Understanding tax rules for employee travel expenses
If you’re an employer, you often pay for your employees’ business-related travel expenses. Here, we take a look at how to apply complex tax rules to figure out whether the payment is taxable to an employee and how employers can navigate these rules.
Step 1:
The first step is for the employer to identify the employee’s tax home. The determination of tax home is important because any expenses paid by the employer for the employee’s transportation between his or her personal residence and his or her tax home are treated as personal commuting expenses and are taxable to the employee.
To identify the employee’s tax home, the employer needs to answer the following question: What is the work location where the employee spends more of his or her time than any other work location?
The identified location is the employee’s tax home, which could be the employee’s personal residence if the employee spends more time working there than at any other location.
Step 2:
The second step is to identify specific destinations to which the employee travels (other than his or her tax-home work location) and determine the tax treatment of travel expenses paid by the employer related to those destinations. Each specific destination must be analyzed separately to determine whether the travel expenses related to the destination are taxable.
To determine the tax treatment, it is necessary to analyze the relationship between the tax-home work location and the other work location. The starting point is to explore an important concept referred to as “away from home.” If the other work location is away from the employee’s tax-home work location, all reasonable expenses paid by an employer related to travel between the tax-home work location and the other work location are nontaxable This includes transportation, meals and lodging.
Step 3:
The third step is to understand that Rev. Rul. 99-7, 1999-1 CB 361, provides that costs for transportation between a taxpayer’s personal residence and a temporary work location are deductible. Thus, employers can pay for these costs on a tax-free basis to employees. In CCA 200026025, the IRS states that if there is a realistic expectation that an employee will perform services at a work location for no more than 35 workdays (or partial workdays) during a calendar year, employment at that location may be treated as temporary for a calendar year in which the employee actually works no more than 35 workdays (or partial workdays) at that location. Thus, if an employee goes to a work location 35 days or less in a calendar year, the transportation expenses paid by the employer are nontaxable to the employee, and no further analysis with respect to that location is required. Based on this, an employer should answer the following question: Does the employee spend 35 days or less in a calendar year at the work location? Note that in answering this question, a day counts as a full day even if the employee is at the work location for only part of the day.
If the answer is yes, expenses paid by the employer for the employee’s transportation expenses are nontaxable to the employee. If the answer is no, the employer should proceed to Step 4 because further analysis is required to determine whether the transportation expenses paid by the employer are taxable or nontaxable to the employee.
Step 4:
Rev. Rul. 99-7 provides that if a taxpayer’s residence is the taxpayer’s principal place of business within the meaning of Section 280A(c)(1)(A), the taxpayer may deduct daily transportation expenses incurred in going between the residence and another work location in the same trade or business, regardless of whether the work location is regular or temporary and regardless of the distance. Thus, if an employee qualifies for this treatment, transportation expenses paid by the employer are nontaxable, and no further analysis is required. Under Section 280A(c)(1), a portion of the personal residence must be used exclusively by the employee for administrative or management activities, and there must be no other fixed location of the trade or business where the employee conducts substantial administrative or management functions. In addition, the personal residence must be used for the convenience of the employer.
To apply the rules described above, an employer should start by answering the following question:
Does the employee use a portion of his or her residence exclusively for administrative or management activities related to the employer?
If the answer is no, the employer should skip to Step 5 for further analysis, since the employee does not qualify for this special home office rule. If the answer is yes, the employer should answer the following additional question:
Is there any other work location of the employer where the employee performs substantial administrative or management activities for the employer?
If the answer is yes, the employer should skip to Step 5, since the employee does not qualify for this special home office rule. If the answer is no, the transportation expenses that the employer pays related to the work location are nontaxable to the employee, as long as the employee’s use of his or her personal residence is for the convenience of the employer. If an employee is using a portion of his or her residence exclusively for the employer’s business, that use is probably a convenience to the employer.
Step 5:
As noted earlier, Rev. Rul. 99-7 provides that a taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location. The Ruling provides rules for determining whether a work location is temporary. Under the Ruling, if employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary in the absence of facts and circumstances indicating otherwise. If employment at a work location is realistically expected to last for more than one year or there is no realistic expectation that the employment will last for one year or less, the employment is not temporary, regardless of whether it actually exceeds one year. If employment at a work location initially is realistically expected to last for one year or less, but at some later date the employment is realistically expected to exceed one year, the employment will be treated as temporary (in the absence of facts and circumstances indicating otherwise) until the date that the taxpayer’s realistic expectation changes; it will be treated as not temporary after that date.
CCA 200026025 provides break-in-service rules for purposes of applying the one-year rule in Rev. Rul. 99-7. It provides that if there is a continuous break of seven months or more, the one-year clock is stopped, and starts again if and when the employee resumes employment at the work location. It also provides that a break of three weeks does not stop the clock. No guidance is provided with respect to breaks that are between three weeks and seven months.
Thus, an employer needs to adopt a rule with respect to breaks that are between three weeks and seven months. The most conservative approach is to adopt a rule that only a break of seven months or more is sufficient to stop the one-year clock, and that any breaks that are less than seven months will not stop the one-year clock. The remainder of this article assumes that the employer has adopted the most conservative approach, because such an approach ensures that the employer will not treat transportation expenses as nontaxable when the IRS might take a contrary position.
To apply these rules, the employer should ask the following questions in the order presented: Has the employee been going to this work location for more than one year?
To answer this question in a manner that accurately applies the rules, the following instructions are necessary: Answer yes even if the employee has not gone to this location on a regular schedule, and even if the employee has not gone frequently.
If the employee has had a break of seven months or more in the past during which he or she completely stopped going to the location, answer yes only if the employee has been going to the work location for more than one year following the break.
If the answer is yes, the work location is not temporary, and any transportation expenses paid by the employer are taxable to the employee. No further analysis is necessary.
If the answer is no, the employer should continue to the following question:
Do you anticipate that when you add the time the employee has been going to this location and the future time that you anticipate the employee will be going to this location, it will add up to more than one year?
To answer this question in a manner that accurately applies the rules, the following instructions are necessary: Answer yes even if the employee’s work at this location is not on a regular schedule and even if it is infrequent.
When you count the time the employee has been going to this location, if the employee has had a break of seven months or more in the past during which he or she completely stopped going to the location, count only the time the employee has gone to the location since the break.
When you count the future time that you anticipate the employee will be going to the location, if you anticipate that the employee will have a break of seven months or more in the future during which he or she completely stops going to the location, count only the time you anticipate the employee will go to the work location before the break.
If the answer is yes, the work location is not temporary, and any transportation expenses paid by the employer are taxable to the employee. No further analysis is necessary.
If the answer is no, the work location is temporary. Any transportation expenses paid by the employer are nontaxable to the employee. No further analysis is necessary.
In summary, the rules for determining whether travel expenses paid by an employer are taxable to an employee are complex. An employer can get to the correct answer regarding taxation by answering a series of questions that apply the rules.
Reference:
Navigating the Tax Rules for Employee Travel Expenses, Journal of Taxation, March 2017