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How to Deduct Travel Expenses

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Travel expenses include transportation, lodging, meals, and related incidentals.  Business travel expenses are fully deductible (except for meal expenses, which are 50% deductible).  The travel expenses must be properly substantiated.

There are different rules for domestic and foreign travel.  There are also different rules depending on whether the travel is exclusively for business, primarily for business, or primarily for personal reasons.

Domestic Travel

Exclusively for Business:  If a taxpayer’s trip is solely for business reasons, all reasonable and necessary travel expenses (travel fares, lodging, transportation, meals, and incidentals) are fully deductible (except that meals are 50% deductible).

Primarily for Business:  the deductible travel expenses include the costs of getting to and from the business destination and any business related expenses while at the business destination.  Personal expenses incurred while at the destination are not deductible.

Primarily for Personal Reasons:  the costs of getting to and from the destination are not deductible because they are considered personal expenses.  However, any business costs the taxpayer pays at the destination will be deductible.

Whether the trip is primarily for business or personal reasons depends on the facts and circumstances of the travel.  The IRS tends to focus on the amount of time spent on business and personal activities.  The primary purpose of the trip is determined based on which purpose (business or personal) exceeds 50% of the time spent on the trip.

Example 1:  Joan has a business in Detroit.  She travels to L.A. for meetings that span four days.  Joan arrives in L.A., spends four days in meetings, and immediately returns home to Detroit.  She spent $500 in airfare, $800 in lodging, and $500 in food.  Since, Joan’s trip is exclusively for business, Joan can claim travel expenses of $1,550 ($500 airfare, $800 lodging, and 50% of $500 food).

Example 2: Same facts as above except Joan spends three days site seeing throughout California.  She spends $600 in lodging, $250 in meals, and $150 in auto expenses while site seeing.  Since the primary purpose of her trip was business (based on 4 days of business versus 3 days personal), she may still deduct the $1,550 travel expenses from Example 1.  However, the expenses for lodging ($600), meals ($250), and auto expenses ($150) she spent while site seeing are nondeductible personal expenses.

Example: Same facts as example 2 except Joan spends 6 days site seeing.  Since the purpose of her trip is now considered personal (based on 4 days of business versus 6 days personal), the costs of getting to and from the destination are nondeductible.  Thus, the $500 airfare to L.A. is no longer deductible.  Her site seeing expenses are also not deductible.  However, Joan may still deduct her business expenses while in L.A. ($800 in lodging and 50% of her $500 food expenses from example 1).

Foreign Travel

Exclusively for Business:  If a taxpayer’s trip is solely for business reasons, all reasonable and necessary travel expenses (travel fares, lodging, transportation, meals, and incidentals) are fully deductible (except that meals are 50% deductible).

Majority of Time on Business:  ALL travel expenses are allocated between deductible business expenses and nondeductible personal expenses.  The expenses should be allocated to deductible and nondeductible categories using a day-to-day allocation method based on business days and personal days.  There are two things to take note of:

  • This differs from the domestic travel rules where the costs of getting to and from and destination are fully deductible if the trip is primarily for business.  For foreign travel, the costs of getting to and from the destination must be allocated if the trip is not exclusively for business, even though the majority of time is spent on business
  • ALL travel expenses (not just getting to and from the destination) must be allocated

Majority of Time for Personal Reasons:  ALL travel expenses (costs of getting to and from the destination, lodging, meals, etc.) are not deductible because they are considered personal expenses.  However, any expenses that the taxpayer pays at the destination will be deductible if they are directly related to business.

While the foreign travel rules require an allocation of expenses if business travel is combined with personal travel, there is a safe harbor.  If the primary purpose of the trip was business AND any of the following exceptions is met, allocation of travel expenses is not required–the trip is treated as being exclusively for business (and 100% of the travel costs are deductible):

  • No more than seven consecutive days are spent outside the U.S.
  • Less than 25% of the total time on the trip is devoted to nonbusiness activities
  • The taxpayer has no substantial control over arranging the trip—a self employed taxpayer is generally considered to have substantial control over his travel and won’t qualify under this exception.  Employees may qualify under this exception.
  • The taxpayer establishes through a facts and circumstances analysis that personal vacation was not a major consideration.
This is just an overview of the travel deduction rules.  They get more complicated.  If you have any questions on how this applies to you, just give us a call.

Comments or questions about this post?  Please let us know through the comment area below!

