Scratching your head when it comes to U.S. tax law and overseas business travel? Here is some help from a top attorney in the field.
U.S. tax law treats incentive travel differently than nonincentive business travel, whether the travel is done inside or outside the United States. This is because an incentive trip is often taken purely for pleasure, even though the company who pays the traveler's expenses has a business motive for doing so.
When a traveler takes a trip purely for pleasure, and someone else pays for that travel for business reasons, the payer can obtain a complete tax deduction under U.S. law for all costs associated with the trip, even for travel outside the United States. But the expenses must be “ordinary” (meaning commonly accepted in the payer's business) and “necessary” (or helpful and appropriate, though not necessarily indispensable, in that business).
The trade-off is that the payer must treat the fair market value of such travel as taxable income received by the traveler. And the payer must report that income to the traveler on Form 1099 (for non-employee expenses) or Form W-2 (for employee expenses) in order for the payer to receive a deduction.
Business Travel Only
By contrast, a person traveling purely for business may avoid being taxed on the value of the trip, even if someone else pays the expenses — and the payer may still claim at least a partial deduction for expenses paid. The trade-off here is that U.S. tax law includes many limitations on the tax deductions that may be claimed for expenses paid in connection with such travel, in addition to the “ordinary and necessary” expense requirement. For example: Nontravel-related business expenses directly connected with meetings held in foreign countries (such as registration fees) are deductible, provided they meet the “ordinary and necessary” expense requirement. But business travel expense deductions for attending meetings held in foreign countries (including meals and miscellaneous expenses) are not permitted at all, no matter who pays the expenses, unless one of two conditions applies. Either the meeting must be held within what is called the North American Area, or it must be just as reasonable to hold the meeting outside the North American Area as in it.
The North American Area includes the U.S. and foreign countries, primarily in the Western Hemisphere, with whom the U.S. has certain tax treaties. (See box, page 34 for listing of destinations included in this area.)
To deduct business travel expenses related to attendance at meetings held outside of these countries, there must be some reason for holding the meeting outside this area other than the attractive nature of the locale. Reasons may relate to the purpose or activities of the meeting, the purpose and activities of the sponsoring organization, where attendees live, and where other meetings of the sponsoring entity have been held or will be held. If a meeting is held by a multinational corporation or association, the “reasonableness” of a meeting being held outside the North American Area will probably be easy to establish. But for other business meetings, the availability of deductions for expenses can be seriously restricted.
Other restrictions on business travel expense deductions apply to travel outside the United States, whether the purpose of the travel is to attend a business meeting or some other business purpose. (Again, they do not apply to incentive travel and other situations where the value of travel is taxed to the traveler.)These restrictions include:
- No deductions are available for business travel expenses if the travel is primarily for the traveler's pleasure and only incidentally for business purposes. If a traveler spends some time, for example, attending a short conference or seminar that is business-related, but spends the lengthier portion of a trip on vacation, no travel expenses will be deductible, no matter who pays them. Only ordinary and necessary non-travel-related business expenses (such as registration fees) are deductible.
- If travel is primarily for business (from the traveler's point of view), deductions may not be taken for that portion of travel expenses equal to the percentage of nonbusiness days in the trip. Business days include those required for reasonably direct travel to and from business destinations, days when the traveler's presence is required at a particular place for a specific business purpose, days when the traveler's principal activity during his normal working hours is business, and days when the traveler is prevented from scheduled work by circumstances beyond his control (such as weather and weekends).
- If travel is entirely for business, or if travel meets certain other requirements so that it will be considered entirely for business under U.S. tax law, all travel expenses are eligible for deduction, provided they meet other tests discussed in this article. Travel is considered to be entirely for business if: (1) the traveler is required to take a trip by his employer (to whom the traveler is not related); (2) the traveler is outside the U.S. for no more than a week (not counting the day of departure, but counting the day of return to the U.S.); (3) less than 25 percent of the traveler's time outside the U.S. is spent on personal activities (counting both departure and return days as time outside the U.S.); or (4) the traveler can establish that a personal vacation is not a “major consideration” in his taking the trip.
