Meals, Lodging, Travel, and Entertainment Expenses. 1 Topic I: Course Overview. 1.1 Course Description. 1.2 Learning Objectives

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1 1 Topic I: Course Overview 1.1 Course Description Course Description This is a basic-level course covering four related subjects: meals and lodging furnished to employees; travel and transportation expenses; meal and entertainment expenses; and substantiation requirements for travel, transportation, meal, and entertainment expenses. 1.2 Learning Objectives Learning Objectives At the end of this course, you will be able to: Apply the convenience of the employer test for purposes of meals and lodging furnished to employees; Understand specific situations in which meals and lodging furnished to employees may or may not be excludible from gross income, as well as how the facts and circumstances of other situations will be taken into account; Identify the circumstances under which travel and transportation expenses will be considered ordinary and necessary business expenses; Know the rules regarding travel for educational purposes; Know what it means to travel away from home ; Identify the taxpayer s home understand what problems that may arise when the taxpayer has no home; Evaluate travel in connection with temporary employment; understand how to evaluate travel that has both business and personal elements; Understand the special rules that apply to foreign travel; Understand the special rules that apply to conventions; Understand the treatment of commuting costs; Define entertainment for federal tax purposes; Identify the circumstances under which meal and entertainment expenses are deductible; Identify the limitations on deductible amounts; Identify the type of information must be maintained to substantiate expenses for travel, transportation, meals, or entertainment; Understand the acceptable recordkeeping methods for such expenses; Know the permissible simplified recordkeeping methods for such expenses; and Know how long such records should be retained

2 1.3 Glossary Glossary Employer Convenience: To qualify for the exclusion the meals and lodging must be furnished for the convenience of the employer. For purposes of this rule, the word "convenience" is not subjective - it means that the employer has an objective business necessity for providing the meals or lodging. Whether or not the employer has an objective business necessity for providing the meals or lodging is determined under all the facts and circumstances of each case. Mandatory Charges to Employees Excludible: If an employer requires an employee to pay a fixed charge on a periodic basis for meals and they are furnished for the convenience of the employer, an amount equal to the fixed charge is excludible from gross income regardless of whether the employee pays the fixed charge out of his own funds or from his stated compensation. However, this rule applies only if the employee is required to pay the fixed charge regardless of whether he accepts the meals. Ordinary and Necessary Requirement: For purposes of the "ordinary and necessary" requirement, an expense is considered "ordinary" if it is normal or common within the taxpayer's business community, even if it is an unusual expense for the taxpayer. An expense is considered "necessary" if it is appropriate and helpful to the trade or business. As a general rule, courts tend to accept the taxpayer's own judgment of the business necessity of an expense, as long as the expense is not personal in nature. However, the taxpayer's characterization of a travel expense as business rather than personal may be viewed skeptically by the IRS. Tax Home: As mentioned earlier, the taxpayer's "home" is generally his principal place of business, but this question is determined under the facts and circumstances of each case. If the taxpayer has no identifiable place of business, but maintains a regular place of abode in a real or substantial sense in a particular city from which the taxpayer is sent on temporary assignments, the tax home will be regarded as being the place of abode. Business and Personal Travel Combined: Care must be taken when undertaking travel that has both business and personal elements. A taxpayer who engages in some personal activities during a business trip can deduct travel expenses to and from his destination only if the trip primarily relates to his business activities. A taxpayer whose trip is primarily for personal activities cannot deduct any travel expenses to or from his destination but expenses while at the destination which are properly allocable to the taxpayer's trade or business are deductible even though the traveling expenses to and from the destination are not deductible. Whether a taxpayer's trip is primarily for business or personal activities depends on all the facts. The amount of time the taxpayer spends on personal activities compared to the time spent on business activities is an important factor. Cost of Commuting: As a general rule, the costs of commuting between a taxpayer's residence and place of employment are not deductible, even if the taxpayer lives very far away from his place of employment. However, if a taxpayer has his place of business in his home he can deduct the cost of round-trip transportation between his qualifying home office and his client's or customer's place of business. Entertainment: As with travel expenses (discussed in Topic III), meal and entertainment expenses must be ordinary and necessary to the taxpayer's business in order to be deductible. Expenses are "ordinary" if they are normal or common within the taxpayer's business, even if they are unusual for the taxpayer. Expenses are "necessary" if they are appropriate or helpful for the taxpayer's business. "Entertainment" generally is defined as any activity generally considered to constitute entertainment, amusement, or recreation. Entertainment may also include items that satisfy the taxpayer's personal or family needs, such as food and beverages or a hotel suite while the taxpayer is on vacation. On the other hand, entertainment does not include items which are not remotely entertaining, even if they satisfy an individual's personal needs. Active Business Discussion: The "active business discussion" alternative of the "directly related" test is satisfied if the following four requirements are met: - 2 -

