Finance literacy

How to manage business travel & entertainment expenses for your startup

Written By

Cenk Tukel, founder and CEO of Tukel, Inc. Consulting and Accounting

Graphic illustration of stacks of coins with arrows pointing in different directions | How to create a travel and entertainment (T&E) expense policy for your startup | Mercury
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Traveling, taking clients out to dinner, staying at hotels during an onsite, attending conferences, hosting team-building events — these are all common facets of running a company. And another important facet of running a company is understanding how all this spending on travel and entertainment could qualify as tax-deductible depending on their legitimacy as business expenses.

To make sure your company is spending responsibly, certain guardrails must be in place to protect the business from extravagant expenses, IRS penalties, discrimination, or ambiguity within the organization. Compliance with IRS requirements on business travel and entertainment (T&E) expenses is highly crucial to avoid severe penalties. Though business travel and entertainment (T&E) is common and necessary for many business owners and their teams, the absence of a formal policy, lack of understanding around what is and is not covered, and failure to keep organized records of spending are all key risks that can result in severe taxes and penalties, and lead to carelessly exuberant spending that hurts your cash flow.

Note: ​If you don’t have an in-house HR or finance team with the required experience and skills, you may want to work with a professional service firm on this subject.​

Below, we dig into some of the key considerations around managing your business travel, lodging, meal, and entertainment expenses — and how to make sure you’re compliant come tax time.

What is a travel & entertainment expense policy?

A travel and entertainment expense (T&E) policy is a set of documented guidelines that describes which business-related travel, meal, lodging, and entertainment expenses are covered and eligible for reimbursement by employees and contractors.

In addition to outlining what constitutes approved spend, a T&E policy lays out the necessary guidelines for getting approvals and reimbursements, as well as the approved payment methods for particular expenses. For example, some companies might prefer for employees to put certain expenses on a designated company card, whereas others might be more flexible with having employees pay with their personal cards and get reimbursed afterward.

While a company’s T&E expense policy will largely be determined internally based on operational and financial decisions, companies must also comply with specific limitations and requirements imposed by the IRS and other regulatory organizations to be compliant with general rules, deductions, and tax regulations. And while the policy needs to be comprehensive, it should also be easy for employees to use and follow.

Below are some of the points that your policy should cover:

  • The effective date
  • Who the policy applies to (usually all the employees and contractors of the company, including the owners)
  • Permittable expenses and spending limits
  • Documentation requirements (e.g., how should employees submit receipts for their spending, or are there certain thresholds under which receipts aren’t required?)
  • Detailed procedures for using expense management systems, tools, and company cards

Did you know?

Rather than starting from scratch, you can easily leverage a template like the one from Tukel Inc. Accounting to create your travel and entertainment (T&E) expense policy.

Get the Template

Why does your company need a travel and entertainment policy?

There are a few different reasons why it’s important to have sound policy in your startup. Below, we break down some of the main benefits:

It ensures more control over your company’s finances

A formal expense policy establishes controls and checks to prevent errors, fraud, or misuse of company funds. You can set spend limits, train your team, build in necessary approvals, and take measures to enforce organizational diligence at every level of the business. Together, these different layers can be a valuable safeguard.

As a practical tip, the communication of the T&E policy to all employees and contractors also helps your defense with the IRS that you did your best to ensure company-wide compliance, even if you only have a few employees or contractors. Some companies even provide training to their team to ensure compliance, and document evidence of those trainings by getting attendee’s signatures.

It provides clarity and clear documentation

Tax and expense policies also remove gray areas and set the rules and requirements for all employees and contractors. This ensures that everyone has a clear understanding of all the do’s or don’ts, and feels empowered to make informed decisions about spend without having to seek approval for each expense or reimbursement. Given that all policies should serve as guidance for employees across the organization to follow and refer back to in times of uncertainty, any policy documentation should be comprehensive and easy to understand, leaving little room for interpretation.

It helps with financial planning and tax preparation

Having a clear expense policy in place can prove advantageous as it establishes transparency across company spending and makes it easier to keep track of cash flow. Your expense policy can also set you up for a smooth process come tax season by helping you get a better sense of tax liability. A portion of expenses — though not all — will be tax deductible, and understanding how different expenses are classified by the IRS (e.g., those that are deemed common for your industry or necessary for operating your business) will help you better categorize your expenses and take advantage of the appropriate tax benefits.

What are the risks of not having a compliant travel and entertainment expense policy?

Not complying with IRS requirements may have severe tax and penalty consequences depending on who in particular is incurring those expenses. Below, we break it down by two main categories.

Expenses for shareholders and owners

If the shareholders incur T&E expenses and the company pays for them, it’s okay as long as they can be properly. If they are not compliant and assumed to be non-deductible business expenses, then the IRS may treat these as dividend payments and subject them to dividend tax.

This means that not only will shareholders have to pay dividend tax on these, but they may also have to pay penalties and interest for not treating them as dividends (and not paying the due taxes) in a timely manner.

Expenses for employees and contractors

Similar to the expenses of shareholders, if employee expenses are not compliant, the IRS may conclude two different consequences:

  • Treat these as benefits paid to employees: If the IRS concludes that these payments are not business-related and are likely to be treated as additional benefits, then they will be subject to payroll-related taxes. Both the employee and the company may have to pay income tax, social security, etc. together with the penalties and interest.
  • Treat these as non-deductible expenses: This is a less damaging consequence, but the company still loses the income tax deduction benefit (21% as of 2023) from these expenses. Please note that this is different from payments to shareholders.

