Federal Income Tax Outline: Employee Business Expenses

EMPLOYEE BUSINESS EXPENSES
1. Employee Expenses With Personal and Business Component [§21, §129].

a. What if something is a little of each? (e.g., child care)? Options:

1) Personal (no deduction): there’s a choice involved.

2) Primary: base it on whether the primary purpose is business or personal.

3) Allocate: maybe you can allocate some as business and some as personal.

4) Business: (deduction): but for the child care, at least one of the parents couldn’t work.

b. Henry C. Smith v. Commissioner; Child care is inherently personal, so no deduction.

c. §21: credit for HH/dependent care services up to a certain amount, scales down as income goes up.

1) §21(b)(1) (qualifying individual): depending of the taxpayer who is under 13.

a. If so, applicable %: 35% less 1% per $2k above $15K (min 20%).

2) §21(b)(2)(a) (employment-related expenses): expenses incurred to enable the taxpayer to be gainfully employed for any period for which there are 1 or more qualifying individuals with respect to the taxpayer.

i) expenses for household services, and

ii) expenses for the care of a qualifying individual.

3) §21(d): (earned income limitation): child care deduction can not exceed amount earned, w/ 1 exception: §(e)(2): if spouse is a student, then $250/$500 per month max (if 1/>1 children).

4) §21(e)(1) (maintaining household): over half the cost of maintaining the household for such period is furnished by such individual.

d. §129: you do not have to include value of dependent care as income.

1) §129(a): gross income does not include amounts paid for dependent care if pursuant to a subsection (d) program.

2) §129(a)(2)(A): exclusion: max excludable is $5k/year.

2. Required Items.

a. Pevsner v. Commissioner; no deduction for clothing purchases at YSL by store manager.

1) Under §132, deduction only allowed if:

a. Requirement of employment.

b. Not adaptable to general usage as ordinary clothing.

c. Is not worn as ordinary clothing.

b. Union/ABA dues: deductable.

1) Question under §162 is not whether it’s required - required only makes it stronger.

2) 1.162-6 and -15(c): union dues deductable.

c. Required medical tests: probably not deductable.

1) Normal annual physical is inherently personal, so requiring it does not make it deductable.

d. Commuting: not deductable (Reg. 1.162-2(e))

1) Truly a business element, but personal in that it’s a choice of how to get there.

e. Flowers; no deduction for expenses while staying in hotel during the week.

1) 2 possible definitions of “home”: where you live; principal place of business (IRS adopts this)

2) §162: need to be away from home [overnight] and because of business.

a. If not overnight, just get travel expenses; meal only if with client (50% limitation).

b. If overnight, get travel and meals.

3. Time Away From Home.

a. 6- or 12-month assignment away from home is okay, but at some point (2Y?) she has to move.

b. Hantzis v. Commissioner; summer associate from Boston denied deduction for NY apt.

1) Which of two residents will be your tax home? Look at:

a. Which is more demanding job, where you spend more of your time.

b. Where you make the most money.

4. Educational Expenses.

a. Deductable education expenses: those that maintain & improve skills, or meet express requirements of employer and are not necessary to meet the minimum education requirements of a profession, and do not qualify for a new trade or business (Reg. 1.162-5).

1) E.g., MBA counts (not necessary for new trade/business), but JD/MD doesn’t (necessary).

b. What are educational expenses?

1) Tuition (Reg. 1.162-5)

2) Meals and lodging - less than a year away from home, ‘business’.

a. Can use these deductions to offset income in both years of LLM, so 2 low-income years.

5. Cases

a. Moss v. Commissioner; daily law partner lunch at expensive restaurant not deductible.

1) After they lost, the Moss firm hired their favorite guy from Cafe Angelo to cook on-site; then excludable under §119 - meals furnished on the business premises while engaged in business.

b. Sanitary Farms Dairy, Inc. v. Commissioner; costs of African safari deductable as business expense (advertising).

1) §274: limitation on things that would o/w be deductable.

a. §274(d) requires substantiation - receipts, topic of discussion.

b. §274(n) only 50% of meal expense allowed as deduction for food and beverages.

6. Ways To Pay Business Expenses.

a. Employer Pays: not income if o/w deductable; working condition fringe, so no inclusion in income and no deduction.

1) Employer can deduct, but will take the hit under §274(n).

b. Reimbursed: gross income when payment received, then deduction.

1) 2 types of deduction - those taken when arriving @ GI and those taken from GI to arrive @ taxable income.

2) §62 [AGI]: more important parts are:

a. §62(a)(1) - Can deduct business expenses.

b. §62(a)(2)(A) - Can take deduction that are reimbursed by employer.

