Fun Asia Show Recording-November 21, 2013

How to Turn a Vacation into a Business Deduction

Tax Issue

The unreimbursed cost of travel away from home for business purposes is generally deductible, but travel for personal reasons is never deductible. It is not unusual for travel to include both business and personal elements. Since IRS rules permit a deduction for the business portion of a mixed-use trip, determining what constitutes a business day becomes critical. A careful taxpayer can combine business and personal travel and maximize the amount that is deductible on Schedule C, Form 2106, or a business tax return.

Applicable Tax Law

• Travel expense refers to travel away from home that is overnight or lasting for a period sufficient for the traveler to require sleep away from home. Travel expenses may include travel fares, automobile expenses, meals and lodging, and expenses incident to travel, such as sample rooms, communication costs, local transportation, laundry, tips, etc.
• Travel expenses must be ordinary and necessary in the conduct of the taxpayer’s business and directly attributable to the business in order to be deductible.
• If a trip is undertaken solely for business, all reasonable and necessary travel expenses are business expenses. If a trip is undertaken for nonbusiness purposes, then travel fares and expenses incidental to travel are personal expenses, and meals and lodging are nondeductible living expenses. Scheduling incidental business activities on a personal trip doesn’t convert the trip to a business trip.
• If a taxpayer engages in both business and personal activities while on a trip, the expense of traveling to and from a U.S. destination is deductible only if the trip is related primarily to the taxpayer’s trade or business. If the trip is primarily personal in nature, the expense of traveling to and from the destination is not deductible, even though the taxpayer may engage in business activities at the destination.
• If a taxpayer travels outside the United States primarily for business reasons, the deductible portion of the cost of round-trip travel to the business destination is prorated by the number of business days to the total number of travel days. If the trip is primarily personal in nature, the entire cost of the round-trip travel is a nondeductible personal expense.
• Whether a particular trip is primarily related to the taxpayer’s trade or business, or is primarily personal, depends on facts and circumstances. The amount of time spent on directly-related trade or business activities, compared to the amount spent on personal activities, is generally the determining factor.
• Expenses incurred at the destination that are allocable to the taxpayer’s trade or business are deductible, whether or not the expense of traveling to and from the destination is deductible.
• Travel expenses for a spouse or other family members who accompany the taxpayer are not deductible unless it can be shown that the spouse or family member’s presence on the trip has a bona fide business purpose. Performance of incidental services is insufficient.
• Expenses paid or incurred by a taxpayer in attending a convention or other meeting are deductible only if the taxpayer’s attendance benefits or advances the interests of the taxpayer’s trade or business. If the convention or meeting is for political, social, or other purposes unrelated to the taxpayer’s trade or business, the expenses are not deductible.

Tax Planning Strategies

The taxpayer who wants to turn a vacation into a business deduction must determine that the trip is primarily business in nature. This may be accomplished by planning the trip so that the number of business days is more than the number of personal days. Even if the trip is not primarily business in nature, all eligible business days should be counted in order to maximize the business travel portion of the vacation.

• The term “business day” has no strict definition. If more than half of the normal working day is spent for business purposes, the day is a business day. In some parts of the world, normal working days may be shorter than what the taxpayer is used to at home. A day during which the taxpayer spends much of his or her time taking business cell phone calls or responding to business email or text messages may be counted as a business day, even if the taxpayer is at a vacation location while taking calls or messages. Closing on a major deal in a few hours may represent a day’s work and count as a business day.
• Travel days are treated as business days.
• Days intended to be business days, but on which no business was conducted due to circumstances beyond the taxpayer’s control (such as a power outage or no-show customer), are treated as business days.
• Standby days – days during which the taxpayer must remain available to conduct business with a customer or client – may be counted as business days, whether or not the taxpayer actually is called upon to work.
• Weekends and holidays that fall between business days may be counted as business days if it is impractical or impossible for the taxpayer to return home on the weekend or holiday. weekends or holidays that occur after the last business day of a trip generally do not count as business days.
• If staying at the business destination after business is concluded, but over a Saturday night reduces airfare, the extended stay has the business purpose of reducing travel costs. The extra days are business days as long as the cost of the extended stay is less than or equal to the airfare savings. (Ltr. Rul. 9237014)
• If the business destination is outside the United States, all days are considered business days if one of the following exceptions is met.

