Unless you're a lawyer, interpreting the tax code related to incentive travel and other business-related travel is, to say the least, a daunting task.
So we went to three lawyers to answer your most pressing questions: Jonathan Howe, partner in the Chicago-based law firm of Howe & Hutton; Jed Mandel, a partner in the Chicago law firm of Neal, Gerber & Eisenberg; and Jim Gossett, general counsel for the Society of Incentive and Travel.
What is the difference in how companies are taxed for pure incentives vs. those that include meetings?
“First,” says Gossett, “one must understand that a pure incentive trip is one where the trip is being taken primarily for pleasure. With business meetings, where the purpose is primarily doing business, there are different tax treatments.”
The employee who is awarded a pure incentive trip is responsible for paying the taxes on the fair market value of that trip; that is, whatever the typical cost of airfare, hotel accommodations, ground travel, etc., is. From the company's standpoint, if it awards an incentive trip to an employee, the company will get a dollar-for-dollar deduction for the cost of the trip. (This also applies if the award includes a spouse or significant other.) In many cases, a company will award a cash bonus along with the trip to help offset the taxes the recipient is responsible for paying later — or, as Howe puts it, “grossing up” the award.
“The pound of flesh, taxwise, on pure incentives comes from the recipient,” Howe says. “We urge our incentive houses to tell winners up front that the winning of an award entails the paying of taxes on it, just as if it were a cash bonus. That's also true for incentive merchandise.”
If the primary reason for the trip is business, the company is subject to a number of tax rules that may reduce or even eliminate deductions. For instance, there is no deduction if the company pays the expenses for a spouse on a trip that is determined to be primarily for business. Another example is that there is a 50 percent limit on the deductions a company can take for meals and entertainment.
“There are efforts to get that raised back to the 80 percent limit that existed before the laws changed in 1986, but I don't see any action … in the foreseeable future,” Gossett says.
“Jimmy Carter railed against the three-martini lunch, Reagan got it down to 2.4 martinis, and Clinton got it reduced to one martini,” Howe says. “The 80 percent deduction on business meals and entertainment is gone forever.”
How is incentive income reported, and to whom? What tax forms do you use?
The recipient of a pure incentive trip reports it as income to the IRS on Form 1040, again based on the fair market value of the trip. The company reports it on the W-2 form, both to the employee and to the IRS.
There are cases, of course, in which one company presents an incentive award to another company or an individual in another company. If the reward is given to the company, the awarding company does not have to report it. But if the awarding company presents it to a specified person in that company, then it must be reported on Form 1044-MISC.
“If the recipient of an incentive trip is an independent contractor or a preferred customer,” Howe adds, “it's reported on a Form 1099, and then only if it exceeds $600 in value. If an award is given to a company, which then passes it on to an individual, the company has to W-2 it to that individual, who then pays the taxes on it.”
What are the per-person limits companies can spend and deduct?
“For all practical purposes, there are no per-person limits on the pure incentive side — they are 100 percent deductible — as long as they are deemed ‘ordinary and necessary’ business expenses and aren't what's termed ‘outrageously lavish or extravagant’” Gossett says. “If the IRS were to see that a company awards an employee a $5,000 trip for selling much less worth of product, it would probably disallow the deduction — but that scenario isn't likely to happen.”
With business meetings, there are the usual “ordinary and necessary” expenses and the 50 percent meals and entertainment deductions. But no rule says you can't spend more than a certain amount per person on a pure incentive or a business trip.
As to whether a meeting is deemed “outrageously lavish or extravagant,” Howe says that's an ad hoc decision made by the IRS, which will disallow any deductibility to the awarding company if the IRS deems the award to be, well, too lavish or extravagant.
“There are a lot of intangibles,” he notes, “but I will say that living as we do in the age of greed, the IRS certainly has its antennae tuned to such kinds of … awards.”
Also, in cases where someone pays his or her own expenses on a business trip — an independent planner, for example — the IRS allows no deductions unless the expenses exceed 2 percent of the planner's adjusted gross income. Even then, only the percentage of expenses that exceeds that 2 percent mark is deductible. Example: If you incur expenses that amount to 3 percent of your adjusted gross income, you can only deduct up to the 1 percent level.
How are cruise incentives taxed? How is that different from cruise meetings?
As with any pure incentive, the recipient of a cruise incentive trip is required to pay taxes on the fair market value of the trip.
“The pure cruise incentive is 100 percent deductible to the awarding company,” Howe adds. “Cruise meetings, which in my experience are still going strong and are a big business, are subject to a variety of limitations before they can be deductible.” Three main stipulations: The trip must be aboard a ship of American registry; it must visit only American ports of call; and the limit is $2,000 per participant.
Where can you learn more about incentives and taxes?
Call the IRS at (800) 829-1040, or log on to the IRS Web site, www.irs.gov, where Publication 463 on travel, entertainment, gift, and car expenses, and Publication 535, which covers business expenses in general, are available.
Another way to learn more is to log onto the SITE Web site, www.site-intl.org. An article by Philip Holmes, written with Gossett's assistance, can be downloaded from there.
Howe has written two books on the topic: Incentives & Taxes, which is available through SITE, and Meetings & Taxes, available through Meeting Professionals International (www.mpiweb.org). Both are being revised and should be available in new editions by the end of the year.
“These codes get very sophisticated and require expert advice,” Howe says “My best advice is to seek counsel from a tax attorney. As I'm fond of telling people …, the difference between tax avoidance and tax evasion is about five to eight years.”