Tax Notes Today on October 8, 2008.
We're wondering how it is possible to screw up an interview with Katie Couric.
Americans like their women cute, but isn't Couric a lightweight? Didn't she make a career out of a cheerleader smile, hosting a resolutely lowbrow morning talk show? Hasn't her transition to serious network news anchor been awkward?
All true, but that makes her the perfect interviewer for Alaska Gov. Sarah Palin, who has gotten a fair amount of mileage out of cuteness herself. Couric may have been the only interviewer unafraid to go after Palin, without fear of being accused of being sexist or condescending or not taking her interviewee seriously. In a contest with Couric, winking doesn't work.
After she managed to exceed the low expectations set for her in her debate with the gaffe-prone Sen. Joseph R. Biden Jr., D-Del., Palin released two years of tax returns and her most recent financial disclosure statement. She's the poorest candidate in the race, even though she and her husband are much better off than the average Americans they claim to be.
Readers should envy what is shown on those returns, not because the Palins are rich -- they aren't -- or because they live in a state with a lot of natural beauty. No, readers should be impressed by Todd Palin's ability to turn activities that are hobbies for everyone else into businesses. The first dude actually has a business of snowmobile racing. In 2007 he won $17,000 in the Iron Dog snowmobile competition, but his expenses sheltered that prize. (Section 183(d) requires a profit in three out of five years.)
It's not that hard for a household with no money to file a correct tax return, but what good would we be as tax professionals and provocateurs if we couldn't find a problem? Darn right we found a problem, and we're going to speak directly to the American people about it.
In 2007, the first full year she served as governor, Sarah Palin received $60,441 in reimbursements from the state of Alaska for travel expenses and per diems for days she worked outside the state capital. All of these items were excluded from the Palins' income. There is a question about whether Palin's per diems should be excluded from her income, which turns on whether she correctly identified Juneau as her tax home. Her exclusion of her family's state-paid travel expenses for her husband and children would have to be examined to see if the family members were traveling on official business.
Alaska is the biggest state in terms of landmass. The scenic capital, Juneau, is a real backwater, not accessible by road. More than half the residents of Alaska live in Anchorage. Governors typically live in the governor's mansion in Juneau, especially when the Legislature is in session. The legislative session is usually the first three or four months of the year.
Juneau is 600 miles away from Wasilla, the teensy town where Palin was mayor before being elected governor. As governor, she decided to continue to live in Wasilla, rather than in the governor's residence in Juneau. When the Legislature was not in session, she worked at a state office in Anchorage, 45 miles from Wasilla. She moved herself and her family to Juneau for the legislative session in 2007. Her administrative director, Linda Perez, could not say whether this was a temporary or permanent move.
Palin was reimbursed for travel expenses for travel between Wasilla and Juneau, and per diems for days she worked from Wasilla or the state office building in Anchorage. Her official salary is $125,000 per year. She made a show of selling the state governor's executive jet, and her personal travel expenses were less than one-fifth of her predecessor's, probably due to the cost of operating said jet.
During her first 19 months in office, Palin took per diems for 312 nights spent in her own home in Wasilla, while she was working in state offices in Fairbanks and Anchorage. The per diems totaled $16,951. A governor's office spokesman told The Washington Post that Palin could legally have claimed per diems of $4,461 for her children but did not. She did not ask for reimbursement for her stays in Anchorage. (The Washington Post, Sept. 8, 2008, p. A1.)
Travel reimbursements totaling $43,490 covered the cost of transporting her family, mostly between Juneau and Wasilla, the Post reported. Most of the expenses were for airplane trips on commercial flights. The newspaper characterized these trips as official state business.
Palin's predecessor, Frank Murkowski, charged the state similar amounts for transporting his wife during the four years he was in office -- and she was just one person. During that period, some Alaska state ethics memorandums addressed the use of the state executive jet.
In a September 2004 ethics memorandum, the Alaska state ethics supervisor considered the question of the use of the state executive jet by the wives of government officials. State policy requires reimbursement to the state for spousal travel at the rate of the lowest coach fare applicable to the route. Reimbursement is not required for spousal travel on official business.
The question addressed by the memo was whether the spouses would be allowed to fly free of charge, and the answer was no, according to state ethics law. State law states that a public officer may not "intentionally secure or grant unwarranted benefits" for any person. "Unwarranted" means improper, as in favoring a spouse. There would be no public purpose for an official's spouse to be traveling on the state jet for personal reasons, the memo noted, and it is irrelevant that the spouse occupying an otherwise-empty seat does not cost the state anything more.
