[Federal Register Volume 77, Number 148 (Wednesday, August 1, 2012)]
[Proposed Rules]
[Pages 45520-45523]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-18691]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-101812-07]
RIN 1545-BI83


Reimbursed Entertainment Expenses

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations explaining the 
exception to the deduction limitations on certain expenditures paid or 
incurred under reimbursement or other expense allowance arrangements. 
These proposed regulations affect taxpayers that pay or receive 
advances, allowances, or reimbursements under reimbursement or other 
expense allowance arrangements. These proposed regulations clarify the 
rules for these arrangements.

DATES: Comments or a request for a public hearing must be received by 
October 30, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-101812-07), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
101812-07), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at www.regulations.gov (IRS REG-101812-07).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Patrick Clinton, (202) 622-4930 ; concerning submissions of comments 
and/or requests for a public hearing, Oluwafunmilayo (Funmi) Taylor, 
(202) 622-7180 (not toll free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) explaining the exception to the section 
274(a) and (n) deduction limitations on certain expenditures paid or 
incurred under reimbursement or other expense allowance arrangements. 
The proposed regulations clarify the definition of reimbursement or 
other expense allowance arrangements for purposes of section 274(a) and 
(n) and how the deduction limitations apply to reimbursement 
arrangements between three parties, as addressed in Transport Labor 
Contract/Leasing, Inc. v. Commissioner, 461 F.3d 1030 (8th Cir. 2006), 
rev'g 123 T.C. 154 (2004) (TLC), and Rev. Rul. 2008-23 (2008-18 I.R.B. 
852).
    Section 274(a)(1) limits deductions for certain expenses for 
entertainment, amusement, or recreation activities and for facilities 
used in connection with entertainment, amusement, or recreation 
activities. Section 274(n)(1) generally limits the amount allowable as 
a deduction for any expense for food, beverages, entertainment 
activities, or entertainment facilities to 50 percent of the amount 
otherwise allowable. However, the limitations of sections 274(a)(1) and 
274(n)(1) do not apply to an expense described in section 274(e)(3).
    In general, section 274(e)(3) excepts from the limitations of 
section 274(a) expenses a taxpayer pays or incurs in performing 
services for another person under a reimbursement or other expense 
allowance arrangement with the other person. The exception applies if 
the taxpayer is an employee performing services for an employer and the 
employer does not treat the reimbursement for the expenses as 
compensation and wages to the taxpayer (section 274(e)(3)(A)). In that 
case, the employee is not treated as having additional compensation and 
has no deduction for the expense. The employer bears and deducts the 
expense and is subject to the deduction limitations. See Sec.  1.274-
2(f)(2)(iv)(b) of the Income Tax Regulations.
    If the employer treats the reimbursement as compensation and wages, 
the employee may be able to deduct the expense as an employee business 
expense. The employee bears the expense and is subject to the deduction 
limitations. Section 1.274-2(f)(2)(iv)(b)(1). The employer deducts an 
expense for compensation, which is not subject to the deduction 
limitations under section 274. Section 1.274-2(f)(2)(iv)(b)(2); see 
also section 162.
    The section 274(e)(3) exception also applies if the taxpayer 
performs services for a person other than an employer and the taxpayer 
accounts (substantiates, as required by section 274(d)) to that person. 
Section 274(e)(3)(B). Therefore, in a reimbursement or other expense 
allowance arrangement in which a client or customer reimburses the 
expenses of an independent contractor, the deduction limitations do not 
apply to the independent contractor to the extent the independent 
contractor accounts to the client by substantiating the expenses as 
required by section 274(d). If the independent contractor is

