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Signs of the times: how tax reform has limited access to moving expense deductions.

Prior to the Tax Reform Act of 1986, moving expenses were permitted as a tax deduction in calculating adjusted gross income (AGI) if they were incurred by an employee or self-employed individual as a result of a change in the principal place of work. This treatment resulted in a tax savings for both taxpayers who used the standard deduction as well as taxpayers who itemized their deductions, since the moving expenses could be deducted in either case.

The Tax Reform Act of 1986 changed the tax treatment of moving expenses by requiring that they be classified as an itemized deduction on Schedule A. The change resulted in a hardship for many taxpayers since those who could not itemize lost the opportunity to deduct the costs of moving. The situation was also made worse for taxpayers who were reimbursed by their employers for the move since the reimbursement was required to be included in gross income.

The Revenue Reconciliation Act of 1993 has again made modifications in the treatment of moving expenses effective for costs incurred after December 31, 1993. The new law changes the distance requirement that taxpayers must meet to qualify for the moving expense deduction, changes the classification of the deduction for moving expenses and restricts the types of expenses that qualify for deduction.

Deducting Moving Expenses

Taxpayers who qualify to deduct moving expenses incurred prior to January 1, 1994, must treat the expenses as an itemized deduction on Schedule A. Form 3903 must be filed to calculate the deduction. If the taxpayer is unable to itemize because the total expenses do not exceed the standard deduction for the year, the moving expense deduction is lost. For example, suppose a single taxpayer incurred $1,500 in moving expenses in 1993, paid $1,200 in state income taxes, and made a charitable contribution of $250. The taxpayer incurred no other costs that qualify as itemized deductions such as mortgage interest, medical expenses, or professional dues. Since the taxpayer's expenses total only $2,950, which is less than the $3,700 standard deduction for single taxpayers, the taxpayer will use the standard deduction and will lose the $1,500 deduction for his moving expenses.

Taxpayers who receive reimbursements for moving expenses incurred prior to January 1, 1994, must include the reimbursement in gross income as compensation for services. Amounts received in the form of money, the fair market value of property, or the fair market value of services are considered to be reimbursements. Therefore, if the taxpayer receives cash to pay for the costs of moving, has his moving expenses paid directly by his employer, or has his household goods moved by his employer using the employer's equipment, he is considered to have received a moving expense reimbursement.(1) The amount included as compensation will not be subject to withholding or treated as wages subject to FICA if the employer has a reasonable belief that the employee will qualify for the moving expense deduction.(2)

Income tax, social security tax and Medicare tax must be withheld from reimbursements that will not qualify for deduction either because the taxpayer will not meet the qualifying tests or because the expenses themselves will not qualify. Therefore, a taxpayer who is reimbursed by his employer but who is not able to itemize is doubly disadvantaged since he pays both income and FICA taxes on the amount spent on moving and receives no offsetting deduction.

Under the Revenue Reconciliation Act of 1993, taxpayers who qualify to deduct moving expenses incurred after December 31, 1993, will be permitted to deduct the expenses in computing adjusted gross income. The only moving expenses that will be deductible, however, will be those not paid for by the taxpayer's employer either directly or through reimbursement. Moving expenses that have been paid for by the taxpayer's employer will be excludable from gross income and from wages subject to withholding and FICA.(3) This new law will provide tax equity between taxpayers who are reimbursed for the move and those who are not since neither will be taxed on the amounts spent for the move. It will result in a tax savings as well as simplify the return preparation for many taxpayers. The new provision will be especially helpful for taxpayers starting their first full-time jobs, such as new high school and college graduates, since it is unlikely that they would have enough expenses to qualify for itemization.

Qualifying for the Moving Expense Deduction

For moving expenses to qualify for deduction, the taxpayer must meet a distance and a time requirement. For expenses incurred prior to January 1, 1994, the distance test stipulates that the distance from the taxpayer's former residence to the new principal place of work must be at least 35 miles farther than the distance from the old residence to the old principal place of work.(4) A taxpayer's residence is defined as the dwelling in which he spends more than half the year. Distances are measured by the shortest of the more commonly traveled routes between a taxpayer's residence and place of work.(5) The distance test must be met to qualify for the deduction even if the taxpayer was required to move by his employer.

To illustrate, assume that the taxpayer lives in town A and works in town B, a commuting distance of 10 miles. The taxpayer takes a new job in town C which is 40 miles from his home. Since his new place of work is only 30 miles farther from his old residence than his old place of work was from his old residence (40 miles - 10 miles), he will not qualify to deduct his moving expenses.

