Chapter 20
Travel and Entertainment Expense Deductions

Unreimbursed employee travel expenses are deductible but are subject to the 2% of adjusted gross income (AGI) floor (19.1) and may also be subject to the reduction of overall itemized deductions on Schedule A depending on your income (13.7). If you are self-employed, travel expenses are claimed on Schedule C, so neither the 2% floor nor the overall reduction of itemized deductions applies to the expenses.

The types of deductible travel expenses are highlighted in Table 20-1. Generally, you must be away from home to deduct travel expenses on overnight business trips, but local lodging costs to attend a business meeting or training required by an employer may also be deductible. Whether you are an employee or self employed, meals and entertainment costs are subject to restrictions, including a 50% deduction limit (20.16).For employees, the 50% limit applies prior to the 2% floor (20.30). On one-day business trips within the general area of your employment, only transportation costs may be deducted; meals may not.

To support your travel expense deductions, keep records that comply with IRS rules (20.28). If you are employed, you can avoid the 2% of AGI deduction floor only if your employer maintains an “accountable” reimbursement plan (20.31).

As an employee, you report unreimbursed employee transportation and travel expenses on Form 2106. You can use short form 2106-EZ if you are not reimbursed by your company and you do not claim depreciation on a car used for business. Unreimbursed expenses from Form 2106 or 2106-EZ are entered on Schedule A, where they are subject to the 2% of AGI floor. Under an “accountable plan” arrangement, an employer’s expense allowance for travel costs is not reported as income on Form W-2 if you substantiated the expenses to your employer and returned any unsubstantiated portion of the allowance (20.31).

20.1 Deduction Guide for Travel and Transportation Expenses

Table 20-1 summarizes the rules for deducting local business transportation costs and travel expenses while “away from home” (20.6) on business trips. Generally, commuting expenses from your home to your place of business when you are not away from home are not deductible (20.2). However, you may be able to claim a deduction for daily transportation expenses incurred in commuting (20.2) to a temporary job location; see Table 20-1.

See 20.29 for how to report deductible expenses if you are self-employed, and 20.30 if you are an employee.

20.2 Commuting Expenses

The cost of travel between your home and place of work is generally not deductible, even if the work location is in a remote area not serviced by public transportation. Nor can you justify the deduction by showing you need a car for faster trips to work or for emergency trips. Travel from a union hall to an assigned job is also considered commuting. If you join a car pool, you may not deduct expenses of gasoline, repairs, or other costs of driving you and your passengers to work.

According to the IRS, if you use your cell phone to make calls to clients or business associates while driving to your office, you are still commuting and your expenses are not deductible. Similarly, the deduction is not allowed if you drive passengers to work and discuss business.

Deductible commuting expenses. The IRS allows these exceptions to its blanket ban on commuting expense deductions.

If you are on a business trip out of town, you may deduct taxi fares or other transportation costs from your hotel to the first business call of the day and all other transportation costs between business calls.

If you use your car to carry tools to work, you may deduct transportation costs where you can prove that they were incurred in addition to the ordinary, nondeductible commuting expenses. The deduction will be allowed even if you would use a car in any event to commute; see the Examples below.

Commuting to a temporary place of work. Whether you can deduct commuting expenses to a temporary place of work may depend on the location of the temporary assignment and whether you have a regular place of business or a home office that is your principal place of business. According to the IRS, if you have a regular place of work outside of your home, or you have a home office that is your principal place of business, you may deduct the cost of commuting between your home and a temporary (see below) work location, regardless of where the temporary location is. If you do not have a regular place of work but normally work at several locations in the metropolitan area where you live, you may deduct the costs of commuting to a temporary location that is outside that metropolitan area, but not to a temporary location within the metropolitan area.

If you do not have a regular place of work and all of your jobs are outside the metropolitan area where you live, none of your commuting costs are deductible under the IRS rule. In one case, a commuting cost deduction was denied to an iron worker who lived in Yuba City, California, and who obtained temporary work assignments at a union hall in Sacramento, 40 miles from her home. All of the temporary jobs were in or near Sacramento. The Tax Court agreed with the IRS that none of her commuting costs to the temporary locations were deductible because she did not work in the Yuba City area where she lived. Since all of her assignments were in other cities, her decision to live in Yuba City was for personal, not business, reasons.

What is a temporary place of work? A temporary work location is one at which your employment is realistically expected to last, and actually does last, for one year or less. If at first you realistically expect an assignment to last for no more than one year but that expectation changes, the IRS will generally treat the employment as temporary until the date that it became realistic to expect that the work would exceed one year.

Accountants, architects, engineers, and other professionals often have to travel to job sites of their clients. If such work at the site is temporary and they can show they also have a regular work office, they may deduct commuting expenses from their homes to their work sites.

20.3 Overnight-Sleep Test Limits Deduction of Meal Costs

The overnight-sleep rule prevents the deduction of meal costs on one-day business trips. To be deductible, meal costs must be incurred while “away from home” and this test requires that they be on a business trip that lasts longer than a regular working day (but not necessarily 24 hours) and requires time off to sleep (not just to eat or rest) before returning home. Meal costs while away from home are subject to the 50% deduction limit (20.17). Taking a nap in a parked car off the road does not meet the overnight-sleep test.

Several courts held that the IRS rule was unreasonable and outdated in the world of supersonic travel, and they would have allowed the New Yorker on the one-day trip to Washington, D.C., to deduct the cost of his lunch. The Supreme Court disagreed and upheld the IRS rule as a fair administrative approach.

Meal costs during overtime. Such costs are not deductible if you are not away from your place of business. Thus, for example, a resident physician could not deduct the cost of meals and sleeping quarters at the hospital during overnight or weekend duty.

20.4 IRS Meal Allowance

If you find it difficult to keep records of meal costs while away from home (20.3) on business trips, you may prefer to claim an IRS meal allowance. In government tables, the allowance is referred to as the “M&IE” rate (meals and incidental expenses). In addition to meals and tips for food servers, the allowance (M&IE rate) includes a limited number of “incidental” expenses such as fees and tips for porters, baggage carriers, hotel maids, or room stewards. Self-employed individuals may claim the M&IE allowance as well as employees who have expenses that are not reimbursed under an “accountable” plan (20.32).

Meal allowance on 2017 tax returns. For travel during 2017 within the continental U.S. (referred to as CONUS locations), the standard meal allowance (M&IE) for most locations is $51 per day, but higher rates of $54, $59, $64, $69, or $74 apply in major cities and other high-cost locations (such as resort areas) designated by the government. Whether the basic rate or a high-cost-area rate applies for a locality is determined by the federal government’s General Services Administration (GSA) for each fiscal year, effective October 1; the per locality rate is in effect for that entire fiscal year.The IRS allows taxpayers to use the applicable M&IE rates in figuring their meal allowance deduction.

The location-specific CONUS M&IE rates can be obtained from the GSA website at www.gsa.gov/perdiem. If you travel to more than one area on a given day, use the M&IE rate for the area where you stop for sleep. A special M&IE rule applies to workers in the transportation industry, as discussed below.

You must keep a record of the time, place, and business purpose of the trips. As long as you have this proof, you may claim the allowance even if your actual costs are less than the allowance.

