More on Taxing Sarah Palin’s Per Diem

Over at TaxProf, Paul Caron has links to Sarah Palin’s newly released tax returns. It appears, as Paul says, that Governor Palin did not report her per diems or the travel reimbursements for her family as income. In support of this position, an opinion from a lawyer was also released.

As Paul points out, the opinion cites no authority for the positions that the lawyer takes. Moreover, the opinion does not directly discuss whether the per diem payments were taxable, but only discusses whether Governor Palin was justified in relying upon the Form W-2 provided to her by the State of Alaska, which did not report the per diem payments as income.

The letter is somewhat baffling to interpret. On the one hand, it is correct that, for purposes of avoiding penalties, Governor Palin might be entitled to rely upon the Form W-2 for purposes of demonstrating reasonable cause for the position that she took on her tax return. In fact, Treas. Reg. sec. 1.6664-4(b)(1) provides that “ taxpayer’s reliance on erroneous information reported on a Form W-2, Form 1099, or other information return indicates reasonable cause and good faith, provided the taxpayer did not know or have reason to know that the information was incorrect.”

But, on the other hand, that regulation only applies for purposes of determining whether Governor Palin can escape penalties. It should not be taken to mean that Governor Palin would be further excused from paying the underlying tax on the underreported amount of income. I am not aware of any rule or regulation that says that you can escape tax because you relied on someone else to figure out your taxes for you and they made a mistake. (Indeed, the exception in the regulation mentioned above militates in favor of exactly the opposite conclusion—because the relevant penalties are determined as a percentage of the underpayment of tax. If Governor Palin were excused from paying the tax because of her employer’s mistake, then there would be no underpayment of tax and no penalty could, as a practical matter, be imposed upon her, making the sentence quoted above totally and completely superfluous.)

It would seem that Governor Palin’s return is ripe for an audit because, as I’ve blogged earlier, there is a distinct possibility that these per diem payments are taxable in her hands. I’ve done some more digging on the travel reimbursements and they also require some further scrutiny.

Others have mentioned (e.g., Francine Lipman in one of the comments to my earlier blog post) that section 274(m) contains very stringent restrictions on the deductibility of an employee’s spouse’s and family members’ travel expenses. But the pertinent rules for Governor Palin are likely those under section 132, which deals with fringe benefits, given that we are concerned her with reimbursements and not expenses that she is trying to deduct herself. Under Treas. Reg. sec. 1.132-5(t)(1), if an employer’s deduction for the travel expenses of an employee’s spouse or family member is disallowed under section 274(m), then the stringent rules of that section will not apply in determining whether the reimbursement is excludible from the employee’s gross income as a “working condition” fringe benefit. The expense still must pass muster under section 162 as an ordinary and necessary business expense, however. In this regard, the regulation goes on to state: “The amount will qualify for deduction and for exclusion as a working condition fringe benefit if it can be adequately shown that the spouse’s, dependent’s, or other accompanying individual’s presence on the employee’s business trip has a bona fide business purpose. . . .” So, Governor Palin would still have to show a business purpose for her husband’s or children’s presence on the trip. (It is worth noting that under Treas. Reg. sec. 1.132-5(t)(2), this rule applies regardless of whether the employer is exempt from tax.)

It will be interesting to see whether the IRS initiates an audit of Governor Palin’s returns to flesh out all of the facts necessary to make a more definitive determination as to whether the per diem payments and travel reimbursements should have been reported by her as gross income.

-Tony Infanti

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