1. The taxpayer has no substantial control over arranging the trip. Self-employed taxpayers or business owners generally do not meet this exception. Employees who are not managing executives, not related to the employer, and who are reimbursed or receive a travel allowance for the trip do not have substantial control.
2. The trip lasts seven consecutive days or less, counting the departure day but not the return day.
3. The taxpayer is out of the United States for more than a week and less than 25% of the taxpayer’s total time outside the United States was spent on nonbusiness activities.
4. Vacation is not a major consideration, even though the taxpayer may have had substantial control over arranging the trip.

■       The presence of family members accompanying the taxpayer on a trip need not affect the number of eligible business days. If days spent driving to a business destination count as business days, it doesn’t matter that the spouse and children are also in the car.

■       The cost of a hotel room for a couple or a family is usually not much more than the cost of a hotel room for one person. The business traveler can ask the hotel for a room rate schedule that shows single rates for the eligible business days.

Examples

Example #1: Angie, an Enrolled Agent, has signed up to attend the IRS Nationwide Tax Forum in San Jose, CA. She flies to California on Monday and returns home the following Monday. The forum takes place all day Tuesday, Wednesday, and Thursday. Angie stays at her son’s home during the entire time she is in California and enjoys her grandchildren in the evenings and after the forum is over. The primary purpose of the eight-day trip is business: only three days (Friday, Saturday, and Sunday) are personal since the travel days are treated as business days. Angie has no lodging expenses, but she may deduct her airfare, airport transportation costs, meals (subject to IRS limits) and incidental expenses during the five business days, the cost of getting to and from the forum from her son’s home, and forum registration fees.

Possible Risks

• Taxpayers must document all business expenses and how business days are determined, especially when counting partial days, standby days, weekends, holidays, etc., as business days. In addition to the usual receipts and meeting notes, taxpayers should keep cell phone records, emails, time logs, mileage records, and any other proof to substantiate business activities. Failure to keep adequate records may result in denial of a deduction for business travel expenses.
• Taxpayers often want to deduct expenses for a spouse or other person who comes along on a business trip and performs only incidental services. The IRS has consistently disallowed business travel deductions in this situation.
• Adding vacation time to a business trip may increase the number of personal days to the point that the cost of getting to and from the business destination becomes nondeductible.
• Amounts claimed as business travel expenses must be reduced by any employer or client reimbursements received.
• Business travel expenses of employees are combined with other miscellaneous expenses on Schedule A, subject to the 2% AGI limitation. A lot of effort may go into keeping records that result in no deduction. On the other hand, large employee deductions for business travel expenses could trigger AMT.
• Convention expenses, even if generally related to the taxpayer’s trade or business, may not necessarily lead to a travel expense deduction. For example, attendance as a delegate does not in itself provide a business purpose. Attendance at the convention must benefit the taxpayer’s own trade or business; otherwise, the travel is personal.
• Business travel is determined in relation to the tax home of a taxpayer. The tax home is not necessarily where the taxpayer gets mail or where the taxpayer’s family lives.
• Travel expenses paid by an employee might not be deductible. For example, an S corporation owner-employee might pay travel expenses for another employee out of his own funds when the company is low on cash. Those expenses are a liability of the S corporation and not a deductible ordinary and necessary expense of the owner-employee. Such expenditures should be treated as loans to the corporation.
• Travel expenses may result in a passive activity loss. If the taxpayer cannot show material participation, the loss will not be allowed

Court Cases

Court Case: In Example #4, page 8-14, the IRS did not challenge any of George’s travel expenses, which were allocated according to the number of days spent working at each condo. However, the examiner determined that rental losses generated on both properties by the travel expenses would not be allowed because of the passive activity loss rules. The case ended up in Tax Court. The Court determined that George and his wife participated materially in the Maui rental activity, but not in the Molokai rental activity. This was a partial victory for George and his wife. Even though all of the travel expenses qualified as business expenses, only the loss on the Maui activity was allowed. The loss on the Molokai property had to be suspended. (Pohoski, T.C. Memo 1998-17, January 13, 1998)