Virtual CFO Services - Although video conferencing has made inroads in the ranks of business travelers, there still are situations where it's necessary to travel away-from-home overnight for face-to-face meetings with staff, management, or customers. In the current vacation season, businesspeople or professionals who must travel for work reasons should keep in mind that they may be able to qualify for a travel bargain by piggybacking a short vacation onto an out-of-town business trip. The traveler gets to deduct his vacation airfare if the trip is set up the right way. And if the travel is undertaken for an employer, a properly set up reimbursement arrangement for the business portion of the trip will be income- and payroll-tax-free.
Overview. Travel that takes the taxpayer outside of the U. S. is treated the same way as travel within the U.S., (covered in detail at Weekly Alert ¶ 5 07/09/2015) if:
(1) the trip is undertaken solely for business reasons (50% of meals, and 100% of other costs, are deductible, or are treated as tax-free to a reimbursed traveler if the accountable plan rules are met); or
(2) the trip is undertaken primarily for personal reasons, but there is some business done during the trip (only business-related lodging, and 50% of business-related meals, are deductible as travel expenses, or are treated as tax-free to a reimbursed traveler if the accountable plan rules are met). (Reg. § 1.162-2(b); Reg. § 1.274-4(a))
The foreign business travel rules diverge from those for domestic business travel when the taxpayer undertakes a trip primarily for business reasons, but also takes some personal days while abroad. In this situation, the transportation expenses are fully deductible—despite the personal days—if one of four tests, explained below, are met. If none of the four tests are met, transportation expenses must be allocated under special rules between (deductible) business and (nondeductible) personal activities.
AB Tax Accounting observation: The allocation rules for foreign business travel apply only to transportation expenses—the cost of getting there and back. The other costs are subject to the usual rules: lodging expenses and 50% of meals while on business status are deductible (and are tax-free to a traveling employee if the accountable-plan rules are met). Purely personal expenses are nondeductible by a self-employed taxpayer or an unreimbursed employee, may be deductible as compensation by an employer that reimburses the expenses, and are taxed to a reimbursed traveler.
Fully deductible foreign transportation costs. When an individual goes on a foreign business trip, the full cost of the round-trip transportation is treated the same way as for a domestic business trip as long as the travel meets any of the following four tests.
AB Tax Accounting observation: This means that the entire cost of the round-trip transportation is deductible (and tax-free to an employee if the accountable plan rules are met) even if some vacation time is taken at the foreign destination.
Test #1—no substantial control over arranging trip. To meet this test, the traveler must have no substantial control over arranging the trip outside the U.S., considering all the facts and circumstances. (Reg. § 1.274-4(f)(5)(i)) An employee who travels outside the U.S. for his employer under a reimbursement or other expense allowance arrangement is considered not to have substantial control over arranging the trip if he isn't a managing executive of the employer (someone who can make his own travel plans and doesn't need someone else's OK), or related to the employer (within the meaning of Code Sec. 267(b), but using a 10% test). Just because a person can control the timing of the trip doesn't mean he has substantial control. (Reg. § 1.274-4(f)(5)(i))
A self-employed person generally can't meet the “no substantial control” test. (IRS Publication 463, 2014, pg. 7)
Test #2—away one week or less. This test is met if the traveler is outside the U.S. for a week (seven consecutive days) or less. For purposes of this test, the day of departure from the U.S. isn't counted, but the day of arrival back in the U.S. is counted. (Reg. § 1.274-4(b)(2); Reg. § 1.274-4(c))
When figuring the 1-week period, any travel between U.S. points is not counted. (Reg. § 1.274-4(e)) For this purpose, the “U.S.” is defined as the 50 States and the District of Columbia. (Reg. § 1.274-4(a))
AB Tax Accounting illustration Bob lives and works in Denver and takes a business trip to Paris. Bob leaves Denver on Tuesday and flies to New York. On Wednesday, he flies nonstop from New York to Paris, arriving the next morning. He has business meetings on Thursday, Friday, and Saturday and sightsees from Sunday until Tuesday. He flies back to New York, arriving Wednesday afternoon. On Thursday, he flies to Denver. Result: the cost of the round trip from Denver to Paris is deductible. Bob was away from Denver for more than a week. But because the day of departure doesn't count, and because the travel between U.S. points doesn't count, Bob was outside the U.S. for exactly seven days.
Test #3—less than 25% on personal matters. Even if the foreign trip lasts longer than one week, there's no allocation of round-trip transportation costs if less than 25% of the time outside the U.S. was spent on personal matters. (Reg. § 1.274-4(b); Reg. § 1.274-4(d)(1) ) Here, the travel days—both the day of departure from the U.S. and the day of return to the U.S.—are counted. (Reg. § 1.274-4(c); IRS Publication 463, 2014, pg. 7)
When applying this test, any travel between U.S. points is not counted. (Reg. § 1.274-4(e)) Similar to the above, for this purpose, the “U.S.” is defined as the 50 States and the District of Columbia. (Reg. § 1.274-4(a))
Test #4—vacation not a major consideration. Even if one of the three other tests doesn't apply, a full deduction for foreign transportation cost is still available if the taxpayer can show that vacationing was not a major consideration in making the trip, even if the traveler has substantial control over arranging the trip. (Reg. § 1.274-4(f)(5)(ii); IRS Publication 463, 2014, pg. 7 )
AB Tax Accounting illustration John, chief executive officer of International Co., Inc., must fly to Frankfurt to meet with German regulators. He spends a week on business, plus four days on vacation. His round-trip transportation costs, plus meals (at 50%) and lodging during the business days, may be deductible.
