Payment by Employer of Expenses for Club Dues, Meals and Entertainment, and Spousal Travel

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[IA-17-94; EE-36-94]

RIN 1545-AS74

Payment by Employer of Expenses for Club Dues, Meals and

Entertainment, and Spousal Travel

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to

reimbursements and other expense allowance arrangements under section

62(c) of the Internal Revenue Code of 1986 (Code), working condition

fringe benefits under section 132(d) of the Code, and expenses for club

dues, spousal travel, and business meals and entertainment that are

disallowed as a deduction to the employer under section 274(a)(3),

(m)(3), and (n)(1) of the Code. The proposed regulations reflect

changes to the law made by sections 13209, 13210, and 13272 of the

Omnibus Budget Reconciliation Act of 1993, 107 Stat. 469 (1993) (OBRA).

The persons affected by the proposed regulations are persons who

provide or receive the use of club membership dues, spousal travel

expenses, or business meals and entertainment.

DATES: Written comments and requests for a public hearing must be

received by March 24, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (IA-17-94), room 5228,

Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submissions may be hand delivered to:

CC:DOM:CORP:T:R (IA-17-94), room 5228, Internal Revenue Building, 1111

Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning regulations under sections 62 and 132, David N. Pardys,

(202) 622-6040; concerning regulations under section 274, John T.

Sapienza, Jr., (202) 622-4920; and concerning submissions, Christina

Vasquez, (202) 622-7190, (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Income Tax

Regulations under sections 62(c), 132(d), and 274 of the Internal

Revenue Code (Code) to reflect changes made to section 274 of the Code

by sections 13209, 13210, and 13272 of OBRA (107 Stat. 469, 542). These

provisions amended section 274 of the Code by limiting the deductible

portion of meal and entertainment expenses to 50 percent, by

eliminating the deduction for club dues, and by restricting the

deduction for spousal travel. The amendments to the regulations under

sections 62 and 132 of the Code concern the income tax consequences to

employees when their employer's (or third party payor's) deduction is

disallowed by the amendments to section 274 of the Code. Proposed rules

relating to the definition of club for purposes of the dues deduction

disallowance under section 274(a)(3) of the Code were published in the

Federal Register on August 12, 1994 on page 41414.

Explanation of Provisions

Section 61(a)(1) of the Code states that, except as otherwise

provided, gross income includes compensation for services, including

fees, commissions, fringe benefits, and similar items. In addition, if

an employer reimburses an employee for expenses paid by the employee in

connection with the performance of services as an employee, the amount

reimbursed generally is includible in the employee's gross income.

Section 62(a)(2) of the Code allows an employee to deduct employer

reimbursements for expenses paid by the employee in connection with the

performance of services as an employee from gross income to arrive at

adjusted gross income when the amounts are paid under a reimbursement

or other expenses allowance arrangement with his or her employer.

Section 62(c) of the Code provides that, for purposes of section

62(a)(2)(A), an arrangement will not be treated as a reimbursement or

other expense allowance arrangement if: (1) the arrangement does not

require the employee to substantiate the expense; or (2) the

arrangement provides the employee the right to retain any amount in

excess of the substantiated amount.

Section 132 of the Code provides that certain fringe benefits

provided by an employee to an employee may be excluded from the

employee's gross income. An employer-provided membership in any club

organized for business, pleasure, recreation, or other social purposes

is a fringe benefit includable in gross income unless otherwise

specifically excluded. Similarly, an employer's payment of travel

expenses with respect to a spouse, dependent, or other individual

accompanying an employee on business is a fringe benefit includable in

gross income unless otherwise specifically excluded. See Sec. 1.61-

21(a) of the Income Tax Regulations. Section 1.132-5 of the regulations

permits exclusion of employer-provided membership in a club, or an

employer's payment of travel expenses with respect to a spouse,

dependent, or other individual, accompanying an employee on business as

a working condition fringe benefit, provided that the payments for

these items would be deductible by the employee under sections 162 or

167 of the Code.

OBRA amended section 274 of the Code to disallow a deduction for

(1) 50% of business meal and entertainment expenses; (2) amounts paid

or incurred for membership in any club organized for business,

pleasure, recreation, or other social purpose; and (3) amounts paid or

incurred with respect to a spouse, dependent, or other individual

accompanying the taxpayer (or an officer or employee of the taxpayer)

on business travel, unless the accompanying individual is an employee

of the taxpayer, the travel of the accompanying individual is for a

bona fide business purpose, and the travel expenses would otherwise be

deductible by the accompanying individual.

