As I mentioned in the January 2017 AFSA Tax Guide (for the 2016 tax year), all income is generally included in one’s gross income calculation for federal income tax purposes. (Please read it first if you missed it: http://www.afsa.org/sites/default/files/2016afsaTaxGuide.pdf) From there, benefits like deductions, credits, and exemptions are matters of “legislative grace.” So a federal authority must create (or interpret) a law that allows the taxpayer to subtract amounts from gross income.
A combination of laws, interpreted by the federal courts, is what authorizes a Foreign Service employee to deduct a portion of their home leave expenses. Stratton v. IRS, 448 F.2d 1030 (9th Cir. 1971); SEE THE UPDATE BELOW FOR CHANGES BY THE TAX CUTS AND JOBS ACT OF 2017. Therein, the Ninth Circuit explained that because Section 903 of the Foreign Service Act (22 USC § 4083) requires a Foreign Service employee to take home leave periodically, the portion of expenses deductible as Trade or Business Expenses under Section 162 of the Internal Revenue Code applies:
“… the fact that both the Department and its foreign service officers, and probably Congress as well, view home leave to be in the nature of a vacation, does not alter the fact that it was also a compulsory job requirement. Unlike other taxpayers, Stratton did not have a choice as to where he could spend a substantial portion of the family treasury. He did not have the option of investing his money or spending it on a new car, a boat, a trip to another country abroad, or an expensive hobby.
Instead, he was mandatorily required to take a vacation in the United States. It may not be a particularly onerous burden to many foreign service officers, but it still is an unavoidable expense imposed by the employer and by statute for reasons pertaining directly to the employee's trade or business.
Thus, we hold that the travel expenses, including food and lodging, attributable solely to taxpayer Bruce Cornwall Stratton while he was on home leave were related primarily to his trade or business as a foreign service officer within the meaning of § 162(a),"
This case (mandatory authority only in the Ninth Circuit, but highly persuasive in the rest of the country) has been treated well by other courts and the IRS since it was published over forty years ago. For example, see Brewin v. IRS, 639 F.2d 805 (DC 1981) (reversing the Tax Court to allow home leave expense deductions because "the home leave travel expenses of Messers. Teil and Brewin relate primarily to their trade or business as foreign service officers.") Here's the Tax Court Case that it reversed: Brewin v. IRS, 72 T.C. 1055 (1979)(home leave expense deduction denied because they were personal in nature, not for production of income).
Referring back to the 2016 AFSA Tax Guide, this decision means that Home Leave Expenses can most easily be claimed and deducted as miscellaneous itemized deductions (report with Form 2106, subject to a 2 percent floor and don't forget the 50-percent limit for meals and entertainment).
I finish by emphasizing that personal expenses, unrelated to a trade or business are not deductible. As seen in Brewin, the Tax Court applies a high level of scrutiny to the nature of the expenses deducted under Section 162. So avoid attempting to deduct things like meals and lodging for family members (or even more extravagant vacation-like expenses, even while on home leave). The Section 162 rule of thumb should be to only deduct expenses that are ordinarily incurred in the production of income and necessary to produce that income (office supplies, gas on travel between professional engagements, etc.)
UPDATE following the December 22, 2017 TAX CUTS AND JOBS ACT: IRC Section 67 Miscellaneous Itemized Deductions has been suspended until 2026. This change places the deduction for unreimbursed home leave expenses in a state of flux. Consult Treasury Reg 1.162-2 Traveling Expenses; 1.162-17 Reporting and Substantiation of Certain Business Expenses of Employees; and your tax professional to plan an properly claim what deductions might still be still possible under IRC 162.
Circular 230 Notice: Pursuant to U.S. Treasury Department Regulations, all tax advice herein is not intended or written to be used, and may not be used, for the purposes of avoiding tax-related penalties under the Internal Revenue Code or promoting, marketing or recommending advice on any tax-related matters addressed herein.
The EFM Lawyer.