Moore Colson :: News & Resource Center

Don’t get tripped up by travel expense rules

For many companies and their employees, business travel is a way of life. And though deducting travel expenses may seem like a routine business practice, the rules are complex — and a wrong turn can have significant tax consequences. If yours is like most businesses, it reimburses workers or provides advances for their travel expenses. The IRS tends to scrutinize expense reimbursement plans, so it’s a good idea to review yours periodically to be sure it qualifies as an “accountable plan.” If it doesn’t, both your company and staff may be in for an unpleasant tax surprise.

Away from home

Generally, deductible travel expenses are an employee’s ordinary and necessary expenses of traveling away from home for work. “Away from home” means:

For most people, their tax home is their regular place of business. But there are special rules for employees who work in several different places, are on the road most of the time or are on a temporary or indefinite job assignment away from their regular place of business.

An employee doesn’t necessarily have to stay away from home overnight to satisfy the rest requirement. Suppose, for example, that Bob leaves home at 6 a.m. and drives to a business lunch with a client six hours away. He rents a hotel room for six hours, takes a nap, has dinner, meets with another client from 8 p.m. to 10 p.m. and then drives home. Bob is considered to be “away from home” for tax purposes.

Even if an employee isn’t away from home, his or her lodging expenses may be deductible under certain circumstances. Last year, the IRS announced that it would allow deductions for local lodging expenses if:

1. The lodging is temporary,
2. The lodging is necessary for an employee to participate in or be available for a bona fide business meeting or function of the employer, and
3. The expenses are otherwise deductible by the employee as a business expense or would be deductible if paid by the employee.

This rule is intended to assist employers who wish to invite employees to stay at local hotels for retreats or other business functions.

Rules of the road

The types of travel expenses that are deductible depend on the specific circumstances. Generally airfare, taxis, rental cars, lodging, meals (subject to the limitations discussed below), business calls and tips can be written off. However, lavish or extravagant travel expenses aren’t deductible. An expense won’t be considered lavish or extravagant — even if it takes place at a deluxe restaurant or luxury hotel — as long as it’s reasonable under the circumstances.

Generally only 50% of business-related meal or entertainment expenses are deductible. The 50% rule doesn’t apply if the employer reimburses the employee under an accountable plan (more on this under “Travel plans,” below) because the employee isn’t able to claim the deduction. It also doesn’t apply to the self-employed if clients reimburse them for these expenses; in these situations, the clients are subject to the 50% rule.

Deductions for lodging — and for other travel expenses greater than $75 — generally must be substantiated with adequate records, such as credit card receipts, canceled checks or bills. Records should indicate the amount, date, place, essential character of the expense and business purpose.

A hotel receipt, for instance, should indicate the name and location of the hotel, along with the dates the employee stayed there. Charges for lodging, meals, telephone calls and other expenses have to be itemized. A restaurant receipt should show the restaurant’s name and location, the date, the number of people served and the amount, including separate charges for items other than food and beverages, such as taxes and gratuities.

Travel plans

For companies that reimburse their employees’ travel expenses, there are tax advantages to having an accountable plan. If you satisfy the requirements for an accountable plan, reimbursed travel expenses are deductible by the company, excluded from employees’ income and exempt from FICA and other payroll taxes.

If your plan is nonaccountable, the company still gets a tax deduction, but reimbursed expenses will be subject to payroll taxes and included in employees’ income. Employees may be able to deduct some or all of the expenses, but only if they itemize and only to the extent the expenses exceed 2% of their adjusted gross income.

A plan is accountable if:

Keep in mind that, even with an accountable plan, certain expenses may be ineligible and treated as if they were reimbursed under a nonaccountable plan. For example, reimbursements for nondeductible expenses, such as nonwork-related lunches for employees, would be treated as paid under a nonaccountable plan.

Mapping out a strategy

If you reimburse employees for business travel, review your policies and procedures to be sure your arrangements qualify for the tax advantages of an accountable plan. But even if you don’t have an accountable plan, you may still be able to reap tax savings. Either way, be sure to discuss this with your tax advisor.

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The ins and outs of inherited retirement plans

The rules dealing with inherited IRAs and other tax-advantaged retirement plans, such as 401(k)s, are among the most confusing provisions of federal tax law. But taking the time to become familiar with them is worthwhile. Remember, retirement plan withdrawals are generally subject to income tax. So if your estate includes substantial sums in such plans, understanding the tax implications for your beneficiaries can help you plan accordingly. (If you’re a beneficiary, you may be able to reduce the tax impact of your inheritance.)