Party hacks don't get a free seat on the plane either. A June 2006 Alaska state ethics memorandum discussed use of state aircraft for campaigning and partisan political activities. The answer was again no, but the memo also addressed travel for mixed official and campaign purposes. "If performance of official duties is the primary purpose of a trip, a public officer will not violate the Ethics Act by using state aircraft for the trip," the memo stated. The memo warned that judgment must be exercised and "indiscriminate" use of the state jet avoided.
Kim Garnero, director of the Division of Finance for the state of Alaska, told the Post that conducting state business is required for travel reimbursement. Perez explained that the governor's office takes the position that the children were traveling on official business when they were invited to public events. One of the events for which the children's travel was billed to the state was the Iron Dog snowmobile race.
"The rules are a mess -- or, more articulately, a morass of confusion," said Mary B. Hevener, an expert on compensation tax questions. "The IRS won't issue letter rulings, and taxpayers around the country have been struggling for 20 years to figure them out," said Hevener, who works with a group of compensation specialists at Morgan, Lewis & Bockius LLP.
Section 162(a)(2) provides the basic deduction for business travel expenses. Deductible travel expenses must be reasonable and necessary, incurred away from home, and incurred in pursuit of a trade or business. "Away from home" means the employee must stay over for sleep or rest. (Rev. Rul. 75-170, 1975-1 C.B. 60.) Employer reimbursements of expenses that are deductible are excludable by the employee.
Are Palin's living costs duplicated if she has the use of the governor's official residence in Juneau and chose not to use it? The larger rationale for the travel expense deduction (and per diem exclusion) is that the individual's living costs are being duplicated. If living costs are not being duplicated, the rationale is absent. Garnero noted that the governor's practice of doing her family's cooking saved the state money.
The taxability of Palin's travel reimbursements has to be determined in reference to her tax home. Her tax home is her principal place of business. It need not be the same as her residence.
The state of Alaska has a per diem plan that pays for state employees' meals, incidental expenses, and travel when they are traveling on state business away from their duty station. The state's daily per diem rate for meals and incidental expenses is $60. (This rate is less than the maximum federal meal and incidental rate for Anchorage, and for most other locations in Alaska.)
Each state employee has a duty station, and the governor's duty station is Juneau, because Juneau is the capital, Garnero explained. There is no statutory assignment of duty station to the governor. (Alaska per diem law is contained in sections 39.20.110-190. For the state's per diem policy, see http://fin.admin.state.ak.us/dof/travel/resource/tax.pdf.)
Where is Palin's tax home? The governor basically took the position that her tax home was Juneau, her duty station, so that per diems for time spent in her Wasilla residence while conducting state business could be excluded from her income. According to her, she did not claim per diems when she was not in Juneau and not conducting state business. She has claimed per diems for 312 nights out of the roughly 570 days she has been governor. (These numbers include 2008. She was sworn in on December 4, 2006.)
According to Rev. Rul. 73-529, 1973-2 C.B. 37, an individual's tax home must satisfy three criteria: (1) use of the home before the temporary assignment and continued work contracts during that assignment; (2) living costs must be duplicated; and (3) marital or lineal family members residing at the home. The individual has no tax home if she fails to satisfy at least two of these criteria for the claimed tax home.
It is possible for an individual to have no tax home from which to be away. Many are the touring crew members and traveling salespeople who have no tax home, despite owning a personal residence that the law does not allow to be treated as a tax home. (Henderson v. Commissioner, 143 F.3d 497 (9th Cir. 1998), James v. United States, 308 F.2d 204 (9th Cir. 1962).)
Must an employee's tax home and personal residence be in the same place? No. That was the situation in Letter Ruling 8018015. In a fairly typical situation, the taxpayer was transferred by his employer to a new workplace, while his children stayed in school, living in his residence at his former workplace to finish the school year, before moving to a new residence at the new workplace.
The IRS ruled that the costs of travel between the two places did not qualify as a business expense deduction because the taxpayer's new workplace was his tax home. The IRS concluded that the maintenance of the old residence was a personal expense. Moreover, because the taxpayer's wife had no trade or business, she was deemed to have shifted her tax home simultaneously with the taxpayer. Her travel expenses were nondeductible as well.
There is an argument that when Palin decided to spend most of her working time at the Anchorage state office building, her tax home became Wasilla/Anchorage. If so, her per diems for asserted travel away from Juneau to Wasilla/Anchorage would have been improperly paid, because the days spent in Wasilla/Anchorage would have been expenses of living in her tax home and would be taxable to her.