- A traveler cannot deduct expenses that he pays to have another person (spouse, child, or whomever) travel with him, unless that other person (1) is the traveler's employee, client, customer, business associate, or business consultant; (2) has a bona fide business purpose for the travel; and (3) would be able to deduct his own expenses, under the rules discussed in this article, if the other person paid those expenses.
What About Meals?
Deductions for meal and entertainment expenses in connection with business travel are available only for “ordinary and necessary” expenses that are not “lavish or extravagant” and meet one of the following tests:
Directly Related Test:
(1) the meals or entertainment take place in a clear business setting or (2) the main purpose of the expense is the active conduct of business, and (3) the traveler engages in business during the meal or entertainment period, and (4) there is more than a general expectation of getting a specific business benefit from the expenditure.
(1) the meals or entertainment are associated with the traveler's trade or business, and (2) the meals or entertainment directly precede or follow a substantial business discussion.
Unreimbursed meal or entertainment expenses in connection with business travel are only 50 percent deductible, even if they meet all the other requirements for tax deductibility.
All applicable tax laws are now crystal clear to you, right? Maybe not, considering their complexity.
The discussion in these pages is not intended as legal advice, and readers are encouraged to consult their own tax attorneys or accountants for advice on how the rules discussed apply to their specific situations.
James F. Gossett is a partner at the Chicago law firm Arnstein & Lehr. He is also general counsel to the Society of Incentive & Travel Executives as well as to other nonprofit organizations. Gossett can be reached at firstname.lastname@example.org.
THE “AREA” INCLUDES…
The North American Area, as it relates to U.S. tax law affecting business travel, includes:
American Samoa, Baker Island, Barbados, Bermuda, Canada, Dominica, Dominican Republic, Grenada, Guam, Guyana, Honduras, Howland Island, Jamaica, Jarvis Island, Johnston Island, Kingman Reef, Marshall Islands, Mexico, Micronesia, Midway Islands, Northern Mariana Islands, Palau, Palmyra, Puerto Rico, Saint Lucia, Trinidad and Tobago, United States of America, U.S. Virgin Islands, and Wake Island.
And Now a Word About… Value-Added Taxes
VALUE-ADDED TAXES (VAT) are assessed on certain costs related to international meetings and incentives, and they can be steep — as much as 25 percent in some countries. Often, you can recover a portion of those charges. But you need to know the reclaim procedures before your event.
WHICH COUNTRIES CHARGE VAT? Most European countries, some Asian countries, Canada, and South America. Not all countries refund VAT to U.S. companies, and the percentage that can be refunded varies.
WHAT'S TAXED? Although taxable costs varies by country, they usually include site fees, room rentals, catering, equipment rental, shipping, labor, hotel rooms, meals, professional fees, and car rental. (For more on VAT, see “Guide to Budgeting,” page 14.)
WHO'S ELIGIBLE TO RECLAIM VAT? Any individual traveler or any taxable corporation outside the country where the claim is being filed. Independent planners must be sure that all charges are billed directly to the client company, says a spokesperson for New York City — based Meridian VAT Reclaim, a Profit Recovery Group International Company. A nonprofit association that charges an attendee-registration fee might, in some countries, have to register for VAT, add it to the registration fee, and report the difference between the VAT it charges and the VAT it pays. Check with a VAT reclaim company to be sure.
WHAT'S THE RECLAIM PROCEDURE? Original invoices only, with proof of payment, must be submitted with a VAT reclaim form; credit card receipts are not acceptable. Invoices must be in a style acceptable to VAT authorities. The form must be completed in the local language. Each country has a reclaim deadline. For a list of reclaim companies, see the “2001 Resource Guide,” starting on page 60.
Cruise Ships and Tax Law
One might think that a cruise ship meeting would be appealing for those who wish to escape the North American Area but want to avoid meeting on foreign shores for tax reasons. Unfortunately, however, business travel expense deductions for attending shipboard meetings are also generally prohibited.
For the trip to be deductible, all of the ship's ports of call must be in the United States or U.S. possessions, and the ship must be registered in the U.S. — and there are very few that are. The meeting sponsor must also send a signed statement detailing the amount and nature of scheduled business activities, as well as the number of hours the traveler participated in such activities.
Even if all these requirements are met, an individual's business expense deductions for attending shipboard meetings cannot exceed $2,000 per year.