Business Expense Deductions

March 13, 2024

8754 / How does an employer’s reimbursement or failure to reimburse an employee’s expenses impact a taxpayer’s business expense deductions?

<div class="Section1"> The tax treatment of an employee’s business expenses depends on whether the employee is reimbursed for them by the employer. The IRC provides that expenses paid or incurred by the taxpayer, in connection with the performance of services as an employee, under a reimbursement or other expense allowance arrangement with the employer are deductible in full from gross income, to arrive at adjusted gross income, so long as the expenses otherwise qualify as business expense deductions.<a href="#_ftn1" name="_ftnref1">1</a> Generally, this deduction will be available only to the extent that the reimbursement is includable in the employee’s gross income.<a href="#_ftn2" name="_ftnref2">2</a> <hr /> Planning Point: In some jurisdictions (California and Illinois, for example) employers are required to reimburse employees for employment expenses. This may create the need for employers to reimburse employees for the cost of maintaining a home office. Further, the FLSA does not permit an employer to require an employee to pay for business expenses if doing so would reduce the employee’s earnings to below the minimum wage. However, simply providing cash reimbursement may generate additional taxable income for the employee. The miscellaneous itemized deduction for expenses incurred in the “trade or business of being an employee” was suspended for 2018-2025. Employers may instead wish to consider a program where the employer leases or purchases the required equipment for the employee’s use. <hr /> Employers are generally required to report certain employee reimbursements for business expenses on Form W-2. The reporting requirements apply to the following groups: (1) employers who do not require substantiation (or whose employees fail to substantiate expenses); (2) employers who advance amounts for expenses and do not require the return of (or do not receive) unused amounts; and (3) employers who reimburse a per diem or other fixed amount that exceeds government specified rates. The rules, thus, generally apply only to reimbursements for unsubstantiated expenses and unreturned excess amounts.<a href="#_ftn3" name="_ftnref3">3</a> It is not uncommon for an employee to incur expenses in connection with work that are not reimbursed by the employer. Examples include an employee’s use of his own automobile or subscriptions to work-related professional journals. Prior to 2018, the same business expenses that are deductible by a self-employed person are deductible if incurred by an employee, but in the case of an employee, the deduction is allowable only as an itemized deduction. As such, it is treated as a so-called “miscellaneous itemized deduction.”<a href="#_ftn4" name="_ftnref4">4</a> Miscellaneous itemized deductions are allowed only to the extent that the aggregate of such deductions exceeds 2 percent of the taxpayer’s adjusted gross income.<a href="#_ftn5" name="_ftnref5">5</a> Note that all miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025. An employee cannot choose to forego reimbursement for a business expense for which his employer would pay and claim a deduction. “[A] business expense deduction is not allowable to an employee to the extent that the employee is entitled to reimbursement from the employer for an expenditure related to his status as an employee.”<a href="#_ftn6" name="_ftnref6">6</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 62(a)(2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 62(c), Treas. Reg. §§ 1.162-17(b)(2), 1.162-17(c). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.62-2. <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.67-1T(a)(1)(i). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 67. <a href="#_ftnref6" name="_ftn6">6</a>. Lucas v. Commissioner, 79 TC 1 (1982). </div>

March 13, 2024

8737 / What is a business expense deduction?

