Reimbursed expenses: proposed reliance regulations clarify deduction limit.

• Author: Josephs, Stuart R
• Position: FedTax

IRC Sec. 274(n)(1) limits the deduction for food or entertainment expenses to 50 percent of the amount otherwise allowable. However, Sec. 274(e)(3) excepts from this limit expenses paid or incurred by the taxpayer in performing services for another person under a reimbursement or other expense allowance arrangement with that other person.

This exception applies if the taxpayer is an employee performing services for an employer who does not treat the reimbursed expenses as employee compensation [Sec. 274(e)(3)(A)]. Thus, the employee has no deduction for the expense. Instead, the employer bears and deducts the expense and is subject to the deduction limits [Regs. Sec. 1.274-2(f)(2)(iv)(b)].

If the employer treats the reimbursement as compensation, the employee may be able to deduct the expense as an employee business expense. The employee bears the expense and is subject to the deduction limits [Regs. Sec. 1.274-2(1)(2)(iv)(b)(1)]. The employer deducts an expense for compensation, which is not subject to the deduction limits [Regs. Sec. 1.274-2(I)(2)(iv)(b)(2)].

The Sec. 274(e)(3) exception also applies if the taxpayer performs services for a person other than an employer and the taxpayer accounts [substantiates, as required by Sec. 274(d)] to that person [Sec. 274(e)(3)(B)].

Therefore, in a reimbursement or other expense allowance arrangement in which a client reimburses an independent contractor (IC)'s expenses, the deduction limits do not apply to the IC to the extent the IC accounts to the client by substantiating the expenses as required by Sec. 274(d). If the IC is subject to the deduction limits, these limits do not apply to the client [Regs Sec. 1.274-2(f)(2)(iv)(a)].

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Previous Litigation

In Transport Labor Contract/Leasing, Inc (TLC) v Comm., 461 F3d 1030 (8th Cir. 2006), reversing 123 TC 154 (2004), TLC was a leasing company that paid truck drivers a per diem that it did not treat as compensation. TLC billed its clients leasing the drivers for the wages and per diem allowances. The clients paid TLC.

The Tax Court applied the Sec. 274(n)(1) limit to TLC as the drivers' common law employer subject to Sec. 274(e)(3)(A).

The Eighth Circuit stated that the Tax Court should have considered the Sec. 274(e)(3)(B) exception between TLC and its clients. TIE was providing services to its clients under a reimbursement or other expense allowance arrangement and accounted to the clients. Therefore, TLC qualified for this...