Travel outside the continental United States. Different rates apply for travel in Alaska, Hawaii, Puerto Rico, and U.S. possessions, as well as for travel to foreign countries. These rates (OCONUS) can be obtained by using links from the GSA website at www.gsa.gov.

Transportation industry workers. Employees or self-employed persons in the transportation industry may elect to claim a special M&IE rate. For the first nine months of 2017, the rate is $63 per day for any CONUS location and $68 per day for any OCONUS location.The rates may change effective October 1, 2017; see the e-Supplement at jklasser.com for an update.The special rate avoids the need to apply the CONUS or OCONUS rates on a locality-by-locality basis. You cannot combine the two methods. If the special rate is used for one trip, it must be used for all trips during the same year.

Allowance must be reduced. The allowance is prorated for the first and last day of a trip. You may claim 75% of the allowance for the days you depart and return. Alternatively, you may claim 100% of the allowance if you are away for a regular “9-to-5” business day.

If you are an employee and claim a deduction based on the allowance, you must reduce the deduction by 50% on Form 2106 or Form 2106-EZ and the balance, when added to your other miscellaneous deductions, is subject to the 2% of AGI floor on Schedule A (20.30). If you are self-employed, the allowance is claimed on Schedule C, where it is subject only to the 50% reduction (20.29).

A higher deduction percentage is allowed to interstate truck drivers, pilots, railroad operators, and other transportation industry employees subject to Department of Transportation hours of service limits, who are allowed to deduct 80% (instead of 50%) of meal costs.

20.5 Business Trip Deductions

The following expenses of a business trip away from home (20.7) are deductible if not reimbursed by your employer:

• Plane, railroad, taxi, and other transportation fares between your home and your business destination
• Hotel and other lodging expenses. You need receipts or similar evidence for lodging expenses; there is no IRS standard lodging allowance as there is for meals (20.4). Although lodging costs are generally deductible only on business trips “away from home” (20.7), the IRS will allow an employee to deduct local lodging costs (not away from home) if the lodging is necessary on a temporary basis for the employee to participate in a bona fide business meeting or function of the employer (20.6).
• Meal costs. You may claim your actual meal costs if you maintain records, or you may use the standard meal allowance (20.4). Whichever method you use, only 50% of the unreimbursed meal costs are deductible (20.16).
• Tips, telephone, and telegraph costs
• Laundry and cleaning expenses
• Baggage charges (including insurance)
• Cab fares or other costs of transportation to and from the airport or station and your hotel. Also deductible are cab fares or other transportation costs, beginning with your first business call of the day, of getting from one customer to another, or from one place of business to another.
• Travel costs to find a new job are deductible (19.8).
• Entertainment expenses incurred while traveling away from home are deductible subject to restrictions, including the 50% deduction limit (20.16).

Cruise ship. If you travel by cruise ship on a business trip, your deductible cruise costs are limited to twice the highest federal per diem rate for travel in the United States on that date multiplied by the number of days in transit.

Important: Recordkeeping requirements. See the section for recordkeeping rules to support a deduction for unreimbursed travel expenses or to avoid being taxed on employer reimbursements (20.27).

20.6 Local Lodging Costs

Lodging costs are generally deductible only on trips “away from home” (20.7). However, the IRS allows an exception for certain local lodging costs that enable you to participate in a business meeting or training. An IRS safe harbor allows the deduction if: (1) the lodging is necessary for you to participate in or be available for a business meeting, conference or training, (2) if you are an employee, your employer requires you to stay overnight, (3) the lodging does not extend for more than 5 days and does not recur again within the same calendar quarter, and (4) the lodging is not lavish or extravagant under the circumstances. For employees, the deduction must be claimed as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor (20.30).

Even if the safe harbor does not apply, the IRS allows a deduction for local lodging costs that have a bona fide business purpose under all the facts and circumstances.

If your employer pays for lodging that satisfies the above safe harbor or the facts-and-circumstances test, the value of the lodging is considered a “working condition” fringe benefit that is excludable from your pay (3.9). Similarly, if you pay for qualifying local lodging and are reimbursed by your employer, the reimbursement is excluded from your pay provided the reimbursement is made under an “accountable” plan (20.32).

According to the IRS, local lodging that an employer temporarily provides to a new employee who is searching for a residence near the employer’s premises does not qualify under the “facts and circumstances” test. The employer’s payment is considered to be primarily for the employee’s personal benefit (rather than for a noncompensatory business reason) and the value of the lodging must be included in the employee’s taxable pay. The employer may deduct it as an ordinary and necessary business expense (compensation). Similarly, if an employer pays for an employee’s overnight hotel stay at a nearby hotel because the employee is working late on a special project and has a long commute, the expense is considered to be primarily for the employee’s personal benefit and the value of the lodging must be reported as additional pay to the employee.

On the other hand, if an employer pays for a hotel room near the employer’s office so an employee on “night duty”can be available for emergencies, this is considered to be a non-compensatory business reason, and the value of the lodging is not taxable under the facts and circumstances test. It is excluded from the employee’s income as a working condition fringe (3.9).

20.7 When Are You Away From Home?

You have to meet the “away from home” test to deduct the cost of meals (only 50% deductible) and lodging while traveling. You have to be away from your tax home and satisfy the overnight-sleep rule (20.3) to be “away from home.” In general, your tax home is the city or general area in which your regular place of business or post of duty is located, regardless of where your family is.

Are you constantly on the road? If you move from job to job and do not work within any particular locality, an IRS agent may disallow your travel deductions on the grounds that your tax home is wherever you work; thus, you are never “away from home.” You are considered a transient worker.

If your deduction is questioned because you have no regular or main place of business, you may be able to show that your tax home is the area of your residence. If you meet the following three tests, the IRS will treat your residence as your tax home: (1) you do some work in the vicinity of your residence, house, apartment, or room and live there while performing services in the area; (2) you have mortgage expenses or pay rent for the residence while away on the road; and (3) the residence is in an area where you were raised or lived for a long time, or a member of your immediate family such as your parent or child lives in the residence, or you frequently return there.

According to the IRS, if you meet only two of these three tests, it will decide on a case-by-case basis if your residence is your tax home. If you meet less than two of the tests, the IRS will not allow a deduction; each of your work locations is treated as your tax home.

If you live in a trailer at each job assignment and have no other home, each job location is your principal place of business and you are not “away from home.”

Permanent duty station of service members. The Supreme Court held that a member of the Armed Forces is not away from home when he or she is at a permanent duty station. This is true even if the service member has to maintain a separate home for family members who are not permitted to live at the duty station.

20.8 Fixing a Tax Home If You Work in Different Locations

If you regularly work in two or more separate areas, your tax home is the area of your principal place of business or employment. You are away from home when you are away from the area of your principal place of business or employment. Therefore, you may deduct your transportation costs to and from your minor place of business and your living costs there.

Professional sports players, coaches, and managers. When the only business of such persons is the professional sport, their home is the “club town.” But if they are in another business in addition to their professional playing, how much time is spent and how much is earned at each place determines whether their club’s hometown or the place of their off-season business is their tax home. If it is the club’s hometown, they deduct travel and living expenses while away from that town—including the time they are where the second business is. (If the second place is where their families also live, they may not deduct the families’ expenses there.) If the town where the other business is located is the tax home, then expenses in the club’s hometown may be deducted.

