A business receives a notice from the IRS with that dreaded word: Audit. An audit could greatly impact any business, but employees may also be impacted as well. The article Are Expense Reimbursements Taxable Income? discussed the importance of reimbursing employees for business expenses under an accountable plan. Under such a plan expense reimbursements are not taxable income, but if an IRS audit shows that the expenses are not valid business expenses, then those reimbursements could become taxable income to the employee.
How Can an Employee Prove That His Expenses are Valid Business Expenses?
In the previous article it was stated that the employee must substantiate his business expenses by providing the employer with evidence of the amount, time, place, and business purpose of the expenses within a reasonable period of time after they are paid or incurred. Some expenses require more in the way of substantiation than others, so this article will focus on the following types of expenses:
- Travel expenses
- Lodging
- Use of personal vehicle for business
- Meals
Some employee-incurred travel expenses can only be substantiated as business expenses if they occur while the employee is away from his tax home. What exactly is an employee’s tax home? IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, defines an employee’s tax home as follows: “Generally, your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. It includes the entire city or general area in which your business or work is located.” Travel expenses that qualify as business expenses are listed in Table 1-1 of Publication 463.
In most cases, the IRS requires actual receipts for travel expenses only if the expense is greater than $75. However, there are exceptions, especially lodging expenses. Since lodging bills may contain other expenses in addition to room charges (such as meals, telephone calls, laundry, Internet access, and video rentals), a hotel or motel must provide an itemized bill. If any portion of a lodging bill is for personal expenses (such as those video rentals), then only the business expenses should be itemized on an employee’s expense report.
Whenever an employee uses his own personal vehicle for travel, he may either be reimbursed on a cents per mile basis or for actual costs. However, if he uses his vehicle for both business and personal purposes, he must allocate how much is for business use. Either method can only be substantiated if the employee maintains a mileage log for the vehicle. Reporting only the number of miles driven does not constitute proof of business use.
What Rules Apply to Meals?
An employee may incur meal costs either when he is traveling away from his tax home, or if the meal has a business purpose. If the employee is traveling away from his tax home and the meal is for him only, the entire meal is a valid business expense. If he pays for the meals of others, then the meal must have a business purpose and he must provide the following information.
- The names of the individuals in attendance
- The business purpose of the meeting
- The date and place of the business meeting
Any meal that does not take place away from the employee’s tax home may be treated as a business expense only if the employee provides substantiation that the meal had a business purpose. The same information as noted above must be supplied.
As many employees know, a business may deduct only 50% of meal and entertainment expenses on its income tax return. However, this rule does not apply to employee expense reimbursements for meals. If an employee’s meal expenses are reimbursed under an accountable plan and are properly substantiated, then the reimbursement to the employee is 100% nontaxable to the employee, even though it is only 50% deductible by the employer.
Why Business Expense Substantiation is Vital
Businesses often require their employees to incur expenses that will later be reimbursed by the business. Without proper substantiation, expense reimbursements may be treated as taxable income, resulting in the loss of income for the employee because of having to bear the cost of the taxes on the income. So it is vital that employees who incur business expenses keep detailed records and receipts so they can keep more of the income that they earn.
Robert W Ditmer - With a Master of Science in Library and Information Science from Drexel University, Robert W. Ditmer began his career as a Research ...