<div class="Section1"> A business expense deduction is a deduction allowed for ordinary and necessary expenses paid or incurred in connection with an individual’s trade, business or profession.<a href="#_ftn1" name="_ftnref1">1</a> The deduction allowed under IRC Section 62(a)(1) for expenses of a trade or business is the provision which technically allows for business income to be taxed on a net income basis, whether it be a corporate business or the business of individual taxpayers operating as sole proprietors or partners. In the case of a sole proprietorship or partnership, IRC Section 62(a)(1) operates to assure that all trade or business expenses, deductible as delineated under specific IRC Sections, are effectively allowed as above-the-line deductions, rather than itemized deductions. In the case of a sole proprietor, all but a few of these expenses are deducted in Schedule C of Form 1040. For purposes of determining whether an expense may be deducted as a business expense, an expense is considered to be “ordinary” if it is one that is commonly incurred in the trade or occupation of the taxpayer. An expense is “necessary” if it is found to be appropriate or helpful to the taxpayer’s business or occupation. Among the common expenses in this category are: employees’ salaries; office rent; interest on business loans; the cost of supplies and utilities; traveling; entertainment; advertising; and automobile expenses. Note that the deduction for most forms of business entertainment, with the exception of meals, was suspended for 2018-2025. Generally, business expenses of a self-employed individual (sole proprietor, independent contractor, or professional) may be deducted from gross income to arrive at adjusted gross income. The deductions are taken on Schedule C of Form 1040 in computing the net gain or loss from the taxpayer’s business or profession. The IRS has ruled that a full-time life insurance salesperson who is treated as a “statutory employee” for FICA purposes is not an “employee” for purposes of IRC Sections 62 and 67. Such individuals may thus treat unreimbursed business expenses as “above the line” deductions. This ruling was issued in part to clarify that taxpayers who are treated as “statutory employees” for FICA purposes (as are life insurance salespersons) are not necessarily treated as “employees” for other purposes.<a href="#_ftn2" name="_ftnref2">2</a> The term “statutory employee” refers to certain individuals described in IRC Section 3121(d)(3)(B), who are subject to FICA withholding requirements (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8722">8722</a>). The ruling’s effect was essentially limited to those individuals. <hr> Planning Point: Although many employers have required employees to return to offices, others are permitting employees to continue working remotely. It’s important to remember that common law employees are not entitled to deduct business expenses in the same manner as self-employed taxpayers. In some jurisdictions (California and Illinois, for example) employers are required to reimburse employees for employment expenses. This may create the need for employers to reimburse employees for the cost of maintaining a home office. Further, the Fair Labor Standards Act (FLSA) does not permit an employer to require an employee to pay for business expenses if doing so would reduce the employee’s earnings to below the minimum wage. However, simply providing cash reimbursement may generate additional taxable income for the employee. The miscellaneous itemized deduction for expenses incurred in the “trade or business of being an employee” was suspended for 2018-2025. Employers may instead wish to consider a program where the employer leases or purchases the required equipment for the employee’s use. <hr> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8738">8738</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8753">8753</a> for a detailed discussion of the various types of business expenses commonly deducted by taxpayers. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 162(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Rul. 90-93, 1990-2 CB 33. </div></div>

March 13, 2024

8739 / When is a taxpayer considered to be “away from home” for purposes of deducting business travel expenses? What if the taxpayer is away for an extended period of time for business reasons?