Deductible expense types

On the topic of what qualifies as a compliant T&E business expense, the IRS states: “Business travel, lodging, meal, and entertainment expenses must be ordinary and necessary. They can't be lavish, extravagant, or for personal purposes.”

In general terms, all “business-related” travel, lodging, meal, and entertainment expenses may be deducted but with some exceptions and limitations. Let’s break it down:

Meal expenses

As of January 1, 2022, you can generally deduct only 50% of any otherwise deductible business-related meal expenses you reimburse for your employees. The deduction limit applies even if you reimburse them for 100% of the expenses, meaning you may still pay your employee back for the full meal amount but can only deduct 50% of it for tax purposes.

The general practice is that you will be paying your team the full 100% meal expense but take the tax benefit on 50% of the amount.

The 50% deduction limit applies to reimbursements you make to your employees for:

  • Meal expenses incurred while traveling away from home on business
  • Meals for business customers at your place of business, a restaurant, or another location
  • Expenses incurred at a business convention, reception, business meeting, or business luncheon at a club
  • Meals you furnish on your premises to your employees

Entertainment expenses

In general, entertainment expenses like concert tickets or golf games are not deductible.

However, a company-wide party can be deducted when it is substantiated by related invoices, the attendee list, and the business purpose (like a year-end party for the whole team at a luxury hotel). The difficulty is that there are a lot of situations that can be a little fuzzy when determining the exact nature and purpose of the event. When in doubt, err on the side of being conservative with what you consider a business-related entertainment expense and a non-business expense.

For example, a dinner with one of your shareholders where you don’t discuss business or have a clear business purpose doesn’t necessarily constitute a tax-deductible entertainment expense, because it could just as easily be construed as a friendly outing between two people who happen to have a business relationship, versus a meal that is business-related in nature. Misrepresented, this spending may be treated as dividends/ benefits and thus either non-deductible or more probably as dividends subject to additional tax.

Travel and lodging expenses

You can deduct all your travel expenses for getting to and from your business destination if your trip is entirely for business. This includes the following travel expenses:

  • Travel by airplane, train, bus, or car from your home or office to your business event, hotel, airport, etc. destination. (Keep in mind that commuting between your home and office is not a travel expense and cannot be expensed. Commuter benefits are a separate topic related to payroll.)
  • Taxi, commuter bus, and airport limousine fares for these and other types of transportation that take you between:
    • The airport or station and your hotel; and
    • The hotel and the work location of your customers or clients, your business meeting place, or your temporary work location.
  • Sending baggage and/or shipping samples or display materials between your regular and temporary work locations.
  • Operating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard mileage rate, as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses.

If a spouse, dependent, or other individual goes with you (or your employee) on a business trip or to a business convention, you generally can’t deduct their travel expenses. You can, however, deduct the travel expenses of someone who goes with you if that person:

  • Is your employee,
  • Has a bona fide business purpose for the travel,
  • Would otherwise be allowed to deduct the travel expenses.

If a business associate travels with you and meets the conditions above, you can deduct the travel expenses you have for that person. A business associate is someone with whom you could reasonably expect to actively conduct business. This person can be a current or prospective (likely to become) customer, client, supplier, employee, agent, partner, or professional advisor.

A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as typing notes or assisting in entertaining customers, aren’t enough to make the expenses deductible.

Example: You drive to Chicago on business and take your spouse with you. Your spouse isn’t your employee, but occasionally types notes, performs similar services, and accompanies you to luncheons and dinners. You pay $299 a day for a double room. (A single room costs $199 a day.)

In this example, the performance of the services your spouse occasionally helps with don’t establish a real business need, so your spouse’s presence on the trip isn’t necessary to the conduct of your business — and their expenses are therefore non-deductible. You can deduct the total cost of driving your car to and from Chicago, but you can only deduct $199 a day for your hotel room. If both you and your spouse use public transportation, you can only deduct your fare.

Documentation and information requirements

Even if you comply with all the requirements above, you always need to be able to substantiate your claims to the IRS, which brings up the requirement of documentation. Should you face any kind of audit or inquiry, you may be required to pull up spending records from 3–5 years ago — and if you haven’t been diligent about keeping those records over time, it’s going to have you scrambling to get everything in order.

So what does this mean? It’s important to realize that a simple spreadsheet of expenses or credit card and bank statements are not enough by themselves to provide the requisite information regarding the business purpose of the expenses.

To safeguard your deductions and mitigate the risk of facing a tax audit (or being unprepared to substantiate your tax claims should your company face one), it’s advisable to take the following steps:

  • Obtain and retain receipts and bills that clearly display the date, place, and amount of the expense. (Credit card slips alone are not sufficient enough as they tend not to itemize the expenses.)
  • Maintain a contemporaneous written record of all individuals present at any and all events, outlining their business affiliation and/or role within your business.
  • Clearly articulate the specific business purpose of any and all events, providing a detailed account of any business discussions or activities that transpired.

In a lot of ways, travel and entertainment expenses are an investment in your company’s future — they help garner relationships that fuel growth, build a strong company culture that enables employee satisfaction, and allows you to expand your geographic footprint beyond your core operating locations. But understanding how to spend responsibly and appropriately is a core tenet to scaling your company with care and ensuring compliance come tax season.

Notes
Written by

Cenk Tukel, CPA, is the founder and CEO of Tukel, Inc. Consulting and Accounting, which provides comprehensive advisory and consulting services to their clients. They act as their one-stop-shop for clients' bookkeeping, accounting, tax, HR, payroll, and more.

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