Airline pilots. It is important for airline pilots who fly in and out of various locations to determine a tax home for income and deduction purposes. Generally, the IRS considers an airline pilot’s tax home to be the airport at which the pilot is regularly based. For example, in one case the IRS barred a pilot from claiming the foreign earned income exclusion (36.1) because his tax home was deemed to be his base in New York, rather than in London, where he and his wife actually lived.

20.9 Tax Home of Married Couple Working in Different Cities

When a husband and wife work and live in different cities during the week, one of them may seek to deduct travel expenses away from home. Such deductions have generally been disallowed, but courts have allowed some exceptions. Each spouse may have a separate tax home.

20.10 Deducting Living Costs on Temporary Assignment

A business trip or job assignment away from home (20.7) at a single location may last a few days, weeks, or months. If your assignment is considered temporary, you may deduct travel costs (see below) while there because your tax home has not changed. An assignment is considered temporary by the IRS if you realistically expect it to last for one year or less and it actually does last no more than one year. If an assignment is realistically expected to last more than a year it is considered indefinite, and you cannot deduct your living costs at the area of the assignment because that location becomes your tax home. This is true even if the assignment actually lasts only a year or less. That is, you can be away for a year or less and still be barred from claiming a deduction if at the time you started the assignment you realistically expected it to last for more than a year. Likewise, employment that is initially temporary may become indefinite due to changed circumstances; see the Examples below.

Deductible travel costs on temporary trip. While on a temporary job assignment expected to last a year or less, you may deduct the cost of meals and lodging there, even for your days off. If you return home, say for weekends, your living expenses at home are not deductible. You may deduct travel expenses, meals, and lodging en route between your home and your job assignment provided they do not exceed your living expenses had you stayed at the temporary job location. If you keep a hotel room at the temporary location while you return home, you may deduct your round-trip expenses for the trip home only up to the amount you would have spent had you stayed at the temporary workplace.

Separate assignments over a period over a year. Where over a period of years you work on several separate assignments for one client, the IRS may attempt to treat the separate assignments as amounting to a permanent assignment and disallow living costs away from home, as in Mitchell’s situation, below.

No regular job where you live. That you do not have regular employment where you live may prevent a deduction of living costs at a temporary job in another city. The IRS may disallow the deduction on the grounds that the expenses are not incurred while you are away from home; the temporary job site is the tax home.

20.11 Business-Vacation Trips Within the United States

On a business trip to a resort area, you may also spend time vacationing. If the primary purpose of the trip is to transact business and the area is within the United States (50 states and the District of Columbia) you may deduct all of the costs of your transportation to and from the area, lodging, and 50% of meal expenses, even if you do spend time vacationing. If the main purpose of the trip is personal, you may not deduct any part of your travel costs to and from the area. The amount of time spent on business as opposed to sightseeing or personal visits is the most important issue in determining your primary purpose. Regardless of the primary purpose of your trip, you are allowed to deduct expenses related to the business you transacted while in the area.

No deductions will be allowed if you attend a convention or seminar where you are given videotapes to view at your own convenience and no other business-related activities or lectures occur during the convention. The trip is considered a vacation.

If your trip is primarily for business, and while at the business destination you extend your stay for a few days for nonbusiness reasons, such as to visit relatives, you deduct travel expenses to and from the business destination.

Reimbursement for weekend travel. If your employer extends your business trip over a weekend to take advantage of discount airfares that require a Saturday night stayover, you may deduct the cost of meals, lodging, and other incidental expenses incurred for the additional night. The reason for the stayover has a business purpose: to cut travel costs. If your employer pays for the expenses directly or if you are reimbursed under an accountable plan (20.32), the payment is not taxable to you.

20.12 Business-Vacation Trips Outside the United States

On a business trip abroad, you may deduct your travel expenses (the 50% limit applies for meals), even though you take time out to vacation, provided you can prove: (1) the primary purpose of the trip was business and (2) you did not have control over the assignment of the trip.

Fixing the date of the trip does not mean that you had control over the assignment. IRS regulations assume that when you travel for your company under a reimbursement or allowance arrangement, you do not control the trip arrangements, provided also that you are not: (1) a managing executive of the company; (2) related to your employer (20.4); or (3) have more than a 10% stock interest in the company. You are considered a managing executive if you are authorized without effective veto procedures to decide on the necessity of the trip. You are related to your employer if the employer is your spouse, parent, child, brother, sister, grandparent, or grandchild.

Rule for managing executives and self-employed persons. If you are a managing executive, self-employed, related to your employer, or have a more-than-10% stock interest, your deduction for transportation costs to and from your business destination may be limited. However, a full deduction for transportation costs is allowed if:

1. The trip outside the United States took a week (7 consecutive days) or less, not counting the day you left the U.S. but counting the day you returned,
2. If the trip abroad lasted more than a week, you spent less than 25% of your time, counting the days your trip began and ended, on vacation or other personal activities, or
3. In planning the trip you did not place a major emphasis on taking a vacation.

If the vacationing and other personal activities took up 25% or more of your time on a trip lasting more than one week, and you cannot prove that the vacation was a minor consideration in planning the trip, you must allocate travel expenses between the time spent on business and that spent on personal affairs. The part allocated to business is deductible; the balance is not. To allocate, count the number of days spent on the trip outside the United States, including the day you leave the U.S. and the day you return. Then divide this total into the number of days on which you had business activities; include days of travel to and from a business destination.

If you vacation at, near, or beyond the city in which you do business, the expense subject to allocation is the cost of travel from the place of departure to the business destination and back. For example, you travel from New York to London on business and then vacation in Paris before returning to New York. The expense subject to allocation is the cost of traveling from New York to London and back; see Example 2 below. However, if from London you vacationed in Dublin before returning to New York, you would allocate the round-trip fare between New York and Dublin and also deduct the difference between that round-trip fare and the fare between New York and London; see Example 3 below.

Weekends, holidays, and business standby days. If you have business meetings scheduled before and after a weekend or holiday, the days in between the meetings are treated as days spent on business for purposes of the 25% business test discussed above. This is true although you spend the days for sightseeing or other personal travel. A similar rule applies if you have business meetings on Friday and the next scheduled meeting is the following Tuesday; Saturday through Monday are treated as business days. If your trip is extended over a weekend to take advantage of reduced airfares, the additional expense of meals, lodging, and other incidental expenses is deductible (20.10).

20.13 Deducting Expenses of Business Conventions

Conventions and seminars at resort areas usually combine business with pleasure. Therefore, the IRS scrutinizes deductions claimed for attending a business convention where opportunities exist for vacationing. Especially questioned are trips where you are accompanied by your spouse and other members of your family. Deducting expenses of foreign conventions is subject to restrictions (20.15).

Generally, you may not deduct expenses of attending investment conventions and seminars (19.16). You also may not deduct the costs of business conventions or seminars where you merely receive a video or download of business lectures to be viewed at your convenience and no other business-related activities occur during the event.

