Are Reimbursed Expenses "Deductions"?

In Lewis v. Commissioner (T.C. 1974-59), the petitioner was being reimbursed by his employer for 60 percent of his home maintenance costs, including depreciation on the home, in exchange for making his home available for the use of his employer. This was before the introduction of section 280A (which came only two years later), and the Tax Court found in favor of the petitioner, allowing the reimbursement to be excluded from income.

In the conclusion, the judge writes as follows (emphasis added):

We hold that petitioner, having adequately accounted to his employer, is relieved by the regulation promulgated with respect to section 274(d) from making a comparable section 274(d) substantiation to the respondent. It follows that it is our conclusion that, under the essentially atypical facts of this case, petitioner is entitled to deduct against the reimbursement the expenses in issue relating to the maintenance of his residence.

This leads me to a question: when income is excluded on account of expenses incurred, are those expenses technically considered "deductions" for all intents and purposes of the Code?

This question is relevant, for example, due to the requirement of Form 4562 that it be filed by any taxpayer who claims "[a] deduction for any vehicle reported on a form other than Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business". If my employer reimburses me for my vehicle expenses, would the IRS expect me to file this form?

Or perhaps more materially, if I am employed as an illegal trafficker in controlled substances, and my employer reimburses my employee business expenses, do I get to exclude the reimbursement amount from my wages?

This leads me to a question: when income is excluded on account of expenses incurred, are those expenses technically considered "deductions" for all intents and purposes of the Code?

One thought process is as follows: Employee incurs a valid business expense, subject to reimbursement by his employer. The accounting, on the EE’s end, would be a debit to Receivable and a credit to Cash. Upon reimbursement, the employee would take down the Receivable.

It is well settled under the law that when you (employee) pay someone else’s expense (employer’s), immediate indebtedness is created.

If the above accounting is proper, I’ve always wondered about the Receivable that the employee books…and what happens to it when the employee fails get the amount timely reimbursed. We know what the case law says: You cannot deduct someone else’s “expense.” Therefore employee, if you failed to obtain timely reimbursement, you cannot deduct the expense, because the expense was not yours. Wouldn’t the employee simply retort, “I’m not proposing to deduct any expense. I’m proposing to write off the Receivable that was created when I paid my *employer’s* expense, but became worthless when I failed to timely submit an expense report.”

I must say, the Code/Tax Law is a bit vague when it comes to basic accounting matters.

Maybe these thoughts will get the ball rolling on your question(s)…

I'd say it makes a difference whether the reimbursement was made under an "accountable" plan or not. Under an accountable plan, it'd be a wash and not reportable. Otherwise, it'd be income, and the treatment of expense will be based on facts of the case - possibly deductible, possibly non-deductible (if an employee business expense).

Or perhaps more materially, if I am employed as an illegal trafficker in controlled substances, and my employer reimburses my employee business expenses, do I get to exclude the reimbursement amount from my wages?. Sure you do. It's an accountable plan. But look at the next step. Jeff-Ohio points out that they aren't your expenses; they're your employer's expenses. So even though the judge points out that you, the employee, do not have to again account for them once you've done so for your employer, the employer does have to account for them, and some may well be non-deductible.

If the above accounting is proper, I’ve always wondered about the Receivable that the employee books…and what happens to it when the employee fails get the amount timely reimbursed. We know what the case law says: You cannot deduct someone else’s “expense.” Therefore employee, if you failed to obtain timely reimbursement, you cannot deduct the expense, because the expense was not yours. Wouldn’t the employee simply retort, “I’m not proposing to deduct any expense. I’m proposing to write off the Receivable that was created when I paid my *employer’s* expense, but became worthless when I failed to timely submit an expense report.”

I don't think the expense becomes the employer's and not the employee's by virtue of an accountable plan's existence. Rather, the expense is both the employer's and the employee's.

Section 62(a)(2)(A) characterizes expenses paid under a reimbursement arrangement as a deduction from gross income alongside all other types of employee business expenses that are allowable for AGI. These expenses, covered by paragraph 2 of subsection a, are characterized as paid in connection with the business of performing services as an employee.

In 1989, regulations on accountable plans were issued in response to new substantiation requirements enacted through the Family Support Act of 1988 (Pub. L. 100-485). These regulations took the position that under an accountable plan, the payor (i.e. the employer) must be able "to conclude that the expense is attributable to the payor's business activities" (1.62-2(e)(3)). These regulations also provided that reimbursement of such expenses would not be includible in the employee's gross income (1.62-2(h)).