3) Differences b/t above the line and below the line:

a. If you choose the standard deduction, no benefit from itemized deductions.

b. Not treated well even though ‘business’ expenses; 2 hurdles (plus AMT):

i. Hurdle 1: §67: only allowed if exceeds 2% of AGI.

ii. Hurdle 2: §68: if AGI above a certain amount ($?), reduction of itemized deductions by lesser of 3% or 80% of otherwise allowable.

c. Meals and lodging deductible; no difference b/t reimbursement & employer paying (except timing).

----
Distinction Between Deductable Business or Investment Expenses and Nondeductible Personal, Living, or Family Expenses.
-Occurs when mixing personal pleasure with potentially deductable business.
-Much basic consumption performs some “income producing” function.

a. If personal expenses could be deducted, personal consumption would be omitted from the tax base.

b. If business deductions were not allowed, gross income, not net income, would be taxed.

Allowing business deductions for personal consumption produces both horizontal and vertical inequities.

a. Taxpayers with similar incomes have different abilities to obtain these deductions depending on their occupations.

b. Taxpayers with higher income often have more opportunities obtain these deductions than taxpayers with lower incomes.

Pevsner v. Commissioner (261)
(Manager of clothing store, YSL, expected to wear YSL clothing at work. She wears while at work, while commuting, to fashion shows sponsored by YSL, and to business luncheons where she represents YSL. Regular customers use the clothing for general purposes; Manager is not a ‘normal’ purchaser of the clothing. Employer says OK to wear clothing away from work, manager does not wear them away from work, however.)
Issue: whether the manager of a clothing store is entitled to deduct as an ordinary and necessary business expense the cost of purchasing and maintaining YSL clothes and accessories worn by the taxpayer in her employment.?

§162(a): allows a deduction for ordinary and necessary expenses incurred in the conduct of a trade or business.

§262: bars a deduction for “personal, living, or family expenses).

-General Rule for deductibility of clothing expenses:

Deductable as a business expense only if:

1. the clothing is a type specifically required as a condition of employment.

2. it is not adaptable to general usage as ordinary clothing.

3. it is not so worn.

In this case, YSL clothing is adaptable for general usage as ordinary clothing and the manager was not prohibited from using them as such.

-Objective test: no reference is made to the taxpayer’s lifestyle or personal taste.

1. Adaptability for personal or general use depends upon what is generally accepted for ordinary street wear.

2. The court uses the objective test because it provides a practical administrative approach that allows a taxpayer or revenue agent to look only to objective facts in determining whether clothing required as a condition of employment is adaptable to general use as ordinary street wear. The court rejects an argument that a taxpayer’s personal taste can dictate whether clothing is appropriate for general use.

3. Objective test promotes substantial fairness among the greatest number of taxpayers.

The Inherently Personal Standard
Court disallowed deduction for payments by a businessman to a minister for business and personal advice based on prayer.

Expenditure “inherently personal in nature.”

All benefits provided by ministers are inherently personal in nature.

Public Employees
A position that entailed a “definite work assignment” and was not undertaken as a “tax dodge” would qualify as a trade or business and its expenses could be deducted.
Unreimbursed Expenses
Courts tend to be suspicious of any expense paid by an employee not reimbursed by the employer.

a. An employee who fails to seek reimbursement to which she is entitled also may lose a deduction.

b. A deduction is not allowable to an employee to the extent she is entitled to reimbursement from her employer.

Domestic Services and Child Care.
Decision to have a child is an inherently personal decision. If no child was had, no child care expenses would be incurred.

§21 provides a tax credit for qualifying child care expenses.

a. Taxpayers with adjusted gross income of $15,000 or less may offset tax liability by 35% of their employment-related dependent care expenses.

1. That percentage is reduced by 1% for each additional $2000 of adjusted gross income of the taxpayer, until it reaches 20% for taxpayers with an AGI above $43,000.

2. The amount of creditable expenses is limited to the income of the lower-earning spouse, or if single: to earned income.

3. Students are deemed to earn a limited amount of income.

4. Ceiling on creditable expenses of $3,000 for one dependent, and $6,000 for more than one.

i. Credit can not exceed $1,050 for one dependent or $2,100 for 2+.

