After waiting almost five years, the Internal Revenue Service apparently is ready to make a real attempt to address what it recognized was a problem back in 2007 - how to treat local lodging expenses incurred by an employee.
Since then, times have changed. A considerable shift toward telework opportunities has taken place, as has a desire by many employers to save on brick-and-mortar expenses. When employer and employee do get together now, it is more likely to involve local lodging expense than in the past, as the opportunity for team-building and connecting becomes more essential to the business. With the cost of travel continuing to rise, too, more company- or department-wide events are being held "in town" to avoid airfare expenses.
Nevertheless, there it has sat, like the elephant in the room -- Treasury regulations that prohibit employees from deducting most local lodging expenses.
Proposed reliance regs (Reg-137589-07, 4/26/12) now explicitly allow employees to treat local lodging expenses as working condition fringe benefits or accountable plan reimbursements. It also frees employers to more confidently treat local lodging expenses as deductible travel expenses. Further, these regulations offer safe harbors and examples, as well as the promise of further clarification during the public hearing and comment process that will follow.
Under current practice, employees generally cannot deduct lodging expenses for the costs of staying in the location where they work, as opposed to away-from-home travel that requires an overnight stay. If they seek reimbursement from their employer or the employer pays for local overnight accommodations directly, the employer has usually been faced with the choice of treating it as a working condition fringe benefit or as taxable compensation.
Sometimes treatment as a working condition fringe is marginal. If payment is taken from an accountable plan, qualification of the entire plan may be jeopardized. If treated only when reclassified subsequently as compensation, payroll taxes and withholding nevertheless must be determined, and the employee is none too happy having taxable income for effectively giving up an evening to be in the office.
To appreciate the proposed regulations, a look at past practice is necessary. Treasury Reg. Ã‚Â§1.262-1(b)(5), which remains on the books, denies local lodging expense unless it qualifies as a legitimate Code Section 217 moving expense: "The costs of the taxpayer's lodging not incurred in traveling away from home are personal expenses and are not deductible unless they qualify as deductible expenses under Section 217." This regulation left no room for arguing that the expense might qualify as a trade or business expense under Code Section 162.
Realizing that the Section 262 regulation's absence of a Section 162 exception was impractical, if not plain wrong, the IRS issued Notice 2007-47. Notice 2007-47 provided that, pending the issuance of additional published guidance and if certain prerequisites were followed, the IRS would not apply Reg. Ã‚Â§1.262-1(b)(5) to expenses for lodging of an employee not incurred while the employee is traveling away from home, provided certain conditions were met:
• The lodging must be on a temporary basis;
• The lodging must be necessary for the employee to participate in or be available for a bona fide business meeting or function of the employer; and,
• The expenses must be otherwise deductible as a Code Section 162(a) trade or business expense.
NEW SAFE HARBORS
Although Notice 2007-47 provided an employer and employee some degree of security if a deduction or reimbursement was questioned, the lack of elaboration in connection with each condition was unsettling. Now, safe harbors within the proposed regulations add a much greater degree of clarity to each of the Notice 2007-47 safe harbors. The proposed regs provide the following safe harbors for an employee to deduct local lodging expenses if:
• 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 function;
• The period of lodging does not exceed five calendar days and does not recur more frequently than once per calendar quarter;
• The employer requires the employee to remain at the activity or function overnight; and,
• The lodging is not lavish or extravagant and does not provide significant personal pleasure, recreation or benefit.
Although the IRS qualifies its illustrations with the disclaimer that your facts may vary, the proposed regulations offer several examples of acceptable and non-acceptable circumstances in which local lodging is a legitimate trade or business expense. In its preamble, the IRS listed the following reasons for using local lodging as personal in nature that will generate compensation when provided by the employer:
• A weekend at a luxury hotel provided by the employer;
• Lodging to avoid a long-distance commute;
• Lodging because the employee must work overtime;
• Housing for a recently relocated employee; or,
• Lodging for the employee's indefinite personal use.
On the other end of the scale, the regulations under new Section 1.162-31 offer three examples of local lodging expenses that are deductible if incurred in carrying on a taxpayer's trade or business:
• To attend employer-mandated training at a local hotel;
• To house athletes for last-minute training and to ensure the players' preparedness; or,
• For housing an employee who is on call outside of normal working hours, on a rotating basis with other employees as a condition of employment, to respond to business emergencies.
One particular example under the proposed regs, however, indicates that the IRS is not ready to give away the store. This example involves a long-distance employee who normally has a two-hour drive each way and is working on a project that requires him to work late. The IRS claims that the employee realizes taxable income; the employer, on the other hand, can deduct the lodging as a business expense paid "to maximize the employee's availability to work on the project."
MORE TO COME
While the proposed regs are not effective until issued as final regs, the IRS provided that taxpayers can rely on them now if they are claiming a deduction for expenses incurred during a tax year for which the statute of limitations is still open. As a result, Notice 2007-47 was also declared obsolete.
One can only guess at the number of other situations taxpayers may want addressed before final regulations are issued. One differentiator within the regulations is testing whether the lodging expense is routine, both to the particular employee and for the employer. Regular meetings with teleworkers might need to be addressed within these boundaries. Although mere overtime work does not justify a night's lodging as illustrated in the reg's example, one can imagine that that, too, has its limits -- say, for work on a special project that ends at midnight and starts back up again at 7 a.m. the next day.
How the IRS will adapt to changing work environments remains to be tested, with "buy local" perhaps a slogan that encompasses local lodging, at least more so than in the past.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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