Interpreting the U.S. Tax code with respect to any industry can be tough, but the subtleties of the tax code in relation to incentives are downright perplexing.
Questions in hand, we turned to well-known meetings expert and lawyer Jonathan T. Howe for guidance. Howe, whose advice is often found in these pages, serves as general counsel to Meeting Professionals International and the International Special Events Society, and is the special adviser to the American Bar Association Standing Committee on Meetings and Travel.
Financial & Insurance Meetings contributing writer Bob Andelman recently spoke with Howe from the Chicago offices of his law firm, Howe & Hutton Ltd.
FINANCIAL & INSURANCE MEETINGS: What is the IRS definition of incentive travel?
JONATHAN HOWE: The IRS has not really defined incentive travel, but the definition I like to use is that it is a structured program in which a person who achieves certain goals and objectives is going to be rewarded with a trip to a destination that will be outstanding, and that it can be for that individual plus his spouse or significant other, as the case may be, and it is based on pre-established criteria. That's known as a “pure incentive.”
FIM: Who shoulders the tax burden when it comes to incentives?
HOWE: The fair market value of an incentive trip is taxable to the award winner as income. If the winner is an employee, he or she gets the value included on his or her W-2. If he is not an employee, he receives a 1099. And if the spouse or significant other is there, he or she will get either a W-2 or a 1099.
Here's something else: Incentives are deductible to the corporation or the sponsor because they are done to advance the trade or business of the organization. In our era of the Sarbanes-Oxley Act, in which you need to have even more business justification for what you are doing, a good, true, pure incentive program is one that is going to have a little bit easier jump over the bar of Sarbanes-Oxley.
Having said that, there is a second type of incentive program #8212;the one in which we try to minimize the tax exposure to the participant and still allow the deduction to the sponsor on the basis that this is a qualified business meeting that relates to the trade or business of the organization. Those people are there because they have achieved a level of performance, and the organization wants to make sure that others have the opportunity to share their experiences, and the company runs it as a meeting. So even if you had to qualify to attend by virtue of meeting certain goals and objectives, the company could write it off as a meeting, and the individual who attended it would not be considered to have taxable income. If the spouse or significant other were there, however, the trip would still be taxable income to that individual.
FIM: Must the sponsoring company alert participants that they will shoulder the tax burden?
HOWE: Sure. At the end of the year, the participant is going to get that 1099, or it is going to be shown on his W-2. I think that you should point out at the get-go to the employee that he or she is the company's best salesperson, or the best manager of HR (or whatever it might be), and as a bonus, here is what we are giving you.
FIM: Would you advise companies to tell participants up front about the fair market value of their trips?
HOWE: There's no reason not to. Some companies doing a pure incentive will say to an employee, “Here is the fair market value (and let's make it easy, let's say the fair market value is $1,000), and you are in a 39 percent tax bracket, so we are going to give you an additional check of $390 to pay the taxes.” It's what we call “grossing it up.”
FIM: How about a simple definition of fair market value?
HOWE: Fair market value is what it would cost to put this program together if I were going to buy it in the marketplace.
FIM: Do the rules differ for programs outside of North America?
HOWE: Well, if it is a pure incentive, no. If it is a meeting, then you have to ask: Is it as reasonable to conduct the meeting outside North America as it would be to conduct it inside North America? Second, who else is going to be there? Third, what is the purpose of the meeting? And fourth, what else does the IRS want to ask you?
FIM: Do the same rules apply to incentive merchandise as incentive travel?
HOWE: For the most part, what we have talked about regarding travel is going to be true with merchandise. Merchandise in excess of $600 requires a 1099. So if I send you a TV and it costs $599, I am probably not going to 1099 you.
FIM: What about debit cards used for employee incentives?
HOWE: Same thing. If it is a $300 debit card, they are probably not going to 1099 it, but if it is more than $600, they will.
FIM: Does the incentive trip have to be deemed ordinary and necessary to be deductible to the company?
HOWE: In business, an expense has to be deemed ordinary and necessary. But remember, “incentive” means that it has special value that goes above being at the Motel 6. So if you are doing an incentive to reward people, then I think we can reasonably assume that the expenses are going to be ordinary and necessary as judged against the nature of the program.
The corollary, or the opposite, is that it cannot be lavish or extravagant. So the question becomes: What is lavish and extravagant versus ordinary and necessary? We have been waiting for the IRS to define that over the years, and we don't have a whole lot of guidance except for anecdotal-type cases. Basically, a lot of it is in the mind of the beholder. For example, an incentive trip is not a reward for the president, the CEO, and the chairman of the board. However, even though [the level of accommodations] might be above the norm for a meeting, sending these people is consistent with purposes and objectives of the program.
FIM: Is all this rocket science, or is it common sense?
HOWE: I would say a lot of common sense should come into play here, although there is a little bit of rocket science, if you will, as to how you shape, form, and design the program,
FIM: Do you foresee any IRS changes in the next six months?
HOWE: The deductibility of food and beverage, and entertainment, has been an issue since about 1985. We are now at the 50 percent limitation on that. At one point, it was 100 percent. Raising the limit would be one area in which I think there could be movement, but chances for success are slim. [After this interview, a provision restoring the tax deductibility of travel expenses of spouses who accompany partners on business trips was voted down by the Senate, but the bill will likely be introduced again this fall.]
FIM: Do you have any other advice?
HOWE: Make sure that your collateral materials and program are designed to advance the trade or business. I also always like to say: The difference between tax avoidance and tax evasion is about five to eight years. So be careful out there.