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230

 

 

Getting Schooled—Providing Employee Educational Assistance

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There are two primary methods for business owners to provide tax-free educational assistance to themselves and to their employees.  The methods are:

  • Working Condition Fringe Benefit
  • Section 127 Plan

Working Condition Fringe Benefit

Educational expenses paid under this method are deductible by the employer and are tax free to the employee.  The educational expenses are also excluded from payroll taxes such as FICA and FUTA.  There is no limit on the amount of educational expenses that qualify; however, the educational expenses must be ordinary and necessary business expenses.

To qualify as a working condition fringe benefit, the educational program must relate to maintaining or improving the skills required by the employee’s job.  The education itself must NOT lead to the student qualifying for a new trade or business.  Education required to meet the minimum skill level required for the job does NOT qualify.  Job related education may be furnished directly by the employer or through a third party such as an educational institution or seminar organization.  The educational expenses of the business owner also qualify.

Example:  ABC Corp employees Joan as an engineer.  Joan is climbing the corporate ladder and believes an MBA will help her develop management skills to help her advance her career.  ABC Corp pays for her MBA.  Since the MBA will improve her skills, the educational expenses paid by ABC Corp will not be taxable to her.  In addition, ABC Corp can take a deduction for the educational expenses.

Example 2: John is a law student working in a law firm as a legal assistant.  The law firm offers to pay John’s law school tuition.  These expenses will NOT qualify as a working condition fringe benefit because the law degree is required for John to meet the minimum requirements for his job as an attorney.  However, the tuition may qualify for exclusion as a Section 127 plan.

Section 127 Plan

A Section 127 plan is a qualified education assistance program.  The first $5,250 of qualified educational assistance provided during the year is exempt from tax, including FICA and FUTA.

To qualify under Section 127, a plan is required.  The plan must:

  • Be in writing
  • Provide educational assistance exclusively to employees (possibly including owners)
  • Not provide employees with a choice of education assistance and taxable compensation
  • Provide reasonable notice of the availability and terms of the program
  • Not discriminate in favor of highly compensated employees or their dependents
  • Not pay more than 5% of the benefits to more-than-5% owners or their spouses or dependents

Children of owners can participate in a Section 127 plan if they are at least 21 years of age, are legitimate employees, are not more than 5% owners, and are not dependents of the owner.  Children under age 21 can still participate in Section 127 plans, but their educational expenses are subject to the nondiscrimination rules (which could disqualify the plan).

Example:  ABC Corp is owned by John.  ABC Corp has three employees—Adam (John’s son) and two unrelated employees.  All employees are 22 years old.  John does not claim Adam as a dependent.  ABC Corp pays $5,000 towards each employee’s tuition.  Since Adam is at least 21 years old, is a legitimate employee, is not a dependent, and is not a more-than-5% owner, the tuition paid on his behalf is not counted as being for a highly compensated employee or a more than 5% owner.  All employees may exclude the $5,000 tuition payment from their incomes.

Example 2:  Same facts as above except that Adam (John’s son) is 20 years old.  Since Adam is under age 21, he is attributed ownership from his father (i.e., Adam is considered a 100% owner).  Since 33% of the benefits ($5,000 tuition for Adam divided by $15,000 total tuition paid) are paid for a more-than-5% owner, EACH employee must report the $5,000 tuition payment as income.

Key Difference between a Working Condition Fringe Benefit and Section 127 Plans:

  • A $5,250 cap applies to Section 127 Plans, but not working condition fringe benefits
    • If over $5,250 is spent on educational expenses under a Section 127 plan, the excess may qualify as a working condition fringe benefit
  • The cost of travel, meals, and lodging may qualify as a working condition fringe benefit but not under a Section 127 plan
  • The working condition fringe benefit is not subject to nondiscrimination rules
  • The limitation on expenses that qualify a student for a new job or to meet minimum eligibility requirements will not qualify as a working condition fringe benefit, but may qualify under a Section 127 plan.

These rules are fairly complex.  If you need help navigating through these rules, give us a call and we’ll be happy to help.

 

If you found this article informative, subscribe to our Tax Newsletter.

 

 Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230

Special Tax Credit for Restaurants

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There is a tax credit available to restaurants that have tipped employees.  The credit is based on the FICA taxes paid by the restaurant on reported tips.  Although this credit has been available to restaurants for years, many tax professionals fail to inform their clients that the credit is available.  If you’re a restaurant owner, keep reading.

Background

Restaurants must pay FICA taxes on any tips reported by tipped employees.  This requirement has been criticized by the restaurant industry since 1987 because reported tips in excess of the minimum wage are not counted as wages under the Fair Labor Standards Act (FLSA).  Since tips in excess of minimum wage are not counted as wages under the FLSA, it is argued that it is not appropriate to require restaurants to pay FICA taxes on these tips.

