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Regs detail the 50% deduction limit for leased employees

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in Office Management,Payroll Management

There’s more to leasing employees than clients ­remitting their pay to the leasing company. Employees who incur meal expenses are usually reimbursed for those expenses. Snag: While employees can be ­reimbursed 100% for their substantiated meal expenses, business deductions are limited to 50%.

Normally, the employer is stuck with this deduction disallowance. But the involvement of the leasing company complicates matters. Proposed regulations assign the deduction disallowance to the party—the client or the leasing company—that receives an accounting of expenses.

The regs won’t become effective until final regs are issued, but you may rely on them for any tax year for which the statute of limitations has not expired. (77 F.R. 45520, 8-1-12)

Reimbursement arrangements clarified

The regs clarify that a reimbursement or other expense allowance arrangement involving employees is an arrangement under which employees receive advances, allowances or reimbursements for their business expenses from a payer—the employer, the employer’s agent or a third party.

The regs reiterate that whoever reimburses the employee bears the 50% deduction disallowance.

For arrangements involving independent contractors, the regs clarify that written agreements can provide that clients or customers may reimburse independent contractors for expenses that are subject to the 50% limitation, in which case the 50% limitation applies to the clients. Alternatively, agreements can specify the party that will be subject to the 50% limitation.

Three parties, two steps

The regs don’t change reimbursements between employees and employers—so-called two-party arrangements. For three-party arrangements, the regs require a two-step process. First, analyze the arrangement between the employee and the initial payer. Second, analyze the arrangement between the initial payer and the third party.

Example. Leaseco leases employees to Mega. The contract requires Mega to reimburse Leaseco for employees’ traveling expenses, including meal expenses. Two outcomes are possible, with Mega on the hook both times:

•  The contract between Leaseco and Mega doesn’t identify the party that is subject to the 50% disallowance. Employees account to Leaseco for their traveling expenses. Leaseco sends Mega copies of employees’ receipts, along with a statement showing the reimbursed amounts. Result: Employees and Leaseco have established a reimbursement arrangement, as have Leaseco and Mega. Since Leaseco accounts to Mega for employees’ expenses, Mega bears the 50% deduction disallowance.

•  The contract requires employees to account directly to Mega, which reimburses them. Result: Mega again bears the 50% deduction disallowance because the reimbursement arrangement is a classic two-party arrangement.

AVOID THE TWO-STEP: What’s not important to the IRS is the party that is considered the employer. Who bears the 50% deduction disallowance, according to the IRS, is strictly a business matter established by contract. Tip: You can avoid any hidden tax liabilities by delineating responsibility for employees’ meal and entertainment expenses as part of the leasing contract negotiation process. Once a leasing contract is signed, don’t sign side agreements or letters, or orally agree with the leasing firm to contract alterations.

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