IRS releases final regs. on sec. 274 reimbursement arrangements.

• Author: Brown, Mark

On Aug. 1 the IRS released final regulations (T.D. 9625) to clarify a portion of the 50% meals and entertainment deduction under Sec. 274. The final regulations apply to expenses paid or incurred in tax years beginning after Aug. 1,2013.

The regulations aim to clarify the exception under Sec. 274(e)(3) to the 50% deduction limit prescribed in Sec. 274(n). This exception deals with taxpayers that pay or incur expenses under a "reimbursement or other expense allowance arrangement." The final regulations define a reimbursement arrangement and lay out information on who is subject to the 50% limit in these arrangements.

Background

Generally, Sec. 274(n) limits a taxpayer to deducting 50% of expenses for food and beverages as well as expenses considered "entertainment, amusement, or recreation." A few exceptions to this limit are listed in Sec. 274(e). Specifically, Sec. 274(e)(3) explains that expenses a taxpayer paid or incurred under a reimbursement plan would be eligible for the full deduction by the taxpayer. Sec. 274(e)(3) goes on to outline rules for reimbursement arrangements where the services are performed for an employer, and also where services are performed for a third party.

In the case of an employee who performs services for his or her employer, the exception applies if the employer reimburses the employee for expenses paid or incurred and does not treat the reimbursement as compensation to the employee. In this case, the employee has no additional compensation and no deduction. The employer takes the deduction for the reimbursement paid, but it is limited to 50% of the expenses. The exception is available to only one party in the reimbursement arrangement. The deduction limitation still applies to the second party that ultimately bears the expense.

The exception under Sec. 274(e)(3) also applies if the taxpayer performs services for a third party other than an employer (i.e., a client or customer). Taxpayers who are not employees are referred to as "independent contractors" for Sec. 274 purposes. In an arrangement in which a client or customer reimburses an independent contractor, the deduction limits do not apply to the independent contractor. As long as the independent contractor properly substantiates the expenses according to Sec. 274(d), a full deduction is allowed. The client or customer then is limited to the 50% deduction.

Final Regulations

The final regulations were issued to define the reimbursement arrangement for...