Planning is particularly important if you’ve designated someone other than your spouse as the beneficiary of your 401(k) or similar retirement plan (or you’re the nonspouse beneficiary). The tax code now permits nonspouses to stretch plan distributions — and the resulting taxes — out over their own life expectancies through a “nonspousal rollover,” but not all plans offer this option.

Minimum distribution rules

One key to understanding the tax treatment of inherited IRAs is knowing how required minimum distributions work. Generally, as the original owner of a retirement plan, you must begin taking distributions by April 1 of the year following the year you reach age 701⁄2. In some cases, you can delay distributions from an employer-provided plan if you continue working.

Calculating required minimum distributions is complicated, but typically the amount you must withdraw each year is based on your life expectancy or on the joint life expectancies of you and your spouse or another designated beneficiary.

Having a designated beneficiary, especially one who’s younger than you, can reduce required distributions after your death, maximizing the benefits of tax deferral. If you don’t choose a beneficiary or if you designate your estate as the beneficiary, distributions — and the taxes on them — will be accelerated.

Postdeath distributions

The rules on postdeath distributions are complex. But generally your beneficiary must begin taking distributions over his or her life expectancy. If the beneficiary is your spouse and is younger than 701⁄2, however, there’s another option: Your spouse can move the assets into an IRA in his or her own name and delay distributions until he or she reaches age 701⁄2.

401(k) and similar plans work a little differently than IRAs. Although the tax code permits a beneficiary to stretch out required minimum distributions over his or her life expectancy, many plans — for purposes of administrative convenience — require the beneficiary of a deceased participant to withdraw the benefits in a lump sum or within five years.

A surviving spouse can defer the tax by rolling the funds into an IRA in his or her own name. But until recently, a beneficiary other than your spouse didn’t have that option. Unless the plan permitted distributions over the beneficiary’s life expectancy, a nonspouse beneficiary had to withdraw the funds in a lump sum or over five years, which would mean larger current tax liability, perhaps pushing the beneficiary into a higher tax bracket.

Fortunately, the Pension Protection Act of 2006 changed the law to allow nonspousal beneficiaries to transfer assets from a qualified plan into an “inherited IRA.” But nonspousal rollovers go into an IRA in the name of the deceased participant, not in the beneficiary’s own name. And the beneficiary can’t defer distributions until age 701⁄2. Rather, the beneficiary must take required minimum distributions over his or her life expectancy, beginning no later than the end of the year following the year the participant dies. To qualify, the funds must be moved directly to the IRA through a trustee-to-trustee transfer by the end of the year following the year the qualified plan participant dies.

Despite this welcome change in the law, qualified plans aren’t required to allow nonspousal rollovers. Even for plans that allow them, the deadlines are tight. A full year after the year the participant dies may seem like a long time, but administering an estate can be a lengthy process, and it’s not unusual for a year or more to pass before qualified plan assets are transferred.

Plan now

If you have a sizable 401(k) or similar plan and have named a beneficiary other than your spouse, check to see whether the plan allows nonspousal rollovers. If it does, be sure that your heirs are aware of IRS deadlines. If it doesn’t, consider rolling the funds into an IRA during your lifetime.

Even if your plan allows nonspousal rollovers, you still might want to transfer the funds to an IRA to avoid any risk that your heirs will miss the deadline and be forced to take distributions on an accelerated schedule. Whichever strategy you adopt, be sure to prepare valid beneficiary designations and store them in a safe place that’s accessible to your heirs.

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529 plans
A college savings strategy that makes the grade

As the cost of a college education continues to soar, it’s more important than ever to design an investment strategy that prepares your family for this major expense. Over the last several years, the 529 plan has emerged as perhaps the most powerful tool for financing higher education costs. And the recent expansion of the “kiddie tax” has further enhanced the 529 plan’s advantages over other options.

Why do 529 plans score so high?

529 plans are education investment accounts operated by states and certain educational institutions. Contributions to a 529 plan aren’t federal-tax deductible, but some states allow a deduction. Earnings can be withdrawn tax free so long as they’re used to pay qualified higher education expenses, including:

Tuition and fees,
Books, supplies and equipment, and
Certain room and board costs.

There are other benefits to 529 plans, such as:

Generous contribution limits. Most states allow you to contribute between $200,000 and $300,000 on behalf of a single beneficiary.

Control. 529 plans allow you to enjoy significant tax advantages while retaining a great deal of control over the funds, including the power to change beneficiaries, transfer the funds to another 529 plan or even revoke the account (subject to penalties). Typically, you have less control with other savings tools.

