IRS acquiesces to TLC Leasing – explains meals deduction limit in employee leasing setting Rev Rul 2008-23, 2008-18 IRB
IRS has acquiesced to the Eighth Circuit’s holding in Transport Labor/Contract Leasing (TLC Leasing) that a company leasing truck drivers to client companies wasn’t subject to the Code Sec. 274(n) deduction limit on meal reimbursements it made to drivers because it substantiated these expenses to the clients. Instead, the Eight Circuit said the client companies were subject to the limitation because they ultimately bore the expenses. The ruling clarifies IRS’s stance on reimbursed meal expenses involving leasing companies by way of three examples.
Observation: The new ruling isn’t limited to leased truckers. Its conclusions may be applied to any situation where leased employees are reimbursed for expenses subject to the Code Sec. 274(n) deduction limit.
Background. Business-related meals such as those incurred while away from home overnight on business generally are subject to the Code Sec. 274(n) 50% deduction limit for meal and entertainment expenses. Under Code Sec. 274(n)(3), for tax years beginning in 2008 or thereafter, an 80% deduction limit applies to certain transportation workers, such as interstate truck operators and interstate bus drivers under Department of Transportation regulations. Under Code Sec. 274(e)(3)(B) and Code Sec. 274(n)(2)(A), the Code Sec. 274(n) deduction limit doesn’t apply to a taxpayer who incurs an expense on behalf of a person other than an employer under a reimbursement or other expense allowance arrangement with the other person, if the taxpayer accounts for the expense to the other person, and the payment is not treated as compensation. This requires the taxpayer to substantiate each element of the expense to the person for whom he incurs the expense (time, place, business purpose and amount). Here, the Code Sec. 274(n) limit applies to the person for whom the expense was incurred.
Reg. § 1.274-2(f)(2)(iv)(a) provides that for Code Sec. 274 purposes, a reimbursement or other expense allowance arrangement is defined as it is under Code Sec. 62(a)(2)(A), i.e., an arrangement that shows the business connection of the expense, substantiates it, and provides for a return of excess reimbursements.
M&IE (meals and incidental expenses) incurred while traveling away from home on business are treated as an expense for food and beverages and are subject to the Code Sec. 274(n) limit. An employee who is reimbursed for M&IE may follow simplified substantiation procedures (time, place and business purpose).
In 2004, the Tax Court held in TLC Leasing that a company that leased truck drivers to independent trucking companies was the common-law employer of each driver-employee and, as a result, per diems paid by the leasing company to cover amounts spent by the drivers for food and beverages while traveling away from home were subject to the Code Sec. 274(n) deduction limit on meals. In the decision, client trucking companies submitted reports to TLC for each payroll period showing the gross wages and per diem amounts for each driver-employee. TLC made the appropriate payments to each driver-employee and sent the client company an invoice showing total expenses for all the driver-employees leased to the client.
The Tax Court’s holding reached the result IRS had urged (but did so for different reasons).
In 2006, the Eighth Circuit reversed the Tax Court and held on the facts that the Code Sec. 274(n) limit did not apply to TLC because it was not the party that ultimately bore the per diem expenses. [See Federal Taxes Weekly Alert 08/31/2006] Instead, the limit applied to the client companies, who actually bore the per diem expense under the reimbursement arrangement between the parties. The appellate court concluded that status as a common law employer is not dispositive in the Code Sec. 274(n) analysis, but did not explicitly reject that status as a relevant factor.
IRS acquiescence. In Rev Rul 2008-23, IRS acquiesces in the result in TLC and agrees with the Eighth Circuit’s opinion that the Code Sec. 274(n) deduction limit should apply to the party that ultimately bears the per diem expenses. However, IRS says it does not agree with the opinion to the extent that it could be read to imply that status as a common law employer is relevant to the Code Sec. 274(n) analysis.
Observation: The new ruling is much more than an unconventional vehicle for an acquiescence. It also formulates IRS’s approach to situations where a reimbursed expense is substantiated and submitted to one party who in turn passes on the cost to someone else. The ruling also clarifies when IRS will and will not treat an M&IE (or a meals expense only) as substantiated to a third party. In TLC, there was no formal substantiation of the truckers’ meal expenses in the generally accepted sense.
