SECTION 2. BACKGROUND AND

CHANGES

.01 Section 162(a) of the Internal Revenue Code allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Under that provision, an employee or self-employed in

additional payments to Taxpayer or Taxpayer disposes of Taxpayer’s interest in the S corporation.

Similar transactions may be structured using a partnership in the place of the S corporation.

ANALYSIS

The transaction described in this notice has been designed to use a straddle, one or more transitory shareholders, and the rules of subchapter S to allow Taxpayer to claim an immediate loss while deferring an offsetting gain in Taxpayer’s investment in the S corporation. The Service intends to challenge the purported tax benefits from this transaction on a number of grounds. First, the Service may disallow Taxpayer’s loss under § 165(c)(2) by asserting that the loss was not incurred in a transaction undertaken for profit. See Smith v. Com- missioner, 78 T.C. 350 (1982) and Fox v. Commissioner, 82 T.C. 1001 (1984) (disallowing losses from straddle transactions). Second, the Service may disregard the transitory ownership of the shareholders other than Taxpayer. See Comtel Corporation v. Commissioner, 376 F.2d 791 (2d Cir. 1967) (transitory shareholders’ interests not respected). Under this argument, the Service would allocate all of the income and losses from the activities of the S corporation to Taxpayer. Third, the Service may disallow Taxpayer’s loss deduction under § 269 by asserting that Taxpayer acquired control of the S corporation with the principal purpose of avoiding or evading federal income tax. In addition, the Service may challenge the allowance of the loss deduction based on other statutory provisions, including § 988, and judicial doctrines, including the step transaction doctrine and the doctrines of economic substance, business purpose, and substance over form. Transactions that use a partnership instead of an S corporation also will be challenged under the partnership anti-abuse rule contained in § 1.701–2 of the Income Tax Regulations. See § 1.701–2(d) (Ex. 8).

Transactions that are the same as, or substantially similar to, the transaction described in this notice are identified as “listed transactions” for purposes of § 1.6011– 4T(b)(2) of the temporary Income Tax Regulations and § 301.6111–2T(b)(2) of the temporary Procedure and Administration Regulations. See also § 301.6112–1T, A–4. The transaction described in this notice and

the transaction described in Notice 2002– 50, 2002–28 I.R.B. 98, (Partnership Straddle Tax Shelter) are substantially similar transactions. For purposes of § 1.6011–4T(b)(2) and § 301.6111–2T(b)(2), a transaction will be considered the same as, or substantially similar to, the transaction described in this notice even if the gain and loss legs of the straddle are triggered in separate taxable years, or if, at the time relevant for making such determination, the corporation in the transaction has not elected under § 1377(a)(2) to treat the S corporation’s taxable year as though it consisted of two separate taxable years. Further, it should be noted that, independent of their classification as “listed transactions” for purposes of §§ 1.6011–4T(b)(2) and 301.6111–2T(b)(2), transactions that are the same as, or substantially similar to, the transaction described in this notice may already be subject to the disclosure requirements of § 6011, the tax shelter registration requirements of § 6111 or the list maintenance requirements of § 6112 (§§ 1.6011–4T, 301.6111– 1T, 301.6111–2T and 301.6112–1T, A–3 and A–4).

Persons who are required to satisfy the registration requirement of § 6111 with respect to the transaction described in this notice and who fail to do so may be subject to the penalty under § 6707(a). Persons who are required to satisfy the list-keeping requirement of § 6112 with respect to the transaction and who fail to do so may be subject to the penalty under § 6708(a). In addition, the Service may impose penalties on participants in this transaction or substantially similar transactions, or, as applicable, on persons who participate in the promotion or reporting of this transaction or substantially similar transactions, including the accuracy-related penalty under § 6662, the return preparer penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting penalty under § 6701.

The principal author of this notice is Demetri Yatrakis of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Mr. Yatrakis at (202) 622–3060 (not a toll-free call).

October 15, 2002 691 2002–41 I.R.B.

ance that relates to days of travel substantiated in accordance with § 1.62– 2(e), that exceeds the amount of the employee’s expenses deemed substantiated for such travel pursuant to rules prescribed under § 274(d) and § 1.274–5(g) or § 1.274– 5(j), and that the employee is not required to return, is subject to withholding and payment of employment taxes. See §§ 31.3121(a)–3, 31.3231(e)–1(a)(5), 31.3306(b)–2, and 31.3401(a)–4 of the Employment Tax Regulations. Because the employee is not required to return this excess portion, the reasonable period of time provisions of § 1.62–2(g) (relating to the return of excess amounts) do not apply to this portion.

.09 Under § 1.62–2(h)(2)(i)(B)( 4 ), the Commissioner may, in his or her discretion, prescribe special rules regarding the timing of withholding and payment of employment taxes on per diem allowances.

.10 Section 1.274–5(j)(1) grants the Commissioner the authority to establish a method under which a taxpayer may elect to use a specified amount for meals paid or incurred while traveling away from home in lieu of substantiating the actual cost of meals.

