Wednesday, September 19, 2012

IRS clarifies deduction limits for meals/entertainment reimbursement to employees/contractors

Doeren Mayhew 

The IRS has issued proposed reliance regulations to clarify the exception to the 50 percent meal and entertainment expenses deduction limit under Code Sec 274(n) where amounts are paid or incurred under reimbursement or other expense allowance arrangements. While the IRS generally takes a strict approach under these new regulations, they do provide a helpful roadmap both to businesses and to contractors, as well as employees, for setting up and following through on reimbursement arrangements. As "proposed reliance regulations," taxpayers are allowed to use them immediately to their advantage.

In 1993, Congress passed the Omnibus Reconciliation Act (OBRA). OBRA amended Code Sec. 274 by limiting the deductible portion of meal and entertainment expenses to 50 percent.

Code Sec. 274(e)(3) provides an exception from the limitation for 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. This exception applies if the taxpayer is an employee performing services for an employer and the employer does not treat the reimbursement for the expenses as compensation and wages to the taxpayer. Additionally, the exception applies if the taxpayer performs services for a person other than an employer and the taxpayer accounts (substantiates, as required by Code Sec. 274(d)) to that person.

Court case
In 2006, the Eighth Circuit Court of Appeals handed down its decision in Transport Labor Contract/Leasing, Inc.. In that case, a corporation was in the business of leasing drivers to trucking companies. The Tax Court had applied the Code Sec. 274(n) limitation to the taxpayer as the drivers' common law employer subject to Code Sec. 274(e)(3)(A). Reversing the Tax Court, the Eighth Circuit held that the taxpayer's reimbursement and expense allowance arrangement it had with its clients enabled it to claim a reimbursement arrangement exception under Code Sec. 274(e)(3). The IRS acquiesced in the decision (in part) in Rev. Rul. 2008-23.

New regulations
Under the new regulations, a reimbursement or other expense allowance arrangement involving persons who are not employees is an arrangement under which 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 if either:
  • A written agreement between the parties expressly provides that the client or customer will reimburse the independent contractor for expenses that are subject to the deduction limitations, or
  • A written agreement between the parties expressly identifies the party that is subject to the limitations under Reg. §1.274-2(a)-(e) and Code Sec. 274(n).
The regulations also clarify that the rules for applying the exceptions to the Code Sections 274(a) and (n) deduction limitations apply to reimbursement arrangements with employees, whether or not a payor is an employer. Additionally, the new regulations apply to multiple-party reimbursement arrangements. Multiple-party reimbursement arrangements are separately analyzed as a series of two-party reimbursement arrangements.

NPRM REG-101812-07

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