Nickel-and-dimed. It's an expression most people are familiar with, but how does it happen to contractors? You might immediately answer with "fuel costs" or "licensing fees," yet an often overlooked way that construction companies lose cash flow is by failing to properly deduct meal and entertainment (M&E) expenses.

Of course, in the construction business, there may not be much "entertainment" involved in your M&E expenses unless you or one of your managers is entertaining a key client or prospect. Typically, however, contractors do incur a significant amount of these costs in providing food and beverages on job sites and during project meetings. And it's here that the nickel-and-diming can take place.

The popular per diems

To cover workers' food and incidentals, many contractors issue per diems. In this case, for tax purposes, you don't need to track each individual's expenses; you can use IRS tables for meals and incidentals as well as for lodging, meals and incidentals during out-of-town travel.

Bear in mind that phone expenses aren't considered "incidental" and may be reimbursed over and above the per diem amount. The IRS per diem tables list localities in the United States and abroad. They reflect seasonal cost variations as well as varying costs of the locales themselves — so a big city's rates may be higher than a smaller city's or town's.

If you prefer not to consult the IRS tables, you may use a simplified "high-low" method within the continental United States to reimburse employees up to $246 a day for high-cost localities and up to $148 for others. But this option is available only for lodging, meals and incidentals. It's not available for just meals and incidentals — lodging must be part of the equation.

Per diems' +/-

On the upside, the per diem method is simple and requires little record keeping. But it may better suit smaller construction companies that don't regularly incur a large amount of employee expenses. That's because construction companies must be extremely careful that they pay each employee no more than the appropriate per diem amount. The consequences of exceeding per diem amounts can be harsh. In fact, just a few years ago, the IRS issued a revenue ruling warning employers of the risks of mishandling per diem expense reimbursements.

Specifically, if you routinely pay allowances exceeding the federal per diem rates but don't fulfill the requirements for an "accountable plan" by tracking the allowances and requiring employees to document their expenses or pay back excess amounts (more on this below), the entire amount of the expense allowances is subject to income and employment tax.

An accountable plan

If you've run into trouble with your construction company's per diems, or you've recently found yourself at risk of running amuck of the rules, it may be time to establish an accountable plan. Here you create a formal arrangement under which you advance, reimburse or provide allowances for business expenses.

To be accountable under IRS rules, your plan must meet several criteria. You must pay expenses that would otherwise be deductible by the employee, and the payments must be for "ordinary and necessary" business expenses (such as lodging charges for out-of-town jobs). Also, employees must substantiate these expenses — including amounts, times and places, and purposes — ideally at least monthly. Last, workers need to return any advances or allowances they can't substantiate within a reasonable time, typically 120 days.

If you fail to meet these criteria, the IRS will treat your plan as nonaccountable, transforming all reimbursements into wages taxable to the employee, subject to income and employment taxes — though potentially deductible by the employee.

Accountable plans' +/-

The primary advantage of an accountable plan is that your construction business may deduct the expenses (subject to a 50% limit for meals and entertainment) and employees may usually exclude 100% of the advances or reimbursements from their income. In contrast, deductibility of business expenses by an employee is subject to various limitations that may reduce or eliminate the benefit of the deduction.

The main disadvantage is that an accountable plan takes more time up front to establish and requires meticulous record keeping. You must support each expenditure with the details listed above. Again, the tipping point is the amount and nature of the M&E expenses your construction company typically faces.

Little things

As year end approaches, you'll likely have a number of larger tax issues to consider. For example, a couple of depreciation-related tax breaks ushered in by the stimulus act are due to expire. (Your CPA can tell you more.)

Little things such as M&E expenses can add up fast — particularly if ignored over the course of several years. Now may be the ideal time to take a look at these costs and ensure those nickels and dimes stay in your pocket.