Under final tax regulations, employees who aren’t traveling away from home overnight, but who stay overnight at a local hotel, may have their substantiated lodging expenses reimbursed as a tax-free working condition, provided you have a bona fide reason to require them to stay overnight at the hotel.
Warning: Expenses that are lavish or extravagant, or that provide employees with a social or personal benefit, don’t qualify for tax-free reimbursement under these regs. The regs became effective Oct. 1, 2014, but you may apply them retroactively to reimbursements made to employees in any open tax year. (79 F.R. 59112, 10-1-14)
(Editor's note: This is a good time to download our free step-by-step payroll compliance guide to each pay period, month and calendar quarter of the upcoming year.)
Safe harbor or facts-and-circumstances. The regs establish a safe harbor under which you may make tax-free reimbursements to employees if the lodging is necessary for them to fully participate in bona fide, conferences, training activities or other business functions; they stay at local hotels for not more than five calendar days once per calendar quarter; they’re required to remain at the activity overnight; and the lodging isn’t lavish or extravagant.
If employees’ local lodging doesn’t fit squarely into the safe harbor, you may still exclude their expenses as a working condition fringe benefit if, under all the facts and circumstances, their local lodging expenses are paid or incurred to further the company’s business. According to the regs, one key factor in meeting the facts-and-circumstances test is whether employees incur expenses due to an employer-imposed bona fide job condition or requirement.
Example. Mega conducts a seven-day training session at a local hotel near its headquarters. Jennifer, who works at Mega’s headquarters, must attend. Mega requires all attendees to stay overnight for the bona fide purpose of facilitating the training. Result: Jennifer’s local lodging expenses can’t be excluded from her income under the safe harbor, since the training lasts for seven days. However, her expenses are still excludable, since Mega satisfies the facts-and-circumstances test.
Out of pocket and out of luck. The regs clarify that you can’t make tax-free reimbursements for local lodging expenses incurred by new hires who are house hunting; for expenses incurred by employees who work overtime and can’t make it home; or for expenses incurred for a weekend at a luxury hotel or resort. However, since these expenses are fully taxable to employees, you may deduct them as compensation expenses.