[Federal Register Volume 61, Number 105 (Thursday, May 30, 1996)]
[Rules and Regulations]
[Pages 27005-27007]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-13298]



=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8666]
RIN 1545-AS74


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations relating to 
reimbursement and other expense allowance arrangements for expenses of 
business meals and entertainment that are disallowed as a deduction 
under section 274(n), and working condition fringe benefit treatment 
for expenses for club dues and spousal travel that are disallowed as a 
deduction under sections 274(a)(3) and 274(m)(3). The final regulations 
reflect changes to the law made by the Omnibus Budget Reconciliation 
Act of 1993. The persons affected by the final regulations are persons 
who provide or receive the use of business meals and entertainment, 
club membership dues, or spousal travel expenses.

EFFECTIVE DATE: May 30, 1996.

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 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

     On December 16, 1994, a notice of proposed rulemaking relating to 
payment by an employer of expenses for business meals and 
entertainment, club dues, and spousal travel was published in the 
Federal Register (59 FR 64909). A public hearing was held on April 14, 
1995.
     Written comments responding to the notice were received. After 
consideration of all the comments, the proposed regulations are adopted 
as revised by this Treasury decision. The significant comments on the 
proposed regulations and the principal revisions made in the final 
regulations are discussed below.

Explanation of Provisions

    This Treasury decision contains final regulations 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). The 
OBRA provisions amended section 274 of the Code by (1) limiting the 
deductible portion of meal and entertainment expenses to 50 percent; 
(2) eliminating the deduction for club dues; and (3) 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.
    Comments to the proposed regulations concerned whether payment of 
expenses for club dues and spousal travel by an employer exempt from 
taxation under subtitle A of the Internal Revenue Code were eligible 
for the working condition fringe exclusion. The final regulations 
provide that any reference in the regulations to an employer's 
deduction disallowed by sections 274(a)(3) or 274(m)(3) of the Code 
will be treated as a reference to the amount which would be disallowed 
as a deduction to the employer if the employer were not exempt from 
taxation.
    Other comments suggested that the final regulation extend the 
section 274(e)(2) option of an employer to avoid the section 274 
disallowance for payment of spousal travel to persons who pay expenses 
described in section 274(e)(9). To achieve consistent results for 
payments to independent contractors and employees with respect to 
spousal travel, the final regulations adopted this suggestion.
    A number of comments requested clarification of the term other 
individual in section 274(m)(3). In particular, the comments asked that 
the term be clarified so as not to preclude the deduction for travel 
expenses of a business associate accompanying the taxpayer (or an 
officer or employee of the taxpayer) on business travel. The regulation 
was amended to reflect these comments.
    One comment concerned the person to whom a fringe benefit is 
taxable. The rules concerning to whom a fringe benefit is taxable are 
set forth in Sec. 1.61-21(a)(4). For rules concerning volunteers, see 
Sec. 1.132-5(r).
    Several comments involved the amount of the employer's disallowed 
deduction when the expenses of a spouse, dependent, or other individual 
accompanying an employee on a noncommercial flight qualify as a working 
condition fringe benefit. This issue is under further consideration. In 
addition, other comments requested clarification of what constitutes a 
deductible expenditure for spousal travel under the general rule of 
section 162(a). The rules for deducting travel expenses of a spouse are 
in Sec. 1.162-2(c).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 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, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

    Drafting Information. The principal authors of these 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. Personnel from other offices of the IRS and Treasury Department 
also participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

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. In Sec. 1.62-2, paragraph (h)(1) is amended by adding a 
second sentence at the end of the paragraph to read as follows:


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

* * * * *

[[Page 27006]]

    (h) * * * (1) * * * 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 paragraph (d)(2) of this section due solely to section 274(n), 
then notwithstanding paragraph (h)(2)(ii) of this section, these 
nondeductible amounts are neither treated as gross income nor subject 
to withholding and payment of employment taxes.
* * * * *
     Par. 3. In Sec. 1.132-5, paragraphs (s) and (t) are added to read 
as follows:


Sec. 1.132-5   Working condition fringes.

* * * * *
    (s) Application of section 274(a)(3)--(1) In general. 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 treats the amount paid or incurred for membership in any 
club organized for business, pleasure, recreation, or other social 
purpose as compensation under section 274(e)(2), 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. See Sec. 1.274-2(f)(2)(iii)(A).
    (2) Treatment of tax-exempt employers. In the case of an employer 
exempt from taxation under subtitle A of the Internal Revenue Code, any 
reference in this paragraph (s) to a deduction disallowed by section 
274(a)(3) shall be treated as a reference to the amount which would be 
disallowed as a deduction by section 274(a)(3) to the employer if the 
employer were not exempt from taxation under subtitle A of the Internal 
Revenue Code.
    (3) Examples. The following examples illustrate this paragraph (s):

    Example 1. Assume that Company X provides Employee B with a 
country club membership for which it paid $20,000. 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) may 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), if 
X does not treat the club membership as compensation under section 
274(e)(2). Thus, B may exclude from gross income $8,000 (40 percent 
of the club dues, which reflects B's business use). X must report 
$12,000 as wages subject to withholding and payment of employment 
taxes (60 percent of the value of the club dues, which reflects B's 
personal use). B must include $12,000 in gross income. X may deduct 
as compensation the amount it paid for the club dues which reflects 
B's personal use provided the amount satisfies 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 as compensation to B under section 
274(e)(2). No portion of the $20,000 will be considered a working 
condition fringe benefit because the section 274(a)(3) disallowance 
will apply to B. Therefore, B must include $20,000 in gross income.

