OBRA and NEPA change tax treatment of moving expenses and short-term assignments - Omnibus Budget Reconciliation Act of 1993, Comprehensive National Energy Policy Act of 1992

Many individuals and businesses will face higher costs with the various tax law changes enacted by the Omnibus Budget Reconciliation Act of 1993 (OBRA), which was signed into law by President Clinton in August 1993. This article highlights the tax law changes relating to employee relocation expenses and discusses the effect on both the individual and the employer, as well as the interplay between the rules governing relocations and section 1938 of the Comprehensive National Energy Policy Act of 1992 (NEPA), which modified the treatment of away-from-home travel expenses.

Summary of OBRA Changes

OBRA(1) has substantially modified the employmentrelated moving expense deduction, both by restricting the expenses that qualify(2) and by moving the deduction "above the line." The class of employees eligible for the moving-expense deduction remains unchanged, except to the extent the distance requirement for the move has been increased from 35 miles to 50 miles.(3) (The employee's new place of work must now be 50 miles farther from the employee's old residence than the employee's old place of work was from the employee's old residence). (See Exhibit I.)

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As a result of OBRA, effective in 1994, moving expense deductions are allowed only for the reasonable costs of moving household goods and personal effects from the former residence to the new residence, and for traveling (including lodging during the period of travel but excluding meals) from the former residence to the new place of residence.(4) Under pre-1994 law, deductions(5) were allowed for the following expenses:

* Any pre-move house-hunting and 30 days of temporary living expenses in the general location of the new job (which were deductible, prior to 1994, subject to a $1,500 cap).

* Any expenses for the sale and/or purchase of a residence or settlement and/or acquisition of a lease (which in 1993 was deductible, subject to a $3,000 cap). Sale-related expenses that are no longer deductible include real estate commissions, attorney's fees, escrow and title fees, transfer, recording and stamp taxes, and points or other loan-related charges. In addition, title insurance premiums, title fees, appraisal fees, loan origination fees, and other noninterest loan-related charges are no longer deductible.

* Any meal and entertainment expenses while moving (which were deductible in 1993).

* Any moves where the employee's new principal place of work is less than 50 miles farther from the employee's former residence than was the employee's former principal place of work. (The pre-1994 limit was 35 miles.) (See Exhibit II.)

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Exhibit III provides a comparison of the law before and after OBRA. The good news is that unreimbursed moving expenses are deductible above-the-line. Prior to 1994, these expenses, including reimbursed moving expenses, were deductible below-the-line, but without regard to the two-percent adjusted gross income (AGI) floor on miscellaneous itemized deductions. Because of the change, moving expense deductions will effectively become available for state tax purposes in States that begin with federal adjusted gross income in computing state taxable income.

Exhibit III Moving Expense -- Relocation

Pre-OBRA

Reasonable Expenses

(A) Moving household goods and personal effects from the former residence to the new residence.

(B) Traveling (including meals and lodging) from the former residence to the new place of residence.

(C) Pre-Move House Hunting Trip: Traveling (including meals and lodging) after obtaining employment, from the former residence to the general location of the new principal place of work and back to the former residence, for the principal purpose of searching for a new residence.

(D) Temporary Living Expenses: Meals and lodging while occupying temporary quarters in the general location of the new principal place of work during any period of 30 consecutive days after obtaining employment.

(E) Qualified residence sale expenses, purchase expenses, or lease expense.

Post-OBRA

Reasonable Expenses

(A) Moving household goods and personal effects from the former residence to the new residence.

(B) Traveling (including lodging) from the former residence to the new place of residence.

The bad news is that, with all the new limitations on deductions, more expenses will be subject to expensive gross-ups.

Gross-up Calculation

To reduce the federal and state income tax burden on transferred employees for those reimbursed taxable expenses, most companies will provide additional compensation by grossing-up taxable expenses based on the tax rates affecting the relocated employee that are in effect at the time of the relocation. Gross-ups may or may not include the Old Age, Survivor and Disability insurance portion of FICA but should include the Hospital Insurance (Medicare) portion. See Exhibits IV and V, which detail the mathematical equations relating to the income tax gross-up for employee relocations.