3 The taxpayer has more than a general expectation of deriving a business benefit, other than goodwill, at some future time. During the entertainment period the taxpayer must actively engage in a business meeting or other bonafide business transaction. The principal character of a combined business and entertainment activity must be the active conduct of the taxpayer's business. Generally, entertainment expenses attributable to non-business guests are not deductible, even if the non-business guests accompany the business guests with whom the taxpayer has an active business discussion. Standard Mileage Rate: Taxpayers who use automobiles for business travel may use the standard mileage rate. The standard mileage rate is adjusted (usually each year) for inflation by the IRS. Taxpayers must elect to use the standard mileage rate in the first year that the car is placed in service for business purposes. However, even if a taxpayer uses the standard mileage rate, he must still substantiate the time, place, and business purpose of the travel. The IRS also publishes different standard mileage rates to be used for travel for medical or moving purposes-so a taxpayer wishing to use the standard mileage rate for business travel should use the business mileage rate (which is usually higher than the rate for medical or moving travel). Record Retention: After taxpayers have gathered and organized all necessary records to substantiate their expenses for the tax year, many often wonder how long they should retain their records. Simply put, taxpayers should retain their records for as long as they may be needed in the event of an audit. In most cases, this is three years from the date that the return was due or the date the return was filed, whichever is later. However, in some cases, this may be extended to six years, if there is a substantial understatement of income. In cases of fraud, there is no limit on how far back the IRS can go to audit a return. Thus, very conservative or cautious taxpayers might decide to retain their records indefinitely. 1.4 Course Overview Course Overview The course begins by examining four related topics: meals and lodging furnished to employees, travel and transportation expenses, business meal and entertainment expenses, and substantiation requirements related to each. First, the course discusses the circumstances under which meals and lodging furnished by employers to their employees are excludible from the employees' gross income, accounting for such factors as whether the employer has an objective business necessity for providing the meals and lodging. 1.5 Course Overview (cont'd) Course Overview (cont'd) This course then examines the treatment of travel and transportation expenses, including concepts such as what it means to travel "away from home," and to evaluate travel in connection with temporary employment. Next, business meal and entertainment expenses will be considered. The definition of "entertainment" will be discussed, along with the circumstances under which meal and entertainment expenses are deductible

4 Finally, this course examines recordkeeping and substantiation requirements - including what information needs to be retained, how long it should be retained, and permissible simplified recordkeeping methods. 2 Topic II: Meals and Lodgings Furnished to Employees 2.1 Overview Overview This topic examines the treatment of meals and lodging furnished to employees by their employer under I.R.C In particular, this topic examines the various factors relevant to the analysis of whether the meals and lodging can be excluded from the employees' gross income. The value of meals furnished to an employee by the employer is excludible from the employee's gross income if the following two tests are met: The meals are furnished on the business premises of the employer; and The meals are furnished for the convenience of the employer. The central question in this inquiry is whether the meals and lodging are furnished for the convenience of the employer. This topic examines the "convenience of the employer" test in detail. 2.2 Employer Convenience Employer Convenience To qualify for the exclusion the meals and lodging must be furnished for the convenience of the employer. For purposes of this rule, the word "convenience" is not subjective - it means that the employer has an objective business necessity for providing the meals or lodging. Whether or not the employer has an objective business necessity for providing the meals or lodging is determined under all the facts and circumstances of each case. 2.3 Non-compensatory Business Reason Non-compensatory Business Reason Meals furnished to an employee for a substantial non-compensatory business reason are furnished for the employer's convenience. If an employer furnishes meals to provide additional compensation to an employee, the meals are not furnished for the employer's convenience. Meals furnished to promote morale or goodwill also do not qualify

5 If an employer furnishes meals to an employee for a substantial non-compensatory business reason, the meals will be regarded as furnished for the convenience of the employer, even though such meals may also be furnished for a compensatory reason. A mere declaration that meals are furnished for a non-compensatory business reason is not sufficient. This determination is based on all the facts and circumstances. As a general rule, meals furnished before or after the working hours of the employee will not be regarded as furnished for the convenience of the employer. 2.4 Non-compensatory Business Reason (cont'd) Non-compensatory Business Reason (cont'd) An exception to this rule is that, in the case of restaurant or other food service employees, meals provided for each meal period in which the employee works are excludible, if furnished during, immediately before, or immediately after the employee's shift. Example: Food Service Employee A waitress works a 7 a.m. to 4 p.m. shift, and receives breakfast immediately beforehand and lunch immediately afterwards at no charge. She may exclude those meals. She may not exclude the value of a meal served without charge on her days off. Meals are regarded as furnished for a substantial non-compensatory business reason when furnished to an employee during working hours to have the employee available for emergency call during meal periods, if it is demonstrated that emergencies that would require a job call during meal periods have occurred or can reasonably be expected to occur. Example: Employee Must Be Available for Emergencies A physician employed at a medical institution, required to be available for duty at all times, receives free meals at the institution. Emergencies requiring his services can arise at any time. The meals are considered to be furnished for a substantial non-compensatory business reason. 2.5 Non-compensatory Business Reason (cont'd) Non-compensatory Business Reason (cont'd) "Emergencies" do not have to be life-threatening situations - employees who are needed for urgent business or special projects can exclude the value of meals they receive, but not if they are free to leave their place of employment to run personal errands. Example: Employee Must Be Available for Customers X Co. employs Yvette. X's business requires extensive telephone contact with its customers, some of which occurs during the lunch period. Yvette works at X's main office and is furnished lunch in the company dining room, which is equipped with telephones used to contact customers. Yvette's duties require her to be available to respond to customer calls during her lunch period, and she may not leave the office. Yvette is entitled to exclude the meals

