UAL Corporation and Subsidiaries v. Commissioner

117 T.C. No. 2UNITED STATES TAX COURT
UAL CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18573-98. Filed July 13, 2001.
U, an international airline, paid its pilots and
flight attendants (collectively, employees) per diem
allowances. U paid the allowances to all employees;
i.e., those who departed from and returned to their
home bases on the same day and those who departed from
and returned to their home bases on different days. U
neither required nor received substantiation from the
employees as to their uses of the allowances.
Held: U may deduct the per diem allowances as
personal service compensation under sec. 162(a)(1),
I.R.C.
George B. Javaras, Todd F. Maynes, and Natalie Hoyer Keller,
for petitioner.
James C. Lanning, for respondent.
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LARO, Judge: Respondent determined deficiencies of
$1,478,718, $61,867,523, $1,751,161, and $45,981,293 in
petitioner’s 1983, 1984, 1986, and 1987 Federal income taxes,
respectively.1 Following concessions, we must decide whether
petitioner may deduct the per diem allowances paid to its flight
attendants and pilots (collectively, employees) for day trips and
overnight trips (as defined below). We hold it may deduct the
per diem allowances as personal service compensation under
section 162(a)(1).2
FINDINGS OF FACT
Most facts were stipulated. The parties’ stipulation of
facts and the exhibits submitted therewith are incorporated
herein by this reference. The stipulated facts are found
accordingly. Petitioner is a consolidated group of corporations
that files a consolidated Federal income tax return on the basis
of the calendar year. Its principal office was in Elk Grove
Township, Illinois, when its petition was filed. United Air
Lines, Inc. (United), is an airline that provides passenger and
1
Respondent has determined no deficiency for 1985 because
the limitations period was closed when the underlying notice of
deficiency was issued. We discuss 1985 because petitioner’s
deduction of the per diem allowances for that year affects
petitioner’s tax liability for the subject years.
2
Section references are to the Internal Revenue Code in
effect for the subject years. Rule references are to the Tax
Court Rules of Practice and Procedure.
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cargo service worldwide. United was petitioner’s subsidiary
during 1985, 1986, and 1987.
During the subject years, United employed approximately
12,000 flight attendants and 6,150 pilots. Each of the employees
was assigned to a series of flights (pairings) that typically
originated and terminated at the home base of one or more of the
employees assigned to the pairing. Most of the pairings required
that the employees spend one or more nights away from their home
bases (overnight trips). The other pairings brought the
employees back to their home bases on the day of departure (day
trips).
United paid the employees compensation and benefits pursuant
to collective bargaining agreements (union contracts) which it
had entered into with the employees’ respective unions. Under
the union contracts, United paid the employees regular
compensation plus a per diem allowance. United paid each flight
attendant a per diem allowance equal to $1.50 times the number of
hours that he or she was on duty or on flight assignment. United
initially paid the same per diem allowance to each pilot but
increased the pilots’ per diem rate from $1.50 per hour to $1.55
per hour effective April 1, 1986. Neither United nor petitioner
required that the employees substantiate their use of the per
diem allowances, and neither United nor petitioner has any
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written substantiation as to the employees’ actual use of the per
diem allowances.
United’s computerized system allowed it to record accurately
the employees’ duty assignments. United used these records to
calculate each employee’s per diem allowance. United included
its payment of an employee’s per diem allowance in his or her
salary check and listed the amount of the per diem allowance
included in the check on the corresponding check stub. United
issued to each employee a monthly report of the per diem
allowances which it had paid to him or her.
On its 1985, 1986, and 1987 Federal income tax returns,
petitioner claimed under section 162(a)(2) that it could deduct
the per diem allowances as employee travel expenses. For 1985,
United paid the employees per diem allowances totaling
$35,532,698 for overnight trips and $1,867,757 for day trips.
For 1986, United paid the employees per diem allowances totaling
$53,867,516 for overnight trips and $2,635,763 for day trips.
For 1987, United paid the employees per diem allowances totaling
$59,777,494 for overnight trips and $2,918,385 for day trips. As
to 1987, petitioner took into account section 274(n), as amended
in 1986, and deducted only 80 percent of the per diem allowances
paid during 1987. For financial accounting purposes, petitioner
also reported its payment of the per diem allowances as a travel
expense.
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United did not withhold Federal income tax on its payment of
the per diem allowances, and it neither withheld nor paid Federal
Insurance Contribution Act (FICA) tax with respect to the per
diem allowances. United did not report the per diem allowances
as wages or nonwage compensation on the employees’ Forms W-2,
Wage and Tax Statement.
OPINION
We must decide whether petitioner may deduct the per diem
allowances paid to the employees. Petitioner argues it may
deduct the per diem allowances as personal service compensation
because they arose out of an employer/employee relationship.
Respondent argues that petitioner may not deduct the per diem
allowances as personal service compensation because it lacked the
requisite compensatory intent at the time of payment. We agree
with petitioner.
Our inquiry begins with the relevant text. Section 162(a)
lets a taxpayer deduct all ordinary and necessary expenses
incurred during the taxable year in carrying on a trade or
business. Section 162(a)(1) includes within the ambit of section
162(a) “a reasonable allowance for salaries or other compensation
for personal services actually rendered”. Payments are
deductible under section 162(a)(1) to the extent they are
“reasonable and * * * in fact payments purely for services.”
Sec. 1.162-7(a), Income Tax Regs.
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The parties agree that the per diem allowances, if paid for
services, would not make any of the employees’ total compensation
unreasonable. Thus, we limit our focus to the second
requirement. Under that requirement, a deduction under section
162(a)(1) turns on the factual determination of whether the facts
and circumstances of the case establish that the payor made the
payment to the payee for services rendered. Sec. 1.162-7(a),
Income Tax Regs. Whether the payor makes the payment to the
payee intending to compensate him or her for services rendered is
a pertinent factor to consider. See, e.g., Paula Constr. Co. v.
Commissioner, 58 T.C. 1055, 1058-1059 (1972), and the cases cited
therein, affd. without published opinion 474 F.2d 1345 (5th Cir.
1973).
We conclude that United paid the per diem allowances to the
employees for services rendered. We reach that conclusion from
the certainty that United would not have paid the per diem
allowances to the employees but for: (1) The bona fide
employer/employee relationship and (2) the need to pay those
allowances in order to secure the employees’ services. The
presence of such a bona fide employment relationship and such a
need to pay per diem allowances in order to secure personal
services is enough under the facts at hand to persuade us that
United paid the per diem allowances to the employees for their
services. Accord Kowalski v. Commissioner, 65 T.C. 44, 52
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(1975), revd. 544 F.2d 686 (3d Cir. 1976), revd. 434 U.S. 77(1977), where we stated: “Even though we have found that the meal
allowance was not intended as additional compensation, it was
obviously compensatory to a trooper to the extent it paid for
food which he otherwise would have had to pay for from some other
source.”3 We also bear in mind, and find as a fact, that United
paid the per diem allowances to the employees intending to
compensate them for their personal services.