Substantiating to third party. The ruling establishes IRS’s position where (1) an employee (or independent contractor) adequately substantiates a M&IE expense to an initial payor (i.e., a company like TLC) that initially makes the reimbursement, and (2) the initial payor in connection with its performance of services for a third party, is reimbursed under a reimbursement or other expense allowance arrangement with a third party. In this instance, IRS rules that if the initial payor accounts to the third party in the same manner that the employee (or independent contractor) accounted for the expenses to the initial payor, then the initial payor satisfies Code Sec. 274(e)(3)(B) and the third party bears the expenses and is subject to the Code Sec. 274(n) deduction limit on the expenses.
IRS illustrates this principle, and what it will treat as adequate substantiation to the third party, with three examples, all dealing with these common facts:
- Leasing Company (LC) leases its employee truck drivers to Client under a contract that provides that LC will calculate Client’s periodic payments to cover LC’s expenses (driver wages, payments of M&IE to drivers under a reimbursement arrangement between LC and the drivers, and other expenses) plus a profit. The M&IE are incurred while drivers travel overnight away from home on business. All reimbursements paid to Driver are paid under a “reimbursement or other expense allowance arrangement,” within the meaning of Code Sec. 274(e)(3) between LC and each driver. Neither LC nor Client deducts the M&IE amounts as compensation on its originally filed income tax return, and neither of them treat the M&IE amounts as wages for withholding purposes.
- The employee leasing contract does not address which party reimburses the drivers’ M&IE for purposes of applying the Code Sec. 274(n) deduction limit.
- Driver adequately accounts for his M&IE expenses to LC.
- Either LC or Client may be Driver’s employer under the usual common law rules.
Illustration1: After Driver accounts to LC for M&IE, LC calculates his wages and any M&IE payments that may be due, and sends Client a billing invoice for a periodic payment due. The invoice does not itemize the M&IE reimbursement, but immediately after LC pays Driver, it sends Client a statement indicating the amount paid to Driver as a M&IE reimbursement. LC also accounts for the M&IE amount by delivering to Client a copy of the substantiation that Driver had originally submitted to LC. Client accepts the substantiation and acknowledges that the portion of its periodic payment equal to the amount that LC paid to reimburse Driver’s M&IE is paid under a reimbursement arrangement with LC and is subject to the Code Sec. 274(n) deduction limit.
Illustration2: The facts are the same as in the first illustration except that Driver accounts for his M&IE to Client who in turn sends the paperwork to LC, which (a) calculates Driver’s wages and any M&IE reimbursements that may be due, and (b) sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. After Client makes the invoice payment, LC pays both Driver’s wages and M&IE reimbursement, and sends Client a statement indicating the amount paid to Driver as an M&IE reimbursement, and referring to the substantiation Client had received from Driver and had submitted (via a copy) to LC.
Results. In both illustrations (1) and (2), IRS concludes that LC meets the requirements of Code Sec. 274(e)(3) because (1) LC can prove that it has established a reimbursement or other expense allowance arrangement with Client, and (2) LC accounts to Client by (in the first illustration) delivering a copy of the substantiation that Driver had provided to LC or (in the second illustration) referring to the substantiation Driver originally submitted to Client. LC is not subject to Code Sec. 274(n) deduction limit and, instead, Client bears the expense of the M&IE, and is subject to the Code Sec. 274(n) for the M&IE, regardless of whether LC or Client is Driver’s employer under the usual common law rules.
If the initial payor does not properly substantiate the M&IE expenses to the third party payor, then the initial payor will be treated as bearing the expenses and will be subject to the Code Sec. 274(n) deduction limit.
Illustration3: After calculating Driver’s wages and any M&IE payments that may be due, LC sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. Client pays LC the lump-sum periodic payment, and then LC pays both Driver’s wages and M&IE reimbursement.
Result. Because LC provides Client with only a lump-sum, non-itemized billing invoice, and does not account to Client or have a reimbursement or other expense allowance arrangement with Client, LC bears the expense of the M&IE and it is subject to the Code Sec. 274(n) deduction limit on Driver’s M&IE, regardless of whether LC or Client is Driver’s employer under the usual common law rules. Even if LC had provided an itemized invoice to Client designating part of the payment as an M&IE reimbursement. LC still does not satisfy Code Sec. 274(e)(3)(B) because it didn’t adequately account to Client and didn’t have a reimbursement or other expense allowance arrangement with Client.