6 Where the employer provides meals to employees who are restricted to a short meal period due to business reasons, and who cannot be expected to eat elsewhere in such a short period, the meals are excludible under the substantial non-compensatory business reason test. Example: Short Meal Period A bank teller who works from 9 a.m. to 5 p.m. is furnished lunch without charge in a cafeteria on the bank's premises. The teller's lunch period is limited to 30 minutes because the bank's peak workload occurs at that time. Because the teller cannot obtain lunch elsewhere in such a short time period, he is entitled to exclude the meals. 2.6 Non-compensatory Business Reason (cont'd) Non-compensatory Business Reason (cont'd) Meals are considered furnished for a substantial non-compensatory business reason if provided because the employee could not otherwise obtain meals within a reasonable meal period due to the unavailability of adequate eating facilities in the vicinity of the employer's business premises. Example: No Available Eating Facilities Sam works the night shift at Y Co. Because all the eating facilities in the vicinity of Y's business premises are closed during his shift, he is unable to obtain meals within a reasonable meal period. The meals furnished to Sam by Y Co. satisfy the substantial non-compensatory business reason test. Meals are regarded as furnished for a substantial non-compensatory business reason when furnished to employees who for security reasons are not allowed to leave the employer's premises for meal breaks. Example: Not Allowed to Leave for Security Reasons Casino Co. employs a large staff of workers in its casinos. Because of the risk that an employee could walk out of the casino with either cash or tokens from the casino, Casino Co. follows industry standard by forbidding employees from leaving the premises during their work shifts. At the end of the shifts, each employee is searched as they leave the building. To do so before each meal break would be unwieldy. Because their employer keeps them on the premises for a legitimate non-compensatory business reason, the employees may exclude the meals. 2.7 Non-compensatory Business Reason (cont'd) Non-compensatory Business Reason (cont'd) The IRS has stated that it will not attempt to substitute its judgment for the business decisions of an employer as to what specific business policies and practices are best suited to addressing the employer's business concerns. The IRS will consider whether the employer's policies are reasonably related to the needs of the employer's business (apart from a desire to provide additional compensation to its employees) and whether these policies are in fact followed in the actual conduct of the business. If such reasonable procedures are adopted and applied, and they preclude employees from obtaining a proper meal off the employer's business premises during a reasonable meal period, the exclusion from gross income will apply

7 2.8 Lodging Excludible, Meals Excludible Lodging Excludible, Meals Excludible Where an employer provides lodging on its business premises to employees under circumstances that entitle employees to exclude the lodging from income (this topic is discussed later in the course), all meals served on the business premises are excludible without restriction. Example: Lodging Excludible, Meals Excludible Earl is employed by a federal agency at a government facility where he is provided lodging that is excludible from income. He is not required to be available for duty during his meal periods. All meals furnished to him at the facility are excludible from income. 2.9 Mandatory Business Meetings Mandatory Business Meetings Meals provided at regular mandatory business meetings qualify for the exclusion if the meetings are necessary to the operation of the employer's business. Example: Mandatory Business Meetings Greg, an officer of M Corp., is required to attend daily luncheon conferences for the purpose of providing necessary daily contact among M's officers and staff. The luncheon conferences conserve time during normal working hours that otherwise would be consumed by conferences among various executives during the course of the day. The meals are considered to be furnished for the convenience of the employer More Than Half of Employees Satisfy Test More Than Half of Employees Satisfy Test All employees are treated as satisfying the convenience of the employer test if more than half of the employees satisfy that test. Example: More Than Half of Employees Satisfy Test Z Corporation has 100 employees. Meals are furnished to all employees. Fifty-five employees are restricted to a short meal period due to business reasons. Because more than half of the employees satisfy the convenience of the employer test, all of Z's employees are treated as satisfying the test. Therefore, all employees may exclude the value of the meals Option to Decline Purchase Option to Decline Purchase It does not make any difference whether or not employees are charged for meals, or whether employees have the option to accept or reject the meals. These facts have no bearing on the question of whether or not the meals are furnished for the convenience of the employer

