Don’t Get Tripped Up
Mapping the Best Route for Higher Travel-expense DeductionsSome business owners and managers think of traveling for business as burdensome; however, others enjoy such trips and seek opportunities for additional travel. One reason is that the IRS business travel rules make it possible to obtain unique tax benefits. For example, the deduction for the round-trip cost of travel undertaken primarily for business can effectively subsidize a mini-vacation taken along the way, or result in a partially tax-free perk for an employee.
The deduction for travel expenses must pass various tests — in particular, whether a sufficiently direct connection exists between the expenses and the income-producing activity of the taxpayer and whether the expenses are excess or personal in nature. In addition to these controversial rules, the IRS limits deductions for business travel when involving foreign travel, including conventions, cruise-ship conventions, and when spouses accompany the business traveler. This article will explain the often-complex limits on deductions.
In general, deductions for travel expenses are allowed because the costs either are duplicative of expenses that the taxpayer must pay in any event (e.g., a taxpayer who rents a hotel room while out of town on a two-week business trip must continue to pay rent or other expenses for his residence even though he is away), or require the taxpayer to pay more for some expenses than he would if he were at home (e.g., meals). Nonetheless, the deduction allows somewhat of windfall to the taxpayer because, in the Supreme Court’s words, “at least part of what he spends … represents a personal living expense that other taxpayers must bear without receiving any deduction at all.”
Travel to a business convention is treated as business travel if attendance benefits the taxpayer’s trade or business. If a business convention takes place outside of the U.S. but within the North American area, the trip is treated the same way as any other form of business travel. In general, the North American area includes Canada, Mexico, Puerto Rico, the U.S. Virgin Islands, Bermuda, and numerous Caribbean countries such as Barbados, Costa Rica, the Dominican Republic, Grenada, Jamaica, Saint Lucia, Trinidad, and Tobago.
If the foreign convention takes place outside of the North American area, then there’s no business travel deduction unless the meeting is directly related to the active conduct of the taxpayer’s trade or business, and the taxpayer can prove that it is as reasonable for the convention to be held outside of the North American area as within it. An example of this would be the residences of the active members of the sponsoring organizations and places where other meetings of the sponsors have been or will be held.
Even if a foreign convention satisfies the ‘as reasonable’ test, the taxpayer does not automatically get a deduction for all his travel expenses. Foreign-convention travel expenses remain subject to the allocation rules that apply to foreign business travel.
The foreign business-travel rules diverge from those for domestic business travel when the taxpayer undertakes a trip primarily for business reasons, but also takes some personal days at the foreign destination. In this situation, the transportation expenses must be allocated between deductible business activities and non-deductible personal activities, unless one of the tests is met. These tests include:
• The traveler had no substantial control over arranging the trip;
• The trip is for one week or less;
• Less than 25% of the time outside the U.S is for personal matters; or
• Vacationing was not a major consideration in arranging the trip.
If foreign travel doesn’t meet one of these four full-deductibility tests, the non-deductible portion of the transportation expenses — the cost of getting there and back — generally is determined by using a day-to-day allocation formula.
When a convention takes place on a cruise ship, another set of rules apply. A cruise ship, for purposes of these rules, is any ship sailing within or outside of U.S. territorial waters. No deduction is allowed for business or professional conventions held on a cruise ship unless:
• The convention is held on a U. S.-registered cruise ship;
• All ports of call during the convention are in the U.S. or U.S. possessions; and
• The taxpayer can establish that the meeting is directly related to the active conduct of his trade or business.
If the convention meets these rules, there still is a dollar cap on the amount deductible. This cap is $2,000 per person annually.
Some taxpayers take their spouses or other companions along on business trips. Although the rules are tough, in some cases it may be possible to deduct the spouse’s (or other companion’s) travel expenses, or be reimbursed for those expenses tax-free. In fact, there may be a benefit to the business traveler even if the spouse’s (or other companion’s) travel expenses aren’t deductible or reimbursable tax-free.
As a general rule, the IRS allows no deduction for travel expenses paid or incurred for a spouse, dependent, or other individual accompanying the taxpayer (or an officer or employee of the taxpayer) on business travel, unless:
• The spouse, etc. is an employee of the taxpayer;
• The travel of the spouse, etc. is for a bona-fide business purpose; and
• The expenses would otherwise be deductible by the spouse, etc.
This rule does not apply to a companion who is the taxpayer’s business associate (e.g., an unrelated fellow employee), makes the trip for a bona-fide business purpose, and could otherwise deduct the travel expense if he or she incurred it.
When an employee is away from home overnight on business, the employer may decide to reimburse the travel expenses of his spouse or other travel companion. If the travel does not qualify as an excludable fringe benefit, the employee must include in gross income the value of the spouse’s or other companion’s company-paid travel expenses.
Where a corporation fails to include the spousal travel in an employee’s W-2, the corporation can be disallowed the deduction. This disallowed deduction does not eliminate the employee being required to report income related to this benefit. This can be particularly burdensome where the employee is a shareholder owner.
An employer can avoid winding up with disallowed deductions for a spouse accompanying an employee on business travel by characterizing the travel as employee compensation on its originally filed return, and as wages for Social Security and income-tax withholding.
What is a bona-fide business purpose for the spouse’s presence? There is no detailed guidance on this question. IRS guidance states that the taxpayer “must prove a real business purpose for the individual’s presence. Incidental services, such as typing notes or assisting in entertaining customers, are not enough to warrant a deduction.”
Depending on the circumstances, however, a bona-fide business purpose probably would be found to exist where the spouse or other companion:
• Performed the duties of a secretary (scheduling meetings and appointments, writing up notes of meetings, checking and answering office e-mail);
• Acted as a translator for the business person (e.g., a spouse fluent in Spanish accompanies an executive on a Latin-American trip); or
• Went along to trade shows and assisted with running the company’s booth or display.
Even if the spouse’s or other companion’s travel isn’t deductible, the taxpayer may still be able to deduct a substantial portion of the trip’s costs. That’s because the rules don’t require the business traveler to allocate 50% of his travel costs to the spouse. The business traveler only has to allocate to the spouse any additional costs incurred for him or her. And if the business traveler drives their own car or rents a car, the cost will be fully deductible even if the spouse is along for non-business purposes. Of course, any separate costs incurred on behalf of a spouse for public transportation and for meals would not be deductible at all.
While the idea of traveling seems straightforward, it should be clear by now that it is almost mind-boggling how complicated the tax rules in this area have become. However, with proper planning and good tax guidance, a traveler can structure business travel to reap the greatest benefit.
Kristina Drzal-Houghton, CPA, MST is the partner in charge of Taxation at Holyoke-based Meyers Brothers Kalicka, P.C.; (413) 536-8510.