When employees travel for work, they expect to be reimbursed for the costs they incur. Developing a clearly stated travel policy that dovetails with IRS regulations can prevent misunderstandings and help ensure that expenses are reasonable and won’t result in the company or its employees paying unexpected taxes.
Accountable or nonaccountable?
How the IRS treats business travel reimbursements depends on whether the company has an accountable plan or a nonaccountable plan. Under an accountable plan, reimbursements for travel, meals and entertainment typically aren’t considered wages to employees. Conversely, reimbursements or expenses made under a nonaccountable plan are reported as wages on employees’ Forms W-2. These payments are subject to income tax withholding, as well as Medicare, Social Security and unemployment tax withholding.
Several requirements must be met for a plan to be considered accountable. For example, employees must do the following:
- Incur the expenses while doing their jobs.
- Adequately account for expenses by providing receipts or other records that prove the time and place of their trips, amounts spent, and the business purpose.
- Provide this accounting within a reasonable period of time. What’s considered “reasonable” depends on the facts and circumstances. The IRS notes that an employee accounting for expenses within 60 days after they were incurred or paid would likely meet the criteria.
- Return any excess reimbursements within a reasonable period of time. Even though what’s considered reasonable also will depend on the facts and circumstances, reimbursements made within 120 days after expenses were incurred or paid generally will make the cut.
Businesses that meet these requirements typically can deduct the costs its employees incur as travel, meal or entertainment expenses. Businesses whose travel policies don’t meet the requirements typically have nonaccountable plans — that is, they must report any reimbursements to employees as wages. Of course, these then can be subject to withholding for income tax, Social Security, Medicare and unemployment taxes. The costs also are reported as wages on the company’s tax return.
For many businesses, travel policies go beyond IRS requirements. Management wants to ensure the company’s travel dollars not only can be appropriately deducted, but are reasonable. The following guidelines can help reduce the risk of extravagant excursions incurred on the company’s dime, as well as the opportunity for fraud:
- Travel plans and expenses are authorized in advance.
- Employees are prohibited from authorizing their own travel, and must provide receipts for expenses over an established amount.
- Trips or expenses are undertaken with a clear business need in mind.
- The expenses are reasonable. For instance, many companies require employees to find the least expensive airfare that will allow them to arrive on time, and with a minimum amount of time away from work.
- To be reimbursed for miles driven, an employee must have a valid driver’s license and personal auto insurance.
- The company covers lodging expenses only when a business need requires an employee to travel a minimum distance (such as 50 miles) from his or her typical place of work. (See the sidebar “IRS updates local lodging expense criteria” for recent changes to the tax rules on local lodging expenses.)
- The company doesn’t reimburse amounts paid for hotel, airline or similar clubs. (The IRS typically doesn’t allow deductions for these expenses, either.)
Per diem reimbursements
Accounting for travel expenses can be tedious. One way to cut some of the paperwork is by moving to a per diem or other fixed travel allowance. Even though employees still must show that they traveled on business, as well as the time, place, and purpose of the travel, they’re paid a fixed or per diem allowance for the expenses. Perhaps the most common of these is the mileage allowance. For 2015, it’s 57.5 cents per business mile driven.
For some travel expenses, however, the per diem rate set by the IRS can be significantly less than the costs that even reasonable employees might incur. This is important because amounts reimbursed above this rate are treated as nonaccountable travel expenses. For instance, the per diem rate for lodging in Chicago ranged from $132 to $194 — the exact amount varied by month — between October 2014 and September 2015.
Work with a tax pro
Travel and entertainment expenses often attract the attention of the IRS. Ensuring they comply with regulations, and are reasonable and properly accounted for, is critical. That’s why it’s important to work with your accountant.
IRS updates local lodging expense criteria
Until recently, travel expenses that employees incurred locally — say, to stay at a hotel during a conference that happened to take place near the employee’s home — couldn’t be deducted. The IRS changed that in late 2014. Local lodging expenses that meet certain criteria can be considered ordinary, necessary business expenses and deductible.
Again, the deductibility of travel expenses will depend on the facts and circumstances. For instance, local lodging expenses that aren’t extravagant and that employees incur as a result of a bona fide work condition or employment requirement generally will be deductible.