8 Example: Option to Decline Purchase Doug is permitted to bring his lunch from home rather than purchase lunch at the partially subsidized employee cafeteria. There is no other eating facility located near the business premises. Doug's option to decline to purchase lunch at the cafeteria is not taken into account in determining whether such meals are furnished for the convenience of the employer Mandatory Charges to Employees Excludible Mandatory Charges to Employees Excludible If an employer requires an employee to pay a fixed charge on a periodic basis for meals and they are furnished for the convenience of the employer, an amount equal to the fixed charge is excludible from gross income regardless of whether the employee pays the fixed charge out of his own funds or from his stated compensation. However, this rule applies only if the employee is required to pay the fixed charge regardless of whether he accepts the meals Example Example Example: Mandatory Charge Excludible Tammy, a bank teller, is charged a fixed amount on a periodic basis for lunches furnished at the bank's cafeteria, regardless of whether she eats there. The fixed charge is deducted from Tammy's paycheck. The meals are provided in order to limit Tammy's lunch period to 30 minutes, because the bank's peak workload occurs at that time and it would take Tammy longer than 30 minutes to eat elsewhere. Tammy is entitled to exclude both an amount equal to the fixed charge and the value of the meal from gross income. The result is the same if the fixed charge is not deducted from Tammy's paycheck and Tammy instead pays the charge to the bank out of her personal checking account Lodging Lodging The value of lodging furnished to an employee by the employer is excluded from the employee's gross income if three tests are met: The lodging is furnished on the employer's business premises. The lodging is furnished for the employer's convenience. The employee must accept such lodging as a condition of his employment Sufficient Business Reason Sufficient Business Reason Like employer-provided meals, lodging furnished to employees on the business premises of the employer qualifies for an exclusion under the convenience of the employer test only if the employer has a primary business reason for providing the lodging. Whether a sufficient business reason exists is - 8 -

9 determined from the facts and circumstances of each case. In general, lodging satisfies the convenience of the employer test if the employee could not properly perform his duties without being furnished the lodging. It is not necessary that the employer formally require the employee to accept the lodging. The requirement that the employee must accept the lodging as a condition of employment means that he be required to accept the lodging in order to enable him properly to perform the duties of his employment. In other words, the requirement is satisfied if, as a practical matter, the employee must live in the lodging in order to perform his duties property. Lodging will be regarded as furnished to enable the employee properly to perform the duties of his employment when, for example, the lodging is furnished: because the employee is required to be available for duty at all times, or because the employee could not perform the services required of him unless he is furnished such lodging Remote Work Sites Remote Work Sites In a situation where a work site is inaccessible by normal transportation or is so remote that lodging facilities are unavailable, making it necessary to furnish lodging to workers in order to complete a project, the convenience of the employer test is satisfied. Example: Remote Work Site John is employed by Build It Company as a construction supervisor on a tunnel project at a remote site in Alaska. He works 8-hour days, and is subject to call during off-hours. The site is 40 miles from the nearest city, and is sometimes inaccessible due to weather. Build It Company furnishes rent-free lodging to John and the other employees in a camp at the site, but does not expressly require its employees to reside there. No other lodging is available near the site. The lodging furnished to John satisfies the convenience of the employer test Example Example Example: Remote Work Site Civilian employees of the Navy, whose homes are located on the mainland, are assigned to duty on offshore islands. The Navy transports the workers to and from the island job sites at the beginning and end of each workweek, and provides rent-free lodging. No commercial transportation to and from the islands is available, nor are any other lodging facilities available on the islands. The lodging satisfies the convenience of the employer test

10 2.18 Functional Relationship Functional Relationship In some cases, the convenience of the employer test may be satisfied by showing that furnishing a particular type of lodging is essential to the performance of the employee's duties. Example: Functional Relationship A state furnishes its governor an official residence to enable the governor to carry out the administrative, ceremonial, and social responsibilities of that office, many of which must be performed after the close of the normal workday. The lodging is considered to be furnished at the convenience of the employer Example Example Example: Functional Relationship A national civic organization maintains a residence at its headquarters for its president, who serves a one-year term, during which he is required to move to the headquarters where he resides in the official residence rent-free. When the president is not out-of-town on business, the residence is used frequently for business meetings and official entertainment, both during the day and in the evening. Because the president serves only a one-year term, he cannot reasonably be expected to independently obtain a residence suitable to the office. The lodging is considered to be furnished at the convenience of the employer because it is necessary to the performance of the employee's duties given the scope of the president's responsibilities and his short tenure in office Lodging as Additional Compensation Lodging as Additional Compensation Where the employee is unable to demonstrate a sufficient relationship between the lodging and the performance of specific duties, the lodging is likely to be viewed merely as additional compensation rather than as furnished for the convenience of the employer Example Example Example: Lodging as Additional Compensation Chris, a vice-president of T Company, a U.S. multinational corporation, is transferred to Japan where he is furnished an apartment by T Company. T Company leases a number of housing units in Japan that it provides to its employees rent-free to facilitate their relocation and adjustment to a new culture, thereby mitigating potential detractions from the employees' efficiency and performance. The apartment furnished to Chris is not specially designed for business use, and Chris is not required by T Company to reside there. Chris's business use of the apartment is limited to a few telephone calls per week, and Chris entertains business guests in the apartment only occasionally. The lodging is not considered to be furnished for the convenience of the employer because it primarily benefits Chris; the

