Benefits and Compensation

IRS Proposes Rule on Reimbursed Entertainment Expenses

Employers that pay advances, allowances or reimbursements to employees for work-related entertainment expenses — including taxpayers who, in turn, get reimbursed by their clients for such expenses — have until Oct. 30 to comment on a proposed regulation IRS published Aug. 1. The proposed rule clarifies who — among the employer, its client and an employee or person performing services for a third party that is not an employer — bears the deduction limitation imposed by Code Section 274(n) when a work-related entertainment expense is incurred and reimbursed under a two- or three-party reimbursement or expense allowance arrangement.

The Proposed Rule Defines Reimbursement

The proposed rule defines “reimbursement” or “other expense allowance arrangements” for purposes of Section 274(e)(3) independent of the definition in Section 62 and clarifies how the deduction limitations apply to reimbursement arrangements between three parties.

Arrangements Involving Employees — Under the proposed rule, 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.” The proposed rule clarifies that the payor need not be an employer and that any party that reimburses an employee is a payor and bears the expense (and deduction limitation) if the payment is not treated as compensation and wages to the employee.

Arrangements Involving Non-employees — The proposed separately defines a reimbursement or other expense allowance arrangement involving persons that are not employees as one under which a non-employee (that is, 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, with some further requirements.

Multi-party Arangements — The proposed rule includes an example illustrating how the rules apply to multiple-party reimbursement arrangements. These are separately analyzed as a series of two-party reimbursement reimbursement arrangements.

Effective and Applicability Dates

The proposed rule will apply to expenses paid or incurred in taxable years beginning on or after the date that the proposed regulations are published as final regulations in the Federal Register.

However, the preamble states that taxpayers may apply the proposed rules for tax years beginning before the final regulations are published provided that the period of limitations under Section 6511 has not expired.

For additional information about fringe benefits, see Thompson’s employee benefits library, including the Employer’s Guide to Fringe Benefit Rules.

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