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Taxmap/pubs/p535-060.htm#TXMP7202df83 Chapter 13 Other Expenses

Expenses

Taxmap/pubs/p535-060.htm#TXMP44457b4f What's New

Taxmap/pubs/p535-060.htm#TXMP2262d731
Standard mileage rate.

The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2004 is 37.5 cents a mile for all business miles. For more information, see Car and truck expenses, under Miscellaneous Expenses.

Taxmap/pubs/p535-060.htm#TXMP5e1224cf
Meal expense deduction subject to "hours of service" limits.

In 2005, this deduction increases to 70% of the reimbursed meals your employees consume while they are subject to the Department of Transportation's "hours of service" limits. For more information, see Meal expenses when subject to "hours of service" limits, later.

Introduction

This chapter covers business expenses that may not have been explained to you, as a business owner, in previous chapters of this publication.

Useful items

You may want to see:

See chapter 14 for information about getting publications and forms.

Taxmap/pubs/p535-060.htm#TXMP3a526db3 Travel, Meals, and   Entertainment

Travel, Transportation, Meal, Entertainment, and Gift Expenses

To be deductible for tax purposes, expenses incurred for travel, meals, and entertainment must be ordinary and necessary expenses incurred while carrying on your trade or business. Generally, you also must show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your trade or business.

The following discussion explains how to handle any reimbursements or allowances you may provide for these expenses when incurred by your employees. If you are self-employed and report your income and expenses on Schedule C or C-EZ (Form 1040), see Publication 463.

Taxmap/pubs/p535-060.htm#TXMP756b79ab Reimbursements

Reimbursement

A "reimbursement or allowance arrangement" provides for payment of advances, reimbursements, and charges for travel, meals, and entertainment expenses incurred by your employees during the ordinary course of business. Upon satisfying your established substantiation requirements, you can deduct the allowable amount on your tax return. Because of differences between accounting methods and tax law, these amounts may not be the same. For example, you may deduct 100% of the cost of meals on your business books and records. However, for tax purposes, only 50% of these costs are allowed by law as a tax deduction.

A reimbursement or allowance arrangement (including per diem allowances, discussed later) depends on whether you have: (1) an accountable plan or (2) a nonaccountable plan. If you reimburse these expenses under an accountable plan, then you can deduct the amount allowable to the extent of the tax law as travel, meal, and entertainment expenses on your tax return.

If you reimburse these expenses under a nonaccountable plan, then you must report the reimbursements as wages on Form W-2, Wage and Tax Statement, and deduct them as wages on the appropriate line of your tax return. If you make a single payment to your employees and it includes both wages and an expense reimbursement, you must specify the amount attributable to reimbursement and report it accordingly. See Table 13-1, Reporting Reimbursements.

Taxmap/pubs/p535-060.htm#TXMP3a1f7e37 Accountable Plans

An accountable plan, requires your employees to meet all of the following requirements. They must:

1. have paid or incurred deductible expenses while performing services as your employees,
2. adequately account to you for these expenses within a reasonable period of time, and
3. return any excess reimbursement or allowance within a reasonable period of time.

An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements are also met.

• The advance is reasonably calculated not to exceed the amount of anticipated expenses.
• You make the advance within a reasonable period of time.

If any expenses reimbursed under this arrangement are not substantiated, or an excess reimbursement is not returned within a reasonable period of time by an employee, you are not allowed to deduct these expenses as reimbursed under an accountable plan. Instead, treat the reimbursed expenses as paid under a nonaccountable plan, discussed later.

Taxmap/pubs/p535-060.htm#TXMP6730a337 Adequate accounting.

Your employees must adequately account to you for their travel, meals, and entertainment expenses. They must give you documentary evidence of their travel, mileage, and other employee business expenses. This 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.

Taxmap/pubs/p535-060.htm#TXMP294b30d5 Excess reimbursement or allowance.

An excess reimbursement or allowance is any amount you pay to an employee that is more than the business-related expenses for which the employee adequately accounted. The employee must return any excess reimbursement or other expense allowance to you within a reasonable period of time.

Taxmap/pubs/p535-060.htm#TXMP0819b596 Reasonable period of time.

A reasonable period of time depends on the facts and circumstances. Generally, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time.

1. You give an advance within 30 days of the time the employee incurred the expense.
2. Your employees adequately account for their expenses within 60 days after the expenses were paid or incurred.
3. Your employees return any excess reimbursement within 120 days after the expenses were paid or incurred.
4. You give a periodic statement (at least quarterly) to your employees that asks them to either return or adequately account for outstanding advances and they comply within 120 days of the date of the statement.

Taxmap/pubs/p535-060.htm#TXMP1a9488c1 How to deduct.

You can claim a deduction for travel, meals, and entertainment expenses if you reimburse your employees for these expenses under an accountable plan. Generally, the amount you can deduct for meals and entertainment, is subject to a 50% limit, discussed later. If you are a sole proprietor, or are filing as a single member Limited Liability Company, deduct the reimbursement on line 24b, Schedule C (Form 1040) or line 2, Schedule C-EZ (Form 1040).

