13. Other Expenses

Important Changes for 2002

Standard mileage rate.   The standard mileage rate for the cost of operating your car, van, pickup, or panel truck in 2002 is 36½ cents a mile for all business miles. See Car allowance, later.

Meal expense deduction subject to hours of service limits.   In 2002, this deduction increases to 65% of the reimbursed meals your employees consume while they are subject to the Department of Transportation's hours of service limits. For more information, see Meal expenses when subject to hours of service limits, later.

Introduction

This chapter covers expenses you as a business owner may have that are not explained in earlier chapters of this publication.

Topics

This chapter discusses:

• Travel, meals, and entertainment
• Bribes and kickbacks
• Charitable contributions
• Education expenses
• Franchises, trademarks, and trade names
• Lobbying expenses
• Penalties and fines
• Repayments (claim of right)

Useful Items You may want to see:

Publication

• 15-B   Employer's Tax Guide to Fringe Benefits
• 463   Travel, Entertainment, Gift, and Car Expenses
• 529   Miscellaneous Deductions
• 542   Corporations
• 946   How To Depreciate Property
• 1542   Per Diem Rates

Form (and Instructions)

• Sch A   (Form 1040) Itemized Deductions
• 1099-MISC   Miscellaneous Income
• 6069   Return of Excise Tax on Excess Contributions to Black Lung Benefit Trust Under Section 4953 and Computation of Section 192 Deduction

See chapter 14 for information about getting forms and publications.

Travel, Meals, and Entertainment

To be deductible, expenses incurred for travel, meals, and entertainment must be ordinary and necessary expenses of carrying on your trade or business. Generally, you also must show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your trade or business.

The following discussion explains how you deduct any reimbursements or allowances you make for these expenses incurred by your employees. If you are self-employed and incur these expenses yourself, see Publication 463 for information on how you can deduct them.

Reimbursements

How you deduct a reimbursement or allowance arrangement (including per diem allowances, discussed later) for travel, meals, and entertainment expenses incurred by your employees depends on whether you have an accountable plan or a nonaccountable plan. A reimbursement or allowance arrangement is a system by which you pay advances, reimbursements, and charges for your employees' business expenses and they substantiate their expenses to you so you can substantiate your deduction of the advance, reimbursement, or charge. If you make a single payment to your employees and it includes both wages and an expense reimbursement, you must specify the amount of the reimbursement.

If you reimburse these expenses under an accountable plan, deduct them as travel, meal, and entertainment expenses. If you reimburse these expenses under a nonaccountable plan, you must report the reimbursements as wages on Form W-2, Wage and Tax Statement, and deduct them as wages. See Table 13-1.

Accountable Plans

To be an accountable plan, your reimbursement or allowance arrangement must require your employees to meet all the following rules.

1. They must have paid or incurred deductible expenses while performing services as your employees.
2. They must adequately account to you for these expenses within a reasonable period of time.
3. They must return any excess reimbursement or allowance within a reasonable period of time.

An arrangement under which you advance money to employees is treated as meeting (3) above only if the following requirements are also met.

• The advance is reasonably calculated not to exceed the amount of anticipated expenses.
• You make the advance within a reasonable period of time.

If any expenses reimbursed under this arrangement are not substantiated, or are an excess reimbursement that is not returned within a reasonable period of time by an employee, you cannot treat these expenses as reimbursed under an accountable plan. Instead, treat the reimbursed expenses as paid under a nonaccountable plan, discussed later.

Adequate accounting.   Your employees must adequately account to you for their expenses. They must give you documentary evidence of their travel, mileage, and other employee business expenses. This evidence should include items such as receipts, along with either a statement of expenses, an account book, a diary, or a similar record in which the employee entered each expense at or near the time the expense was incurred.

Excess reimbursement or allowance.   An excess reimbursement or allowance is any amount you pay to an employee that is more than the business-related expenses for which the employee adequately accounted. The employee must return any excess reimbursement or other expense allowance to you within a reasonable period of time.

