The CPA Journal

Perks and Pitfalls for the Peripatetic Taxpayer

By Barry Martin, CPA, City University of New York–Staten Island

IRC section 162(a)(2) allows a deduction for “traveling expenses (including amounts expended for meals and lodging other than amounts that are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business.” A similar deduction is allowed by IRC section 212(1) and (2) for deductions relating to income-producing activities not constituting a trade or business.

As stated in the IRC, “travel” expenses is a far broader term than “transportation” expenses. Travel expenses include not only actual transportation, but the cost of lodging, meals (subject to the 50% limitation), local transportation, telephone use, and similar expenses while in a “travel mode.”

Assuming the expenditures are not lavish or extravagant and are incurred in the pursuit of a trade or business, the critical criterion is whether the taxpayer is “away from home” while incurring these expenses. This sole qualification has been the focus of an enormous amount of contention. Just where is a taxpayer’s home for the purposes of this statute? What constitutes being “away from home”? The answers are not always clear and are further muddied by disagreements between various courts of appeal in the absence of a clear answer from the Supreme Court.

Because travel expenses can be quite substantial, and the deductibility frequently hinges on the “facts and circumstances,” proper planning and documentation are crucial for the peripatetic taxpayer. There are many scenarios to consider, from the simple to the complex, and an analysis must consider the IRC, the courts, and revenue rulings.

Deductibility: Background

The separation of business expenses from personal expenses is pervasive in the tax law. Expenses related to a trade or business or for the production of income are generally deductible, while those of a personal nature are not. Why, then, does IRC section 162(a)(2) allow so many expenses of a personal nature? The answer is that they represent a duplication of expenditures necessitated because the taxpayer is away from home for business. It then follows that duplication requires that the travel be away from an area where the taxpayer continues to pay for the same expenses incurred while away from home. Effectively balancing this concept is the idea that taxpayers are expected to live reasonably close to their place of business and that the choice not to do so is a personal one that will not make living expenses deductible, even though they are incurred away from home. Thus, to balance fairness against the possibility of abuse (converting personal expenditures into deductible ones), the operational definition of “home” has been expanded from meaning simply one’s residence.

Home: Where the Heart Is, or Where the Briefcase Is?

Central to the concept of travel expenses is the definition of home, because one must be away from it to be in “travel mode.” Does “home” in the IRC refer to the everyday meaning of residence, or is it something more peculiar to tax law? The answer depends on the authority.

The taxpayer who spends large amounts of time at a business location far from his residence has led to a concept embraced by the IRS and the Tax Court, that of a “tax home”: the taxpayer’s regular place of business regardless of the family residence. This tax home is the entire city or general area in which the business or work is located. If a taxpayer has more than one regular place of business, it is the area of the main or principal place of business. The Supreme Court, however, has three times refused to sanction this interpretation, and several circuits of the Court of Appeals have held that home should be interpreted as residence. A quick review of the legislative and judicial history of “home” is in order.

In the majority of cases, a taxpayer’s residence will be in the same general vicinity as her job or place of business. It doesn’t matter how “home” is defined, the taxpayer must be away overnight in order for travel expenses to be deductible. If the taxpayer travels to a distant location but returns the same day, only transportation expenses will be deductible.

But what about extended absences from home? At what point will the IRS assert that the client’s home (under the tax home definition) has changed?

The answer depends on whether the employment away from home is deemed to be “temporary.” If the taxpayer’s residence and regular place of business are in the same general geographic area and he travels away from home on either assignment or for a second business, he will be considered away from home if the work at the other location is considered temporary. The question is whether it would be reasonable for the taxpayer to move his principal residence to the new location under the circumstances? This, in effect, determines whether a duplication of expenditures is necessitated by business purposes. Several interesting high-profile cases have addressed this point.

One involved the entertainer Ethel Merman, who, during her nearly two-year Broadway run on Gypsy, sought to deduct all her living expenses in New York, claiming she was away from her established residence in Colorado. The IRS denied the deductions, claiming her tax home was in New York, which had become her principal place of business. Merman lost in district court, but the Second Circuit reversed, citing the real issue as whether or not it was reasonable for a person in this situation to move to New York on a permanent basis [450 F.2d 66 (2d Cir. 1971)].

Rosenspan v. U.S. [438 F.2d 905 (2d Cir. 1971)] is a case with an interesting twist. Robert Rosenspan, a jewelry salesman, turned the tables on the IRS by claiming travel expenses not while away from his residence, but while away from his tax home. He was employed by two New York City jewelry manufacturers; for about 300 days per year he traveled by car through his sales territory in the Midwest, staying at hotels and eating in restaurants. Five or six times a year he would return to New York and spend several days at his employers’ offices. He used a cousin in Cincinnati as a mailing address, but spent little time there. He maintained that New York was his tax home since the manufacturers were located there; therefore, all his traveling was away from this tax home. The Second Circuit found that because Rosenspan was almost always on the move, he had no home, however it was defined, and could therefore never be in “travel mode.”

