Business Travel and Entertainment

Publication Date: February 2021

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Business Travel and Entertainment

By

Danny C. Santucci

The author is not engaged by this text, any accompanying electronic media, or lecture in the render-ing of legal, tax, accounting, or similar professional services. While the legal, tax, and accounting issues discussed in this material have been reviewed with sources believed to be reliable, concepts discussed can be affected by changes in the law or in the interpretation of such laws since this text was printed. For that reason, the accuracy and completeness of this information and the author's opinions based thereon cannot be guaranteed. In addition, state or local tax laws and procedural rules may have a material impact on the general discussion. As a result, the strategies suggested may not be suitable for every individual. Before taking any action, all references and citations should be checked and updated accordingly.

This publication is designed to provide accurate and authoritative information in regard to the sub-ject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert advice is required, the services of a competent professional person should be sought.

—-From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a Committee of Publishers and Associations.

Copyright February 2021

Danny Santucci

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Table of Contents Business Travel .......................................................................................................................................... 1

Transportation & Travel Distinguished ................................................................................................ 1 Travel Expenses ............................................................................................................................ 1 Transportation Expenses .............................................................................................................. 1

Definition of “Tax Home” ..................................................................................................................... 2 Circuit Court Test .......................................................................................................................... 2 IRS Test ......................................................................................................................................... 2

Employment Area ................................................................................................................... 2 No Tax Home ................................................................................................................................ 2

Itinerant Worker ..................................................................................................................... 3 Two Work Locations ..................................................................................................................... 3

Temporary & Indefinite Assignments .................................................................................................. 3 Temporary Assignment ................................................................................................................. 3 Indefinite Assignment ................................................................................................................... 3 Time .............................................................................................................................................. 4

Prior Law Presumptions .......................................................................................................... 4 One-Year IRS Presumption.................................................................................................. 4 Less than Two-Year Exception ............................................................................................ 4

Regular Home ................................................................................................................. 4 Temporary Job That Became Permanent ........................................................................... 5

Current Law - One-Year Rigid Time Rule ................................................................................. 5 Away From Home Requirement .......................................................................................................... 5

Sleep & Rest Rule .......................................................................................................................... 5 Correll Case ............................................................................................................................. 6

Business Purpose Requirement ........................................................................................................... 6 All or Nothing ................................................................................................................................ 6 Primarily for Business Test ............................................................................................................ 6

Time ........................................................................................................................................ 6 Other Factors ...................................................................................................................... 6

Existing Trade or Business ....................................................................................................... 7 51/49 Percent Test .................................................................................................................. 7

Domestic Business Travel ............................................................................................................. 7 Foreign Business Travel ................................................................................................................ 7

Personal Pleasure .................................................................................................................... 7 Primarily Business ................................................................................................................... 7 Full Deduction ......................................................................................................................... 7 Definition of Business Day ...................................................................................................... 8

Meals & Lodging .................................................................................................................................. 8 50% Deduction Limitation ............................................................................................................ 8

Conventions & Meetings...................................................................................................................... 8 Agenda Test .................................................................................................................................. 9 Foreign Conventions ..................................................................................................................... 9

Factors ..................................................................................................................................... 9 North American Area .............................................................................................................. 9

Allowable Expenses ...................................................................................................................... 10 Cruises .................................................................................................................................................. 10

Deduction Limitation .................................................................................................................... 10

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Reporting Statements ................................................................................................................... 10 Luxury Water Travel ............................................................................................................................. 11

Exceptions ..................................................................................................................................... 11 Family Member Travel Expenses ......................................................................................................... 11

Business Entertainment ............................................................................................................................. 11 Statutory Exceptions - §274(e)............................................................................................................. 12

Food and Beverages for Employees .............................................................................................. 12 Expenses Treated as Compensation ............................................................................................. 12 Reimbursed Expenses ................................................................................................................... 13 Recreational Expenses for Employees .......................................................................................... 13 Employee, Stockholder, and Business Meetings .......................................................................... 13 Trade Association Meetings.......................................................................................................... 13 Items Available to Public ............................................................................................................... 13 Entertainment Sold to Customers ................................................................................................ 13 Expenses Includible in Income of Non-employees ....................................................................... 13

Percentage Reduction for Meals - §274(n)(1) ...................................................................................... 15 Application of Reduction Rule ...................................................................................................... 15 Exceptions - §274(n)(2) ................................................................................................................. 15

Employee Business Expenses Subject to 2% Floor Suspended ............................................................ 16 Entertainment Facilities ....................................................................................................................... 17

Exceptions ..................................................................................................................................... 17 Covered Expenses ......................................................................................................................... 17 Club Dues ...................................................................................................................................... 18

OBRA '93 & TCJA ..................................................................................................................... 18 Sales Incentive Awards ................................................................................................................. 18

Substantiation & Record Keeping - §274(d) ......................................................................................... 18 Documentation ............................................................................................................................. 19

Payback Agreements ............................................................................................................... 19 Employee Expense Reimbursement & Reporting ................................................................................ 19

TRA '86 - Unreimbursed Expenses Become Itemized Deductions ................................................ 19 Family Support Act - Reimbursement Without Accounting Is Income ......................................... 19

Accountable Plans ................................................................................................................... 20 Reasonable Period of Time ................................................................................................. 21

Fixed Date Safe Harbor - #1 ............................................................................................ 21 Period Statement Safe Harbor - #2 ................................................................................ 21

Adequate Accounting .............................................................................................................. 21 Per Diem Allowance Arrangements .................................................................................... 21

Federal Per Diem Rate .................................................................................................... 22 Related Employer Restriction ......................................................................................... 25

Reporting Per Diem Allowances ......................................................................................... 26 Reimbursement More Than Federal Rate ...................................................................... 26 Reimbursement More Than Federal Rate ...................................................................... 27

Nonaccountable Plans............................................................................................................. 28 Self-Employed Persons Reimbursement & Reporting ......................................................................... 28

Expenses Related to Taxpayer's Business ..................................................................................... 28 Reimbursed Expenses Incurred on Behalf of a Client ................................................................... 29

With Adequate Accounting ................................................................................................. 29 Without Adequate Accounting ........................................................................................... 29

Employers ............................................................................................................................................ 29 When Can an Expense Be Deducted? ........................................................................................... 30

Economic Performance Rule ................................................................................................... 30 Corporation ................................................................................................................................... 30 Nondeductible Meals .................................................................................................................... 30

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Employer-Provided Auto .............................................................................................................. 30

Learning Objectives

After reading the materials, participants will be able to:

1. Recognize the “away from home” requirement and related deductions, determine what constitutes transportation and travel expenses noting the tests for tax home and recognize the differences between temporary and indefinite work assignments including their effect on a tax home.

2. Identify the business purpose requirement using the 51/49 percent test, determine de-ductible conventions and meetings, and specify the limitations applied to meals and lodg-ing when traveling.

3. Determine what constitutes business entertainment and identify business entertain-ment activity deduction restrictions and disallowance.

4. Specify the §274(e) exceptions to entertainment deduction disallowance, recognize the necessity of expense substantiation, and determine accountable and nonaccountable plans noting the impact on deductions.

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Business Travel & Entertainment

Business Travel

Travel, meals, and lodging expenses incurred by a taxpayer while away from home in connection with his or her services as an employee are deductible under §162(a)(2). Actual transportation ex-penses paid or incurred by a taxpayer even while not away from home in connection with his or her services as an employee are also deductible. In any event, such expenses are deductible only if the purpose of the trip is “primarily for business.” If they are primarily for pleasure, none of the travel expenses are deductible except for actual business expenses at the destination (Reg. §1.162-2).

Transportation & Travel Distinguished

Travel expenses and transportation expenses both may give rise to tax deductions. However, much confusion exists between the two concepts. This is especially true since travel can have transporta-tion components.

Travel Expenses

Under §162, travel expenses are defined as ordinary and necessary expenses incurred while the taxpayer is in travel status (i.e., traveling away from home in pursuit of a trade or business). Ex-amples of deductible travel expenses undertaken for business include:

(1) Meals (but only 50%, see §274(n)(1)) and lodging, both enroute and at the destination,

(2) Air, rail, ship, bus, and baggage charges,

(3) Telephone and telegraph expenses,

(4) Cost of transportation by taxi, etc. from the airport or station to the hotel, from the hotel to the airport or station, from one customer or place of work to another,

(5) Laundry, cleaning, and clothes pressing costs, and

(6) Reasonable tips to the extent incident to any of the above expenses (Reg. §1.162-2(a); R.R. 63-145; Gibson Products Co., Inc., 8 TC 864(A); Zeagler, TC Memo 1958-93).

However, travel expenses do not include the additional cost of coming home on weekends over what the cost of room and meals would have been at the out of town assignment nor do they include “entertainment” expenses.

Transportation Expenses

Section 162 allows a deduction for local transportation expenses that are directly attributable to the conduct of taxpayer’s business or employment, even if not incurred while “away from home.” Transportation is a narrower concept than travel and does not include meals and lodging. It in-cludes only the cost of transporting the employee from one place to another in the course of his or her employment, while he or she is not away from home in travel status (Reg. §1.62-1(g)).

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Definition of “Tax Home”

To deduct expenses for travel “away from home,” the taxpayer must first determine where home is. Normally this determination is not a problem. However, for those who travel, keep two homes or places of business, or have no definite home, it can be hard to decide where “home” is for tax pur-poses.

There are two tests, one enforced by the IRS, and another followed by the Second and Ninth Circuits. At this time, it is difficult to predict which test will be followed and the courts often switch from one to the other. However, for purposes of our later discussion, I will “adopt” the Service’s test.

Circuit Court Test

The Second and Ninth Circuits follow a subjective approach that places emphasis on where the taxpayer regards his or her residence to be. These circuits reject the Service’s “tax home” concept and define “home” as it is commonly conceived, not as the principal place of business. Home is where the heart is, in these circuits.

IRS Test

Under the Service’s position a taxpayer’s “tax home” is his or her principal place of business, employment station, or post of duty, regardless of where his or her family lives (R.R. 60-189, R.R. 75-432, Barnhill v. Commissioner, 148 F. 2d 913; Karp, TC Memo 1976-325). Where his or her family lives is not determinative. Thus, once a taxpayer moves to a new permanent job location he or she has established a “tax home,” even though his or her family doesn’t immediately join him or her (Harry Carl Taylor II, TC Memo 1985-449, aff’d 5/28/86, CA-4; Twomley v. U.S., 3/17/76 Ct. Cl., 37 AFTR 2d 96-1019, 76-1 USTC 9305). In addition, spouses may have separate tax homes even though they live together and file jointly. (Foote v. Commissioner, 67 T.C. 1 (1976).

