|Travel Expenses and Per Diem Update|
By Victoria Fortuna, Senior Benefits Attorney, ALPA Retirement and Insurance Department
Air Line Pilot, January 2005, p.21
A pilot flying the line is always on business travel, and as such, the pilot's qualifying travel expenses are deductible--as ordinary and necessary business expenses. This article reviews the U.S. federal rules regarding the taxation and deductibility of travel expenses, including per diem reimbursements, for the 2004 tax year (for which individual tax returns are due, generally, by April 15, 2005). For the benefit of your tax advisors, the official rules for tax year 2004 are set forth in IRS Revenue Procedure 2003-80, 2003-45 I.R.B. 1037, 10/21/2003 (and for tax year 2005 are set forth in IRS Revenue Procedure 2004-60, 2004-42 I.R.B., 10/18/2004). General information is also contained in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses. These documents are available on the Internet at www.irs.gov.
Many of ALPA's collective bargaining agreements provide that the airline will pay each pilot a fixed amount, often called "per diem," to cover meals and incidental expenses that the pilot incurs while on a trip. When an airline makes these per diem payments (or otherwise reimburses a pilot for travel expenses), the airline may exclude all or a portion of the per diem payments or reimbursements from the pilot's taxable income reported on the Form W-2, depending on whether the amount paid exceeds the federal per diem rates or special per diem rates applicable to the transportation industry. Frequently, the amount of the per diem payments or reimbursements is not enough to cover the pilot's reasonable business travel expenses, and in those cases, the pilot may be entitled to claim an itemized deduction for the expenses not covered. If a pilot receives no per diem payments or reimbursements from the employer, or receives per diem payments that the employer includes in the pilot's taxable income, the pilot may be entitled to claim an itemized deduction for expenses incurred while on business travel.
Expenses for "overnight trips"
For a pilot's travel expenses either to be excluded from the pilot's taxable income or to be claimed by the pilot as an itemized deduction, the pilot's expenses must be incurred while on a business trip that requires sleep or rest (an "overnight trip"). Expenses incurred on trips that are not overnight trips do not satisfy this requirement. For pilots, the expenses at issue are usually meal and incidental expenses, because the airline invariably pays for lodging directly or reimburses the pilot for it separately.
In the past, the IRS took the position that per diem payments made to employees should be included in the employees' taxable income when the employees were not required to substantiate the business expenses to the employer. To avoid taxation of per diems, an employee was required to substantiate all expenses by submitting to the employer a written accounting, backed by adequate records, showing that the employee actually spent on business expenses the per diem amounts that the employer paid to that employee.
Recognizing the burden of requiring actual substantiation, the IRS now provides that a designated amount of expenses relating to overnight trips may be deemed substantiated. This is especially advantageous to pilots, since the airlines do not customarily require pilots to provide such substantiation, as the per diem payments are paid at an hourly rate, based on the number of hours flown.
For amounts deemed substantiated, the employee need not maintain any records of the amounts actually spent while on the trip. If the employer pays for lodging separately, the designated amount of expenses for meal and incidental expenses (M&IE) that is deemed substantiated is equal to the amount that the federal government would pay its own employees for M&IE when they travel to the same locality. The federal government publishes M&IE rates for every locality in the world.
Reporting of per diem on Form W-2
The employer may exclude from the employees' taxable income all amounts that the IRS deems substantiated (i.e., amounts up to the applicable federal M&IE rate). Amounts excluded do not count as taxable wages on the pilot's Form W-2. If the employer's per diem payments exceed the federal M&IE rate, then the excess amounts are included in the employee's taxable income and are reported as taxable wages on the pilot's Form W-2. Additionally, per diem payments paid for day or other non-overnight trips (trips that do not involve sleep or rest) are included in the employee's taxable income and are reported as taxable wages on the pilot's Form W-2.