Respondent places undue emphasis on the fact that the union
contracts do not specifically characterize the per diem
allowances as personal service compensation. Such a
characterization by the parties to the contracts is not
dispositive as to the characterization of the per diem allowances
for Federal income tax purposes. See Hosp. Corp. of Am. v.
Commissioner, T.C. Memo. 1996-559. Nor is it dispositive that
United reported the per diem allowances as travel expenses for
both tax and financial accounting purposes. The bona fide
employer/employee relationship that United had with the
employees, coupled with their negotiations as to the specifics of
the employees’ compensation package, specifics which included the
payment of per diem allowances, speaks loudly towards a proper
3
Moreover, as the Supreme Court noted in upholding our
decision in that case, the meal allowance given to Kowalski by
way of the cash payments was of a “presumptively compensatory
nature”. Kowalski v. Commissioner, 434 U.S. 77, 94 (1977).
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characterization of those allowances as personal service
compensation. We adopt that characterization.
We conclude by noting that the parties are currently
litigating in the United States Court of Federal Claims the issue
of whether the very same per diem allowances are wages for
employment tax purposes. See United Air Lines, Inc. v. United
States, No. 97-173T (Fed. Cl., filed Mar. 18, 1997).
Interestingly, the Government is arguing that those allowances
are wages for employment tax purposes. Wages for employment tax
purposes are “all remuneration for employment, including the cash
value of all remuneration (including benefits) paid in any medium
other than cash”. Sec. 3121(a). Section 3401 defines wages in
similar terms.
We hold that United may deduct the per diem allowances under
section 162(a)(1) as personal service compensation. Accordingly,
Decision will be entered
under Rule 155.
Reviewed by the Court.
WELLS, CHABOT, GERBER, RUWE, HALPERN, FOLEY, VASQUEZ, and
GALE, JJ., agree with this majority opinion.
WHALEN, J., concurs.
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RUWE, J., concurring: I agree with the result in this case.
However, I believe it is appropriate to elaborate on why the per
diem allowances for day trips and overnight trips are both
deductible as compensation under section 162(a)(1).
United paid its employees per diem allowances at a rate of
$1.50 per hour ($1.55 for pilots for certain portions of the
years in issue) for the number of hours on duty or on flight
assignment. United appears to have arrived at this number by
estimating the expenses that would be incurred by an employee for
one day, $36 ($37.20 for pilots for certain portions of the years
in issue), and then dividing this number by 24 hours. The expert
report relied upon by petitioner attributes most of the per diem
allowance to meal expenses. See infra p. 21. The employees were
not required to substantiate their use of the per diem
allowances, and neither United nor petitioner has any written
substantiation as to the employees’ actual use of the per diem
allowances.
1. Day Trips
The per diem allowance for day trips was to cover meal
expenses that the employees might incur during day trips.1 Meal
1
In his dissenting opinion, see infra p. 38 note 3, Judge
Swift states that the day trip per diem allowances included
amounts for incidental travel expenses. The facts provide no
basis upon which to apportion any amount of the day trip per diem
allowances to incidental travel expenses, and it is very unlikely
(continued...)
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expenditures for nonovernight day trips are personal expenses of
the employees, rather than business travel expenses. United
States v. Correll, 389 U.S. 299 (1967).2 It therefore appears
that United intended to pay the allowances to its employees to
cover their personal expenses incurred during day trips. In
Commissioner v. Kowalski, 434 U.S. 77 (1977), the Supreme Court
held that cash meal payments to an employee were includable in
the employee’s gross income. The Supreme Court noted “the
presumptively compensatory nature of cash payments”. Id. at 94;
see Bank of Stockton v. Commissioner, T.C. Memo. 1977-24(indicating that if payments made to enable employees’ wives to
attend conventions were not deductible as either noncompensatory
business expenses or dividends, then the only reasonable
conclusion would be that the payments were in the nature of
additional compensation to the employees and, unless unreasonable
in amount, would be deductible as compensation); Anchor Natl.
Life Ins. Co. v. Commissioner, 93 T.C. 382, 433 and n.30 (1989)
1
(...continued)
that the type of incidental expenses that were contemplated in
structuring the per diem allowances were incurred on day trips.
See infra p. 21.
2
Based on United States v. Correll, 389 U.S. 299 (1967),
petitioner has conceded that the day trip allowances were not for
travel expenses because its employees’ day trip expenses were not
incurred during overnight travel. Both parties now agree that
the only issue regarding day trip allowances is whether they
constitute compensation to United’s employees.
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(citing Bank of Stockton v. Commissioner, supra, for the
proposition that disallowed business expenses may be deductible
as additional compensation to employees if the compensation does
not exceed the bounds of reasonableness). In the instant case,
the per diem allowances for day trips were for personal expenses
of United’s employees and should be treated as compensation to
the employees.3
Respondent argues that United did not have the requisite
compensatory intent at the time it paid the allowances. However,
3
Although not in effect for the years in issue, sec. 1.62-
2(j), Example (2), Income Tax Regs., confirms this as the proper
treatment. In his dissenting opinion, see infra p. 38 note 3,
Judge Swift erroneously cites sec. 262 and United States v.
Correll, supra, to support his belief that United’s allowance for
its employees’ day trip meal expenses is nondeductible because
such payments were for personal living expenses of United’s
employees. However, sec. 262 only disallows the personal
expenses of the “taxpayer”. Sec. 1.262-1, Income Tax Regs.
Here, UAL is the “taxpayer”. The day trip meal expenses were
“personal expenses” of its employees, not personal expenses of
United. The “taxpayer” in United States v. Correll, supra, was
not a corporation or an employer, but was an individual taxpayer
who was attempting to deduct his own personal expenditures for
meals during nonovernight travel. The Supreme Court was not
faced with, nor did it discuss, the issue of whether an
employer’s payment of its employees’ personal expenses could be
deducted by the employer. On the other hand, in Ginsburg v.
Commissioner, T.C. Memo. 1994-272, Judge Swift himself recognized
that payment of an individual’s personal expenses by a
corporation can be deducted by the corporation if the payment is
in the nature of compensation. See Fred W. Amend Co. v.
Commissioner, 55 T.C. 320, 327-328 (1970), affd. 454 F.2d 399(7th Cir. 1971).
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the relevant statute4 and regulations5 do not require an “intent
to compensate” as a prerequisite to deductibility under section
162(a)(1). Although an “intent to compensate” requirement has
been applied by the courts in numerous cases, the instant
situation is factually distinguishable from the situation in
those cases which involved corporate payments to shareholders or
employees in positions of control. E.g., Paula Constr. Co. v.
Commissioner, 58 T.C. 1055, 1058-1059 (1972), affd. without
published opinion 474 F.2d 1345 (5th Cir. 1973). In the context
of corporate payments to shareholders, careful scrutiny is
required to determine whether the alleged compensation is in fact
a disguised dividend. Owensby & Kritikos, Inc. v. Commissioner,
819 F.2d 1315, 1324 (5th Cir. 1987), affg. T.C. Memo. 1985-267;
Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142, 1156
(1980).6 If a corporate payment to a shareholder/employee is
4
Sec. 162(a)(1) allows a deduction for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business, including “a reasonable
allowance for salaries or other compensation for personal
services actually rendered”.