In claiming a deduction for convention expenses, be prepared to show that your attendance at the convention benefitted your business. Cases and IRS rulings have upheld deductions for doctors, lawyers, and dentists attending professional conventions. One case allowed a deduction to a legal secretary for her costs at a secretaries’ convention. If you are a delegate to a business convention, make sure you prove you attended to serve primarily your own business interests, not those of the association. However, it is not necessary for you to show that the convention dealt specifically with your job. It is sufficient that attendance at the convention may advance or benefit your position. If you fail to prove business purpose, the IRS will allocate your expenses between the time spent on your business and the time spent as a delegate. You then deduct only the expenses attributed to your business activities.

What expenses are deductible? If the convention trip is primarily for business, you may deduct travel costs both to and from the convention, food costs, tips, display expenses (such as sample room costs), and hotel bills. If you entertain business clients or customers, you may deduct these amounts too.

Food and beverage costs are subject to the 50% cost limitation rule (20.25).

Keep records of your payments identifying expenses directly connected with your business dealings at the convention and those that are part of your personal activity, such as sightseeing, social visiting, and entertaining. Recreation costs are not deductible even though a part of your overall convention costs.

Fraternal organizations. You may not deduct expenses at conventions held by fraternal organizations, such as the American Legion, Shriners, etc., even though incidental business was carried on. However, delegates to fraternal conventions may in some instances deduct expenses as charitable contributions (14.4).

20.14 Travel Expenses of a Spouse, Dependent, or Business Associate

Travel costs of a spouse, dependent, or any other individual who accompanies you on a business trip are not deductible unless that person is also your employee or your business associate (partner, agent, advisor, client, customer, supplier) who has a bona fide business reason for taking the trip that would justify claiming a deduction if the person took the trip on his or her own.

Even though the travel costs of a non-employee spouse or other person are not deductible, you may deduct the cost of such person’s participation in the entertainment of business clients at conventions or business trips if the trip or entertainment meets certain tests (20.22). Generally, you may deduct the cost of goodwill entertaining of associates immediately before or after convention business meetings. A convention meeting qualifies as a bona fide business meeting.

20.15 Restrictions on Foreign Conventions and Cruises

You may not deduct expenses at a foreign convention outside the North American area unless you satisfy the general deduction rules (20.12) and also can show the convention is directly related to your business and it was as reasonable for the meeting to be held outside the North American area as within it.

Apart from the United States, the North American area includes Mexico, Canada, Puerto Rico, U.S. Virgin Islands, American Samoa, Northern Mariana Islands, Guam, Marshall and Midway Islands, Micronesia, Palau and U.S. island possessions.

Conventions may also be held in eligible Caribbean countries that agree to exchange certain data with the U.S. and do not discriminate against conventions held in the United States. Antigua and Barbuda, Aruba, Bahamas, Barbados, Bermuda, Costa Rica, Curacao, Dominica, Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Panama, Saint Lucia, and Trinidad and Tobago have qualified and are considered to be within the North American area.

Check with the convention operator about whether the country in which your convention is being held has qualified.

Limited cruise ship deduction. Up to $2,000 a year is allowed for attending cruise ship conventions if all the ports of call are in the U.S. or U.S. possessions and if the ship is registered in the United States. A deduction is allowed only if you attach to your return statements signed by you and by an officer of the convention sponsor that detail the daily schedule of business activities, the number of hours you attended these activities, and the total days of the trip. Do not confuse the $2,000 limitation with the per diem limitation for cruise ship costs (20.5). The per diem limitation does not apply to cruises that meet the tests for the up-to-$2,000 deduction.

20.16 50% Deduction Limit

To be deductible at all, dining and entertainment costs for clients, customers, or employees must meet one of two restrictive tests (20.17). Even if the expenses qualify under one of the tests, only 50% of unreimbursed expenses are generally deductible and this 50% balance is reduced by the 2% of AGI floor if you are an employee. Furthermore, all entertainment costs, including meals, must be backed up with records. If you do not keep adequate records, your deductions will be disallowed. See the discussion of the 50% deduction limit and exceptions to the limit (20.25).

20.17 The Restrictive Tests for Meals and Entertainment

Meal and entertainment costs are deductible, subject to the 50% limit (20.25), if they are ordinary and necessary to your business, and also are either:

1. Directly related to the active conduct of your business (20.18), or
2. Directly preceding or following a substantial and bona fide business discussion on a subject associated with the active conduct of your business. This test applies to dining and entertainment in which you seek new business or to goodwill entertainment to encourage the continuation of an existing business relationship. Under this test, you may entertain business associates in nonbusiness settings such as restaurants, theaters, sports arenas, and nightclubs, provided the entertainment directly precedes or follows the business discussion. Business associates are: established or prospective customers, clients, suppliers, employees, agents, partners, or professional advisers, whether established or prospective (20.19).

Ordinary and necessary expenses are those considered helpful and common practice in your business or profession; they do not have to be indispensable to your business.

20.18 Directly Related Dining and Entertainment

The directly related test limits the deduction of dining and entertainment costs at restaurants, nightclubs, on yachts, at sporting events, on hunting trips, and during social events.

The directly related test for dining and entertainment costs may be met in one of three ways: (1) under the generally related test; (2) as expenses incurred in a clear business setting; or (3) as expenses incurred for services performed. If dining or entertainment fails to meet the directly related tests, it may qualify under the goodwill entertainment rules (20.19), which require the holding of a business discussion before or after the entertainment.

Generally related test. Under this test, you must show a business motive for the dining or entertainment and business activity during the entertainment. You must show that you had more than a general expectation of getting future income or other specific business benefit (other than goodwill). Although you do not have to prove that income or other business benefit actually resulted from the expense, such evidence will help support your claim. What type of business activity will an IRS agent look for? The agent will seek proof that a business meeting, negotiation, or discussion took place during the period of dining or entertainment. It is not necessary that more time be devoted to business than to entertainment. What if you did not talk business? You must prove that you would have done so except for reasons beyond your control.

Clear business setting test. Expenses incurred in a clear business setting meet the directly related test provided also that you had no significant motive for incurring the expenses other than to further your business. Entertainment of people with whom you have no personal or social relationship is usually considered to have occurred in a clear business setting. For example, entertainment of business representatives and civic leaders at the opening of a new hotel or theatrical production to obtain business publicity rather than goodwill is considered to be entertainment in a clear business setting. Also, entertainment that involves a price rebate is considered to have occurred in a clear business setting, as, for example, when a hotel owner provides occasional free dinners at the hotel for a customer who patronizes the hotel.

The cost of a hospitality room displaying company products at a convention is also a directly related expense.

Entertainment occurring under the following circumstances or in the following places is generally not considered as directly related:

• You are not present during the entertainment.
• The distractions are substantial, as at nightclubs, sporting events, or during a social gathering such as a cocktail party.
• You meet with a group that includes persons other than business associates at cocktail lounges, country clubs, golf and athletic clubs, or at vacation resorts.

Services performed test. An expense is directly related if it was directly or indirectly made for the benefit of an individual (other than an employee) either as taxable compensation for services he or she rendered or as a taxable prize or award.

20.19 Goodwill Entertainment

Goodwill entertaining may qualify as deductible entertainment. Dining and entertainment costs may be deductible if a substantial and bona fide business discussion directly preceded or followed the dining or entertainment. Generally, the IRS requires the entertainment to be on the same day as the business discussion in order to be treated as directly preceding or following the business discussion. However, if the guests are from out of town, and you entertain them on the evening before the business discussion, or on the evening of the day after the discussion, the IRS will generally allow the deduction.