Employment Area

According to the Service, the place of employment embraces the entire area, city, or general locality where the taxpayer usually carries on a trade or business (Worden v. Commissioner, T.C. Memo. 1981-366, and Kammerer, TC Memo 1976-11). Therefore, travel within this gen-eral area will not qualify as away-from-home travel. In R.R. 56-49, 1956-1 C.B. 152, a fireman who was assigned to various locations within the same city could not deduct his meals while staying for 24 hours at a firehouse away from his main firehouse.

No Tax Home

Where a taxpayer has no principal place of business or employment but continually changes work locations over an extended area, such as traveling salesmen and musicians, IRS and the courts agree that his or her regular residence or place of abode is his or her tax “home” for purposes of deducting travel expenses (R.R. 73-529, Libby, TC Memo 1964-309; Coburn v. Commissioner, 138 F. 2d 763; Burns v. Gray, 287 F. 2d 698; Harvey v. Commissioner, 283 F. 2d 491; Weidekamp, 29 TC 16). Moreover, deductions have been denied for recurring seasonal temporary jobs away from the taxpayer’s regular “tax home” for several months each year (Dilley, 58 TC 276).

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Itinerant Worker

If such a taxpayer has no “regular place of abode in a real and substantial sense,” the Service classifies him or her as an “itinerant worker” who isn’t entitled to deduct travel expenses. An itinerant’s “tax home” is deemed to vary with his or her jobs. Hence, he or she is never “away from home” and, therefore, isn’t permitted to deduct travel expense (R.R. 73-529, 1973-2 CB 37; Letscher, TC Memo 1969-224; Hicks, 47 TC 71; Searles, TC Memo 1966-104; James v .U.S., 176 F Supp 270; Crossland, TC Memo 1974-277, aff’d 12/18/75, CA-2, 37 AFTR 2d 76-651, 76-1 USTC 9188).

Two Work Locations

If a taxpayer works at two or more separate locations, his or her tax home is where his or her principal employment or business is located. Costs of traveling to and from the minor place of employment and meals and lodging at the minor post may be deductible as away from home travel expense (R.R. 75-432, Deery, TC Memo 1954-175).

Temporary & Indefinite Assignments

Once a “home” has been established, what conduct changes the location of that home for tax pur-poses?

Temporary Assignment

If a taxpayer engages in temporary work away from his or her “tax home,” his or her “tax home” does not shift, and he or she is deemed away from home for the entire temporary period. The reasoning is that the taxpayer cannot be expected to establish a new residence for a temporary assignment (Michaels v. Commissioner, 53 T.C. 269 (1960), acq. 1973-2 C.B. 3). Thus, his or her presence in the temporary location is due to his or her business, rather than a personal choice (Commissioner v. Flowers, 326 U.S. 465, reh’g denied 326 U.S. 812 (1946)). Therefore, in a tem-porary change, the “tax home” stays the same and all expenses for traveling, meals, and lodging are deductible as travel “away from home.” If, however, the change is indefinite (i.e., if its termi-nation cannot be foreseen within a fixed and reasonably short period), the “tax home” is consid-ered to move with him or her and no deduction for travel, meals, and lodging will be allowed.

Indefinite Assignment

When a taxpayer is assigned to work, or changes his or her business to a new location, for an “indefinite period” of time, the new location becomes the taxpayer’s new “tax home” and he or she cannot deduct the expenses of travel, meals, and lodging while there. An indefinite period is where termination of work or business at the new site is not foreseeable within a fixed and rea-sonably short period. Whether an assignment is temporary or indefinite must be determined at the time work commences.

Moreover, any amounts an employee on an indefinite assignment receives from his or her em-ployer for living expenses must be included in the employee’s income, even though they may be called travel allowances and he or she accounts to his or her employer for them (Crawford, TC Memo 1968-196).

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Time

Time is a critical factor in distinguishing a temporary from an indefinite job assignment.

Prior Law Presumptions

Prior tax law made a number of presumptions based on whether the job assignment was expected to last:

(1) For less than a year,

(2) More than one but less than two years, or

(3) More than two years.

One-Year IRS Presumption

An assignment or job expected to last for a year or more was considered indefinite and presumed by the Service not to be temporary. This was referred to as a one-year presump-tion.

According to the Service “an employment or stay of anticipated or actual duration of a year or more at a particular location must be viewed...as strongly tending to indicate pres-ence there beyond a temporary period...” (R.R. 60-189).

Thus, if both the anticipated and actual duration was less than one year and the taxpayer regularly maintained a home near his or her usual place of employment, the Service did not question its temporary nature (R.R. 61-95).

Less than Two-Year Exception

Taxpayers could overcome the one-year presumption by showing:

(1) They realistically expected the job to last less than 2 years,

Note: An expected or actual stay of 2 years or longer is considered an indefinite stay, regard-less of the facts or circumstances (R.R. 54-497; R.R. 75-432; R.R. 83-82)

(2) They expected to return to their tax home after the job ended, and

(3) Their claimed tax home is their regular home in a real and substantial sense (see R.R. 83-82).

Regular Home

Three factors were used to determine if the claimed tax home was the taxpayer’s regu-lar home:

(a) The taxpayer worked in the area of the claimed tax home immediately before their present job and continued to have work contacts (job seeking, leave of absence, on-going business, etc.) in that area during their absence;

(b) The taxpayer had living expenses at the claimed tax home that were duplicated because their work required them to be away from that home; and

(c) The taxpayer's spouse or children lived at the claimed tax home, or the taxpayer often continued to use that home for lodging.

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If the taxpayer’s expectations that the job would last less than 2 years and that they would return to their tax home were realistic and they met all three factors, their travel away from home was considered temporary for travel expense deduction purposes.

If the expectations were realistic, but the taxpayer met only two of the factors, they might be temporarily away from home depending on the facts and circumstances.

If the taxpayer met only one factor, their travel away from home was not considered temporary, and they could not deduct travel expenses (R.R. 83-82).

Temporary Job That Became Permanent

The fact that a temporary job eventually became permanent did not disallow travel ex-pense deductions during the time the job was temporary (Beebe, TC Memo 1971-330). However, many jobs of short duration could convert a temporary employment into an in-definite one.

In Norwood v. Commissioner, 66 T.C. 467 (1976), taxpayer was hired as a bottle maker for one project and then reassigned as foreman for another project, the court found that he could reasonably have expected to be employed in one capacity or another for an indefi-nite period, despite the fact that each of the jobs was temporary in nature. See also Marth v. Commissioner, 342 F.2d 417 (9th Cir. 1965), aff’g per curiam 23 T.C.M. 660 (1964), cert. denied 382 U.S. 844 (1965) where, after 8 years, a temporary job was deemed permanent.

Current Law - One-Year Rigid Time Rule

Effective for amounts paid after 1992, §162(a) now provides that a taxpayer is not temporar-ily away from home during any period of employment that exceeds one year. Thus, employ-ment away from home for more than one year is indefinite, and no deduction for travel ex-penses is allowed.

Note: There is no indication when the taxpayer should determine whether a job is to last more than a year. The Energy Act is apparently designed to end controversies over whether a job is temporary or indefinite by applying a rigid time rule, regardless of taxpayer’s intentions.

This statutory definition of temporary employment does not change the rule that facts and circumstances still determine whether employment away from home at a single location for less than one year is temporary or indefinite (Conf Rept No. 102-1018 (PL 102-486) p.430).

Away From Home Requirement

While transportation is deductible whether or not the trip takes the taxpayer away from home, meals and lodging are deductible only if the taxpayer is “away from home” (§162(a)(2)). To determine whether a taxpayer is away from home the Service has adopted the so-called “sleep and rest” rule.

Sleep & Rest Rule

The rule requires the taxpayer to prove that it is reasonable to need sleep or rest during release time to meet the demands of his or her employment. In other words, his or her duties require him or her to be away from the general area of his or her tax home for a period which is substan-tially longer than an ordinary day’s work and during release time while away, it is reasonable for him or her to sleep or rest to meet the needs of his or her employment or business.

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Correll Case

The “sleep and rest” rule was adopted in United States v. Correll, 389 U.S. 299 (1967), which denied an expense deduction to a traveling salesman for breakfasts and lunches eaten on the road because he returned home each day for dinner. Thus, this rule even covers a taxpayer who conducts a minor or secondary business away from home in the evening. If the taxpayer is able to return to his or her residence each night he or she cannot deduct dinner meals taken at the place of his or her secondary business (Mazzotta, 57 TC 427, aff’d 465 F. 2d 1399).

Business Purpose Requirement

All travel expenses must be divided into two categories, (i) travel costs to and from the destination, and (ii) expenses incurred while at the destination. If a trip is undertaken for other than business purposes, travel costs are nondeductible personal expenses, and meals and lodging are nondeducti-ble living expenses, even though the taxpayer engages in business activities while away from home (Reg. §1.162-2; §262). Expenses incurred at the destination must always be allocated between busi-ness and personal pleasure. Thus, even if a trip is primarily personal, expenses incurred while at the destination are deductible if related to taxpayer’s trade or business, even though the travel expenses to and from the destinations might not be deductible (Reg. §1.162-2(b)(1)).

All or Nothing

Travel costs are, therefore, an “all or nothing” proposition depending on the primary business nature of the trip. On the other hand, the business-related portion of costs at the destination is always deductible, even if the majority of expenses were personal. Nevertheless, if a taxpayer engages in both business and personal activities a deduction for travel expenses is not lost. It is not necessary for the trip to be 100% business related to deduct travel costs. The expenses of travel to and from a destination are still deductible if the trip is primarily for business (Reg. §1.162-2(b)(1)).

Primarily for Business Test

Time

Whether a trip is related primarily to a taxpayer’s trade or business or is essentially personal in nature, depends on the facts and circumstances of each case. The most important factor is the amount of time the taxpayer spends on personal activities in relation to the length of the trip (Reg. §1.162-2(b)(2)).

Other Factors

However, the Service may also consider other factors, including the location of the site (e.g., vacation resorts) and whether the taxpayer had control over planning the trip. The increasing number of organizations that schedule their conventions and seminars in resort areas has caused the Service to closely examine deductions of alleged business trips that are merely disguised vacations. Yet, if it can be shown that the expenses were incurred primarily for business they are deductible despite the resort location.

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Existing Trade or Business

In order to be deductible currently, the travel must be related to an existing business. Travel costs to investigate new or different business opportunities must be capitalized or amortized (except for an initial $5,000) over 180 months under §195.

51/49 Percent Test

How much time must be spent on business to take a travel deduction? As a general rule, a trip is primarily for business if bona fide business is conducted on over 50% of the trip days. However, the application of this “51/49 percent test” depends on where the taxpayer is trav-eling, since different rules apply to foreign travel as compared to domestic travel.