<div class="Section1"> As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8738">8738</a>, the IRS requires that a taxpayer be away from the company’s principal place of business, rather than a residence, in order to deduct business travel expenses that would otherwise be personal in nature (such as food and lodging). The IRS has ruled that a taxpayer’s tax “home”—meaning principal place of business—is not limited to a specific building or worksite, but instead encompasses the entire city or general area in which the business is located.<a href="#_ftn1" name="_ftnref1">1</a> In cases where a taxpayer is required to take extended business trips, determining the location of a taxpayer’s primary place of business becomes difficult, though for most taxpayers, the determination is simple because many taxpayers maintain a residence in the general vicinity of their primary place of business. For taxpayers who are required to travel often for business, such extended business travel raises the question as to where that taxpayer’s tax “home” is located. Generally, in order for the taxpayer to deduct business-related travel expenses, the travel must be temporary in nature (“temporary” for these purposes has been statutorily interpreted to mean an employment period not exceeding one year<a href="#_ftn2" name="_ftnref2">2</a>). In other words, if a taxpayer is assigned to a new work location for an indefinite period of time, the taxpayer’s principal place of business—and tax “home” for travel expense deduction purposes—is transferred to that new location.<a href="#_ftn3" name="_ftnref3">3</a> Often, the analysis of whether a taxpayer who travels for business has acquired a second “tax home” turns upon whether or not it would be reasonable to expect that taxpayer to relocate. For example, the Second Circuit has held that the real issue in a case where the taxpayer resided in Colorado, but had committed to a two year position in New York, was whether or not a reasonable person in her position would have relocated her residence to New York.<a href="#_ftn4" name="_ftnref4">4</a> Congress has clarified the issue so that Section 162 now specifically provides that a taxpayer will not be temporarily “away from home” for any period of employment that exceeds one year for tax years beginning after 1992.<a href="#_ftn5" name="_ftnref5">5</a> If the taxpayer can show that the business travel was realistically expected to last for one year or less, and that travel in fact does last for one year or less, the travel will be considered temporary. On the other hand, if the travel is realistically expected to last for more than one year, or there is no realistic expectation that the travel will last for less than one year, the travel will be considered indefinite regardless of whether it actually lasts for more than one year.<a href="#_ftn6" name="_ftnref6">6</a> A very narrow exception to this rule exists for federal employees who are travelling in connection with the investigation or prosecution of a federal crime.<a href="#_ftn7" name="_ftnref7">7</a> This statutory rule applies for taxpayers travelling for business reasons to a single location for more than one year. The distinction between indefinite and temporary business travel remains important in situations where the taxpayer’s business travel may include multiple travel locations over a period that exceeds one year. In Wilson v. Commissioner, for example, the taxpayer, who was from Idaho, was assigned by his employer to a series of temporary construction jobs in various locations in California over a period of time that exceeded one year. He claimed that, because each of these jobs was temporary, his principal place of business was in Idaho so that he should have been entitled to deduct his travel expenses while working in California. The Tax Court disagreed, finding that, while construction jobs are temporary by nature, all of the facts and circumstances had to be examined to determine whether the business travel was in fact indefinite. In this case, the overarching employment relationship was important and demonstrated an indefinite relationship so that the taxpayer could not reasonably argue that his travel could be segmented into individual construction jobs.<a href="#_ftn8" name="_ftnref8">8</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Rul. 56-49, 1956-1 CB 152. <a href="#_ftnref2" name="_ftn2">2</a>.  Chief Counsel Memo 106447-98 (08-06-1998); Energy Policy Act of 1992 (1938), Pub. L. No. 102-486. <a href="#_ftnref3" name="_ftn3">3</a>.  See Peurifoy v. Commissioner, 358 U.S. 59 (1958). <a href="#_ftnref4" name="_ftn4">4</a>.  Six v. United States, 450 F.2d 66 (2d Cir. 1971). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 162(a) (flush language). <a href="#_ftnref6" name="_ftn6">6</a>.  Rev. Rul. 93-86, 1993-2 CB 71. <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 162(a) (flush language). <a href="#_ftnref8" name="_ftn8">8</a>.  Wilson v. Commissioner, TC Memo 2001-301. </div></div>

March 13, 2024

8741 / Are business-related travel expenses deductible if a taxpayer resides in a location that is far from the taxpayer’s principal place of business?

<div class="Section1"> A taxpayer is entitled to deduct business travel expenses, but is not entitled to deduct the costs incurred in commuting between the taxpayer’s principal residence and place of business.<a href="#_ftn1" name="_ftnref1">1</a> When a taxpayer chooses to reside in a location that is far from the taxpayer’s principal place of business, the issue is not whether the taxpayer is “away from home” when travelling between a residence and place of business, but whether or not the travel expenses are sufficiently connected to a trade or business as to be deductible under Section 162. For example, the Tax Court has denied the taxpayer’s travel expense deductions in a situation where the taxpayer maintained a residence in Tennessee with the taxpayer’s family. The taxpayer was unable to find employment in Tennessee and accepted employment in North Carolina. The family continued to reside in Tennessee and the taxpayer incurred duplicate living expenses as a result, which he attempted to deduct as business travel expenses. The Tax Court denied the deductions, finding that the taxpayer’s choice in maintaining his personal residence far from his principal place of business was not a business expense that was reasonable and necessarily connected to his business. Rather, these duplicate living expenses were the result of the taxpayer’s personal choice to maintain a residence in Tennessee.<a href="#_ftn2" name="_ftnref2">2</a> Similarly, a postal employee who lived and worked in New York, but was promoted to a position (national president of the post office) that required him to spend approximately 300 hours per year in Washington, D.C., was unable to deduct his travel expenses between New York and Washington D.C. The taxpayer’s wife continued to live in their New York residence and the taxpayer stayed in hotels and took his meals there while in Washington D.C. Even though the position required that the taxpayer spend significant time in Washington D.C., it did not require that he continue to maintain a residence in New York. Because of this, the expenses that he incurred while residing in Washington D.C. were found to be personal living expenses, rather than business travel expenses.<a href="#_ftn3" name="_ftnref3">3</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. See, e.g., United States v. Tauferner, 407 F.2d 243 (10th Cir. 1969); Sanders v. Commissioner, 439 F.2d 296 (9th Cir. 1971). <a href="#_ftnref2" name="_ftn2">2</a>. Tucker v. Commissioner, 55 TC 783 (1971). <a href="#_ftnref3" name="_ftn3">3</a>. McAvoy v. Commissioner, TC Memo 1965-289. </div>

