IRS proposes regulations on club dues, spousal travel, and meal and entertainment expenses.

Since the enactment of the Revenue Reconciliation Act of 1993 (RRA), there has been considerable confusion among employers and employees on how to treat the new restrictions on deductibility of club dues, spousal travel, and meal and entertainment expenses. Generally, the RRA increased the nondeductible portion of meal and entertainment expenses from 20% to 50% and disallowed all deductions for club dues and spousal travel for amounts paid or incurred after Dec. 31, 1993. The confusion centered around when employer reimbursements of these expenses would have to be included in wages on Form W-2 and whether an employer would be entitled to a compensation deduction if the reimbursements were included in employee income. The IRS issued proposed regulations on Dec. 15, 1994 that bring some clarity to the area and provide employers with some choices.

These proposed regulations relate to meal and entertainment expenses, club dues and spousal travel that is business related. As under prior law, if meals, entertainment, club dues or spousal travel is furnished to employees and any expenses are not business related, the value of the provided benefits is income subject to withholding to the employee and deductible by the employer as compensation. (See Sec. 132 and the regulations for some limited exceptions to income inclusion, e.g., meals furnished at certain employee cafeterias.)

Business meal and

entertainment expenses

Prior to 1994, 20% of meal and entertainment expenses was nondeductible. Although no specific rules were ever issued by the Service, employers universally treated the 20 % as nondeductible at the employer level, and no amount was included in the employee's income, as long as the employee met the rules for substantiating the expenses under a reimbursement arrangement; see Sec. 62(c) and Regs. Sec. 1.62-2. In the new proposed regulations, Regs. Sec. 1.62-2(h) is amended to make this prior treatment official. Prop. Regs. Sec. 1.62-2(h) provides that a reimbursement or advance for business meal and entertainment expenses will not be considered wages subject to withholding, notwithstanding the deduction disallowance to the employer.

Club dues

One important issue regarding the disallowance of deductions for club dues was partially resolved in August 1994, in proposed regulations defining the term "club." Generally, dues paid to clubs organized to provide entertainment activities to members and clubs organized for business, pleasure, recreation or other social purposes are nondeductible. However, in Prop. Regs. Sec. 1.274-2(a)(2)(iii), the IRS excluded business leagues, trade associations, chambers of commerce, boards of trade, real estate boards, professional associations, and civic and public service organizations from the definition of club, unless a principal purpose of the organization is to conduct or provide access to entertainment activities for members or their guests.

To exclude business-related,, employer-reimbursed club dues from an employee's income, it is necessary to conclude that such dues are a working condition fringe benefit under Sec. 132(d). However, in order to qualify as working condition fringe benefit, the payment must be deductible by the employee if the employee pays it. The Service has now solved this technical problem by proposing to amend Regs. Sec. 1.132-5 to allow business-related club dues to qualify as working condition fringe benefits if (1) the employer has not treated the amounts as compensation, (2) the amounts would have been deductible without regard to Sec. 274(a), and (3) the employee substantiates the expense.

On the employer side, Sec. 274(e)(2) and (3) effectively give the employer a choice. The employer can choose not to deduct business-related reimbursed club dues on its return and not to include the reimbursement in the employee's income. Alternatively, the employer can choose to include the reimbursement in the employee's Form W-2 income and to deduct the amount of the reimbursement as a compensation deduction. An employer need not make the same choice for all employees but can decide on an employee-by-employee basis. If the employer claims the compensation deduction, the employee cannot claim a deduction for any of the club dues.

Spousal travel

One important point to note is that the spousal travel deduction disallowance (Sec. 274(m)(3)) applies to a lot more than spouses. The deduction disallowance applies to spouses, dependents and any other individual who is not an employee who accompanies a taxpayer on business travel. Therefore, businesses that bring clients or potential clients on business trips can be subject to disallowance of travel expenses.

In Prop. Regs. Sec. 1.274-2(f)(2)(iii), the IRS chose to treat spousal travel in the same way as it treated club dues. That is, spousal travel will be treated as a working condition fringe benefit to the employee if the employee's spouse travels for a legitimate business purpose and (1) the employer has not treated the amounts as compensation, (2) the amounts would have been deductible by the employee without regard to Sec. 274(m)(3), and (3) the employee substantiates the expense.

For the employer, the proposed regulations provide the same choices for spousal travel as for club dues. The employer can either not deduct the expense and not include it in the employee's income, or can include the expense in the employee's income and deduct the expense as compensation. Similarly, if the employer treats the reimbursement as compensation, the employee will lose the deduction. Although there were technical difficulties in reaching this result (the Sec. 274(e)(2) and (3) rules do not seem to apply to expenses disallowed under Sec. 274(m)), the preamble to the proposed regulations states that the Treasury and the IRS believe that club dues and spousal travel should be treated similarly.

These proposed regulations should make it a little easier for employers to decide how to treat these expenses and provide some certainty for the future.