Some employers may show excluded, nontaxable per diem amounts on a pilot's Form W-2, even when the per diem paid is nontaxable. But if the total amount of per diem payments exceeds the M&IE rates, however, the employer must report (1) the total amount of excluded payments on Form W-2, in Box 12, labeled Code L [for "Substantiated employee business expense reimbursements (nontaxable)"] and (2) the amounts exceeding the federal M&IE limits in Box 1 as taxable wages, Box 3 as wages subject to the 6.2 percent FICA Social Security tax, and Box 5 as wages subject to the 1.45 percent FICA Medicare tax. For tax year 2004, wages up to $87,900 ($90,000 in 2005) are subject to the 6.2 percent FICA Social Security tax, and all taxable wages are subject to the 1.45 percent FICA Medicare tax. Any amount that is excluded from a pilot's taxable income is not subject to any FICA taxes, either employer-paid or employee-paid.
70 percent deduction limit
Apart from lodging, most pilot travel expenses are for "business meals." For most employers and employees, the deduction for business meals is limited to 50 percent of the amount spent. However, employers and employees in the transportation industry are covered by a special rule, under which the deduction for business meals is higher--70 percent for 2004 and 2005, 75 percent for 2006 and 2007, and 80 percent for tax years after 2007.
The 70 percent limit on deductibility applies only to expenses for business meals. Thus, when an airline employer makes per diem payments to a pilot and excludes such payments from the pilot's taxable income, the airline's deduction for such per diem payments is limited to 70 percent of the amount of the payments, in 2004. However, if the airline includes the amount of the per diem payments in the pilot's taxable income, the entire amount is 100 percent deductible by the airline, as a payment of wages. The deduction of a pilot who claims an itemized deduction for business meal expenses on a tax return is limited to 70 percent of the amount of the expense in 2004.
Business expenses other than business meals are not subject to the 70 percent limit on deductibility. Thus, for example, reasonable business expenses for lodging, taxicab fares, and telephone calls are 100 percent deductible by the payor (airline or pilot).
Federal M&IE rates
To find out how much of the per diem payments may be excluded from a pilot's income, or how much may be deemed substantiated by a pilot claiming an itemized deduction, the taxpayer has to refer to the federal government's various travel and per diem regulations.
The General Services Administration (GSA) determines the per diem rates that apply to travel within the 48 contiguous states, or CONUS (for Continental United States). For 2004, GSA has set the CONUS M&IE per diem rates at $31, $35, $39, $43, $47, and $51. Although only one M&IE rate applies to most CONUS localities for each day in the year, up to four M&IE rates apply to some localities, depending on the timing of that locality's in- and off-seasons. CONUS per diem rates are usually updated annually in October, and in 2004, as in years past, the IRS has given taxpayers the flexibility to use the prior per diem rates for expenses incurred after the new rates are published, provided that the taxpayer consistently uses the prior per diem rates for the last 3 months of the calendar year
For other business travel destinations, called OCONUS (for outside CONUS), the Defense Department issues the federal M&IE rates for Alaska, Hawaii, and all U.S. territories and possessions, and the State Department issues them for all foreign countries. The federal government's M&IE per diem rates for OCONUS business travel are usually much higher than the maximum CONUS rate--in many cases, more than $100.
The OCONUS M&IE rates may change frequently and may also vary within the year to reflect in- and off-seasons. Following is a sampling of the daily M&IE rates that applied for November 2004: Anchorage--$81, Buenos Aires--$61, Frankfurt--$95, Island of Oahu--$91, London--$135, Madrid--$112, Melbourne--$110, Mexico City--$104, Montreal--$115, Oslo--$129, Paris--$126, Rome--$160, San Juan--$71, Tokyo--$169, and Zurich--$124.
The M&IE rates may be obtained via the Internet. The CONUS rates can be found at www.policyworks.gov/perdiem. The OCONUS rates are available at www.state.gov/m/a/als/prdm.