.11 The Internal Revenue Service intends to issue regulations pursuant to § 274(d) granting the Commissioner the authority to establish a method under which a taxpayer may elect to use a specified amount for incidental expenses paid or incurred while traveling away from home in lieu of substantiating the actual cost of incidental expenses. The regulations are expected to apply to incidental expenses paid or incurred after September 30, 2002.

.12 Sections 3.02, 4.04(5), and 5.06 provide transition rules for the last 3 months of calendar year 2002 due to changes in the effective date of the CONUS rates published by GSA.

.13 Section 3.02(3) of this revenue procedure contains revisions to the definition of incidental expenses.

.14 Section 4.03 of this revenue procedure contains revisions to the optional method for substantiating meal and incidental expenses.

.15 Section 4.05 of this revenue procedure is added to provide a new optional method for substantiating incidental expenses.

.16 Section 5.04 of this revenue procedure contains revisions to the list of high

dividual may deduct expenses paid or incurred while traveling away from home in pursuit of a trade or business. However, under § 262, no portion of the travel expenses that is attributable to personal, living, or family expenses is deductible.

.02 Section 274(n) generally limits the amount allowable as a deduction under § 162 for any expense for food, beverages, or entertainment to 50 percent of the amount of the expense that otherwise would be allowable as a deduction. In the case of any expenses for food or beverages consumed while away from home (within the meaning of § 162(a)(2)) by an individual during, or incident to, the period of duty subject to the hours of service limitations of the Department of Transportation, § 274(n)(3) gradually increases the deductible percentage to 80 percent for taxable years beginning in 2008. For taxable years beginning in 2002, the deductible percentage for these expenses is 65 percent.

.03 Section 274(d) provides, in part, that no deduction shall be allowed under § 162 for any traveling expense (including meals and lodging while away from home) unless the taxpayer complies with certain substantiation requirements. The section further provides that regulations may prescribe that some or all of the substantiation requirements do not apply to an expense that does not exceed an amount prescribed by such regulations.

.04 Section 1.274–5(g) of the regulations, in part, grants the Commissioner the authority to prescribe rules relating to reimbursement arrangements or per diem allowances for ordinary and necessary expenses paid or incurred while traveling away from home. Pursuant to this grant of authority, the Commissioner may prescribe rules under which such arrangements or allowances, if in accordance with reasonable business practice, will be regarded (1) as equivalent to substantiation, by adequate records or other sufficient evidence, of the amount of such travel expenses for purposes of § 1.274–5(c), and (2) as satisfying the requirements of an adequate accounting to the employer of the amount of such travel expenses for purposes of § 1.274–5(f).

.05 For purposes of determining adjusted gross income, § 62(a)(2)(A) allows an employee a deduction for expenses allowed by Part VI (§ 161 and following), subchapter B, chapter 1 of the Code, paid

or incurred by the employee in connection with the performance of services as an employee under a reimbursement or other expense allowance arrangement with a payor.

.06 Section 62(c) provides that an arrangement will not be treated as a reimbursement or other expense allowance arrangement for purposes of § 62(a)(2)(A) if it—

(1) does not require the employee to substantiate the expenses covered by the arrangement to the payor, or

(2) provides the employee with the right to retain any amount in excess of the substantiated expenses covered under the arrangement. Section 62(c) further provides that the substantiation requirements described therein shall not apply to any expense to the extent that, under the grant of regulatory authority prescribed in § 274(d), the Commissioner has provided that substantiation is not required for such expense.

.07 Under § 1.62–2(c)(1) a reimbursement or other expense allowance arrangement satisfies the requirements of § 62(c) if it meets the requirements of business connection, substantiation, and returning amounts in excess of expenses as specified in the regulations. Section 1.62–2(e)(2) specifically provides that substantiation of certain business expenses in accordance with rules prescribed under the authority of § 1.274–5(g) or 1.274–5(j) will be treated as substantiation of the amount of such expenses for purposes of § 1.62–2. Under § 1.62–2(f)(2), the Commissioner may prescribe rules under which an arrangement providing per diem allowances will be treated as satisfying the requirement of returning amounts in excess of expenses, even though the arrangement does not require the employee to return the portion of such an allowance that relates to days of travel substantiated and that exceeds the amount of the employee’s expenses deemed substantiated pursuant to rules prescribed under § 274(d), provided the allowance is reasonably calculated not to exceed the amount of the employee’s expenses or anticipated expenses and the employee is required to return any portion of such an allowance that relates to days of travel not substantiated.

.08 Section 1.62–2(h)(2)(i)(B) provides that if a payor pays a per diem allowance that meets the requirements of § 1.62– 2(c)(1), the portion, if any, of the allow

2002–41 I.R.B. 692 October 15, 2002

cost localities and to the high-low rates for purposes of section 5.

.17 Section 7 of this revenue procedure is revised by renumbering section 7.07 of Rev. Proc. 2001–47 as section 7.08 in this revenue procedure; by renumbering section 7.08 of Rev. Proc. 2001–47 as section 7.10 in this revenue procedure; and by inserting sections 7.07 and 7.09 in this revenue procedure to describe the application of section 4.05 of this revenue procedure.