Arguably one of the most difficult areas to administer for payroll professionals is business travel.
Much documentation is required to substantiate expense reimbursements for employees taking business trips, and faulty procedures can result in the employer having to add such expenses to employee income and apply appropriate employment taxes to those amounts.
Internal Revenue Service Publication 463, Travel, Entertainment, Gift, and Car Expenses, defines qualified tax-free travel expenses as the ordinary and necessary expenses of traveling away from home for business, profession, or job. Although some organizations may categorize business travel as a benefit, or a perquisite, it is not.
For tax purposes, qualified amounts paid by employers are excepted from income under Section 62 of the Internal Revenue Code. Generally, if such expenses would otherwise be deductible for an individual on travel for business, then employers that pay or reimburse employees for amounts spent while on business travel do not need to add such amounts to employee income.
However, employers need to apply such a travel expense program using an accountable plan to maintain tax-free status of the amounts paid. Similarly, the travel time of employees on business needs to be accounted for to comply with potential state tax requirements on earnings, as well as federal regulations for wage and hour (for traveling workers who are not exempt from overtime pay).
Accountable plans: three requirements
To be considered an accountable plan under federal tax provisions, a reimbursement or other employee expense allowance arrangement must comply with these requirements:
• Business connection—The reimbursements, advances, or allowances provided to employees under the plan must be for work-related expenses that would be deductible by the employee if claimed as a deductible business expense on the worker's personal return. Any advance payments must be reasonably related to business expenses that a worker is expected to incur.
• Substantiation—Employees must substantiate, within a reasonable period of time, the amount, time, use, and business purpose of the allowance or expense payment. In lieu of substantiation of actual expenses, employers can use one of the IRS-approved ‘‘deemed’’ substantiation methods, such as per diems.
• Return of excess payments—The plan must require employees to return, within a reasonable period of time, any reimbursements or advances that exceed substantiated expenses, or, in the case of a per diem, payments for days not traveled. However, if an employee uses part of an advance payment that exceeds the amount that was incurred and substantiated to pay for other business expenses, the excess amount that was used need not be returned.
A reasonable period of time depends on the facts and circumstances, according to IRS Publication 535, Business Expenses.
Employers are provided with two safe-harbor procedures for determining what constitutes a ‘‘reasonable period of time’’ for employees to comply with the accountable plan requirements of substantiating expenses and refunding excess payments. While the IRS rules generally note that reasonable-time determinations will be made on a case-by-case basis, they also outline these methods for meeting the timeliness requirements:
• Under the fixed date method, IRS will treat as timely: advance payments made no more than 30 days before an employee incurs business expenses; expenses that are substantiated within 60 days after they are incurred or paid; and excess payments that are returned to the employer within 120 days after being incurred or paid.
• Using the periodic statement method, an employer can issue periodic statements to employees, at least quarterly, regarding unsubstantiated expenses or unreturned excess payments, and the timeliness requirements will be satisfied if employees substantiate the expenses and refund any excess within 120 days of the statement.
Federal substantiation requirements
To be excluded from taxable wages, several different types of reimbursed costs incurred during business travel need to be documented based on the nature of the expense. A variety of options exist for substantiating certain costs, such as lodging and meals, where exact amounts need not be reported to qualify as tax-free, while others require a more direct-cost approach, such as airfare or other transportation amounts.
It is important that records be kept of all the expenses and any advances that are covered by an employer. Employees can use a log, diary, notebook, or other written records to track expenses. Employers also need a system to implement an accountable plan that identifies costs and ensures appropriate substantiation exists on the amounts. If reimbursements for travel are made at the same time as regular wage payments, the reimbursement for expenses must be separately paid or separately identified, or the reimbursement will be considered taxable wages.
IRS has instructed its field examiners that travel-expense reimbursement plans that show a ‘‘pattern of abuse’’ should be declared nonaccountable and all reimbursements made under them considered taxable income to the employees.