Domestic Business Travel

If a trip within the United States is primarily for business (i.e., more than 50%), the taxpayer may deduct the entire travel cost to and from the destination as a business expense (Reg. §1.162-2). In addition, the taxpayer may deduct the cost of meals (up to 50%), lodging, and other business-related expenses. For tax purposes, the United States is defined as travel within the fifty states and the District of Columbia.

Foreign Business Travel

For travel outside the United States, there are more restrictive requirements.

Personal Pleasure

If a taxpayer travels outside the U.S. primarily for personal pleasure or for vacation, travel costs to and from the destination are not allowed but business expenses at the destination are allowed (Reg. §1.162-2(b)).

Primarily Business

If the trip outside the U.S. is primarily for business (e.g., more than 50%) but there were some nonbusiness activities, not all of the travel costs from home to the business destination and back may be deductible by an individual. The cost will have to be allocated between business and nonbusiness activities. The amount of the foreign travel costs to and from the business destination, which is not deductible, is obtained by multiplying the total business traveling expense by the total number of nonbusiness days outside the U.S., and dividing the result by the total number of days outside the U.S. (Reg. §1.274-4(f)).

Full Deduction

To be fully deductible, foreign travel must be primarily for business (e.g., more than 50%) and meet at least one of the following conditions (§274(d); Reg. §1.274-4):

(1) The taxpayer is an employee who is not related to his or her employer;

Note: An employee is related to his or her employer if the employee owns, directly or indi-rectly, more than 10% (Reg. §1.274-5(e)(5) and Rev. Rul. 80-62).

(2) The trip lasts less than eight days (including the return travel day, but excluding the departure day);

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(3) Less than 25% of the total number of days on the trip are nonbusiness days;

(4) Taxpayer had little control over arranging the business trip; or

Note: The exception regarding control applies if the taxpayer is on an expense allowance and is not either:

(a) A managing executive who has the power to decide on the necessity of the trip; or

(b) Related to his or her employer.

Even if the taxpayer meets one of the two criteria listed above, lack of control can be estab-lished when you are required to attend a function by a client or customer.

(5) Personal vacation or holiday was not a major consideration in making the trip.

Where the travel is not primarily for business or fails to satisfy one of the above conditions, an allocation of the travel expenses must be made. A deduction for foreign travel expenses is not allowed if the trip is primarily personal.

Definition of Business Day

A day is treated as a “business day” if:

(a) The taxpayer travels by a reasonably direct route and he or she does not interrupt his or her travel by engaging in a substantial diversion for nonbusiness reasons (e.g., the day of departure and the day of return);

(b) The taxpayer must attend a specific business meeting on a particular day; or

Note: It does not matter that only a small part of the day is devoted to business purposes and the rest is used for personal pleasure.

(c) The taxpayer’s principal activity was business.

If the taxpayer was prevented from engaging in business by circumstances beyond his or her control, the day is still considered a business day. Weekends, holidays, or other “standby” days that fall between the taxpayer’s business days are also considered business days. How-ever, such days are not business days if they fall at the end of the taxpayer’s business activities and the taxpayer merely elects to stay for personal purposes.

Meals & Lodging

The cost of meals and lodging is deductible under §162(a)(2) when the taxpayer is traveling away from home. However, meals and lodging must be incurred during “travel status” or for entertain-ment purposes to be deductible.

50% Deduction Limitation

The amount of an otherwise allowable deduction for meals (but not lodging) is reduced by 50% (§274(n)(1)). This reduction applies to travel, pre-2018 entertainment, and former “quiet busi-ness” meals.

Conventions & Meetings

The expenses of attending a convention or other meeting, including the cost of travel, meals, lodging, and incidental expenses, can be deductible as a business expense (Treas. Reg. §1.162-2(d)).

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Deductibility depends on whether attendance primarily benefits or advances the taxpayer’s trade or business. If the convention is primarily for political, social, or other purposes not directly related to taxpayer’s trade or business, the expenses are not deductible. Thus, unless the taxpayer can show that his or her attendance advances the interest of his or her own employment or business, travel expenses incurred in attending a convention are nondeductible and, if paid for by another, must be included in taxpayer’s income.

Agenda Test

Under R.R. 59-316, the Service compares an individual’s business and employment duties with the purposes of the meeting as stated in the program or agenda. The “primarily for business” test is satisfied when the agenda of the convention or meeting is so related to the conduct of the taxpayer’s trade or business that attendance was predominantly for a business purpose (Reg. §1.162-2(d); R.R. 60-16, R.R. 63-266, and Reed v. Commissioner, 35 T.C. 199 (1960)). Other rele-vant factors include:

(1) The amount of time devoted to business compared to recreational and social activities;

(2) If the location is related to the operation of the taxpayer’s trade or business;

(3) The attitude of the organization sponsoring the convention; and

(4) Whether attendance is mandatory (Thomas v. Patterson, 289 F.2d 108 (5th Cir.), cert. de-nied 368 U.S. 837 (1961)).

Foreign Conventions

The rules on foreign conventions, which were added to the Code as part of the Tax Reform Act of 1976, are distinct from the rules on foreign travel. No deduction is allowed for a convention, seminar, or similar meeting held outside the North American area, unless the meeting is directly related to the taxpayer’s trade or business, and it is as reasonable for the meeting to be held outside as within the North American area (§274(h)(1)).

Factors

The factors determining reasonableness are:

(1) The purpose of the meeting and the activities taking place at the meeting,

(2) The purposes and activities of the sponsoring organizations or groups,

(3) The residences of the active members of the sponsoring organization,

(4) The places at which other meetings of the sponsoring organizations or groups have been held or will be held, and

(5) Such other relevant factors as the taxpayer may present (§274(h)(1)).

There is no limit on the number of trips for which deduction may be claimed, and no subsist-ence or coach fare deduction limitations (Summary of Misc. Tax Bills, Staff Joint Committee on Taxation, 12/23/80).

North American Area

The “North American” area means the U.S., its possessions (including Puerto Rico), the Trust Territory of the Pacific Islands, Canada, and Mexico (§274(h)(3)(A)). Certain Caribbean

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countries and Bermuda are included in the term “North American area” and expenses for attending a convention, seminar, or similar meeting in such a country are deductible if the country:

(1) Is a “beneficiary country;”

(2) Has entered into an agreement with the U.S. (bilateral or multilateral) for the exchange of tax information; and

(3) Has no tax laws discriminating against conventions held in the U.S. (§274(h)(6)(A)).

Allowable Expenses

Expenses permitted under §274(h) include:

(1) Transportation expenses to and from the place of the convention and meals while in travel status;

(2) Registration fees and other related expenses;

(3) Meals and lodging while away from home attending the convention; and

(4) Other incidental related travel expenses, such as taxi fares.

Cruises

Deduction Limitation

Up to $2,000 per individual per year is deductible for business conventions conducted on a cruise ship, provided the ship is registered in the U.S. and all ports of call of the cruise ship are located in the U.S. or U.S. possessions (§274(h)(2)). No deductions are available for cruises on foreign flag vessels, or for cruises calling on foreign ports. A “cruise ship” means any vessel sailing within or without the territorial waters of the U.S. (§274(h)(3)(B)).

Reporting Statements

Two written statements must be attached to the return:

(1) A taxpayer's statement, signed by the individual attending the meeting and including information with respect to:

(a) The total days of the trip (excluding the days of transportation to and from the cruise ship port),

(b) The number of hours of each day of the trip that the individual devoted to scheduled business activity,

(c) The program of the scheduled business activity of the meeting, and

(d) Such other information as may be required by the IRS.

(2) A sponsor’s statement, signed by an officer of the sponsoring organization or group, in-cluding:

(a) A schedule of the business activity of each day of the meeting,

(b) The number of hours during which the individual attending the meeting attended such scheduled business activities, and

(c) Such other information as may be required by regs. (§274(h)(5)).

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Luxury Water Travel

Section 274 limits the deduction for travel by ocean liner, cruise ship, or other form of “luxury” water transportation. The amount deductible is based on the highest per diem allowed per day to employ-ees of the executive branch of the U.S. Government while away from home, but serving in the U.S. The luxury water travel limitation is twice that per diem multiplied by the number of days the tax-payer is engaged in luxury water travel (§274(m)(1)(A)).

Exceptions

The luxury water travel limitation does not apply to:

(1) Expenses treated as compensation paid to an employee or otherwise included in the gross income of the recipient;

(2) Reimbursed expenses where the services are performed for an employer and the em-ployer hasn’t treated the reimbursement as compensation;

(3) Expenses for recreational or social activities primarily for the benefit of employees;

(4) Services and facilities which are made available by the taxpayer to the general public; or

(5) Services and facilities which are sold to customers (§274(m)(1)(B)(ii)).

Family Member Travel Expenses

Travel expenses paid or incurred for a spouse, dependent, or other individual who accompanies a taxpayer on business travel is generally not deductible. Providing incidental services or help is also not sufficient to generate a deduction (Reg. §1.162-2(c)).

Before 1994, such travel expenses were deductible if the individual’s presence on the trip had a bona fide business purpose. In addition, the mere fact that a spouse spent a substantial amount of time on personal matters, such as attending to laundry and greeting guests, did not rule out a finding of bona fide business purpose.

Since 1994, however, travel expenses paid or incurred for an individual who accompanies the tax-payer on business travel is not deductible unless the individual:

(1) is the taxpayer’s employee,

(2) has a bona fide business purpose for the travel, and

(3) would otherwise be allowed to deduct the travel expenses.

Business Entertainment

Paying for entertainment expenses incurred on behalf of the company due to business responsibili-ties has been a traditional benefit. Formerly, taxpayers could deduct entertainment expenses in-curred for business purposes. To be deductible the expenses had to be ordinary and necessary and incurred in the operation of a business regularly carried on by the taxpayer. In addition, they had to be "directly related to" or "associated with" the taxpayer's business and properly substantiated as such. Entertainment expenses also could not be lavish or extravagant.

However, for 2018 and later, no deduction is allowed with respect to:

(1) an activity generally considered to be entertainment, amusement, or recreation,

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Note: Entertainment means any amusement or recreational activity and includes entertaining guests at such places as nightclubs, country clubs, theaters, sporting events, and on yachts, or on hunting, fishing, vacation, and similar trips. It may also embrace any activity that satisfies the per-sonal, living, or family needs of any individual, such as food and beverages, a hotel suite, or a car to the taxpayer's business customer or his or her family (Reg. §1.274-2(b)).

Comment: Entertainment does not include supper money furnished to an employee, a hotel room maintained for employees while in business travel, or a car used in the active conduct of a trade or business even though used for routine personal purposes such as commuting to and from work. However, if an employer furnishes the use of a hotel suite or a car to an employee who is on vaca-tion, this would constitute entertainment of the employee.

