Taxpayers who seek deductions for employee business expenses will find the deduction barred if the taxpayer cannot show that he/she was not entitled to reimbursement from his/her employer for the expenses shown on the Form 2106.  This was the issue that tripped up the taxpayer in the case of Howard v. Commissioner, T.C. Summ. Op. 2017-65.

Employees are considered to be in a trade or business and thus are allowed a deduction for expenses incurred in pursuit of that trade or business if the expenses are “ordinary and necessary” expenses.[1]  However, if the employer offers to reimburse the expenses (such as via an expense reimbursement policy), but the employee does not take the employer up on the offer no deduction is allowed.  The expense in that case would not be “necessary” as the taxpayer had a source of reimbursement.

Mr. Howard had claimed a deduction on Schedule A for employee business expenses of amounts ranging from $9,065 to $17,185 for the three years before the Court.  The IRS claimed that such amounts were not deductible because they were reimbursable under his employer’s (CRA) reimbursement policy and Mr. Howard had simply failed to seek reimbursement.

The Tax Court summarized the policy as follows:

CRA’s travel reimbursement policy provided reimbursement to CRA employees for reasonable work-related expenses they incurred while traveling on its behalf, including expenses paid or incurred for air travel, personal vehicles, rental cars, hotels, and meals, among other things. In accordance with CRA’s travel reimbursement policy, petitioner was entitled to reimbursement for employment-related travel expenses upon the approval of the authorized “approver for each project”, the verification of receipts by the accounting department, and the submission of expense reports, which petitioner submitted as required.

CRA also maintained a “Delegation of Authority/Purchasing Power” policy (purchasing power policy). CRA’s purchasing power policy defines “direct” expenses as those “related to billable client engagements” and defines “indirect” expenses as “non-billable costs that are typically associated with internal support departments, corporate functions, or practice areas”. Most notably, the policy sets forth “approval thresholds” for direct and indirect expenses, as follows:

So now we turn to Mr. Howard’s expenses shown on Schedule A.  The Court notes that Mr. Howard claimed that he should be allowed a deduction because CRA did not reimburse him for the claimed expenses.  The IRS argued that even though CRA did not reimburse him, the taxpayer simply failed to file a claim for reimbursement of the expenses, although he had the right to do so under CRA’s reimbursement policy.

Mr. Howard responded to the IRS’s argument that he could have been reimbursed as follows:

Petitioner claims that CRA’s purchasing power policy provides further limitations on CRA’s general reimbursement policy and insists that he was not entitled to reimbursement for indirect expenses. He further argues that the unreimbursed employee business expenses on the Schedules A relate to indirect expenses incurred on behalf of CRA.

The Court did not read the policy to apply as Mr. Howard claimed.  The opinion notes:

After careful review of CRA’s reimbursement and purchasing power policies we find that the policies cover reimbursement for air travel, personal vehicles, rental cars, hotels, and meals, among other things. Because substantially all of petitioner’s unreimbursed employee business expenses appear to be covered by the reimbursement policy, petitioner must show that he sought, but was denied, reimbursement from CRA. See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), aff’g T.C. Memo. 1984-533. In this regard, we have reviewed the travel reimbursement expense reports petitioner submitted to CRA. In accordance with CRA’s reimbursement policy, those reports show that the company reimbursed petitioner for the expenses included on the expense reports. If, as petitioner claims, CRA did not reimburse him for some of his CRA-related travel, CRA’s records strongly suggest that petitioner failed to seek reimbursement for those expenses. Accordingly, petitioner is not entitled to deductions for unreimbursed employee business expenses on his Schedules A for the years in issue.

It may be the case that Mr. Howard is correct in his interpretation of the policy—but the only evidence he had to back up that view was his statement that this was the way CRA applied the policy.  Since the policy document itself did not clearly state that the purchasing power policy applied to reimbursements and that the expenses Mr. Howard did not submit for reimbursement were indirect expenses under that policy, he failed to meet his burden.

As the Court noted, he could have submitted the expenses—having had them denied for reimbursement would have eliminated the issue the IRS prevailed upon.  That would present the most solid evidence of the limits of the reimbursement policy.

Alternatively, he could have submitted additional information from his employer about how the policy was applied, although care must be taken to ensure that the party providing this “proof” is in a position of authority to rule on the issue and that any documentation is not simply being issued as a “favor” to the employee to help him/her prevail on the tax issue.  The IRS and court may want to see evidence the company really did deny such claims when made by other employees and they have not actually reimbursed similar expenses when other employees submitted claims.

[1] IRC §162(a)