Know the Rules for Travel Deductions
Sending employees on business trips is a crucial element for countless companies and can result in tax headaches for both the employer and the employee if the tax regulations are not adhered to.
If the rules are followed, the cost of the employee’s travel will be fully deductible to the employer, with the exception of meals, which are only 50% deductible, and tax-free reimbursement to the employee. In addition, the reimbursement is not subject to FICA or payroll withholding.
On the other hand, if the rules are not followed, the expenses are still deductible by the employer, but the reimbursement must be added to the employee’s taxable wages, subject to both FICA and payroll withholding.
Deductions and Reimbursements
An employer is able to deduct ordinary and necessary business expenses, including travel and lodging expenses that are not lavish or extravagant and, under the rules of working condition fringe benefits, any item that is deductible by the employer is not required to be included in the employee’s salary.
In addition, an advance or reimbursement made to an employee under an “accountable plan,” which requires the employee to adequately account for the expenses and return any excess advances, is deductible by the employer and not subject to FICA or income tax withholding.
Reimbursements made under a non-accountable plan are fully taxable to the employee, and the only way for the employee to deduct the expenses is as a miscellaneous itemized deduction on his or her 1040.
That requires the employee to itemize his or her deductions as opposed to taking the standard deduction, and the employee business expense category of itemized deductions is subject to a 2% of AGI non-deductible threshold. This frequently results in the employee being able to deduct none or only a portion of the expenses.
With the exception noted below, to deduct the cost of lodging and meals, the taxpayer must be away from home overnight. Any trip that is of such a length as to require sleep or rest to enable the taxpayer to continue working is considered "overnight." In addition, the trip must be taken primarily for ordinary and necessary business reasons while the employee is away from home.
Safe Harbor Exception
There is a safe harbor exception to the “away from tax home” overnight rule to deduct lodging expenses when the lodging is required by the employer and is necessary for the individual to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function.
The lodging cannot exceed five calendar days and may not recur more frequently than once per calendar quarter. The lodging cannot be lavish or extravagant under the circumstances and cannot provide any significant element of personal pleasure, recreation, or benefit.
Even if the safe harbor conditions aren’t met, “facts and circumstances” may still allow favorable treatment of the expenses. One factor is whether the taxpayer incurs an expense because of a bona fide condition or requirement of employment imposed by the taxpayer's employer and the expenses are not lavish or extravagant.
The IRS allows deductions for travel expenses because they are duplicate living expenses incurred by a taxpayer who has a regular home and thus incurs additional expenses while traveling. That is why a taxpayer generally isn’t allowed to claim travel deductions unless the taxpayer has a tax home and travels away from it.
The IRS defines “tax home” as the taxpayer’s regular or principal (if more than one regular) place of business, or if the taxpayer has no regular or principal place of business, the taxpayer's regular place of abode.
When considering duplicate expenses and the tax home definition, there may be situations when an itinerant employee, such as a traveling salesperson, does not maintain a permanent residence. For those individuals, home is wherever they are, and thus they cannot deduct meals and lodging.
How Long is Temporary?
Another issue that comes into play is the definition of "temporarily" away from home. How long is being away from home considered temporary, and when does the IRS consider it a permanent move, for which meal and lodging expenses not deductible as moving expenses are not allowed?
The IRS has ruled that if employment away from home in a single location is realistically expected to last (and does in fact last) for one year or less, the employment is "temporary" in the absence of facts and circumstances indicating otherwise.
If employment away from home in a single location initially is realistically expected to last for one year or less, but at some later date the employment is realistically expected to exceed one year, the employment will be treated as temporary (in the absence of facts and circumstances indicating otherwise) until the date that the taxpayer's realistic expectation changes.
For more information: IRS Travel Guidelines
We know the business travel rules are complicated, and you are encouraged to call this office if you have questions about them or need assistance in structuring your travel policies to ensure the best tax outcome for the business and its employees.
Have a question about business travel and taxes? Call us at (831) 462-0330 and let's discuss your business.