5
“The test of deductibility in the case of compensation
payments is whether they are reasonable and are in fact payments
purely for services.” Sec. 1.162-7(a), Income Tax Regs.
6
In Elliotts, Inc. v. Commissioner, 716 F.2d 1241 (9th Cir.
1983), revg. and remanding T.C. Memo. 1980-282, the Court of
Appeals for the Ninth Circuit discussed the problem of
determining whether purported compensation payments are in fact
disguised dividends. The Court of Appeals noted that the test
(continued...)
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characterized as additional compensation, then the corporate
taxpayer is allowed a deduction. If the payment is characterized
as a dividend, no deduction is allowed. Thus, a corporate
taxpayer has an incentive to make purported compensation payments
which are in fact disguised dividends. As the majority opinion
correctly states, the payor’s intent is simply a pertinent factor
to consider, not a prerequisite to deductibility.7
6
(...continued)
for deductibility under sec. 162(a)(1) is a two-prong test
requiring (1) that amount of compensation must be reasonable, and
(2) the payments must in fact be purely for services. Id. at
1243. The Court of Appeals then made the following observation:
The existence of a compensatory purpose can often be
inferred if the amount of the compensation is
determined to be reasonable under the first prong. For
these reasons, courts generally concentrate on the
first prong–-whether the amount of the purported
compensation is reasonable. Courts have generally not
delved into whether a compensatory purpose exists under
the second prong except in those rare cases where the
Commissioner has come forward with evidence that
purported compensation payments, although reasonable in
amount, were in fact disguised dividends. By and
large, the inquiry under section 162(a)(1) has turned
on whether the amounts of the purported compensation
payments were reasonable.
* * * * * * *
In the rare case where there is evidence that an
otherwise reasonable compensation payment contains a
disguised dividend, the inquiry may expand into
compensatory intent apart from reasonableness. * * *
[Id. at 1243-1244; citations and fn. refs. omitted.]
7
In Kowalski v. Commissioner, 65 T.C. 44 (1975), revd. 544
F.2d 686 (3d Cir. 1976), revd. 434 U.S. 77 (1977), a Court-
reviewed opinion, this Court stated:
(continued...)
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The Court of Federal Claims and the Court of Appeals for the
Federal Circuit have considered similar per diem allowances,
albeit in the context of the employment tax regime. Am.
Airlines, Inc. v. United States, 40 Fed. Cl. 712 (1998), affd. in
part, revd. in part, and remanded 204 F.3d 1103 (Fed. Cir. 2000);
Am. Airlines, Inc. v. United States, 204 F.3d 1103 (Fed. Cir.
2000). In its opinion, the Court of Federal Claims found that
the portion of the per diem allowance attributable to meal
expenses was the equivalent of a wage concession in the context
of a labor negotiation. Am. Airlines, Inc. v. United States, 40
Fed. Cl. at 721.8 The court noted:
The evidence that American’s per diem rates were driven
by competitiveness with other airlines is not helpful
to plaintiff, as it is equally consistent with a
different motivation than compensating for employees’
actual expected travel expenses, to wit, keeping up
with its competitors’ wage and benefit packages.
* * * [Id. at 720.]
7
(...continued)
Even though we have found that the meal allowance was
not intended as additional compensation, it was
obviously compensatory to a trooper to the extent it
paid for food which he otherwise would have had to pay
for from some other source. * * * [Id. at 52.]
8
“It would be naive to ignore that the ‘meal expense’
concession was tantamount to wage concessions in the context of a
labor negotiation.” Am. Airlines, Inc. v. United States, 40 Fed.
Cl. 712, 721 (1998), affd. in part, revd. in part, and remanded
204 F.3d 1103 (Fed. Cir. 2000).
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The day trip allowances were compensation in the form of
fringe benefits.9 Section 61(a)(1) provides that gross income
includes “Compensation for services, including fees, commissions,
fringe benefits, and similar items”. (Emphasis added.) As
applicable for the years 1985 through 1988, section 1.61-
2T(a)(3), Temporary Income Tax Regs., 50 Fed. Reg. 52286 (Dec.
23, 1985), provides that “A fringe benefit provided in connection
with the performance of services shall be considered to have been
provided as compensation for services.” (Emphasis added.)
The regulations applicable to the years in issue recognize
that employer-provided meals or meal allowances are taxable
fringe benefits unless specifically excluded from income under
section 132.10 Section 1.132-6T, Temporary Income Tax Regs., 50
Fed. Reg. 52308 (Dec. 23, 1985), recognizes that meals or meal
allowances to employees (for meals not otherwise deductible under
section 162(a)(2)) are generally considered to be taxable income
9
The Court of Federal Claims and the Court of Appeals for
the Federal Circuit considered similar per diem allowances within
the framework of fringe benefits. Am. Airlines, Inc. v. United
States, 40 Fed. Cl. at 722; Am. Airlines, Inc. v. United States,
204 F.3d at 1110.
10
For the years in issue, sec. 132 excluded the following
fringe benefits from gross income: (1) No-additional-cost
service; (2) qualified employee discount; (3) working condition
fringe; and (4) de minimis fringe.
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unless specifically excluded as a de minimis fringe benefit.11
The temporary regulations provide:
Thus, except as otherwise provided in this section, the
provision of any cash fringe benefit (or any fringe
benefit provided to an employee through the use of a
charge or credit card) is not excludable as a de
minimis fringe. For example, the provision of cash to
an employee for personal entertainment is not
excludable as a de minimis fringe. [Sec. 1.132-6T(c),
Temporary Income Tax Regs., supra.]
The allowance of a deduction for day trip allowances would
not undercut the strict substantiation requirements of section
274(d). Section 274 generally disallows certain entertainment,
gift, and travel expenses. In the case of allowances paid to
cover expenses incurred during travel, section 274 applies only
if the amount is otherwise deductible as a “travel” expense.
Thus, section 1.274-1, Income Tax Regs., provides that “If a
deduction is claimed for an expenditure for entertainment, gifts,
or travel, the taxpayer must first establish that it is otherwise
allowable as a deduction under chapter 1 of the Code before the
provisions of section 274 become applicable.”12 Since any meal
11
Logic dictates that in order for meal money to be excluded
from gross income as a “de minimis fringe benefit”, meal money
provided to employees must be a “fringe benefit”.
12
See sec. 1.274-5(e), Income Tax Regs. (the term “business
expenses” includes ordinary and necessary expenses for travel,
but does not include personal expenses, and advances,
reimbursements, or allowances for personal expenses must be
reported as income by the employee); sec. 1.274-5T(f)(1),
Temporary Income Tax Regs., 50 Fed. Reg. 46027-46028 (Nov. 6,
(continued...)
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expenditures by employees during day trips would not be
deductible by the employees as travel expenses, United States v.
Correll, 389 U.S. at 299, section 274(d) has no application.13
2. Overnight Trips
The holding that the per diem allowances for overnight trips
are deductible as compensation under section 162(a)(1) is
consistent with the characterization of the day trip allowances.