(2) membership dues with respect to any club organized for business, pleasure, recreation, or other social purposes, or

Note: A club is an entertainment facility unless it is used primarily to further the taxpayer’s trade or business and the expense item is directly related to the active conduct of that trade or business (§274(a)(2)(C)).

(3) a facility or portion thereof used in connection with any of the above items.

Statutory Exceptions - §274(e)

Entertainment expenses remain deductible under one of the nine exceptions contained in §274(e)(1)-(9):

Food and Beverages for Employees

Expenses for food or beverages furnished on the taxpayer's business premises primarily for em-ployees are deductible (§274(e)(1)). Also deductible is the cost of maintaining the facilities for furnishing the food and beverages (Reg. §1.274-2(f)(2)(ii)).

After 2025, no deduction will be allowed for employer-provided:

(1) excludable §119(a) meals provided to employees (and their spouses and dependents) for the employer’s convenience on the employer’s premises; or

Note: Until 2025, if an employer provides meals to employees (and their spouses and dependents) for the employer’s convenience (i.e., a substantial noncompensatory business reason) and on the employer’s business premises, the employer can claim a 50% business expense deduction (§274(n)).

(2) §132(e) food, beverage, and facility expenses for meals that are de minimis fringe.

Note: Until 2025, employer-provided meals, made available to substantially all employees regard-less of employee status, are fully deductible if they are de minimis fringe benefits. De minimis fringes are benefits that are so small as to make accounting for them unreasonable or impractical.

Despite the 2025 change, an employer will still be able to deduct 50% of its expenses food, bev-erages, and related facilities furnished on the taxpayer's business premises primarily for employ-ees (e.g., a company cafeteria or executive dining room) under §274(e)(1).

Expenses Treated as Compensation

An employer may furnish an employee with goods, services, and the use of a facility or an allow-ance that might generally constitute entertainment. These costs are deductible if the employer includes such items as compensation to the employee and withholds income tax for this

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compensation (§274(e)(2)). However, such compensation when added to the employee's other compensation still must be reasonable (Reg. §1.274-2(f)(2)(iii)).

Reimbursed Expenses

Expenses paid by the taxpayer under a reimbursement or other expense allowance arrangement in connection with the performance of services are deductible if such person "adequately ac-counts" for such expenses (§274(e)(3)).

Recreational Expenses for Employees

The expense of providing recreational, social, or similar activities primarily for the benefit of tax-payer's employees is deductible as is the expense of using a facility for recreational, social, or similar activities (§274(e)(4)).

Note: Officers, shareholders, or other owners, or highly compensated employees are not consid-ered employees for purposes of this exception. A person is a shareholder or other owner, only if he or she and his or her family hold a 10% or more interest in the business (Reg. §1.274-2(f)(2)(v)).

Employee, Stockholder, and Business Meetings

Expenses directly related to business meetings of a firm's employees, partners, stockholders, agents, or directors are deductible (§274(e)(5). Minor social activities may be provided. However, the expense is not deductible if the primary purpose of the meeting was social (Reg. §1.274-2(f)(2)(vi)).

Trade Association Meetings

Expenses directly related to business meetings or conventions of exempt organizations such as business leagues, chambers of commerce, real estate boards, trade associations, and profes-sional associations are deductible (§274(e)(6) and Reg. §1.274-2(f)(2)(vii)).

Items Available to Public

A taxpayer may deduct the ordinary and necessary cost of providing entertainment or recrea-tional facilities to the general public as a means of advertising or promoting goodwill in the com-munity (§274(e)(7)).

Entertainment Sold to Customers

Entertainment expense rules do not apply to the expense of providing entertainment, goods, and services, or use of facilities, which are sold to the public in a bona fide transaction for adequate and full consideration (§274(e)(8).

Expenses Includible in Income of Non-employees

Expenses includible in the income of persons who are not employees are deductible (§274(e)(9)).

Note: These deductions must satisfy strict substantiation requirements; however, the taxpayer will not have to substantiate the time and place of the entertainment (§274(d).

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Review Questions

Under NASBA-AICPA self-study standards, self-study sponsors are required to present review ques-tions intermittently throughout each self-study course. The following questions are designed to meet those requirements and increase the benefit of the materials. However, they do not have to be com-pleted to receive any credit you may be seeking with regards to the text. Nevertheless, they may help you to prepare for any final exam.

Short explanations for both correct and incorrect answers are given after the list of questions. We recommend that you answer each of the following questions and then compare your answers. For more detailed explanations and references, you may do an electronic search using Ctrl+F (if you are viewing this course on computer), consult the text Index, or review the general Glossary.

1. Under Reg. §1.62-1(g), what does the tax concept of “transportation” include?

a. air, rail, ship, bus, and baggage charges.

b. meals and lodging, both en route and at the destination.

c. transporting an employee from one place to another in the course of employment while not away from their tax home.

d. reasonable tips while traveling.

2. Under R.R. 61-95, when is a taxpayer deemed to be engaged in temporary work away from his tax home?

a. if an assignment is expected to last for a year or more.

b. if both the anticipated and actual duration of an assignment is less than one year.

c. if the taxpayer had living expenses at the claimed tax home that were duplicated because their work required them to be away from that home.

d. if the taxpayer’s spouse or children lived at the claimed tax home or the taxpayer often continued to use that home for lodging.

3. When may travel costs, considered primarily for business, be deducted as a business expense?

a. bona fide business is conducted on over 50% of the trip days.

b. the expenses were incurred at a vacation resort but business was conducted.

c. the expenses were incurred by a taxpayer who had control over planning the trip.

d. the travel is related to investigating new or different business opportunities.

4. When are expenses of attending a convention or other meeting most likely deductible as a business expense?

a. If the convention is for political purposes.

b. If the convention is for social purposes but could have business benefits.

c. When attendance advances the interest of the taxpayer’s own employment or business.

d. When the convention or other meeting is held outside the North American area.

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5. Which of the following is an example of a §274(e) exception to the disallowance of entertain-ment expenses?

a. expenses treated as compensation.

b. a nightclub or sporting event.

c. a theater event.

d. a country club fees.

Percentage Reduction for Meals - §274(n)(1)

Deductions for meals (and formerly for entertainment) are reduced by 50%. Specifically, under §274(n)(1), this reduction applies to any expense for food or beverages (and formerly any cost for an entertainment activity). The percentage reduction is applied to the amount "allowable" as a deduc-tion (§274(n)(1)).

Note: Travel and transportation expenses are not affected by this reduction rule, only meals (in-cluding meals while in travel status).

The percentage reduction rule also applies to related expenses, for example, taxes and tips relating to a meal.

Application of Reduction Rule

The percentage deduction rule is applied after determining the amount of the allowable deduc-tion under §162 and §274. However, in the case of a separately stated meal cost incurred in the course of luxury water travel, the percentage disallowance rule is applied prior to application of the limitation on luxury water travel expenses.

Exceptions - §274(n)(2)

Six exceptions are provided to the percentage reduction rule and relate to §274(e). The 50% lim-itation does not apply to the following:

(1) Expenses treated as compensation (§274(e)(2); §274(n)(2)(A)&(B)),

(2) Reimbursed expenses (§274(e)(3) and §274(n)(2)(A)),

Note: However, the 50% limitation will apply to the person making the reimbursement (S Rept No. 99-313 (PL 99-514) p. 71),

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(3) Recreational expenses for employees (§274(e)(4) and §274(n)(2)(A)),

(4) Items available to the public (§274(e)(7) and §274(n)(2)(A)),

(5) Entertainment sold to customers (§274(e)(8) and §274(n)(2)(A)), and

(6) Expenses includible in the income of persons who are not employees (§274(e)(9) and §274(n)(2)(A)).

Employee Business Expenses Subject to 2% Floor Suspended

Section 67 placed a 2% floor on miscellaneous itemized deductions. In other words, expenses that fell within this category were deductible only to the extent that, in the aggregate, they exceeded 2% of adjusted gross income (AGI). When miscellaneous itemized deductions were nondeductible be-cause they did not exceed 2% of AGI, they were lost. There was no carryover.

Unreimbursed expenses attributable to the trade or business of being an employee were such mis-cellaneous itemized deductions (§§62 & 67). They included:

(a) business bad debt of an employee;

(b) business liability insurance premiums;

(c) damages paid to a former employer for breach of an employment contract;

(d) depreciation on a computer a taxpayer’s employer requires him to use in his work;

(e) dues to a chamber of commerce if membership helps the taxpayer perform his job;

(f) dues to professional societies;

(g) educator expenses (except for special $250 above the line deduction);

(h) home office or part of a taxpayer’s home used regularly and exclusively in the taxpayer’s work;

(i) job search expenses in the taxpayer’s present occupation;

(j) laboratory breakage fees;

(k) legal fees related to the taxpayer’s job;

(l) licenses and regulatory fees;

(m) malpractice insurance premiums;

(n) medical examinations required by an employer;

(o) occupational taxes;

(p) passport fees for a business trip;

(q) repayment of an income aid payment received under an employer’s plan;

(r) research expenses of a college professor;

(s) rural mail carriers’ vehicle expenses;

(t) subscriptions to professional journals and trade magazines related to the taxpayer’s work;

(u) tools and supplies used in the taxpayer’s work;

(v) purchase of travel, transportation, meals, entertainment, gifts, and local lodging related to the taxpayer’s work;

(w) union dues and expenses;

(x) work clothes and uniforms if required and not suitable for everyday use; and

(y) work-related education

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However, from 2018 through 2025, all miscellaneous itemized deductions subject to the 2% floor are suspended. Thus, taxpayers may not claim the above-listed items as itemized deductions for the tax-able years to which the suspension applies. An individual also remains unable to claim such deduc-tions in calculating his or her AMT liability.

Entertainment Facilities

Deduction for amounts paid or incurred in connection with an "entertainment facility" are generally disallowed (§274(a)(1)(B)). An "entertainment facility" is one used in connection with an entertain-ment, amusement, or recreation activity (§274(a)(1)). The term includes such items as a yacht, hunt-ing lodge, fishing camp, swimming pool, tennis court, bowling alley, motorcar, airplane, apartment, hotel suite, or a house in a vacation resort.

Exceptions

However, for purposes of disallowance, an entertainment facility, for purposes of the disallow-ance rules does not include:

(1) Facilities located on the taxpayer's business premises and used in connection with furnish-ing food and beverages for employees (§247(e)(1)),

(2) Facilities, the expenses of which are treated as employee compensation (§247(e)(2)),

(3) Recreational facilities for employees (§247(e)(4)),

(4) Facilities made available to the general public (§247(e)(7)), and

(5) Facilities used in taxpayer's trade or business of selling such facilities or entertainment (§247(e)(8)).