An officially scheduled meeting at a convention is generally considered a bona fide business discussion.

20.20 Home Entertaining

The cost of entertaining business customers or clients at home is deductible provided a business discussion occurs before, during, or after the meal. When you claim such a deduction, be ready to prove that your motive for dining with them was business rather than social. Have a record of the entertainment costs, names of the guests, and their business affiliations.

20.21 Your Personal Share of Entertainment Costs

If the entertaining occurred while on a business trip away from home, you deduct your own meal costs as travel expenses away from home (20.7). If the entertaining occurred within the locality of your regular place of business, the IRS will generally not disallow your deduction of your own part of the meal cost unless you are claiming a substantial amount that includes personal living expenses. In such a case, which generally is limited to situations where personal meals are regularly claimed as part of an “abusive” pattern, the IRS will follow the stricter Tax Court rule (sometimes referred to as the “Sutter” rule) and allow only that part of the meal cost that exceeds what you would usually spend on yourself when alone.

20.22 Entertainment Costs of Spouses

A deduction is allowed for the spouses’ share of the entertainment costs if they were present during entertainment that qualified as directly related entertainment (20.18). For goodwill entertainment, the cost of entertainment of the spouses is deductible if your share and the business associate’s share of the entertainment is deductible. The IRS recognizes that when an out-of-town customer is accompanied by his or her spouse, it may be impracticable to entertain the customer without the spouse. Under such circumstances, the cost of the spouse’s entertainment is deductible if the customer’s entertainment costs are also deductible. Furthermore, if your spouse joined the party because the customer’s spouse was present, the expenses of your spouse are also deductible.

20.23 Entertainment Facilities and Club Dues

You may not deduct the expenses of maintaining and operating facilities used to entertain clients and customers. By law, entertainment facilities are not considered business assets. Examples of entertainment facilities are yachts, hunting lodges, fishing camps, swimming pools, tennis courts, automobiles, airplanes, apartments, hotel suites, or homes in a vacation area. A season box seat or pass at a sporting event or theater is not considered an entertainment facility; see the special rule for skybox rentals (20.25).

The disallowance rule applies to operating expenses such as rent, utilities, and security, and also to depreciation, but not to such expenses as interest, taxes, and casualty losses that are deductible without having to show business purpose.

Exceptions. A deduction may be allowed for expenses such as the cost of food and drinks incurred at an entertainment facility, if they meet certain rules (20.17–20.22).

Club dues. You may not deduct dues for country clubs, golf and athletic clubs, airline clubs, hotel clubs, business luncheon clubs, and other clubs organized for business, pleasure, recreation, or other social purposes. However, IRS regulations generally allow a deduction for dues paid to (1) civic or public service organizations such as Kiwanis, Lions, and Rotary clubs; (2) professional organizations such as medical or bar associations; and (3) chambers of commerce, trade associations, business leagues, real estate boards, and boards of trade. The deduction for dues is allowed provided that the organization in (1)–(3) does not have a principal purpose of providing entertainment for members or their guests.

20.24 Restrictive Test Exception for Reimbursements

As an employer, you can deduct expense allowances or other reimbursements of employee expenses that you treat as compensation and from which you withhold federal tax. You are not subject to the 50% deduction limit for meals and entertainment; the employee is, when claiming the meals on Form 2106.

A similar rule applies to meal allowances or reimbursements that you give to an independent contractor and that you report as compensation on Form 1099-MISC where the contractor does not adequately account for the expenses.

The restrictive tests (20.17) do not apply to such reimbursements. They are deductible if they are “ordinary and necessary” business expenses, and you have records to back up the deduction.

20.25 50% Cost Limitation on Meals and Entertainment

You generally may not deduct the full amount of your deductible expenses for business meals and entertainment expenses, such as tickets to sports events. Unless one of the exceptions below applies, only 50% of the otherwise allowable amount for food, beverages, and entertainment is deductible. However, the deductible percentage for workers subject to the Department of Transportation’s “hours of service” limits is 80% rather than 50%.

Taxes and tips are considered part of the cost subject to the 50% limit. If your employer reimburses your expenses, the 50% limit applies to the employer.

The 50% limit applies to both employees and the self-employed. It applies to the IRS meal allowance deduction (20.4). For employee expenses the limit is taken into account on Form 2106 or 2106-EZ (if you are not reimbursed by your employer and do not claim depreciation for a business car), and on Schedule C for self-employment expenses.

Tickets. The deductible amount for a ticket treated as an entertainment expense is generally restricted to the face value of the ticket. Amounts in excess of face value paid to ticket agencies or scalpers are not deductible. Also see the special rule for skybox rental costs below. The deductible cost of tickets is also generally subject to the 50% limitation. However, a full deduction is allowed for tickets to qualifying charitable sporting events; see Exception 7 below.

Exceptions to 50% cost limitation. In the following cases, you may claim a full deduction for meals and entertainment; the 50% limitation does not apply:

1. As an employer, you pay for an employee’s meals and entertainment that are treated as taxable compensation to the employee and as wages for purposes of withholding of income tax.
2. You reimburse an independent contractor for meal and entertainment expenses he or she incurs on your behalf and the contractor does not adequately account for the expenses. You should report and deduct the reimbursements as compensation to the contractor, assuming the reimbursements are ordinary and necessary business expenses.
3. As an employer, you incur expenses for recreational, social, or similar activities (including facilities) primarily for the benefit of employees who are not highly compensated employees. For example, the expenses of food, beverages, and entertainment for a company-wide summer party are not subject to the 50% limit.
4. Expenses for meals and entertainment, including the use of facilities made available to the general public, such as a free concert, for advertising or goodwill purposes. For example, the IRS allowed a real-estate broker to fully deduct the cost of free dinners it provided to potential investors who attended its sales presentations. The 50% deduction limitation for meals does not apply to promotional activities that are made available to the general public. According to a Congressional committee report, a 100% deduction would be allowed in this case: A wine merchant provides customers with wine and food to demonstrate the suitability of the wine with certain types of meals. The cost of the wine, food, and other costs associated with the wine-tasting function would be fully deductible.
5. Expenses for meals and entertainment sold to the public in your business, such as meal expenses if you run a restaurant, or the cost of providing entertainment if you run a nightclub. These expenses are fully deductible.
6. Food or beverage provided to your employees as a tax-free de minimis fringe benefit (3.10). This would include expenses of a cafeteria on your premises for employees where meal charges cover the direct operating cost of the cafeteria. The de minimis benefit exception allows a full deduction for all meals provided to employees on employer premises if more than half of the employees who are provided meals are furnished them for the employer’s convenience (substantial noncompensatory business purpose). If the more-than-half test is met, the meals are tax free to all the employees (3.12).

7. The price of tickets to charitable sports events (including amounts in excess of face value) provided the ticket package includes admission to the event. To qualify, a charitable sports event must: (1) be organized for the primary purpose of benefitting a tax-exempt organization; (2) contribute 100% of its net proceeds to such organization; and (3) use volunteers for substantially all work performed in carrying out the event. According to Congressional committee reports, a golf tournament that donates all its proceeds to charity is eligible to qualify under this exception, even if it offers prize money to the golfers who participate or uses paid concessionaires or security personnel. However, tickets to a college football game or similar scholastic events generally do not qualify because they do not satisfy the requirement that substantially all work be performed by volunteers.

