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Tax Definition of the United States | US Tax Lawyers

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The tax definition of the United States is highly important for US tax purposes; in fact, it plays a key role in identifying many aspects of US-source income, US tax residency, foreign assets, foreign income, application of certain provisions of tax treaties, et cetera. While it is usually not difficult to figure out whether a person is operating in the United States, there are some complications associated with the tax definition of the United States that I wish to discuss in this article.

Tax Definition of the United States is Not Uniform Throughout the Internal Revenue Code; Three-Step Analysis is Necessary

From the outset, it is important to understand that the tax definition of the United States is not uniform. Different sections of the Internal Revenue Code (“IRC”) may have different definitions of what “United States” means.

Therefore, one needs to engage in a three-step process to make sure that the right definition of the United States is used. First, the geographical location of the taxpayer must be identified. Second, one needs to determine the activity in which the taxpayer is engaged. Finally, it is necessary to find the right IRC provision governing the taxation of that taxpayer engaged in the identified specific activity in that specific location; then, look up the tax definition of the United States with respect to this specific IRC provision.

General Tax Definition of the United States

Generally, for tax purposes, the United States is comprised of the 50 states and the District of Columbia plus the territorial waters (along the US coastline). See IRC § 7701(a)(9). The territorial waters up to 12 nautical miles from the US shoreline are also included in the term United States.

General Tax Definition of the United States Can Be Replaced by Alternative Definitions

As it was pointed out above, this general definition is often modified by the specific IRC provisions. The statutory reason why this is the case is the opening clause of IRC § 7701(a) which specifically allows for the general definition to be replaced by alternative definitions of the United States: “when used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof … .”

Hence, instead of relying on the general tax definition of the United States in IRC § 7701(a), one needs to look for alternative definitions specific to the IRC provision that is being analyzed. Moreover, the fact that there is no express alternative definition is not always sufficient, because one may have to determine the intent (most likely from the legislative history of an IRS provision) behind the analyzed IRC provision to see if an alternative tax definition of the United States should be used.

General Tax Definition and Possessions of the United States

While the object of this small article does not include a detailed discussion of the alternative tax definitions of the United States, it is important to note that the Possessions of the United States (“Possessions”) are not included within the general tax definition of the United States. They are not mentioned in IRC § 7701(a)(9); IRC 1441(e) even states that any noncitizen resident of Puerto Rico is a nonresident alien for tax withholding purposes. Similarly, IRC § 865(i)(3) defines Possessions as foreign countries for the purposes of sourcing income from sale of personal property.

On the other hand, Possessions may be included within some of the alternative tax definitions of the United States. For example, for the purposes of the Foreign Earned Income Exclusion, Possessions are treated as part of the United States.

Thus, it is very important for tax practitioners and their clients who reside in Possessions to look at the specific IRS provisions and determine whether an alternative definition applies to Possessions in their specific situations.

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Itemized Deductions Limitation in 2013

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The American Taxpayer Relief Act of 2012 added a limitation for itemized deductions claimed on 2013 returns of individuals with incomes of $250,000 or more ($300,000 for married couples filing jointly).

In reality this is not a new law; this is basically a re-birth of the famous “Pease limitation” that was the part of the Omnibus Budget Reconciliation Act of 1990. This limitation was later phased out during the era of Bush tax cuts and completely eliminated for the year 2010. Subsequently, additional legislation extended the elimination of the Pease limitation from 2010 through 2012. Now, as part of the New Year’s compromise, the American Taxpayer Relief Act of 2012 reinstated the provision with an upgrade; the provision is codified as 26 USC §68.

In order to understand how the provision works, it is important to emphasize that the idea is to limit the impact of certain itemized deductions, but not to completely eliminate the tax advantages of such deductions.

Types of Itemized Deductions Affected by the Limitation

Armed with this understanding, let’s look at the details of the Pease limitation. First, the provision mostly applies to the following types of itemized deductions: charitable contributions, mortgage interest, state/local/property taxes and miscellaneous itemized deductions. However, the statute expressly excludes medical expense deductions, the investment interest deduction, casualty, theft, or gambling loss deductions (see 26 USC §68(c)).

Limitation and Thresholds

For the tax year 2013, 26 USC §68 starts to limit the itemized deductions once the AGI exceeds $250,000 for individuals and $300,000 for joint filers (these are the items indexed for inflation). The limitation will consist of the less of (a) 3% of the adjusted gross income above the threshold amount, or (b) 80% of the amount of the itemized deductions otherwise allowable for the taxable year.

For example, in a hypothetical where a an individual earns $300,000 in 2013 and his itemized deductions consist of mortgage interest and property tax deductions of $50,000, the individual’s itemized deductions will be reduced by $ 1,500.

Based on the information in our hypothetical (and disregarding any other facts and factors), here are the calculations:

(a) $300,000 AGI – $250,000 (threshold for 2013) = $50,000; 3% x $50,000 = $1,500;
(b) 80% x $50,000 of itemized deductions = $40,000.

Since $1,500 is less than $40,000, this is the amount that should be used to reduce the taxpayer’s itemized deductions.