Jack Bogdanski of Lewis & Clark Law School questioned Palin's argument that Juneau was her tax home when she spent the vast majority of her time working in Anchorage and living in Wasilla. He essentially argues that Palin's tax home moved to the place where she did most of her work, regardless of Juneau being her official duty station, so that per diems for trips to Anchorage/Wasilla would be taxable.
The Alaska state policy on per diems reiterates federal law and does not automatically assign the employee a tax home at the employee's assigned duty station. "Where an employee does not work the majority of their time at their duty station, it becomes more difficult to determine the employee's tax home, and therefore whether the per diem is taxable," state policy states.
"If the employee does not work at their PCN duty station at least 50 percent of the time (vacation does not count toward time worked at the duty station), then the State must first consider whether the employee works the majority of their time at another location, making this location their principal place of business. If they do, this other location becomes their tax home," state policy states.
The one-year rule of section 162(a)(2) becomes pertinent here. Section 162(a)(2) states that taxpayers will not be "temporarily away from home" during any period of employment that exceeds one year. So if an employee is in a temporary location for a year or longer, the law deems the employee's tax home to be in the new location. The law also asks whether the employee reasonably expected to spend a year or longer in the temporary location. If so, the employment at the new location is treated as indefinite in duration. (For Rev. Rul. 93-86, 1993-2 C.B. 71, see Doc 93-12190 or 93 TNT 241-3 .)
Thus the state policy, reiterating federal law, notes: "If an assignment to a location is expected to last more than one year, or actually lasts longer than one year, then any per diem paid at this 'temporary' location is considered compensation." Garnero explained that the state implements this policy by looking backward, to determine how long the employee stayed in a single location, and then forward, treating all future per diem payments as taxable. That is, the state does retroactively tax per diems already paid if the employee stayed in one location too long.
Basically, state policy says that Palin's tax home is not automatically her duty station if she works somewhere else more than half the time, which she does. The state is supposed to identify whether she will be outside her duty station for a year or longer, but state policy indicates that per diems might continue to be paid and taxed to the employee.
"The governor's office never asked us what to do with the governor's per diem," said Garnero. The state can rely on Palin's representations about her tax home unless it has actual knowledge to the contrary. (Reg. section 1.274-5T(e)(2)(B)(ii).)
Bogdanski argues that the state should have known that Palin's tax home would be Wasilla/Anchorage. "The state apparently did not follow these established policies in the case of the governor, because if it had, her long-term per diems would have appeared on her W-2 wage statement filed with the IRS," Bogdanski said on his Web site. (See http://bojack.org/.)
State law does not require the governor to adhere to state travel rules. As a matter of statute, the governor and lieutenant governor, as elected officials, are not subject to the state of Alaska travel policies, but they follow them anyway. (Section 39.20.060.) The governor reviews her own per diem submissions as claimant. Her per diem submissions are processed by her administrative office continually as receipts come in, Perez explained.
There is some slippage between cup and lip when it comes to the governor's Form W-2. Garnero explained that the payroll, which produces Form W-2, and accounting, which pays per diems, are two separate, aging computer systems, so that "human interface" is required to get the two to talk. If an employee's per diem payments become taxable because the employee has stayed more than a year in a single location, she explained, then a human being has to make the change so that the per diem shows up on the employee's Form W-2.
Bogdanski argued that trips from her tax home in Wasilla to Juneau would constitute nonexcludable commuting rather than excludable business travel. Here he recognized that Juneau is a workplace, but not that the Anchorage tax home is also a workplace. But travel between workplaces is excludable. Palin would be entitled to per diems for work-related trips between her tax home, her principal place of duty, and Juneau, which would be a minor post of duty. She could amend her claims and her tax return for this treatment.
The IRS considered the question of major and minor workplaces in Rev. Rul. 75-432, 1975-2 C.B. 60. If an employee travels away from a principal place of duty to a minor post of duty, the cost of meals and lodging at the latter are deductible (or excludable). This result obtains when the employee has a permanent residence near the minor post of duty, but the deduction or exclusion is limited to expenses attributable to the employee's conduct of business there. (Rev. Rul. 61-67, 1961-1 C.B. 25.)
A third possibility is that Palin had multiple work locations, so that it could be argued that the one-year rule of section 162(a)(2) does not apply. According to legislative history, the one-year rule applies only if the employee is away from home in a single location. (See H.R. Conf. Rep. No. 102-1018, 102d Cong., 2d Sess. 429, 430 (1992).)