Considering that this exclusion from gross income is not explicitly supported by any provisions of the Code, the IRS must have relied on general theories of income when developing these regulations. They must have reasoned that reimbursements under the new rules were of such a strict character that there was no opportunity for the taxpayer to have received anything that could be called "income" under section 61. In any case, all payments that would otherwise give rise to deductible expenses under section 62(a)(2)(A) now serve to reduce the taxpayer's basis in those very expenses.

Section 62(a)(2)(A) would appear to no longer serve any useful function - but that's not quite true. The 1.62-2 regulations themselves rely on that section as a basis for the type of expense that is eligible for reimbursement. Thus, even though expenses are no longer deducted under 62(a)(2)(A), there is still such a thing as a "62(a)(2)(A) expense". Recall that these are expenses incurred by the employee in the employee's trade or business of performing services as an employee. Only this type of expense can be submitted for reimbursement, and it can only be reimbursed under an accountable plan if it is also attributable to the employer's business.

These expenses are both expenses of the employer and the employee. That characterization doesn't change depending on whether an expense is reimbursed or not - thus, an unreimbursed expense would be deducted as normal (that is, if it weren't for the current moratorium on 2% miscellaneous deductions).

I will conclude here that reimbursed expenses are not deductions. However, I'm still not sure about the section 280E issue. Nilodop, you argue that the limitation doesn't apply to the employee, but have you considered Regs. 1.62-2(d)(2), which reads as follows?

(2)Other bona fide expenses.
If an arrangement provides advances, allowances, or reimbursements for business expenses described in paragraph (d)(1) of this section (i.e., deductible employee business expenses) and for other bona fide expenses related to the employer's business (e.g., travel that is not away from home) that are not deductible under part VI (section 161 and the following), subchapter B, chapter 1 of the Code, the payor is treated as maintaining two arrangements. The portion of the arrangement that provides payments for the deductible employee business expenses is treated as one arrangement that satisfies this paragraph (d). The portion of the arrangement that provides payments for the nondeductible employee expenses is treated as a second arrangement that does not satisfy this paragraph (d) and all amounts paid under this second arrangement will be treated as paid under a nonaccountable plan. See paragraphs (c)(5) and (h) of this section.

While we're at it, we may as well touch on the issue of when the reimbursements should be deducted. Jeff, you may recall our discussion about a similar issue on the following thread: viewtopic.php?f=8&t=12648

Section 62 is just a “where” type of Section, as in “where,” on the tax return, things get deducted. Other Code Sections tell us “if” something is deductible.

I don't think the expense becomes the employer's and not the employee's by virtue of an accountable plan's existence.

Sure it does. It is the primary argument the IRS makes in these cases: It was the employer’s expense because the employer agreed to reimburse it.

Rather, the expense is both the employer's and the employee's.

But never at the same time.

Via a long history of faulty-logic case law, employees get whipsawed when they incur a legitimate business expense that their employer agrees to reimburse, but it never gets reimbursed because the terms of the reimbursement arrangement were violated, such as the timely submission of an expense report.

The expense in question only becomes the employee’s expense the minute it is determined that it won’t be reimbursed by the employer. The accounting would go like this:

Employee incurs a $50 office supply expense on Day1. ER will reimburse it if it shows up on an expense report in the following 60-days.

Basic accounting would tell us that on Day1 the EE should debit Receivable for $50 and credit Cash for $50. Under the tax rules, we would do that because the expense is subject to reimbursement, meaning it is not the employee’s expense on Day1 (through Day60). From Day1 through Day60, this is the employer’s expense.

Now, Day61 rolls around. Case law would tell the EE to debit Non-deductible Expense for $50 and credit off the Receivable for $50.

Effectively, on Days1 through 60, the expense is that of the employer. But the employer can’t deduct it because it’s contingent. When Day61 rolls around, and no expense report is submitted, the contingency is resolved such that the employer has no obligation to make the payment. In effect, on Day61, the expense gets pushed back to the employee.

The part about all of this that is troublesome is this:

Now, Day61 rolls around. Case law would tell the EE to debit Non-deductible Expense for $50 and credit off the Receivable for $50.

Case law would have us believe that it is non-deductible because the employer would have reimbursed it, thereby rendering it not an expense of the EE. That’s well and good, but it falls flat in the above fact pattern, because it no longer is an employer expense on Day61. Some might say it remains an employer expense, just one the employer refuses to reimburse. But if that’s the case, then the EE has a bad debt.

Case law also takes the position that if the ER has a reimbursement policy, but it wasn’t reimbursed, then the expense must be personal in nature. That’s messed up logic as well.

The case law here is quite magical: We have a clear business expense – but no one ever gets to deduct it. The deduction magically disappears.