Contact Sherayzen Law Office for Tax Planning Help Regarding Pease Limitation

If you are potentially facing the limitation of your itemized deductions, it is possible that you are overlooking tax alternatives that may mitigate the impact of Pease Limitation. If you wish to explore such alternatives as part of your overall tax plan, contact the experienced tax firm of Sherayzen Law Office.

Deductibility of Meals on Schedule C: General Overview

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Virtually every business incurs some type of meal-related expenses. A question arises as to whether such meals are deductible and to what extent. This article provides a general overview of this topic; remember, though, that the deductibility of meals is highly fact-dependent and this article only provides an educational background to this issue, NOT a legal advice.

General Rule

Generally, expenses incurred with respect to the entertainment-related meals are not deductible, unless the taxpayer is able to establish that the expense is directly related to the active conduct of a business or trade.

However, if a meal expense directly precedes or follows a bona fide business discussion (including a convention meeting), then it is deductible if it is established that the expense was associated with the active conduct of a trade or business. The taxpayers needs to be able to establish that this is the case.

Restrictions on the General Rule

The Internal Revenue Code (IRC) places two broad restrictions on the general rule. First, if neither the taxpayer nor the taxpayer’s employee is present at the meal, then, generally, meal expenses are not deductible.

Second, a meals deduction is not allowed where the expense is lavish or extravagant under the circumstances. This topic has been the subject of controversy for some time now as large corporations have engaged in entertaining their important guests in a manner that the IRS may sometime classify as “lavish.”

It is important to point out that these restriction would not apply to certain exceptions to the general rule.

Exceptions to the General Rule

IRC Section 274(e) specifically provides that some exceptions are not subject to the general rule described above and are deductible as ordinary and necessary expenses (as long as they are properly substantiated). The exceptions are:

a. Food and beverages furnished on the business premises primarily to the taxpayer’s employees;

b. Expenses for services, goods, and facilities that are treated as compensation or wages for withholding tax purposes. If the recipient is a specified individual, then the employer’s deduction cannot exceed the amount of compensation reported. IRC Section 274(e)(2)(B) defines who is a “specified individual”; here, it is sufficient to state that it generally means an officer, director, ten-percent shareholder or a related person;

c. Reimbursed expenses: “expenses paid or incurred by the taxpayer, in connection with the performance by him of services for another person (whether or not such other person is his employer), under a reimbursement or other expense allowance arrangement with such other person”. IRC Section 274(e)(3). However, this exception applies only if: (1) services are performed for an employer and the employer has not treated such expenses as wages subject to withholding; or (2) where the services are performed for a person other than an employer and the taxpayer accounts to such person;

d. Expenses for recreational, social, or similar activities (including facilities therefor) primarily for the benefit of employees (other than employees who are highly compensated employees (within the meaning of section 414(q)). See IRC Section 274(e)(4) for further details on treatment of shareholders. The most common example of this exception are company picnics;

e. Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors. IRC Section 274(e)(5);

f. Expenses directly related and necessary to attendance at a business meeting or convention of any organization described in section 501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and boards of trade) and exempt from taxation under section 501(a). IRC Section 274(e)(6);

g. Expenses for goods, services, and facilities made available by the taxpayer to the general public. IRC Section 274(e)(7);

h. Expenses for goods or services (including the use of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration in money or money’s worth. IRC Section 274(e)(8); and

i. Expenses paid or incurred by the taxpayer for goods, services, and facilities furnished to non-employees as entertainment, amusement, or recreation to the extent that the expenses are includible in the gross income of a recipient and reported on a Form 1099-MISC by the taxpayer.

It is very important to note that exceptions a, e, and f maybe subject to the “50-Percent Limitation” rule.

50-Percent Limitation Rule

Generally, a taxpayer can only deduct 50 percent of the allowable meal and entertainment expenses, including such expenses incurred in the course of travel. The process in calculating the 50-percent limitation involves, first, the calculation of the allowable deductions through the process of exclusion of non-allowable deductions (e.g. lavish portion of the meal) and addition of related expenses (e.g. taxes, tips, room rental, and parking fees) and, then, the 50-percent rule applies. Note that the allowable deductions for transportation costs to and form a business meal are not reduced.

The 50-percent rule maybe subject to various statutory modifications based on profession or the nature of activity. For example, the transportation workers may deduct 80 percent. There are also complications with respect to a leasing company and independent contractors.

Exceptions to the 50-Percent Limitation Rule

The 50-Percent Limitation rule is riddled with exceptions.

First, exceptions b, c, d, g, h and i described above (see Exceptions to General Rule section) are not subject to the 50-Percent Limitation rule.

Second, the food expenses classified as de minimis fringe benefits and excludable from the recipient’s gross income are also not subject to the 50-Percent limitation rule.

Third, there are somewhat complicated exceptions related to the tickets to a sporting events.

Fourth, employee’s meal expenses incurred while moving are not subject to the 50-Percent Limitations rule if they are reimbursed by the employer and includible in the employee’s gross income.

There are various other exceptions to the 50-Percent Limitations rule such as food and beverages provided to employees on certain vessels, oil or gas platforms, drilling rigs, and so on.

Conclusion

This article provides a general review of the rules regarding deductibility of meal on Schedule C. However, this is only an educational article and it does NOT offer a tax or legal advice. You should see a tax professional regarding your specific facts.