Actual cost substantiation, reporting
Employee travel costs paid by employers can be tax free only if made under an accountable plan. Certain elements of these costs must be tracked and reported in exact amounts in order to keep the plan compliant. These costs include:
• amounts paid for air, train, or bus tickets, and other related expenses and surcharges (additional rules apply to travel by ship);
• amounts paid for taxis, airport limousines, or commuter busses;
• telephone charges while on business travel, including business communication by fax machine or other communications devices; and
• baggage and shipping of materials to the temporary work place.
Documentary evidence will be considered adequate to support an expenditure if it includes sufficient information to establish the amount, date, place, and the essential character of the expenditure. According to IRS Publication 535, Business Expenses, ‘‘evidence should include items such as receipts, along with either a statement of expenses, an account book, a day-planner, or similar record in which the employee entered each expense at or near the time the expense was incurred.’’
For example, a hotel receipt is sufficient to support expenditures for business travel if it contains the name, location, date, and separate amounts for charges of lodging, meals, and telephone. On the other hand, a canceled check made payable to a named payee would not by itself support a business expenditure without other evidence showing that the check was used for a certain business purpose, IRS said.
Note that, under IRS regulations modified in 2000, employees are not required to produce documentation for most travel-related expenses that are less than $75. Costs for lodging, however, are excluded from the rule and must be documented regardless of the amount. Some employers maintain a policy of requiring documentation for incurred costs that are less than $75, but IRS does not require such documentation.
Options in substantiation
Unlike airfare tickets and the items listed above, other costs incurred during business travel do not require substantiation using exact amounts expended, but instead can conform to rates established by the federal government to meet tax-free treatment criteria. Recording and reporting exact amounts for these other costs remains an option under an accountable plan, but for administrative convenience, federal law and regulations allow for these different methods to meet the substantiation requirement for these common business travel costs:
• lodging/hotel expenditures;
• meals and incidentals; and
• vehicle use while on business travel.
For lodging and hotel expenses and meals and incidentals, an employer can reimburse employees' business travel expenses by means of a per diem allowance. Per diem, Latin for ‘‘per day,’’ is a sum of money calculated on a daily basis and may be paid in advance or after an expense is incurred.
For the use of a vehicle while on travel, employers have the option of applying in an accountable plan the standard mileage rate and calculating the expense per mile, as opposed to requiring substantiation of actual costs.
Per diem rates
Using per diem rates, paid at the applicable federal rate, the amounts of lodging, meals, and incidental expenses are deemed substantiated for purposes of avoiding taxability of expense reimbursements. Per diem rates can also be paid based on another flat rate or stated schedule that is reasonably calculated not to exceed ordinary and necessary business expenses.
The amount of expenses deemed substantiated by employers that pay per diem allowances in lieu of reimbursing employees for actual expenses for lodging, meals, and incidental expenses incurred for business-related travel is the lesser of the per diem allowance, or the amount computed at the federal per diem rate for the ‘‘locality of travel’’ for the period the employee is away from home. ‘‘Locality of travel’’ is where the employee stops to sleep or rest.
When using per diem rates as a method of substantiation, employees need only account for time, place, and business purpose of travel. Receipts for lodging and meals are not required under a per diem allowance, and employees whose actual expenses are less than their per diem are not required to refund the excess. Excess amounts advanced for days not actually traveled must be returned, however.
The per diem allowance must cover lodging, meals, and incidental expenses for travel away from home. Incidental expenses include laundry and dry cleaning, fees, and tips for services.