The M&IE rates are not reduced on account of any meals that an airline or a hotel provides to a pilot. The "Incidental Expense" portion of the M&IE rates includes fees and tips for services such as porters and baggage carriers, transportation between places of lodging or business and places where meals are taken if suitable meals cannot be taken at the temporary duty site, and the mailing cost associated with filing travel vouchers and payment of employer-sponsored credit card billings. However, the Incidental Expense portion does not include such expenses as taxicab fares, telephone calls, laundry, and cleaning and pressing of clothes. These expenses, to the extent they constitute reasonable business expenses, are 100 percent deductible by the payor (airline or pilot). If the pilot is claiming a deduction, the pilot's aggregate miscellaneous itemized deductions (including business expenses) must exceed 2 percent of adjusted gross income (see "Itemized Deductions," page 22).
Optional rates for transportation industry
The IRS provides two special rules for determining the applicable M&IE rates in the transportation industry. Compliance with either of these rules is optional. Under the first special rule, which applies to both employers and employees in the transportation industry, an employer or employee may apply a single CONUS M&IE rate or a single OCONUS M&IE rate instead of determining the actual federal M&IE rate that applies to a specific travel locality. Under this special rule, the standard M&IE rate for tax years 2004 and 2005 is $41 for all CONUS localities and $46 for all OCONUS localities. A transportation industry employer may (but need not) use these standard rates in determining how much of its per diem payments to employees is excludable from the employees' taxable income, and employees may (but need not) use these standard rates in determining the itemized deductions. An employer or employee may adopt this standard rate for all CONUS travel only, for all OCONUS travel only, or for all CONUS and OCONUS travel. Although using this method is simpler, it may result in lesser amounts being excluded from an employee's taxable income or being deducted by an employee who travels chiefly to higher-cost cities within the United States or who travels to international destinations.
Under the second optional rule, transportation industry employers (but not employees) may lump all per diem payments made to a pilot during a certain period (not exceeding one calendar month), to determine the maximum amount excludable, and include in taxable income only the amount of the per diem payments, if any, that exceeds the maximum amount excludable. This rule is helpful when some per diem payments are more than, but others are less than, the applicable federal M&IE rate. Assume, for example, that a pilot is paid $35 in per diem for each day of travel, regardless of the destination. If 16 full days are spent on travel in one month, the actual per diem payment will be $560 (16 x $35). If 8 of the 16 days are in cities where the federal M&IE rate is $31 and 8 are in cities where the federal M&IE rate is $47, then without the special rule for employers in the transportation industry, the exclusion would be only $528 [(8 x $31) + (8 x $35)], even though the maximum excludable amount under the federal M&IE rates is $624 [(8 x $31) + (8 x $47)]. Using the special rule available to transportation industry employers, however, the entire per diem payment of $560 is excludable because it is less than the maximum amount of $624 deemed substantiated that month under the special M&IE rates. Employees may not use this special rule when computing itemized deductions on their individual tax returns.
Applying federal M&IE rates
For an example of how the federal M&IE rates are applied, assume a collective bargaining agreement entitles a pilot to per diem payments equal to $2.50 per hour. Assume also that a pilot covered by the agreement flies a 2-day trip in January 2004, with report for duty at 12:01 a.m. on the first day, an overnight stay in Chicago, and release from duty at midnight on the second day.
The 2004 federal M&IE rate for Chicago is $51 per day, so the maximum excludable amount for this trip is $102 ($51 x 2). The pilot is actually paid per diem of $120 ($2.50/hour × 48 hours), so $102 is excluded from the pilot's taxable income and is shown on the pilot's Form W-2, Box 12, Code L. The remaining $18 is included in the pilot's taxable income and reported on Form W-2 in Box 1 (and Boxes 3 and 5, as applicable) as taxable wages. Alternatively, if the collective bargaining agreement entitles such pilot to per diem payments equal to only $1 per hour, the entire per diem payment of $48 ($1/hour x 48 hours) would be excluded from the pilot's taxable income because this amount is less than the maximum excludable amount of $102. However, in this case, the pilot may claim an itemized deduction of 70 percent of $54 for the difference between the excluded payment of $48 and the federal M&IE rate of $102, without needing to substantiate the expenses actually incurred (the actual deduction for 2004 expenses is limited to 70 percent of $54, as explained below).