[[Page 45521]]

subject to the deduction limitations, the limitations do not apply to 
the client. See Sec.  1.274-2(f)(2)(iv)(a).
    TLC applied these rules to a reimbursement arrangement involving 
three parties in the trucking industry. In some cases, truck drivers 
are paid wages and a per diem meals allowance by a company that leases 
the drivers to a client trucking company. The client trucking company 
pays the leasing company for the driver's expenses plus an additional 
fee, and the parties deduct their respective expenses. Under section 
274(e)(3), if the parties have a reimbursement or other expense 
allowance arrangement, the section 274(n) limitation applies to only 
one party.
    TLC was a leasing company that paid truck drivers a per diem 
allowance that it did not treat as compensation. TLC billed the client 
leasing the drivers for the drivers' wages and per diem allowances, and 
the client paid TLC. The Tax Court applied the section 274(n) 
limitation to TLC as the drivers' common law employer subject to 
section 274(e)(3)(A).
    The Eighth Circuit stated that the Tax Court should have considered 
the section 274(e)(3)(B) exception between TLC and the client. TLC was 
providing services to its clients under a reimbursement or other 
expense allowance arrangement and accounted to the client. Therefore, 
TLC qualified for the exception in section 274(e)(3)(B) and the 
incidence of the section 274(n) limitation was on the client that bore 
the per diem expense.
    Rev. Rul. 2008-23 acquiesces in the result in TLC and similarly 
holds that the party that ultimately bears the expense in a three-party 
reimbursement arrangement is subject to the section 274(n) limitation. 
The revenue ruling clarifies that a party's status as a common law 
employer is not relevant to the section 274(n) analysis, which the 
Eighth Circuit's opinion could be read to imply.
    Rev. Rul. 2008-23 clarifies another issue raised by the TLC 
opinion. To define the term reimbursement or other expense allowance 
arrangement for purposes of section 274(e)(3), the Eighth Circuit 
looked to Sec.  1.274-2(f)(2)(iv)(a), which provides that the term 
reimbursement or other expense allowance arrangement in section 
274(e)(3) has the same meaning as in section 62(2)(A) (dealing with 
employee business expenses, later renumbered 62(a)(2)(A)), but without 
regard to whether the taxpayer is an employee of the person for whom 
the taxpayer provides services. Thus, TLC defined reimbursement or 
other expense allowance arrangement for purposes of section 274(e)(3) 
by reference to section 62(a)(2)(A) and the regulations at Sec.  1.62-
2, which provide the rules for the employee reimbursement arrangements 
called accountable plans. The TLC court's definition is inaccurate to 
the extent it relies on the accountable plan rules, which cover 
employee reimbursement arrangements only, in determining the existence 
of a reimbursement or other expense allowance arrangement for purposes 
of identifying who bears the expense under section 274(e)(3)(B).
    Rev. Rul. 2008-23 clarifies that the Sec.  1.274-2(f)(2)(iv)(a) 
reference to section 62(2)(A) predates the enactment of section 62(c), 
which addresses certain arrangements not treated as reimbursement 
arrangements, and the accountable plan regulations, which govern 
employer-employee reimbursement arrangements and their employment tax 
consequences. Therefore, Rev. Rul. 2008-23 holds that the section 
274(e)(3) exception may apply to an expense reimbursement arrangement 
without regard to whether it is an accountable plan.

Explanation of Provisions

1. Definition of Reimbursement or Other Expense Allowance Arrangement

    The focus of the accountable plan rules under section 62(c) and the 
applicable regulations is the taxability of reimbursements and 
allowances paid to employees and their treatment for employment tax 
purposes. The purpose of the rules under section 274(e)(3) is to 
provide an exception to the section 274(a) and (n) deduction 
limitations. Given these different purposes, the proposed regulations 
amend Sec.  1.274-2(f)(2)(iv)(a) to provide an express definition of 
reimbursement or other expense allowance arrangement for purposes of 
section 274(e)(3) independent of the definition in section 62(c).
    Under the proposed regulations, a reimbursement or other expense 
allowance arrangement involving employees is an arrangement under which 
an employee receives an advance, allowance, or reimbursement from a 
payor (the employer, its agent, or a third party) for expenses the 
employee pays or incurs in performing services as an employee. A 
reimbursement or other expense allowance arrangement involving persons 
that are not employees is an arrangement under which an independent 
contractor receives an advance, allowance, or reimbursement from a 
client or customer for expenses the independent contractor pays or 
incurs in performing services if either (1) a written agreement between 
the parties expressly provides that the client or customer will 
reimburse the independent contractor for expenses that are subject to 
the deduction limitations, or (2) a written agreement between the 
parties expressly identifies the party that is subject to the 
limitations under Sec.  1.274-2(a)--(e) and section 274(n). Specific 
comments are requested on the definition of reimbursement or other 
expense allowance arrangement and on alternative definitions or 
approaches that would ensure that the deduction limitations apply to 
one of the parties to an expense reimbursement arrangement.

