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The IRS has issued proposed regulations that allow an employee to treat local lodging expenses as working condition fringe benefits or accountable plan reimbursements, and allow an employer to treat the expenses as deductible business expenses.

New Rules Would Enhance Deduction of Lodging Expenses

  • 5/16/2012

New Rules Would Enhance Deduction of Lodging Expenses

The IRS has issued proposed regulations that allow an employee to treat local lodging expenses as working condition fringe benefits or accountable plan reimbursements, and allow an employer to treat the expenses as deductible business expenses. There is also a new safe harbor.

CCH Take Away: "This is welcome news and is a very good tool for employers," Marianna Dyson, member, Miller & Chevalier Chartered, Washington, DC, told CCH. "The IRS has recognized that there are situations where the demands of the job require that employees should be reimbursed because of business exigencies," Dyson said. "The IRS is trying to put some contours to the problem. It is making a distinction — the deduction applies to circumstances that do not happen routinely." A deduction may not be available merely because the employee works overtime and is too tired to go home, she added.

Background

Under current regulations, employees may be able to deduct expenses for job-related travel away from home, but generally cannot deduct lodging expenses for the costs of staying in the locality where they work. If the employer reimburses the employee or pays for the lodging expenses directly, the employer, in most cases, can deduct the payments as compensation expenses. However, the employee has to recognize the payments as compensation income.

Comment: There can be tax consequences for the employer, Dyson said. If an expense was reclassified as compensation, instead of a nontaxable fringe benefit, there is a real risk to the employer of owing payroll taxes, she noted. Plus, the employer may have secondary liability for the employee’s income taxes, she said.

In the preamble to the regulations, the IRS explains that the following reasons for using local lodging are considered personal, not business-related:

  • 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
  • Lodging for the employee’s indefinite personal use

In these circumstances, the expenses are not deductible by the employee, and are treated as compensation if paid by the employer.

Reliance regulations

In 2007, the IRS announced in Notice 2007-47 that it would amend the current regulations to change the treatment of local lodging. At that time, the IRS indicated without elaboration that, until it amended the regulations, it would not challenge an employee’s deduction for local lodging if the lodging was temporary and was "necessary" for the employee to participate in a business function of the employer.

Now the IRS has proposed to amend its regulations under Code Sections 162 (trade or business expenses) and 262 (personal expenses). Instead of disallowing all local lodging expenses, the new regulations provide that the expenses are deductible if incurred in carrying on a taxpayer’s trade or business, based on all the facts and circumstances.

Examples in the proposed reliance regulations allow an employee deduction (or treat an employer payment as nontaxable):

  • To attend employer-mandated training at a local hotel
  • To house athletes for last-minute training and ensure the players’ preparedness
  • For housing an employee who is on call to respond to business emergencies outside of normal working hours

Comment: These regulations will open up a lot of discussion about what is a legitimate lodging expense; employers need to think about this judiciously, Dyson said.

While the proposed regulations are not effective until issued as final, 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.

Safe harbor

The proposed regulations also provide a safe harbor 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.
  • The lodging is not lavish or extravagant and does not provide significant personal pleasure, recreation or benefit.

Comment: The IRS did not address the cost of meals during lodging.

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