However, it is necessary to provide additional explanation for
why the allowances for overnight trips are not “travel” expenses
as to petitioner.
Section 61(a)(1) provides that compensation for services,
including fringe benefits, is included in gross income. Section
62(a), which allows an employee a deduction for expenses incurred
12
(...continued)
1985) (same).
13
Note also that the regulations under sec. 274 regarding
substantiation refer only to travel away from home. Sec. 1.274-
5(a)(1) and (b)(2), Income Tax Regs.; sec. 1.274-5T(a)(1) and
(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,
1985). Thus, this Court declined to apply sec. 274(d) to a
taxpayer’s business use of his automobile which was purely local.
Cobb v. Commissioner, 77 T.C. 1096, 1101 (1981), affd. without
published opinion 680 F.2d 1388 (5th Cir. 1982); Gestrich v.
Commissioner, 74 T.C. 525, 530-531 (1980), affd. without
published opinion 681 F.2d 805 (3d Cir. 1982). Sec. 274(d) was
subsequently amended for taxable years after Dec. 31, 1985, to
provide that no deduction shall be allowed for listed property,
which includes any passenger automobile, unless strict
substantiation requirements are met.
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in his employment in computing adjusted gross income, provides,
in pertinent part:
the term “adjusted gross income” means * * * gross
income minus the following deductions:
* * * * * * *
(2) Certain trade and business deductions of
employees.--
(A) Reimbursed expenses of employees.–-
The deductions allowed by part VI (section
161 and following) which consist of expenses
paid or incurred by the taxpayer, in
connection with the performance by him of
services as an employee, under a
reimbursement or other expense allowance
arrangement with his employer.
However, pursuant to the regulations, if an employee is paid
under a reimbursement or expense allowance agreement and makes an
“adequate accounting” to the employer, then the employee is not
required to report the allowance in income. Sec. 1.274-5(e)(2),
Income Tax Regs; sec. 1.274-5T(f)(2), Temporary Income Tax Regs.,
50 Fed. Reg. 46028 (Nov. 6, 1985). An employee could meet the
adequate accounting requirement if the allowance is fully
substantiated by the employee to the employer. Sec. 1.274-
5(e)(4), Income Tax Regs.; sec. 1.274-5T(f)(4), Temporary Income
Tax Regs., 50 Fed. Reg. 46029 (Nov. 6, 1985). Alternatively,
the employee could meet the adequate accounting requirement if
the per diem allowance fell under either Rev. Rul. 80-62, 1980-1
C.B. 63, or Rev. Rul. 84-164, 1984-2 C.B. 63, because the
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allowances would be deemed substantiated up to the amounts set
forth in those rulings. Sec. 1.274-5(f), Income Tax Regs.; sec.
1.274-5T(g), Temporary Income Tax Regs., 50 Fed. Reg. 46030-46031
(Nov. 6, 1985). If the total allowance received exceeded the
amount of deductible expenses incurred by the employee, then the
excess would have to be reported as income on the employee’s tax
return. Sec. 1.274-5(f), Income Tax Regs.; sec. 1.274-5T(g),
Temporary Income Tax Regs., supra.
For the years in issue, Rev. Rul. 80-62, supra, treated $44
per day as substantiated for purposes of section 274(d) while
Rev. Rul. 84-164, supra, treated $14 per day as substantiated for
purposes of section 274(d). The determination of which ruling
applies depends on what expenses the per diem allowances are
intended to cover. A plain reading of Rev. Rul. 84-164, supra,
indicates that it applies when an allowance arrangement is
exclusively for meals. On the other hand, in Murphy v.
Commissioner, T.C. Memo. 1993-292, we held that Rev. Rul. 80-62,
supra, applied where an allowance arrangement was designed to
cover both meals and incidental expenses.
Respondent argues that Murphy v. Commissioner, supra, was
incorrectly decided.14 Respondent argues that Rev. Rul. 80-62,
14
The parties agree that the issue of the appropriate ruling
to apply is limited to per diem allowances paid before Jan. 1,
1989. Rev. Proc. 89-67, 1989-2 C.B. 795 (construing Rev. Rul.
(continued...)
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supra, applies only where the reimbursement includes an amount
for lodging expense, and that Rev. Rul. 84-164, supra, applies to
situations involving meals and incidental expenses, but not
lodging. However, Rev. Rul. 80-62, supra, does not require a
lodging expense and by its specific terms, Rev. Rul. 84-164,
supra, limits its applicability to allowances for meals only and
deems $14 as the amount substantiated.
In analyzing the expenses which the revenue rulings are
designed to cover, a logical disconnect surfaces. Under a plain
reading of the two rulings, combined with our decision in Murphy
v. Commissioner, supra, the difference between the amount that
can be deemed substantiated under each ruling, $30, can be
attributed solely to incidental expenses. However, Rev. Rul. 80-
62, 1980-1 C.B. at 64, also requires that “the employer
reasonably limits payment of such travel expenses to those that
are ordinary and necessary in the conduct of the trade or
business”. Assuming the revenue rulings are consistent in terms
of the amount applicable to meals under each ruling, it seems
logical that $14 of the allowance petitioner paid would
constitute the amount that the rulings accept as reasonable for
meal expenses. This being so, petitioner would bear the burden
of proving that the additional amount of the allowance for
14
(...continued)
84-164, 1984-2 C.B. 63, to cover meals and incidental expenses).
- 21 -
overnight trips ($23.20 for pilots, $22 for other employees)15
was reasonable as required by Rev. Rul. 80-62, supra. Am.
Airlines, Inc. v. United States, 204 F.3d at 1111.
The evidence in the record indicates that the per diem
allowances for overnight trips (excluding meals) were for tips
for waiters, baggage handlers and drivers, transportation between
hotels and restaurants, telephone calls, personal laundry,
newspapers, and shoeshines.16 Petitioner relied on an expert
report which it claims shows that the amount of the allowances
was a reasonably accurate estimate of actual travel costs
incurred by the employees. Petitioner presented evidence that,
of the maximum $36 allowance ($37.20 for pilots for certain
portions of the years in issue) for overnight trips, between $4
and $7 was for incidental expenses. Thus, the reasonableness of
the amount of the per diem allowance for overnight trips was
based mostly on amounts attributable to the costs of meals. The
problem in the instant case is that Rev. Rul. 84-164, supra,
15
Petitioner paid a per diem allowance of $1.50 per hour
($1.55 per hour for pilots for certain portions of the years in
issue) to its employees. The maximum allowance an employee was
entitled to for one 24-hour period was $36 ($37.20 for pilots for
certain portions of the years in issue). Subtracting $14 from
this maximum allowance for 1 day to account for meal expenses
leaves $22 ($23.20 for pilots for certain portions of the years
in issue) which would not be attributable to meals.
16
Petitioner either directly paid, provided, or reimbursed
employees for costs of lodging, ground transportation between
airports and hotels, parking, and cleaning uniforms.