Reasonable period of time.   A reasonable period of time depends on the facts and circumstances. Generally, actions that take place within the times specified in the following list will be treated as taking place within a reasonable period of time.

1. You give an advance within 30 days of the time the employee has the expense.
2. Your employees adequately account for their expenses within 60 days after the expenses were paid or incurred.
3. Your employees return any excess reimbursement within 120 days after the expense was paid or incurred.
4. You give a periodic statement (at least quarterly) to your employees that asks them to either return or adequately account for outstanding advances and they comply within 120 days of the statement.

How to deduct.   You can take a deduction for travel, meals, and entertainment expenses if you reimburse your employees for these expenses under an accountable plan. The amount you deduct for meals and entertainment, however, may be subject to a 50% limit, discussed later. If you are a sole proprietor, deduct the reimbursement on line 24 of Schedule C (Form 1040). If you file a corporation income tax return, include the reimbursement in the amount claimed on the Other deductions line of Form 1120, U.S. Corporation Income Tax Return, or Form 1120-A, U.S. Corporation Short-Form Income Tax Return. If you file any other income tax return, such as a partnership or S corporation return, deduct the reimbursement on the appropriate line of the return as provided in the instructions for that return.

Table 13-1. Reporting Reimbursements

If the type of reimbursement (or other expense allowance) arrangement is under:	Then the employer reports on Form W-2:
An accountable plan with:
Actual expense reimbursement: Adequate accounting made and excess returned	No amount.
Actual expense reimbursement: Adequate accounting and return of excess both required but excess not returned	The excess amount as wages in box 1.
Per diem or mileage allowance up to the federal rate: Adequate accounting made and excess returned	No amount.
Per diem or mileage allowance up to the federal rate: Adequate accounting and return of excess both required but excess not returned	The excess amount as wages in box 1. The amount up to the federal rate is reported only in box 12 - it is not reported in box 1.
Per diem or mileage allowance exceeds the federal rate: Adequate accounting made up to the federal rate only and excess not returned	The excess amount as wages in box 1. The amount up to the federal rate is reported only in box 12 - it is not reported in box 1.
A nonaccountable plan with:
Either adequate accounting or return of excess, or both, not required by plan	The entire amount as wages in box 1.
No reimbursement plan	The entire amount as wages in box 1.

Per Diem and Car Allowances

You may reimburse your employees under an accountable plan based on travel days, miles, or some other fixed allowance. In these cases, your employee is considered to have accounted to you for the amount of the expense that does not exceed the rates established by the federal government. Your employee must actually substantiate to you the other elements of the expense, such as time, place, and business purpose.

Federal rate.   The federal rate can be figured using any one of the following methods.

1. For per diem amounts:
   1. The regular federal per diem rate.
   2. The standard meal allowance.
   3. The high-low rate.
2. For car expenses:
   1. The standard mileage rate.
   2. A fixed and variable rate (FAVR).

Car allowance.   Your employee is considered to have accounted to you for car expenses that do not exceed the standard mileage rate. For 2002, the standard mileage rate is 36½ cents per mile for each business mile.

You can choose to reimburse your employees using a fixed and variable rate (FAVR) allowance. This is an allowance that includes a combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your employees' variable operating costs (such as gas, oil, etc.) plus a flat amount to cover your employees' fixed costs (such as depreciation, insurance, etc.). For information on using a FAVR allowance, see Revenue Procedure 2001-54 in Internal Revenue Bulletin 2001-48. You can read Revenue Procedure 2001-54 at many public libraries.

Per diem allowance.   If your employee actually substantiates to you the other elements (discussed earlier) of the expenses reimbursed using the per diem allowance, how you report and deduct the allowance depends on whether the allowance is for lodging and meal expenses or for meal expenses only and whether the allowance is more than the federal rate.

Regular federal per diem rate.   The regular federal per diem rate is the highest amount the federal government will pay to its employees for lodging, meal, and incidental expenses (or meal and incidental expenses only) while they are traveling away from home in a particular area. The rates are different for different locations. Publication 1542 lists the rates in the continental United States.