The IRS ruled in Letter Ruling 9536012 that the one-year rule does not apply to employees who work at multiple locations. The employees were union officers who were reimbursed by the union under its reimbursement plan for travel to committee meetings, contract negotiations, meetings with government, and council meetings, among other functions. They were on call 24 hours a day. They worked at home and in union field offices.
Each had a primary duty station, which the IRS ruled was the tax home, but it noted that it was possible to abandon that tax home. The IRS concluded that some of the officers had indeed abandoned their tax homes, having had little or no business contact with them for two years. For these officers, travel reimbursements were not excludable, because there were no living expenses being duplicated.
Here the special "travel away from home" rule for state legislators does not apply but provides a useful analogy. Section 162(h)(4) states that a state legislator's tax home is the district he or she represents, provided it is at least 50 miles from the capitol building. Section 162(a) itself, in flush language, does the same for Congress. These provisions have the effect of allowing the member to deduct the costs of living in the federal or state capital while on legislative duty.
But these provisions are properly understood as exceptions to the general rule. Under the general rule, a member's tax home would be his or her workplace, the capitol, and the costs of being there would not be deductible. There is no special rule like that for governors, probably because most of them live in official residences or at least in residences in or near the capitol building. So Palin falls under the general rule of tax home as principal place of business.
After the Post reported the per diem payments, Palin got an opinion from a Washington, D.C., lawyer, Roger Olsen, that her reliance on the state's treatment of her per diem payments as excludable from income was proper.
Olsen opined that it was proper for Palin to receive per diem payments when she was conducting state business outside Juneau, on the ground that Juneau, as her assigned duty station, was also her tax home. Although Palin did not claim per diems for work in Anchorage and Fairbanks, Olsen opined that she would have been entitled to do so because she was conducting state business away from her duty station in Juneau.
Olsen's opinion was intended for dissemination to the press. Olsen argues that Palin could rely on the state's treatment of her per diem payments. Palin's returns were prepared by H&R Block.
Olsen wrote: "The income tax aspects of fringe benefits are complex and highly technical, and not subject to second-guessing by laymen."
Would the state of Alaska be affected if Palin misidentified her tax home? You betcha. Even though the governor and lieutenant governor are statutorily exempt from the state's travel policies, they follow them anyway, so that the plan maintains its status as an "accountable plan" under applicable federal tax regulations.
Garnero noted that the state is conscientious about adhering to the federal requirements. "We run our travel program under an accountable plan as best we can under the IRS rules," she said.
States are subject to federal rules on fringe benefits. States have to report taxable fringes to the federal government on information returns, and withhold federal income tax, and run the risk of having their accountable plans disqualified.
Per diems are cash payments to employees that are excludable if they are proper. Improper per diems are wages. The tax law allows employers to pay per diem allowances that do not exceed the federal per diem rates (which vary for different locations around the country). But if traveling employees would not be allowed to deduct the per diems, or if the per diems exceed the federal rates, then the payments are treated as wages. Qualifying per diem plans and plans that reimburse substantiated business expenses are called "accountable plans."
"Accountable plan" is a creature of reg. section 1.62-2. For a plan to qualify, reimbursement must be paid for business expenses and should not exceed reasonably anticipated expenses. A plan can be an accountable plan even without actual substantiation of expenses or clawback of excess payments.
Under reg. section 1.62-2(c)(3), improper per diems will be treated as having been paid out of a "nonaccountable" plan, making all per diem payments made from it taxable to all employees who receive them. Employees would then have to take miscellaneous itemized deductions, subject to limits. Under reg. section 1.62-2(i), a single employee can become taxable for failure to substantiate expenses. All of an employee's per diems are taxable if the employee is not in travel status during the period for which the per diems are claimed. (Reg. section 1.62-2(e)(3).)
The antiabuse rule of reg. section 1.62-2(k) states that when there is a pattern of abuse, all per diem payments made from the plan are taxable to all employees who receive them. In Rev. Rul. 2006-56, the IRS ruled that a plan was a nonaccountable plan because it had no mechanism to determine when a per diem exceeded the amount deemed substantiated, and routinely paid allowances in excess of the allowable per diem rate.
Take the Kids
Not only are the rules a mess, they are puritanical to boot. There is an unstated assumption that somebody, somewhere, might be having fun, and it is the IRS's job to put a stop to it.
The transportation of the Palin children to Juneau and various official events is another question. The larger dollars at stake are in the airfares paid for Palin's spouse and children.
Olsen noted that state law allows reimbursement for travel for the spouse of the governor when traveling on state business. He gave short shrift to the travel issue, devoting only one paragraph of his opinion to it.
