Deducting Business Travel Expenses: A Refresher

During the COVID-19 pandemic, business travel nearly came to a halt. Today, it is on the rebound, as “Zoom-fatigued” executives craving face-to-face interaction hit the road again. With more people getting out of their offices, now is a good time for a refresher on the tax deductibility of business travel expenses.

What is your tax home?

Taxpayers are permitted to deduct their ordinary and necessary expenses of business-related travel away from their “tax home.” “Ordinary” means common and accepted in the taxpayer’s industry. “Necessary” means helpful and appropriate for the business. Expenses are not deductible if they are for personal purposes, or if they are lavish or extravagant. That does not mean you cannot fly first class or stay in luxury hotels, but you will need to show that the expense was reasonable under the circumstances.

Your tax home is not necessarily the place where you maintain your family home. Rather, it refers to the city or general area where your main place of business is located. Suppose, for example, that Walter lives in Philadelphia but works in New York City five days a week, returning to Philadelphia on the weekends. Walter’s tax home is New York, so his expenses for traveling there are not deductible. And while travel to Philadelphia on the weekends is away from his tax home, those trips are for personal reasons, so those expenses also are not deductible. Special rules apply to taxpayers who have several places of business or who have no regular place of business (for example, consultants who are always on the road).

Generally, you are considered to be traveling away from home if your duties require you to be away from your tax home for substantially longer than an ordinary day’s work and you need to get sleep or rest to meet work demands while away. This includes temporary work assignments. However, you are not permitted to deduct travel expenses in connection with an indefinite work assignment (that is, more than a year) or one that is realistically expected to last more than a year.

What is deductible?

Assuming these requirements are met, commonly deductible travel expenses include (but are not limited to):

• Air, train or bus fare to the business destination, plus baggage fees;
• Car rental expenses or the cost of using your own vehicle, plus tolls and parking;
• Transportation while at the business destination, such as taxis or ride shares between the airport and hotel and to and from work locations;
• Lodging and meals;
• Tips paid to hotel or restaurant workers; and
• Dry cleaning and laundry service.

Meal expenses are generally 50% deductible. This includes meals eaten alone while traveling for business. It also includes meals with others, if the meals are provided to a business contact, serve an ordinary and necessary business purpose and are not lavish or extravagant.

Related Read: Meals and Entertainment Expenses under the New Tax Law

Who can claim the deduction?

Self-employed people may deduct travel expenses on Schedule C, but employees currently are not permitted to deduct unreimbursed business expenses, including travel expenses.

However, businesses may deduct employees’ travel expenses to the extent that they provide advances or reimbursements to employees or pay the expenses directly. Advances or reimbursements are excluded from wages (and, therefore, are not subject to income or payroll taxes) if they are made according to an “accountable plan.” In this case, the expenses must have a business purpose, and employees must substantiate their expenses and pay back any excess advances or reimbursements within a reasonable time.

What records should you keep?

To deduct business travel expenses, you must substantiate them with adequate records — typically, receipts, canceled checks or bills — that show the amount, date, place and nature of each expense. Receipts are not required for nonlodging expenses less than $75, though these expenses must still be documented in an expense report.

Keep in mind that an employer may have its own substantiation policies that are stricter than the IRS requirements. If you use your own car or a company car for business travel, you can deduct your actual costs or the standard mileage rate.

For lodging and meal and incidental expenses (M&IE) — such as small fees or tips — employers can use the alternative per-diem method to simplify expense tracking. Self-employed individuals can use this method for M&IE, but not for lodging.

Under this method, taxpayers use the federal lodging and M&IE per-diem rates for the travel destination to determine reimbursement or deduction amounts. This avoids the need to keep receipts to substantiate the actual cost. However, it is still necessary to document the time, place and nature of the expense.

To make things even simpler, the optional high-low substantiation method allows a taxpayer to use two per-diem rates for all business travel: One for designated high-cost localities and a lower rate for all other localities. Currently, those rates are $309 and $214, respectively, and the M&IE-only rates are $74 and $64, respectively.

Turn to your advisor

The rules regarding business travel deductions can be complicated. In addition to the rules explained above, there are special rules for international travel and travel with your spouse or other family members. If you are uncertain about the tax treatment of your travel expenses, contact your financial advisor.

SIDEBAR:   Mixing business and pleasure

If you take a business trip in the United States primarily for business, but also take some time for personal activities, you are still permitted to deduct the full cost of airfare or other transportation to and from your destination. However, other expenses, including lodging and meals, are deductible for only the business portion of your trip.

Generally, a trip is primarily for business if you spend more time on business activities than on personal activities. For example, you might travel to Las Vegas for a week, attend a trade show for five days and spend the weekend gambling or going to shows.