Internet access.   Per diem rates are available on the Internet. If you have a computer and a modem, you can access per diem rates at www.policyworks.gov/perdiem.

Standard meal allowance.   The federal rate for meal and incidental expense (M & IE) is the standard meal allowance. You may pay an allowance for meal and incidental expenses only if, for example, you reimburse actual lodging expenses or do not reimburse lodging expenses because there are none.

High-low method.   This is a simplified method of computing the federal per diem rate for lodging and meal expenses for traveling within the continental United States. It eliminates the need to keep a current list of the per diem rate in effect for each city in the continental United States.

Under the high-low method, the per diem amount for travel during 2002 is $204 ($42 for M & IE) for certain high-cost locations. All other areas have a per diem amount of $125 ($34 for M & IE). The high-cost locations eligible for the $204 per diem amount under the high-low method are listed in Publication 1542 (Revised February 2002).

Reporting per diem and car allowances.   The following paragraphs explain how to report per diem and car allowances. The manner in which you report them depends on how the allowance compares to the federal rate.

Allowance LESS than or EQUAL to the federal rate.   If your allowance for the employee is less than or equal to the appropriate federal rate, that allowance is not included as part of the employee's pay in box 1 of the employee's Form W-2. Deduct the allowance as travel expenses (including meals that may be subject to the 50% limit, discussed later). See How to deduct under Accountable Plans, earlier.

Allowance MORE than the federal rate.   If your employee's allowance is more than the appropriate federal rate, you must report the allowance as two separate items.

You include the allowance amount up to the federal rate in box 12 (code L) of the employee's Form W-2. Deduct it as travel expenses (as explained above). This part of the allowance is treated as reimbursed under an accountable plan.

You include the amount that is more than the federal rate in box 1 (and in boxes 3 and 5 if they apply) of the employee's Form W-2. Deduct it as wages subject to income tax withholding, social security, Medicare, and federal unemployment taxes. This part of the allowance is treated as reimbursed under a nonaccountable plan as explained later under Nonaccountable Plans.

Meals and Entertainment

Under an accountable plan, you can generally deduct only 50% of any otherwise deductible business-related meal and entertainment expenses you reimburse your employees. The deduction limit applies even if you reimburse them for 100% of the expenses.

Application of the 50% limit.   The 50% deduction limit applies to reimbursements you make to your employees for expenses they incur for meals while traveling away from home on business and for entertaining business customers at your place of business, a restaurant, or another location. It applies to expenses incurred at a business convention or reception, business meeting, or business luncheon at a club. The deduction limit may also apply to meals you furnish on your premises to your employees (discussed in chapter 2).

Related expenses.   Taxes and tips relating to a meal or entertainment activity you reimburse to your employee under an accountable plan are included in the amount subject to the 50% limit. Reimbursements you make for expenses, such as cover charges for admission to a nightclub, rent paid for a room to hold a dinner or cocktail party, or the amount you pay for parking at a sports arena, are all subject to the 50% limit. However, the cost of transportation to and from an otherwise allowable business meal or a business-related entertainment activity is not subject to the 50% limit.

Amount subject to 50% limit.   If you provide your employees with a per diem allowance (discussed earlier) only for meal and incidental expenses, the amount treated as an expense for food and beverages is the lesser of the following.

• The per diem allowance.
• The federal rate for M & IE.

If you provide your employee with a per diem allowance that covers lodging, meals, and incidental expenses, you must treat an amount equal to the federal M & IE rate for the area of travel as an expense for food and beverages. If the per diem allowance you provide is less than the federal per diem rate for the area of travel, you can treat 40% of the per diem allowance as the amount for food and beverages.

Drilling rigs.   The 50% limit does not apply to the food or beverages an employer provides on an oil or gas platform or drilling rig located offshore or in Alaska. This exception also applies to food and beverages provided by an employer at a support camp that is near and integral to an oil or gas platform or drilling rig located in Alaska.

Meal expenses when subject to hours of service limits.   You can deduct 65% of the reimbursed meals your employees consume while away from their tax home on business during or incident to any period subject to the Department of Transportation's hours of service limits.