Employers choosing to apply per diem rates for travel expenses must include as wages amounts in excess of the federal rates used. IRS allows employers the following options to choose between types of per diem arrangements for substantiating lodging, meals, and incidental expenses:
• Regular federal per diem rate/per diem substantiation method. The federal per diem rate is equal to the sum of the federal lodging expense rate and the federal meal and incidental expense of travel. The federal government publishes per diem rates for federal employees traveling on government business that may be used by other employers to establish allowances that will satisfy the substantiation requirements, IRS said. The per diem rates, which range from $116 in several areas of the country to $411 in Manhattan (for 2010, combined lodging and meals and incidentals) can be found at http://www.gsa.gov/perdiem, and the list is extensive, covering more than 700 continental U.S. areas. The rates show lodging only, meals and incidentals only, and a combined amount, and these are the maximums employers are allowed to use in covering business travel and not have to include as wages. These rates cover localities in the continental United States (CONUS), and separate rates are developed for U.S. localities outside of the continental United States (OCONUS), as well as for foreign localities.
• High-low substantiation method. Under this method, there are two levels of per diem rates that may be used in lieu of the extensive list of rates that apply to federal employees for travel within the continental United States. Dozens of high-cost localities are identified by IRS each year and the applicable per diem rate for travel to such as location is consistent for each (for 2010: $258 per day; $193 for lodging and $65 for meals and incidental expenses). The rate for all other locations (the low-cost localities) traveled to within CONUS also is consistent at $163 per day ($111 for lodging, $52 for meals and incidental expenses) for 2010. The high-low substantiation method may not be used for travel OCONUS or if the employer's per diem covers only for meals and incidental expenses.
If the employer uses the high-low method to set per diem rates for an employee, the employer generally may not switch to the per diem method for that same employee for travel within CONUS during the same calendar year.
Employers also can provide employees with a per diem allowance only for meals and incidentals. This can occur only if the employer pays the employee for actual expenses for lodging based on receipts submitted, the lodging is provided by the employer either directly or through the provider, there is no reasonable belief that any lodging expenses were incurred by the employee, or the allowance is computed on a basis similar to that used in computing the employee's wages, such as the number of hours worked or miles traveled.
The ‘‘standard meal allowance’’ method is an alternative to the actual cost method. It allows employers to set an amount for employee meals and incidental expenses, instead of keeping records of actual costs. The set amount varies depending on where and when employees travel. (Note that the standard meal allowance rates above do not apply to travel in Alaska, Hawaii, or any other location outside the continental United States.)
Under these situations, the amount treated as an expense for food and beverages is the lesser of the per diem allowance; and the federal rate for meals and incidental expenses, or the ‘‘standard meal allowance.’’
Accounting for partial days
For meals taken on the partial days of travel to and from a destination, meal allowances need to be prorated (a reduced amount for each day) depending on the meals required while traveling. Employers can prorate by using one of two IRS-approved methods: three-quarters of the standard meal allowance can be claimed, or by using a method that can be consistently applied and that is in accordance with reasonable business practice.
Finally, IRS allows for an ‘‘incidental-expenses-only method,’’ where incidental expenses are limited generally to tips and other small expenses only if employees do not pay or incur any meal expenses. Employees cannot use this method on any day that the standard meal allowance is used. This method also is subject to the proration rules for partial days, according to IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Adequate tracking required
In 2008, IRS said that if an employer fails to track payments made under a per diem plan, the employer must ensure that they do not exceed the ‘‘deemed substantiation’’ limit, or ‘‘all of the per diem payments made under the plan will be treated as taxable wages.’’ If an employer makes a good faith effort to comply and to track payments, however, ‘‘only the excess per diem payments will be considered taxable wages in [an] audit.’’
Vehicle expenses
Costs incurred when employees operate and maintain a car when traveling away from home on business can be tax-free. Employers have the option of substantiating costs using actual expenses with receipts, or combining the standard business mileage rate (with a record of miles traveled) with receipts for business related tolls and parking.
If employees rent a car while away on business, only the business-use portion of the expenses are tax free. If the rental car agreement includes the cost for gasoline, employees cannot also claim the standard mileage rate for business miles driven. Actual costs incurred, in addition to the cost of the rental, are necessary for full substantiation.
This article was originally published in IOMA's monthly newsletter, 'Payroll Practitioner's Monthly', and is republished here with the express written permission of IOMA, Copyright(c) 2010.
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