Skybox rental costs. A skybox is a private luxury seating area at a sports arena. Skybox seats are generally rented for the season or for a series of games such as the World Series. The deductible amount for a rental covering more than one game or performance may not exceed the sum of the face values of non-luxury box seat tickets for the number of seats in the box. The allowable amount is also subject to the 50% cost limitation. Separately stated charges for food or beverages at the skybox are deductible if the amount is reasonable, and such charges are subject to the 50% cost limitation for entertainment expenses. For example, assume that for two games, you paid $2,500 for a skybox containing 10 seats ($125 per seat, $1,250 per game). The cost of a non-luxury box seat ticket is $40, so 10 non-luxury box seat tickets would cost $400 for each game, or $800 for both. You may deduct 50% of the $800 non-luxury face value, or $400. If you had rented the skybox for one game, you could deduct $625 (50% of $1,250) for that skybox because the special limitation applies only where the rental is for more than one game or other performance.

20.26 Business Gift Deductions Are Limited

Deductions for gifts to business customers and clients are restricted. Your deduction for gifts is limited to $25 per person per year. You and your spouse are treated as one person in figuring this limitation even if you do not file a joint return and even if you have separate business connections with the recipient. The $25 limitation also applies to partnerships; thus a gift by the partnership to one person may not exceed $25, regardless of the number of partners.

In figuring the $25 limitation to each business associate, do not include the following items:

1. A gift of a specialty advertising item that costs $4 or less on which your name is clearly and permanently imprinted. This exception saves you the trouble of having to keep records of such items as pens, desk sets, plastic bags, and cases on which you have your name imprinted for business promotion.
2. Signs, displays, racks, or other promotional material that is used on business premises by the person to whom you gave the material.
3. Incidental costs of wrapping, insuring, mailing, or delivering the gift. However, the cost of an ornamental basket or container must be included if it has a substantial value in relation to the goods it contains.

If you made a gift to the spouse of a business associate, it is considered as made to the associate. If the spouse has an independent bona fide business connection with you, the gift is not considered as made to the associate unless it is intended for the associate’s eventual use.

If you made a gift to a corporation or other business group intended for the personal use of an employee, stockholder, or other owner of the corporation, the gift generally is considered as made to that individual.

Packaged food or drink given to a business associate is a gift if it is to be consumed at a later time. Theater or sporting event tickets given to business associates are entertainment, not gift, expenses if you accompany them. If you do not accompany them, you may elect to treat the tickets either as gifts, which are subject to the $25 limitation, or as entertainment expenses subject to the entertainment expense rules, such as the requirement to show a business conference before or after the entertainment and the 50% cost limitation.

Gifts not coming within the $25 limit are: (1) scholarships that are tax free under the rules in Chapter 33; (2) prizes and awards that are tax free under the rules in 11.1; and (3) awards to employees, discussed below.

Employer deduction for awards to employees. There is an exception to the $25 gift deduction limitation for achievement awards of tangible personal property given to your employees in recognition of length of service or safety achievement. Special deduction limits apply to such achievement awards provided they are given as part of a presentation under circumstances indicating that they are not a form of disguised compensation. For example, awards will not qualify if given at the time of annual salary adjustments, or as a substitute for a prior program of cash bonuses, or if awards discriminate on behalf of highly compensated employees.

The amount of your deduction depends on whether the achievement award is considered a qualified plan award. You may deduct up to $1,600 for all qualified plan awards (safety and length of service) given to the same employee during the taxable year. If the award is not a qualified plan award, the annual deduction ceiling for each employee is $400. The $1,600 overall limit applies if the same employee receives some qualified plan awards and some non-qualified awards during the same year.

To be a qualified plan award, the award for length of service or safety achievement must be given under an established written plan or program that does not discriminate in favor of highly compensated employees. The average cost of all awards under the plan for the year (to all employees) must not exceed $400. In determining this $400 average cost, awards of nominal value are not to be taken into account. In case of a partnership, the deduction limitation applies to the partnership as well as to each partner.

Safety and length of service. A length of service award does not qualify as an employee achievement award if it is given during the employee’s first five years. Furthermore, only one length of service award every five years is considered an employee achievement award.

Safety awards granted to managers, administrators, clerical employees, or professional employees are not considered employee achievement awards. Furthermore, if during the year more than 10% of other employees (not counting managers, administrators, clerical employees, or professional employees) previously received safety awards, none of the later awards are subject to the employee achievement award rules.

Employee’s tax. The employer’s deductible amount for an employee achievement award is tax free to the employee (3.12). For example, you give a qualified plan award costing $1,800 to an employee. You may deduct only $1,600. The employee is not taxed on the award up to $1,600; the $200 balance is taxable.

20.27 Recordkeeping Requirements

Your testimony—even if accepted by an IRS agent or a judge as truthful—is not sufficient to support a deduction of travel and entertainment expenses. By law, your personal claim must be supported by other evidence such as records or witnesses. The most direct and acceptable way is to have records that meet IRS rules discussed below. Failure to have adequate records will generally result in an examination of your return and in a disallowance of your travel and entertainment expense deductions. Only in unusual circumstances will evidence other than records provide all of the required details of proof. If your expenses are reimbursed by your company, you must keep records to support the reimbursement arrangement with your company (20.31).

20.28 Proving Travel and Entertainment Expenses

To satisfy the IRS requirements and to substantiate your expense deductions in the event of an audit, you need two types of records:

1. A computer log, diary, account book, or similar record to list the time, place, and business purpose of your travel and entertainment expenses; and
2. Receipts, itemized paid bills, or similar statements for lodging regardless of the amount, and for other expenses of $75 or more. But note these exceptions:
   • A receipt for transportation expenses of $75 or more is required only when it is readily obtainable. For example, for air travel a receipt or a boarding pass is usually provided.
   • A canceled check by itself is not an acceptable voucher. If you cannot produce a bill or voucher, you may have to present other evidence such as a statement in writing from witnesses to prove business purpose of the expense.

A receipted bill or voucher must show (1) the amount of the expense; (2) the date the expense was incurred; (3) where the expense was incurred; and (4) the nature of the expense.

A hotel bill must show the name, location, date, and separate amounts for charges such as lodgings, meals, and telephone calls. A receipt for meals or lodging is not needed if its cost is covered by a per diem allowance (20.33). The IRS will not allow a credit card statement to substitute for a lodging receipt. The IRS wants detailed receipts to catch personal items such as personal phone calls or the purchase of gifts.

A restaurant bill must show the restaurant’s name and location, the date and amount of the expense, and, when a charge is made for items other than meals or beverages, a description of the charge.

Account book or computer entries. Your records do not have to duplicate data recorded on a receipt, provided that a notation in your record is connected to the receipt. You are also not required to record amounts your company pays directly for any ticket or fare. Credit card charges should be recorded.

Your records for entertainment costs must also show (1) the names of those you entertained; (2) the business purpose served by the entertainment; (3) the business relationship between you and your guests; and (4) the place of entertainment. Inattention to these details of substantiation can cost you the deduction. For example, an executive’s company treasurer verified that the executive was required to incur entertainment expenses beyond reimbursed amounts. He also kept a cash diary in which he made contemporaneous notes of the amounts he spent. But he failed to note place, purpose, and business relationship. Consequently, there was no record that tied the expenses to his employment and the deduction was disallowed.