- 22 -
deems $14 substantiated for purposes of meals, while a much
greater amount of the per diem allowance in the instant case was
based on meals and only a small fraction of the overall allowance
was attributable to incidental expenses.
On the basis of these facts, how could United’s payment of
$36, or $37.20, be reasonable when Rev. Rul. 84-164, supra,
treats meals as substantiated only to the extent of $14 and
petitioner’s own expert report attributed, at most, between $4
and $7 to incidental expenses? Allowing petitioner to deduct the
full allowance under the authority of Rev. Rul. 80-62, supra, in
these circumstances conflicts with the overall function of the
deemed substantiation methods. In Am. Airlines, Inc. v. United
States, 204 F.3d at 1111, the Court of Appeals for the Federal
Circuit commented on this conflict:
American argues that even if it cannot meet the
substantiation requirements of § 274(d), American’s
covered meals and incidental expenses allowance of $36
per day fall in the middle range of the $14 meals-only
safe harbor of Rev. Rul. 84-164 and the $44 full per
diem safe harbor of Rev. Rul. 80-62 1980-1 C.B. 63,
and, therefore, American’s $36 per diem allowance
should be deemed substantiated for § 274 purposes. We
agree with the Government that American’s reasoning is
flawed because it ignores the fact that the deemed
substantiated limit under Rev. Rul. 80-62 includes
lodging, which accounts for a greater portion of an
employee’s daily expenses. Further, under American’s
logic, $22 of this amount would include incidental
expenses, and the burden is upon American to prove that
such an amount would meet the “ordinary and necessary”
requirement of I.R.C. § 162.
- 23 -
The facts at hand present a challenging question because
petitioner does not fit within either of the revenue rulings.
Respondent recognizes the potential discontinuity of coverage
between the two rulings and suggests that the resolution should
be that there is no revenue ruling explicitly in force which
covers the instant case. In my opinion, the inapplicability of
Rev. Rul. 84-164, 1984-2 C.B. 63, as recognized in Murphy v.
Commissioner, supra, combined with petitioner’s failure to prove
entitlement to the deemed substantiation amount in Rev. Rul. 80-
62, 1980-1 C.B. 63, precludes the applicability of either ruling.
It follows that the allowances are not deductible by petitioner
as “travel” expenses.
The issue thus becomes whether petitioner is entitled to
deduct the per diem allowances as compensation. In this regard,
respondent’s sole argument is that petitioner is not entitled to
a deduction under section 162(a)(1) because United did not intend
to compensate its employees for personal services rendered when
it paid the employees per diem allowances. However, as noted
earlier, intent is a pertinent factor to consider, not a
prerequisite to deductibility under section 162(a)(1). As
explained previously, if the amounts paid to the employees cannot
be treated as travel expenses by petitioner, they should be
treated as compensation to the employees. In addition, the trial
judge has found that United paid the per diem allowances to the
- 24 -
employees intending to compensate them for their personal
services.17
Finally, respondent urges this Court to exercise its
discretion to hold petitioner to a “duty of consistency” and not
allow it to recharacterize the allowances as compensation. In
LeFever v. Commissioner, 103 T.C. 525, 541 (1994), affd. 100 F.3d
778 (10th Cir. 1996), this Court addressed the equitable doctrine
of the duty of consistency:
The “duty of consistency” is based on the theory that
the taxpayer owes the Commissioner the duty to be
consistent with his tax treatment of items and will not
be permitted to benefit from his own prior error or
omission. The duty of consistency doctrine prevents a
taxpayer from taking one position one year and a
contrary position in a later year after the limitations
period has run on the first year. [Citations
omitted.][18]
17
It should be noted that the relevant statutes and
regulations have been clarified since the years in issue with
respect to the tax treatment of per diem allowances. Under
current law, per diem allowances are paid under either an
“accountable” plan or a “nonaccountable” plan, and the tax
consequences differ depending on which plan the allowances are
paid under. For discussions of accountable and nonaccountable
plans, see Trucks, Inc. v. United States, 234 F.3d 1340 (11th
Cir. 2000), Brenner v. Commissioner, T.C. Memo. 2001-127, and
United States v. Armstrong, 974 F. Supp. 528 (E.D. Va. 1997).
18
See Hughes & Luce, L.L.P. v. Commissioner, T.C. Memo.
1994-559, affd. on other grounds 70 F.3d 16 (5th Cir. 1995),
wherein we outlined the following requirements for application of
the duty of consistency:
(1) The taxpayer made a representation or reported an
item for Federal income tax purposes in one year, (2)
the Commissioner acquiesced in or relied on that
(continued...)
- 25 -
In the instant case, the periods of limitation with respect to
petitioner’s income tax liability for 1986 and 198719 and
employment tax liability for 1985, 1986, and 1987, are still
open. Respondent’s concern is that, since the tax years for the
individual employees are probably closed, the tax due on the
employees’ income will not be paid. However, a remedy for that
situation is to seek withholding tax from petitioner for the
years in issue, a remedy which respondent is currently seeking in
the Court of Federal Claims. United Air Lines, Inc. v. United
States, No. 97-173T (Fed. Cl., filed Mar. 18, 1997). Petitioner
is simply correcting its tax return to account for its initial
erroneous treatment of the per diem allowances as “travel”
expenses.20
18
(...continued)
representation or report for that year, and (3) the
taxpayer attempts to change that representation or
report in a subsequent year, after the period of
limitations has expired with respect to the year of the
representation or report, and the change is detrimental
to the Commissioner. * * * [Citations omitted.]
19
The only issues in dispute in this case are the
deductibility of the per diem allowances paid for 1985, 1986, and
1987, and the computational items resulting therefrom. No
deficiency was determined for the taxable year 1985 because the
period of limitations for that year had expired at the time the
notice of deficiency was issued. However, the deductibility of
expenses (including per diem allowances) for 1985 directly
affects other tax items, such as net operating loss carrybacks
and carryovers, for the remaining years in issue.
20
Indeed, it appears that petitioner’s claim that the
(continued...)
- 26 -
3. Conclusion
The per diem allowances are not deductible by petitioner as
travel expenses. However, these allowances were required under
the terms of the employment contract that petitioner negotiated
with the union. Petitioner had to pay the allowances in order to
receive the services of its employees. The amount of the per
diem allowance paid to each individual employee was determined
based on the number of hours he or she worked while on duty or on
flight assignment and was directly tied to the quantity of
services rendered. The per diem payments were paid for services
actually rendered by the employees and are deductible under
section 162(a)(1).21
WELLS, CHABOT, GERBER, GALE, and MARVEL, JJ., agree with
this concurring opinion.
20
(...continued)
allowances are deductible as compensation was predicated on
respondent’s determination that the allowances were “wages” for
employment tax purposes.
21
For purposes of this case, respondent has conceded that if
the per diem allowances are deductible as compensation, then the
percentage limitations of sec. 274(n) will not apply.