March 13, 2024

8743 / Can a taxpayer deduct travel expenses for a trip that has both business and personal elements?

<div class="Section1"> The deduction for otherwise personal expenses incurred while a taxpayer is away from home for business purposes is only allowed to the extent that the travel is reasonable and necessary for a taxpayer’s trade or business. However, because there have been many instances where a taxpayer attempts to deduct expenses for what essentially constitutes a personal vacation, the IRS has developed rules that govern a trip that combines both business and personal elements. If the primary purpose behind a taxpayer’s trip is personal, no travel expense deductions for expenses incurred in traveling to and from the destination will be permitted even if the taxpayer does, in fact, engage in some business activities during the course of the trip. However, if a trip has both business and personal elements, the taxpayer may deduct those expenses that are properly allocated to the business portion of the trip even if unable to deduct the expense of traveling to and from the destination because it is found that the trip was primarily undertaken for personal reasons.<a href="#_ftn1" name="_ftnref1">1</a> Whether a trip is primarily business-related or primarily personal is a question of fact. Though all facts and circumstances must be considered, the IRS has provided that an important factor is the amount of time spent on business compared to the amount of time spent on the taxpayer’s personal activities. <hr /> Planning Point: If, for example, a taxpayer spends one week while at a destination on activities which are directly related to his trade or business and subsequently spends an additional five weeks for vacation or other personal activities, the trip will be considered primarily personal in nature in the absence of a clear showing to the contrary. <a href="#_ftn2" name="_ftnref2">2</a> <hr /> Travel expenses for the taxpayer’s spouse (or other family member) to accompany the taxpayer on a business-related trip are not deductible unless the taxpayer is able to show that there is a bona fide business purpose for the spouse or family member’s presence. This is the case even if it is found that the taxpayer’s trip is primarily business-related.<a href="#_ftn3" name="_ftnref3">3</a> Similar rules apply in the case of a taxpayer’s travel expenses related to attendance at a convention—meaning that the expenses are not deductible if the reason for attending is not sufficiently related to the taxpayer’s trade or business. However, the rules make clear that the fact that the taxpayer’s attendance is voluntary will not impede the taxpayer’s ability to deduct related travel expenses—even if the taxpayer actually uses vacation days in order to attend—so long as attendance at the convention is motivated by business reasons.<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.162-2(b)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.162-2(b)(2). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.162-2(c). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.162-2(d). </div>

March 13, 2024

8747 / Can an employer deduct moving expenses for which it reimburses its employees? Are reimbursed moving expenses included in the taxpayer-employee’s gross income?

