If you itemize employee business expenses or are self-employed and you incur expenses related to your business, the IRS requires that you maintain the appropriate supporting documentation. This information would be presented to the IRS representative in the case of an audit.
First and foremost, expenses must be proven to be "ordinary, necessary and reasonable" to your business or employment to be deductible. Your Hawaiian vacation, although expensive and enjoyable, is probably not deductible as a business expense, even though you thought about work while you were lying on the beach!
Basic documentation required includes cancelled checks and receipts which prove that the expense was actually incurred. Auditors generally frown upon "cash receipts", so credit card receipts and cancelled checks are usually better.
For meals and entertaining, the receipt should have a notation which indicates who you entertained, when, where, and the specific business purpose for the activity.
For automobile expenses, you first need to determine the percentage used for business. This is generally calculated by dividing the number of business miles driven by the total miles driven (Note: business mileage does not include your normal commute to and from your primary place of business). The IRS requires that you maintain a written "log" of your business mileage, usually in some sort of calendar or diary. Total mileage should be documented my noting your odometer reading on January 1st and December 31st of each year.
One final word about business expenses: If you are employed at a company that has a reimbursement policy for business expenses, you should apply for reimbursement, rather than paying your expenses and deducting them on your tax return. This is important for two reasons: 1) A one hundred percent reimbursement is always better than a limited deduction on your tax return and, 2) The IRS will not allow any deduction for an expense incurred which would have been reimbursed by an employer, whether or not you actually applied for and received a reimbursement.
