Suppose an employee lives and works in the Chicago area. Her employer has offices and employees across the United States. The employer hosts a national meeting for a group of employees at a hotel in Chicago that lasts for several days. The meeting starts each day with breakfast at 7 a.m. and concludes with dinner and networking until about 10 p.m. Because of the long days, the employer pays for the Chicago employee to stay at the hotel. Are the lodging expenses paid by the employer taxable to the employee for federal income tax purposes?
Most employers would not even ask this question for the employees who are from out of town. It is common knowledge that the lodging expense for an employee from out of town is excluded from the employee's income. A relatively quick look through the Code confirms this.
First, Sec. 132(a)(3) says that an employee's income does not include any fringe benefit that qualifies as a working condition fringe benefit. Next, Sec. 132(d) says that a working condition fringe benefit is any property or services provided to an employee to the extent that, if the employee paid for the property or services, the payment would be allowable as a deduction under Sec. 162. Finally, Sec. 162(a)(2) provides that "there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business." Since the lodging expenses would be deductible by the out-of-town employee if he paid for the expenses himself, payment of the lodging expenses by the employer is excluded from income as a working condition fringe benefit.
It is common sense to conclude that the employee from Chicago is not away from home, and, therefore, the Code provisions stated above do not apply. This commonsense conclusion is backed up by revenue rulings the IRS issued several decades ago. For example, Rev. Rul. 73-529 provides that to be away from home, the distance must be long enough that the employee would need to "stop for substantial sleep or rest." Similarly, Rev. Rul. 75-170 states that to be away from home, the employee "cannot reasonably be expected to complete the round trip without being released from duty . . . for sufficient time to obtain substantial sleep or rest." No matter how bad the traffic might be in Chicago, a trip from one part of the city to another part of the city is not going to meet the definition of being away from home.
On a technical note, it is important to realize that the term "home," when determining whether an employee is away from home, is the employee's tax home, not the employee's residence. It is a long-established principle that an employee's tax home is the employee's primary place of business. The IRS's position on this goes back to at least the 1950s (see, e.g., Rev. Rul. 54-147). Since the employee works in Chicago, it can be concluded that a trip between her office and the hotel in Chicago does not cause her to be away from home.
Where does this leave the analysis? Is the employer in the unfortunate position of telling the employee that even though her lodging expenses will be covered, she is going to have to pay federal income tax on the expenses? The default answer is "yes." Since the employee's tax home is Chicago, she is not away from home, and, therefore, any lodging expenses in Chicago are generally a personal expense rather than a business expense. Sec. 262(a) provides that "no deduction shall be allowed for personal, living, or family expenses," so the employee cannot exclude the hotel lodging from her income as a working condition fringe benefit.
Many employers probably do not give this much thought and, in fact, would not include the lodging expenses in the employee's income. This would not be due to any analysis of the tax law, but simply because they do not have a procedure in place to enter the value of local lodging into their payroll system. In other words, local lodging simply goes unnoticed from a payroll perspective.
These employers may be in luck because the IRS has issued a regulation that allows local lodging expenses to be excluded from an employee's income as a working condition fringe benefit under certain limited circumstances. Employers that are knowledgeable of these regulations can put procedures in place to ensure that they are doing the right thing when they exclude the value of local lodging from an employee's income.
Regs. Sec. 1.162-32 says that local lodging expenses are generally a personal expense, but that, under certain circumstances, the expenses may be deductible as a business expense. The determination of whether the lodging is a business expense is based on all the facts and circumstances, according to the regulation. It goes on to say that "one factor is whether the taxpayer incurs an expense because of a bona fide condition or requirement of employment imposed by the taxpayer's employer." In an apparent effort to avoid abuse in this area, the regulation excludes "lavish or extravagant" lodging from qualifying for the deduction. It also states that local lodging that primarily provides an individual with a "social or personal benefit" does not qualify. That is the full extent of the general guidance under the regulation.
After the general guidance described above, which would require a significant degree of judgment to apply, the regulation takes a more practical turn by establishing a safe harbor for local lodging at business meetings and conferences, such as the meeting in Chicago in the example above. Employers would be well-served by paying close attention to the safe harbor because it takes the guesswork out of determining whether the lodging qualifies for exclusion from an employee's income. Under the safe harbor, local lodging at business meetings and conferences can be excluded from an employee's income as a working condition fringe benefit if all four of the following conditions are satisfied:
- The lodging is necessary for the individual to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function;
- The lodging is for a period that does not exceed five calendar days and does not recur more frequently than once per calendar quarter;
- If the individual is an employee, the employee's employer requires the employee to remain at the activity or function overnight; and
- The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.
The Chicago employee meets the first condition, given the fact that the meetings and activities run from 7 a.m. to 10 p.m. If she had to go home every night, she probably would not be able to keep these hours and fully participate in the activities. She also meets the second condition, as long as the meeting does not last longer than five days. The third condition, although straightforward, is one that most employers do not meet unless they are aware of the safe harbor. If the Chicago employee is not required to stay at the hotel, she does not qualify for the safe harbor. In other words, if the employee had the choice to go home each day or stay at the hotel, the safe harbor is not satisfied. It is assumed that the fourth condition is satisfied, since for the typical business meeting at a hotel, the lodging is probably not lavish or extravagant, and there is probably not a significant element of personal pleasure, recreation, or benefit (although admittedly, what constitutes personal pleasure is a matter of judgment, and the regulations provide no guidance on this).
Suppose all the conditions of the safe harbor are not met, which is likely since the employer does not require the employee to stay at the hotel. This does not mean that the lodging cannot be excluded from the employee's income. It just means that the employer has a greater burden to show that the local lodging is an ordinary and necessary business expense for the employee. It would be much safer to rely on the safe harbor.
The remainder of the regulation is devoted to examples. The examples are particularly insightful because they do not illustrate the safe harbor, but instead illustrate the application of the general guidance. In fact, none of the examples would qualify for the safe harbor for one reason or another. Some of the examples illustrate local lodging that is excluded from an employee's income, while other examples illustrate local lodging that must be included in an employee's income.
Under the examples, local lodging is excluded from an employee's income in the following situations:
- Employees stay at a local hotel where the employer conducts a seven-day training session, and the employer requires the employees to stay overnight at the hotel.
- Players and coaches employed by a professional sports team are required by the team to stay at a local hotel the night before each home game to conduct last-minute training and ensure the players' physical preparedness.
- Once a month, an employee who works daytime hours is required to be on call overnight in order to come to the office to respond quickly to emergencies that may occur at night. The employer pays for the employee to stay at a local hotel the night that he is on duty. Under the examples, local lodging is included in an employee's income in the following situations:
- An employer pays for local lodging for a new employee who resides 500 miles from his new place of employment while the employee searches for a residence.
- An employer pays for lodging near an employee's office during a period of time when the employee works late hours on a special project because the employee's normal commute from her home to the office is two hours each way.
In summary, local lodging for an employee that is paid by the employer may be excluded from an employee's income under certain circumstances. However, this is by no means a given, since local lodging is by default a personal expense that must be included in income. Employers should understand the regulation that permits local lodging to be excluded from income under certain circumstances, and they should consider using the safe harbor provided in the regulation to take the guesswork out of determining whether the lodging can be excluded from an employee's income.
Greg Fairbanks is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.