As noted earlier, the Supreme Court has consistently avoided putting its stamp of approval on the government’s interpretation of “home” to be the area of a taxpayer’s principal place of business or “tax home.” In a significant case, Comm’r v. Flowers [326 U.S. 465 (1946)], the Court enumerated three conditions to be satisfied before a traveling expense deduction can be made:

The expense must be a reasonable and necessary traveling expense, as that term is generally understood. This includes such items as transportation fares and food and lodging expenses incurred while traveling.

The expense must be incurred while away from home.

The expense must be incurred in the pursuit of business (i.e., there must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or the employer). Moreover, such an expenditure must be necessary or appropriate to the development and pursuit of the business or trade.

The Court noted that the word home has engendered much litigation but found it unnecessary to decide on the definition in Flowers because the expenditures were deemed not to be in the pursuit of a trade or business and, thus, were nondeductible regardless of how home was defined.

This idea that there needs to be a direct connection between the travel and business (i.e., to be of business necessity) runs through the case law. A taxpayer who chooses to live a substantial distance from a single business location for personal convenience cannot deduct these travel expenses. In addition, since the law seeks to relieve the duplication of expenses, the work away from home must be of a temporary nature and not expected to last for an indefinite amount of time. In other words, if the work is not temporary, the taxpayer is expected to move closer to the work location. This gave rise to so much litigation (this concept of temporary vs. indefinite) that it was settled, for the most part, through legislation.

For years beginning after 1992, employment away from home at a single location that lasts for more than one year will be considered to be of indefinite duration [IRC section 162(a)]. This one-year test has ended a good deal of contention. (Prior to the enactment of the one-year test, it was generally the IRS’s position that two years away from home would deem a job not temporary.) There are two points worth noting: First, the one-year test refers to being away from home at a single location. Therefore, a taxpayer who travels to several different locations which cumulatively last more than one year is not affected by the rule with respect to the time limit. Second, each less-than-one-year absence must still pass the temporary nature test. Therefore, two of the criteria enumerated in Revenue Ruling 83-82 are still significant in determining whether less-than-one-year assignments or business trips are temporary or indefinite in nature. According to this ruling there must be—

a business (rather than personal) reason for incurring living expenses at a distant location from one’s “tax home,” such as insufficient work to supply year-round employment, and

a regular place of abode in a real and substantial sense.

The question arises in the case of an assignment that lasts more than one year: Are only the “one-year plus” expenses disallowed, or do the expenses for the entire period away become nondeductible? The answer depends on how long the assignment was expected to last. If it was expected to last less than one year, but in fact extends to more than one year, deductible expenses cease at the 12-month line. If the assignment was expected from the outset to last more than one year, none of the expenses are deductible. The IRS considers the realistic expectations at the outset of the assignment to be of paramount importance in the temporary vs. permanent debate no matter how long the assignment actually lasts.

As a corollary to the above rules, if an employee is reimbursed for travel expenditures by his employer and the assignment is deemed to be of an indefinite nature, making the expenditures nondeductible, the reimbursements must be reported as taxable income. This is true regardless of whether the plan is accountable.

Away from Home

There is virtually no disagreement with the meaning of “away from home.” The Supreme Court has ruled that the away- from-home requirement means the taxpayer has to be away from home “overnight” (389 U.S. 299). This has been expanded through later interpretations to include situations where it is reasonable for the taxpayer to stop for needed sleep or rest. Therefore, a trip—regardless of the distance—where the taxpayer leaves and returns in the same day would not qualify for travel expense deductions for meals and lodging.

Now that the terms home and away from home have been defined, they can be applied in various situations involving where taxpayers live and work, beginning with the simplest (and most typical) and proceeding to the more complex.

One Residence, One Regular Business Location

For the taxpayer with one job or business and one residence, the rules are clear-cut. The client must be temporarily away from home for business purposes, as defined by the preceding discussion. The area of residence will be considered the tax home as long as the out-of-town assignments are not of an indefinite nature. The area of the taxpayer’s residence can be quite extensive and includes the entire metropolitan area where business is conducted. If the travel is within commuting distance, the expenditures are generally nondeductible.

One Residence, Multiple Business Locations

Things get more complex when the taxpayer has more than one business at various locations some distance apart. Here, a determination must be made as to which is the principal business and, thus, which is the principal business location. Travel expenses away from this location for secondary business purposes are deductible, whereas travel expenses within this location are of a personal nature and nondeductible [under IRC section 162(a)(2), of course]. Therefore, the determination of which business interest is major and which are minor is crucial.

Under this scenario, the facts and circumstances of each case determine the outcome. There are three guiding factors:

1) the total time spent at each job or business site,
2) the degree of business activity in each area, and
3) the relative financial significance of each area. These criteria allow an objective approach to an essentially subjective determination.