2. Two-Party Reimbursement Arrangements

    The proposed regulations clarify that the rules for applying the 
exceptions to the section 274(a) and (n) deduction limitations apply to 
reimbursement or other expense allowance arrangements with employees, 
whether or not a payor is an employer. Under the proposed regulations, 
a payor includes an employer, an agent of the employer, or a third 
party. For example, either an independent contractor or a client or 
customer may be a payor of a reimbursement arrangement. Thus, any party 
that reimburses an employee is a payor and bears the expense if the 
payment is not treated as compensation and wages to the employee.
    In the case of a reimbursement or other expense allowance 
arrangement between an independent contractor and a client or customer 
that includes an agreement expressly providing that the client or 
customer will reimburse the independent contractor for expenses that 
are subject to the deduction limitations, the deduction limitations do 
not apply to an independent contractor that accounts to the client 
within the meaning of section 274(d) and the associated regulations, 
but they do apply to the independent contractor and not to the client 
if the independent contractor fails to account to the client. 
Alternatively, the parties may enter into an express agreement 
identifying the party that is subject to the deduction limitations.

3. Multiple-Party Reimbursement Arrangements

    The proposed regulations include an example illustrating how the 
rules apply to multiple-party reimbursement arrangements. Multiple-
party reimbursement arrangements are separately analyzed as a series of 
two-party reimbursement arrangements. Thus, for example, an arrangement 
in

[[Page 45522]]

which (1) an employee pays or incurs an expense subject to limitation, 
(2) the employee is reimbursed for that expense by another party (the 
initial payor), and (3) a third party reimburses the initial payor's 
payment to the employee, is analyzed as two two-party reimbursement 
arrangements: one arrangement between the employee and the initial 
payor, and another arrangement between the initial payor and the third 
party. Examples illustrate that the limitations apply to the party that 
receives an accounting and that ultimately bears the expense.

Effective/Applicability Date

    The regulations are proposed to apply to expenses paid or incurred 
in taxable years beginning on or after the date these regulations are 
published as final regulations in the Federal Register. However, 
taxpayers may apply these regulations for taxable years beginning 
before the date these regulations are published as final regulations in 
the Federal Register for which the period of limitations under section 
6511 has not expired.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ``Addresses'' 
heading. The IRS and Treasury Department request comments on all 
aspects of the proposed rules. All comments will be available at 
www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the hearing will be 
published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Jeffrey T. 
Rodrick and Patrick Clinton of the Office of Associate Chief Counsel 
(Income Tax & Accounting). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendment to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority:  26 U.S.C. 7805 * * * Section 1.274-2 also issued 
under 26 U.S.C. 274(o). * * *

    Par. 2. Section 1.274-2 is amended by revising paragraph (f)(2)(iv) 
to read as follows:


Sec.  1.274-2  Disallowance of deductions for certain expenses for 
entertainment, amusement, recreation, or travel.