If you are filing an income tax return for a corporation, the reimbursement should be included with the amount claimed on the Other deductions line of Form 1120, U.S. Corporation Income Tax Return, or Form 1120-A, U.S. Corporation Short-Form Income Tax Return. If you are filing any other business income tax return, such as a partnership or S corporation return, deduct the reimbursement on the appropriate line of the return as provided in the instructions for that return.

Taxmap/pubs/p535-060.htm#TXMP0634d17b Per Diem and Car Allowances

Per Diem and Car Allowances

You may reimburse your employees under an accountable plan based on travel days, miles, or some other fixed allowance. In these cases, your employee is considered to have accounted to you for the amount of the expense that does not exceed the rates established by the federal government. Your employee must actually substantiate to you the other elements of the expense, such as time, place, and business purpose.

Taxmap/pubs/p535-060.htm#TXMP59c0c5f2 Federal rate.

The federal rate can be figured using any one of the following methods.

1. For per diem amounts:
   1. The regular federal per diem rate.
   2. The standard meal allowance.
   3. The high-low rate.
2. For car expenses:
   1. The standard mileage rate.
   2. A fixed and variable rate (FAVR).

Taxmap/pubs/p535-060.htm#TXMP1e161d2d Car allowance.

Your employee is considered to have accounted to you for car expenses that do not exceed the standard mileage rate. For 2004, the standard mileage rate is 37.5 cents per mile for each business mile.

You can choose to reimburse your employees using a fixed and variable rate (FAVR) allowance. This is an allowance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your employees' variable operating costs (such as gas, oil, etc.) plus a flat amount to cover your employees' fixed costs (such as depreciation, insurance, etc.). For information on using a FAVR allowance, see Revenue Procedure 2002-61 in Internal Revenue Bulletin 2002-39. You can read Revenue Procedure 2002-61 at many public libraries or online at www.irs.gov.

Taxmap/pubs/p535-060.htm#TXMP2e1890a6 Per diem allowance.

If your employee actually substantiates to you the other elements (discussed earlier) of the expenses reimbursed using the per diem allowance, how you report and deduct the allowance depends on whether the allowance is for lodging and meal expenses or for meal expenses only and whether the allowance is more than the federal rate.

Taxmap/pubs/p535-060.htm#TXMP4c7de0fa Regular federal per diem rate.

The regular federal per diem rate is the highest amount the federal government will pay to its employees while away from home on travel. It has two components:

1. lodging expense, and
2. meal and incidental expense (M & IE).

The rates are different for different locations. Publication 1542 lists the rates in the continental United States.

Taxmap/pubs/p535-060.htm#TXMP4cc602f0 Standard meal allowance.

The federal rate for meal and incidental expenses (M & IE) is the standard meal allowance. You may pay only an M & IE allowance to employees who travel away from home if:

• you pay the employee for actual expenses for lodging based on receipts submitted to you,
• you provide for the lodging,
• you pay for the actual expense of the lodging directly to the provider,
• you do not have reasonable belief that 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 (that is, number of hours worked or miles traveled).

Taxmap/pubs/p535-060.htm#TXMP541928d3 Internet access.

Per diem rates are available on the Internet. You can access per diem rates at www.policyworks.gov/perdiem.

Taxmap/pubs/p535-060.htm#TXMP254fdb85 High-low method.

This is a simplified method of computing the federal per diem rate for lodging and meal expenses for traveling within the continental United States. It eliminates the need to keep a current list of the per diem rate in effect for each city in the continental United States.

Under the high-low method, the per diem amount for travel during 2004 is $207 ($46 for M & IE) for certain high-cost locations. All other areas have a per diem amount of $126 ($36 for M & IE). The high-cost locations eligible for the $207 per diem amount under the high-low method are listed in Publication 1542.

Taxmap/pubs/p535-060.htm#TXMP02ee00ef Reporting per diem and car allowances.

The following discussion explains how to report per diem and car allowances. The manner in which you report them depends on how the allowance compares to the federal rate. See Table 13-1.

Taxmap/pubs/p535-060.htm#TXMP33ceb86b Allowance less than or equal to the federal rate.

If your allowance for the employee is less than or equal to the appropriate federal rate, that allowance is not included as part of the employee's pay in box 1 of the employee's Form W-2. Deduct the allowance as travel expenses (including meals that may be subject to the 50% limit, discussed later). See How to deduct under Accountable Plans, earlier.

Taxmap/pubs/p535-060.htm#TXMP038a9975 Allowance more than the federal rate.

If your employee's allowance is more than the appropriate federal rate, you must report the allowance as two separate items.

Include the allowance amount up to the federal rate in box 12 (code L) of the employee's Form W-2. Deduct it as travel expenses (as explained above). This part of the allowance is treated as reimbursed under an accountable plan.

Include the amount that is more than the federal rate in box 1 (and in boxes 3 and 5 if they apply) of the employee's Form W-2. Deduct it as wages subject to income tax withholding, social security, Medicare, and federal unemployment taxes. This part of the allowance is treated as reimbursed under a nonaccountable plan as explained later under Nonaccountable Plans.