<div class="Section1"> Editor’s Note: The 2017 tax reform legislation suspended the ability of taxpayers to deduct moving expenses under IRC Section 217 for 2018-2025. Although the Section 132 employer deduction for moving expenses is also suspended from 2018 through 2025, an exception exists for members of the armed forces (and their spouses and dependents) who are on active duty.<a href="#_ftn1" name="_ftnref1">1</a> The rules discussed below generally apply for tax years beginning prior to 2018 unless otherwise noted. Prior to 2018, generally, if an employer reimbursed an employee for business-related moving expenses (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8746">8746</a>), that employer was entitled to deduct the reimbursed amount as an ordinary and necessary business expense under IRC Section 162. If a taxpayer is reimbursed by the employer for non-qualified moving expenses (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8746">8746</a>), the taxpayer must include those reimbursed amounts in gross income as compensation for services rendered.<a href="#_ftn2" name="_ftnref2">2</a> A taxpayer is not required, however, to include amounts reimbursed for “qualified moving expenses” in gross income (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8746">8746</a>). These qualified moving expenses are instead treated as a fringe benefit that is specifically excluded from an employee’s income.<a href="#_ftn3" name="_ftnref3">3</a> In order for a moving expense reimbursement to be excludable from the employee’s gross income, the reimbursement must be related to an expense that would be deductible by the employee (if the employee had paid it directly, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8746">8746</a>) under IRC Section 217. If the employee actually did deduct the expense in a prior year, reimbursement for the expense is not excludable under Section 132.<a href="#_ftn4" name="_ftnref4">4</a> For tax years beginning after 2017 and prior to 2026, reimbursement for moving expenses (where the move is motivated by employment or self-employment) is included in the gross income of the recipient as compensation for services.<a href="#_ftn5" name="_ftnref5">5</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 132(g). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 82. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 132(a)(6). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 132(g). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 82. </div></div>

March 13, 2024

8749 / What special rules apply when a taxpayer deducts business-related entertainment expenses and meals?

