Transport Labor Contract/Leasing v. C.I.R.

• Decision Date: 23 August 2006
• Docket Number: No. 05-3827.,05-3827.
• Citation: 461 F.3d 1030
• Parties: TRANSPORT LABOR CONTRACT/LEASING, INC. & SUBSIDIARIES, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

461 F.3d 1030

TRANSPORT LABOR CONTRACT/LEASING, INC. & SUBSIDIARIES, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 05-3827.

United States Court of Appeals, Eighth Circuit.

Submitted: May 18, 2006.

Filed: August 23, 2006.

Glenn M. Kurtz, argued, New York City (Michael I. Saltzman and Kathleen Pakenham, New York City, on the brief), for appellant.

Bethany Hauser, Justice Dept., argued, Washington, DC (Bruce R. Ellisen, Justice Department, Washington, DC, on the brief), for appellee.

Before LOKEN, Chief Judge, JOHN R. GIBSON and COLLOTON, Circuit Judges.

LOKEN, Chief Judge.

The Internal Revenue Code allows an employer to deduct the cost of employee travel expenses (unless treated as income to the employee), provided the employer maintains records properly substantiating the expenses. See 26 U.S.C. §§ 162(a)(2), 274(d). However, the deduction is limited to fifty percent of "any expense for food or beverages." 26 U.S.C. § 274(n)(1)(A).

Eligible trucking companies may pay their drivers a fixed per diem for driving expenses that is deductible, subject to the § 274(n) limitation. In recent years, many small and medium-sized trucking companies have reduced their overall labor costs by contracting with a Professional Employer Organization ("PEO") to provide essential services such as paying employees, employment taxes, and workers compensation premiums, and administering employee benefit plans. See Delcastillo v. Odyssey Res. Mgmt., Inc., 431 F.3d 1124, 1126 n. 1 (8th Cir.2005). This case raises a surprisingly complex question — if neither the PEO nor its client properly limited the deduction for per diem payments in accordance with § 274(n), who is responsible for the resulting tax deficiency?

A subsidiary of taxpayer Transport Labor Contract/Leasing, Inc. ("TLC"), provided PEO services by hiring truck drivers as its employees and then leasing them back to its trucking company clients. In upholding a substantial deficiency asserted by the Commissioner of Internal Revenue,¹ the Tax Court held that TLC was subject to the § 274(n) limitation because it was the common law employer of the drivers. Transp. Labor Contract/Leasing, Inc. v. Comm'r, 123 T.C. 154, 2004 WL 1777588 (2004), 90 T.C.M. (CCH) 42 (2005). TLC appeals. We review the Tax Court's legal conclusions de novo and its findings of fact for clear error. Campbell v. Comm'r, 164 F.3d 1140, 1142 (8th Cir.1999). We conclude the Tax Court misapplied § 274 and TLC proved at trial that it is not subject to the § 274(n) limitation. Accordingly, we reverse.

I.

As the Commissioner's regulations explain, and as fairness to taxpayers would perhaps demand, Congress crafted § 274 so that the § 274(n) limitation on allowable meal expense deductions "shall be applied only once, either (1) to the person who makes the expenditure or (2) to the person who actually bears the expense, but not to both." 26 C.F.R. § 1.274-2(f)(2)(iv)(a); see 26 U.S.C. § 274(n)(2). In most situations, there are two possible candidates, the employer or the employee. If the per diem payment is treated as income to the employee, it is potentially deductible by the employee as a business expense, so the burden of the § 274(n) limitation is placed on the employee, not on the employer. More often, however, the employer will choose to treat per diem payments as expense reimbursements, not as income to its employees, because reimbursements are not wages for purposes of the employer's worker's compensation insurance premiums and unemployment tax obligations. In that case, the employer may take the business expense deduction, so it is subject to the § 274(n) limitation. See 26 U.S.C. § 274(e)(2); 26 C.F.R. § 1.274-2(f)(2)(iv)(b).

The question is more complex when, as here, there are three relevant parties. In such cases, a special exception to § 274(n) applies if the per diem payment was "paid or incurred by one person . . . under a reimbursement or other expense allowance arrangement with another person other than an employer." 26 C.F.R. § 1.274-2(f)(2)(iv)(c), applying 26 U.S.C. § 274(e)(3).² The Tax Court first faced this issue in Beech Trucking Co. v. Commissioner, 118 T.C. 428, 2002 WL 1035452 (2002), where a trucking company argued that it was not subject to the § 274(n) limitation on per diem payments because it had leased the truck drivers from a PEO. The Tax Court rejected this contention, concluding that the § 274(n) limitation applied to the trucking company "as the common law employer of its drivers and as the party that . . . actually bore the expense . . . for which the per diem payments were made." 118 T.C. at 443.