The legislative history to OBRA indicates that Congress did not

intend that the business meal and entertainment expenses disallowance

provided by section 274(n) of the Code should result in income to

employees. ``The committee believes that denial of some part of the

deduction is appropriate as a proxy for income inclusion of the

consumption element of the meal or entertainment.'' H.R. Rep. No. 111,

103d Cong., 1st Sess. 645 (1993). Thus, consistent with Congressional

intent as evidenced by the legislative history, these proposed

regulations amend the regulations under section 62 of the Code to the

extent necessary to provide that a reimbursement or advance for

business meal and entertainment expenses will not be considered wages

subject to withholding and employment taxes under Sec. 1.62-2 of the

regulations, notwithstanding the deduction disallowance to the employer

of 50 percent of that amount.

The proposed regulations also amend the regulations under section

132 of the Code to provide that denial of a deduction to the employer

for the employer's payment of an employee's membership in a club, or

for the employer's payment of travel expenses of a spouse, dependent,

or other individual accompanying an employee on business travel, does

not provide those items from qualifying as working condition fringe

benefits. These amounts may qualify as a working condition fringe

benefit to the extent that (1) the employer has not treated such

amounts as compensation under section 274(e)(2) of the Code; (2) the

amounts would be deductible under section 162 (without regard to

sections 274(a) and 274(M)(3)); and (3) the employee substantiates the

expenses within the meaning of section 274.

An employer may choose to exercise the option of avoiding any

section 274 disallowance at the employer level by characterizing

employer-provided club membership dues or payment of travel expenses

with respect to a spouse, dependent, or other individual accompanying

an employee on business travel as compensation. Section 274(e)(2). If

the employer makes this election, the amount of such expenditure is

fully includable in gross income by the employee as compensation. The

proposed regulations under section 132 of the Code do not provide the

employee with any exclusion from gross income in this situation because

the section 274 disallowance applies to the employee.

The proposed regulations also modify Sec. 1.274-2(f)(2)(iii) of the

regulations to include spousal travel described in section 274(m)(3) of

the Code among the expenses deductible by the employer when treated as

compensation pursuant to section 274(e)(2). To the extent that the

employer treats all or parts of club dues as compensation to the

employee, the employer is permitted a deduction under section 162(a) of

the Code pursuant to section 274(e)(2). The Department of the Treasury

and the IRS believe that items described in section 274(a)(3) and

(m)(3) of the Code should be treated similarly. Therefore, the proposed

regulations modify Sec. 1.274-2(f)(2)(iii) of the regulations to

achieve this consistent treatment.

Clerical changes have been made to Sec. Sec. 1.274-2(c)(6) and

1.274-2(f)(2)(i) of the regulations to alert the reader to the fact

that these provisions apply only to transactions before January 1,

1987. Both paragraphs pertain to a former version of section 274(e)(1)

of the Code that was repealed by section 142(a)(2)(A) of the Tax Reform

Act of 1986.

Special Analyses

It has been determined that these proposed regulations are not a

significant regulatory action as defined in Executive Order 12866.

Therefore, a regulatory assessment is not required. It has also been

determined that section 553(b) of the Administrative Procedure Act (5

U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter

6) do not apply to these regulations, and, therefore, an initial

Regulatory Flexibility Analysis is not required. Pursuant to section

7805(f) of the Internal Revenue Code, these regulations will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on their impact on small business.

Comments and Public Hearing

Before adopting these proposed regulations as final regulations,

consideration will be given to any written comments that are submitted

(preferably a signed original and eight (8) copies) to the Internal

Revenue Service. All comments will be available for public inspection

and copying in their entirety.

A public hearing has been scheduled for Friday, April 14, 1995, 10

a.m. in the IRS Auditorium, Seventh Floor, 7400 Corridor, Internal

Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Because

of access restrictions, visitors will not be admitted beyond the

building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must

submit written comments and an outline of the topics to be discussed

and the time to be devoted to each topic by March 24, 1995.

A period of 10 minutes will be allotted to each person or team for

making comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these proposed regulations are David N.

Pardys, Office of the Associate Chief Counsel (Employee Benefits and

Exempt Organizations), and John T. Sapienza, Jr., Office of the

Assistant Chief Counsel (Income Tax and Accounting), IRS. However,

personnel from other offices of the IRS and Treasury Department

participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.62-2 is amended by adding a second sentence to

paragraph (h)(1) as follows:

Sec. 1.62-2 Reimbursements and other expense allowance arrangements.

* * * * *

(h) Withholding and payment of employment taxes--(1) When excluded

from wages. * * * If an arrangement provides advances, allowances, or

reimbursements for meal and entertainment expenses and a portion of the

payment is treated as paid under a nonaccountable plan under paragraphs

(d)(2) of this section due solely to section 274(n), then

notwithstanding paragraph (h)(2)(i) of this section, these

nondeductible amounts are not treated as wages and are not subject to

withholding and payment of employment taxes.