Excuses for Inadequate Records

Substantial compliance. If you have made a “good faith” effort to comply with the IRS rules, you will not be penalized if your records do not satisfy every requirement. For example, you would not automatically be denied a deduction merely because you did not keep a receipt.

Accidental destruction of records. If receipts or records are lost through circumstances beyond your control, you may substantiate deductions by reasonable reconstruction of your expenditures.

Exceptional circumstances. If, by reason of the “inherent nature of the situation,” you are unable to keep adequate records, you may substantially comply by presenting the next best evidence. A supporting memorandum from your files and a statement from the persons entertained may be an adequate substitute. IRS regulations do not explain the meaning of “inherent nature of the situation.”

20.29 Reporting T&E Expenses If You Are Self-Employed

You must keep travel and entertainment (T&E) records in accordance with IRS rules (20.28). You may claim the meal allowance (20.4) on overnight business trips. The reimbursement rules (20.31) do not apply to you.

In preparing your tax return, you report your expenses on the appropriate lines of Schedule C or Schedule C-EZ (40.6). You do not use Form 2106. An advantage of reporting on Schedule C (or C-EZ) is that your travel and entertainment expenses (T&E) are not subject to the 2% of adjusted gross income (AGI) floor. Only 50% of meals and entertainment costs are deductible, but there are exceptions (20.25).

20.30 Employee Reporting of Unreimbursed T&E Expenses

If you are paid a salary with the understanding that you will pay your own expenses and you pay all of your travel and entertainment (T&E) expenses without reimbursement, you report all of your salary or commission income as shown on Form W-2. You report your expenses on Form 2106 or Form 2106-EZ (19.3). Meals and entertainment are only 50% deductible (20.25). You must also keep records (20.28) to support your deduction. The deductible amount from Form 2106 or Form 2106-EZ is entered on Schedule A as a miscellaneous expense subject to the 2% of AGI floor (19.1). If your total miscellaneous expenses, including the unreimbursed T&E costs, do not exceed 2% of adjusted gross income, none of the miscellaneous expenses will be deductible.

If your employer has a reimbursement plan but the rules for accountable plans are not met, reimbursements are treated as part of your taxable pay (20.35).

20.31 Tax Treatment of Reimbursements

Compliance rules are imposed on employees and employers for reporting reimbursed travel and entertainment expenses in order to prevent reimbursement arrangements from being used to avoid the 2% of adjusted gross income (AGI) floor for employee miscellaneous expenses (19.1). Plans that allow reimbursements that do not comply with the IRS rules are called non-accountable plans. All reimbursements made to you under a non-accountable plan are reported as salary or wage income on your Form W-2. You then deduct your expenses, if at all, as miscellaneous deductions subject to the 2% of AGI floor (20.35).

Accountable plans. If your employer’s reimbursement plan meets the IRS rules, the plan is treated as an accountable plan and reimbursements made to you by the plan are not reported as taxable wages on your Form W-2. You also do not have to deduct expenses, assuming the reimbursement equals your expenses. In other words, there is a bookkeeping “wash” in which the full amount of expenses offsets the reimbursement without being reduced by the 2% of AGI floor, and in the case of meal and entertainment costs, by the 50% reduction. Even though your employer may only deduct 50% of qualifying meal and entertainment expenses, you are not taxed on any part of a reimbursement of such costs if the accountable plan rules are met.

To qualify a plan as accountable, your employer must see to it that you submit adequate proof of your expenditures, and that you return any excess advances (20.32). To reduce recordkeeping for actual costs, the company may reimburse you according to certain fixed per diem allowance rates (20.33). Your company must also determine how much of the advance or reimbursement, if any, is to be reported on your Form W-2.

Reimbursements of club dues or spousal travel costs. If you are reimbursed for nondeductible club dues (20.23) or nondeductible travel costs of a spouse or other person (20.14), the reimbursement may be treated by your employer as taxable wages. If it is, you are not allowed an offsetting deduction. If the reimbursement is not treated as taxable wages by your employer, and you substantiate a business purpose for the club dues or for a travel companion’s presence, the reimbursement is considered to be a tax-free working condition fringe benefit (3.9).

20.32 What Is an Accountable Plan?

A reimbursement or allowance arrangement is an accountable plan (20.31) if you must:

• Adequately account to your employer for your expenses; and
• Return to your employer any excess reimbursement or allowance that you do not show was spent for ordinary and necessary business expenses.

If these terms are met and your expenses are fully reimbursed, you do not report the expenses or the reimbursement on your return. If the reimbursement is less than your payment of expenses, you use Form 2106 and Schedule A to claim a deduction for the unreimbursed expenses. The unreimbursed expenses are subject to the 2% of AGI floor on Schedule A (19.3).

What is an adequate accounting? You adequately account to your employer by submitting receipts and an account book, diary, or similar record in which you entered each expense at or near the time you had it. You must account to your employer for all amounts received as advances, reimbursements, or allowances, including amounts charged on a company credit card. Your records and supporting information must meet IRS rules (20.28). You must also pay back reimbursements or allowances that exceed the expenses that you adequately accounted for, or the nonreturned excess will be taxable under the rules for non-accountable plans (20.35).

The accounting requirements are eased if you are reimbursed under a per diem arrangement covering meals, lodging, and incidental expenses (20.33) or you receive a flat mileage allowance (20.34).

Time limits for receiving advances, substantiating expenses, and returning excess payments. The general rule is that these events must occur within a reasonable time. Under an IRS “safe harbor,” the following payments are considered to be within a reasonable time:

• Advance payments—if given to you within 30 days before you reasonably anticipate to pay or incur expenses;
• Substantiation of expenses—if provided to your employer within 60 days after the expense is paid or incurred; and
• Return of excess—if done within 120 days after you pay or incur expense.

An employer may set up a “periodic statement method” to meet IRS rules. Here, an employer gives each employee periodic statements (at least quarterly) that list the amounts paid in excess of expenses substantiated by the employee and request substantiation of the additional amounts paid, or a return of the excess, within 120 days of the date of the statement. Substantiation or return within the 120-day period satisfies the reasonable time test.

Allocating reimbursements to meals and entertainment. Only 50% of meals and entertainment expenses are deductible. Therefore, if you adequately account for your expenses, and receive a flat reimbursement that is partly for meals and entertainment, and partly for other expenses, you must allocate part of the reimbursement to meals and entertainment if the employer has not provided an item-by-item breakdown. You must make this allocation if you want to deduct expenses exceeding reimbursements because on Form 2106, you must separately list meals and entertainment costs and reimbursements for meals and entertainment. The Form 2106 instructions have a worksheet for allocating the reimbursement based on the percentage that your meal costs bear to the total T&E expenses.

20.33 Per Diem Travel Allowance Under Accountable Plans

Instead of providing a straight reimbursement for substantiated out-of-pocket travel expenses, an employer may use a per diem allowance to cover meals, lodging, and incidental (20.4) expenses of employees on business trips away from home. If you are not related to the employer, you do not have to give your employer proof of your actual expenses if you receive a per diem allowance or reimbursement that is equal to or less than the federal travel rate for the particular area. You do have to account for the time, place, and business purpose of your travel. If you do not provide such an accounting for some travel days, you must be required to return the per diem allowance received for such days in order for the employer’s plan to qualify. If these tests are met, the allowance satisfies the accountable plan (20.32) requirements and it does not have to be reported as income on your Form W-2.