Minimal impact on financial aid. 529 plan assets are generally considered to be the property of the parent or grandparent — rather than of the student — so the impact on financial aid eligibility is minimized.

Gift tax relief. Contributions to a 529 plan, like other college savings accounts, are taxable gifts to the beneficiary. You can minimize gift taxes, however, by taking advantage of the annual gift tax exclusion, which allows you to give up to $12,000 ($24,000 for married couples) to each recipient gift-tax free.

Unlike other college savings accounts, a 529 plan allows you to accelerate up to five years’ worth of annual exclusions. That means you can make a contribution in the first year of up to $60,000 ($120,000 for a married couple) free of gift taxes — and the assets are removed from your taxable estate. But if you die before the five-year period ends, a portion of the gift may be included back in your estate.

No kiddie tax issues. A child subject to the kiddie tax must pay tax on unearned income at his or her parent’s marginal tax rate. Until recently, the kiddie tax applied to children under age 14. So an effective college savings strategy was to transfer appreciated securities or other assets to a child, who could liquidate the assets after age 14 and pay tax at his or her own lower rate, reaping overall tax savings for the family. But effective in 2008 for most taxpayers, the age threshold has been raised to age 19 — and to 24 for full-time students — eliminating the advantages of this strategy. Shifting assets into a tax-free 529 plan avoids any kiddie tax issues.

Are you doing your homework?

If you have college-bound kids or grandkids, there’s no doubt that you should consider a 529 plan. Keep in mind that contribution limits, investment approaches and tax advantages vary from state to state, so be sure to shop around for a plan that best meets your needs.

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Tax Tips

HSAs: Healthy investments

If you’re covered by a high-deductible health plan, consider opening a Health Savings Account (HSA). You can make tax-deductible contributions to an HSA and take tax-free withdrawals to pay for uninsured medical expenses. For 2008, a high-deductible plan is one with a deductible of $1,100 or more for individual coverage or $2,200 or more for family coverage. In addition, annual out-of-pocket expenses must not exceed $5,600 ($11,200 for family coverage).

This year, you can contribute up to $2,900 to an HSA, or $5,800 if you have family coverage. If you’ll be 55 or older by the end of 2008, you can contribute an additional $900. You may also be able to transfer funds from an IRA or flexible spending account into an HSA.

Contractor vs. employee

In the last few years, the IRS has showed renewed interest in the independent contractor vs. employee issue. If you haven’t examined your business’s independent contractor relationships recently, now is a good time to do so. Using independent contractors can be advantageous because you aren’t required to withhold income taxes or pay employment taxes. But if the IRS reclassifies a contractor as an employee, you could be in for some significant back taxes and penalties.

Whether an individual is an independent contractor or employee must be determined on a case-by-case basis. The IRS lists three main categories to distinguish between the two types:

1. Behavioral control,
2. Financial control, and
3. Relationship between the parties.

Generally, individuals are considered employees if you control what they do and how they do it. (This would be applicable under the behavioral control category.) For example, if you set an individual’s hours and require him or her to perform the work on your premises, the IRS is more likely to label the individual as an employee.

Meanwhile, individuals who furnish their own equipment and materials and perform services for other companies are more likely to be considered independent contractors (an example of financial control). If there were a written contract between the business and the individual, this would indicate contractor status (an example of a relationship between the parties).

Why you may want to trade life insurance for cash

Did you know that you can trade unneeded life insurance for cash? A “life settlement” allows you to sell a life insurance policy to a third party, such as an institutional investor or insurance company. The buyer takes over the premium payments and then collects the benefits when you die. In most cases, the proceeds of a life settlement are significantly higher than the policy’s cash surrender value, though lower than the death benefit.

If you’re contemplating a life settlement, be sure to discuss the transaction with your tax advisor. There’s some uncertainty in the tax law about the treatment of the settlement proceeds. Many experts believe that they’re tax free up to your cost basis in the policy, that the excess of the policy’s cash value over your basis is capital gain and that any additional amounts are ordinary income. But there’s currently no assurance that the IRS will view it the same way.

Do you have a contingency plan?

When estate planning, many individuals assume that they’ll outlive their beneficiaries. But what if this doesn’t happen? Unless you name a contingent beneficiary — such as a charitable organization or family friend — your assets will be distributed according to state intestacy laws. And if no known heirs can be identified, your wealth could become the property of the state. Although this scenario is probably unlikely, it’s better to plan for this possibility and be safe, not sorry.

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