11 potential indirect benefit to T Company from enhanced job performance is not sufficient to satisfy the test Lodging Essential to Duties Lodging Essential to Duties Lodging may not satisfy the convenience of the employer requirement even though an employee is required to be available for duty at all times or for longer than normal working hours. The specific facts and circumstances of each case must indicate that the lodging is necessary to enable the employee to perform his duties. Example: Available at All Times A state psychiatric institution requires a portion of its nonmedical staff to be on call on a 24-hour basis to respond to emergencies, such as fires, storms, electrical blackouts, and disturbances. Staff members willing to accept this duty are furnished lodging rent-free on the grounds of the institution and receive special training. The lodging satisfies the convenience of the employer test Example Example Example: Available at All Times George is the general manager of Restaurant Management Company, which operates various restaurants, cocktail lounges, and snack bars in a multi-building apartment, condominium, hotel and office complex. Restaurant Management Company rents one apartment in the complex in order to have a representative available in case of an emergency. Restaurant Management Company furnishes the apartment to George, and retains the rental amount from his salary because it considers the apartment to be compensation. George supervises the operation of all of Restaurant Management Company 's facilities, and normally works from 7 a.m. to 10 p.m. He is also frequently called upon to deal with a variety of emergencies and problems arising late at night or early in the morning The convenience of the employer test is satisfied because George's duties require his availability to respond to problems on a 24-hour basis Lodging Essential to Duties (cont'd) Lodging Essential to Duties (cont'd) The extensive responsibilities of the manager in the foregoing example illustrate that the lodging was necessary to ensure his availability at all times. Absent such a demonstration, the convenience of the employer requirement will not be satisfied. Example: Not Available at All Times Brian is the president and majority shareholder of Good Hotel. Good Hotel furnishes Brian a rent-free apartment in the hotel. No other employees, including the manager of the hotel, receive lodging. Brian's duties are primarily promotional; he does not participate in the day-to-day management of the hotel. The convenience of the employer requirement is not satisfied because Brian's duties do not require him to be available at all times or for longer than normal hours

12 The convenience of the employer test is not satisfied where the employee does not render substantial services after office hours. Example: No Substantial After-Hours Service Dana, a part-owner and officer of a funeral home, Rest, is employed full-time in the business. Rest provides Dana with lodging in a residence adjacent to the funeral home which is connected by telephone and intercom. Dana occasionally handles business calls in the evening. Although the nature of the business requires that someone be available to answer the phone and respond to business matters on a 24-hour basis, Rest employs a night shift for that purpose. The convenience of the employer test is not satisfied because Dana is not required to be available for duty at all times Business Premises Business Premises Both meals and lodging must be furnished on the business premises of the employer in order to qualify for the exclusion. The following two factors are important in the term "business premises": o o "Spatial" - which focuses on the physical extent of the employer's property; and "Functional" - which focuses on the performance of services by the employee. Although both of these factors apply to meals and lodging, most controversy arises with regard to lodging. This is because cafeterias for employees typically are clearly part of the employer's business premises. Also, where both meals and lodging are provided at the same location, the threshold issue is whether the lodging satisfies the business premises test; if so, then the meals automatically qualify Business Premises (cont'd) Business Premises (cont'd) In order to satisfy the "spatial" definition, the lodging usually must be on, or immediately adjacent to, the physical business premises of the employer. Lodging that is only in the vicinity of the employer's business premises will not qualify for the exclusion. Example: Not Part of Business Premises A supervisor of a manufacturing plant, who is on 24-hour call, is required to live in an employerowned house one mile from the plant. No services are performed in the house. The lodging does not qualify for an exclusion because the house is not an integral part of the business property (i.e., the plant). Lodging that is adjacent to, but not actually on, the employer's physical business premises may qualify for the exclusion. Lodging that is completely separate from the employer's physical business premises will not qualify for the exclusion, even if it is very close by. Example: Lodging Adjacent to Business Premises A hotel manager is furnished lodging in a house across the street from the hotel on a lot adjacent to lots used for hotel parking. The lodging satisfies the business premises requirement because the house is adjacent to business property of the hotel