<div class="Section1"> Editor’s Note: Congress lifted the 50 percent cap for 2021 and 2022, so that business meals were fully deductible under the 2020 year-end Consolidated Appropriations Act (CAA). This change was designed to support the restaurant industry during the COVID-19 recovery efforts, and, as such, the deduction was limited to food and beverages purchased in a restaurant. IRS guidance clarified that “restaurants” for this purpose include only businesses that prepare and sell food or beverages to customers for immediate consumption on the premises or off the premises. Pre-packaged meals and goods that are purchased for consumption at a later time, such as from a grocery store or convenience store, did not qualify. Meals provided through an employer-operated eating facility were not eligible for the 100 percent deduction even if the employer contracted with a third-party vendor to supply the meals. As is typically the case, the deduction was subject to the caveat that the meal expense was not lavish or extravagant.<a href="#_ftn1" name="_ftnref1">1</a> Editor’s Note: Under the 2017 tax reform legislation, the previously existing 50 percent deduction for entertainment expenses that are directly connected with a business activity was suspended for 2018-2025. This applies to any activity considered entertainment, recreation or amusement, including membership dues with respect to any club organized for business, pleasure, recreational or social purposes.<a href="#_ftn2" name="_ftnref2">2</a> The 50 percent deduction for meal expenses remains in effect (including meals consumed while travelling for business). The 2017 tax reform legislation expanded the 50 percent deduction for meals to include expenses associated with providing meals through an eating facility meeting de minimis fringe benefit requirements ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8910">8910</a>).<a href="#_ftn3" name="_ftnref3">3</a> The deduction for meals provided at the convenience of the employer expires after December 31, 2025.<a href="#_ftn4" name="_ftnref4">4</a> Special restrictions apply when a taxpayer deducts business meal and entertainment expenses. A taxpayer is generally entitled to deduct the cost of a business meal if (a) the meal is not lavish or extravagant (b) the taxpayer (or employee of the taxpayer) is present at the meal and (c) the food or beverages are provided to the taxpayer or a business associate.<a href="#_ftn5" name="_ftnref5">5</a> Entertainment expenses (prior to 2018) were typically only deductible if the taxpayer established that the activity was directly related to or associated with the taxpayer’s trade or business.<a href="#_ftn6" name="_ftnref6">6</a> Recently released IRS guidance has confirmed that the rules governing the deductibility of business meals prior to tax reform will continue to apply (i.e., the 50 percent deduction for business meals will continue in effect). However, if the food or beverage in question is purchased in connection with a simultaneous event that constitutes “entertainment,” the food and beverages must either be purchased separately, or must be separately stated on the receipt.<a href="#_ftn7" name="_ftnref7">7</a> Under the regulations, what amounts to “entertainment” is determined on an objective basis so that if an activity is generally considered to be entertainment, it will be treated as such even if it can be characterized as something else. However, the specific trade or business involved is taken into account.<a href="#_ftn8" name="_ftnref8">8</a> Example: A theatre critic attends a theatrical production that she will review. Even though attending a theatrical performance is usually considered entertainment, with respect to the theatre critic, it is business and, thus, the cost of the ticket would not be disallowed under the new rules. If a manufacturer had taken a client to attend the same production, the manufacturer would not be entitled to deduct the ticket costs. Generally, the deduction for the ordinary and necessary cost of business meals (i.e., those expenses which are not lavish and extravagant), are reduced by half, so that only 50 percent of allowable costs are deductible.<a href="#_ftn9" name="_ftnref9">9</a> For certain taxpayers who are employed in the transportation industry, and are frequently required to have meals away from home (such as flight crews, interstate truck drivers, etc.), 80 percent of the cost of business meals is deductible for tax years beginning after 2007.<a href="#_ftn10" name="_ftnref10">10</a> In order to deduct the cost of business-related meals, taxpayers must also establish that the meal was either “directly related” or “associated with” the taxpayer’s business (i.e., the taxpayer must show that the expense was incurred directly before, during, or after a bona fide business discussion) in order to deduct the cost.<a href="#_ftn11" name="_ftnref11">11</a> Under the final regulations, the food or beverages must be provided to a current or prospective business associate. The regulations define this to include a person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective. The final regulations clarify that employees are also included in the definition of business associate.<a href="#_ftn12" name="_ftnref12">12</a> The deduction for business entertainment expenses was also generally limited to 50 percent of otherwise allowable costs.<a href="#_ftn13" name="_ftnref13">13</a> If the amount of the allowable deduction is reduced because the expense is found to be lavish or extravagant, the 50 percent limitation is applied after the cost has been reduced by the portion that is deemed to be unacceptable.<a href="#_ftn14" name="_ftnref14">14</a> <hr> Planning Point: Elimination of the deduction for business-related entertainment expenses while preserving the 50 percent deduction for business meals generated questions as to when a business meal becomes entertainment so as to be non-deductible under the tax reform law. Some speculated that this line is crossed when the meal becomes “lavish and extravagant”, a standard that existed pre-reform to deny the deduction for meal expenses that were essentially deemed unreasonable. The final regulations continue to reference the pre-existing “lavish and extravagant standard” (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8751">8751</a>), which can help in determining whether the 50 percent deduction for business meals is permissible. <hr> If an employee is fully reimbursed for the expense of business meals and entertainment (prior to 2018), such expenses are fully deductible by the employer, although the 50 percent limitation will apply to the employer’s deduction.<a href="#_ftn15" name="_ftnref15">15</a> However, if the expenses are not reimbursed, the employee is subject to the 50 percent limitation described above. Furthermore, the unreimbursed expenses that are deductible after that limitation are then subject to the 2 percent floor on miscellaneous itemized deductions (all miscellaneous itemized deductions subject to the 2 percent floor were suspended from 2018-2025).<a href="#_ftn16" name="_ftnref16">16</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Notice 2021-25. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 274(a). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 274(n). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 274(o). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 274(k), Treas. Reg. § 1.274-12(a). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 274(a). <a href="#_ftnref7" name="_ftn7">7</a>.  Notice 2018-76. <a href="#_ftnref8" name="_ftn8">8</a>.  Treas. Reg. § 1.274-11(b)(1)(iii). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 274(n). <a href="#_ftnref10" name="_ftn10">10</a>.  IRC § 274(n)(3). <a href="#_ftnref11" name="_ftn11">11</a>.  IRC § 274(a)(1)(A). <a href="#_ftnref12" name="_ftn12">12</a>.  Treas. Reg. § 1.274-12(b)(3). <a href="#_ftnref13" name="_ftn13">13</a>.  IRC § 274(n). <a href="#_ftnref14" name="_ftn14">14</a>.  H.R. Rep. No. 841, 99th Cong., 2d Session at II-25 (1986). <a href="#_ftnref15" name="_ftn15">15</a>.  IRC § 274(n)(2)(A). <a href="#_ftnref16" name="_ftn16">16</a>.  IRC §§ 274(n)(1), 67(b). </div></div>

March 13, 2024

8751 / What limitations apply to prevent a taxpayer from deducting lavish or extravagant business-related entertainment expenses?