Federal travel rate. Tables published by the government show the federal travel rate for areas within the continental U.S. (called CONUS locations) and for areas outside the continental U.S., including Hawaii and Alaska (called OCONUS locations). New CONUS tables are released every October, effective for the government’s October 1–September 30 fiscal year (20.4). You can obtain the CONUS per diem rates from the General Services Administration website at www.gsa.gov. The OCONUS rates can also be accessed from the GSA website.

If an employer uses the CONUS per diem rates to reimburse employees in the first nine months of the year, the CONUS per diem method must also be used for those employees for the last three months of the year; the “high-low” method (see below) may not be used for those employees until the following calendar year. Where employees are reimbursed in the first nine months using the CONUS per diem rates, the employer may reimburse their travel during the last three months using the per diem rates for the first nine months, or may use the new per diem rates taking effect October 1.

High-low method. For business trips within the continental United States (CONUS), employers may use the IRS’ “high-low” method to reimburse employees for lodging, meals, and incidental expenses instead of using the locality-by-locality per diem CONUS rates set by the General Services Administration (GSA) for federal government workers. For each employee, either the federal per diem rates or the high-low method has to be used for the entire year.

There is a high-cost area rate and a rate for all other areas within CONUS. The rates are announced by the IRS in an annual notice that lists the areas qualifying for the high-cost rate as well as the months for which the high-cost rate may be used if the area qualifies for less than the full year. For the period beginning October 1, 2016, and ending September 30, 2017, the rate for designated high-cost areas within CONUS was $282 per day, and the rate for all other areas within CONUS, the “low” rate, was $189 per day (IRS Notice 2016-58). For the period beginning October 1, 2017, and ending September 30, 2018, the rate for designated high-cost areas increases to $284 and the rate for other areas increases to $191 per day (IRS Notice 2017-54).

For employer deduction purposes, $68 of the $282/$284 high-cost-area rate and $57 of the $189/$191 low-cost area rate, must be allocated to meals. Only 50% of the allocated meals portion is generally deductible (20.25). The meal deduction percentage is 80% for meal costs of transportation workers such as pilots and interstate truck/bus drivers who are subject to Department of Transportation limits on service hours.

Transition rules require employers that used the high-low rates for a particular employee during the first nine months of a year to continue to use the high-low method for that employee for the remainder of that calendar year. If an employer used the high-low method for business trips during the first nine months of 2017, then for the last three months, the employer may use the new high-low rates ($284 or $191) along with the list of high-cost localities that took effect October 1, 2017 (as shown in Notice 2017-54). Alternatively, the employer may use the pre-October high-low rates ($282 or $189) and pre-October high-cost localities (from Notice 2016-58) for the last three months provided that those pre-October rates and localities are used for all employees who are reimbursed under the high-low method. An employer may not use the high-low method until 2018 for an employee whose expenses within CONUS for January through September 2017 were reimbursed using the locality-by-locality per diem CONUS rates set by the General Services Administration (GSA) for federal government workers.

Employees related to the employer. The IRS per diem rules that allow you to avoid accounting for actual expenses do not apply if you work for a brother, sister, spouse, parent, child, grandparent, or grandchild. They also do not apply if you are an employee-stockholder who owns more than 10% of the company’s stock.

Reporting a per diem allowance. If the allowance does not exceed the federal travel rate or IRS high-low rate, the reimbursement is not reported on Form W-2. If your expenses do not exceed the reimbursement, you do not have to report the expenses or the reimbursement on your tax return; see Example 1 below. If your expenses exceed the allowance, you may deduct the excess by reporting the expenses and reimbursement on Form 2106. The net amount from Form 2106, after applying the 50% reduction for meals, is claimed on Schedule A as a miscellaneous expense subject to the 2% of AGI floor; see Example 2 below.

If the allowance exceeds the federal rate, the allowance up to the federal rate is reported by the employer in Box 12 of your Form W-2, using Code L . This amount is not taxable. However, the excess allowance will be included as wages in Box 1 of your Form W-2; see Example 3 below.

Allowance covering only meals and incidentals. If your employer gives you a per diem allowance covering only meals and incidental expenses, it is not taxable to you if you are not related to the employer and the allowance does not exceed the IRS meal allowance rate for that locality (M&IE rate; see 20.4). Alternatively, for travel within CONUS, your employer may use the meals rate under the high-low method to substantiate the allowance. For 2017, the amount allocable to meals under the high-low method is $68 for high-cost localities and $57 for other areas (see “High-low method” above). Thus, an allowance for meals and incidental expenses for 2017 travel within CONUS is not be taxable to you if it does not exceed the applicable $68/$57 meals rate.

20.34 Automobile Mileage Allowance

If your employer paid you a fixed mileage allowance of up to 53.5 cents per mile for business miles driven in 2017, the amount of your driving costs is treated as substantiated under the accountable plan rules (20.32), provided you show the time, place, and business purpose of your travel. If the allowance is in the form of an advance, it must be given within a reasonable period before the anticipated travel and you must also be required to return within a reasonable period (20.32) any portion of the allowance that covers mileage that you have not substantiated.

If these tests are met, the allowance will not be reported as income on Form W-2, and you will not have to report the allowance or expenses on your return; see Example 1 below. If you do not prove to your employer the time, place, and purpose of your travel, the entire reimbursement is treated as paid from a non-accountable plan and will be reported as income on Form W-2.

Your employer may reimburse you for any parking fees and tolls in addition to the mileage allowance.

Fixed and variable rate allowance (FAVR). In lieu of setting the allowance at the IRS standard mileage rate, an employer may use a fixed and variable rate allowance, called a FAVR, that gives employees a cents-per-mile rate to cover gas and other operating costs, plus a flat amount to cover fixed costs such as depreciation or lease payments, insurance, and registration. A FAVR allowance must reflect local driving costs and allows employers to set reimbursements at a rate that more closely approximates employee expenses. If your employer sets up a qualifying FAVR under IRS guidelines, you will be required to provide records substantiating your mileage and certain car ownership information. Expenses up to the FAVR limits are deemed substantiated and will not be reported as wages on your Form W-2.

20.35 Reimbursements Under Non-Accountable Plans

A non-accountable plan is one that either does not require you to adequately account for your expenses or allows you to keep any excess reimbursement or allowances over the expenses for which you did adequately account.

Your employer reports allowances or reimbursements for a non-accountable plan as part of your salary income in Box 1 of your Form W-2. The allowance or reimbursement is also subject to income tax and FICA tax (Social Security and Medicare) withholding. You may be able to deduct travel expenses if you itemize deductions. You must complete Form 2106 or 2106-EZ (meal expenses will be subject to the 50% limit (20.25). and enter the amount from the form as an unreimbursed employee expense on Schedule A, where it is subject to the 2% of AGI floor (19.1). If the expenses are not allowed because of the 2% floor, you will be unable to offset the taxable reimbursement (allowance) included on your Form W-2.