- 27 -
THORNTON, J. concurring: The majority concludes that the
per diem payments are deductible on the ground that the payments
are compensatory in nature. The majority does not address to
what extent, if any, this case implicates statutory rules (i.e.,
sections 162(a)(2) and 274(d)(1)) affecting the deductibility of
travel expenses. Absent any clear indication to the contrary,
the majority opinion might be construed as indulging a suppressed
premise that the compensatory nature of the payments overrides or
renders moot the operation of rules pertaining to travel
expenses.1 To that extent, the majority opinion might be
susceptible to criticism such as that registered by the
dissenters. It would not appear necessary or appropriate,
however, to construe any implicit premises of the majority
opinion so broadly, for on the facts of this case, it appears
that the per diem payments do not in fact represent travel
expenses.
The majority rightly concludes that the per diem payments
were compensatory in nature. The facts also support an
1
Two possible bases for such a suppressed premise suggest
themselves: (1) That treatment as compensation under sec.
162(a)(1) trumps treatment as travel expenses under secs.
162(a)(2) and 274(d)(1)–-a proposition that seems difficult to
square with the statutory regime; or (2) that because the per
diem payments are compensatory, ipso facto they are not travel
expenses. Without further explication, this latter proposition
might be thought to exemplify a species of the so-called “masked
man fallacy” (“I know who my father is; I do not know who the
masked man is; so, my father is not the masked man.”).
Blackburn, Think: A Compelling Introduction to Philosophy 30
(1999).
- 28 -
affirmative conclusion that these payments were not travel
expenses. The pilots and flight attendants could use the per
diem payments as they pleased, just as they could use their base
salaries as they pleased. The per diem payments were not
contingent on the employees’ incurring or accounting for any
travel expenses. Indeed, the per diem payments were in addition
to amounts United provided its employees for practically all
travel expenses except meals and incidentals.2
Rather than provide its employees meals and incidentals,
United agreed, as part of a negotiated union contract, to pay
them small hourly wage enhancements for all hours they were on
duty or on flight assignment. The union contract refers to the
wage enhancements as per diem payments. The nomenclature does
not affect the reality, however, that the bargain struck was for
additional compensation, not for meals, incidentals, or other
travel expenses.
The fact that the per diem payments were computed by
reference to time spent on duty or aboard the aircraft does not
suggest that the per diem payments are travel expenses. Rather,
it suggests the contrary. Hours on duty or on board an aircraft
would appear to encompass substantially all the pilots’ and
flight attendants’ hours on the job. Moreover, from United’s
2
The record reveals that in addition to providing its
pilots and flight attendants per diem payments, United also
provided them–-either directly or through reimbursement--lodging,
ground transportation between airports and hotels, and uniform
laundering.
- 29 -
perspective, hours its employees spend in flight do not represent
travel away from its place of business (i.e., the aircraft), any
more than aviation fuel represents a cost of travel. After all,
United’s business is air transportation.
Consider the hypothetical case of a flight crew that goes on
duty and boards one of United’s aircraft only to sit on the
tarmac for some hours (for any of the myriad reasons especially
familiar to a traveling Court) without ever taking flight.
Presumably, the pilots and flight attendants on this aircraft
would be entitled to per diem payments based on the number of
hours they were on duty, without having gone anywhere. Some of
them might return home, if home were nearby; others might go to
hotels. They might lay over variously for short times or long
times, subsisting lavishly or meanly. But each of them would
receive the predetermined per diem payment, based on the number
of hours spent sitting on the tarmac. In this hypothetical case,
it seems clear that the per diem payments are too indirectly
related to any employee travel to be considered travel expenses.
It would make no material difference to the analysis if the
employees’ hours on duty were airborne.
WELLS, CHABOT, GERBER, BEGHE, and MARVEL, JJ., agree with
this concurring opinion.
- 30 -
CHIECHI, J., concurring in part and dissenting in part: I
concur in the majority’s holding that the per diem allowances for
day trips that United paid to its employees are deductible under
section 162(a)(1). I dissent from the majority’s holding that
the per diem allowances for overnight trips that United paid to
its employees are deductible under section 162(a)(1). I believe
that the amounts of such per diem allowances for overnight trips
claimed as deductions under section 162(a)(2) are deductible
under that section.
- 31 -
SWIFT, J., dissenting: This case involves claimed ordinary
deductions in the range of $100 million and extensive arguments
by the parties. If it works (which I don’t believe it does), the
majority opinion is remarkable in its brevity.
Recharacterization of Per Diem Allowances
as Employee Compensation
The majority opinion suggests that respondent’s
characterization herein for corporate income tax purposes of
United’s per diem allowances is inconsistent with respondent’s
characterization of the per diem allowances in the pending
employment tax litigation. See majority op. p. 8. I disagree.
As I understand respondent’s positions, in both the income
tax and the employment tax contexts, respondent is treating the
per diem allowances as travel expenses. Respondent simply takes
the position, as a matter of law, that the income tax and the
employment tax regimes are not necessarily in pari materia and
that under those different tax regimes the day-trip per diem
allowances and the excess of the overnight per diem allowances
(i.e., the portion of the per diem allowances not substantiated)
are nondeductible to United for corporate income tax purposes
(because of United’s failure to satisfy the substantiation
requirements of section 274(d)) and are subject to employment tax
liability (not because the unsubstantiated and excess travel per
diem allowances actually constitute wage compensation to United’s
- 32 -
employees but because the employment tax provisions treat
unsubstantiated and excess per diem travel allowances as subject
to employment taxes as if they were compensation). Any
disagreement with that legal interpretation should be addressed
on the merits, and the innuendo in the majority opinion of
factual inconsistency on respondent’s part in the
characterization of per diem allowances is inappropriate.
The more significant concern with regard to “inconsistent”
characterizations in this case should be with United's efforts to
recharacterize entirely the per diem allowances that United, its
employees, and the labor unions, for all other purposes, treated
as employee travel expenses.1 United now, years later, and
solely for Federal income tax purposes, attempts to
inconsistently treat such travel expenses as employee
compensation, outside the scope of the substantiation
requirements of section 274(d), and fully deductible under
section 162(a)(1).
An extensive body of case law limits a taxpayer’s ability to
change the treatment of reported items of income and deductions.
See, e.g., Norwest Corp. & Subs. v. Commissioner, 111 T.C. 105,
146-147 (1998); LeFever v. Commissioner, 103 T.C. 525, 541-545
(1994), affd. 100 F.3d 778 (10th Cir. 1996).
1
The parties’ stipulation of facts filed with the Court in
this case repeatedly acknowledges United’s specific treatment of
the per diem allowances as travel expenses.
- 33 -
From the record herein, it appears that United and other
airlines, not respondent, initially sought what some might regard
as an additional inconsistency in the treatment of the per diem
allowances. Respondent’s audit of the per diem allowances within
the airline industry began as employment tax audits of travel
expenses. In the context of those employment tax audits (and
while still contesting any employment tax adjustments and likely
only as a protective measure against the possibility that the
employment tax adjustments might be sustained), United and other
airlines raised the issue via claims for refund as to the
deductibility, for corporate income tax purposes, of the
unsubstantiated and excess per diem allowances relating to the
overnight trips and of the full per diem allowances relating to
the day trips.
