Travel & Entertainment--Income & Payroll Tax
Although the computer age and modern telecommunications have reduced the need for in-person contact, many businesses like yours still must send employees out of town on business, or require them to entertain clients and customers. How these travel and entertainment expenses are handled can have an important effect on your P&L, your paperwork burden, and on the tax results for you and your employees.
Requiring employees to substantiate travel or entertainment expenses that are bona-fide business deductions, means that partial or complete advances or reimbursements aren't treated as compensation income to the employee. The good news for both the company and the employee is that the advance or reimbursement isn't subject to social security taxes or to income tax withholding. The bad news for the company is that it can only deduct 50 percent of any business-related meal or entertainment expense, and that includes meals consumed by employees while they are on travel status.
To top it off, a fairly detailed recordkeeping system must be in place if the reimbursement is to be free of payroll tax and withholding: For travel, employees must submit a written statement of the time, place, destination and business purpose of the trip and the amount of expenses incurred by category (e.g., travel, meals, lodging). For meals or entertainment, a written statement is required showing time, place and cost of the event, who was entertained and the business purpose of the meal or entertainment (if the event follows or precedes a business discussion, additional recordkeeping is required). Finally, the employee must keep and turn in to the employer documentary evidence such as receipts for all lodging expenses and for all other $75 or more travel and entertainment expenses ($25 or more for pre-October 1, 1995 expenses).
Fortunately there are some shortcuts, depending on the type and frequency of the travel and entertainment expenses. For example, the paperwork burden and the cost of travel expenses can be cut by giving employees a flat daily allowance varying by destination to cover meals, lodging and incidental expenses while they are on travel status. If the daily allowances don't exceed IRS-determined maximums, they are payroll and income tax free with a minimum of paperwork--all that's required is a record of the time, place and business purpose of the travel. To-the-penny accounting of expenses, plus receipts, are not necessary. Of course, a flat daily allowance may not be appropriate if the employee traveling is an executive who requires first-class accommodations.
One way to cut out all that paperwork and coincidentally boost company tax deductions is simply to give employees a flat allowance for anticipated travel and entertainment, and not require these expenses to be substantiated at all. On the plus side, the allowance will be fully deductible as compensation (assuming the employees' compensation packages are reasonable) and there will be no paperwork to plow through. On the minus side, the allowance will be subject to payroll and income tax withholding, and the company won't have a close handle on actual travel and entertainment expenses. And employees will be saddled with some unfavorable tax consequences, even if they deduct the travel and entertainment expenses on their own returns.
It sounds complicated, and it is. That's why we urge you to call us for a confidential audit of your company's travel and entertainment expenses, and a report on the best way to handle them from the paperwork, cost and tax viewpoints.