What if this pilot's expenses exceed $102? Regardless of the amount excluded from the pilot's income, if the pilot's expenses exceed the federal M&IE rate of $102, an itemized deduction is available for all reasonable amounts spent (less the amount excluded from the pilot's taxable income), but only if the pilot can actually substantiate all expenses (under and over $102). For example, if the airline paid the pilot nontaxable (excluded) per diem payments of $48, but the pilot's actual expenses were $120, the pilot could claim an itemized deduction of 70 percent of $72 ($120 minus $48) only if the pilot could actually substantiate, with appropriate documentation, the entire $120 in expenses. Alternatively, as stated above, the pilot could claim an itemized deduction of 70 percent of $54 ($102 minus $48) without substantiating any expenses, since all expenses up to $102 are deemed substantiated.
If a trip involves several travel destinations, the federal M&IE rate for the city in which sleep or rest next occurs is applied, except for the last day of the trip, where the rate for the city in which the sleep or rest last occurred is applied. Assume, for example, that a pilot leaves from a New York domicile on Tuesday, has an overnight stay in Des Moines on Tuesday night, another overnight stay in St. Louis on Wednesday night, and returns to the New York domicile on Thursday. The Des Moines rate applies for Tuesday, and the St. Louis rate applies for Wednesday and Thursday. The rate for New York, the pilot's domicile, is never applied, because the pilot is not considered on business travel there.
The IRS says that an individual is considered on business travel when away from his or her "tax home." For this purpose, the tax home is the employee's main place of business or post of duty, regardless of where the family home is maintained. A pilot's tax home would normally be his or her domicile, and expenses of commuting to the domicile would, therefore, not be deductible. If a pilot has a temporary assignment (less than 1 year) to another domicile, however, the tax home would not change, and expenses for commuting to the new, temporary domicile would be deductible. Note that the tax home for purposes of determining whether one is on business travel under federal law does not dictate whether the pilot is subject to state income taxes in the state where his or her tax home is located.
Prorating the M&IE limit
The full M&IE amount is available only for a full calendar day of business travel (i.e., from 12:01 a.m. through midnight). For a partial day of travel, the applicable M&IE amount must be prorated. The IRS says the required proration may be done in either of two ways.
Under the first method, for any partial calendar day of travel, 75 percent of the full M&IE amount may be excluded from income. Assume, for example, that a pilot's trip begins at 11:55 p.m. on Monday and ends at 12:05 a.m. on Wednesday and that the pilot's required rest occurred in cities with an applicable M&IE per diem rate of $47. Applying this method of proration, the applicable M&IE per diem amount would be $35.25 (.75 x $47) for Monday, $47 for Tuesday and $35.25 (.75 x $47) for Wednesday. The second method of prorating is any reasonable business practice consistently applied. For an employee who travels away from home from 9 a.m. one day to 5 p.m. the next, for example, the IRS will consider a method of prorating that results in an amount equal to two times the applicable federal M&IE rate to be a reasonable business practice, even though only one and one-half times the federal M&IE rate would be excluded under the first method.
Most airlines exclude per diem payments from pilots' taxable income to the maximum extent legally permissible. A pilot who has business travel expenses that the employer did not reimburse may claim those expenses as an itemized deduction on his or her tax return. A person claiming this itemized deduction must complete Form 2106, "Employee Business Expenses." Form 2106, and all other IRS forms and publications, may be obtained on the IRS website at www.irs.gov or by calling the IRS at 1-800-TAXFORM.
To claim any business travel expense as an itemized deduction, a pilot must be able to substantiate the time, place, and business purpose of the business travel, as well as the amount of the expense. The time, place, and business purpose must be substantiated with actual records, such as the pilot's logbook. The amount of the business expense must also be substantiated, but in the case of business meals, the amount may be deemed substantiated (no written records will be required) by using the federal M&IE rates. The amount of other business travel expenses must be substantiated with records. (The IRS will not require a receipt to substantiate the amount spent on any single purchase, such as a single meal expense, if the expense is under $75; but this rule does not apply to lodging expenses, for which receipts are necessary even if the expense is under $75.)
