For many companies, business travel is a way of life. Deducting travel expenses is often a routine business practice, but the rules are complex—and a wrong turn can have significant tax consequences.

Things get even more complicated if your business reimburses or provides advances for employee 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.

Leaving 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. There are special rules for employees who have multiple work locations, are on the road most of the time, or have a temporary or indefinite job assignment away from their regular place of business.

An employee does not necessarily need to be 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 have been “away from home” for tax purposes.

Even if an employee is not away from home, his or her lodging expenses may be deductible under certain circumstances. The IRS generally allows deductions for local lodging expenses if:

  1. The lodging is temporary,
  2. 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
  3. 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.

Following the rules

The types of travel expenses that are deductible depend on the specific circumstances. Typically, businesses may write off the costs of airfare, taxis, rental cars, lodging, meals, business calls and tips. Expenses that are lavish or extravagant are not deductible, but an expense will not be considered lavish or extravagant — even if it takes place at a deluxe restaurant or luxury hotel — as long as it is reasonable under the circumstances.

Deductions 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.

Getting accountable

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

If your plan does not qualify as an accountable plan, the company still gets a tax deduction, but reimbursed expenses will be included in employees’ income and subject to payroll taxes. The employee may be able to deduct some or all of the expenses that were added to their income, 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.

Per Diem rates may simplify travel expenses

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 are deemed to have been paid from an accountable plan even if employees spend less than the allotted amount and pocket the excess.  Federal per-diem rates are set by the U.S. General Services Administration, and can be found at www.gsa.gov.

With this method, 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.

Another option is to reimburse actual lodging expenses and use the federal per-diem rate for meals and incidental expenses.

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.

Mapping out a strategy

Review your policies and procedures to be sure your reimbursement arrangements qualify for the tax advantages of an accountable plan, and be sure to discuss this important topic with your tax advisor.