Travel expenses are a favorite deduction of many clients, because they love to travel and especially enjoy it when the IRS is subsidizing part of the expense. In order to deduct travel expenses, however, you must show that the expense has a business purpose and is ordinary and necessary to the business.
Travel expenses that have a business purpose include:
- Meeting customers/prospects/vendors residing in a different location;
- Searching for investment property;
- Meeting with business partners, both current and prospective; and
- Holding annual shareholder meetings (usually held in conjunction with an annual board meeting).
The phrase “ordinary and necessary" generally is defined to mean, “in the ordinary course of business" and that “the expense will contribute to the success of the business. "
If a taxpayer travels to a destination and while at such destination engages in both business and personal activities, traveling expenses to and from the destination are deductible only if the trip is related primarily to the taxpayer's trade or business.
If the trip is primarily personal in nature, the traveling expenses to and from the destination are not deductible even though the taxpayer engages in business activities while at such destination. Expenses while at the destination which are directly related to the taxpayer's trade or business are deductible even though the traveling expenses to and from the destination are not deductible.
Whether a trip is related primarily to the business or is personal depends on the facts and circumstances in each case. The amount of time during the period of the trip that is spent on personal activity compared to the amount of time spent on business is an important factor in determining the deductibility of the travel expense. Generally, if business is conducted more than 50% of the time in an eight-hour business day, the travel expense is deductible.
Travel expenses incurred on behalf of a spouse, dependent or other individual accompanying the taxpayer are not deductible. However, if the spouse, dependent or other individual is an employee of the taxpayer or there is a bona fide business purpose, then the travel expense is deductible.
Travel expenses involving a cruise ship typically are not deductible. However, they can be deductible if you are attending a convention on a cruise ship and you can show that attendance benefits your trade or business. No deductions for cruise ship expenses are allowed for meetings related to personal investments, political causes or other purposes.
There are additional restrictions relating to cruise ship travel. For example, there is a $2,000 annual limit on cruise conventions and you must attach a written statement to your tax return that includes certain facts about the convention.
Normally, expenses require simple documentation such as a receipt. However, travel expenses require additional documentation. If the IRS finds the taxpayer does not have sufficient documentation, the expense will not be deductible. The taxpayer must document the amount, time, place and business purpose of the travel expense.
Sufficient documentation of a business expense includes receipts, cancelled checks or bills. Although a contemporaneous log is not required, we normally recommend that our clients keep an itinerary of the business trip listing all business activities as documentation of the travel expense. The log should list all elements of the expense (e. g. , amount, time, place and purpose) as this has high credibility with the IRS. Documentary evidence, such as receipts or paid bills, is not generally required for expenses that are less than $75. However, the IRS has ruled that all lodging expenses must be documented.
The taxpayer may deduct a standard allowance as set by the federal government. This is called a per diem deduction. In lieu of receipts, taxpayer will deduct the per diem rates. Per Diem travel expense deductions are not allowed for owners.
Good news for those who hate keeping track of all of those pesky receipts when they travel. The IRS will allow you to deduct your meals and incidental expenses for travel away from home even without receipts. This is their Per Diem Allowance program.
The way it works is that the IRS has a table indicating the amount of deduction you can take on a daily basis for meals and incidentals while traveling away from home. If you choose to use this flat, per diem amount, you do not have to keep track of the receipts for these expenses. If you are not an owner in the business, you can even use the per diem method for travel and lodging. Owners can only use the per diem method for meals and incidentals.
Of course, per diem allowances, like deductions for actual expenses, may be used only if the time, place and business purpose of the travel are substantiated by adequate records or other evidence.
The IRS has issued per diem rates based upon the Continental United States ("CONUS") travel and foreign travel. New CONUS per diem rates become effective on October 1 of each year, and remain in effect through September 30 of the following year. Federal rates are on the Internet at http://www.gsa. gov/.
If employee expenses are substantiated using a per diem amount, and reimbursement exceeds the relevant federal rates for that type of allowance, then the employee is required to include the excess in gross income. The excess portion must be reported on the employee's W-2 and is subject to withholding. However, as long as the reimbursement amount does not exceed the relevant federal rates, then the amount is not taxable to the employee!
Other technical rules apply to using per diem rates. Be sure to work with your CPA to make sure you are following all of the technical rules before using the per diem method for documenting travel expenses.
Tom Wheelwright is not only the founder and CEO of Provision, but he is the creative force behind Provision Wealth Strategists. In addition to his management responsibilities, Tom likes to coach clients on wealth, business, and tax strategies. Along with his frequent seminars on these strategies, Tom is an adjunct professor in the Masters of Tax program at Arizona State University. For more information please visit http://www.provisionwealth.com.