In the instant income tax controversy and in the majority
opinion, it is simply not appropriate to comment negatively on
respondent’s position in the pending employment tax litigation
with United.
As stated, the inconsistencies that we should be focusing on
and addressing herein are the many factual inconsistencies
between United’s treatment of the per diem allowances as travel
expenses for all purposes other than belatedly for its corporate
Federal income tax purposes.
- 34 -
On its face, the majority opinion is inadequate to support a
finding that the per diem allowances constituted employee
compensation “for services rendered”, as opposed to travel
expenses. In its summary “Findings of Fact”, see majority op.
pp. 2-5 and also the Headnote, the majority opinion repeatedly
describes the amounts in controversy as “per diem” related to
employee “trips”. Surely, “per diem” related to employee “trips”
constitutes travel expenses. The majority’s avoidance of the
word “travel”, when mentioning the per diem allowances, does not
conceal the character of the per diem allowances as travel
expenses.
No mention is made in the majority’s Findings of Fact that
the per diem allowances represent a payment “for services”. In
fact, in the majority’s brief Findings of Fact, nothing is found,
or even mentioned, as to the “purpose” or “intent” for which the
per diem allowances were paid (other than “for” employee
“trips”).2 Nothing about this opinion “speaks loudly”, see
2
In analyzing whether an intent to compensate existed, we
typically consider, among other factors: Whether there was
corporate authorization for the payment of compensation; whether
the books and records of the corporation reflected that the
payments were treated as payments of compensation; whether the
payments were reported to the recipients on Forms W-2, Wage and
Tax Statement, as wage compensation; and whether the payments
were treated as compensation on the employer’s and employees’ tax
returns as filed. See, e.g., Paula Constr. Co. v. Commissioner,
58 T.C. 1055, 1059 (1972), affd. without published opinion 474
F.2d 1345 (5th Cir. 1973); Elec. & Neon, Inc. v. Commissioner, 56
T.C. 1324, 1338-1340 (1971), affd. without published opinion 496
(continued...)
- 35 -
majority op. p. 7, except perhaps its ultimate conclusion under
which millions of dollars of United’s travel expenses become
fully deductible in spite of United’s failure to satisfy the
substantiation requirements of section 274(d), discussed below.
In Am. Airlines, Inc. v. United States, 204 F.3d 1103, 1108
(Fed. Cir. 2000), in connection with the ongoing employment tax
dispute, the U.S. Court of Appeals for the Federal Circuit
appears to have held that the travel expenses in issue (if, on
remand, they are found to have been reasonably expected to be
incurred by the airline employees) could not be recharacterized
as wage compensation for employment tax withholding purposes. In
this regard, the Court of Appeals for the Federal Circuit relied
on and quoted both section 31.3121(a)-1(h) (regarding employment
tax withholding) and section 31.3401(a)-1(b)(2) (regarding income
tax withholding), Employment Tax Regs., which provide as follows:
§ 31.3121(a)-1(h): Amounts paid specifically–- either
as advances or reimbursements–-for traveling or other bona
fide ordinary and necessary expenses incurred or reasonably
expected to be incurred in the business of the employer are
not wages. Traveling and other reimbursed expenses must be
identified either by making a separate payment or by
specifically indicating the separate amounts where both
wages and expense allowances are combined in a single
payment. [Emphasis added.]
§ 31.3401(a)-1(b)(2): Traveling and other
expenses. Amounts paid specifically–-either as
2
(...continued)
F.2d 876 (5th Cir. 1974); Prince v. Commissioner, T.C. Memo.
1997-324.
- 36 -
advances or reimbursements–-for traveling or other bona
fide ordinary and necessary expenses incurred or
reasonably expected to be incurred in the business of
the employer are not wages and are not subject to
withholding. Traveling and other reimbursed expenses
must be identified either by making a separate payment
or by specifically indicating the separate amounts
where both wages and expense allowances are combined in
a single payment. [Emphasis added.]
United’s attempt to recharacterize as deductible
compensation the day-trip per diem travel allowances and the
excess portion (over $14) of the overnight per diem travel
allowances should be rejected.
The Substantiation Requirements of Section 274(d)
I do not understand the casual manner by which the majority
opinion bypasses the substantiation requirements of section
274(d).
It appears to me that the substantiation requirements for
travel expenses under section 274(d) are applicable to day-trip
travel allowances, as well as to overnight travel allowances.
The language of section 1.274-5T(a)(1), Temporary Income Tax
Regs., 50 Fed. Reg. 46027 (Nov. 6, 1985), states that “no
deduction or credit shall be allowed with respect to–-(1)
Traveling away from home * * *”. This regulatory language does
not say that the requirements of section 274(d) do not apply to
day-trip travel expenses. Any such reading would be contrary to
the explicit language of the statute, as pointed out below.
- 37 -
Further, the first two sentences of section 1.274-5(e),
Income Tax Regs., as applicable to 1985, 1986, and 1987, and
section 1.274-5T(f)(1), Temporary Income Tax Regs., 50 Fed. Reg.
46027 (Nov. 6, 1985), confirm that even if travel expenses are
paid in connection with the “performance of services” and are
otherwise deductible under section 162 (which is what the
majority opinion holds), they must still satisfy the
substantiation requirements of section 274(d).
A closer look at the relevant statutory language is helpful.
There are important differences in the language and operation of
section 162(a)(2) (an allowance provision that relates only to
overnight travel expenses) and of section 274(d)(1)
(a disallowance provision that relates to any and all travel
expenses).
Section 162(a)(2) provides that deductions for all taxpayers
are allowed for any:
(2) traveling expenses (including amounts expended for
meals and lodging other than amounts which are lavish or
extravagant under the circumstances) while away from home in
the pursuit of a trade or business. [Emphasis added.]
Section 274(d)(1), however, in pertinent part provides:
SEC. 274(d). Substantiation required.–- No deduction
or credit shall be allowed–-
(1) under section 162 or 212 for any traveling
expense (including meals and lodging while away from
home),
- 38 -
* * * * * * *
unless the taxpayer substantiates by adequate records or by
sufficient evidence * * * [Emphasis added.]
Note that in section 274(d)(1) the “away from home” language
is located within the parenthesis (whereas in section 162(a)(2)
that language is outside the parenthesis), making it clear that
all travel expenses are covered by the disallowance provision of
section 274(d). Note also the familiar definitions of “taxpayer”
in sections 1313(b) and 7701(a)(1) that include the term
“corporation”.3
Various tax treatises and court opinions explicitly or
implicitly recognize that the substantiation requirements of
section 274(d) apply to corporations, not just to employees of
corporations (as the majority opinion may be read to suggest).
For example, see Bittker & Eustice, Federal Income Taxation of
Corporations and Shareholders, par. 5.03[1], at 5-12 (7th ed.
