two were also checking out home-entertainment systems, which the company installs, at a consumer-electronics show, most of the trip was tax-deductible.

The travel, entertainment, and meal expenses taken by the Cramers are well-known perks of owning a business. They're nice, but they're not the only way to have fun on Uncle Sam's dime. With a little imagination and some careful planning, you can deduct a lot more. How about writing off some Cuban cigars? A NASCAR team? A country club membership? And what better time than now, with the pain of tax season over, to think about tax-deductible pleasure?

TOO CAREFUL? ''Just because it's a tax deduction doesn't mean you can't enjoy it,'' says Denver accountant James Vonachen. Rather than abusing opportunities, ''most people are more conservative than they need to be,'' says Rory Deutsch, a tax-law partner at Roberts, Sheridan & Kotel in New York.

The rule of thumb is the commonsense notion that a deduction must be directly related to a legitimate business purpose. Sound simple? Consider some deductions the U.S. Tax Court has approved through the years. In 1954, the owners of a Pennsylvania dairy farm prevailed in writing off an African safari as a publicity stunt--but only after proving that the board of directors had weighed the potential benefits of the trip. In 1983, the owner of a Wisconsin slaughterhouse, who wrote off sponsorship of a local-circuit race car, beat the Internal Revenue Service by proving that his farmer-clients saw the company's name on the vehicle. Another racing aficionado was NASCAR fan Paul S. Dwyer, a Colorado real estate developer. He set up a separate company for racing. The IRS disallowed it, insisting it was a hobby. But in 1991, the Tax Court, noting, among other factors, that Dwyer quit driving after two winless years, disagreed.

So it's not so simple after all. Obviously, thinking big means making sure your claim is backed by the proper paperwork. One New York law firm, for instance, rents an upstate getaway during ski season. The firm invites clients (no spouses) for work-play weekends and writes off the cost. The lawyers make sure dated computer and fax documents prove work got done--even if it was between ski runs.

For all tax deductions--and particularly the more interesting ones--documentation is crucial, says Bernard Kent, a CPA at Coopers & Lybrand. When entertaining clients, he advises keeping a log of whom you took out and what business was discussed. With more exotic deductions it's best to keep records of internal company discussions, too.

RED FLAGS. Clearly, inventive deducting does increase the odds of an audit--and defending a deduction can be more expensive than just paying up. But what really raises red flags at the IRS is proportion. Deductions too high for adjusted gross income will automatically kick out your return for review. (The IRS is secretive about the magic percentage, but accountants figure it's around 35% to 40%.)

Some deductible pleasures fly under the IRS's radar completely. It's no secret that up to $25 in freebies per employee are deductible as de minimus benefits--no receipts required. But did you think, as one Manhattan law firm did, to use that provision to write off cigars that happened to be from Cuba? More substantial in-office items might include TVs and video and stereo equipment. What the IRS may eventually want to know is how they improved your ability to conduct business.

As Tax Court cases show, what may appear to be a wild scheme to some--and to the IRS--often passes judicial muster. Unfortunately, though, precedent is no surefire guide, since court decisions are based narrowly on the facts of each case. But one point is clear: There's often no law against mixing business and pleasure.

By Edith Updike in New York, with Stuart Weiss in Portland, Ore.


Updated June 15, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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