An employer may exclude from income an employee’s business-related travel if the expense qualifies as a working condition fringe benefit under Section 132(a)(2) of the Internal Revenue Code and the amounts are paid or reimbursed under an accountable plan. A working condition fringe benefit is an expense that the employee would be allowed to deduct from income. The regulations under Section 132 extend this rule to independent contractors providing services to the employer as well.
To come under the accountable plan rules, travel expenses must be 1) ordinary and necessary expenses, 2) incurred while away from home, and 3) in the pursuit of a trade or business. Such expenses include meals and lodging (to the extent not lavish or extravagant), transportation expenses and the costs for operating a car for business. An “ordinary” expense is a common or frequent occurrence for the business; a “necessary” expense is appropriate and helpful for the development of employer’s business. (For a discussion of “away from home,” see the September/October 2009 edition of Crow’s Nest “Temporarily-Away-From-Home Travel Expenses.”)
Expenses for travel from a residence to business location are generally nondeductible commuting expenses. Also, under Section 274(m)(3), travel expenses of an individual accompanying an employee on business travel, including the employee’s spouse or dependent, are nondeductible personal expenses treated as the employee’s wages unless:
When an employee and family members live at a temporary place of business, the employee may deduct travel expenses (including commuting), but the deduction for meals and lodging is limited to the employee’s expenses allocable to the presence there for the performance of the employee’s duties (Rev. Rul. 55-604, 1955-2 C.B. 49).
A reimbursement or other expense allowance arrangement qualifies as an accountable plan if:
Travel expenses reimbursed under an arrangement that fails to meet these requirements are income to the worker either as wages or self-employment compensation.
An arrangement meets the business connection requirement if the employer pays advances, allowances (including per diem allowances, allowances only for meals and incidental expenses, and mileage allowances), or reimbursements only for deductible business expenses that the worker pays or incurs while performing services for an employer while away from home. For the meal allowances, advances, or reimbursements to be excluded from income, the meal expenses must be incurred while the worker is away from home a sufficiently long time, typically long enough to require a period of sleep or rest, which generally means an overnight stay. Workers who travel and return to their main work area within the course of a normal workday are normally not considered away from home.
Substantiation of Expenses
For expenses governed by Section 162, the worker must submit enough information to allow the employer to identify the specific nature of each expense and attribute the expense to the worker’s business activity. Generally, the worker must submit an expense account or other written statement showing the business nature and amount of each expense. However, under Section 274(d) of the Code, workers must submit actual substantiation of the amount of their expenses, as well as the time, place, and business purpose for expenses generally considered to be entertainment, amusement, or recreation.
Expenses may be substantiated by the following documentation:
Car expenses may be substantiated using either of two methods: the Standard Mileage Rate for use of a car or actual expenses.
If travel includes both business and personal travel, the worker’s records must show how much is related to business. Foreign travel expenses are generally required by Section 274(c) of the Code to be prorated between business and non-business expenses.
Excess Return Requirement
To meet the return of excess requirement, a worker must refund to the employer any amount paid in excess of the worker’s substantiated (or deemed substantiated) expenses within a reasonable time. Generally, the time period is reasonable if:
Also, it is considered reasonable if workers are provided with a periodic statement (at least quarterly) that asks them to either return or adequately account for outstanding amounts and they do so within 120 days.
If an organization’s arrangement routinely pays allowances in excess of the amount that may be deemed substantiated without requiring actual substantiation of all the expenses or repayment of the excess amount, the IRS will treat the arrangement as a nonaccountable plan and the entire amount of the allowance will be subject to tax as wages or self-employment income of the worker. (See Rev. Rul. 2006-56, 2006-46 IRB 874.)ęCopyright 2009 by Windstar Technologies, Inc. Windstar reserves all rights to this electronic material. Information contained in this publication is based on the best information available at the time of publication. While believing the information in this publication to be accurate, Windstar accepts no legal responsibility for its accuracy
Paula N. Singer, Esq. chairman of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer, Newton, MA, has over 25 years of experience providing advice and compliance services to employers on cross-border employment matters. She is also the editor of "US Tax Compliance For Immigrants And Employers: The Lawyer's Complete Guide". To learn more, see: http://www.ilw.com/books/tax.shtm. For more information, visit www.windstar.com. For additional information, call 1-800-259-6398 or email: firstname.lastname@example.org.
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