In this case, TLC's per diem payments were not treated as truck driver wages, so all agree that the § 274(n) limitation did not apply to the drivers. The question, then, is whether the limitation's tax burden falls on TLC or on the trucking companies under § 274(e)(3) and its interpretive regulations. The Tax Court held that TLC is subject to the § 274(n) limitation because it was the common law employer of the drivers. On appeal, the Commissioner argues that the Tax Court's analysis was flawed. We agree. The flaw, as we see it, was in focusing exclusively on the common law employer issue that was dispositive in Beech Trucking. We are inclined to agree with the application of § 274 in Beech Trucking — if the trucking company, rather than the PEO, was the "employer," then the trucking company was subject to the § 274(n) limitation because § 274(e)(3) did not apply. This exception did not apply because the per diem expense was not "incurred by the taxpayer [the trucking company], in connection with the performance by him of services for another person," as § 274(e)(3) requires.

In this case, the Tax Court held that TLC, the PEO, was the common law employer.³ This means § 274(e)(3) might apply, and the § 274(n) issue cannot be resolved simply by identifying the employer. Section 274(e)(3) might apply because the per diem expenses were "paid or incurred by the taxpayer" (TLC, the PEO) "in connection with the performance by him of services" (the leased services of the PEO's truck drivers) "for another person" (the trucking company). Thus, the Tax Court erred in stopping its analysis with the common law employer issue. Instead, it should have determined whether TLC as employer was entitled to the § 274(e)(3) exception, which requires a determination of (i) whether TLC incurred the per diem expenses "under a reimbursement or other expense allowance arrangement with such other person" (its trucking company clients), and if so (ii) whether TLC "account[ed] . . . to such person" in the manner § 274(e)(3)(B) requires.

II.

Following the Tax Court's initial adverse decision, TLC filed a motion for reconsideration, arguing that it qualified for the exception in 26 U.S.C. § 274(e)(3)(B). TLC also pointed out that the Court's decision would result in tax duplication because it did not reduce the deficiencies by the increased taxes paid by trucking company clients who applied the § 274(n) limitation in those tax years. The Tax Court rejected the § 274(e)(3) contention solely on the ground that it was raised in TLC's pleadings but abandoned in its trial memorandum. 90 T.C.M. (CCH) at 63. On appeal, the Commissioner argues that this ruling was not an abuse of the Tax Court's discretion. We disagree.

As an initial matter, we disagree with the tax court that TLC abandoned or waived the issue. TLC's First Amended Petition expressly alleged that the Commissioner "erred in determining that petitioner's per diem expenses did not come within an exception to the deduction limitation for reimbursed expenses provided in IRC § 274(e)(3)(B)." The Tax Court's decision acknowledged that the case turned on the proper application of § 274(e)(3) and its interpretive regulations. See 123 T.C. at 178. Having correctly identified the governing statute, the Tax Court was obliged to apply § 274(e)(3)(B) correctly, whether or not TLC developed the issue in detail in its trial memorandum. Thus, the § 274(e)(3)(B) issue was sufficiently raised "for purposes of our appellate review." United States v. White Plume, 447 F.3d 1067, 1074 (8th Cir.2006). Any errors of law in interpreting this statute are a proper subject of our review, whether or not the Tax Court deemed them "abandoned."

Moreover, the Tax Court's disposition of this case, and particularly its summary rejection of the motion for reconsideration, shows an almost cavalier disregard for a governing legal principle — that the § 274(n) limitation "shall be applied only once." 26 C.F.R. § 1.274-2(f)(2)(iv)(a). In its trial memorandum, TLC cited legislative history explaining that § 274(e)(3) "prevents the double disallowance of a single expenditure," yet the Tax Court declared the issue of tax duplication not timely raised. 90 T.C.M. (CCH) at 63. We may review an issue not raised in the trial court when "failure to consider the issue would be inconsistent with substantial justice." Estate of Vak v. Comm'r, 973 F.2d 1409, 1412 (8th Cir.1992).

III.

The question whether TLC qualified for the § 274(e)(3) exception requires a summary of additional facts. TLC's standard Exclusive Lease Agreement made no reference to per diem payments to truck drivers. But the record on appeal includes a detailed and well-supported description of the manner in which TLC substantiated its per diem payments and communicated that information to its clients.

Undisputed evidence established that TLC's trucking company clients initially determined the drivers' total compensation and the proportion (if any) that TLC should allocate to per diem payments. Each client was free to change the percentage of gross compensation allocated to per diem payments, a decision that did not affect TLC's profit. Each pay period, the trucking company submitted a "batch report" showing each driver's gross pay and days on the road for that period. Using that data, TLC paid the drivers...