The principal place of work is the place where the taxpayer spends most of his working time or where his business activities are centered.(6) The new place of work is where the taxpayer is employed on a permanent or indefinite basis rather than on a temporary basis. If the taxpayer is just starting full-time work after graduating from high school or college or is re-entering the labor market after a substantial period of unemployment or part-time employment, the distance from the old residence to the new place of work must be at least 35 miles since the taxpayer did not have a former place of full-time work for the distance test.(7)

The Revenue Reconciliation Act of 1993 will make it more difficult for taxpayers to meet the distance requirement. The Act increases the distance requirement from 35 miles to 50 miles. It is interesting to note that the distance requirement was 50 miles once before for expenses incurred prior to January 1, 1977. With the 1993 Act, Congress has decided, once again, to limit a taxpayer's ability to qualify for the deduction.

Taxpayers must also meet a time requirement in order to qualify for the moving expense deduction. The time test was not changed by the new tax law and stipulates that taxpayers must meet either a 39-week or 78-week employment requirement. Under the 39-week requirement, a taxpayer must be a full-time employee in the general location of the new principal place of work for at least 39 weeks during the 12-month period immediately following arrival at the new work location.(8) Under the 78-week requirement, the taxpayer must either be a full-time employee or a self-employed individual on a full-time basis for at least 39 weeks during the 12-month period following his arrival and for at least 78 weeks during the 24-month period following his arrival. Only weeks of work during which the taxpayer was employed or self-employed full-time count towards the 39- or 78-week requirement.(9) What qualifies as full-time employment depends on the customary practices of the trade or business.(10) For example, a teacher who does not work during the summer is still considered a full-time employee for the entire year.

The taxpayer does not have to be employed by the same employer during the 39-week requirement or be self-employed in the same trade or business for the 78-weeks, as long as he is employed in the same general location. If the taxpayer fails to meet the 39- or 78-week requirement because of death, long-term disability, being fired without cause or being transferred for the benefit of the employer, the requirement is waived.(11) If the taxpayer is married, then either spouse can satisfy the 39-or 78-week requirement although the weeks each worked cannot be combined.(12)

Costs That Qualify As Moving Expenses

If a taxpayer meets the time and distance tests, some or all of his moving costs may qualify as moving expenses. For expenses incurred prior to January 1, 1994, there are two categories of costs that qualify as moving expenses--direct and indirect moving expenses. The direct moving expenses include the reasonable costs of moving household goods and personal effects to the new residence and the costs of traveling to the new residence.(13) The costs of a mover or renting a moving van, packing and crating, storage while in transit, connecting and disconnecting utilities, and transporting household pets all qualify as costs of moving household goods. Travel expenses include the costs of one-way transportation for the taxpayer and members of his household, meals and lodging enroute including the arrival day, and meals and lodging incurred in the location of the old residence within one day after it is no longer suitable for occupancy. Only 80% of the costs of meals is deductible.

If the taxpayer uses his own automobile to transport himself, his family and his household goods to the new residence, he can compute his transportation costs using his actual out-of-pocket expenses for gas and oil or he can use a mileage rate of 9[cents] per mile. Tolls and parking are added to the total costs under both methods.

The costs that qualify as indirect moving expenses include house-hunting costs, temporary living expenses after arriving in the general location of the new place of work, and residence sale, purchase or lease expenses. These expenses are limited to a maximum of $3,000.

Househunting expenses, which include transportation, meals and lodging while searching for a new residence, are permitted as a deduction only if they are incurred after obtaining employment. This requirement is different than that governing direct moving expenses which can be deducted even if the taxpayer did not secure a new job before the move. Temporary living expenses include the costs of meals and lodging while residing in a temporary residence in the location of the new place of work during any period of 30 consecutive days.(14) The temporary living expenses do not include transportation or other personal living expenses. Househunting and temporary living expenses can comprise only $1,500 of the $3,000 limit on indirect expenses.(15)

The expenses of selling, purchasing or acquiring or settling a lease on a residence can also be treated as indirect moving expenses. Real estate commissions, attorneys' fees, title and escrow fees and advertising expenses all qualify as selling or purchasing expenses. If these costs are used to reduce the amount of gain realized on the sale of the old residence or used to increase the basis of the new residence, however, they cannot be treated as a moving expense. Payments to a lessor for a release from a lease, expenses of obtaining a sublessee, and expenses incurred to acquire a lease, such as a real estate commission, qualify as lease expenses.(16)

In order to qualify as a moving expense, the expenses must bear a reasonable proximity in time to beginning work at the new principal place. Moving expenses incurred within one year after beginning work are considered reasonably proximate in time.(17) Therefore, if an employee begins a new job and moves his household goods and family to the new location six months later, the moving costs would still qualify for deduction.

Moving Expenses Incurred After December 31, 1993

The types of expenses that will qualify for deduction have been sharply reduced by the Revenue Reconciliation Act of 1993. None of the indirect costs will be deductible if incurred after December 31, 1993. Therefore, only the costs of moving household goods and personal effects and the costs of traveling to the new location will be deductible. In addition, the costs of meals incurred while traveling to the new residence will no longer be deductible.