Covered Expenses

Entertainment facility expenses subject to disallowance include depreciation and operating costs, such as rent, and utility charges for water and electricity, expenses for maintenance, preserva-tion, or protection of a facility (for example, repairs, painting, and insurance charges), and salaries or subsistence expenses paid to caretakers or watchmen (Reg. §1.274-2(e)(3)(i)).

However, the following costs (even though incurred in connection with an entertainment facility) are not subject to the entertainment facility rules:

(1) Interest, taxes, and casualty losses on entertainment facilities are deductible as ordinary interest, taxes, or casualty losses,

(2) Out-of-pocket expenses for such items as food and beverages or expenses of catering, gasoline, and fishing bait, furnished during entertainment at a facility, and

(3) Actual business use of a facility, such as using a plane or car for business transportation or chartering a yacht to an unrelated person.

Disallowed entertainment facility expenses are considered personal or family assets and not busi-ness assets. Thus, the depreciation deduction and the investment credit on such facilities are barred (Conf Rept, PL 95-600, 11/6/78, p. 249).

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Club Dues

Formerly, §274(a)(2) provided an exception to the entertainment facility rule and allowed deduc-tions for expenditures:

(1) In connection with social, athletic, sporting, and other clubs,

(2) Where the taxpayer established that the facility was used primarily for trade or business, and

(3) The expense was directly related to the conduct of such trade or business.

The taxpayer had to use the club more than 50% for business purposes and only that portion of his or her dues allocable to entertainment that was "directly related" to the active conduct of his or her business was deductible after application of the percentage reduction rule.

OBRA '93 & TCJA

OBRA '93 allows no deduction for club dues for membership in any club organized for busi-ness, pleasure, recreation, or any other social purpose for taxable years beginning after De-cember 31, 1993. This rule applies to all types of clubs, including business, social, athletic, luncheon, and sporting clubs. Specific business expenses (e.g., meals) incurred at a club are still deductible but only to the extent they otherwise satisfy the standards for deductibility.

For 2018 and later, the TCJA specifically provides that no deduction is allowed with respect to membership dues with respect to any club organized for business, pleasure, recreation, or other social purposes.

Sales Incentive Awards

An employer who entertains an employee or permits him or her to use an entertainment facility will generally not be allowed to deduct the expenditure unless he or she treats the amount as compensation paid to the employee and withholds tax on the payments. Thus, if an employer rewards an employee and his wife by giving them an expense paid vacation, the employer will not get a deduction unless that amount is added to compensation and taxes are withheld (Reg. §1.274-2(f)(2)(iii)).

Substantiation & Record Keeping - §274(d)

The most important requirement in sustaining deductions is to keep adequate and detailed records. The three basic sections, 162, 212, and 274, all require record keeping. However, §274(d) also re-quires thorough substantiation by adequate records or by sufficient evidence corroborating the tax-payer's own statement to support deductions for the following items:

(1) Travel (§274(d)(1));

(2) Business gifts (§274(d)(2)); and

(3) Listed property (§280F(d)(4) & §274(d)(3)).

Note: Prior to 2018, §274(d) also listed "any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity."

The Tax Reform Act of 1984 had contained a contemporaneous record rule for not only autos but for entertainment expenses as well. However, in May of 1985 Congress, under tremendous public

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pressure, repealed the contemporaneous record rule and now requires the taxpayer to keep "ade-quate records or sufficient evidence corroborating their own statements."

Documentation

In general, a diary and record of receipts is the best method of satisfying these substantiation requirements. A receipt is required for every expenditure above $75. The documentation must also include the:

(1) Amount of such expense or other item,

(2) Time and place of the travel or the date and description of the gift,

(3) Business purpose of the expense or other item, and

(4) Business relationship to the taxpayer of the person receiving the benefit (§274(d)).

In general, the substantiation and documentation requirements fall on the taxpayer who claims the deduction. However, the employee's accounting of reimbursed expenses to his or her em-ployer will shift this burden to the employer (See Reg. §1.274-5(e)).

Payback Agreements

The disallowance of travel and entertainment expenses (and also unreasonable compensa-tion) can result in a double disallowance for employee/shareholders. When such company expenses are disallowed the company is not only denied a deduction but the executive can have dividend income. One possible solution is a payback agreement requiring the executive to return any reimbursement that is later disallowed as a company deduction. The executive deducts the repayment provided the agreement was binding at the time of the reimburse-ment.

Employee Expense Reimbursement & Reporting

TRA '86 - Unreimbursed Expenses Become Itemized Deductions

The TRA '86 changed the deductibility of business expenses incurred by employees. In 1987, all unreimbursed employee business expenses became deductible only as miscellaneous itemized deductions - a "below-the-line" deduction. Miscellaneous itemized deductions are subject to §67 and could only be deducted to the extent (together with all other miscellaneous itemized deduc-tions) they exceed 2% of adjusted gross income (AGI).

Current Law Reminder: From 2018 through 2025, all miscellaneous itemized deductions subject to the 2% floor are suspended.

However, reimbursed employee business expenses could still be claimed as an "above-the-line" deduction exempt from the 2% limit. This was accomplished by permitting employees who re-ceived expense allowances to net expenses and reimbursements without first reducing the ex-penses by the 2% of AGI limit. Only excess expenses became itemized deductions; excess reim-bursement constituted ordinary income.

Family Support Act - Reimbursement Without Accounting Is Income

Beginning in 1989, the Family Support Act of 1988 severely limited above-the-line deduction treatment for employee travel expenses. Under the Act, employees who are not required to

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account for the expense reimbursements received must include these amounts in income. Ex-penses were then only taken as itemized deductions subject to the 2% AGI limit.

Note: Currently, all miscellaneous itemized deductions that are subject to the 2% floor are sus-pended through 2025.

In addition, employers must withhold income taxes on reimbursements without regard to any expenses that the employee may have. The Family Support Act also gave the Service authority to impose FICA and FUTA taxes on unaccounted expense reimbursements.

Effective also January 1, 1989, employees can only claim above-the-line deductions for business expenses when the expenses are actually substantiated (under §274(d)) to the person providing the reimbursement under a reimbursement or other expense allowance arrangement that qual-ifies as an "accountable plan."

Definition: A reimbursement or other expense allowance arrangement is a system or plan that an employer uses to pay, substantiate, and recover the expenses, advances, reimbursements, and amounts charged to the employer for employee business expenses. Arrangements can include per diem and mileage allowances. They can also be a system used to keep track of amounts received from an employer's agent or a third party (Reg. §1.62-2(c)).

Note: If a single payment includes both wages and an expense reimbursement, the amount of the reimbursement must be specifically identified. If an employee is paid a salary or commission with the understanding that they will pay their own expenses, there is no reimbursement or allowance arrangement.

Reimbursements treated as paid under an accountable plan are not reported as compensation. Reimbursements treated as paid under nonaccountable plans are reported as compensation.

Note: The employer makes the decision whether to reimburse employees under an accountable plan or a nonaccountable plan. An employee who receives payments under a nonaccountable plan cannot convert these amounts to payments under an accountable plan by voluntarily accounting to the employer for the expenses and voluntarily returning excess reimbursements to the employer (Reg. §1.62-2(c)(3)).

Accountable Plans

To be an accountable plan, the employer's reimbursement or allowance arrangement must meet all three of the following rules:

(a) Expenses must have a business connection (i.e., the employee must have paid or in-curred deductible expenses while performing services for the employer and the advance must reasonably relate to anticipated business expenses),

(b) Employees must adequately account to the employer (under §162 & §274) for these expenses within a reasonable period of time, and

(c) Employees must return any excess reimbursement or allowance within a reasonable period of time (§62(a)(2); Reg. §1.62-2(c)).

If all these rules are met, the employer does not include any reimbursements in the employ-ee's income (Box 10, Form W-2). If expenses equal reimbursement,there is no deduction for the employee (Reg. §1.62-2(c)(4); Reg. 1.3231(e)-3(a)).

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Reasonable Period of Time

The definition of "reasonable period of time" depends on the facts. However, the regula-tions create two "safe harbors."

Fixed Date Safe Harbor - #1

The Service considers it reasonable to:

(i) Receive an advance within 30 days of when the employee has an expense,

(ii) Adequately account for expenses within 60 days after they were paid or incurred, and

(iii) Return any excess reimbursement within 120 days after the expense was paid or incurred (Reg. §1.62-2(g)(1); Reg. §1.62-2(g)(2)(i)).

Period Statement Safe Harbor - #2

If an employer provides employees with periodic statements (no less frequently than quarterly) stating the amount, if any, paid under the arrangement in excess of the ex-penses the employee has substantiated and requesting the employee to substantiate any additional business expenses that have not yet been substantiated (whether or not such expenses relate to the expenses with respect to which the original advance was paid) and/or to return any amounts remaining unsubstantiated within 120 days of the statement, an expense substantiated or an amount returned within that period will be treated as being substantiated or returned within a reasonable period of time (Reg. §1.62-2(g)(2)(ii)).

Adequate Accounting

Employees adequately account by giving the employer documentary evidence of travel and other employee business expenses, along with a statement of expense, an account book, a diary, or a similar record in which the employee entered each expense at or near the time they made it. Documentary evidence includes receipts, canceled checks, and bills (Reg. §1.274-5T(f)(4)).

Per Diem Allowance Arrangements

A per diem allowance satisfies the adequate accounting requirements as to amount if:

(a) The employer reasonably limits payments of the travel expenses to those that are ordinary and necessary in the conduct of the trade or business,

(b) The allowance is similar in form to and not more than the federal rate,

(c) The employee is not related (as defined under the rules applicable to the standard per diem meal allowance) to the employer, and

(d) The time, place, and business purpose of the travel are proved (Reg. §1.62-2(c)(1); Reg. §1.62-2(e); Reg. §1.274-5T(g); R.P. 2011-47 & R.P. 2019-48).

Note: A receipt for lodging expenses is not required in order to apply the Federal per diem rate for the locality of travel (R.P. 2011-47 & R.P. 2019-48).

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If the IRS finds that an employer's travel allowance practices are not based on reasonably accurate estimates of travel costs, including recognition of cost differences in different areas, the employee is not considered to have accounted to the employer, and the em-ployee may be required to prove their expenses (Reg. §1.274-5T(f)(5)(iii)).

Federal Per Diem Rate

The federal per diem rate can be figured by using any one of three methods:

(1) The regular (or standard) federal per diem rate (for combined lodging, meals, and incidental expenses),

Note: The term "incidental expenses" includes fees and tips given to porters, baggage carriers, bellhops, hotel maids, stewards or stewardesses, and others on ships, and hotel servants in foreign countries but, since 2003, does not include expenses for laun-dry, cleaning and pressing of clothing, lodging taxes, or the costs of telegrams or tele-phone calls (R.R. 2002-63 & Federal Travel Regulations, 41 C.F.R. Part 300 (2002)).