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Exhibit V Employee Relocation Income Tax Gross-Up Calculation

Gross-up Equation

Amount to be Grossed-Up 1-[federal income tax rate + state rate + Medicare rate - (federal rate x state rate)]

Gross-up Calculation for Relocation into State of Illinois For Individual in the following brackets

      31%          Amount to be grossed-up
                           .6548
      36%          Amount to be grossed-up
                           .6063
      39.6%        Amount to be grossed-up
                           .57138

Note: This exhibit assumes a 3-percent State of Illinois tax rate and a 1.45-percent Medicare tax rate.

No Further Need for IRS Form 4782

Under pre-OBRA rules, businesses were required to include all moving expense reimbursements in the employees' gross income and to give each employee a copy of Form 4782, detailing the amount of reimbursements of moving expenses, to assist the employee in claiming moving expense deductions in respect of amounts that had been included in the employee's income. Starting in 1994, any reimbursements of deductible moving expenses are completely excludable from the employee's income. The employer need no longer provide Form 4782 to it employees. Hence, reimbursements made in 1994 that qualify as an excludable benefit are not reported in box 1 of the 1994 Form W-2, but in box 13.

OBRA changed the rules applying to reimbursements for moving expenses incurred after 1993, including payments made directly to third parties and services furnished in-kind. The new rules do not apply to reimbursements made after 1993 for moving expenses incurred before 1994. Reimbursement of moving expenses incurred after 1993 are treated as a fringe benefit excludable from the employee's gross income and wages if (1) the expenses would be deductible by the employee if they had been directly paid or incurred by the employee, and (2) the employee did not deduct the expenses in a prior year. In addition, the reimbursements should be made under rules similar to those relating to an accountable plan. Reimbursements made after December 31, 1993, for moving expenses incurred after that date do not qualify as an excludable fringe benefit are included in the employee's wages.(6)

In addition, employees who incurred meal expense as part of a qualified business related move in 1993 but were not reimbursed by their employer until 1994 are eligible to claim a deduction for those expenses subject to the pre-1994 80-percent limitation. The advance proof of Form 3903, issued by the IRS in July, is incorrect, for it erroneously states that the employee may deduct those qualified meal expenses using the new 1994 50-percent limitation. The IRS is currently redesigning the form.

Tax Treatment of Short-Term Assignments

Pursuant to NEPA and Rev. Rul. 93-86, 1993-2 C.B. 71, travel expenses connected with, and the cost of meals and lodging at, an assignment away from the employee's "tax home" that is temporary--as distinguished from permanent, indefinite, or long-term--are deductible. Under the legislation, assignments of less than one year's duration are treated as temporary.(7)

Exhibit VI Classification of Short-Term Assignments Temporary v.

Indefinite/Permanent/Long-Term Assignments

Pre-NEPA

Benchmarks used to determine if assignment is "temporary"--

(1) An anticipated or actual duration of less than two years and an expectation of returning to the individual's "tax home" after the assignment.

(2) A business, rather than personal, reason for incurring living expenses at a distant location from one's "tax home."

(3) A regular place of abode in the real and substantial sense is located at the individual's claimed "tax home."

To meet this requirement the following three objective factors should be evaluated:

(A) Whether the employee has used this claimed abode prior to the current assignment and continues to maintain this abode.

(B) Whether the employee's living expenses are duplicated.

(C) Whether the individual has family members currently residing in or continues to use the claimed abode for purpose of lodging.

Satisfaction of Objective Factors Satisfy three factors = Temporary assignment Satisfy one or none = Indefinite assignment Satisfy two factors = Need to review all "facts and circumstances"

Post-NEPA

Assignments where the period of employment away from the individual's tax home is less than one year are treated as a temporary assignment.

Assignments where the period of employment away from the individual's tax home lasts longer than one year or is for an indefinite period of time are treated as an "Indefinite assignment.

