Don’t get tripped up by travel expense rules

For many companies and their employees, business travel is a way of life. And though deducting travel expenses may seem like a routine business practice, the rules are complex — and a wrong turn can have significant tax consequences.If yours is like most businesses, it reimburses workers or provides advances for their travel expenses. The IRS tends to scrutinize expense reimbursement plans, so it’s a good idea to review yours periodically to be sure it qualifies as an “accountable plan.” If it doesn’t, both your company and staff may be in for an unpleasant tax surprise.

Away from home

Generally, deductible travel expenses are an employee’s ordinary and necessary expenses of traveling away from home for work. “Away from home” means:

• Job duties require the employee to be away from the general area of his or her “tax home” substantially longer than an ordinary day’s work, and
• The employee needs to sleep or rest to meet the work demands while away from home.

For most people, their tax home is their regular place of business. But there are special rules for employees who work in several different places, are on the road most of the time or are on a temporary or indefinite job assignment away from their regular place of business.

An employee doesn’t necessarily have to stay away from home overnight to satisfy the rest requirement. Suppose, for example, that Bob leaves home at 6 a.m. and drives to a business lunch with a client six hours away. He rents a hotel room for six hours, takes a nap, has dinner, meets with another client from 8 p.m. to 10 p.m. and then drives home. Bob is considered to be “away from home” for tax purposes.

Even if an employee isn’t away from home, his or her lodging expenses may be deductible under certain circumstances. Last year, the IRS announced that it would allow deductions for local lodging expenses if:

• The lodging is temporary,
• The lodging is necessary for an employee to participate in or be available for a bona fide business meeting or function of the employer, and
• The expenses are otherwise deductible by the employee as a business expense or would be deductible if paid by the employee.

This rule is intended to assist employers who wish to invite employees to stay at local hotels for retreats or other business functions.

Rules of the road

The types of travel expenses that are deductible depend on the specific circumstances. Generally airfare, taxis, rental cars, lodging, meals (subject to the limitations discussed below), business calls and tips can be written off. However, lavish or extravagant travel expenses aren’t deductible. An expense won’t be considered lavish or extravagant — even if it takes place at a deluxe restaurant or luxury hotel — as long as it’s reasonable under the circumstances.

Generally only 50% of business-related meal or entertainment expenses are deductible. The 50% rule doesn’t apply if the employer reimburses the employee under an accountable plan (more on this under “Travel plans,” below) because the employee isn’t able to claim the deduction. It also doesn’t apply to the self-employed if clients reimburse them for these expenses; in these situations, the clients are subject to the 50% rule.

Deductions for lodging — and for other travel expenses greater than $75 — generally must be substantiated with adequate records, such as credit card receipts, canceled checks or bills. Records should indicate the amount, date, place, essential character of the expense and business purpose.

A hotel receipt, for instance, should indicate the name and location of the hotel, along with the dates the employee stayed there. Charges for lodging, meals, telephone calls and other expenses have to be itemized. A restaurant receipt should show the restaurant’s name and location, the date, the number of people served and the amount, including separate charges for items other than food and beverages, such as taxes and gratuities.

Travel plans

For companies that reimburse their employees’ travel expenses, there are tax advantages to having an accountable plan. If you satisfy the requirements for an accountable plan, reimbursed travel expenses are deductible by the company, excluded from employees’ income and exempt from FICA and other payroll taxes.

If your plan is nonaccountable, the company still gets a tax deduction, but reimbursed expenses will be subject to payroll taxes and included in employees’ income. Employees may be able to deduct some or all of the expenses, but only if they itemize and only to the extent the expenses exceed 2% of their adjusted gross income.

A plan is accountable if:

• Reimbursed expenses have a business connection — that is, the employee must have paid or incurred deductible expenses while performing his or her job,
• Employees adequately account to the company for these expenses within a reasonable time, usually within 60 days after the expenses are paid or incurred, and
• Employees return any excess reimbursements or advances within a reasonable time, usually within 120 days after the expenses are paid or incurred.

Keep in mind that, even with an accountable plan, certain expenses may be ineligible and treated as if they were reimbursed under a nonaccountable plan. For example, reimbursements for nondeductible expenses, such as nonwork-related lunches for employees, would be treated as paid under a nonaccountable plan.

Mapping out a strategy

If you reimburse employees for business travel, review your policies and procedures to be sure your arrangements qualify for the tax advantages of an accountable plan. But even if you don’t have an accountable plan, you may still be able to reap tax savings. Either way, be sure to discuss this with your tax advisor. •

Pack light

Employers and employees can simplify their lives by using per-diem allowances for travel expenses. If you reimburse employees based on federal per-diem rates, they’re deemed to have been paid from an accountable plan, even if employees spend less than the allotted amount and pocket the excess. Employees needn’t worry about keeping track of every amount they spend, but they still have to provide records showing the time, place and business purpose to their employers. The federal government publishes per-diem rates for many destinations in the United States and abroad.

For travel in the United States, you can simplify the process even more by using the “high-low” substantiation method. Rather than tracking different per-diem rates for each locality, you simply use one rate for high-cost locations (currently $237) and one for low-cost locations (currently $152). Keep in mind that you need to check IRS Publication 1542 to determine if a location is considered high or low cost.

Another option is to reimburse actual lodging expenses and use the federal per-diem rate for meals and incidental expenses. Current meals-only rates are $58 for high-cost locations and $45 for low-cost locations.

To determine whether a per-diem approach is right for your business, weigh the added convenience against the potentially larger tax deductions available if you track actual expenses.