If the pilot uses the federal M&IE rates (CONUS and/or OCONUS) to substantiate the amount of business meals, only 70 percent of the amount deemed substantiated is deductible in 2004, and then only to the extent that the pilot's aggregate miscellaneous itemized deductions (including business expenses) exceed 2 percent of adjusted gross income. Note that a pilot's union dues constitute deductible employee business expenses for this purpose. As stated above, the limit on deductibility of a pilot's business meals will increase to 75 percent for 2006 and 2007, and 80 percent for tax years after 2007.
For an example of how the itemized deductions work, let's first consider a pilot who received per diem payments that, although excluded from the pilot's taxable income, were less than the applicable federal M&IE rate or otherwise did not fully compensate for the pilot's expenses. This pilot may claim an itemized deduction for travel expenses incurred, limited to the difference between the amount excluded from his or her taxable income and the maximum M&IE federal amount that could be excluded for each day of travel. The pilot will not have to substantiate this deduction.
Assume the pilot had a 2-day trip with an overnight stay in Chicago and received total per diem payments equal to $40. Assume further that the entire amount of $40 was excluded from his or her taxable income under the above rules. If the maximum amount that could be excluded for the trip was actually $102 ($51 per day, assuming the pilot had exactly 2 full calendar days of travel), the pilot could take an itemized deduction in 2004 equal to 70 percent of $62 ($102 minus $40), for additional meal and incidental expenses that actually were incurred and that the airline did not reimburse. This amount is deemed substantiated by IRS.
What if the pilot had reasonable expenses of $110 for meals and incidentals on this trip? This exceeds by $8 ($110 minus $102) the amount that the IRS deems substantiated. A pilot who wishes to claim the entire amount spent would have to substantiate, with adequate records, the total expenses of $110, including the amounts that were excluded from taxable income. As noted above, for this purpose, the IRS says an actual receipt is needed only for any individual expense (such as a single meal) that exceeds $75. (Note: An itemized deduction for a lodging expense must always be backed up by a receipt, even if the expense is under $75.)
For an example of how the itemized deduction works for an OCONUS locality, assume that a pilot receives international per diem equal to $3 per hour and that in November 2004 the pilot flew a trip to Paris that lasted exactly 3 full calendar days. Assume further that the pilot was paid per diem for 72 hours, or $216 ($3 x 72). The federal M&IE rate for Paris in November was $126 per day, or $378 for 3 days ($126 x 3). If the pilot's employer excluded the full per diem payment of $216 from the pilot's taxable wages, the pilot could claim an itemized deduction for 70 percent of $162 ($378 minus $216), without substantiating any expenses.
Let's now consider a pilot who incurred business travel expenses but received no per diem payments or other reimbursements that were excluded from taxable income. In this case, all of the pilot's reasonable business expenses are eligible for the itemized deduction (subject to the 70 percent limit on business meals and the 2 percent floor discussed above). The pilot's meal and incidental business expenses actually incurred on overnight trips will be deemed substantiated up to the applicable federal M&IE limits. A pilot who desires to deduct actual expenses that are greater than the federal M&IE limits must substantiate all expenses, including those that fall below the applicable federal M&IE limits.
Assume, for example, that a pilot works for an airline that makes no per diem payments or that includes the pilot's per diem payments in the pilot's taxable income. Assume further the pilot was on business travel (overnight trips) for 20 full calendar days in one month and that the daily federal M&IE rate for each locality of travel was $47. In such a case, the amount that the IRS deems substantiated is $940 (20 x $47), and the pilot could claim an itemized deduction for meals and incidental expenses--without having to substantiate the amount--equal to 70 percent of $940. Of course, the pilot would still be required to substantiate the time, place, and business purpose of the travel, and to meet the 2 percent floor discussed above.
Obtain competent tax advice
As with most matters concerning taxes, the federal law governing the taxation of pilots' expenses and per diem payments is complex and can sometimes be confounding. ALPA does not provide tax advice to individual members, and therefore, all pilots are urged to obtain competent tax advice about applying to their own situations the information presented in this article.