07.21.10

Maximize Your Business Tax Deduction for Reimbursed Expenses

Sara Zeller and Yolimar Martinez-Nadal

Many businesses, including government contractors, pass along costs incurred under a contract to their customers. These direct contract costs may include meal and incidental expenses (“M&IE”) incurred on behalf of the customers. For example, your employee may incur meal expenses while travelling away from home as part of performing services under the contract. You, as the employer, will reimburse them for properly substantiated expenses. Then the expenses are included on an invoice to your customer for full reimbursement under the contract terms.

The Internal Revenue Service (“IRS”) only allows a tax deduction for 50% of any meals and entertainment expenses incurred in the regular course of doing business. There are specific exceptions to this limitation, and one is when the taxpayer is fully reimbursed by a customer for the M&IE; therefore, the customer is subject to the 50% limitation as the ultimate bearer of the expense.

When you are the business owner that receives full reimbursement under the contract, you want to make certain that you are entitled to 100% of the original expense since you received 100% of the reimbursement. To ensure this, a business needs to properly state the responsibilities in the contract and provide proper documentation with the invoices.

In Revenue Ruling 2008-23, the IRS addressed the situation where the taxpayer leased employees to customers. As long as the proper documentation is provided to the customer on what M&IE is incurred, the IRS ruled that the 50% limitation applies to the party that ultimately bears the per diem expenses (i.e. M&IE), regardless of which party is the employer under the common law rules. Proper documentation is the detailed records that would meet the IRS substantiation requirements. The IRS further explained that the leasing company would be subject to the 50% limitation on M&IE if they did not provide proper substantiation to their customer.

Many businesses in the Washington, D.C. area are government contractors, whose ultimate customer is the government. Although the government is not a taxable entity, it is not outside the realm of possibility that the IRS would apply these requirements to government contractors. Therefore, all businesses that are reimbursed for M&IE should ensure that their contracts and invoices are properly stated.

The contract and the invoice should clearly state that the M&IE costs and related 50% limitation are being passed to your customer. If the IRS finds that proper communication and agreement with the customer did not occur, you will be subject to the 50% limitation on the reimbursed M&IE, including per diems.

If you have questions regarding this issue, please contact Sara Zeller or Yolimar Martinez-Nadal in Argy’s corporate tax department.

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