The IRS released proposed regulations under Sec. 274 clarifying which party is subject to the rule under Sec. 274(n)(1)(A) that limits the deduction for meals to 50% of the expenses incurred (REG-101812-07). As the IRS emphasized, only one party is intended to be subject to the limitation, and there has been controversy over who is subject to it when multiple parties are involved.
In the preamble, the IRS explained that the proposed regulations are intended to settle issues raised in Transport Labor Contract/Leasing, Inc., 461 F.3d 1030 (8th Cir. 2006), rev’g 123 T.C. 154 (2004), acq. in result, Rev. Rul. 2008-23.
Sec. 274(a) limits the amount of food and entertainment expenses that are deductible, and deductions for meals are generally limited to 50% of the expenses incurred (Sec. 274(n)). Under Sec. 274(e)(2)(A), employers are not subject to the limitation to the extent they treat the expenses as compensation to the employees.
Sec. 274(e)(3) provides two exceptions from the Sec. 274(a) limits for reimbursed expenses. Sec. 274(e)(3)(A) excepts expenses a taxpayer pays or incurs in performing services for another person under a reimbursement or other expense allowance arrangement where the employer does not treat the reimbursement as compensation to the employee. In that case, the employee does not have additional compensation or a deduction for the expense, but the employer deducts the expense and is subject to the deduction limit. If the employer treats the reimbursement as compensation, 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 limit. The employer deducts the expense as compensation, which is not subject to the deduction limit under Sec. 274.
Sec. 274(e)(3)(B) 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. The Eighth Circuit applied this subsection in the Transport Labor case. In that case, the taxpayer, a leasing company that provided truck drivers to its clients, charged the clients for the wages and the per diem allowance it paid the truckers. Because the taxpayer provided services to its clients under a reimbursement or other expense allowance arrangement and accounted to the clients, it qualified under Sec. 274(e)(3)(B) for the exception from the Sec. 274(n) limit with respect to the per diem expense and instead the clients were subject to the limit.
The proposed regulations set out a new definition of reimbursement or other expense allowance arrangement for purposes of Sec. 274(e)(3). This definition is independent of the definition for accountable plan purposes in Sec. 62(c). The proposed regulations also clarify that the rules for applying the exceptions to the Secs. 274(a) and (n) deduction limits apply to reimbursement or other expense allowance arrangements with employees, whether or not a payor is an employer. Any party that reimburses an employee is a payor and bears the expense if the payment is not treated as compensation and wages to the employee.
The regulations also permit taxpayers involved in multiparty arrangements involving nonemployees (i.e., independent contractors) to provide by agreement who will be subject to the 50% limit. Absent an agreement, the limit will apply to an independent contractor if he or she does not account for the expense under Sec. 274(d), and to the client or customer if the independent contractor meets the substantiation requirements.
The proposed regulations include an example illustrating how the rules apply to multiparty reimbursement arrangements, such as the one found in Transport Labor. Multiparty reimbursement arrangements are separately analyzed as a series of two-party reimbursement arrangements.
The proposed regulations will be effective on the date they are published as final in the Federal Register. However, taxpayers may apply these regulations to tax years beginning before the effective date for which the limitation period under Sec. 6511 has not expired.