13 2.27 Business Premises (cont'd) Business Premises (cont'd) Compare the result when the lodging is not adjacent to the employer's physical business premises, even though it is very close. Example: Lodging Not Adjacent to Business Premises A motel manager lives in a house furnished by his employer two blocks from the motel. The employee performs all of his duties at the motel. The lodging does not qualify for the exclusion because the house is physically separated from the motel property. Although a physical nexus must exist between the lodging and the employer's business premises, the lodging does not have to be part of the principal structure of the business premises. Example: Lodging Not Adjacent to Business Premises A physician employed at a hospital is furnished a house on the hospital grounds but apart from the immediate premises of the hospital. The lodging satisfies the business premises test because it is located on property that is adjacent to the principal structure of the premises Business Premises (cont'd) Business Premises (cont'd) Government employees may not exclude lodging on the theory that the government's entire territory qualifies as the "business premises" of their employer. However, if a government employee demonstrates an integral relationship between his lodging and his duties, he may be entitled to an exclusion. Example: Integral Relationship Vernon, a resident watchman in a forest preserve district, is required to reside in his assigned district where he is provided lodging. Vernon's duties include patrolling his district on foot and by car and responding to emergency calls on a 24-hour basis. Vernon is able to view a substantial part of his district from his residence and frequently surveys the area with field glasses. The lodging is considered to be on the business premises of the employer because its location is strategic to the performance of Vernon's duties. As mentioned earlier, the term "business premises" has two components - the spatial concept, which has just been covered, and the functional concept, which will be covered now. The functional concept requires that the employee perform a sufficient amount of services at the place where the meals or lodging are provided. This question is determined under all the facts and circumstances of each case. Example: Functional Concept A president of a civic organization is furnished lodging in an official residence that is frequently used evenings and weekends for business meetings and entertainment. The lodging is considered to be on the business premises because the employee performs a substantial portion of his duties there

14 2.29 Business Premises (cont'd) Business Premises (cont'd) Business-related use of lodging must be substantial to satisfy the business premises requirement. There must be a direct nexus between the lodging furnished and the business interests of the employer. Example: Sufficient Nexus The president of a Japanese subsidiary of a U.S. corporation uses his residence during evenings and on weekends for business meetings and entertainment. The house is specifically designed to accommodate business activities. It is important to the corporate image that the president has an impressive residence, and it is customary in Japan to host many business functions at home. The lodging satisfies the business premises test. Occasional use of a residence for business entertainment does not qualify. In this situation, there is not a sufficient nexus between the lodging furnished and the business interests of the employer. Example: Insufficient Nexus An executive employed in Japan by a U.S. company is furnished lodging to facilitate his relocation and adjustment to a new culture. He occasionally entertains business guests and makes international business calls at his residence. The lodging does not satisfy the business premises test because the employee does not perform a significant portion of his services there Business Premises (cont'd) Business Premises (cont'd) Although most of the controversies concerning the business premises requirement involve lodging which is discussed later, the functional premises concept also applies to meals served to employees at locations other than the employer's physical business premises. Example: Meals A corporation holds daily luncheon meetings in a hotel suite not located in the company's office building. The meetings are essential to the management of the business. The hotel suite is considered to be on the business premises of the corporation because the employees perform significant duties there Reimbursement and Cash Allowances Not Allowed Reimbursement and Cash Allowances Not Allowed Meals and lodging must be furnished in kind to qualify for the exclusion. Cash allowances or other reimbursements in lieu of meals or lodging must be included in the employee's gross income

15 2.32 Example Example Example: Cash Reimbursement Mary a physician, is a shareholder and employee of Care, a medical services corporation. Under an agreement between a hospital and Care, Mary treats patients at the hospital and is required to make daily rounds there. The hospital does not impose any guidelines concerning the manner in which Mary attends to patients, and does not require Mary to eat meals at the hospital. On days when she makes patient rounds, Mary normally eats breakfast and lunch in the hospital's cafeteria with other physicians employed by Care, but is not required by Care to do so. The hospital allows physicians the privilege of signing a meal ticket rather than paying cash for each meal. Each month, the hospital delivers Mary's meal tickets to Care, which pays the hospital for the meals. However, the hospital has no formal agreement with Care to provide meals to Care's employees. Mary is not entitled to exclude the value of the meals Cash Option - No Exclusion Cash Option - No Exclusion If an employee has an option to receive additional compensation in lieu of meals or lodging in kind, the value of the meals or lodging is not excludible from gross income. Example: Choice Bars Exclusion Beth is employed by an institution, and is given the choice of residing at the institution free of charge or residing elsewhere and receiving a cash allowance in addition to her regular salary. If Beth elects to reside at the institution, the value of the lodging is not excludible from gross income, regardless of whether the circumstances of Beth's employment would satisfy the convenience of the employer and condition of employment tests Types of Expenses That Qualify Types of Expenses That Qualify Types of Expenses that Qualify for the Exclusion The IRS generally takes the position that groceries and other types of unprepared food are not "meals" and do not qualify for the exclusion. In other words, in the IRS's view, the definition of "meals" is limited to prepared foods. Some courts have rejected this position. Also, as a general rule, items related to the use of the furnishing of meals or lodging are excludible. For example, the value of utilities or furnishings provided to make the lodging habitable is excludible. However, these items are not excludible if they are purchased by the employee. Finally, the value of meals or lodging provided to an employee's spouse and dependents is also excludible, provided that all other requirements previously discussed have been satisfied