* * * * *

Par. 3. Section 1.132-5 is amended by adding paragraphs (s) and (t)

to read as follows:

Sec. 1.132-5 Working condition fringes.

* * * * *

(s) Application of section 274(a)(3). (1) If an employer's

deduction under section 162(a) for dues paid or incurred for membership

in any club organized for business, pleasure, recreation, or other

social purpose, is disallowed by section 274(a)(3), the amount, if any,

of an employee's working condition fringe benefit relating to an

employer-provided membership in the club is determined without regard

to the application of section 274(a) to the employee. To be excludible

as a working condition fringe benefit, however, the amount must

otherwise qualify for deduction by the employee under section 162(a).

If an employer characterizes as compensation under section 274(e)(2)

the amount paid for or incurred for membership in any club organized

for business, pleasure, recreation, or other social purpose, then the

expense is deductible by the employer as compensation and no amount may

be excluded from the employee's gross income as a working condition

fringe benefit.

(2) Examples. These examples illustrate this paragraph (s):

Example 1. Assume that Company X provides Employee B with a

country club membership valued at $20,000 which X does not treat as

compensation under section 274(e)(2). B substantiates, within the

meaning of paragraph (c) of this section, that the club was used 40

percent for business purposes. The business use of the club (40

percent) will be considered a working condition fringe benefit,

notwithstanding that the employer's deduction for the dues allocable

to the business use is disallowed by section 274(a)(3). Therefore, B

may exclude from gross income $8,000 (40 percent of the club dues,

which reflects B's business use). B must include $12,000 in gross

income as a fringe benefit (60 percent of the value of the club

dues, which reflects B's personal use). X may deduct as compensation

the value of the club dues which reflects B's personal use provided

the amount satisfied the other requirements for a salary or

compensation deduction under section 162.

Example 2. Assume the same facts as Example 1 except that

Company X treats the $20,000 which it pays for Employee B's club

dues as compensation under section 274(e)(2). B can substantiate,

within the meaning of paragraph (c) of this section, that the club

was used 40 percent for business purposes. The business use of the

club (40 percent), however, will not be considered a working

condition fringe benefit because the section 274(a)(3) disallowance

will apply to B. Therefore, B must include $20,000 (the entire of

the club membership) in gross income.

(t) Application of section 274(m)(3). If an employer's deduction

under section 162(a) for amounts paid or incurred for the travel

expenses of a spouse, dependent, or other individual accompanying an

employee is disallowed by section 274(m)(3), the amount, if any, of the

employee's working condition fringe benefit relating to the employer-

provided travel is determined without regard to the application of

section 274(m)(3). To be excludible as a working condition fringe

benefit, however, the amount must otherwise qualify for deduction by

the employee under section 162(a). The amount will qualify for

deduction and for exclusion as a working condition fringe benefit if it

can be adequately shown that the spouse's, dependent's, or other

accompanying individual's presence on the employee's business trip has

a bona fide business purpose and if the employee substantiates the

travel within the meaning of paragraph (c) of this section. If the

travel does not qualify as a working condition fringe benefit, the

employee must include in gross income as a fringe benefit the value of

the employer's payment of travel expenses with respect to a spouse,

dependent, or other individual accompanying the employee on business

travel. See Secs. 1.61-21(a)(4) and 1.162-2(c). If an employer

characterizes as compensation under section 274(e)(2) the amount paid

for or incurred for the travel expenses of a spouse, dependent, or

other individual accompanying an employee, then the expense is

deductible by the employer as compensation and no amount may be

excluded from the employee's gross income as a working condition fringe

benefit.

Par. 4. Section 1.274-2 is amended as follows:

1. The second sentence of paragraph (c)(6) is added.

2. The paragraph heading for (f)(2)(i) is revised.

3. The paragraph heading and introductory language of paragraph

(f)(2)(iii) is revised.

The revised and added provisions read as follows:

Sec. 1.274-2 Disallowance of deductions for certain expenses for

entertainment, amusement, or recreation.

* * * * *

(c) * * *

(6) * * * This paragraph (c)(6) applies to club dues paid or

incurred before January 1, 1987.

* * * * *

(f) * * *

(2) * * *

(i) Business meals and similar expenditures paid or incurred before

January 1, 1987.* * *

* * * * *

(iii) Certain entertainment and travel expenses treated as

compensation. Any expenditure by a taxpayer for entertainment (or for

use of a facility in connection therewith) or for travel described in

section 274(m)(3), if an employee is the recipient of the entertainment

or travel, is not subject to the limitations on allowability of

deductions provided for in paragraphs (a) through (e) of this section

to the extent that the expenditure is treated by the taxpayer--

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 94-30877 Filed 12-15-94; 8:45 am]

BILLING CODE 4830-01-4-M