IRS regulations permit certain non-away-from-home lodging expenses to be treated as deductible business expenses by the employer and tax-free working condition fringe benefits or accountable-plan reimbursements to the employee. The regulations provide a safe harbor; local lodging expenses are treated as ordinary and necessary business expenses if all these conditions are met (Reg § 1.162-32(b)):
(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, his employer requires him to remain at the activity or function overnight.
(4) The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.
The regulations include a provision that, even if the safe harbor conditions aren’t met, “facts and circumstances” may still allow favorable treatment of the expenses. According to Reg § 1.162-32(a), “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.”
Example – Safe Harbor: A business conducts a 2-day business-related sales training program at a hotel and conference center near its main office. The employer requires both its field and in-house sales force to attend the training and stay at the hotel overnight between Day 1 and Day 2 for the bona fide purpose of facilitating the training. If the company pays the lodging costs directly to the hotel, the stay is a working condition fringe benefit to all attendees (even to employees who live in the area who are not on travel status), and the company may deduct the cost as an ordinary and necessary business expense. If the employees pay for the lodging costs and are reimbursed by the company, the reimbursement is of the accountable plan variety and is tax-free to the employees and deductible by the company as an ordinary and necessary business expense.
Example – Self-Employed: Continuing the example above. . .If a locally based self-employed consultant who does business with the company was required by the company to attend the sessions and to stay at the hotel, he could deduct the lodging expense if he paid for it himself, or exclude the expense if he were reimbursed by the company after accounting to it in full for his costs.
Example – Facts and Circumstances: Able Company conducts a seven-day training session for its employees at a hotel near the company’s main office. The training is directly connected with Able's trade or business. Some employees attending the training are traveling away from home and some employees are from the local area. Able requires all employees attending the training to remain at the hotel overnight for the bona fide purpose of facilitating the training. The company pays the costs of the lodging at the hotel directly to the hotel and does not treat the value as compensation to the employees.
Because the training is longer than five calendar days, the safe harbor does not apply. However, the value of the lodging is excluded from income since the facts and circumstances test is satisfied: The training is a bona fide condition or requirement of employment and Able has a noncompensatory business purpose for paying the lodging expenses and is not paying the expenses primarily to provide a social or personal benefit to the employees. The lodging Able provides is not lavish or extravagant. If the employees who are not traveling away from home had paid for their own lodging, the employee could have deducted the expenses 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), and the company may deduct the lodging expenses of all the employees as ordinary and necessary business expenses under section 162(a). (Based on example 1 from final regs)Effect on Sole Proprietors – Part of paragraph (a) of the final regulations says, “Under certain circumstances, however, local lodging expenses may be deductible under section 162(a) as ordinary and necessary expenses paid or incurred in connection with carrying on a taxpayer's trade or business, including a trade or business as an employee.” Therefore, deducting local lodging could apply to a sole proprietor. However, the self-employed individual would still have to meet the "no personal benefit" and "bona fide activity" tests. For example, if a self-employed tax return preparer attends the ClientWhys Fall Seminar in the same city where his office is located, it would be hard to qualify to deduct overnight hotel costs at the meeting location unless there was an evening session, too.