What if a trip is primarily for pleasure, but you conduct some business while you are there? In that case, your travel expenses are nondeductible. However, you may write off otherwise deductible expenses for business activities during your trip.

Bad Debt Deduction: When Debt is Really Equity

The tax code allows you to claim a deduction for business debts that have become worthless, but qualifying for the deduction may be more complicated than you think.

In a recent case, the IRS denied more than $17 million in bad debt deductions on the grounds that the advances in question represented equity rather than debt, hitting the taxpayer with millions of dollars in taxes and penalties. The U.S. Tax Court, in Allen v. Commissioner, sided with the IRS.

When is the deduction available?

The bad debt deduction is valuable because you can use it to reduce ordinary income. However, keep in mind that it is available only for business bad debts. Nonbusiness bad debts (for example, from personal loans) generate capital losses, which can be used only to offset capital gains plus up to $3,000 in ordinary income.

Generally speaking, a bad debt deduction is available if 1) you hold a bona fide debt, 2) the debt instrument or documentation is not a security, and 3) the debt has become worthless — that is, there is no reasonable expectation of payment. If a debt has become partially worthless, you may be able to deduct the portion of the debt that is uncollectible, but only if you have charged it off for accounting purposes during the tax year.

Debt or equity?

In Allen, the IRS and Tax Court agreed that the taxpayer’s bad debt deduction failed to meet the first requirement listed above. That is because the worthless “loans” in the case represented equity rather than bona fide debt.

The taxpayer managed a real estate enterprise made up of several companies that he owned or controlled. In the tax years under review, he caused certain entities within his enterprise to advance millions of dollars to various related entities. The taxpayer argued that the advances were intended as bona fide loans, but the IRS determined that his “business purpose was to infuse capital into recipient companies and then redistribute those funds to himself and his related business entities as equity.”

To determine whether the advances were debt or equity, the Tax Court analyzed 13 factors as set forth in a prior case:

1. Names given to the certificates evidencing indebtedness;
2. Presence or absence of a fixed maturity date;
3. Source of principal payments;
4. Right to enforce payment of principal and interest;
5. Participation in management;
6. Status of the contribution in relation to regular corporate creditors;
7. Intent of the parties;
8. Thin or adequate capitalization;
9. Identity of interest between creditor and stockholder;
10. Source of interest payments;
11. Ability of the company to obtain loans from outside lending institutions;
12. Extent to which the advance was used to acquire capital assets, and
13. Failure of the debtor to repay on the due date or seek a postponement.

No single factor is controlling, and the factors are not necessarily weighted equally. Rather, the court considers each factor in the context of the specific facts and circumstances of the case.

Tax Court findings

In this case, the court found that seven of the factors (3, 4, 7, 8, 9, 10 and 11) favored equity, three (1, 2, and 5) favored debt and three (6, 12 and 13) were neutral. The court acknowledged that the purported loans were evidenced by promissory notes that identified fixed maturity dates, and that the taxpayer’s participation in management did not increase by virtue of the advances.

However, several factors supported the conclusion that the advances were, in substance, equity infusions:

• Repayment of the advances was dependent on the recipients’ sales.
• Although the taxpayer had a contractual right to enforce payment, the recipients had no ability to repay the debts. So, in substance, there was no right to enforce payment.
• There was no real expectation of payment, evidenced by a complete lack of interest payments and the fact that the taxpayer continued to make advances even after claiming bad debt deductions.
• The recipients were thinly capitalized when they received the advances.
• The interests of the purported lenders and borrowers were “significantly intertwined.”
• The lack of interest payments indicated that the purported lenders were “not expecting substantial interest income and, instead, [were] more interested in future earnings.”
• The recipients were not creditworthy at the time the advances were made and would have had trouble obtaining loans from outside lenders.

Takeaways

The Allen case is instructive for taxpayers hoping to ensure that advances (particularly to related parties) are treated as debt rather than equity. Executing appropriate loan documentation is important, but it is not enough. It is also critical that the borrower is creditworthy and sufficiently well capitalized to support a realistic expectation of repayment, and that the parties treat the transaction like a loan.

Sidebar:  Want to avoid penalties? Show good faith

In Allen v. Commissioner (see main article), the U.S. Tax Court upheld the IRS’s imposition of significant underpayment penalties: 20% of the amount by which taxes were underpaid. Taxpayers can avoid these penalties by showing that they acted with reasonable cause and in good faith.

In determining the existence of reasonable cause and good faith, courts look at a taxpayer’s experience, education and sophistication, among other factors. They also place significant emphasis on the taxpayer’s efforts to assess the proper tax liability, including reasonable, good-faith reliance on professional advice. In Allen, there was no evidence that the taxpayer sought professional advice when he determined that the “loans” were worthless or took any other steps to assess the proper tax liability.

For more information, contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Tax Services.