(2) The meals only (or standard meal) allowance (for meals and incidental expenses only), or

(3) The high-low method (for combined lodging, meals, and incidental expenses or lodging only).

The regular federal per diem rate and the standard meal allowance are often grouped together and called the "standard" system. The high-low method is sometimes referred to as the "simplified" system.

Method #1 - Regular (or Standard) Federal Per Diem Rate

The regular federal per diem rate is the highest amount that the federal government will pay to its employees for lodging, meal, and incidental expenses while they are traveling (away from home) in a particular area. This rate is equal to the sum of the Federal lodging expense rate and the Federal meal and incidental expenses (M&IE) rate for the locality of travel (R.P. 2011-47 & R.P. 2019-48).

The rates are different for different locations:

(i) Continental United States: Federal rates applicable to a particular locality in the continental United States ("CONUS") are published annually (effective October 1 to September 30) by the General Services Administration.

(ii) Outside the Continental United States: Rates for a particular nonforeign locality outside the continental United States ("OCONUS") (including Alaska, Hawaii, Puerto Rico, the Northern Mariana Islands, and the possessions of the United States) are established by the Secretary of Defense and reprinted by various tax services.

(iii) Foreign Travel: These rates are published once a month by the Secretary of State.

The rate in effect for the area where the employee stops for sleep or rest must be used. IRS Pub. 1542 gives the rates in the continental United States. However, internet access to the CONUS and OCONUS rates may be found at https://www.gsa.gov/travel/plan-book/per-diem-rates &

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https://www.defensetravel.dod.mil/ . Foreign per diem rates can be found on the In-ternet at https://aoprals.state.gov/ .

Special Rule: Since 2000, the IRS adopted the federal fiscal year that runs from October 1 to September 30 for per diem rates.

Method #2 - Meals Only (or Standard Meal) Allowance - M&IE

The M&IE portion of the regular Federal per diem rate can be used by itself as a per diem allowance solely for meals and incidental expenses (Reg. §1.274-5(h); Temp Reg. §1.274-5T(j)). This is often referred to as the "standard meal allowance" or "meals only per diem allowance." This method replaces the actual cost method.

Under this method, when a payor pays a per diem allowance solely for meal and inci-dental expenses in lieu of reimbursing actual expenses for such expenses incurred by an employee for travel away from home, the daily expenses deemed substantiated is an amount equal to the Federal M&IE rate for the locality of travel for such day.

A per diem allowance is treated as paid solely for meal and incidental expenses if:

(1) The payor pays the employee for actual expenses for lodging based on receipts submitted to the payor,

(2) The payor provides the lodging in kind,

(3) The payor pays the actual expenses for lodging directly to the provider of the lodging,

(4) The payor does not have a reasonable belief that lodging expenses were or will be incurred by the employee, or

(5) The allowance is computed on a basis similar to that used in computing the em-ployee's wages or other compensation (e.g., the number of hours worked, miles traveled, or pieces produced) R.P. 2011-47 & R.P. 2019-48.

Note: Per diem amounts are deductible without the need to substantiate actual amounts. However, the elements of time, place, and business purpose must still be substantiated.

Employees & Self-Employed

The standard meal allowance can be also used by:

(i) an employee who is not reimbursed or is reimbursed but, under a nonaccount-able plan, or

(ii) a self-employed person.

Formerly, if an employee was not reimbursed for their business expenses such as meals, they had to complete Form 2106 to claim an itemized deduction subject to the 50% limit for meals and the 2% floor of §67. However, for 2018 through 2025, unreimbursed employee expenses or those paid under a nonaccountable plan sub-ject to §67 (the 2% floor) are disallowed as deductions.

If self-employed persons use the standard meal allowance method for non-entertain-ment-related meal expenses and they aren’t reimbursed or they are reimbursed un-der a nonaccountable plan, they can generally deduct only 50% of the standard meal

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allowance. This 50% limit is figured on Schedule C (§274(n); R.P. 2011-47 & R.P. 2019-48).

Limitations

The standard meal allowance cannot be used to prove the amount of meals while traveling for medical, charitable, or moving purposes. However, it can be used when traveling for investment reasons and to prove meal expenses incurred in connection with qualifying educational expenses while traveling away from home (§162; §212; §274(d); Reg. §1.1625).

Transportation Workers' Special Rate

Workers in the transportation industry can use a special standard meal allowance. A taxpayer is in the transportation industry only if their work:

(1) Directly involves moving people or goods by airplane, barge, bus, ship, train, or truck, and

(2) Regularly requires the taxpayer to travel away from home which, during any single trip away from home, usually involves travel to localities with differing Fed-eral M&IE rates.

Eligible workers can claim a $66 a day standard meal allowance for any locality of travel in CONUS and/or $71 for any locality of travel in OCONUS. If the special rate is used for any trip, the regular standard meal allowance is not permitted for any other trips that year (R.P. 2011-47, R.P. 2019-48 & Notice 2020-71).

M&IE Break Out & 50% Limitation

When any per diem allowance is paid for combined lodging, meal, and incidental expenses (M&IE), the employer must treat an amount equal to the standard meal allowance for the locality of travel as an expense for food and beverage (R.P. 2011-47 & R.P. 2019-48). Thus, the payor is subject to the 50% deduction limitation on meal and entertainment expenses.

If the per diem allowance is paid at a rate that is less than the federal per diem rate, the payor may treat 40% of the allowance as the M&IE rate (R.P. 2011-47 & R.P. 2019-48).

Departure, Return & Partial Days - M&IE Proration

For departure, return, or any partial days of business travel, the standard meal al-lowance must be prorated using one of two methods:

(1) method 1: claim 3/4 of the standard meal allowance, or

(2) method 2: prorate using any consistently applied method that is in accordance with reasonable business practice.

This proration is also required for the M&IE portion of the regular federal per diem rate or the high-low rate.

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Method #3 - High-Low Method

If an employer pays a per diem allowance in lieu of reimbursing actual expenses for lodging, meal, and incidental expenses incurred by an employee for travel away from home and the employer uses the high-low substantiation method for travel within CONUS, the expenses deemed substantiated for each day (or part of the day) are equal to a "high" or "low" rate depending on the locality of travel for such day.

Note: The high-low substantiation method may be used in lieu of the regular federal per diem rate, but not the meals only (or standard meal) allowance (R.P. 2010-39).

This is a simplified method of computing the federal per diem rate for travel within the continental United States ("CONUS"). Called the "high-low method," it eliminates the need to keep a current list of the per diem rate in effect for each city in the U.S.

Effective for per diem allowances paid to any employee on or after October 1, 2020, the combined lodging, meals, and incidental expense "high" rate is $292 per day ($221 for lodging only) and $198 per day ($138 for lodging only) for all other locations (No-tice 2020-71, Sec. 5 of R.P. 2011-47 and R.P. 2019-48). For purposes of applying the high-low substantiation method, the Federal M&IE rate is treated as $71 for a high-cost locality and $60 for any other locality within CONUS.

Note: Under R.P. 2011-47, R.P. 2019-48 & Notice 2020-71, some areas are treated as high-cost localities on only a seasonal basis.

An employer that uses this method with respect to an employee has to use that method for all amounts paid to that employee during the calendar year.

Comment: In July of 2011, the IRS announced the discontinuance of the high-low method because it believed few taxpayers used it. (Ann. 2011-42). Later, taxpayers that had been using the method requested that the Service continue it. As a result, on September 30, 2011, the IRS issued R.P. 2011-47 continuing the high-low substantia-tion method. The IRS also stated it will no longer publish annual updates of these sub-stantiation rules and procedures.

Related Employer Restriction

A taxpayer cannot use the Federal per diem rate (including the high-low method) if they are related to their employer (§267(b)(2); Reg. §1.274-5T(f)(5)(ii); Sec. 6 of R.P. 2011-47 and R.P. 2020-71). A taxpayer is related to their employer if:

(1) The employer is their brother or sister, half-brother or half-sister, spouse, ances-tor, or lineal descendant (§267(c)(4)),

(2) The employer is a corporation in which the taxpayer owns, directly or indirectly, more than 10% in value of the outstanding stock (Reg. §1.2745T(f)(5)(ii)), or

Note: A taxpayer may be considered to indirectly own stock, if they have an interest in a corporation, partnership, estate, or trust that owns the stock or if a family mem-ber or partner owns the stock.

(3) Certain fiduciary relationships exist between the taxpayer and the employer in-volving grantors, trusts, beneficiaries, etc. (§267(b)).

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Usage & Consistency per Employee

The per diem method used is made on an employee-by-employee basis. The employer must be consistent in the method used for each employee during the calendar year.

Unproven or Unspent Per Diem Allowances

If an employee does not prove that they actually traveled on each day for which they received a per diem, they must return this unproven amount of the travel advance within a reasonable period of time. If the employee does not return the unproven amount, then it will be considered paid under a nonaccountable plan (R.P. 2011-47 & R.P. 2019-48). The employer includes as income in box 1 of the employee's Form W-2 the unproven amount of per diem allowance as excess reimbursement.

Travel Advance: If an employer provides an employee with an expense allowance before they actually have the expense, and the allowance is reasonably calculated not to exceed expected expenses, this is referred to as a travel advance. Under an accountable plan, an employee must adequately account to their employer for this advance and be required to return any excess within a reasonable period of time or it will be treated as paid under a nonaccountable plan (Reg. §1.62-2(c)(3)(ii); Reg. §1.62-2(f)(1); Reg. §1.62-2(g)(2)).

However, an employer's reimbursement arrangement is still considered an accounta-ble plan even if the employee does not return the amount of an unspent per diem allowance to the employer as long as the employee proves that they did travel that day. This is an accountable plan because the amount (up to the amount computed under the regular per diem rate or high-low method) of the allowance is deemed proven.

Reporting Per Diem Allowances

If an employee is reimbursed by a per diem allowance (daily amount) received under an accountable plan, two facts affect reporting:

(i) The federal rate for the area where the employee traveled, and

(ii) Whether the allowance or the employee's actual expenses were more than the fed-eral rate.

Reimbursement More Than Federal Rate

If the per diem allowance is less than or equal to the federal rate, the allowance will not be included in box 1 of the employee's Form W-2. The employee does not need to re-port the related expenses or the per diem allowance on their return if the expenses are equal to or less than the allowance. They do not complete Form 2106 or claim any of the expenses on Form 1040.

Note: Since 2018 and until 2026, Form 2106 can only be used by Armed Forces reservists, qualified performing artists, fee-basis state or local government officials, and employees with impairment-related work expenses. Due to the suspension of miscellaneous itemized deductions subject to the 2% floor under §67(a), employees who do not fit into one of the listed categories may not use Form 2106.

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When the actual expenses are more than the federal rate, the employee formerly com-pleted Form 2106 and deducted those expenses that were more than the federal rate on Schedule A (Form 1040).

