Small Business Taxes & ManagementTM--Copyright 2014, A/N Group, Inc.
The IRS has issued new regulations (Sec. 1.162-32) with respect to lodging expenses paid or incurred by an individual when not traveling away from home. In general, such expenses are personal, living, or family expenses and are nondeductible. Under certain circumstances, however, local lodging expenses may be deductible under Section 162(a) as ordinary and necessary expenses of a trade or business, including a trade or business as an employee. Whether local lodging expenses are paid or incurred in carrying on a taxpayer's trade or business is determined under all the facts and circumstances. 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. Expenses paid or incurred for local lodging that is lavish or extravagant under the circumstances or that primarily provides an individual with a social or personal benefit are not incurred in carrying on a taxpayer's trade or business.
Safe Harbor for Local Lodging
The new regulations provide a safe harbor under which local lodging expenses will be treated as ordinary and necessary business expenses. You must meet four tests to satisfy the safe harbor:
Notice that you have to meet all four tests. The third test needs a little explanation. The employee can't control the reason for staying overnight. Thus, an employee can't decide to stay simply because it's going to be a late night and he doesn't want to drive home.
If you fail the safe harbor above, you may still be able to claim a deduction, but you'll have to support the claim based on the facts and circumstances. Falling under the safe harbor means you'll just have to show you met the safe harbor tests. That should be easier than meeting the facts and circumstances test.
Keep in mind that whichever way you qualify the expenses, you must still have the supporting documentation such as receipts. You should also make a note of the reason the employee (or you if you're self-employed) had to remain overnight.
Example 1-- Madison conducts a seven-day training session for its employees at a hotel near its main office. The training is directly connected with Madison's trade or business. Some employees attending the training are traveling away from home and some are not. Madison requires all employees attending the training to remain at the hotel overnight for the bona fide purpose of facilitating the training. Madison pays the costs of the lodging at the hotel directly to the hotel and does not treat the value as compensation to the employees.
The conference fails to meet the safe harbor because it exceeds five days. However, the value of the lodging may be excluded from income if the facts and circumstances test is satisfied.
In this case the training is a bona fide condition or requirement of employment and Madison has a noncompensatory business purpose for paying the lodging expenses. It is not paying the expenses primarily to provide a social or personal benefit to the employees, and the lodging Madison provides is not lavish or extravagant. If the employees who are not traveling away from home had paid for their own lodging, the expenses would have been deductible by the employees under Section 162(a) as ordinary and necessary business expenses. Therefore, the value of the lodging is excluded from the employees' income as a working condition fringe (under Section 132(a) and (d)).
Madison may deduct the lodging expenses, including lodging for employees who are not traveling away from home, as ordinary and necessary business expenses under Section 162(a).
Example 2-- The facts are the same as in Example 1, except that the employees pay the cost of their lodging at the hotel directly to the hotel and Madison reimburses them and doesn't consider the amount as compensation.
While the safe harbor test is not met, Madison does not have to include the reimbursement in the employees' compensation because if it didn't, the employees could deduct the amount as an employee business expense. Madison can deduct the expenses as an ordinary and necessary business expense.
Example 3-- Madison hires Fred Flood, who currently lives 500 miles from Madison's business premises. Madison pays for temporary lodging for Fred near its business premises while Fred searches for a residence.
Madison is paying the temporary lodging expense primarily to provide a personal benefit to Fred by providing housing while he searches for a residence. Madison incurs the expense only as additional compensation and not for a noncompensatory business purpose. If Fred paid the temporary lodging expense, it would not be an ordinary and necessary employee business expense because the lodging primarily provides a personal benefit. Therefore, the value of the lodging is includible in Fred's gross income as additional compensation. Madison can deduct the expense as a business expense.
Example 4--Sue normally travels two hours each way between her home and her office. She is working on a project that requires her to work late hours. Madison provides her with lodging at a hotel near the office.
Here Madison is paying the temporary lodging expense primarily to provide a personal benefit to Sue by relieving her of the daily commute to her residence. Madison incurs the expense only as additional compensation and not for a noncompensatory business purpose. The value of the lodging is includible in Sue's gross income as additional compensation and Madison can deduct the lodging expense as compensation.
Example 5--Madison requires an employee to be "on duty" each night to respond quickly to emergencies that may occur outside of normal working hours. Employees who work daytime hours each serve a "duty shift" once each month in addition to their normal work schedule. Emergencies that require the duty shift employee to respond occur regularly. Madison has no sleeping facilities on its business premises and pays for a hotel room nearby where the duty shift employee stays until called to respond to an emergency.
Because Madison's expenses for lodging while on the duty shift occur more frequently than once per calendar quarter, the safe harbor does not apply. However, the value of the lodging may be excluded from income if the facts and circumstances test is satisfied.
The duty shift is a bona fide condition or requirement of employment and Madison has a noncompensatory business purpose for paying the lodging expenses. Employer is not providing the lodging to duty shift employees primarily to provide a social or personal benefit to the employees and the lodging Employer provides is not lavish or extravagant. If the employees had paid for their lodging, the expenses would have been deductible by the employees as a business expense. Therefore, the value of the lodging is excluded from the employees' income as a working condition fringe and Madison may deduct the expense.
Example 6--Madison is a public relations firm dealing with companies in crisis. On fast-breaking assignments Madison requires its employees to be available throughout the night to handle information and confer with staff and clients. At these times Madison requires affected employees to stay at a nearby hotel. Madison pays for the lodging expenses directly and does not treat the value as employee compensation.
Because the overnight stays occur more than once a quarter, the safe harbor test does not apply. However, the value of the lodging may be excluded from income if the facts and circumstances test is satisfied. The overnight stays are a bona fide condition of employment and Madison has a noncompensatory business purpose. Madison is not paying the lodging expenses primarily to provide a social or personal benefit the employees. The employees could have deducted the expenses if Madison had not paid them. Therefore, the value of the lodging is excluded from the employees' income as a working condition fringe.
Copyright 2014 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Articles in this publication are not intended to be used, and cannot be used, for the purpose of avoiding accuracy-related penalties that may be imposed on a taxpayer. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 10/07/14