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Proposed Regulations Clarify Deduction Limit in Reimbursement Arrangements
Recently-released proposed reliance regulations clarify the exception to the 50 percent meal and entertainment expenses deduction limit under Internal Revenue Code (IRC) Sec. 274(n), where amounts are paid or incurred under reimbursement or other expense allowance arrangements. The regulations reflect the Eighth Circuit Court’s decision, and the IRS’s agreement, in Transport Labor Contract/Leasing, Inc.
Comment: Transport Labor Contract/Leasing, Inc., involved a corporation in the business of leasing drivers to trucking companies. The Tax Court had applied the IRC 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 reimbursement and expense allowance arrangement that the taxpayer had with its clients enabled it to claim a reimbursement arrangement exception under IRC Sec. 274(e)(3). The IRS supported the decision (in part) in Revenue Ruling 2008-23.
Generally, IRC Sec. 274(n)(1) limits the deduction for meal and entertainment expenses to 50 percent. IRC 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.
The IRC Sec. 274(e)(3) 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 the taxpayer’s compensation and wages. The employee under such an arrangement is not treated as having additional compensation, and has no deduction for the expense; the employer bears and deducts the expense and is subject to the deduction limitations.
Comment: If the employer treats the reimbursement as compensation and wages, the employee may be able to deduct the expense as an employee business expense. In that case, the employee bears the expense and is subject to the deduction limitations. The employer deducts an expense for compensation, which is not subject to the deduction limitations under IRC Sec. 274.
In addition, the exception applies if the taxpayer performs services for a person other than an employer and the taxpayer accounts (substantiates, as required by IRC Sec. 274(d)) to that person. In a reimbursement or other expense allowance arrangement in which a client or customer reimburses the expenses of an independent contractor, the deduction limitations do not apply to the independent contractor if the contractor accounts to the client by substantiating the expenses. If the independent contractor is subject to the deduction limitations, the limitations do not apply to the client.
Proposed reliance regulations
The proposed reliance regulations provide that a reimbursement or other expense allowance arrangement involving nonemployees is an arrangement under which an independent contractor receives an advance, allowance, or reimbursement from a client or customer for expenses the independent contractor incurs in performing services if:
- 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 IRC Sec. 274(n).
Two-party reimbursement arrangement
The proposed reliance regulations also clarify that the rules for applying the exceptions to the IRC Secs. 274(a) and (n) deduction limitations apply to reimbursement arrangements with employees, whether or not a payor is an employer. The IRS explained that a payor includes an employer, an agent of the employer, or a third party.
Where a reimbursement or other expense allowance arrangement provides that the client or customer will reimburse the independent contractor for expenses that are subject to the deduction limitations, the deduction limitations do not apply to an independent contractor that accounts to the client under IRC Sec. 274(d). However, the limitations apply to the independent contractor, rather than the client, if the independent contractor fails to account to the client. The parties may also enter into an agreement identifying who is subject to the deduction limitations, the IRS explained.
Multiple-party reimbursement arrangement
Additionally, the IRS described how the proposed reliance regulations apply to multiple-party reimbursement arrangements. The IRS explained these are separately analyzed as a series of two-party reimbursement arrangements.
The proposed regulations would apply to expenses paid or incurred in tax years beginning on or after the date the regulations are finalized. However, the IRS said taxpayers may apply the regulations for tax years beginning before the date the regulations are finalized for which the period of limitations under IRC Sec. 6511 has not expired.
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