Tax Discussion Document - Always Consult Your Tax Advisor for Tax Advice
Today, companies have choices in the cruise ships they select for their meeting. American flagged vessels have several distinct tax advantages over vessels flagged in foreign nations. Unfortunately, most of the cruise ship fleet today remains flagged in foreign nations and the only American flagged ships operate in Hawaii. There are however, some effective ways of dealing with this issue on foreign flagged vessels as discussed below entitled "Gross Up Cost" and "Net vs. Net Costs".
US Based Companies, organizations and Individuals attending meetings on foreign flagged cruise ships should be aware of certain IRS Regulations so that they can maximize the tax deductibility of the trip.
What about cruises?
For "pure" incentive travel arrangements, cruises present no special problem. Business travel on cruise ships can be deductible, subject to general business travel rules. For conventions/seminars/meetings, travel is deductible if the taxpayer establishes that:
1) The meeting is directly related to his or her trade or business;
2) The ship is of U.S. registry and makes all of its ports of call in the U.S. or its possessions;
3) The taxpayer attaches to his or her tax return: a statement detailing the number of days of the trip and the number of hours devoted each day to business; a statement signed by an officer of the sponsoring organization verifying the above information
As a general rule, certain travel and entertainment expenses incurred by individual (that the company does not pay for) may be deducted from gross income for federal tax purposes when those expenses are incurred in the pursuit of a trade or business. Section 162 (a) of the IRS Code provides the basis for those deductions. It states in part: there shall no be allowed as a deduction all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade and business, including ... (2) traveling expenses (including amounts expended for meals and lodging other than amounts that are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business.
There are however, two scenarios for dealing with this rule in a way that meets IRS regulations. These are;
GROSS UP COSTS
* Grossing up the cost is a calculation that can be used if the company would like to be able to write off the cost of the meeting even if the meeting does not qualify under IRS rules.
* The meeting can be treated like an incentive and charge the attendee with the fair market value of the cruise with the form 1099. Then the employee will have to pay personal taxes based on the amount of the cruise charged on the 1099 form. The company will then reimburse the meeting participant the additional taxes the participant will incur due to the 1099 form. (Example--based on the cost of the cruise being $1,000 per person...and let's say that the individual's employee tax bracket is 30%...the employee will receive a check for $300.00 (from the company) to cover the additional tax increase due to the fact that the participant filled out a 1099 form.)
* Using the "Gross Up Costs" method the company can write off the entire $1300.00 ($1,000 for the cruise plus $300 for the income expense to the employee). Which means the company can write off 100% of the cruise! If the company was thinking about using a North American land based resort, they can only write off 50% of the total cost of the land based meeting program.
When you compare the cost of the cruise (calculate 100% of it as a write off under this scenario) vs. the cost of the land based resort (where only 50% of the total amount is a write off) and in most cases the cruise program usually costs less, therefore making it a smart business choice.
NET VS NET COSTS
* Net vs. Net is another Calculation that can be used to compare a North American land property that the meeting would be eligible for tax deduction vs. a foreign flagged cruise ship.
* Compare the actual cost of the North American land based hotel that qualifies for a tax deduction (with the tax deductions included in the calculations) Make sure you include all the costs for functions (lodging, food, beverage, meeting facility rental charge, AV equipment and entertainment)--remember that all costs are only a write off at 50% of their value!
Compare the North American land based program to the amount the total cost of the cruise (without the tax deductions) in most cases, the cost of the cruise (without the tax advantage) usually comes out less expensive than the cost of the North American land based program (including the 50% tax deductions)
DIFFERENCES BETWEEN INCENTIVE TRAVEL AND MEETINGS
For Pure Incentive Programs
* A 1099 form needs to be filled out by the winner/company for incentive awards valued at $600.00 or more. Therefore the winner is going to have to pay taxes based on the value of the cruise. (Keep in mind that the winner would have to pay taxes on the value of merchandise also).
How is incentive travel different from meetings?
"Pure" incentive travel awards are given as a prize for reaching set goals. Recipients are typically customers, employees, independent contractors, or service providers who have met sales or purchase quotas or performance goals.
For tax purposes, pure incentive travel is "pleasure travel awarded for a business purpose." That means the sponsoring company can deduct the cost of the award (what the business actually paid, regardless of fair market value), and the recipient must report the fair market value of the award as income.
A meeting is defined as an event that takes place primarily for the purposes of educating, motivating, and communicating, without any need for recipients to perform. Meeting planners should make sure they have documentation to prove that an event was indeed a meeting, such as agendas, programs, and pre-meeting materials.
What are the guidelines for "pure" incentive travel?
