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Don’t Let Travel Deductions Trip You Up

March 13, 2024

by Liz McGrath, Tax Director at Schulman Lobel LLP, New York, NY

Did you know that employers may deduct employees’ travel expenses, including amounts for meals and lodging, if both the employer and the employee carefully follow the tax rules? Conversely, if the rules are not followed, the expenses will be taxable to the employee and fully subject to FICA and payroll tax withholding requirements.

In general, employers engaged in any trade or business may deduct ordinary and necessary business expenses paid or incurred during a tax year. Deductible expenses include those incurred by an employee who is away from home in pursuit of a trade or business, excluding any lavish or extravagant expenses.

Determining Whether Expenses Are Deductible and Nontaxable
To determine whether expenses will not be taxable to the employee and not subject to withholding requirements, the following question should be asked: Were the expenses paid to or on behalf of the employee under an “accountable plan or a non-accountable plan”?

Ordinary and necessary business expenses are deductible by the employer and not taxable to the employee if they are paid under an accountable plan. The IRS regulations define an accountable plan as one in which (1) the employee receives the advance or reimbursement for expenses that they are paid or have incurred while performing services as an employee of the employer; (2) the employee must adequately account to their employer for the expense within a reasonable period of time; and (3) the employee must return any excess reimbursement or allowance within a reasonable period of time.

Although an advance or a reimbursement of expenses made under a “non-accountable plan” will be deductible by the employer, it will be treated as compensation to the employee and subject to FICA and income tax withholding. Therefore, it is important that employers follow proper accounting procedures so that employees can report their travel expenses appropriately and in a timely manner.

The Catchall Deductibility Rule for Travel Expenses
There is one condition that makes all ordinary and necessary expenses of business travel deductible. This catchall deductibility is achieved when employees are away on business overnight. If the employee did not stay overnight, then only the cost of travel is deductible as business transportation. However, if the employee stayed overnight at a location away from their home, then the trip is treated as business travel, and the expenses of travel, lodging, and 50% of meals are deductible. In order for a business trip to be considered as qualified business travel, (1) it must involve overnight travel; (2) the employee must travel away from their home; (3) the trip must be undertaken solely, or primarily, for ordinary and necessary business reasons; and (4) the employee must be temporarily away from home (we’ll describe the time period in more detail below).

Sleep or Rest Test for Deductibility
The IRS rules do not say that the employee must be away from dusk to dawn, but the rules say that the trip should be of a length that requires sleep or rest to enable the employee to continue working. Under certain conditions, local non-lavish expenses incurred for lodging while not away from home overnight on business may be deductible. For example, lodging expenses incurred for the employee to participate in a bona fide business meeting, conference, training activity, or other business function are deductible. However, in these instances, lodging may not exceed five days and may not recur more frequently than once per calendar quarter.

Change of Home and Duplicity of Expenses
Deductions of business travel expenses are allowed because the expenses are duplicative of costs normally incurred at the employee’s home, or, specifically, their tax home. Consequently, the employee cannot claim deductions for meals and lodging unless they have a home for tax purposes, and travel away from it overnight. Accordingly, no deduction is allowed when a business person sleeps at a local hotel, instead of traveling back to their nearby home, as the tax home has not changed during the overnight stay.

The tax rules are different when the employee does not maintain a permanent residence. A traveling salesperson, for instance, who moves from place to place, making their “home” wherever they stay, does not have a permanent residence, and therefore, as they will not have duplicative expenses, no deduction for meals and lodging is allowed.

Travel Must Be Temporary
The IRS rules state that an employee’s term away from home must be temporary. Excluding employees in certain professions, an employee will not be treated as temporarily away from home if the business trip exceeds one year. If employment away from home in one location is initially expected to last one year or less, but the term is expected to exceed one year at some later date, the employment will be treated as temporary through the date that the employee’s expectation changed. Finally, the IRS considers that “breaks in service” of three weeks or less, do not “stop the clock” in applying the one-year temporary workplace limit.

International Travel Expense Deductibility
As regards international travel, an employee may take deductions for unreimbursed business expenses if they are away from their home in the U.S. for a period of not more than one year. After more than a year of living overseas, the foreign earned income exclusion rules will provide some tax relief, allowing the employee to exclude the income earned overseas subject to the annual limitation, as they will not be able to deduct away-from-home business expenses.

As spring approaches and we plan our vacations, hoping to find the perfect mix of fun and relaxation, perhaps now is a good time to think about how we can plan our business travel to achieve the optimum in tax savings.