Income Tax I
Bogdanski
Fall 2004

Sample Answers to Question 1

 Exam No. 6262

 

            This question concerns whether or not there are deductions, items to be included in gross ordinary income (none of it would be capital income) for Ursula concerning her moving expenses, free housing, foreign travel expenses – plane fare, meals, and lodging, both for herself and her husband, and whether the barbecue was business entertainment or non-deductible.

 

Ursula’s moving expenses are the first question to be addressed in this answer.  Her company paid the expenses of moving Ursula and her belongings to start work in her new position.  If it was deductible by Ursula, then the cost of her employer paying for the move will not be gross income to Ursula.  To be deductible, moving expenses must be in connection with the commencement of work by the taxpayer as an employee at a new principal place of work, IRC 217(a).  The taxpayer’s new principle place of work must be at least 50 miles away from their former residence, IRC 217(c)(1)(A), and must be a full-time employee, which Ursula appears to be, 217(c)(2).  The reasonable moving expenses would be deductible to Ursula and so they are not gross income to her if the company pays for them.  However, the costs must be reasonable expenses, which may include lodging but not expenses for any meals.  So any expenses paid by the company that are not reasonable or are meals would be gross income to Ursula. 

 

            The next issue to address is the house, which was provided to Ursula rent-free, and whether that constitutes gross income.  Lodgings can be furnished, rent-free, to the taxpayer by her employer if the employee is required to accept such lodging on the business premises of ther employer as a condition of her employment, IRC 119(a)(2).  In interpreting this, three requirements must be met to qualify for this exception from gross income, Benaglia v. Commissioner.  The first is that the lodging must be on the business premises by employer to an employee, their spouse, or dependents.  The house is not on the premises, however, it is across the street.  There is disagreement as to whether a residence nearby may meet this requirement.  Lindeman v. Commissioner, did allow the housing not to be included in the employee’s gross income when the residence was near the business premises.  The second requirement is that it must be provided for the convenience of the employer.  This element is uncertain as well; the location of the home is required to hold several fund-raising dinners at the house.  This is not as necessary to the employer as it would be for the nurses who live in the basement apartments because they are there to respond to emergencies.  This element was illustrated in Benaglia because the court allowed this as not includable in the employee’s gross income as he was needed on the premises frequently to respond to emergencies in the hotel.  Fund-raising dinner’s are not equal to that level of need by the employer.  The third requirement is that the employee is required to accept the lodging as a condition of employment, this element is met because it is provided for in her employment contract.  However, due to the uncertainties in the first and second elements – that it is not on the business premises and may not be for the convenience of the employer as all that are needed are fund-raising dinners – Ursula will not meet IRC 119(a)(2)’s requirements and will likely have to include the fair market value of the rent in her gross income.

 

            The next issue concerns business mixed with personal foreign travel and whether Ursula will have to include the amounts reimbursed to her by the company in her gross income.  None of the trip will be deductible unless Ursula’s primary purpose was for the convention and not for sightseeing, which might be slightly difficult to prove as she spent half of the time on sightseeing and half on business.  It would not be includable in the employee’s gross income if the employee could have deducted it herself.  This foreign travel is, at least in part, for the purpose of a foreign convention, which is governed by IRC 274(h).  Ursula would also need to substantiate her costs under IRC 274(d), which reversed the Cohan case.  Regulation 1.274-5T points out that estimates are not sufficient.  The deduction is not allowed unless the taxpayer can prove that, given the organization, it was as reasonable to hold it outside the country as well as inside the country, IRC 274(h).  It will also be illustrated by what the taxpayer did when she got there under the intent test in Regulation 1.162-2(b) and Rudolph v. United States (US 1962) and Danville Plywood Corporation v. United States (8th Cir. 1990).  When evaluating whether it was reasonable to hold the convention outside the country, the purpose of the meeting and activities taking place there, the purpose and activites of the sponsoring organization or groups, and the residences of the members of the organization and where other meetings have been held have all been taken into account.  Since this convention is sponsored by the international association of health care and drug manufacturing executives and the company Ursula is representing is Healco, a non-profit hospital corporation, unless all members in the group are from American and have always had conventions inside the U.S. prior, the deduction would be allowed.  The entire deduction will not be allowable.  Due to the large number of people taking European vacations and deducting it as a business cost, IRC 274(c) was enacted.  When traveling outside the United States and its possessions, the plane fare and other costs must be prorated.  Looking at the number of days spent on business versus those of recreation is how that prorated fraction can be reached.  Since four days were spent on business and four days were spent sight-seeing then half of Ursula’s plane fare can be deducted.  Bill, Ursula’s spouse, does not have deductible travel to Ursula unless the spouse is an employee of the taxpayer and there for bona fide business purposes and such expenses would otherwise be deductible by the spouse, dependent, or other individual, 274(m)(3).  So, if those are not met then only half of Ursula’s plane fare is deductible.  As to Ursula’s meals, she will not be subject to the 50% exclusion rule unless her employer treats the reimbursement as compensation income under 274(e)(3)(A).  Meals may not be too lavish or extravagant under the circumstances per IRC 162(a)(2) to be deductible, though the IRS has never pursued that requirement.  Fine restaurant meals may be too lavish or extravagant under the circumstances to be deductible as meals.  Even if the meals aren’t too lavish or extravagant under the circumstances, Ursula can still only deduct her meals for the 4 days she spent on business and not her husband’s meals.  As to Ursula’s lodgings, those are also deductible for the 4 days she spent doing business, but not her husband’s lodgings.  Under section 82, half of Ursula’s ticket, the meals and lodging for the four days she was at a sightseeing, and the reimbursement her employer gave her for expenses related to her husband are includable in her gross income.

