Employee Business Expense Deductions
| Publication year | 1983 |
| Pages | 1624 |
1983, October, Pg. 1624. Employee Business Expense Deductions
The deductibility of employee business expenses is subject to the general rules governing all business expenses, as well as to limitations specifically applicable to business expenses incurred by an employee. The existence and interpretation of these specific rules often makes the tax treatment of an employee's expenses more complicated and less certain than treatment of the employer's business expenses. The issue is further clouded by distinctions made between the type or status of the employee involved.
It is essential, for federal income tax purposes, to distinguish between business and personal expenses. Ordinary and necessary business expenses are deductible under § 162(a) of the Internal Revenue Code of 1954, as amended ("Code"), but expenses incurred for personal reasons or for pleasure generally are not deductible.(fn1)
Three requirements must be met for a particular item of expense to be deductible as a business expense. First, an expense must be incurred in a trade or business carried on by the taxpayer.(fn2) This excludes all personal expenses as well as expenses incurred in earning income upon which a tax is payable, but not arising from a trade or business.(fn3) Second, the expense cannot be a capital expenditure, such as an amount paid for machinery, equipment or buildings.(fn4) Finally, the expense must be ordinary and necessary.
An "ordinary" expense is one which is customary and usual. This does not mean customary within the particular taxpayer's experience, but rather, customary or usual for the type of business involved. Thus, an expense may qualify as "ordinary" even though it is the first and only time that the taxpayer incurs it.(fn5) The term "ordinary" is also used to clarify the often difficult distinction between deductible expenses and capital expenditures.(fn6)
The term "necessary" imposes a minimal requirement that the expense be appropriate and helpful for the development of the taxpayer's business.(fn7) Expenses may be necessary and deductible even though they exceed the gross income derived from the trade or business during the year.(fn8)
The timing of business expense deductions is governed by the method of accounting rules which apply to every kind of deduction. Thus, taxpayers on the case receipts and disbursements method of accounting can only deduct an otherwise allowable expense in the taxable year in which it is actually paid.(fn9) An accrual method taxpayer deducts the expense in accordance with the "all events test"; i.e., when all events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy.(fn10)
Business expenses incurred for travel and entertainment also are subject to strict requirements of substantiation in order to be deductible.(fn11) These requirements may or may not apply to an employee, depending on the record-keeping policy of the employer.
It is well-established that the performance of services as an employee constitutes a "trade or business."(fn12) Nonetheless, the attitude of the courts toward employee expenses has been inconsistent. The Tax Court has held that a taxpayer is in the business of being an "employee" and is entitled to deduct entertainment expenses incurred to further his general trade or business, even though he is unemployed at the time.(fn13) On the other hand, courts have denied expense deductions on similar facts since the "expenses were not incurred in the pursuit of the employer's business."(fn14)
The trend of the Tax Court and the Internal Revenue Service ("Service") appears to be toward the former approach. For example, the Service will allow business deductions for expenses incurred in the search for employment if an employee is seeking employment in the same trade or...
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