For 2018 and later, Form 2106 can only be used by Armed Forces reservists, qualified performing artists, fee-basis state or local government officials, and employees with im-pairment-related work expenses.

Due to the suspension of miscellaneous itemized deductions subject to the 2% floor un-der § 67(a), employees who do not fit into one of the listed categories may not use Form 2106 and excess reimbursements are included in wages.

Reimbursement More Than Federal Rate

If an employee's per diem allowance is more than the federal rate, the employer is re-quired to include the allowance amount up to the federal rate in box 12 (code L) of the employee's Form W-2. This amount is not taxable.

However, the per diem allowance in excess of the federal rate will be included in box 1 of the employee's Form W-2. The employee must report this part of the allowance as if it were wage income. The employee is not required to return it to their employer (§3121; Reg. §1.62-2(e)(2)).

If the allowance or advance is higher than the federal rate for the area traveled to, the employee does not have to return the difference between the two rates for the period the employee can prove business-related travel expenses. However, the difference will be reported as wages on Form W-2 (Reg. 1.62-2(f)).

Reporting & Reimbursements Chart (Table 6-1, Pub. 463 (Rev'19))

Type of Reimbursement or Other Expense Allowance Ar-rangement

Employer Reports on Form W-2

Employee Reports on Form 2106

An accountable plan with:

Actual expense reimburse-ment. Adequate accounting made and excess returned

No amount No amount

Actual expense reimburse-ment. Adequate accounting and return of excess both re-quired but excess not re-turned

The excess as wages in box 1 No amount

Per diem or mileage allow-ance up to the federal rate. Adequate accounting made and excess returned

No amount

All expenses and reimburse-ments only if excess expenses are claimed. Otherwise, form

is not filed.

Per diem or mileage allow-ance up to the federal rate: Adequate accounting and re-turn of excess both required but excess not returned.

The excess amount as wages in box 1. The amount up to the fed-eral rate is reported only under

code L in box 12 of Form W-2 - it isn’t reported in box 1.

No amount

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Per diem or mileage allow-ance exceeds the federal rate: Adequate accounting up to the federal rate only and excess not returned.

The excess amount as wages in box 1. The amount up to the fed-eral rate is reported only under

code L in box 12 of Form W-2 - it isn’t reported in box 1.

All expenses (and reimburse-ments reported under code L in box 12 of Form W-2) only if expenses in excess of the fed-eral rate are claimed. Other-

wise, form isn’t filed.

A nonaccountable plan with:

Either adequate accounting or return of excess, or both, not required by plan.

The entire amount as wages in box 1.

All expenses

No reimbursement plan: The entire amount as wages in box 1.

All expenses

Nonaccountable Plans

A nonaccountable plan is a reimbursement or expense allowance arrangement that does not meet the three rules listed earlier under the discussion of accountable plans.

In addition, the following payments made under an accountable plan will be treated as being paid under a nonaccountable plan:

(1) Excess reimbursements the employee fails to return to the employer (Reg. §1.62-2(c)(2)(ii)), and

(2) Reimbursement of nondeductible expenses related to the employer's business (Reg. §1.62-2(d)(2)).

An arrangement that repays the employee for business expenses by reducing their wages, salary, or other compensation will be treated as a nonaccountable plan because the em-ployee is entitled to receive the full amount of their compensation regardless of whether they incurred any business expenses (Reg. §1.62-2(d)(3)(i)).

Reimbursements from nonaccountable plans produce taxable income for the employee. All advances and reimbursements from nonaccountable plans must be included on the employ-ee's W-2 in Box 1.

Formerly, the employee would then complete Form 2106 and itemize their deductions on Schedule A (Form 1040) to deduct expenses for travel, transportation, meals, or entertain-ment. Meal and entertainment expenses were subject to the 50% limit and the 2% of adjusted gross income limit (§62(c); Reg. §1.62-2(c)(5)). However, under the TCJA, entertainment ex-penses and employee business expenses subject to §67 have been suspended making Form 2106 unavailable to most employees.

Employers must withhold (20% optional withholding method is available) on such advances and/or reimbursements. They are subject to FUTA and FICA (non-compliance penalty is placed on the employer).

Self-Employed Persons Reimbursement & Reporting

Expenses Related to Taxpayer's Business

Self-employed persons must report their income and expenses on Schedule C (Schedule C-EZ has been eliminated by the IRS) attached to Form 1040 if they are a sole proprietor, or on Schedule F (Form 1040) if they are a farmer. Form 2106 or Form 2106-EZ is not used.

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Schedule C should be used to report:

(1) Travel expenses, except for meals, on line 24a,

(2) Meals (actual cost or standard meal allowance) and pre-2018 entertainment on line 24b (the 50% limit is figured on line 24c),

(3) Business gift expenses on line 27,

(4) Local business transportation expenses, other than car and truck expenses, on line 27, and

(5) Business car expenses on line 10.

Reimbursed Expenses Incurred on Behalf of a Client

With Adequate Accounting

If a taxpayer receives a reimbursement or an allowance for travel, or gift expenses incurred on behalf of a client, they should provide an adequate accounting of these expenses to the client. When the taxpayer adequately accounts1 to the client for such expenses, the reim-bursed expenses are not included in the taxpayer's income (Reg. §1.274-5(g)(2)). Since the reimbursement is not counted as income, the taxpayer is not entitled to take a deduction. In such a case, the client or customer may claim a deduction for the reimbursement and must substantiate each element of any underlying expense (Reg. §1.274-5(g)(4)).

When a taxpayer separately accounts for and seeks reimbursement for non-entertain-ment-related meal expenses in connection with providing services for a client, they are not subject to the 50% limit on those expenses. However, the client will be subject to the 50% limit.

Entertainment: For 2018 through 2025, expenses with respect to an activity generally consid-ered to be entertainment, amusement, or recreation are nondeductible. Reimbursement of nondeductible expenses constitutes income to the recipient.

Without Adequate Accounting

If the taxpayer does not account to the client, the taxpayer must include any reimburse-ments or allowances in income2. However, the client can deduct the reimbursements or allowances as payment for services if they are ordinary and necessary business expenses. The client must file Form 1099-MISC to report amounts paid to an independent contractor if the total of the reimbursements and any other fees is $600 or more during the calendar year.

Employers

Travel, meals, and business gifts are normal business expenses of conducting a trade, business, or profession. Such expenses are usually deductible, provided the requirements of §162 and §274 are met.

1 Adequate accounting to the client includes the substantiation of each element of any expense (Temp. Reg. §1.274-

5T(h)(3); §274(d)).

2 Publication 463 (Rev ’10) states, "If you do not account to your client for these expenses, you must include any

reimbursements or allowances in income."

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When Can an Expense Be Deducted?

Under the cash method of accounting, business expenses are deducted in the tax year they are actually paid, even if they were incurred in an earlier year. Under the accrual method of account-ing, business expenses are deductible when the taxpayer becomes liable for them, whether or not paid in the same year. All events that set the amount of the liability must have happened, and the taxpayer must be able to figure the amount of the expense with reasonable accuracy.

Economic Performance Rule

Business expenses are generally not deductible until economic performance occurs. If the expense is for property or services provided, or for the use of property, economic perfor-mance occurs as the property or services are provided, or as the property is used.

Corporation

A corporation (other than an S corporation) generally deducts its expenses for business travel and gifts (and entertainment before 2018), including amounts it reimburses or allows its employ-ees of these expenses, on page 1 of Form 1120.

Nondeductible Meals

Employers must report as other compensation on Form W-2 payments made to an employee for nondeductible meals an employee has on trips that do not require a stop for sleep or rest. These payments must be reported on Form W-2 if these payments plus the employee's wages total $600 or more in a calendar year. A separate Form W-2 may be used. Withholding is not required on such meal payments.

Employer-Provided Auto

If the employer provides a car to an employee and allows any personal or commuting use of the car, the employer must report the value of this use as compensation in Box 1 of the employee's Form W-2.

Review Questions

Under NASBA-AICPA self-study standards, self-study sponsors are required to present review ques-tions intermittently throughout each self-study course. The following questions are designed to meet those requirements and increase the benefit of the materials. However, they do not have to be com-pleted to receive any credit you may be seeking with regards to the text. Nevertheless, they may help you to prepare for any final exam.

Short explanations for both correct and incorrect answers are given after the list of questions. We recommend that you answer each of the following questions and then compare your answers. For more detailed explanations and references, you may do an electronic search using Ctrl+F (if you are viewing this course on computer), consult the text Index, or review the general Glossary.

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6. The 50% percentage deduction rule for meals is applied?

a. before determining the amount of the allowable deduction under §162 and §274.

b. after determining the amount of the allowable deduction under §162 and §274.

c. before determining the 2% limitation on itemized deductions.

d. only for entertainment expenses.

7. Which of the following is included as a miscellaneous itemized deduction for purposes of §67?

a. a deduction for business travel airfares.

b. impairment-related work expenses.

c. reimbursed employee business expenses.

d. unreimbursed employee business expenses, including union dues.

8. Which requirement, in addition to other §62 requirements, must an employer’s reimburse-ment arrangement meet to qualify as an accountable plan?

a. employees must adequately account to the employer for the expenses within the taxable year.

b. employees must provide an estimate of expenses within a reasonable period of time.

c. employees must return 50% of meal reimbursements if there is no substantiation.

d. expenses must have a business connection.

9. What is a simplified method of computing the federal per diem rate for travel within the con-tinental United States (CONUS)?

a. high-low method.

b. meals only allowance.

c. regular federal per diem rate.

d. standard system.

10. In which situation is an independent contractor eligible to deduct meal expenses under §274?

a. A client reimburses a contractor for non-entertainment expenses.

b. The contractor is reimbursed for the expenses incurred on behalf of a client and adequately accounts to the client for such expenses.

c. The independent contractor does not account to the client, and any reimbursements or allowances are included in income.

d. reimbursed entertainment expenses relate to the client's business.

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Answers & Explanations

1. Under Reg. §1.62-1(g), what does the tax concept of “transportation” include?

a. Incorrect. Travel expenses are defined as ordinary and necessary expenses incurred while the taxpayer is in travel status and include air, rail, ship, bus, and baggage charges.

b. Incorrect. Travel expenses are defined as ordinary and necessary expenses incurred while the taxpayer is in travel status and include meals and lodging, both en route and at the destination.

c. Correct. Transportation is a narrower concept than travel and does not include meals and lodg-ing. It includes only the cost of transporting the employee from one place to another in the course of his employment, while he is not away from home in a travel status.

d. Incorrect. Travel expenses are defined as ordinary and necessary expenses incurred while the taxpayer is in travel status and include reasonable tips to the extent incident to any other travel expenses.