2000); Stechel, 520 Tax Mgmt. (BNA), “Entertainment, Meals, Gifts
3
In his concurring opinion, Judge Ruwe notes that United’s
per diem allowances covering meal expenses for day trips are not
deductible as travel expenses under United States v. Correll, 389
U.S. 299 (1967). Rather, however, than qualifying as deductible
compensation under sec. 162(a)(1), such day trip meal expenses
remain nondeductible to United because they represent the payment
by United of personal living expenses of United’s employees. See
sec. 262 and the Supreme Court’s holding in Correll. With regard
to the various incidental travel expenses that also were included
in United’s day trip per diem allowances, they remain subject to
the substantiation requirements of sec. 274(d). See sec.
274(d)(1).
- 39 -
and Lodging–-Deduction and Recordkeeping Requirements,” at A-33
(1998); 6 Mertens, Law of Federal Income Taxation, ch. 25D
(1998), for implicit recognition of the application of the
substantiation requirements of section 274(d) to corporations;
see also numerous published court opinions illustrating the
application of the substantiation requirements of section 274(d)
to corporations: Meridian Wood Prods. Co. v. United States, 725
F.2d 1183, 1188-1189 (9th Cir. 1984); Ma-Tran Corp. v.
Commissioner, 70 T.C. 158, 169-170 (1978); Buddy Schoellkopf
Prods., Inc. v. Commissioner, 65 T.C. 640, 642-645 (1975); Henry
Schwartz Corp. v. Commissioner, 60 T.C. 728, 741-743 (1973).
Also, under section 274(a), Congress restricted the
deductions for entertainment, amusement, and recreation expenses
where such expenses are not directly related to or associated
with the active conduct of a taxpayer’s trade or business. Under
section 274(e), however, Congress provided an exception for such
expenses where a taxpayer affirmatively elects to treat, and in
fact does so treat, the expenses as wage compensation subject to
income and employment tax withholding.
Congress obviously knew how to provide a recharacterization
option and an election out of the section 274(d) substantiation
requirements. Had Congress intended to provide taxpayers such as
United with a similar recharacterization option and an election
out of the substantiation requirements of section 274(d) for
- 40 -
travel expenses, it could have so provided. Congress not having
done so, it appears to me inappropriate for us to do so.
$44 or $14 Per Diem Limitation on Overnight Per Diem Allowances
With regard to the section 274(d) substantiation
requirements applicable to United’s overnight per diem
allowances, respondent’s regulations and rulings are to be given
particular weight. See sec. 274(d); sec. 1.274-5(c)(2)(b),
Income Tax Regs. The majority opinion, however, ignores the
specific rulings that respondent promulgated which apply to
employer-provided overnight travel allowances and to the years in
controversy herein.
Rev. Rul. 80-62, 1980-1 C.B. 63 (hereinafter referred to as
the $44 Ruling), provided that, for overnight travel allowances,
the maximum per diem deduction available without substantiation
was $44 per day, which included travel expenses for meals and
lodging, laundry, cleaning and pressing of clothing, and fees and
tips for services, such as for waiters and baggage handlers.
However, Rev. Rul. 84-164, 1984-2 C.B. 63 (hereinafter
referred to as the $14 Ruling), provided that the $44 Ruling did
not apply where the “per diem allowances [were] intended to cover
only employee meal expenses, as when the employer pays for
directly or furnishes the lodging, or when there is no lodging
expense.” (Emphasis added.) The $14 Ruling's stated purpose is
to amplify and to limit the $44 Ruling.
- 41 -
It appears to me that the above language constitutes a
blanket disqualification of the $44 Ruling where there are no
lodging expenses relating to overnight travel to be paid out of
per diem travel allowances. As I read the language of the $14
Ruling, in the context of overnight travel, the maximum allowable
amount that may be deducted under any provision of section 162
without substantiation can be no more than $14 per day in two
instances: (1) Where only employee meals are covered by the
allowances, or (2) where there are no lodging expenses. Our
memorandum opinion to the contrary in Murphy v. Commissioner, T.C.
Memo. 1993-292, does not constitute binding precedent and should
not be followed.4
In the present case, because there were no lodging expenses
to be paid by United’s employees out of the overnight per diem
travel allowances the employees received, section 274(d)(1)
limits the maximum amount deemed substantiated under United’s per
diem program to $14 per day.
Union Negotiations
United and the labor unions specifically bargained for and
characterized the per diem allowances in the union contracts as
travel expenses. United did not pay employment taxes on the per
4
In Rev. Proc. 89-67, sec. 2, 1989-2 C.B. 795, 797, it was
made even clearer that without lodging expenses per diem
allowances would be subject to the $14 limitation.
- 42 -
diem allowances, and the employees did not report the per diem
allowances in income.
Where the tax consequences differ for the characterization
of expenses as either travel or compensation, the
characterization of the expenses by the parties should be adhered
to. The majority opinion simply negates the bargaining positions
of United, on the one hand, and of the labor unions and the
employees, on the other, to pay and to receive travel expenses,
not compensation income.
In his concurring opinion, Judge Thornton is correct to ask
what was bargained for between United, its employees, and the
unions. The answer, however, is explicitly provided in the
stipulated facts –- per diem travel allowances, not compensation.
Paragraph 13 of the stipulation of facts states the following:
Because pilots and flight attendants continuously
traveled for United, requiring specific documentation
for meals and incidental expenses would have been
administratively burdensome. The per diem arrangement
was thus designed to reimburse the employees for meals
and incidental travel expenses, without requiring them
to retain and submit receipts for each individual
expenditure. [Emphasis added.]
The fact that for the administrative convenience of United
and the employees the per diem allowances were computed on an
hourly basis does not convert the allowances into something other
than travel expenses.
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Judicially Created Loophole
The majority opinion appears to create a broad loophole for
corporations and would circumvent Congress' intent with regard to
the substantiation requirements of section 274(d).
The opinion appears to allow expenses that would be
disallowed under section 274(d) to be recharacterized as
deductible compensation, provided the expenses are paid by an
employer to an employee in the context of any employment
relationship. See majority op. p. 6, where the “but for”
analysis is set forth. Because corporations generally have
periods of limitation held open longer than individuals, the
opinion would allow corporations on their tax returns to treat
expenses as travel expenses and to avoid income and employment
tax withholdings thereon. After the periods of limitations have
expired for the employees, the corporations could recharacterize
the travel expenses as compensation. The corporations would
obtain an income tax deduction for the recharacterized
compensation, but the employees would avoid income and employment
taxes on the compensation.
The majority opinion erroneously relies on Commissioner v.
Kowalski, 434 U.S. 77 (1977), in which the Supreme Court held
that cash meal allowances provided to a State trooper were to be
included in the trooper’s gross income. The meal allowances were
not claimed as travel expenses, and substantiation of the
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expenses was not at issue. Further, neither party herein relied
on nor even cited Kowalski.
Lastly, by recharacterizing the travel expenses as
deductible compensation for 1987 and later years, the portion of
the previously treated travel expenses that represented meal and
entertainment expenses become freed from the various percentage
limitations applicable thereto and become fully deductible. See
sec. 274(n). This is exactly what United is seeking to
accomplish in this case for 1987.
For the reasons stated, I dissent.
COHEN and COLVIN, JJ., agree with this dissenting opinion.