Taxmap/pubs/p535-060.htm#TXMP19344967 Meals and Entertainment

Travel, Transportation, Meal, Entertainment, and Gift Expenses

Under an accountable plan, you can generally deduct only 50% of any otherwise deductible business-related meal and entertainment expenses you reimburse your employees. The deduction limit applies even if you reimburse them for 100% of the expenses.

Taxmap/pubs/p535-060.htm#TXMP30a327b9 Application of the 50% limit.

The 50% deduction limit applies to reimbursements you make to your employees for expenses they incur for meals while traveling away from home on business and for entertaining business customers at your place of business, a restaurant, or another location. It applies to expenses incurred at a business convention or reception, business meeting, or business luncheon at a club. The deduction limit may also apply to meals you furnish on your premises to your employees.

Taxmap/pubs/p535-060.htm#TXMP3314bb20 Related expenses.

Taxes and tips relating to a meal or entertainment activity you reimburse to your employee under an accountable plan are included in the amount subject to the 50% limit. Reimbursements you make for expenses, such as cover charges for admission to a nightclub, rent paid for a room to hold a dinner or cocktail party, or the amount you pay for parking at a sports arena, are all subject to the 50% limit. However, the cost of transportation to and from an otherwise allowable business meal or a business-related entertainment activity is not subject to the 50% limit.

Taxmap/pubs/p535-060.htm#TXMP1ef4d550 Amount subject to 50% limit.

If you provide your employees with a per diem allowance only for meal and incidental expenses, the amount treated as an expense for food and beverages is the lesser of the following.

• The per diem allowance.
• The federal rate for M & IE.

If you provide your employees with a per diem allowance that covers lodging, meals, and incidental expenses, you must treat an amount equal to the federal M & IE rate for the area of travel as an expense for food and beverages. If the per diem allowance you provide is less than the federal per diem rate for the area of travel, you can treat 40% of the per diem allowance as the amount for food and beverages.

Taxmap/pubs/p535-060.htm#TXMP2a9b03dc Meal expenses when subject to "hours of service" limits.

For tax years beginning in 2004, 70% of the reimbursed meals your employees consume while away from their tax home on business during, or incident to, any period subject to the Department of Transportation's hours of service limits are deductible.

See Publication 463 for a detailed discussion of individuals subject to the Department of Transportation's hours of service limits.

Taxmap/pubs/p535-060.htm#TXMP444332f6 De minimis (minimal) fringe benefit.

The 50% limit does not apply to an expense for food or beverage that is excluded from the gross income of an employee because it is a de minimis fringe benefit. See Publication 15-B for additional information on de minimis fringe benefits.

Taxmap/pubs/p535-060.htm#TXMP63c01b2b Company cafeteria or executive dining room.

The cost of food and beverages you provide primarily to your employees on your business premises is deductible. This includes the cost of maintaining the facilities for providing the food and beverages. These expenses are subject to the 50% limit unless they qualify as a de minimis fringe benefit, discussed in Publication 15-B, or unless they are compensation to your employees and you treat them as provided under a nonaccountable plan.

Taxmap/pubs/p535-060.htm#TXMP5a32eced Employee activities.

The expense of providing recreational, social, or similar activities (including the use of a facility) for your employees is deductible. The benefit must be primarily for your employees who are not highly compensated.

For this purpose, a highly compensated employee is an employee who meets either of the following requirements.

1. Owned a 10% or more interest in the business during the year or the preceding year. An employee is treated as owning any interest owned by his or her brother, sister, spouse, ancestors, and lineal descendants.
2. Received more than $90,000 in pay for the preceding year. You may choose to include only employees who were also in the top 20% of employees when ranked by pay for the preceding year.

For example, the expenses for food, beverages, and entertainment for a company-wide picnic are not subject to the 50% limit.

Taxmap/pubs/p535-060.htm#TXMP21398a86 Nonaccountable Plans

A nonaccountable plan is an arrangement that does not meet the requirements for an accountable plan. All amounts paid, or treated as paid, under a nonaccountable plan are reported as wages on Form W-2. The payments are subject to income tax withholding, social security, Medicare, and federal unemployment taxes. You can deduct the reimbursement as compensation or wages only to the extent it meets the deductibility tests for employees' pay in chapter 2. Deduct the allowable amount as compensation or wages on the appropriate line of your income tax return, as provided in its instructions.

Generally, amounts paid for meals, entertainment, and amusement provided to individuals who are not your employees are not subject to the 50% limit. Such activities must be directly related to the active conduct of your trade or business. Examples include:

• Amounts paid for meals, goods, services, or the use of a facility. You are allowed a deduction only to the extent it is included in the gross income of the recipient as compensation for services or as a prize or award.
• Expenses that exceed $600 and are required to be reported on an information return, for example, Form 1099-MISC. See the General Instructions for Forms 1099, 1098, 5498, and W-2G for more information about reporting requirements.
• The cost of providing meals, entertainment, goods and services, or use of facilities you sell to the public. For example, if you operate a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is a business expense that is fully deductible.
• The cost of providing meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community is fully deductible.

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