Whenever I teach at firm-wide CPE, I elect to spend the night before the training at the hosting hotel, even when it’s located less than an hour’s drive from my house. I do this because 1) I like to remove traffic from the morning preparation equation, and 2) I’m a spoiled, self-entitled prima donna.
Regardless, my firm typically picks up the tab for the hotel room. It’s no freebie, however; the expense is required to be included in my compensation. Why?
Ordinarily, if an employer provides property — such as a hotel room — to an employee in the course of business, the value of the benefit is excludable from the employee’s income only if the benefit constitutes a working condition fringe under I.R.C. § 132(a)(3). In turn, the property only constitutes a working condition fringe to the employee to the extent that — if the employee had paid the expense himself — it would be deductible to the employee as a business expense under I.R.C. § 162.
Unfortunately, Treas. Reg. § 1.262-1 trumps I.R.C. § 162 and disallows a deduction for any personal, living, or family expenses. Included in this definition is the cost of any “local lodging. ” Local lodging is generally any lodging expenses that are not incurred while traveling away from home.
Applying these provisions to my facts, the payment by my firm for my hotel room would only be excludable to me as a working condition fringe to the extent that, if I paid for the hotel room myself, I could deduct the expense as an unreimbursed business expense. Because the cost of local lodging is a nondeductible personal expense, however, I would not be entitled to deduct the cost of the hotel room if I paid it directly. Thus, I have to include the value of the hotel room in my income as compensation, with my firm getting a corresponding compensation deduction.
The same result occurs if I paid for the hotel room directly, and my firm reimbursed me for the expense. While typically, reimbursements made under an accountable plan are excludable from the income of the employee, this favorable rule applies only where the expense is one that would be deductible by the employee. Since expenses for local lodging are nondeductible, I would not be entitled to tax-free reimbursement by my employer.
Expanding upon these principles further, the same result occurs to the extent of the value of any local lodging afforded to an employee or reimbursed by an employer, including weekend resort getaways, lodging to avoid a late-working employee from having to drive home, or housing for a recently relocated employee until they find something permanent. In all three cases, the value of the lodging — or any reimbursement — is included in the income of the employee.
Got all that?
Good, because its changing.
Today, the IRS issued proposed regulations under Treas. Reg. §1.162-31 and Treas. Reg. §1.262-2 that would allow an employee to either 1) have local lodging expenses paid on their behalf by their employer, or 2) be reimbursed for local lodging expenses paid out of pocket, without the value of the lodging or the reimbursement being included in the employee’s income.
Under the proposed regulations, under certain circumstances expenses for local lodging would no longer be treated as nondeductible personal expenses — but rather as deductible business expenses under Section 162 – thus allowing for tax-free reimbursement or treatment as a working condition fringe. While the determination of whether the local lodging expenses are business rather than personal expenses will be determined under all the facts and circumstances, the critical factor is whether the taxpayer incurs the expense because of a bona fide condition or requirement of employment imposed by the taxpayer’s employer.
Under the regulations, expenses paid or incurred for local lodging that primarily provides an individual with a social or personal benefit are not treated as business expenses, and thus continue to not be eligible to be excluded from income.
The regulations go on to provide a safe harbor, under which any local lodging expenses will be considered business expenses, such that the value of the lodging or any reimbursement are excludable from income. The safe harbor applies where:
(1) 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;
(2) The lodging is for a period that does not exceed five calendar days and does not recur more frequently than once per calendar quarter;
(3) If the individual is an employee, the employee’s employer requires the employee to remain at the activity or function overnight; and
(4) The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.
In my original fact pattern, I still wouldn’t be eligible to exclude the value of the hotel room under the safe harbor, as my stay is not required by my employer, and my liberal use of the “adult” section of the pay-per-view channel certainly constitutes a significant element of personal pleasure. In other situations, however, local lodging that was once includable in employees’ income will now be tax-free. The proposed regulations include the following examples:
Example 1. (i) Employer conducts training for its employees at a hotel near Employer’s main office. The training is directly connected with Employer’s trade or business. Some employees attending the training are traveling away from home and some employees are not traveling away from home. Employer requires all employees attending the training to remain at the hotel overnight for the bona fide purpose of facilitating the training. Employer pays the costs of the lodging at the hotel directly to the hotel and does not treat the value as compensation to the employees.
(ii) Employer has a noncompensatory business purpose for paying the lodging expenses. Employer is not paying the expenses primarily to provide a social or personal benefit to the employees. If the employees who are not traveling away from home had paid for their own lodging, the expenses would have been deductible under section 162(a) as ordinary and necessary business expenses of the employees. Therefore, the value of the lodging is excluded from the employees’ income as a working condition fringe under section 132(a) and (d).
In still other situations, however, the personal benefit inuring to the employee will continue to prevent the employee from being permitted to exclude the value of local lodging from income:
Example 4. (i) Employer hires Employee, who currently resides 500 miles from Employer’s business premises. Employer pays for temporary lodging for Employee near Employer’s business premises while Employee searches for a residence.
(ii) Employer is paying the temporary lodging expense primarily to provide a personal benefit to Employee by providing housing while Employee searches for a residence. Employer incurs the expense only as additional compensation and not for a noncompensatory business purpose. If Employee paid the temporary lodging expense, the expense would not be an ordinary and necessary employee business expense under section 162(a) because the lodging primarily provides a personal benefit to Employee. Therefore, the value of the lodging is includible in Employee’s gross income as additional compensation.
These changes are effective the date final regulations are published; but in the interim, taxpayers may apply the proposed regulations to local lodging expenses.