Spousal Travel – E-Alert:
The New Form 990: Focus Upon Compensation Issues
As you are likely aware, the Internal Revenue Service (IRS) has substantially revised the Form 990 due for tax years ending during or after 2008. While public institutions may not file a Form 990, these issues can directly impact their key executives if they serve as directors, officers or key employees of an institutionally related foundation or other affiliate that is required to file a Form 990.
The new Form 990, and particularly Schedule J, includes a significant focus on the compensation of officers, directors, trustees and certain key and highly compensated employees. Schedule J requires institutions to disclose whether they reimburse the following expenses:
- Companion travel;
- First-class or charter travel;
- Tax indemnification or gross-up payments;
- Discretionary spending accounts;
- Housing allowance or residence for personal use;
- Payments for business use of personal residence;
- Health or social club dues or initiation fees; and
- Personal services (e.g., maid, chauffeur, chef).
As the higher education community is aware, many colleges and universities provide some combination of these benefits to their key executives. Many have speculated that the IRS disapproves of the practice of reimbursing these expenses, presumably on the theory that these items represent "luxury" expenditures that should not be funded with charitable dollars. Therefore, the question becomes, how will the disclosure of these expenditures impact the audit risk of colleges or universities that report payments of this nature? In addition, are these payments prohibited by law, or simply disfavored by the IRS?
With this background, we intend to provide a series of articles that address the legal parameters for the expenses that are most common in the higher education community, and their impact on the income and employment tax and intermediate sanctions liability of schools and their executives.
Companion Travel
The first reimbursement we will address is companion travel, or "spousal travel." It is common practice within colleges and universities that the president's spouse (or the spouses of other key institution officials such as senior executives, athletic directors, etc.) will accompany the president to various functions on school related business trips, including fundraising solicitations or alumni, donor and athletic events. The IRS typically starts from the position that spousal travel should be treated as taxable compensation to the employee. However, it is possible for a school to reimburse the expenses of a spouse, and treat the payment as a nontaxable fringe benefit, if the employee documents the business purpose for the spouse's attendance on the trip.
The governing law is found in Treas. Reg. § 1.132-5(t), which treats spousal travel as a nontaxable working condition fringe benefit if the employee establishes a bona fide business purpose for the spouse's participation. Guidance on the definition of what constitutes a "bona fide" business purpose is often conflicting. Each request for spousal travel must involve an analysis of the facts and circumstances and a determination of whether a valid business purpose exists to support the payment of the spousal travel. However, the following themes emerge from the case law:
- To be a bona fide business purpose, the presence of the spouse must be essential (not just beneficial) to the employee being able to carry out his/her business purpose for the college or university. The spouse's performance of some incidental service does not make it a bona fide business expense. An employee's spouse performing a ministerial task (such as taking notes) or accompanying the employee to luncheons and dinners is not a bona fide business purpose. The spouse must perform substantive business related functions.
- Arguments that spouses are "expected" to be present at related social functions or that the spouse’s presence promotes goodwill with the other attendees are likely to be rejected by the IRS and the courts.
- A determination of whether an employee's spouse serves a bona fide business purpose is normally based on the following criteria:
- The degree to which the "dominant purpose" of the travel is to aid the employee's business purpose of promoting the college or university’s objectives.
- Whether the spouse's presence on the trip is necessary to effectively carry out the duties of the employee.
- The extent to which the spouse's presence on the trip is to provide more than "incidental" business related services (e.g., typing notes, attending to ministerial or scheduling matters, attendance at meals, etc.) to the employee.
- The time spent by the spouse on personal activities in comparison to the activities related to the business of the institution.
In our experience, spousal travel can represent a nontaxable fringe benefit that does not cause W-2 income or employment tax consequences if there is a business purpose for the spouse's participation and the college or university demonstrates the following:
- The school has adopted a well drafted spousal travel policy.
- The policy requires the approval of the spousal travel by an independent third party. In the case of a key executive, that likely involves the president. In the case of the president, an individual that does not report to the president should be selected (e.g., the chair of the Audit Committee).
- The policy requires the employee to submit a detailed voucher that describes (a) the business purpose for the spouse's participation; and (b) the specific activities conducted by the spouse in furtherance of this business purpose.
- The financial staff and key executives are briefed on the relevant legal rules and the process for approving and documenting spousal travel.
However, absent these safeguards, we believe that a school may have a difficult time demonstrating that it consistently applied processes and procedures to ensure the appropriate tax compliance on payments for spousal travel.
Finally, even if the business purpose standard is met, the spouse’s expenses also have to be properly substantiated under the rules set forth in Code Section 274(d) in order for the expenses to be excluded from the employee’s income.
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