Sally P. Schreiber

Local lodging costs may be deductible business expenses

New rules could create refund opportunities for taxpayers who have records to substantiate local lodging expenses.

May 10, 2012
by Sally P. Schreiber, J.D.

Taxpayers are sometimes surprised to find that personal expenses are usually not deductible for federal income tax purposes. Sec. 262(a) states, “[e]xcept as otherwise expressly provided . . . no deduction shall be allowed for personal, living, or family expenses.” The exceptions to this rule are narrow and, as the statute indicates, must be expressly provided in the Code, such as the deduction for medical expenses under Sec. 213.

For lodging expenses, the IRS’s stance has been that the expenses have to be incurred while traveling away from home in order to be deductible. As far back as 1958, it issued Regs. Sec. 1.262-1(b)(5), which provides, in part, that “the costs of the taxpayer’s lodging not incurred in traveling away from home are personal expenses and are not deductible.”  

Local lodging costs may be deductible

In 2007, the IRS backed off from this strict interpretation of Sec. 262, explaining that, until new regulations could be issued, it would not apply Regs. Sec. 1.262-1(b)(5) to expenses for lodging of an employee incurred while the employee is not away from home that an employer provides or requires the employee to obtain, if:

  • The lodging is temporary.
  • The lodging is necessary for the employee’s participation in or availability for the employer’s business function or meeting.
  • The expenses are otherwise deductible by the employee or would be deductible under Sec. 162(a) (ordinary and necessary expenses paid or incurred in carrying on a trade or business) (Notice 2007-47).

The IRS explained that it would not pursue the issue in any tax year ending on or before it issued new guidance and that it would not pursue the issue in any pending exams.

Proposed regulations permit refund claims

On April 25, 2012, the IRS issued further guidance on the deductibility of lodging expenses by taxpayers when not away from home. The guidance, in the form of proposed regulations (REG-137589-07), contains rules that are similar to those in Notice 2007-47 (which these proposed regulations declare obsolete), but the IRS is allowing the rules to be applied in a way that may provide an opportunity for taxpayers and their tax preparers.

The IRS is not making taxpayers wait for the rules to be finalized before they can take advantage of them. The proposed regulations provide that taxpayers may apply the new rules to eligible local lodging expenses paid or incurred in tax years for which the statute of limitation on credit or refund has not expired (Prop. Regs. Secs. 1.162-31(d) and 1.262-1(b)(5)). This means that taxpayers can file amended returns to seek refunds for tax paid on these expenses for years that are still open (three years from filing date/two years from payment of tax). Taxpayers will have to be able to obtain records to substantiate these expenses, but, in many cases, that may not be that difficult.

What is deductible?

Local lodging expenses paid or incurred in carrying on a taxpayer’s trade or business are deductible, depending on the facts and circumstances. In the case of employees, one factor is whether the expense is incurred to satisfy a bona fide requirement imposed by the employer. Expenses that are lavish or extravagant under the circumstances will not qualify (Prop. Regs. Sec. 1.162-31(a)).

As always, purely personal expenses are not deductible (or must be included in income, whichever is the case). For example, if an employer pays for lodging for an employee to lessen her commute while she works overtime on a project, the expenses are deductible by the employer as additional compensation, but they are taxable to the employee (Prop. Regs. Sec. 1.162-31(c), Example (5)).   

Prop. Regs. Sec. 1.162-31(b) provides a safe harbor that allows a deduction for expenses for local lodging to attend business meetings and conferences if:

  • The lodging is necessary for the employee to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function;
  • The lodging does not exceed five calendar days and does not occur more than once each calendar quarter;
  • The employer requires the employee to remain at the activity or function overnight; and
  • The lodging is not extravagant or lavish and does not provide a significant element of personal pleasure.

The proposed regulations provide several examples illustrating the application of the new rules.

Substantiating the expenses

For an employer to be able to deduct local lodging expenses, and for an employee to exclude them from income as a working condition fringe benefit or a payment under a nondeductible plan, the expenses must be substantiated. Under the rules of Sec. 274(d), which applies to expenses for lodging while travelling away from home, taxpayers are required to prove the amount of the expense, the time and place, and the business purpose.  Although it is not clear that the substantiation rules of Sec. 274(d) apply to the new deduction for local lodging, meeting those requirements would be the safest course.

Canceled checks and other statements (such as credit card statements) can establish the amount and time of the expense, and, in some cases, the place. Establishing the business purpose should not be difficult for current lodging expenses, as the employer can include that in materials prepared for the meeting or an employee can prepare a contemporaneous log describing the meeting. It may be more difficult to establish a business purpose for expenses for refund claims, but, in some cases, employers may be able to provide documentation for those as well.

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Sally P. Schreiber, J.D., is a senior editor in the AICPA’s magazines and newsletters group. She contributes to The Tax Adviser and Journal of Accountancy as well as the Corporate Taxation Insider and Tax Insider newsletters.