Owners, managers and salespeople often incur travel and entertainment expenses. Manufacturers and distributors need to understand how to legitimately claim these deductions and properly substantiate them to ward off unwanted IRS attention.
Your company can deduct ordinary and necessary expenses that owners, employees and other business associates (such as prospective customers, suppliers or professional advisors) incur when traveling on business. These expenses include the travel costs of getting to and from your business destination (with the exception of employee commuting expenses), as well as any business-related expenses at your business destination. Examples include:
- Transportation by car, bus, train, boat or plane,
- Car rental at your destination,
- Shipping and baggage fees,
- Lodging and meals,
- Dry cleaning and laundry,
- Tips, and
- Phone and Wi-Fi access charges.
You can deduct all travel expenses if your trip was entirely business related. But be careful to deduct only the business-related portion of the expenses if you extend your business trip for a personal side trip.
In addition, if you have an accountable plan, you can exclude any qualifying employee reimbursements for such expenses from the employee’s taxable income — which also will reduce employment taxes.
Travel expenses, along with meals and entertainment costs, are IRS hot buttons. If your business claims these expenses for tax purposes, expect that the IRS may review your records at some point. So, it’s important to keep track of all expenses, using a log, diary, notebook or any other written record. Hold on to all this documentation for several years in case the IRS inquires about the deductions, including the expense’s:
- Time and place, and
- Business purpose.
If the expense is for meals or entertainment, you also must show the business relationship to the taxpayer of any person entertained. In general, business-related meals and entertainment costs are only 50% deductible — and they can’t be lavish or extravagant.
The IRS’s requirements can turn expense reimbursement into a tedious, time-consuming process. As the employee travels, he or she must collect paper receipts and keep a log of all business meetings.
Then he or she typically submits a monthly expense report for all travel expenses. These reports usually require managerial approval. Administrative delays may occur if documentation is incomplete or a supervisor questions the business purpose (or reasonableness) of an expense item.
The IRS does, however, allow some recordkeeping shortcuts that may be worthwhile. For example, a sales rep who sees the same customers on a regular basis may be able to enter just the customer’s name in her day planner or Outlook calendar, rather than repeat all of the details for every visit.
To simplify matters further, some businesses opt to use IRS-approved per diems, instead of reimbursing employees for their actual expenses for lodging, meals and incidentals while traveling.
Incidental costs don’t include: 1) transportation between places of lodging or business and places where meals are taken, or 2) mailing costs of filing travel vouchers and paying employer-sponsored charge card billings. These costs must be reimbursed separately from per diems.
Per-diem rates vary, depending on where and when the employee travels. If your company uses per-diem rates, employees don’t have to meet the usual recordkeeping rules required by law. Rather, the employer simply pays the specified allowance to employees. However, they still must substantiate the time, place and business purpose of the travel. In addition, individuals who own 10% or more of the business can’t be reimbursed using per-diem rates.
Planning and Training
Recordkeeping is critical when it comes to deducting travel and entertainment expenses. With proper planning and training, a tax advisor can help your company implement strong travel and entertainment expense reimbursement policies and procedures that will withstand IRS scrutiny.
Sidebar: Business vs. Personal Expenses: What’s Deductible?
Family-owned manufacturers tend to toe a fine line between personal and business expenses — and the IRS knows it. For example, a business owner might try to deduct the cost of an airplane ticket for a spouse to accompany the owner to attend a business convention. But unless there’s a bona fide business reason for the spouse’s presence, this expense isn’t deductible for business tax purposes and may need to be reimbursed to the company or included in the owner’s taxable compensation.
When a bill contains both personal and business expenses, it may seem easier to charge it all to the business. However, such shortcuts could lead the IRS to disallow the entire deduction. So, it’s critical to maintain clear and detailed records of how you’ve split the bill to prove you’re complying with the tax rules.
Commingling business and personal expenses may extend beyond travel. Owners may be tempted to deduct, say, salary expense for family members who don’t render services to the company, personal legal fees or home renovation costs as business expenses. There are also some gray areas, such as home office renovations and family birthday parties that are attended by key customers.
It’s important for business owners to understand what qualifies as a business expense and to always keep business accounts separate from personal accounts. If not, the business and its owners could wind up in hot water with the IRS.