The crucial phrase in determining deductibility of your incentive award is whether the program was "ordinary and necessary." However, there is no clear standard of "ordinary and necessary." If the award program benefits the sponsoring company (by encouraging high performance), and the awards are not too lavish, the program usually will be deemed an "ordinary and necessary" business expense.
When is an award too lavish?
In addition to the need for a profitable business relationship between sponsor and recipient, the value of the award must be in line with the value of the business benefit provided by the customer, employee, or supplier. The award of a $5,000 cruise for a customer's purchase of $200 worth of equipment, for example, would probably be seen as "lavish and extravagant." A red flag might go up at the Internal Revenue Service (IRS), which would most likely disallow the deduction.
If the IRS perceives the award as other than furthering that business's interests, it will treat the award as a gift. The giver is limited to a deduction of $75 per recipient per year, but the recipient does not have to report the award as income.
What records need to be kept?
The Treasury Department has clear "substantiation and documentation" guidelines that should be followed, particularly when the recipient is an employee. Awarding companies should protect their deductions by maintaining an account book, a diary, or a statement of expense. They should also retain canceled checks, credit card slips, and hotel receipts. Records should reflect the amount of each expenditure, times and places of travel, the business purpose of each expenditure, and the recipient's business relationship to the awarding company.
What needs to be filed?
Awarding companies can protect their deductions by filing the correct paperwork on recipients. For customers and contractors/suppliers, that means reporting any award that exceeds $600 in value, provided the recipient is not a corporation. File form 1099 MISC, along with Form 1096, by February 28 of the calendar year following the year in which the award was made.
If the recipient is an employee, the employer must declare the value of the award as compensation to the employee and as wages for the purpose of withholding, using a W2 form. Recipients should know that the full cash value of the award (including reimbursed expenses) will be counted as gross income and should be entered on their 1040s.
What if business and pleasure are mixed?
"When a trip is taken for the purpose of business as opposed to pleasure, it is not a 'pure' incentive travel situation," explains Jim Gossett, attorney for the Society of Incentive Travel Executives (SITE). When a trip is made for both reasons, then it is a matter of determining which purpose is dominant.
When it's a business trip, expenses to and from the destination might not be counted as income to the traveler, and may be deductible under certain conditions. When it's pleasure, those expenses would be counted as income. Other expenses can be divided into "primarily business" or "primarily pleasure" categories and treated accordingly.
When expenses are deemed necessary to business and are not reimbursed by the employer, the IRS throws in a caveat: An employee may deduct only the amount of total annual business expenses that exceed 2% of his or her adjusted gross income. The amount of expenses below that limit in not deductible.
What if employees are reimbursed?
The 2 percent rule makes it important for employees to seek reimbursement using a plan that conforms to IRS guidelines. If the employer uses an "accountable reimbursement plan" (employees must substantiate, according to IRS Code 274, each expense being reimbursed), then reimbursed expenses are not counted as income, are not reported as wages, and are not taxed.
When an employee does not substantiate his or her expenses, reimbursed expenses are treated as income, must be reported on the employee's W-2 form, and are subject to income taxes. The employee can deduct these expenses as itemized miscellaneous deductions subject to the 2% rule.
Are there restrictions on per diems and mileage?
The Commissioner of the IRS has the authority to establish standard mileage rates and per diem rates for business travel. If you elect not to follow the guidelines, you are still allowed to deduct your actual expenses, but you must substantiate each item. For more information on per diems, call 800-829-1040 and ask for updates in Code Section 274 of IRS Publication 463.
What about company personnel required on the trip?
When company personnel are required to accompany recipients on a trip, their involvement is treated as a business expense. However, the IRS loves to challenge these deductions.
What about when spouses share in the award?
If the spouse of a recipient is included in a "pure" incentive travel award, the value of the award becomes part of the couple's income and can be fully deducted by the awarding company. If the trip is for business, the cost may be nontaxable (as income) for the recipient, but the spouse's expenses become nondeductible by the recipient unless he or she can prove that the spouse's participation served a "bona fide business purpose." The IRS recently changed the rules to require that the spouse be an employee of the primary business traveler to claim deductions.
Are there special restrictions for foreign travel?
When a trip meets the requirements for "pure" incentive travel, treat foreign travel as you would any other incentive travel award. Problems arise when the trip is characterized as a meeting. The IRS does not allow business deductions for travel to conventions/seminars/meetings outside the "North American area," unless it's proven that the meeting was directly related to the conduct of his or her business.
CEALS - Meetings on Ships
a division of Corporate Events and Leisure Services LLC
We specialize in conferences, workshops and business meetings at sea on cruise ships.
WA State Seller of Travel Lic # 603-078-647
Washington State Seller of Travel 603-078-647