5. Tax credit not refundable if the taxpayer has insufficient tax liability to take full advantage of it.

Travel Expenses
Transportation Expenses
Transportation expenses, such as air fare, taxi fare, or the cost of operating a car, generally are deductable when the taxpayer is traveling on business.
Commuting.

a. Reg. 1.162-2(e): the cost of commuting from home to work and back are nondeductible personal expenses.

i. Work location is fixed.

ii. Decision to live beyond walking distance is a personal one.

b. Flowers; Expense must be incurred in pursuit of business.

i. There must be a direct connection between the expenditure and the carrying on of the taxpayer’s business.

ii. Sole cause of the expense was the taxpayer’s personal desire to reside in Jackson, MS. Where one chooses to live is generally a matter of personal convenience.

Tools of the Trade.

a. Exception to commuting rule for additional expenses that may at times be incurred for transporting job required tools to and from work.

i. IRS will permit a deduction for only the portion of the cost of transporting the work implements by the mode of transportation used which is in excess of the cost of commuting by the same mode of transportation without the work implements.

Commuting to Temporary Employment. (270)
Temporary place of business: a location at which the taxpayer performs services on an irregular or short-term basis.

a. A taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works.

i. If within the metropolitan area, not deductible.

b. If a taxpayer has one or more regular work locations away from the taxpayer’s residence, the taxpayer may deduct daily transportation expenses incurred in going between the taxpayer’s residence and a temporary work location in the same trade or business, regardless of the distance.

c. If a taxpayer’s residence is the taxpayer’s principal place of business within the meaning of §280A(c)(1)(A), the taxpayer may deduct daily transportation expenses incurred in going between the residence and another work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance.

Food and Lodging

a. §162(a)(2) allows a deduction for travel expenses incurred “while away from home in the pursuit of a trade or business.”

i. Deductable as a misc. itemized deduction.

ii. Subject to the 2% adjusted gross income floor of §67.

§67(a): taxpayer can deduct “misc. itemized deductions only to the extent that the aggregate of such deductions exceed 2% of the taxpayer’s adjusted gross income.

iii. United States v. Correll; “away from home” does not include any trip not requiring “sleep or rest”, no matter how far the taxpayer travels.

b. Travel expenses reimbursed by the employer (as well as those incurred by self-employed individuals) are deductable under §62(a)(2)(A).

i. Not subject to the 2% floor.

Hantzis v. Commissioner (272)

(Law student has one home in MA and goes to work for the summer in NY, renting an apartment in NY, but going back and forth from Boston to NY. She tried to deduct her expenses under §162(a)(2). The tax court held that the taxpayer’s home was her place of employment and the cost of traveling from NY to Boston was not incurred while away from home. Also held that the expenses were not incurred in pursuit of a trade or business)

Issue: Was the cost of the taxpayer’s transportation to and from NY, as well as her meals and lodging in NY incurred while away from home while in pursuit of trade or business?

Holding: No, for a taxpayer under the same circumstances to be “away from home in the pursuit of a trade or business,” she must establish the existence of some sort of business relation both to the location she claims as “home” and to the location of her temporary employment sufficient to support a finding that her duplicative expenses are necessitated by business exigencies.

-§262: Except as otherwise provided for in this chapter, no deductions shall be allowed for personal, living or family expenses.

-A person’s taxable income should not include the cost of producing that income.

-To be deductable under §262(a)(2), an expense must be incurred in the pursuit of a trade or business.

Flowers, “the exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors.”

-An expense must also be ‘ordinary and necessary’ and incurred while ‘away from home.’

(Only expenses necessitated by business, as opposed to personal, demands may be excluded from the calculation of taxable income.)

-A traveling expense is deductible only if it is (1) reasonable and necessary, (2) incurred while away from home, and (3) necessitated by the exigencies of business.

-Home - becomes problematic only when the person lives in one place and works in another.

-Where a taxpayer resides and works at a single location, he is always home.

-Where a taxpayer is constantly on the move due to his work, he is never away from home.

-”While away from home requirement = the expense must be the result of business exigencies.

-§162(a)(2) seeks to mitigate the burden of the taxpayer who, because of the exigencies of his trade or business, must maintain two places of abode and thereby incur additional and duplicative living expenses.

Support us by: 

Checking out our amazing store on Etsy: http://www.bohobuttons.com

While in law school I traveled the world.  Puerto Rico.  Egypt.  Israel.  The Netherlands.  All over the United States.  Costa Rica.  Panama... How, you ask?  I found ways to make money on the side.  One of those ways was hosting my apartment on AirBnB.  If you have an extra room, this is a perfect way to make some extra cash.


Since law school, I have traveled to dozens of countries for pleasure with my family.  It's not rocket science.  You just need to know how to start some side hustles.  Another one of my favorite ways to make money is buying and selling stocks and cryptocurrency on Robinhood.  Join now and get a free stock through this link:  Join Robinhood and Get a Free Stock!