Tax Implications of Employer Lodging

Employers who provide non-cash, work-related benefits to employees should consider the potential tax implications of “fringe benefits”. A “fringe benefit” is a form of pay provided to employees in addition to stated pay, such as lodging and meals, that will be taxable to an employee unless an exclusion applies. 26 CFR § 1.162-32 and IRC Sections 132 and 162(a) are the two fringe benefit exclusions employers must consider when providing lodging to employees. Failure to qualify for a fringe benefit exclusion will result in the value of any employer lodging having to be reported by the employee on a W-2 as taxable wages.

EXCLUSION #1: 26 CFR § 1.162-32

26 CFR § 1.162-32 provides two separate avenues for employers to exclude lodging from employee income. The first avenue provides a safe harbor under 26 CFR § 1.162-32(b) that allows employer lodging to be excluded from income when four specific conditions are met. The second avenue allows employer lodging to be excluded from income under 26 CFR § 1.162-32(a) when a more nebulous “facts and circumstances” test is met.

1) Safe Harbor
The first avenue under 26 CFR § 1.162-32 is for the employer lodging to qualify for the safe harbor. According to 26 CFR § 1.162-32(b), employer lodging can be excluded from income when four requirements are met:

1. The lodging must be necessary for the employee to fully participate in or be available for a legitimate business meeting, conference, training activity, or another business function;
2. The lodging must not exceed a period of five calendar days and must not recur more frequently than once per calendar quarter;
3. The employer must require the employee to remain at the activity or function overnight; and
4. The lodging must not be lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.

The 26 CFR § 1.162-32(b) safe harbor requirements are quite specific. If the employer lodging fails to meet any one of the four requirements, the lodging will not be eligible for this safe harbor. However, the employer may still be able to exclude lodging by qualifying under the “facts and circumstances” test under 26 CFR § 1.162-32(a), or under IRC Sections 132 and 162(a).

2) “Facts and Circumstances” Test
The second avenue under 26 CFR § 1.162-32(a) offers a more flexible approach to employer lodging, termed the “facts and circumstances” test. Unlike the 26 CFR § 1.162-32(b) safe harbor, which creates a definitive exclusion for lodging when all four requirements are met, the “facts and circumstances” test simply requires that lodging expenses are paid or incurred in carrying on a taxpayer’s trade or business, as determined under all the facts and circumstances.

26 CFR § 1.162-32(c) provides an example demonstrating when the facts and circumstances test is met. According to 26 CFR § 1.162-32(c), an employer will meet the “facts and circumstances” test when the employer conducts a week-long training session at a nearby hotel that is considered a legitimate employment requirement and not intended to provide personal or social benefits to the employees, and directly pays for non-extravagant lodging for its employees. The example then points out that the training session is ineligible for the safe harbor because it lasts more than five days, but the lodging can be excluded from income because the “facts and circumstances” test is met. Thus, 26 CFR § 1.162-32(c) appears to suggest that the key factors for satisfying the “facts and circumstances” test are:

1. Whether the event is a bona fide condition or requirement of employment.
2. Whether the employer has a noncompensatory business purpose for paying the lodging expenses.
3. Whether lodging expenses are not paid primarily to provide a social or personal benefit to the employees.
4. Whether the lodging is lavish or extravagant.

Unfortunately, employers relying upon the “facts and circumstances” test will find that it requires a nuanced and careful analysis of each situation that cannot achieve guaranteed results. The facts and circumstances test requires more discretion and judgment than qualifying under the safe harbor provision and introduces a level of uncertainty and risk for employers and employees when deciding whether to exclude the employer lodging from employee income.

EXCLUSION #2: IRC 132 and 162(a).

IRC 132 and 162(a) combine to create a second exclusion that allows employers to exclude lodging from employee income. IRC Section 132 outlines a set of fringe benefits that are excluded from an employee’s gross income. IRC Section 162(a) deals with the deductibility of business expenses by employees.

IRC 132(a) provides that gross income shall not include any fringe benefit which qualifies as a “working condition fringe.” IRC Section 132(d) defines “working condition fringe” to mean any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under IRC Section 162 or 167.

IRC Section 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. According to IRS Publication 5137 (rev. 2-2020), qualifying expenses for travel are excludable under IRC Section 162(a)(2) if they are incurred for temporary travel on business away from the general area of the employee’s tax home. “Away from home” has been interpreted by the U.S. Supreme Court to require a taxpayer to travel overnight, or long enough to require substantial “sleep or rest.” U.S. v Correll, 389 U.S. 299, 302-303 (1967). Thus, lodging expenses can be deducted by an employee under IRC Section 162(a)(2) when the lodging expenses are incurred (1) during temporary business travel, (2) away from the employee’s tax home, and (3) the travel requires substantial sleep or rest.

With respect to the first element under IRC Section 162(a)(2), the lodging expenses must be incurred during temporary business travel. To determine whether the business travel is “temporary,” the employer must determine whether an assignment at a single location is realistically expected to last less than one year when the assignment begins. An assignment is considered temporary if it is realistically expected to be, and does in fact, last one year or less. Any assignment that is realistically expected to last for more than one year is considered indefinite and the employee is considered to have moved their tax home to the new work location and therefore ineligible to deduct any lodging expenses. Tax courts view each short-term work assignment at a single location to be its own separate assignment when determining whether any assignment is realistically expected to last for more than one year. Wilson v. C.I.R., 56 T.C.M. (CCH) 1478 (T.C. 1989).

With respect to the second element under IRC Section 162(a)(2), the lodging expenses must be incurred away from the employee’s tax home. An employee’s tax home is the employee’s regular place of business, regardless of where the employee maintains a family home. Publication 5137 (rev. 2-2020) Fringe Benefit Guide. If an employee has more than one regular place of business, the tax home is the employee’s main place of business. Id. The main place of business is generally determined by the time worked, degree of business activity and income earned in each location. Rev. Rul. 54-147, 1954-1 C.B. 51. The tax home includes the entire metropolitan area, and the employee is not away from home unless they leave the metropolitan area.

With respect to the third element under IRC Section 162(a)(2), the travel must require substantial “sleep or rest”. The United States Supreme Court created the “sleep or rest” rule when interpreting the statutory phrase “away from home” to require an employee to travel overnight, or long enough to require substantial “sleep or rest.” U.S. v Correll, 389 U.S. 299, 302-303 (1967). The IRS in Rev. Rul. 61-221 also announced that it will follow the decision in Williams v. Patterson, 286 F.2d 333 (5th Cir. 1961), where the court stated that the ‘correct rule’ governing the deductibility of the cost of meals, lodging, and tips was that if the nature of the employee’s employment was such that when away from home, during released time, it was reasonable for him to need and to obtain sleep or rest in order to meet the exigencies of his employment or business demands of his employment, his expenditures (including incidental expenses, such as tips) for the purpose of obtaining sleep or rest were deductible traveling expenses under IRC Section 162(a).

Conclusion

Understanding the tax nuances associated with employer lodging can be difficult. 26 CFR § 1.162-32 and IRC Sections 132 and 162(a) provide distinct and complicated frameworks for fringe benefit exclusions that employers must consider when providing lodging to employees. Failure to qualify employer lodging from a fringe benefit exclusion will result in taxable income to the employee. Employers should consult with tax professionals to navigate these challenges effectively, ensuring that they not only comply with the law but also optimize their tax positions when providing lodging to employees.