The U.S. Internal Revenue Service has issued a proposed rule that would permit travel expenses incurred while not away from home to be tax exempt to employees as a working condition benefit, so long as certain conditions are satisfied. The proposed rule, Local Lodging Expenses, was published in the Federal Register on April 25, 2012, and is a follow-up to IRS Notice 2007-47, 2007-1 CB 1393, in which the IRS first announced modifications to regulations relating to the taxation of travel expenses paid while not away from home.
Travel Away from the Employee's Tax Home
Section 162(a)(2) of the Internal Revenue Code permits a deduction for ordinary and necessary travel expenses incurred while away from home temporarily in the pursuit of a trade or business. The deduction for expenses incurred while away from home is intended to mitigate the burden on a taxpayer who, because of the travel requirements of his trade or business, must maintain two places of abode and therefore must incur duplicative living expenses.
To be allowed a deduction under code section 162, a taxpayer must establish that the travel expenses were:
• Reasonable and necessary.
• Incurred while away from home.
• Incurred in pursuit of a trade or business.
Conversely, expenses incurred by an employee who is not "away from home" are treated as a personal expense and thus taxable as wages to the employee.
Generally, a taxpayer's "home" for purposes of code section 162(a) is the city or location of his or her principal place of business and not where his or her personal residence is located. A taxpayer's residence can be the principal place of business if it qualifies as a home office for purposes of the home office deduction. Further, an employee without a principal place of business may treat a permanent place of residence at which he or she incurs substantial continuing living expenses as his or her tax home.
In Flowers v. Commissioner, the U.S. Supreme Court held that the taxpayer must be "away from home" to deduct travel expenses. This has been determined to mean that a "sleep or rest rule" or "overnight rule" must be satisfied. This requirement is satisfied if the taxpayer must be away from home for "substantially longer than an ordinary day's work [and] the employee cannot reasonably be expected to make the trip without being released from duty for sufficient time to obtain substantial sleep or rest while away from the principal post of duty, and the release from duty is with the employer's tacit or express acquiescence."
The courts, in considering questions involving deductions for traveling expenses, frequently have stated that each case must be decided on its own facts. Furthermore, there appears to be no set distance for what constitutes "away from home." The IRS has noted the "metropolitan area" is within the "tax home's" geographic reach, but there is no definition of metropolitan area, which can vary substantially around the country.
Employer Advance or Reimbursement of Travel Expenses
If an employee does travel away from home and the employer advances the funds or reimburses the employee for the costs of such travel, the expenses may be treated as a working condition benefit, and thus the value of travel excluded from the employee's wages, if the advance or reimbursement meets the accountable plan rules. To be an accountable plan, the employer's reimbursement or allowance arrangement must meet the following rules:
• The expenses must have a business connection; that is, the employee must have paid or incurred deductible expenses while performing services as an employee of the employer.
• The employee must account adequately to his or her employer for these expenses within a reasonable time (generally 60 days).
• The employee must return any excess reimbursement or allowance within a reasonable time (generally 120 days). Travel expenses can include fares, meals and lodging, and incidental expenses.
The proposed rule allows expenses for lodging that is not away from the employee's tax home to be excluded as a working condition benefit if accountable plan rules are satisfied under a totality of the facts and circumstances test. The proposal, however, contains a safe harbor that would exclude the value of such lodging from the employee's wages. The following conditions must be met to take advantage of the safe harbor:
• The lodging is necessary for the individual to participate in fully or be available for a bona fide business meeting, conference, training activity or other business function.
• The lodging is for a period that does not exceed five calendar days and does not recur more than once per calendar quarter.
• If the individual is an employee, his employer requires him to remain at the activity or function overnight.
• The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation or benefit.
The proposed rule contains several examples to illustrate how the proposed requirements can be satisfied. For example:
When a company runs business-related training near its office and requires employees to stay overnight at the facility, the value of the lodging is excluded from the employees' income, presuming that the accountable plan rules are satisfied. Similarly, the value of the lodging is excluded from an employee's income when the employee is required to stay overnight at a hotel near his employer's business premises in order to be able to respond quickly to emergencies that occur outside of normal working hours.
There are examples where the proposed requirements are not satisfied and therefore the value of the lodging is included in the employee's income as additional compensation. For example:
When an employee who commutes two hours each way is allowed to stay in a local hotel so that she can maximize the hours she puts in on a particular project, the value of the lodging must be included in her income. Likewise, when the employer puts up in temporary lodging an employee who relocated to a new city and is house hunting, the value of the lodging is includible in the employee's income.
The proposed rule will apply to expenses incurred or paid after it becomes final, although taxpayers may apply them for any open taxable period.
Caveats for Employers and Employees
The new regulations are narrowly focused to help employers achieve business-related activities that are somewhat specific in nature. Thus, employers and employees should not take the proposed rule as an opportunity to pay living expenses of employees, which will still be treated as taxable wages. The examples in the proposed rule of what does not qualify as a working condition benefit provide guidance that should be used to ensure that employers are not paying personal living expenses on a tax-exempt basis improperly.
Further, the proposed rule covers only lodging expenses. Meals and other travel-related expenses are not addressed. Presumably, a working dinner provided at the off-site training would itself constitute a working condition benefit to the employees and thus be excluded from wages, without regard to the proposed rule. However, employers need to be careful about other incidental kinds of expenses for which employees might seek reimbursement.
Comments or a request for a public hearing on the proposed rule are being accepted through July 24, 2012.
William Hays Weissman is a shareholder in the Walnut Creek, Calif., office of law firm Littler Mendelson.
Republished with permission. © 2012 Littler Mendelson. All rights reserved.
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