<div class="Section1"> Editor’s Note: Under the 2017 tax reform legislation, the previously existing 50 percent deduction for entertainment expenses that are directly connected with a business activity is suspended for 2018-2025. This applies to any activity considered entertainment, recreation or amusement, including membership dues with respect to any club organized for business, pleasure, recreational or social purposes.<a href="#_ftn1" name="_ftnref1">1</a> The 50 percent deduction for meal expenses remains in effect (including meals consumed while travelling for business). The 2017 tax reform legislation also expanded the 50 percent deduction for meals to include expenses associated with providing meals through an eating facility meeting de minimis fringe benefit requirements.<a href="#_ftn2" name="_ftnref2">2</a> The deduction for meals provided at the convenience of the employer expires after December 31, 2025.<a href="#_ftn3" name="_ftnref3">3</a> The prohibition on the deductibility of lavish or extravagant business-related expenses is tied to the notion that the expense must be reasonable in order to be deducted—a determination that is made based on the facts and circumstances of each individual case. Based on this premise, the courts have allowed taxpayers to deduct expenses that might be considered unreasonable in other contexts. For example, the Tax Court has upheld a taxpayer’s deduction for expenses incurred in using a chauffeured Cadillac to provide local transportation for securities analysts and investment advisors in New York.<a href="#_ftn4" name="_ftnref4">4</a> Conversely, the Tax Court has disallowed deductions for lease payments made on a Rolls Royce by a plastic surgeon. The court’s opinion reflects the importance of whether the expense is reasonable, rather than the level of extravagance displayed. In this case, the taxpayer-surgeon claimed that the Rolls Royce was used in advertising and promoting the quality of his services, and that he only used the car for business travel between the hospital and medical conventions. The Tax Court rejected the petitioner’s argument that the Rolls Royce would attract customers, finding that it had no reasonable relationship to his skill and performance as a plastic surgeon and that there was no evidence that any patients were attracted based on the leasing of the car.<a href="#_ftn5" name="_ftnref5">5</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 274(a). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 274(n). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 274(o). <a href="#_ftnref4" name="_ftn4">4</a>. See Denison v. Commissioner, TC Memo 1977-430. <a href="#_ftnref5" name="_ftn5">5</a>. Connelly v. Commissioner, TC Memo 1994-436. </div>

March 13, 2024

8753 / When is a taxpayer entitled to deduct expenses incurred in maintaining a home office?