 

            Ursula also sponsored a barbecue, invited the employees of the hospital and their families, and did it to thank them.  She paid this out of her own pocket.  The question is whether this is deductible.  Even were it deductible, only 50% would be allowed under IRC 274(n)(1)(B).  However, none of this should be deductible to Ursula under the test in IRC 274(a)(1)(A) – it must be directly related to the trade or business.  She would have needed to have business discussions or a meeting and the monies spent that were on the spouses and dependents of the hospital wouldn’t be deductible.  This will come out of Ursula’s own pocket and is not deductible to her.

 

 

Exam No. 6601

 

Moving

 

            Under §132, moving expenses paid by the employer that would be deductible to the employee under §217 if the employee paid them are not income to the employee.  Ursula’s (U) moving expenses for her new job are not included in her gross income because under §217 if you move for a new job more than 50 miles, you are allowed to deduct the “reasonable expenses” of moving household goods and personal effects and the lodging during this move.  Thus, the expenses paid by Healco for moving U and her belongings 3000 miles to start work in her new position are not included in U’s income.  Further, Healco is a nonprofit, which does not pay tax, so they do not get a business deduction for this expense.

 

Housing

 

            Normally, any lodging provided by an employer is income to the employee equal to its FMV.  However, under §119 and Benaglia, lodging is excluded from the employee's income if they are on the business premises of the employer, it is provided for the convenience of the employer, and the employee is required to accept the lodging as condition of her employment.  Here, U is required to live in this house.  However, it is arguable whether the house is on the “premises of the employer.”  Courts are split on this, but most find that a house directly across the street may qualify as premises of the employer.  Nonetheless, the final condition, convenience of employer may not be met.  It is arguable that having Ursula live there is for their convenience.  U must host dinners, but this it is not necessary to live at the place you host.  Further, she is not a surgeon or emergency room doctor, and so probably does not have “emergency calls” to the hospital.  Thus, the FMV of the lodging would be ordinary income (the costs are not from the sale or disposition of a property) to U in the year she lives there. 

 

Trip to Asia

 

            Travel—The trip to Asia may be a business trip to U and thus not included in income under 274.  First, the convention can only be deducted if the taxpayer can show a business purpose, and it must be as reasonable to be held outside North America as within.  The Convention, World of Medicine, could be held anywhere in the world, so it likely qualifies as business related, and thus not included in U’s income.

 

            For foreign travel to be a business expense under §274, only the qualifying business aspects of the expense are deductible.  The rule for plane fare is that it is pro rated for the number of days for business and days for personal travel.  Here, U’s plane ticket to Asia is only half deductible (4 of 8 days in Asia at convention). 

 

            Any benefits received by the taxpayer are income to their FMV.  (FMV = what going rate).  The meals and lodging are also subject to this business expense rule, so only 4 out of the 8 days are not income to U.  In other words, the costs from the other 4 days spent in Asia are income to U under this rule.  However, the cost for Bill to travel to Asia that were paid by Healco are completely income to U.  There are no deductions for travel expenses (lodging, meals, plane fare) of spouses unless the spouse is an employee of person claiming the deduction, the spouse has a bona fide business purpose for going on the trip, and the additional expenses would otherwise be deductible.  Here, there are no facts to support Bill being an employee of either Healco or U, should she be required to pay for the expense.  Thus, the entire costs paid for Bill’s trip, lodging, plane fare, and meals, are all income to U in the FMV of the expense.   Overall, ¼ of the total cost of Bill and U’s trip to Asia is income free to U. 

 

            For travel meals to be deductible as a business expense the trip must include an overnight stay.  Here, this is met, so Healco’s paying for meals is not income to U.  However, §274 says it is deductible only for those that are not “lavish or extravagant.”  Eating in fine restaurants is probably lavish to most people, so the extra costs over a reasonable meal should be income to U.  Even though the IRS does not generally enforce this provision, the extra cost of the meals should still be included in U’s income.  Here, as with the travel and lodging expenses, Bill’s meals are still ordinary income to U.  She would have gain over the reasonable costs of a meal.

 

            For lodging to be deductible, the taxpayer must be “away from home.”  Under the IRC, away from home has been interpreted to mean away from your place of work.  Asia is definitely away from U’s work in the U.S., so she qualifies.  As with meals, the costs must be reasonable, and not lavish or extraordinary.  Staying in 4-star hotels is lavish to most people, so the extra costs above and beyond reasonable lodging is income to U, even for the four days she was at the convention.  Because she was only at the convention 4 days, the other 4 nights of hotel paid by Healco are completely income to U. 

 

BBQ

 

            For the BBQ thrown by U at her residence to be deductible as a business entertainment expense it must be directly related to the taxpayer’s trade or business, or there must be a bona fide business discussion either before or after the fun and reasonable association between fun and the active conduct of the taxpayer’s trade or business.  Even if one of these is met, the deduction is only up to 50% of the expenses incurred.  §274(n)(1)(B).  However, U is required to substantiate these expenses under §274(d).  Because U’s position is CEO of the hospital, and the house is hospital owned, the party for the employees is likely to be business entertainment.  These entertainment expenses include the musical guests, decorations and catering.  The food is also a deductible business expense if it has a substantiated business purpose.  As the BBQ likely increased good will and helped U connect with the employees (a justified business event) it probably qualifies.   Business meals also have a 50% cap under §274, so U would be able to deduct the 50% of the cost of the entire BBQ from her adjusted gross income under §212.  (below the line deduction).  However, the costs she could deduct would be subject to the 2% floor of §67 miscellaneous deductions.    Thus, U could deduct these costs but only to the extent that they exceed 2% of her AGI, minus $100.

 

 

Exam No. 6884 – See .pdf file here.