Assignments that are anticipated to last for greater than one year should be considered permanent/indefinite/long-term assignments and processed in a fashion similar to the relocation assignments. Alternatively, all reimbursements for travel, meals, and lodging incurred while the employee is on an assignment for greater than one year may be included in the employee's income as additional compensation and grossed-up, so that the employee does not incur any additional tax liability. Assuming that this does not create an unreasonable compensation issue, the employer will be allowed a tax deduction for the amounts included in the employee's income.

All "temporary" work assignments should be reviewed in light of the new legislation, and a determination of the correct classification (temporary v. indefinite/permanent/long-term) must be made. Also, these "assignments" must be monitored on a continuing basis as the classification may change and thus alter the deductibility of the costs.

The following examples illustrate the effect of the one-year limitation on the deductibility of away-from-home travel costs.

Example (1). Individual A is an engineer with a tax home in Illinois. He is sent to Arizona on June 28, 1994, to install and optimize a new telecommunication system for a customer and is expected to return to Illinois by December 20, 1994. During the assignment, the customer purchases additional equipment that requires A to remain in Arizona until April 1995, when A returns to Illinois.

Individual A's away-from-home assignment lasted ten months, even though he had realistically expected the work to be completed within a six months. Since he had intended to return to his original home after the assignment, the job is temporary in nature, and his travel expenses are deductible.

Example (2). Individual B is a program manager with her tax home in New York. She is sent to the West Coast in February 1994 to work with potential customers in California on the design and location of telecommunications infrastructure equipment. She is not expected to return to Illinois until sometime in May 1995. During her assignment, B puts in long hours and is able to return home to Illinois during December 1994.

Individual B had realistically expected her work away-from-home to last longer than one year, but the job actually lasted only ten months. Her employment assignment is indefinite in nature, and her travel expenses are consequently nondeductible.

Example (3). Individual C is the Director of Sales for the Southeast Region of the United States and has a tax home in Arizona. In March 1994, he is sent to Florida on an assignment with NASA. It is expected that the preparation of the bid and the bidding process will require C to remain in Florida until December 1994. In November, however, NASA changes the specifications of the project and C is thereafter not expected to return to Arizona until after June 1995.

Individual C realistically expected his assignment to last nine months. Changed circumstances after eight months rendered it unrealistic for him to expect the assignment to last one year or less. His assignment is considered temporary for eight months, and his travel expenses that period are deductible; the assignment becomes indefinite in November and no deduction is available after the date on which his realistic expectation changed.

In Linetsky v. Commissioner, T.C. Memo 1994-306, the Tax Court recently held that, where the duration of a temporary assignment was realistically expected to be limited, the costs relating to the temporary assignment were deductible as "away from home" expenses. In 1986, the taxpayer, an engineering specialist who resided in Illinois, was hired by an employment agency for a six-month assignment in Tennessee. The assignment actually took 18 months to complete. The Tax Court held that the taxpayer's assignment in Tennessee should be classified as temporary in nature and, hence, the costs associated with the assignment were deductible as ordinary and necessary business expense. Accordingly, under pre-NEPA rules, when it can be clearly demonstrated that the employee's assignment was intended from the outset to be for a limited duration, the assignment should be considered temporary with its related cost being deductible.

Conclusion

The provisions enacted by both OBRA and NEPA give rise to more income inclusion for employees, effectively increasing the liability of businesses that attempt to make their employees whole through a gross-up mechanism.

(1)OBRA [sections] 13213.

(2)I.R.C. [sections] 217(b)(1).

(3)I.R.C. [sections] 217(c)(1).

(4)I.R.C. [sections][sections] 217(b)(1)(A) and 217(b)(1)(B).

(5)Treas. Reg. [sections][sections] 217-2(b)(1)(i) through -2(b)(1)(i)(v).

(6)Announcement 94-2, 1994-2 I.R.B. 39 (reimbursement for moving expenses).

(7)An employee's "tax home" is generally considered to be located at either (i) the employee's regular or principal place of business, or (ii) if the employee has no principal place of business, then at the employee's regular place of abode.

COPYRIGHT 1994 Tax Executives Institute, Inc.
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