* * * * *
    (f) * * *
    (2) * * *
    (iv) Reimbursed entertainment, food, or beverage expenses--(A) 
Introduction. In the case of any expenditure for entertainment, 
amusement, recreation, food, or beverages made by one person in 
performing services for another person (whether or not the other person 
is an employer) under a reimbursement or other expense allowance 
arrangement, the limitations on deductions in paragraphs (a) through 
(e) of this section and section 274(n)(1) apply either to the person 
who makes the expenditure or to the person who actually bears the 
expense, but not to both. If an expenditure of a type described in this 
paragraph (f)(2)(iv) properly constitutes a dividend paid to a 
shareholder, unreasonable compensation paid to an employee, a personal 
expense, or other nondeductible expense, nothing in this exception 
prevents disallowance of the expenditure to the taxpayer under other 
provisions of the Code.
    (B) Reimbursement arrangements involving employees. In the case of 
an employee's expenditure for entertainment, amusement, recreation, 
food, or beverages in performing services as an employee under a 
reimbursement or other expense allowance arrangement with a payor (the 
employer, its agent, or a third party), the limitations on deductions 
in paragraphs (a) through (e) of this section and section 274(n)(1) 
apply--
    (1) To the employee to the extent the employer treats the 
reimbursement or other payment of the expense on the employer's income 
tax return as originally filed as compensation paid to the employee and 
as wages to the employee for purposes of withholding under chapter 24 
(relating to collection of income tax at source on wages); and
    (2) To the payor to the extent the reimbursement or other payment 
of the expense is not treated as compensation and wages paid to the 
employee in the manner provided in paragraph (f)(2)(iv)(B)(1) of this 
section (however, see paragraph (f)(2)(iv)(C) of this section if the 
payor receives a payment from a third party that may be treated as a 
reimbursement arrangement under that paragraph).
    (C) Reimbursement arrangements involving persons that are not 
employees. In the case of an expense for entertainment, amusement, 
recreation, food, or beverages of a person who is not an employee 
(referred to as an independent contractor) in performing services for 
another person (a client or customer) under a reimbursement or other 
expense allowance arrangement with the person, the limitations on 
deductions in paragraphs (a) through (e) of this section and section 
274(n)(1) apply to the party expressly identified in an agreement 
between the parties as subject to the limitations. If an agreement 
between the parties does not expressly identify the party subject to 
the limitations, the limitations apply--
    (1) To the independent contractor (which may be a payor described 
in paragraph (f)(2)(iv)(B) of this section) to the extent the 
independent contractor does not account to the client or customer 
within the meaning of section 274(d) and the associated regulations; 
and
    (2) To the client or customer if the independent contractor 
accounts to the client or customer within the meaning of section 274(d) 
and the associated regulations. See also Sec.  1.274-5.
    (D) Reimbursement or other expense allowance arrangement. The term 
reimbursement or other expense allowance arrangement means--
    (1) For purposes of paragraph (f)(2)(iv)(B) of this section, an 
arrangement under which an employee receives an advance, allowance, or

[[Page 45523]]

reimbursement from a payor (the employer, its agent, or a third party) 
for expenses the employee pays or incurs; and
    (2) For purposes of paragraph (f)(2)(iv)(C) of this section, an 
arrangement under which an independent contractor receives an advance, 
allowance, or reimbursement from a client or customer for expenses the 
independent contractor pays or incurs if either--
    (a) A written agreement between the parties expressly states that 
the client or customer will reimburse the independent contractor for 
expenses that are subject to the limitations on deductions in 
paragraphs (a) through (e) of this section and section 274(n)(1); or
    (b) A written agreement between the parties expressly identifies 
the party subject to the limitations.
    (E) Examples. The following examples illustrate the application of 
this paragraph (f)(2)(iv).