    (t) Application of section 274(m)(3)--(1) In general. 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 treats 
as compensation under section 274(e)(2) the amount paid 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. See 
Sec. 1.274-2(f)(2)(iii)(A).
    (2) Treatment of tax-exempt employers. In the case of an employer 
exempt from taxation under subtitle A of the Internal Revenue Code, any 
reference in this paragraph (t) to a deduction disallowed by section 
274(m)(3) shall be treated as a reference to the amount which would be 
disallowed as a deduction by section 274(m)(3) to the employer if the 
employer were not exempt from taxation under subtitle A of the Internal 
Revenue Code.
    Par. 4. The last sentence of Sec. 1.274-1 is revised to read as 
follows:


Sec. 1.274-1  Disallowance of certain entertainment, gift and travel 
expenses.

    * * * For specific provisions with respect to the deductibility of 
expenditures: for an activity of a type generally considered to 
constitute entertainment, amusement, or recreation, and for a facility 
used in connection with such an activity, as well as certain travel 
expenses of a spouse, etc., see Sec. 1.274-2; for expenses for gifts, 
see Sec. 1.274-3; for expenses for foreign travel, see Sec. 1.274-4; 
for expenditures deductible without regard to business activity, see 
Sec. 1.274-6; and for treatment of personal portion of entertainment 
facility, see Sec. 1.274-7.
    Par. 5. Section 1.274-2 is amended as follows:
    1. The section heading for Sec. 1.274-2 is revised.
    2. In paragraph (c)(6), a second sentence is added at the end of 
the paragraph.
    3. The paragraph heading for paragraph (f)(2)(i) is revised.
    4. Paragraph (f)(2)(iii) is revised.
    5. Paragraph (g) is added.
    The revised and added provisions read as follows:


Sec. 1.274-2  Disallowance of deductions for certain expenses for 
entertainment, amusement, recreation, or travel.

* * * * *
    (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--(A) In general. 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

[[Page 27007]]

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--
    (1) On the taxpayer's income tax return as originally filed, as 
compensation paid to the employee; and
    (2) As wages to the employee for purposes of withholding under 
chapter 24 (relating to collection of income tax at source on wages).
    (B) Expenses includible in income of persons who are not employees. 
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), is not subject to the limitations on allowability of 
deductions provided for in paragraphs (a) through (e) of this section 
to the extent the expenditure is includible in gross income as 
compensation for services rendered, or as a prize or award under 
section 74, by a recipient of the expenditure who is not an employee of 
the taxpayer. The preceding sentence shall not apply to any amount paid 
or incurred by the taxpayer if such amount is required to be included 
(or would be so required except that the amount is less that $600) in 
any information return filed by such taxpayer under part III of 
subchapter A of chapter 61 and is not so included. See section 
274(e)(9).
    (C) Example. The following example illustrates the provisions this 
paragraph (f):

    Example. If an employer rewards the employee (and the employee's 
spouse) with an expense paid vacation trip, the expense is 
deductible by the employer (if otherwise allowable under section 162 
and the regulations thereunder) to the extent the employer treats 
the expenses as compensation and as wages. On the other hand, if a 
taxpayer owns a yacht which the taxpayer uses for the entertainment 
of business customers, the portion of salary paid to employee 
members of the crew which is allocable to use of the yacht for 
entertainment purposes (even though treated on the taxpayer's tax 
return as compensation and treated as wages for withholding tax 
purposes) would not come within this exception since the members of 
the crew were not recipients of the entertainment. If an expenditure 
of a type described in this subdivision properly constitutes a 
dividend paid to a shareholder or if it constitutes unreasonable 
compensation paid to an employee, nothing in this exception prevents 
disallowance of the expenditure to the taxpayer under other 
provisions of the Internal Revenue Code.
* * * * *
    (g) Additional provisions of section 274--travel of spouse, 
dependent or others. Section 274(m)(3) provides that no deduction shall 
be allowed under this chapter (except section 217) for travel expenses 
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 certain conditions are met. As 
provided in section 274(m)(3), the term other individual does not 
include a business associate (as defined in paragraph (b)(2)(iii) of 
this section) who otherwise meets the requirements of sections 
274(m)(3)(B) and (C).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: March 26, 1996.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 96-13298 Filed 5-29-96; 8:45 am]
BILLING CODE 4830-01-P