The performance of services by an individual as an employee is considered to be a trade or business for purposes of Sec. 162. Generally, an employee is engaged in the business of earning his pay. Consequently, an employee may deduct amounts paid by him for expenses connected with his employment if they satisfy the statutory test of being "ordinary and necessary." See, e.g., Trent v. Commissioner, 291 F. 2d 669 (2d Cir. 1961); Ñoland v. Commissioner, 269 F. 2d 108 (4th Cir. 1959).

Section 7701 (a) (26) of the Code provides that the term "trade or business" includes the performance of the functions of a public office. To the extent the holder of a public office is a salaried employee, the special rules and limitations applicable under sections 62(2) and 162 to employees in general would also apply to the trade or business expenses paid or incurred by a public official. The staff believes that the President should be treated as an employee for purposes of section

162.3

In addition to the requirements of Sec. 162, expenses relating to travel, entertainment, and gifts are subject to the limitations of Sec. 274 which are discussed below.

The IRS and court cases clearly hold that an employee may not deduct expenses, which might otherwise be considered ordinary and necessary, if the employee has a right of reimbursement against his employer which he failed to exercise, or if the employer would have originally paid the expense itself had the employee so requested. In these situations the costs are considered to be the obligations of the employer. See Noland v. Comissioner, supra; Heidt v. Comissioner, 274 F.2d 25 (7th Cir. 1959). The employee cannot obtain a deduction since he is considered as having paid the expenses of another rather than having incurred the expenses in his own trade or business. It has also been held in similar cases that the employee could not deduct his expenses because they did not satisfy the statutory requirement of "being necessary," since he could have been reimbursed by his employer. See, for example, Horace E. Podems, 24 T.C. 21 (1955); and Eugene J. Rogers, T.C. Memo. 1959-192. Each of these cases involved Internal Revenue Service employees whose deductions were disallowed to the extent that they could have obtained reimbursement for their expenses from the government. The case of Leonard E. Austin, T.C. Memo. 1962-22, also involved this issue. In that case the court disallowed deductions for research and experimentation expenditures incurred at home by an employee of the Bendix Aviation Corporation. The court stated:

"For aught that this record shows, petitioner could have had reimbursement from Bendix for those expenses which he incurred while working for that company; but he refrained, for reasons of his own, from seeking reimbursement. Such portion of the expenses were those of Bendix, and petitioner cannot convert them into his own by paying them and not seeking reimbursement therefor. Heidt v. Commissioner, 274 F. 2d 25 (C.A. 7); Horace E. Podems, 24 T.C. 21."

For withholding purposes, section 3401 (c) of the Code provides that the term "employee" includes an officer, employee, or elected official of the United States. Furthermore, the President has treated himself as an employee on his tax returns, in that the claimed business expenses were treated as itemized deductions pursuant to section 62(2)— which applies only to employees-rather than as deductions in arriving at adjusted gross income pursuant to section 62(1). The staff agrees with the classification of the President as an employee of the United States for tax purposes.

Standards under which employee business expenses are determined to be "ordinary and necessary" were originally rather strictly defined in Internal Revenue Service rulings. However, more recent court decisions have been less restrictive than the Internal Revenue Service position. Given the status of the present law, it is not always clear exactly which standard is appropriate for the deduction of employee business expenses.

With respect to home office expenses, the position of the Internal Revenue Service regarding employee business expense deductions is that such expenses must be required by the taxpayer's employer as a condition of employment. Revenue Ruling 62-180, 1962-2 Č.B. 52, sets forth these standards as they apply to determining the deductibility of home office expenses. That revenue ruling states:

"An employee who, as a condition of his employment, is required to provide his own space and facilities for performance of his duties and regularly uses a portion of his personal residence for that purpose may deduct a pro-rata portion of the expenses of maintenance and depreciation on his residence. However, the voluntary, occasional, or incidental use by an employee of a part of his residence in connection with his employment does not entitle him to a business expense deduction for any portion of the depreciation and expenses of maintaining his residence." The test that employee expenses cannot be deducted unless they are required as a condition of employment was affirmed for certain expenses other than home office expenses in Revenue Ruling 70-474, 1970-2 C.B. 35, which dealt with an employee's cost of maintaining and acquiring uniforms. In that ruling the IRS stated that:

