IRS Proposes Rule on Reimbursed Entertainment Expenses
|Date Posted: August 16, 2012|
Employers that pay advances, allowances or reimbursements to employees for work-related entertainment expenses -- including taxpayers who, in turn, get reimbursed by their clients for such expenses -- have until Oct. 30 to comment on a proposed regulation IRS published Aug. 1. The proposed rule clarifies who -- among the employer, its client and an employee or person performing services for a third party that is not an employer -- bears the deduction limitation imposed by Code Section 274(n) when a work-related entertainment expense is incurred and reimbursed under a two- or three-party reimbursement or expense allowance arrangement.
Section 274(a) limits the amount of entertainment expenses that are deductible, and under Section 274(n), deductions for meals are generally limited to 50 percent of the expenses incurred. These limitations do not apply to expenses that a taxpayer pays or incurs in performing services for another person under a reimbursement or other expense allowance arrangement with the other person provided that if the arrangement is between an employer and employee, the employer does not treat the reimbursement as compensation and wages to the employee. Under Section 274(e)(3)(B), the limitations also do not apply if the taxpayer performs services for a person other than an employer and the taxpayer accounts to that person in accordance with the substantiation requirements of Section 274(d).
The proposed rule is an outgrowth of the 2006 decision in Transport Labor Contract & Leasing, Inc. v. Commissioner (8th Circuit U.S. Court of Appeals), and Revenue Ruling 2008-23. In the TLC case, the taxpayer, a leasing company, provided truck drivers to its trucking company clients and charged the clients for the wages and per diem allowance the taxpayer paid to the truckers. The 8th Circuit held that because the taxpayer was providing services to its clients under a reimbursement or other expense allowance and accounted to the client for such expenses, the taxpayer qualified for the Section 274(e)(3)(B) exception and that the trucking company clients -- not the taxpayer -- were subject to the Section 274(n) deduction limit.
In the decision, the 8th Circuit defined reimbursement or other expense allowance for purposes of Section 274(e) by referring to Code Section 62(a)(2)(A) and the rules under it. Notably, Those rules are relevant to employee reimbursement arrangements called accountable plans. The IRS acquiesced in the result in TLC in Rev. Rul. 2008-23; however, that ruling further provided that the Section 274(e)(3) exception may apply to an expense reimbursement arrangement without regard to whether it is an accountable plan.
In the preamble to the proposed rule, IRS states that “The TLC court’s definition is inaccurate to the extent it relies on the accountable plan rules, which cover employee reimbursement arrangements only, in determining the existence of a reimbursement or other expense allowance arrangements for purposes of identifying who bears the expense under Section 274(e)(3)(B).”
What the Proposed Rule Does
The proposed rule defines “reimbursement” or “other expense allowance arrangements” for purposes of Section 274(e)(3) independent of the definition in Section 62 and clarifies how the deduction limitations apply to reimbursement arrangements between three parties.
Arrangements Involving Employees -- Under the proposed rule, a reimbursement or other expense allowance arrangement involving employees “is an arrangement under which an employee receives an advance, allowance or reimbursement from a payor (the employer, its agent or a third party) for expenses the employee pays or incurs in performing services as an employee.” The proposed rule clarifies that the payor need not be an employer and that any party that reimburses an employee is a payor and bears the expense (and deduction limitation) if the payment is not treated as compensation and wages to the employee.
Arrangements Involving Non-employees -- The proposed separately defines a reimbursement or other expense allowance arrangement involving persons that are not employees as one under which a non-employee (that is, an independent contractor) receives an advance, allowance or reimbursement from a client or customer for expenses the independent contractor pays or incurs in performing services, with some further requirements.
Multi-party Arangements -- The proposed rule includes an example illustrating how the rules apply to multiple-party reimbursement arrangements. These are separately analyzed as a series of two-party reimbursement reimbursement arrangements.
Effective and Applicability Dates
The proposed rule will apply to expenses paid or incurred in taxable years beginning on or after the date that the proposed regulations are published as final regulations in the Federal Register.
However, the preamble states that taxpayers may apply the proposed rules for tax years beginning before the final regulations are published provided that the period of limitations under Section 6511 has not expired.
Finding out More
The proposed regulation is published at 77 Fed. Reg. 45520 (Aug. 1, 2012).
Transport Labor Contract & Leasing v. Commissioner is published at 461 F. 3d 1030 (8th Cir., 2006).