Individuals subject to the Department of Transportation's hours of service limits include the following.

• Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations.
• Interstate truck operators and bus drivers who are under Department of Transportation regulations.
• Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations.
• Certain merchant mariners who are under Coast Guard regulations.

De minimis (minimal) fringe benefit.   The 50% limit does not apply to an expense for food or beverage that is excluded from the gross income of an employee because it is a de minimis fringe benefit. See Publication 15-B for additional information on de minimis fringe benefits.

Company cafeteria or executive dining room.   You can deduct the cost of food and beverages you provide primarily to your employees on your business premises. This includes the cost of maintaining the facilities for providing the food and beverages. These expenses are subject to the 50% limit unless they qualify as de minimis fringe benefits, discussed in Publication 15-B, or unless they are compensation to your employees and you treat them as provided under a nonaccountable plan, as discussed later.

Employee activities.   You can deduct the expense of providing recreational, social, or similar activities (including the use of a facility) for your employees. The benefit must be primarily for your employees who are not highly compensated employees.

For this purpose, a highly compensated employee is an employee who meets either of the following requirements.

1. Owned a 10% or more interest in the business during the year or the preceding year. An employee is treated as owning any interest owned by his or her brother, sister, spouse, ancestors, and lineal descendants.
2. Received more than $90,000 in pay for the preceding year. You may choose to include only employees who were also in the top 20% of employees when ranked by pay for the preceding year.

These expenses are not subject to the 50% limit. For example, the expenses for food, beverages, and entertainment for a company-wide picnic are not subject to the 50% limit.

Nonaccountable Plans

A nonaccountable plan is an arrangement that does not meet the requirements for an accountable plan. All amounts paid, or treated as paid, under a nonaccountable plan are reported as wages on Form W-2. The payments are subject to income tax withholding, social security, Medicare, and federal unemployment taxes. You can deduct the reimbursement as compensation or wages only to the extent it meets the deductibility tests for employees' pay in chapter 2. Deduct the allowable amount as compensation or wages on the appropriate line of your income tax return, as provided in its instructions.

Other Reimbursed Expenses

You may provide meals and entertainment to individuals who are not your employees. These expenses may or may not be subject to the 50% limit, depending on the circumstances.

Nonemployee.   If you provide a person who is not your employee with meals, goods, services, or the use of a facility and the item you provide is considered entertainment, you can deduct the expense only to the extent it is included in the gross income of the recipient as compensation for services or as a prize or award. If you are required to include these expenses on an information return (Form 1099-MISC), you cannot claim a deduction for them unless you file the necessary information return. For more information about when to file Form 1099-MISC, see the General Instructions for Forms 1099, 1098, 5498, and W-2G. These expenses are not subject to the 50% limit.

Director, stockholder, or employee meetings.   You can deduct entertainment expenses directly related to business meetings of your employees, partners, stockholders, agents, or directors. You can provide some minor social activities, but the main purpose of the meeting must be your company's business. These expenses are subject to the 50% limit.

Trade association meetings.   You can deduct expenses directly related to and necessary for attending business meetings or conventions of certain exempt organizations. These organizations include business leagues, chambers of commerce, real estate boards, and trade and professional associations. Meal and entertainment expenses are subject to the 50% limit.

Sale of meals or entertainment.   You can deduct the cost of providing meals, entertainment, goods and services, or use of facilities you sell to the public. For example, if you run a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is a business expense. These expenses are not subject to the 50% limit.

Advertising to promote goodwill.   You can deduct the cost of providing meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. For example, the expense of sponsoring a television or radio show is deductible. You can also deduct the expense of distributing free food and beverages to the general public. These expenses are not subject to the 50% limit.

Charitable sports event.   The 50% limit does not apply to the expenses covered by a package deal that includes a ticket to a charitable sports event if the event meets certain conditions. See Entertainment tickets in chapter 2 of Publication 463 for a list of the conditions a charitable sports event must meet.

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