"Generally, the cost of acquisition and maintenance of uniforms is deductible [by an employee] as an ordinary and necessary business expense under section 162 of the Internal Revenue Code of 1954 if the uniforms are (1) specifically required as a condition of employment and (2) [do not take the place of regular clothing]." However, at times the Internal Revenue Service has wavered somewhat from the "required as a condition of employment" test in arguments before courts and in occasional revenue rulings. For example, in Revenue Ruling 64-272, 1964-2 C.B. 55, the IRS ruled that a college professor could deduct the cost of maintaining an office at home. The professor had research and publication duties in addition to the usual lecture and teaching duties. Because the college did not furnish adequate space and facilities for carrying on such research, the IRS ruled that the professor could deduct depreciation on a portion of the maintenance expense for his personal residence. Although the ruling found that it was necessary that the professor furnish his own facilities, the standard implied by this ruling appears to come closer to a test of whether the expense is necessary to enable the employee to perform his job well in the most convenient manner rather than whether the expenditure is required as a condition of employment.

Moreover, in a recent Tax Court case, Steven A. Bodzin, 60 T.C. 820 (1973), the IRS argued that an employee should not be allowed deductions for a home office because the expense "was not required in order for the [taxpayer] to properly perform his employment duties." According to the IRS, the taxpayer must prove "that the nature of his duties required working after normal working hours and

that his employer failed to provide him with an office that was adequate and reasonably accessible for the performance of such work." However, some courts which have heard this issue have decided that a less restrictive standard than that urged by the Internal Revenue Service is appropriate. In the Bodzin case mentioned above, a majority of the Tax Court held that (60 T.C., at 825)

"The applicable test for judging the deductibility of home office expenses is whether, like any other business expense, the maintenance of an office in the home is appropriate and helpful under all the circumstances."

The court stated that a finding that the home office was simply for the taxpayer's personal convenience would bar a deduction if the court concluded that personal convenience was the primary reason for maintaining the office. Such a finding would displace any conclusion to "appropriateness" and "helpfulness."

Furthermore, the Tax Court believes that this standard should apply to other types of employee expenses as well. In Marvin L. Dietrich, T.C. Memo. 1971-159, a case which dealt primarily with home office expenses of a physician who was an employee, the court also applied the appropriate and helpful standard to the deduction of the cost of trade journals. In that case the court stated:

"With regard to other types of employee expenses, we have often allowed deductions for items which were not required by an employer, but which were appropriate for the job. [For example] as for clothes, it is sufficient that they are appropriate for the job and that they are not adaptable for ordinary street wear. . The court went on to hold that the costs of the trade journals were appropriate and useful and thus were deductible by the employee.

At least one other court has approved the "appropriate and helpful" standard. See, for example, Newi v. Commissioner, 432 F. 2d 998 (2nd Cir. 1970).

The IRS is presently appealing the Bodzin case. Thus, whether the IRS position or the position taken by the Tax Court and the Second Circuit will become generally applicable to all taxpayers is yet to be decided.

In cases where a deduction for home office expenses is appropriate, the Internal Revenue Service has argued that the portion of the expenses allocable to business use should be determined on the basis of availability for use rather than actual use, i.e., the ratio of time actually used for business purposes to the total time it is available for all uses. Rev. Rul. 62-180, 1962-2 C.B. 52, 54. However, in George W. Gino, 60 T.C. 304, 314 (1973) (followed in Lena M. Anderson, T.C. Memo. 1974-49), the Tax Court held that the expenses should be allocated on the basis of actual business use as compared with actual total use. The Tax Court relied heavily on the position taken in Treas. Regs. § 1.274-2(e) (4), relating to entertainment facilities, etc., that it is the actual use of a facility that establishes primary business use rather than availability of use.

Expenses for the Production of Income

Section 212 (which permits deductions for expenses incurred for the production of income, for managing property held for the production or income, or in connection with determining taxes) allows a deduction for only "ordinary and necessary expenses" in the same

manner as does section 162. However, under section 212, the fact that the President is an employee of the Federal Government is not relevant because, for purposes of section 212, ordinary and necessary expenses attributable to property held for the production of income are deductible if paid or incurred by him in his capacity as an investor (rather than in the pursuit of trade or business by an employee under section 162). Since the deduction under sec. 212 does not depend on whether the expenses are paid or incurred in connection with a trade or business, the "appropriate and helpful" standard the courts have adopted with respect to employee trade or business expenses under section 162 and the "required as a condition of employment" standard the Internal Revenue Service has developed with respect to such expenses are not relevant for purposes of section 212. However, as a general rule, the requirement that no deduction can be taken if the taxpayer has a right to reimbursement for the expense holds under section 212 as well as under section 162. See Estate of Elmer B. Boyd et al., 28 T.C. 564 (1957). This rule would apply where the taxpayer had a fixed right to reimbursement. See Electric Tachometer Corp., 37 T.C. 158 (1961). In the President's case, section 212 is relevant primarily with respect to his deductions of depreciation and expenses on his property at 500 Bay Lane in Key Biscayne. It is well established in case law that real property which is not held for rental purposes can nonetheless be considered held for the production of income. See, e.g., Drown v. United States, 203 F. Supp. 514 (D.C. Calif., 1962) and Mary Laughlin Robinson, 2 T.C. 305 (1943).

