Are Incentive Cruises Tax Deductible?
The confusion about tax deductibility for incentive cruises stems from the fact that the 1986 Tax Reform Act did not specifically discuss the issue of incentive cruises. Yes, it does address incentive travel and it does cover “luxury water transportation” as well as “business travel outside North America”; but it’s altogether mum on specific “incentive cruises.” So, if you’ve wondered why you can’t get a simple answer to your questions, that’s why… Let’s take it step by step to shed a little light on the subject…
I. A pure travel incentive
Here is a brief overview of the essential tax implications for “pure” travel incentive i.e. a trip taken primarily as a reward or acknowledgment, rather than business meeting, as put forth by Chicago-based Jonathan T. Howe, General Counsel for S.I.T.E. The sponsoring company can deduct the cost of the award. The recipient must report the fair market value of the award as income for tax purposes. The above 2 facts are not affected by the venue of the trip, land or sea. The tax rules vary somewhat depending on whether the recipients of the cruise award are customers, employees or independent contractors / service providers:
A) Travel awards to customers
Incentive expenditures are generally deductible by company as ordinary and necessary business expenses, as long as they appear to promote the company’s business and they’re not too lavish in relation to the business benefit which might be gained. (Travel expenditures usually will not be found too “lavish and extravagant” merely because of the destination or the quality of accommodation). There’s no set limit on the costs which may be incurred and the award is generally included in the customer’s income a for tax purposes. If the travel opportunity was actually a “gift (i.e. not given in recognition of a performance) the recipient has no tax burden; however, no deduction is allowable to corporations for gifts in excess of $25.
B) Travel awards to employee ( and spouse)
The company treats the award on its tax return as “compensation to the employee,” (not as a travel expense), and as wages to the employee for purposes of withholding. The company should use the “fair market value” of the trip as wages, and withhold Federal income and FICA taxes and pay FICA and FUCA taxes on that value… There are several instances where all or part of the travel award will not be taxed as income for the employee:
(1) Where the trip is “primarily” for business purposes, travel expenses to/from the destination for the employee (Not the spouse) will be excludable in the employees income.
(2) The portion of the expenses incurred at the destination by the employer which are properly allowable to business purposes need not be included by the employee as income.
C) Travel awards to independent contractors and other service providers
Similar tax treatment as with employees, i.e. the expenses are deductible by the corporation under Tax Code 162 and 274, and are included in the income of the recipient under Sections 61 and 74. Additionally, the value of the trip must be included on a Form 1099 filed by the awarding company in accordance with rules referenced in “B” above.
How to lighten the tax burden for the recipients
Some of our clients do it this way… If the fair market value of the trip were $1000, with the employee’s tax bracket at 28%, an extra $280 would be added on a one-time basis to the employee’s compensation to offset the tax he’ll pay on the trip. Of course, there’s also tax to pay on the extra $280 (about $78) which is also added into the compensation, etc. Requires a bit of calculator work but it solves the problem.
To avoid any tax burden whatsoever for your participants, there’s a radical solution. A corporation has 2 choices when using a foreign-registered ship for business purposes:
(1) If the sponsoring organization tax deducts the expenses of the cruise program, the participants must carry the tax burden.
(2) However, if the sponsoring corporation chooses not to take the tax deduction, there’s no tax burden to pass on to the participants.
Since cruise programs without benefit of the tax deduction usually cost less than a comparable resort program – even after the land-based tax deduction benefit is factored in – this is a choice worth considering.
II. Travel awards “primarily for business”
Additional special rules apply where both the awarding company and the recipient attempt to characterize the travel as predominantly for business:
A) No deduction is allowed for expenses allocable to a meeting held outside the North American area (“North America” includes Canada, Mexico, Puerto Rico, U.S. Virgin Islands and the Caribbean Basin “beneficiary countries”), unless:
1) The meeting is directly related to active conduct of the taxpayer’s trade; and
2) It was “as reasonable” for the meeting to be held outside the North American area as within it.
B) Taxpayers who attend meetings directly related to the active conduct of business, held on U.S. flagships, cruising only to U.S. ports, are allowed a limited business expense deduction up to $2000 per year. (Two information statements are also required). For specific guidelines about your incentive program at sea, call your professional tax advisor.