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Guest Article

Deloitte logo

(From the April 28, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Guidance on Deduction for Leased Employees' Meals and Incidental Expenses -- and Dismissal of "Common Law Employee" Relevance


As part of the Tax Reform Act of 1986, Congress "simplified" deductions for certain meals and incidental expenses and other expenses in IRC § 274. (This simplification now runs to 14 pages in the Internal Revenue Code.) IRC § 162(a)(2) outlines the general rules that permit deductions for all usual business expenses incurred in carrying out a trade or business. However, IRC § 274 focuses only on deduction rules for business expenses involving "travel and entertainment." The most recent travel and entertainment expense issue involves deductions for meals and incidental expenses as covered in IRC §274(d)(1). That provision dictates the substantiation required to use that deduction and IRC § 274(n) generally limits that deduction to only 50 percent of meals and incidental expenses (M&IE) actually incurred by employees.

Who Gets the Deduction "Hair-cut" on Expenses for Leased Employees' Meals and Incidentals?

Revenue Ruling 2008-23 addresses the specific question of whether the 50 percent M&IE deduction limit imposed by IRC § 274(n) will be levied on the leasing company or the client of the leasing company when a business leases employees from a leasing company and the leasing company reimburses the employees' expenses for meals and incidental expenses (M&IE in IRS parlance) incurred while working for the specific client. Under the revenue ruling's assumed facts, neither the leasing company nor the client deducts the M&IE amounts as compensation nor do they withhold tax on the value of the M&IE.

IRS's Analyses of the Deduction "Rights" Under Three Scenarios

Revenue Ruling 2008-23 describes three different deduction limit scenarios involving drivers' M&IE. In each case the following basic facts apply:

  • the driver is an employee who is reimbursed at the M&IE rate and has accounted for reimbursement as required under law,
  • neither the leasing company nor the client deduct the M&IE amount as wages paid to the driver on their originally filed tax returns,
  • nor do they treat the M&IE amounts as wages subject to withholding; therefore, the driver is not subject to IRC § 274(n) which limits deductions to 50 percent of M&IE.

Situation 1 -- The driver provides the leasing company with M&IE substantiation that satisfies IRC §274 requirements. The leasing company sends the client a bill for a lump-sum amount which does not itemize the driver's M&IE. The client pays the billed amount. Once the leasing company is paid, the leasing company pays the driver both wages and an M&IE reimbursement. In this situation, the revenueruling holds section 274(n) limits the leasing company's deduction to 50 percent of the M&IE.

Situation 2 -- Leasing company has information from the driver on the driver's M&IE and the company sends its client substantiation for the M&IE amounts. The client accepts the substantiation and acknowledges that part of the client's payment is reimbursement for the amount of M&IE substantiated and that the client and the leasing company agree the leasing company is not subject to IRC § 274(n). The client bears the cost of the M&IE and the client is subject to the 50 percent deduction limit, regardless of whether the leasing company or the client is the driver's employer under usual common law rules.

Situation 3 -- Leasing company has a copy of the M&IE substantiation the driver originally submitted to the client. Leasing company, as the payor to the driver, must decide if the leasing company's deduction of expenses under IRC § 162(a) is subject to the 50 percent limitation under IRC § 274(n). The leasing company sends the client a statement showing the amounts paid to the driver as a reimbursement for M&IE and refers to the driver's substantiation the client had forwarded to the leasing company. Client acknowledges the substantiation paid by the leasing company is under a reimbursement arrangement between the leasing company and the client. The client also acknowledges that the leasing company accounts to the client by referring to the substantiation in a way that satisfies IRC § 274(d). Consequently, the client's deduction for reimbursement to the M&IE is subject to the 50 percent deduction limitation under IRC § 274(n)

IRS's Real Concern -- Court's Use of "Common Law Employer" as a Relevant Distinction

In fact, Revenue Ruling 2008-23 appears to have been generated primarily by the IRS's concern about the use of the term "common law employer" in a court of appeals decision, Transport Labor Contract/Leasing Inc. v. Commissioner, 461 F.3d 1030 (8th Cir. 2006). The Transport Labor Contract/Leasing Inc. case reversed a Tax Court ruling on the issue of whether a client of a leasing company or the leasing company was subject to the 50 percent deduction limit. In the view of the IRS expressed in the Revenue Ruling 2008-23, the appeals court's ruling appeared to suggest that status as a "common law employer" was a relevant factor in determining whether the 50 percent deduction limit applied to the leasing company or to its client. The IRS begs to differ, specifically by stating:

The Internal Revenue Service acquiesces in the result in TLC and agrees with the appellate court's opinion that the sec. 274(n) limitation should apply to the party that ultimately bears the per diem expenses. However, the Internal Revenue Service 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 section 274(n) analysis.

Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.


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