As a result of lobbying by the restaurant industry, Congress created a tax credit in 1993 to offset some of the FICA taxes paid by restaurants on excess tips (tips that get the employee over minimum wage). The credit is named the Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips.  They tried, but couldn’t come up with a longer name.

How it Works

The credit is calculated as 7.65% of tips in excess of the federal minimum wage.  For purposes of this tax credit, the federal minimum wage is capped at $5.15, and not at the normal $7.25 federal minimum wage.  Michigan’s minimum wage of $7.40 is not relevant to this credit; however, under Michigan law the employee’s base wage plus tips must be at least $7.40.

Example:  JoJo’s Restaurant has a tipped employee who earns $2.65 per hour.  The employee worked 1,500 hours during 2012 and had tips of $8,000.   

The tip tax credit is calculated as follows:

Hourly Tip Rate:         $5.33     ($8,000 tips divided by 1,500 hours)

Tips Deemed Wages:    $2.50     ($5.15 federal minimum wage less $2.65 wage)

Excess Tips per Hour:   $2.83     ($5.33 total tips less $2.50 tips treated as wages)

Total Excess Tips:      $4,245    ($2.83 excess tips per hour times 1,500 hours worked)

Tip Tax Credit               $325       ($4,245 times 7.65% FICA rate)

The tip tax credit for this single employee is $325. 

The tip tax credit is calculated for each individual employee.  Modern payroll software makes it much easier to determine how much of each employee’s tips are deemed wages and how much are excess tips.

There has been some confusion as to whether restaurant owners could claim the credit on unreported tips discovered during an IRS audit.  The answer is yes—restaurant owners can claim the tip tax credit on unreported tips discovered during an audit (good news if you’re looking for a silver lining during an audit.)

 

Find this article informative?  Subscribe to our Tax Newsletter.

 

Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230

 

Reporting Unclaimed Property

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As a business owner, you’ve probably received a notice from the Michigan Department of Treasury advising you to report and turn over to the state any unclaimed property you have.  Many businesses have unclaimed property resulting from normal operations.  Some examples include uncashed payroll checks, uncashed vendor checks, credit balances on accounts receivable, etc.  Any of these assets must be reported and turned over to the state if they remain unclaimed for a certain period of time.  For example, uncashed payroll checks must be reported and turned over to the state after one year and uncashed vendor checks must be reported and turned over to the state after three years.

The due date for filing the unclaimed property annual report is July 1, 2012 for property reaching its dormancy period (e.g., one year for uncashed payroll checks) as of March 31, 2012.

Example:  You issue two paychecks.  The first paycheck is issued March 27, 2011 and the second is issued April 3, 2011.  The March 27 paycheck is dormant for one year on March 31, 2012, and must be reported and turned over to the state by July 1, 2012.  The second paycheck issued on April 3, 2011 has not been dormant for one year on March 31, 2012 and must not yet be reported.  If this paycheck remains unclaimed on March 31, 2013, it must be reported and turned over by July 1, 2013.

Penalties for Not Filing or Turning over Unclaimed Property

Penalty and interest may be assessed as follows:

  • interest at 1% over prime per month on the property or the value of the property from the date the property should have been paid and/or
  • penalty at 25% of the value of the property that should have been paid

If the state audits a business for compliance with unclaimed property reporting, the state can go back 10 years.  A concern is that the state is outsourcing its audit function to third party auditors who are paid on a contingency basis based on the amount of unclaimed property they find.  Additionally, third party auditors may only audit a recent period, then extrapolate the value of any unreported unclaimed property over the ten years.  This could result in substantial penalties and interest.

If You Don’t Have Unclaimed Property

If you are certain you don’t have unclaimed property to report and pay over, you can file Form 4305, Attestation of Compliance with Unclaimed Property Reporting, by January 31, 2012.

Voluntary Compliance Agreement

The state is providing businesses that have not previously reported or have underreported unclaimed property in the current and past four years with an opportunity to comply with the reporting and payment requirements by entering into a Voluntary Disclosure Program by filing Form 4869.  The program will waive all penalty and interest on property voluntarily submitted to the state.  The deadline to enter into this agreement is January 31, 2012.

Questions…

There is some uncertainty about whether the Department of Treasury has the authority to enter into these Voluntary Compliance Agreements or to require business to report when they DO NOT have unclaimed property.  The State Bar of Michigan issued an email to its members this past week questioning the Department’s ability to impose these requirements.   The State Bar issued a letter to the Department of Treasury regarding the uncertainty of these requirements.  The State Bar has not yet heard back from the Department.

So…if you have any questions regarding this issue please feel free to contact us.

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