For purposes of determining if property is held for the production of income under sections 167 (a) (2) and 212(1), "income" includes gain from the disposition of property. See George W. Mitchell, 47 T.C. 120, 128 (1966), nonacq., 1970-2 C.B. xxii; see Frank A. Newcombe, 54 T.C. 1298, 1302 (1970). Furthermore, Treas. Regs. § 1.212-1(b) provides that "income" includes income which may be realized in subsequent years and that it is not necessary, for the deduction of expenses under section 212, that property be currently productive. Thus, in Mitchell depreciation deductions were allowable with respect to property held in order to realize anticipated appreciation.

In Newcombe, supra, at page 1303, the Tax Court stated that in determining whether or not property is held for the production of income, the key question is the purpose or intention of the taxpayer in light of all the facts and circumstances. The use of property as a personal residence is, of course, a factor indicating that the property is held for personal use rather than for the production of income. Charles F. Neave, 17 T.C. 1237 (1952); Warren Leslie, Sr., 6 T.C. 488 (1946); and Frank A. Newcombe, 54 T.C. at 1300. The recreational character of property, such as a beach cottage, is a factor that tends to indicate that property is held for personal use and enjoyment rather than for the production of income.

Of course, any expenses which are deductible must relate to the property as it is held for the production of income. Treasury Regs. §1.212-1(d) states that:

"such expenses must be reasonable in amount and must bear a reasonable and proximate relation to the production or collection of taxable income or to the management, conservation, or maintenance of property held for the production of income.

In determining what expenses can be allowed in the case of real estate not held for rental purposes, the courts have generally allowed expenses for insurance, protective agency expenses, utility expenses, and caretaker expenses. See for example William C. Horrmann, 17 T.C. 903 (1951); and Andrew F. McBride, Jr., 50 T.C. 1 (1968). These cases also permit depreciation charges to be deducted under section 167(a) (which provides for a depreciation deduction both for property used for a trade or business under sec. 162 and for property held for the production of income under sec. 212).

In the case of real property including a residence held for the production of income, where the property is not currently being held for rent as furnished, the courts generally have denied deductions for depreciation of furniture and other personalty in the residence. Even when the furniture and furnishings have not been used for the taxpayer's personal purposes, the courts have denied deductions because, so far as they could tell, the furniture and furnishings were in the residence to make the residence more attractive to a possible purchaser or renter (James J. Sherlock, T.C. Memo 1972-97) or because the residence was a reasonably convenient place to store the furniture and furnishings (Hickman v. Commissioner, 207 F. 2d 460 (4th Cir., 1953), affg. T.C. Memo. 1953-17).

It should be noted that, as to depreciation deductions, property which is held for the production of rents or other current income may be distinguished from property which is held for production of income only in the sense that there is a hope that a sale in the future would produce greater proceeds than a sale at present. Thus, if the sole rationale for section 212 treatment of the property is that it will appreciate in value, then it would seem that no depreciation deductions should be allowed (unless the property consists of several parts and the hoped-for appreciation would be expected to occur only in the nondepreciable portion of the property). For example, under appropriate factual circumstances, depreciation would be allowable for a building where it was expected that only the land would appreciate in value.

Limitation on Business Expenses for Travel, Entertainment and Gift Purposes

Sec. 274 limits deductions that might otherwise be available under Sec. 162 for expenses for entertainment, travel and gifts.

Specifically, Sec. 274 (a) states that no deduction can be taken with respect to entertainment "activities" unless the expense attributable to the activity is directly related to the active conduct of the taxpayer's trade or business, or is both directly associated with that trade or business and incurred directly preceding or following a substantial and bona fide business discussion.

The section further states that no deduction can be taken for expenses in connection with a "facility" used for entertainment purposes unless that facility is used primarily for the furtherance of the taxpayer's trade or business. Treasury Regulation section 1.2742(e) (4) (iii) states that a facility used in connection with entertainment will be determined to be used primarily for the furtherance of a taxpayer's trade or business if the taxpayer can establish that in 50 percent of the days in which the property was used, it was used for business purposes. Notwithstanding this provision, subdivision (i)