Travel Expense Deduction Strategies

By Joseph Anthony
Reprinted with permission from Microsoft Small Business Center

When you hit the road for business trips, you have to know the rules for deducting your hotel and meal expenses. While the rules haven't changed much lately (proposals to increase the percentage of a meal that can be deducted haven't gone anywhere), they're still a little tricky. There are several different ways to deduct meal and lodging expenses when you or your employees are on the road. The method you use could make a difference in terms of how much money -- and time -- you save.

Here's a breakdown:

• The basic method: tallying actual costs. Keeping careful track of actual food and lodging costs is the method with which most small businesses are familiar. Save your receipts, document your costs and the business purposes of your activities and take your deductions.

• Alternative No. 1: per diem for businesses (the "high-low" method). You as the employer can give your employees a per diem allowance. The simplest way of doing this, known as the high-low method, lets you choose from only two different rates for meals, hotels and incidental expenses for business trips within the continental United States.

Per diem allowances within the U.S. under this method are $204 per day in so-called "high-cost" areas, which include major cities such as New York, Chicago, Washington, D.C., and San Francisco. Most of the country, however, falls under a per diem rate of $129 per day. For more details on per diem rates, go to the IRS Web site (www.irs.gov) and search for "per diem rates."

One advantage of the per diem route is that you don't have to keep track of the actual receipts for meals and hotel costs. However, the paperwork burden is not entirely eliminated: You and your employees still have to keep track of the time, place and purpose of each business expense.

If you decide to use the high-low method, you have to use it for all travel for the entire year.

• Alternative No. 2: per diem for businesses (the federal meals-and-lodging travel rate method). Instead of the high-low method, you can choose to take per diem deductions, or reimburse your employees, based on the federal per diem rates, which vary depending on the location. These per diem rates actually can be more favorable than those under the high-low rate, but you'll want to take a look at the rates in the cities you are traveling to and do a comparison before deciding which works to your advantage.

• Per diem for sole proprietors. If you're an unincorporated sole proprietor, you also are entitled to take per diem deductions for meals, but not per diems for hotels.

I've had more than one discussion with sole proprietors about this. It ticks them off, and I don't blame them, but these are the rules: You can use the government's meal per diem rates (which currently are $31, $35, $39, $43, $47, and $51 per day, depending on the city), but you cannot use the federal travel rate method or the high-low method for taking lodging deductions. You'll have to keep track of those actual hotel expenses regardless of whether you use the per diem rates or deduct actual meal expenses.

On the other hand, as a sole proprietor, you're not locked in to taking either the per diem deduction or actual meal expenses for all your trips for the whole year. You can decide with each trip which method to use for that trip. You do, however, have to be consistent in using the same method for the entire trip.

• Foreign travel per diems. Foreign trips are subject to different rules and per diem rates and requirements. If you happen to have a qualifying business trip overseas -- and the rules for deducting overseas travel differ significantly from those governing domestic business travel -- you can check out the foreign per diem possibilities at the State Department site (search for "foreign per diem rates").

Don't forget the basics
Regardless of the method used, the meals have to be considered ordinary and necessary expenses for your business. You don't have to actually conduct paying business during the meal; however, you do have to have either:

• A more-than-general expectation of getting some sort of business benefit in the future, or

• A substantial business discussion either immediately before or after the meal.

A couple of other things: You generally cannot deduct meals with your business partners or co-workers unless you establish a clear business purpose for the meal. You cannot deduct anything that would be considered lavish or extravagant under the circumstances. And you also are restricted, regardless of the meal or deduction method, to getting a tax break for only 50% of the deduction.