2. Under R.R. 61-95, when is a taxpayer deemed to be engaged in temporary work away from his tax home?

a. Incorrect. An assignment or job expected to last for a year or more was considered indefinite and presumed by the Service not to be temporary. This was referred to as a one-year presump-tion.

b. Correct. If both the anticipated and actual duration was less than one year and the taxpayer regularly maintained a home near his usual place of employment, the Service did not question its temporary nature.

c. Incorrect. One of the factors used to determine whether the claimed tax home was the tax-payer’s regular home is whether the taxpayer had living expenses at the claimed tax home that were duplicated because their work required them to be away from that home.

d. Incorrect. One of the factors used to determine whether the claimed tax home was the tax-payer’s regular home is whether the taxpayer’s spouse or children lived at the claimed tax home or the taxpayer often continued to use that home for lodging.

3. When may travel costs, considered primarily for business, be deducted as a business expense?

a. Correct. As a general rule, a trip is primarily for business if bona fide business is conducted on over 50% of the trip days. However, the application of this “51/49 percent test” depends on where the taxpayer is traveling, since different rules apply to foreign travel as compared to do-mestic travel.

b. Incorrect. The Service may consider other factors, including the location of the site (e.g., vaca-tion resorts). The increasing number of organizations that schedule their conventions and semi-nars in resort areas has caused the Service to closely examine deductions of alleged business trips that are merely disguised vacations.

c. Incorrect. The Service may consider other factors, including whether the taxpayer had control over planning the trip.

d. Incorrect. In order to be deductible currently, the travel must be related to an existing busi-ness. Travel costs to investigate new or different business opportunities must be capitalized or amortized (except for an initial $5,000) over 180 months under §195.

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4. When are expenses of attending a convention or other meeting most likely deductible as a business expense?

a. Incorrect. If the convention is primarily for political purposes not directly related to taxpayer’s trade or business, the expenses are not deductible.

b. Incorrect. If the convention is primarily for social purposes not directly related to taxpayer’s trade or business, the expenses are not deductible.

c. Correct. Unless the taxpayer can show that his attendance advances the interest of his own employment or business, travel expenses incurred in attending a convention are nondeductible and, if paid for by another, must be included in taxpayer’s income.

d. Incorrect. No deduction is allowed for a convention, seminar, or similar meeting held outside the North American area, unless the meeting is directly related to the taxpayer’s trade or busi-ness, and it is as reasonable for the meeting to be held outside as within the North American area.

5. Which of the following is an example of a §274(e) exception to the disallowance of entertain-ment expenses?

a. Correct. The cost of goods, services, and the use of a facility or an allowance that might gener-ally constitute entertainment furnished by employer is deductible if treated as compensation to the employee.

b. Incorrect. A nightclub or sporting event is considered entertainment and is now disallowed.

c. Incorrect. Country club fees have been considered entertainment and disallowed since 1993.

d. Incorrect. A theater event is considered entertainment and is now disallowed.

6. The 50% percentage deduction rule for meals is applied?

a. Incorrect. The percentage deduction rule is applied after determining the amount of the al-lowable deduction under §162 and §274.

b. Correct. The percentage deduction rule is applied after first determining what amounts qualify under §162 and §274.

c. Incorrect. Itemized deductions that were subject to the 2% limitation have been suspended through 2025.

d. Incorrect. For 2018 and later, entertainment expenses are completely disallowed.

7. Which of the following is included as a miscellaneous itemized deduction for purposes of §67?

a. Incorrect. Miscellaneous itemized deductions do not include business travel airfares for pur-poses of §67.

b. Incorrect. Miscellaneous itemized deductions do not include impairment-related work ex-penses for purposes of §67.

c. Incorrect. Miscellaneous itemized deductions do not include reimbursed employee business expenses for purposes of §67

d. Correct. Miscellaneous itemized deductions include unreimbursed employee business ex-penses, including union and professional dues and office-at-home expenses to the extent deduct-ible. Section 67 places a 2% floor on miscellaneous itemized deductions.

8. Which requirement, in addition to other §62 requirements, must an employer’s reimburse-ment arrangement meet to qualify as an accountable plan?

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a. Incorrect. To qualify as an accountable plan for employee expense reimbursement and report-ing purposes, employees must adequately account to the employer for the expenses sooner than 180 days.

b. Incorrect. To qualify as an accountable plan for employee expense reimbursement and report-ing purposes, employees must adequately account to the employer for the expenses within a reasonable period of time.

c. Incorrect. To qualify as an accountable plan for employee expense reimbursement and report-ing purposes, employees must return any excess reimbursement or allowance within a reasona-ble period of time.

d. Correct. To qualify as an accountable plan for employee expense reimbursement and reporting purposes, expenses must have a business connection (i.e., the employee must have paid or in-curred deductible expenses while performing services for the employer and the advance must reasonably relate to anticipated business expenses).

9. What is a simplified method of computing the federal per diem rate for travel within the con-tinental United States (CONUS)?

a. Correct. The high-low method is a simplified method of computing the federal per diem rate for travel within the continental United States (CONUS) because it eliminates the need to keep a current list of the per diem rate in effect for each city in the CONUS.

b. Incorrect. The meals only allowance is often referred to as the standard meal allowance or meals only per diem allowance. Under this method, when a payor pays a per diem allowance solely for meal and incidental expenses in lieu of reimbursing actual expenses for such expenses incurred by an employee for travel away from home, the daily expenses deemed substantiated is an amount equal to the Federal meal and incidental expenses (M&IE) rate for the locality of travel for such day.

c. Incorrect. The regular federal per diem rate is the highest amount that the federal government will pay to its employees for lodging, meal, and incidental expenses while they are traveling (away from home) in a particular area. This rate is equal to the sum of the Federal lodging expense rate and the Federal meal and incidental expenses (M&IE) rate for the locality of travel.

d. Incorrect. The regular federal per diem rate and the standard meal allowance are often grouped together and called the "standard" system.

10. In which situation is an independent contractor eligible to deduct meal expenses under §274?

a. Incorrect. If a client reimburses a contractor for non-entertainment expenses covered by §274(d), then to the extent the contractor does substantiate the reimbursed expenses, the reim-bursement is not included in his income and he may not take a deduction; or to the extent the contractor does not substantiate the reimbursed expenses, the reimbursement is included in in-come and he may not take a deduction because he failed to substantiate as required by §274(d)).

b. Incorrect. If the taxpayer is reimbursed for meal expenses incurred on behalf of a client and adequately accounts to the client for such expenses, the reimbursed expenses are not included in the independent contractor's income. Since the reimbursement is not counted as income, the independent contractor is not entitled to take a deduction.

c. Correct. If the independent contractor does not account to the client, the contractor must include any reimbursements or allowances in income.

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d. Incorrect. If the reimbursed expenses relate to the client's business and not the contractor's, the contractor still has income but is denied a deduction.

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Glossary

Accountable plan: An employer reimbursement or allowance arrangement for reimbursing employ-ees for business expenses incurred on behalf of the employer.

Adjusted gross income (AGI): Total income reduced by allowable adjustments, such as for an IRA, student loan interest, alimony, and Keogh deductions. The AGI is important in determining whether various tax benefits are phased out.

Business expenses: Ordinary and necessary expenses, typically under §162, incurred in a taxpayer's business or trade.

Business purpose: A requirement that an expense claimed as a deduction from taxable business in-come must serve a genuine business purpose.

CONUS: An acronym for travel expenses incurred within the "Continental United States."

Entertainment expense: Costs incurred in hosting social events for customers or suppliers to obtain or maintain their business patronage or goodwill.

Itemized deductions: A popular term used to describe a limited group of expenditures by individuals allow as deductions from adjusted gross income.

OCONUS: Acronym for "outside the continental United States."

Per diem allowance: A daily allowance, usually for travel, lodging, or miscellaneous out-of-pocket expenses while conducting a business transaction.

Substantiation: Proof, in the form of records and receipts, that an expenditure was actually made.

Transportation: Movement within a general geographical work area.

Travel: Movement from one destination to another while away from your tax home overnight.

a

Keywords & Phrases

5

50% limit, 15, 24

A

accountable plan, 20, 26

accrual method, 30

actual cost method, 23

adequate accounting, 21

adequate records, 19

adjusted gross income, 16, 19

agents, 13

AGI, 16, 19, 20

away from home, 1, 2, 3, 5, 6, 8, 10, 11

B

beneficiary country, 10

breakage, 16

business connection, 20

business expenses, 1, 7, 18, 19, 20, 21, 30

business premises, 12, 17

business purpose, 6, 8, 9, 11, 18, 21, 23

business transportation, 17

C

calendar year, 26, 30

canceled check, 21

cash method, 30

children, 4

clothes, 1, 16

club dues, 18

compensation, 11, 12, 15, 18, 23, 30, 33

CONUS, 24, 25

conventions, 6, 10, 13, 18

country clubs, 12

cruise ship, 10, 11

D

damages, 16

documentary evidence, 21

E

economic performance, 30

employee compensation, 17

entertainment expenses, 11, 12, 18, 19

entertainment facilities, 17

entertainment facility, 17, 18

excess reimbursement, 19, 20, 21

expense allowance arrangement, 13

F

Family Support Act, 19, 20

Federal per diem rate, 21, 23

FICA, 20

foreign conventions, 9

foreign travel, 7, 8, 9

Form 1040, 28

Form 1120, 30

Form 2106, 28

Form W-2, 20, 30

FUTA, 20

G

gross income, 11

H

highly compensated employees, 13

home office, 16

I

indefinite assignment, 3

insurance premiums, 16

itemized deductions, 16, 17, 19, 20

itinerant worker, 3

L

legal fees, 16

local transportation, 1

lodging, 1, 3, 4, 7, 8, 10, 16, 21, 22, 23, 24, 25

b

M

made available, 11, 17

meals and lodging, 1, 3, 5, 6, 8

membership dues, 12, 18

N

North American area, 9, 10

O

OCONUS, 24

ordinary and necessary expenses, 1

P

per diem allowance, 21, 23, 24, 25, 26

percentage reduction rule, 15, 18

personal pleasure, 6, 7, 8

primarily for business, 1, 6, 7, 8, 9

principal place of business, 2

professional associations, 13

R

regular home, 4

reimbursements, 19, 20

research expenses, 16

S

safe harbor, 21

sporting events, 12

standard meal allowance, 22, 23, 24

substantiation, 19, 25

substantiation requirements, 19

T

tax home, 2, 3, 4, 5

tax year, 30

taxable year, 17, 18

temporary assignment, 3

tips, 1, 15

tools, 16

transportation expenses, 1, 15

travel away from home, 5, 23

travel expense, 1, 2, 3, 5, 6, 8, 9, 10, 11, 15, 19, 21

U

uniforms, 16

unreasonable compensation, 19