These objective tests were clearly applied in Markey v. Comm’r, where the Court of Appeals for the Sixth Circuit reversed a Tax Court decision that the court said was based on subjective tests to determine the taxpayer’s tax home [490 F.2d 1249 (6th Cir. 1974)]. Markey maintained his residence in Lewisberg, Ohio, and spent five days each week, 50 weeks each year in Warren, Mich., as a consultant. He sought to deduct all his meals, lodging, and other expenses in Warren, asserting that he was away from his home in Lewisberg. The Tax Court allowed the deductions, saying that “the determining factor is that the taxpayer’s business interests in Lewisberg were more important to him than those in Warren and required his presence in Lewisberg for some time each week.” The Circuit Court disagreed, applying the objective tests of where the taxpayer spent most of his time and where he received a more significant financial return.

A more difficult case occurs where the taxpayer spends most of his time at one location but earns more income at another. Which test should carry more weight in determining his tax home? In general, the courts (including Markey) have held that the time factor is more important than the monetary factor, especially when circumstances indicate stronger community ties to the area of the residence. In Sherman vs. Comm’r [16 T.C. 332 (1955)], a taxpayer who resided in Worcester, Mass., frequently traveled to New York, where he earned approximately twice as much income. His travel expenses were allowed because he spent much more time in Worcester and had obvious ties to that community.

In a situation where approximately equal time is spent in different locations, the courts have looked to where the taxpayer has the strongest community ties and interests. Nevertheless, there have been some Tax Court decisions which concluded that the taxpayer has essentially two homes and therefore is never in travel mode. The circuit courts have been critical of this conclusion, because section 162(a)(2) was specifically enacted to remedy a case of duplicate expenditures.

The rules concerning major and minor business interests can create strange conclusions when a minor business interest is run out of a residence, yet the major business interests are at a distant location. In this case, taxpayers are away from home and in travel mode when at their principal residence. But, if they return to their principal residence for essentially personal reasons—not for business purposes—those expenses are nondeductible.

Married Couple, Different Business Locations

It is not uncommon for a married couple to share a residence but work at business locations far apart. Each spouse has a separate tax home and can be considered to be away from home when in the shared residence. However, this does not necessarily mean that expenditures made while returning to or at the residence are deductible. Unless there is a compelling business reason to return to the residence, the choice to return home is a personal one and the expenses are considered personal.

Perpetually Peripatetic

For truly peripatetic taxpayers—constantly traveling from place to place with no regular place of business or residence—the tax laws offer no relief. Because there is no home to be away from, it follows that there can be no travel mode, and no deductible travel expenses. These taxpayers are considered to be “itinerant” and carry their tax homes with them.

Obviously, this is an undesirable tax status. It can be avoided if it can be shown that there is someplace where the tax payer regularly lives that can become the tax home despite the lack of a regular place of business. In Revenue Ruling 73-529, the IRS identified three criteria used to determine whether there is, indeed, a tax home:

Whether the taxpayer performs a portion of his business in the vicinity of his claimed abode and uses it for lodging while performing business there;

Whether the taxpayer’s living expenses incurred at the claimed abode are duplicated because his business requires him to be away from it;

Whether the taxpayer has not abandoned the area in which both his traditional place of lodging and his main home are located, or whether members of the taxpayer’s family live at the main home or the taxpayer often uses the home for lodging.

If all three factors are satisfied, the tax home is where one regularly lives and travel expenses can be deducted. If two factors are satisfied, there may be a tax home, depending upon facts and circumstances. If only one factor is satisfied, the taxpayer is deemed to be transient and travel expenses are nondeductible.

The Need for Planning

As noted earlier, traveling expenses can be substantial; however, without some forethought and planning, it can be quite easy to run afoul of the rules allowing deductibility. The following are some basic planning strategies:

All out-of-town assignments should be temporary in nature. Even short assignments can be considered indefinite if they were expected to last more than one year from the outset. If possible, a written document should indicate that the assignment is expected to last less than one year.

Because the one-year rule applies only to an assignment at a single location, careful scheduling can ensure that each lasts less than one year. Similarly, advance planning could break up longer projects.

Avoiding the itinerant tax status is essential. Taxpayers must meet at least two of the three tests discussed above to do so. In many cases, some basic planning can accomplish this. Revenue Ruling 73-529 looked at two situations. In one, the taxpayer, an outside salesman, rented a room in his sister’s house where he stored his furniture and other belongings while on the road. His employer’s headquarters were in the city where this house was located, and he had lived there for several years. Even though he only returned home for one month a year, he was not deemed itinerant. In the second situation, use of the room was free, the employer’s headquarters were in a different city, and the taxpayer had no ties to the area. He was considered an itinerant. The need for planning in this situation is obvious.

Editor:
Edwin B. Morris, CPA
Rosenberg, Neuwirth & Kuchner

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