16 2.35 Knowledge Check #1 3 Topic III: Travel and Transportation Expenses 3.1 Overview Overview This topic discusses the treatment of travel and transportation expenses. In particular, this topic discusses: under what circumstances travel and transportation expenses will be considered "ordinary and necessary" business expenses; travel for educational purposes; what it means to travel "away from home"; identifying the taxpayer's "home"; problems that may arise when the taxpayer has no "home"; how to evaluate travel in connection with temporary employment; how to evaluate travel that has both business and personal elements; special rules that apply to foreign travel; special rules that apply to conventions; and the treatment of commuting costs. 3.2 Overview (cont'd) Overview (cont'd) Generally, a taxpayer may deduct ordinary and necessary expenses while traveling away from home in the pursuit of business or in connection with the production of income. Qualifying travel expenses include lodging, a portion of the cost of meals, and similar costs incurred while away from home, but do not include entertainment or commuting expenses. 3.3 Ordinary and Necessary Requirement Ordinary and Necessary Requirement For purposes of the "ordinary and necessary" requirement, an expense is considered "ordinary" if it is normal or common within the taxpayer's business community, even if it is an unusual expense for the taxpayer. An expense is considered "necessary" if it is appropriate and helpful to the trade or business. As a general rule, courts tend to accept the taxpayer's own judgment of the business necessity of an expense, as long as the expense is not personal in nature. However, the taxpayer's characterization of a travel expense as business rather than personal may be viewed skeptically by the IRS

17 3.4 Connection to Trade or Business Requirement Connection to Trade or Business Requirement In addition to satisfying the "ordinary and necessary" requirement, the taxpayer's expenses must also be incurred in the carrying on of a trade or business in order to be deductible. Although the term "trade or business" is not specifically defined in the Internal Revenue Code, it is generally understood that a taxpayer must be engaged in an activity for profit. Taxpayers with expenses that regularly exceed income may have their deductions disallowed on the grounds that they did not engage in their activities for profit. In order to be deductible as a business expense under 162, expenses must be incurred in connection with an existing trade or business. The treatment of expenses incurred in connection with a new trade or business is beyond the scope of this course. However, expenses incurred in connection with the expansion of an existing trade or business are deductible under 162. The treatment of non-business travel, such as travel for charitable or medical purposes, is also beyond the scope of this course. 3.5 Travel Expenses for Educational Purposes Travel Expenses for Educational Purposes In order for travel expenses incurred in connection with education to be deductible as a business expenses, the education itself must be deductible as a business expense. Although an in-depth discussion of educational expenses is beyond the scope of this course, it is worth noting that under I.R.C. 274(m)(2), the costs of travel as a form of education by itself are not deductible. In other words, the taxpayer can travel abroad to attend a course of study, but the taxpayer cannot claim that the travel experience itself was educational. 3.6 Example Example Example: Travel for Education Francis, a Romance language and literature teacher, takes a trip to France to refresh her language skills. Francis takes a second trip to Spain for a Spanish literature course offered only at the University of Madrid. Francis may not deduct any of her travel expenses to France because the costs of travel as a form of education are not deductible business expenses. However, Francis may deduct the costs of her trip to Spain, subject to the 50% reduction rule for meals and entertainment and the 2% floor on miscellaneous itemized deductions (both of these limitations are discussed later in the course)

