Palin per diems: State didn't follow its normal policies
Yesterday we posted our analysis of Sarah and Todd Palin's 2006 and 2007 tax returns. We concluded that the travel payments the Palins received for their children's travel were definitely taxable income, and that since the Palins did not report the kids' payments, they owe substantial back federal taxes (in the neighborhood of $6,000) on them.
And their tax deficiency could run substantially higher. For example, we left open the possibility that the amounts paid for Sarah Palin's own travel might have been taxable. We noted that the issue probably turned on whether the Anchorage area (including Wasilla) was her "tax home," as opposed to Juneau. If Anchorage was her "tax home," per diem allowances and other amounts paid for her expenses in Anchorage or Wasilla would be taxable, thus increasing her tax liability substantially.
An alert reader, Richard J. Koppel, an attorney in southern California, points out that the State of Alaska had already issued a policy paper on this very tax issue, years before Palin became governor. The state concluded then that long-term per diems (such as those now being paid to Sarah Palin) were taxable, because when an employee spends a majority of his or her time over an extended period in a given location on state business, that location becomes his or her "tax home," even though it is not his or her official Alaska "duty station." The state apparently did not follow these established policies in the case of the governor, because if it had, her long-term per diems would have appeared on her W-2 wage statement filed with the IRS.
The official memo, apparently written by someone in the state's Finance Division, is entitled "Income Tax Implications of Long-Term Per Diem." That document, bearing dates in both 2000 and 2004, appears on the state website, here. The most pertinent passage is this:
If the employee does not work at their PCN duty station at least 50% of the time (vacation time does not count toward time worked at the duty station), then the State must first consider whether the employee works the majority of their time at another location, making this location their principle place of business. If they do, this other location becomes their tax home. This occurs in situations where an employee is in long-term travel status at this other location for a period of time which is expected to exceed one year. It can also occur when a seasonal employee is assigned to a project or series of projects in one general location for two or more years in a row.This document is a potential blockbuster. It establishes two important facts:
Please note, per diem becomes taxable at the point at which it is determined the assignment will last one year or more. The following are a couple of examples to illustrate:
• An employee is assigned to a project which is expected to last 16 months. Since we know from the beginning that the project assignment will place the employee at this location for more than one year, all per diem paid to the employee at this location (starting with the first day) will be taxable.
• An employee is assigned to a project which is expected to last four months. At the end of the second month, the employee is assigned to a subsequent project which is expected to last ten months. Because the total time it is expected the employee will be assigned to this location will exceed one year, all per diem becomes taxable at this location starting with the third month.
We have discussed this issue with the IRS and the following summarizes the IRS comments on the one-year rule and taxable per diem.
• One year does not necessarily mean 365 consecutive days.
• Interruptions generally do not start the clock over again on the one-year rule unless they are significant (significant was not defined, but IRS rulings indicate seasonal shutdowns are not considered significant).
• The one-year rule requires the employer to look at the total time spent at the "temporary" location. If an assignment to a location is expected to last more than one year, or actually lasts longer than one year, then any per diem paid at this "temporary" location is considered compensation. The one-year rule applies beginning with the date the employer determines the assignment will exceed one year. Also, the IRS looks at “location” broadly and encompasses a general vicinity (generally a 50 mile radius).
• The remoteness of the duty assignment does not change the application of the one-year rule.
• The fact the employee may be incurring duplicate lodging expenses does not change the rule. The IRS has long ruled that duplicate expenses have no bearing on the determination of the tax home.
• With regards to seasonal employees, if the employee is assigned to the same general location two years in a row, or would otherwise meet the one-year rule, per diem paid would be considered compensation.
• The employer essentially has an obligation to determine the employee's tax home.
(1) The state has long acknowledged that it had a duty to determine whether Palin's "tax home" was really Anchorage and Wasilla, a conclusion which would have required that her per diems be reported as taxable income.
(2) The state knew that when an employee is planning to spend a majority of her time on state business in the Anchorage area for a four-year period, Anchorage is the employee's "tax home," and per diems for time spent in the "tax home" are taxable income.
So why didn't Alaska officials follow the state's official policies and report Palin's per diems as taxable income on her W-2? Only they can answer that.
And how can the tax lawyer whose opinion was released by the McCain campaign on Friday say that "no special consideration was ever given to Governor Palin, notwithstanding that she was the governor of Alaska"?
UPDATE, 10/7, 4:40 p.m.: The state is now "reviewing" the situation in light of the questions raised by this post. As well it should.