The U.S. tax system applies to U.S. citizens no matter where they are in the world. Our tax laws also provide various limitations, exclusions and other benefits based on where the person is when the income is received or expense is incurred.
If the assumptions of a static taxpayer who doesn’t travel or move around are not met, the concepts underlying this system may no longer hold true. The system breaks down.
Consider an airline pilot who travels all over the world. Is the pilot to file tax returns in every county and also in the U.S. for his or her earnings and expenses? The same concepts apply to truckers who drive all over North America.
The recent tax court case, Tucker v. Commissioner, T.C. Summary Opinion 2008-78, highlights a few of these difficulties.
Facts & Procedural History
The taxpayer was a pilot employed by Southwest Airlines. He worked as both a line captain and check airman, responsible for piloting an aircraft and training other employees. He estimated that he earned more as a check airman than as a line captain.
He lived in Birmingham, Alabama. His flight assignments were primarily in Chicago, and he would travel to and from Birmingham as needed.
His employer, Southwest Airlines, reimbursed him for travel expenses and he rented an apartment in Chicago for overnight stays. He had a “crash pad” in Chicago for times he ended up in Chicago overnight.
Pursuant to Southwest’s travel reimbursement policy, the taxpayer was reimbursed for travel expenses on an hourly basis for a period that began 1 hour before the scheduled departure time of any given flight assignment and ended one-half hour after the flight assignment terminated.
The taxpayer claimed a $28,536 employee business expense deduction for his business expenses. This included expenses for travel between Birmingham and Chicago, apartment rental and maintenance costs, and meal expenses.
The IRS audited their tax returns and proposed to disallow the expenses, which resulted in the tax court litigation at issue in this article.
Employee Business Expenses
The Employee Business Expense Deduction allows employees to deduct expenses for meals and lodging incurred while traveling away from home in connection with their employment. Expenses traveling from the taxpayer’s residence to his place of business are generally non-deductible personal expenses.
To qualify for this deduction, the expenses must be directly connected to the taxpayer’s business and incurred while the taxpayer is away from their tax home. The tax home is determined by the location of the taxpayer’s regular or principal place of business.
These rules raise questions as to what is a “residence” and what is a “tax home?”
Update: Until 2018, pilots who chose to itemize their deductions were able to deduct ordinary and necessary business expenses from their federal taxes. These expenses included unreimbursed travel costs, union dues, pilot uniforms, and medical examinations required by the FAA. However, the Tax Cuts and Jobs Act (TCJA) eliminated the ability to itemize deductions for these expenses for tax years starting on or after January 1, 2018. Consequently, pilots who continue to itemize their deductions are no longer able to reduce their tax liability by deducting these expenses, resulting in a higher tax burden for many pilots who have to cover these costs themselves. Taxpayers should discuss ways to reimburse expenses, as the expenses are generally deductible for the employer and not income to the taxpayer–such as tool and equipment plans.
“Residence” vs. “Tax Home”
A “residence” is generally where the taxpayer maintains the most connections. There are several factors that are to be considered in determining what location qualifies as the taxpayer’s residence, such as what state the taxpayer is registered to vote and drive, where the taxpayer’s bills and other correspondence are received, etc.
A “tax home” is typically the place where the taxpayer’s regular place of business is located. If there is more than one regular place of business, the taxpayer’s “tax home” is the taxpayer’s principal place of business.
For example, if an employee lives in one state but works in another, their tax home would generally be considered to be where they work, rather than where they live. This means that if they travel for business purposes, they may be eligible to deduct certain expenses, such as transportation costs, lodging, and meals, as long as they are incurred while they are away from their tax home.
There is an exception to these general rules. The exception blurs the line between a “residence” and “tax home.” With this exception, a taxpayer’s personal residence can serve as their “tax home” if their principal place of business is deemed “temporary” rather than “indefinite.” This exception is based on the Peurifoy v. Commissioner, 358 U.S. 59, 60 (1958) case, where the Supreme Court established this principle.
The determination of whether a taxpayer’s personal residence may be considered as the “tax home” under the exception to the general rule depends on whether the principal place of business is “temporary” or “indefinite.” A place of business is temporary if the employment is expected to be terminated within a short period, while employment is considered indefinite or substantial if its termination cannot be foreseen within a fixed or reasonably short period of time. If the employment away from home, even if temporary at first, becomes substantial or indeterminate, then the taxpayer’s home becomes the situs of such employment for tax purposes. These are factual questions that taxpayers bear the burden of proving.
Where is the Tax Home?
Tucker believed that his tax home was in Dallas, as that is where his supervisor was located. If this was true, Tucker would have been traveling from his residence to his work in Dallas, and then from his work in Dallas to Chicago. The expenses associated with the later segment may have been tax deductible.
The IRS and the U.S. Tax Court concluded that Tucker’s “tax home” was Chicago, as that is where many of his flights originated and terminated. According to the court, Tucker was merely traveling from his home in Birmingham to his work in Chicago, which makes the travel expenses non-deductible personal expenses. The travel expenses may have been deductible if Tucker’s “tax home” was in some city other than Chicago, such as Birmingham (possibly the airport that Tucker departed from in Birmingham).
The State Tax Implications
Although not discussed in the case, Tucker will also have to consider the state income tax consequences of where his income originates.
Federal law provides that certain interstate transportation and commerce employees, such as pilots, are subject to tax in their state of residence and any state in which they earn more than 50 percent of their pay for being a pilot. This is determined by looking at whether the pilot’s flight time in any non-residence state exceeds 50 percent of the total flight time worked by the pilot while employed during the calendar year. The pilot may be entitled to a tax credit in his residence state for taxes on his pay that is paid to other states.
In Tucker’s case, this may mean that he may be subject to state tax on his pay in Alabama. He may also be subject to tax in Illinois or some other state, depending on whether he spends more than 50 percent of his flight time in that state. Tucker may get a tax credit in Alabama for any taxes paid to Illinois or the other state.
Taxpayers, including long-time pilots, are often surprised by these rules. The government usually raises the personal expense issue for the first time when the taxpayer undergoes an audit. With regard to the receipt of income, the state governments usually raise the issue for the first time by providing the taxpayer with a notice of lien or levying on the taxpayer’s assets. These liens and levies are based on the taxpayer having not filed tax returns in the extra states and the states assessing the tax by sending the notice of assessment to the wrong address. This is often triggered by the airlines incorrectly withholding and/or reporting income to the state governments. Advance tax planning can help eliminate these types of tax problems and, in some cases, can produce significant tax savings.
This case highlights the difficulties that taxpayers face when it comes to determining their “tax home” and what expenses are deductible. This impacts pilots, truckers, and others who frequently travel. It also highlights the importance of advance tax planning to avoid potential tax problems and maximize tax savings. It’s essential to be aware of these tax implications and seek professional advice to ensure compliance with tax laws and regulations.