18 3.7 Away from Home Requirement Away from Home Requirement In addition to satisfying the "ordinary and necessary" and the "carrying on of a trade or business" requirements, a taxpayer must also travel "away from home" in order to deduct the expenses associated with that travel. For purposes of the phrase "away from home," the word "away" means that the taxpayer must stay overnight, or long enough to require sleep or rest. Working long hours, or at great distances from the taxpayer's residence is not sufficient, by itself, to satisfy this requirement. The word "home" refers to the taxpayer's principal place of business, and not the taxpayer's residence, except in the unusual case where the taxpayer's residence is also his principal place of business. The following examples illustrate the requirement that the taxpayer's travel must be long enough to require sleep or rest. Example: Overnight Stay Deductible Guy is a railroad conductor who regularly rents a hotel room near the railroad station where he sleeps and eats during a 6-hour layover during an 18-hour workday. Guy may deduct his meal and lodging costs because his layover is long enough to obtain sleep or rest and is required by his job. 3.8 Example Example Example: Travel Expenses Not Deductible Helen, a consulting engineer, works with clients in a three state area by making one-day trips to each client. Helen frequently leaves at 6:30 a.m. and does not return until midnight. During the day, Helen stops in a rest area and closes her eyes for 20 minutes to refresh herself for the drive. Helen cannot deduct her travel expenses because she is not away from home long enough to obtain substantial sleep or rest. 3.9 Tax Home Tax Home As mentioned earlier, the taxpayer's "home" is generally his principal place of business, but this question is determined under the facts and circumstances of each case. If the taxpayer has no identifiable place of business, but maintains a regular place of abode in a real or substantial sense in a particular city from which the taxpayer is sent on temporary assignments, the tax home will be regarded as being the place of abode

19 3.10 Tax Home for a Temporary Assignment Tax Home for a Temporary Assignment A taxpayer who accepts a temporary job assignment at a distant work site is permitted to deduct his travel expenses while away from home, but a taxpayer whose distant job assignment is indefinite gets no travel expense deduction. As a general rule, if employment away from home in a single location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary, in the absence of facts and circumstances indicating otherwise Tax Home for an Indefinite Assignment Tax Home for an Indefinite Assignment If employment away from home in a single location is realistically expected to last for more than one year, or there is no realistic expectation that the employment will last for one year or less, the employment is indefinite, regardless of whether it actually exceeds one year. If employment away from home in a single location initially is realistically expected to last for one year or less, but at some later date the employment is realistically expected to exceed one year, that employment will be treated as temporary (in the absence of facts and circumstances indicating otherwise) until the date that the taxpayer's realistic expectation changes Exception Exception Exception to the One-year Rule Traveling expenses incurred by certain federal employees engaged in federal criminal investigations or prosecutions, or providing support services for such investigation or prosecution, are exempted from the rule requiring temporary work to be for a duration of one year or less Example Example Example: Work Expected to, and Does, Last Less Than One Year Avery is regularly employed in City 1. Avery accepted work in City 2, which is 250 miles from City 1. Avery realistically expected the work in City 2 to be completed in 6 months and planned to return to City 1 at that time. In fact, the employment lasted 10 months, after which time Avery returned to City 1. Since Avery realistically expected that the work in City 2 would last only 6 months, and it did in fact last less than 1 year, the City 2 employment is temporary and Avery's travel expenses paid or incurred in City 2 are deductible

20 3.14 Example Example Example: Work Expected to Last More Than One Year, but Is Completed in Less Than One Year Brennan is regularly employed in City 1. Brennan accepted work in City 2, which is 250 miles from City 1. Brennan realistically expected the work in City 2 to be completed in 18 months (and he planned to return to City 1 at that time), but in fact it was completed in 10 months. Brennan's employment in City 2 is indefinite because Brennan realistically expected that the work in City 2 would last longer than 1 year, even though it actually lasted less than 1 year. Thus, Brennan's travel expenses paid or incurred in City 2 are nondeductible Example Example Example: Work, Originally Expected to Last Less Than One Year, Now is Expected to Last More Than One Year Christina is regularly employed in City 1. Christina accepted work in City 2, which is 250 miles from City 1. Christina realistically expected the work in City 2 to be completed in 9 months and Christina planned to return to City 1 at that time. After 8 months, however, Christina was asked to remain for 7 more months (for a total actual stay of 15 months). Christina at first realistically expected that the work in City 2 would last only 9 months. However, due to changed circumstances occurring after 8 months, it was no longer realistic for Christina to expect that the employment in City 2 would last for 1 year or less. Therefore, Christina's employment in City 2 is temporary for 8 months, and indefinite for the remaining 7 months. Thus, Christina's travel expenses paid or incurred in City 2 during the first 8 months are deductible, but Christina's travel expenses paid or incurred thereafter are nondeductible Fixed Residence Required Fixed Residence Required The taxpayer also must prove that he had a fixed residence so that he was "away from home" at the distant job site. The IRS requires the taxpayer to prove that he had a "regular place of abode in a real and substantial sense." The IRS analyzes whether: the taxpayer has used the residence for lodging while performing work in its vicinity just before the distant job, and whether the taxpayer continues to maintain bona fide work contacts (job seeking, business, etc.) during the distant employment; the taxpayer incurs duplicate living expenses at the distant job site because his work requires him to be away from his residence; and the taxpayer either (a) has a family member (marital or lineal only) currently residing at the abode, or (b) continues to frequently use the residence as his lodging