<div class="Section1"> Editor’s Note: The 2020 CARES Act did not change the rules governing the home office deduction. While more employees are working from home in the wake of the coronavirus pandemic, the business expense deduction for home office expenses of employees remains suspended under the 2017 tax reform legislation’s suspension of all miscellaneous itemized deductions. Only self-employed taxpayers are entitled to the existing home office deduction. A taxpayer is only entitled to deduct expenses for a home office if the taxpayer is able to meet the restrictive requirements imposed by the IRC and the courts with regard to this business deduction. A deduction for use of a part of the taxpayer’s residence as an office will not be allowed unless a portion of the dwelling is used exclusively and on a regular basis as (a) the principal place of business for any trade or business of the taxpayer; or (b) the place of business used by the taxpayer for meeting patients, clients or customers in the normal course of the taxpayer’s business.<a href="#_ftn1" name="_ftnref1">1</a> If the taxpayer uses a separate structure as a home office, the use requirements are less restrictive and the use must only be “in connection with” the taxpayer’s trade or business.<a href="#_ftn2" name="_ftnref2">2</a> A home office will qualify as a taxpayer’s principal place of business if both of the following are true: (1) The taxpayer uses the home office exclusively and regularly for administrative or management activities of the trade or business; and (2) The taxpayer has no other fixed location for conducting substantial administrative or management activities of the trade or business.<a href="#_ftn3" name="_ftnref3">3</a> That a taxpayer chooses to have a third party perform administrative or management activities (such as billing) for the taxpayer will not, in itself, cause a disallowance of the deduction. Example: Josh is an electrician who is self-employed. Most of his time is spent on-site with customers examining and repairing their electrical systems, but he maintains a small office in his home that is used exclusively and regularly for activities such as ordering supplies, calling his customers and keeping his books. Josh writes up estimates and records of work completed on-site at his customers’ premises. He has engaged a local bookkeeping service for billing his customers, but he does not conduct any other substantial administrative or management activities outside of his home office. His home office will qualify for a home office deduction. <hr /> Planning Point: If the taxpayer is an employee and uses part of the taxpayer’s home for business, the taxpayer must be able to show that, in addition to the requirements discussed above (1) the use is for the convenience of the employer and (2) no part of the home is rented to the employer and used to perform services as an employee for that employer.<a href="#_ftn4" name="_ftnref4">4</a> Note that the 2017 tax reform legislation eliminated the deduction for expenses associated with the trade or business of being an employee (in other words, the home office deduction for traditional W-2 workers was suspended for 2018-2025). <hr /> If the home office is merely appropriate and helpful, the deduction for home office expenses will be disallowed.<a href="#_ftn5" name="_ftnref5">5</a> For tax years beginning on or after January 1, 2013, the IRS has authorized an optional safe harbor method for calculating the amount of a taxpayer’s home office deduction. The taxpayer calculates the home office deduction by multiplying the square footage of the home used for business purposes by a prescribed rate of $5.00. Under this safe harbor, the maximum allowable portion of a home that may be used for qualified business purposes is 300 square feet, which results in a maximum allowable home office deduction of $1,500.<a href="#_ftn6" name="_ftnref6">6</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 280A(c)(1). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 280A(c)(1)(C). <a href="#_ftnref3" name="_ftn3">3</a>. IRS Publication 587, Business Use of Your Home (2018). <a href="#_ftnref4" name="_ftn4">4</a>. IRS Pub. 587. <a href="#_ftnref5" name="_ftn5">5</a>. IRS Pub. 587, above. <a href="#_ftnref6" name="_ftn6">6</a>. Rev. Proc. 2013-13, 2013-6 IRB 478. </div>

March 13, 2024

8742 / Is a taxpayer entitled to a deduction for travel expenses when the taxpayer has multiple places of business?

<div class="Section1"> If a taxpayer regularly conducts business in more than one location, a determination must be made as to which location is the “principal” place of business. This determination must be made by examining all the facts and circumstances of the particular case, but the IRS has identified the following factors as important: (1) The total time spent at each of the business locations; (2) The degree of business activities conducted at each location; and (3) Whether the financial return in each location is significant or insignificant.<a href="#_ftn1" name="_ftnref1">1</a> Though all three factors are important, the IRS generally considers the amount of time spent at each location to be the most important factor.<a href="#_ftn2" name="_ftnref2">2</a> For example, the Tax Court has held that a taxpayer who maintained a business in New York and another in Massachusetts was entitled to deduct expenses while travelling in New York because the taxpayer spent more of his time in Massachusetts.<a href="#_ftn3" name="_ftnref3">3</a> In situations where the taxpayer’s time is relatively evenly divided, all of the facts and circumstances will be analyzed to determine which place of business constitutes the taxpayer’s “principal” place of business.<a href="#_ftn4" name="_ftnref4">4</a> Once the taxpayer’s principal place of business is determined, the general rules applicable in determining whether travel expenses are deductible are applied. Thus, a taxpayer can deduct expenses for meals and lodging while conducting business in a secondary business location if an overnight trip is required. Transportation expenses can be deducted between the principal and secondary places of business even if an overnight stay is not required.<a href="#_ftn5" name="_ftnref5">5</a> Expenses incurred while the taxpayer is in the vicinity of his principal place of business are not deductible. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 54-147, 1954-1 CB 51. <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Rul. 63-82, 1963-1 CB 33; Rev. Rul. 61-67, 1961-1 CB 25. <a href="#_ftnref3" name="_ftn3">3</a>. Sherman v. Commissioner, 16 TC 332 (1951). <a href="#_ftnref4" name="_ftn4">4</a>. See, e.g., Bernard v. United States, 87-1 USTC 1092 (1971). <a href="#_ftnref5" name="_ftn5">5</a>. Rev. Rul. 63-82, above. </div>