    Example 1.  (i) Y, an employee, performs services under an 
arrangement in which L, an employee leasing company, pays Y a per 
diem allowance of $10x for each day that Y performs services for L's 
client, C, while traveling away from home. The per diem allowance is 
a reimbursement of travel expenses for food and beverages that Y 
pays in performing services as an employee. L enters into a written 
agreement with C under which C agrees to reimburse L for any 
substantiated reimbursements for travel expenses, including meals, 
that L pays to Y. The agreement does not expressly identify the 
party that is subject to the deduction limitations. Y performs 
services for C while traveling away from home for 10 days and 
provides L with substantiation that satisfies the requirements of 
section 274(d) of $100x of meal expenses incurred by Y while 
traveling away from home. L pays Y $100x to reimburse those expenses 
pursuant to their arrangement. L delivers a copy of Y's 
substantiation to C. C pays L $300x, which includes $200x 
compensation for services and $100x as reimbursement of L's payment 
of Y's travel expenses for meals. Neither L nor C treats the $100x 
paid to Y as compensation or wages.
    (ii) Under paragraph (f)(2)(iv)(D)(1) of this section, Y and L 
have established a reimbursement or other expense allowance 
arrangement for purposes of paragraph (f)(2)(iv)(B) of this section. 
Because the reimbursement payment is not treated as compensation and 
wages paid to Y, under section 274(e)(3)(A) and paragraph 
(f)(2)(iv)(B)(1) of this section, Y is not subject to the section 
274 deduction limitations. Instead, under paragraph (f)(2)(iv)(B)(2) 
of this section, L, the payor, is subject to the section 274 
deduction limitations unless L can meet the requirements of section 
274(e)(3)(B) and paragraph (f)(2)(iv)(C) of this section.
    (iii) Because the agreement between L and C expressly states 
that C will reimburse L for expenses for meals incurred by employees 
while traveling away from home, under paragraph (f)(2)(iv)(D)(2)(a) 
of this section, L and C have established a reimbursement or other 
expense allowance arrangement for purposes of paragraph 
(f)(2)(iv)(C) of this section. L accounts to C for C's reimbursement 
in the manner required by section 274(d) by delivering to C a copy 
of the substantiation L received from Y. Therefore, under section 
274(e)(3)(B) and paragraph (f)(2)(iv)(C)(2) of this section, C and 
not L is subject to the section 274 deduction limitations.
    Example 2.  (i) The facts are the same as in Example 1 except 
that, under the arrangements between Y and L and between L and C, Y 
provides the substantiation of the expenses directly to C, and C 
pays the per diem directly to Y.
    (ii) Under paragraph (f)(2)(iv)(D)(1) of this section, Y and C 
have established a reimbursement or other expense allowance 
arrangement for purposes of paragraph (f)(2)(iv)(C) of this section. 
Because Y substantiates directly to C and the reimbursement payment 
was not treated as compensation and wages paid to Y, under section 
274(e)(3)(A) and paragraph (f)(2)(iv)(C)(1) of this section Y is not 
subject to the section 274 deduction limitations. Under paragraph 
(f)(2)(iv)(C)(2) of this section, C, the payor, is subject to the 
section 274 deduction limitations.
    Example 3.  (i) The facts are the same as in Example 1, except 
that the written agreement between L and C expressly provides that 
the limitations of this section will apply to C.
    (ii) Under paragraph (f)(2)(iv)(D)(2)(b) of this section, L and 
C have established a reimbursement or other expense allowance 
arrangement for purposes of paragraph (f)(2)(iv)(C) of this section. 
Because the agreement provides that the 274 deduction limitations 
apply to C, under section 274(e)(3)(B) and paragraph (f)(2)(iv)(C) 
of this section, C and not L is subject to the section 274 deduction 
limitations..
    Example 4. (i) The facts are the same as in Example 1, except 
that the agreement between L and C does not provide that C will 
reimburse L for travel expenses.
    (ii) The arrangement between L and C is not a reimbursement or 
other expense allowance arrangement within the meaning of section 
274(e)(3)(B) and paragraph (f)(2)(iv)(D)(2) of this section. 
Therefore, even though L accounts to C for the expenses, L is 
subject to the section 274 deduction limitations.

    (F) Effective/applicability date. This paragraph (f)(2)(iv) applies 
to expenses paid or incurred in taxable years beginning after the date 
these regulations are published as final regulations in the Federal 
Register.
* * * * *
    Par. 3. Section 1.274-8 is revised to read as follows:


Sec.  1.274-8  Effective/applicability date.

    Except as provided in Sec. Sec.  1.274-2(a), 1.274-2(e), 1.274-
2(f)(2)(iv)(F) and 1.274-5, Sec. Sec.  1.274-1 through 1.274-7 apply to 
taxable years ending after December 31, 1962.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-18691 Filed 7-31-12; 8:45 am]
BILLING CODE 4830-01-P