Partially deductible foreign transportation costs. If foreign travel doesn't meet one of the four full-deductibility tests, above, the nondeductible portion of the transportation expenses—the cost of getting there and back—generally is determined by using a day-to-day allocation formula. Under this formula, total travel expenses are multiplied by the ratio of the total number of non-business days spent outside the U.S. to the total number of days spent outside the U.S. (Reg. § 1.274-4(f)(1)) For purposes of this allocation, the days of departure from, and return to, the U.S. generally are treated as business days spent outside the U.S. (Reg. § 1.274-4(d)(2)(i))
AB Tax Accounting illustration Ruth, a partner in an international law firm based in New York, takes a business trip to Zurich. She spends seven days on business and seven days skiing, and her round-trip air-fare cost is $1,600. Test #3 doesn't apply because she spends more than 25% of her time on personal matters. If Ruth isn't protected by either Test #1, Test #2, or Test #4, she determines the nondeductible part of her transportation cost as follows: 7 personal days ÷ 14 total days × $1,600 = $800. The cost of the 7-day business stay (lodging, 50% of meals) is deductible; the cost of the personal stay is not.
While the nondeductible part of foreign travel costs is generally determined under the above formula, the regs allow taxpayers to use other allocation formulas if they more clearly reflect the period of foreign travel attributable to personal matters. (Reg. § 1.274-4(d)(2))
Special rules apply where the pleasure part of a trip is not located at or near the foreign location where business is transacted. If the pleasure part of the trip takes place beyond the business destination, then the airfare to be allocated in part to business travel and in part to personal travel is figured on the basis of a round trip from the U.S. location to the business location. (Reg. § 1.274-4(f)(2))
AB Tax Accounting illustration Henry, a 20% shareholder-employee of U.S. Co., Inc., schedules a 5-day business trip to London from New York. From London, he proceeds to Paris for a 13-day vacation. U.S. Co. reimburses him for the entire trip after he accounts in full for the expenses. The round-trip cost from New York to London is $1,000.
Roughly $278 of the New York-to-London air fare (5/18ths of $1,000) is tax free. So is the cost of 50% of his meals and all of his lodging while in London. The balance of the airfare, and the cost of his meals and lodging in Paris, are taxable to him as compensation income. U.S. Co. treats the business part of the air fare ($278) and the London meals (at 50%) and lodging costs as deductible business expenses. The balance of the corporation's cost is deductible as compensation (assuming the executive's total compensation package is “reasonable”).
If the pleasure part of the trip takes place en route to or from the business destination, then the allocation of the nondeductible airfare is figured on the round trip from the U.S. departure point to the non-business destination. (Reg. § 1.274-4(f)(3))
Illustration Alice, a New Yorker, flies to Paris on August 4 to attend a business conference that begins on August 5. The conference ends at noon on August 14. That evening she flies to Dublin where she visits with friends until the afternoon of August 21, when Alice flies directly home to New York. The primary purpose for the trip is to attend the conference. If Alice did not stop in Dublin, she would arrive home the evening of August 14. She doesn't qualify for any of the exceptions that would allow her to consider her travel entirely for business.
August 4 through 14 (11 days) are business days and August 15 through 21 (7 days) are nonbusiness days. Alice can deduct the cost of her meals (subject to the 50% limit), lodging, and other business-related travel expenses while in Paris, but can't deduct her expenses while in Dublin. She also cannot deduct 7/18 of what it would cost her to travel round-trip between New York and Dublin. Alice pays $750 to fly from New York to Paris, $400 to fly from Paris to Dublin, and $700 to fly from Dublin back to New York. Round-trip air-fare from New York to Dublin would be $1,250. She figures the deductible part of her air travel expenses by subtracting 7/18 of the round-trip fare and other expenses she would have had in traveling directly between New York and Dublin ($1,250 × 7/18 = $486) from her total expenses in traveling from New York to Paris to Dublin and back to New York ($750 + $400 + $700 = $1,850). Her deductible air travel expense is $1,364 ($1,850 − $486). (IRS Publication 463, 2014, pg. 8)
Non-business days may be treated as business days. If allocation of foreign travel costs is required because of non-business activities, every day the traveler is treated as having spent on business increases the deduction for transportation costs.
There are five instances where a “non-business” day is treated as a “business” day for expense allocation purposes. (Reg. § 1.274-4(d)(2))
(1) Generally, the departure date and return date are considered business days. So if a traveler leaves the U.S. on a Wednesday night and returns early on a Friday morning, both days count as full business days. There are exceptions for indirect routes or substantial nonbusiness diversions along the way.
(2) The taxpayer's presence is required at a particular place for a specific and bona fide business purpose. If an employer requires an employee to be present at a particular date and place for business reasons, the day is a business day even though, because of the scheduled length of the meeting, the employee spends more time on nonbusiness activity (e.g., sightseeing) than on business.
(3) As long as an individual does business during working hours, other personal activities, like an evening out on the town, won't turn the business day into a personal day.
(4) Days when doing business is prevented due to circumstances beyond the individual's control (for example, bad weather, or a client cancels a business meeting) are business days.
(5) Weekend days and reasonably necessary standby days between business meetings are treated as business days, no matter what the individual does with his or her time.
AB Tax Accounting illustration Tina is sent by her employer to Mexico City on business. She is scheduled to participate in business conferences on Wednesday, Friday, and Monday. Thursday, Saturday, and Sunday are business days, not personal days, no matter what she does with her time. But if there had been no business meeting scheduled in Mexico City after Friday, then Saturday and Sunday would count as personal days.
Please call me if you have any questions about these rules. Together we can make sure that you'll get all the deductions to which you're entitled come next filing deadline. I look forward to hearing from you. Click this link to view our YouTube video
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Amare Berhie
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