When to Deduct Moving Expenses

Moving expenses are deductible by the taxpayer in the year paid or incurred.(18) For expenses incurred before January 1, 1994, an exception permits a cash basis taxpayer who is reimbursed in the year after the expenses are incurred to deduct the moving expenses in the year of the reimbursement instead of in the year the expenses are paid. Does this mean that a taxpayer who moves in 1993 and receives a reimbursement in 1994 can use the new rules to deduct his moving expenses as a deduction for AGI in 1994? Unfortunately, the answer is no since the new provisions apply only to reimbursements for expenses incurred after December 31, 1993. Therefore, the taxpayer will have to deduct the expenses as an itemized deduction on his 1993 or 1994 return. If a taxpayer deducts his moving expenses in 1993 and receives a reimbursement in 1994, the reimbursement cannot be excluded from gross income.

Effects of the New Rules

The new moving expense rules will result in both benefits and disadvantages for taxpayers. A taxpayer who is unable to itemize his deductions will benefit from the new tax treatment since the moving expenses can now be taken as a deduction for AGI. A taxpayer who can itemize his deductions but who needs the moving expenses to bring him above the standard deduction amount will also benefit since he will now be able to realize the full benefit of his moving expenses as a deduction for AGI and continue to use the standard deduction.

For example, if a single taxpayer has $1,500 in moving expenses and $2,500 in other itemized deductions in 1993, he would be able to itemize since the $4,000 total exceeds the $3,700 standard deduction. He would, however, receive a tax benefit from only $300 of his moving expenses since the standard deduction would have been $3,700 anyway. If he defers the move to 1994, he will have a $3,700 standard deduction in 1993 and can deduct the $1,500 in moving expenses as a deduction for AGI in 1994.

Some taxpayers may lose the ability to deduct moving expenses because of the higher distance test in 1994. Taxpayers will also face significantly curtailed deductions since indirect costs and meals will no longer be deductible.

Taxpayers who are reimbursed should find tax return preparation to be simpler since Congress intends that rules similar to the accountable plan rules governing employee business expense reimbursements will apply to moving expense reimbursements. Reimbursements for employee business expenses are excluded from gross income if they are paid under an arrangement which requires the employee to substantiate the expenses to the employer and return any amounts received in excess of the substantiated expenses.(19)

The new moving expense provisions will also affect other aspects of the taxpayer's tax liability. Since reimbursements of qualified expenses will no longer be included in gross income, a taxpayer's adjusted gross income will be lower. As a result, taxpayers may find it easier to deduct other itemized deductions that are based on adjusted gross income such as the medical expense deduction, which must exceed 7.5% of AGI, the casualty and theft deduction that must exceed 10% of AGI, and the miscellaneous deduction for expenses such as professional dues and subscriptions that must exceed 2% of AGI. A greater amount of these expenses will be deductible for taxpayers with lower adjusted gross incomes.

Taxpayers who are active participants in employer-maintained retirement plans may also find that they can deduct more of their contributions to their individual retirement accounts (IRAs) since the deduction limit is phased out as adjusted gross income increases. A lower AGI can result in a higher IRA deduction. State tax liabilities may also be reduced since many states use Federal adjusted gross income as the starting point for the calculation of state taxes.

Footnotes

1 Reg. Sec. 1.82-1(a)

2 Reg. Secs. 31.3401(a)(15)-1(a) and 31.3121(a)(11)-1(a)

3 Sec. 13213 of H.R. 2264

4 Code Sec. 217(c)(1)

5 Reg. Sec. 1.217-2(c)(2)(iii)

6 Reg. Sec. 1.217-2(c)(3)(ii)

7 Reg. Sec. 1.217-2(c)(2)

8 Code Sec. 217(c)(2)(A)

9 Reg. Sec. 1.217-2(c)(4)(iv)

10 Reg. Sec. 1.217-2(c)(4)(iv)(a)

11 Code Sec. 217(d)(1)

12 Reg. Sec 1.217-2(c)(4)(v)

13 Code Sec. 217(b)(1)(A) and (B)

14 Code Sec. 217(b)(1)(D)

15 Code Sec. 217(b)(3)(A)

16 Code Sec. 217(b)(2)(A)-(C)

17 Reg. Sec. 1.217-2(a)(3)

18 Code Sec. 217(a)

19 Code Sec. 62(c)(2)

Hans J. Dykxhoorn, PhD, CPA, and Kathleen E. Sinning, PhD, are professors of accountancy in the Hawarth College of Business at Western Michigan University in Kalamazoo.
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Author:Dykxhoorn, Hans J.; Sinning, Kathleen E.
Publication:The National Public Accountant
Article Type:Cover Story
Date:Jul 1, 1994
Words:2882
Previous Article:Restructuring the tax system.
Next Article:FASB No. 116.
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