The governor's deputy chief of staff decides whether family members should be reimbursed for travel on official business, Perez explained. The practice has been to treat family members as traveling on official business when they are invited to an event, she explained.
Most events to which the entire family is invited are not government-sponsored. Rather, the events are privately sponsored events of the ribbon-cutting, public appearance variety. As administrative director, Perez has to sign off on this travel, but the deputy chief of staff made the reimbursement decisions.
Perez gave as an example the invitation extended by the Alaska Federation of Natives to the entire Palin family to attend its event. Piper Palin, the governor's youngest daughter, is the poster child for the Alaska National Education Association, so she was treated as traveling on official business when she attended the NEA event. Perez noted that no reimbursement would be forthcoming for just hauling the family around the state.
"There's a business purpose for the travel," Garnero told Tax Analysts. "It's not a benefit to the governor. The state never would have paid it had there not been a business purpose. We don't just pay to have their family keep them company." She added that in historical practice, the first spouse has some official duties. Garnero admitted that she had not known about the Palin children's reimbursed air travel until reporters pointed it out.
Section 262 and reg. section 1.262-1 provide that personal expenses are not deductible (or excludable) if they would not be deductible under section 162. Reg. section 1.162-2(b)(1) states that meals and lodging are deductible only if the trip is "related primarily to the taxpayer's trade or business" and not "primarily personal in nature."
Reg. section 1.162-2(c) denies deduction of expenses for family travel unless it can be adequately shown that the family members' presence on the trip has a "bona fide business purpose" over and above the performance of incidental services.
After 1986, family travel is not deductible by the employer under section 274(m)(3), and technically not excluded working condition fringe benefits under section 132. But reg. section 1.132-5(t) states that when section 274(m)(3) applies to deny the employer's deduction, the employee's inclusion is determined under section 162 and its regulations and case law. There is no automatic inclusion when a deduction is denied. This applies even when the employer is tax exempt, according to reg. section 1.132-5(t)(2).
Palin appears to be arguing that the family's presence at official events was necessary, so that the costs of their air travel should be excluded from the couple's income. For this argument she can thank Roy Disney, Walt's brother, who won a case 40 years ago allowing exclusion of travel expenses that Walt Disney Productions paid for his wife. Alaska is in the Ninth Circuit.
In United States v. Disney, 267 F.Supp. 1 (C.D. Calif. 1967), affirmed, 413 F.2d 783 (9th Cir. 1969), the corporation insisted that wives accompany their husbands on business trips and argued that their presence was important at public and social events. Mrs. Disney was not an employee. Nonetheless, the court believed testimony that her presence enhanced the corporation's image as a provider of family entertainment.
The district court held that because the business of the corporation was family entertainment, there was a bona fide business reason for paying the costs of spousal travel. And mixing business and pleasure was no problem for the court, if the latter was incidental. The court allowed exclusion of all of Mrs. Disney's travel expenses, except for the cost of the week she spent holed up in the Waldorf Astoria, during which did not attend public or social functions.
The taxpayer in Stratton v. Commissioner, 448 F.2d 1030 (9th Cir. 1971), did not have Disney's lawyers. He was a foreign service officer who went on "home leave" from his permanent duty station in Karachi, Pakistan. The taxpayer deducted the unreimbursed expenses of his and his family's travel to the United States, where he consulted with his superiors and rested. The taxpayer argued that the State Department required him to take home leave. The Tax Court disallowed all the deductions on the ground that home leave was personal.
The Ninth Circuit allowed the taxpayer's expenses for himself on the view that home leave was a compulsory vacation. But the court would not allow deduction of the family's expenses, relying on reg. section 1.162-2(c), despite the established practice of foreign service officers' families going on home leave. The court noted that the family members were not State Department employees, and there is no requirement that they go on home leave. The taxpayer's wife, the court added, had no proven public relations duties, unlike the wife in Disney.
For the Palins, case law would require a trip-by-trip analysis of whether the husband and children were traveling on official business. It could be argued that the cost of the children accompanying the first dude to the Iron Dog competition was not incurred for an official function, but rather was part of his business of snowmobile racing.
The taxability of Palin's travel reimbursements has to be determined in reference to her tax home. Her tax home is her principal place of business. It need not be the same as her residence.
There is an argument that when Palin decided to spend most of her working time at the Anchorage state office building, her tax home became Wasilla/Anchorage.
Palin appears to be arguing that the family's presence at official events was necessary, so that the costs of their air travel should be excluded from the couple's income.
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