It’s a new year. And what better way to start than with the fundamental lesson I teach my students in our first few classes: “Everything is income. Everything including all your non-cash receipts.” Yeah, I actually sing that to the class, to the tune of Everything is Awesome from the Lego movie. It scans. Treas. Reg. 1.61-1(a) emphasizes that point when it tells us that “Gross income includes income realized in any form, whether in money, property, or services.”
So employer-provided housing is income to an employee, just as if the employer paid the employee cash and the employee spends that cash to rent a house. But we all know that Congress also permits taxpayers to exclude certain types of income from taxation. Part of the art of tax practice is to try and find applicable exclusions to reduce the gross income that must be reported. One such exclusion is §119 which sometimes permits an exclusion for the value of housing provided by an employer to an employee.
In Cory H. Smith v. Commissioner, T.C. Memo. 2023-12 (Jan. 12, 2023) (Judge Toro), we learn a useful lesson about the scope of the business premises requirement in §119: housing that is not within the physical boundaries of the employer’s facilities is highly unlikely to qualify for the §119 exclusion. Mr. Smith’s employer hired him to work in Pine Gap, Australia. It provided a house for him to live in about 11 miles away from his office, in a small city outside of Pine Gap. While Mr. Smith initially properly reported the provided housing as income, he later got mixed up with some super aggressive tax advisors who convinced him to amend his returns to exclude the housing. His tax advisors told him he could do that under §911, even though that reneged a Closing Agreement he had signed. That bum advice gave us Lesson From The Tax Court: The Finality Of Closing Agreements, TaxProf Blog (Sept. 12, 2022). Today, Judge Toro examines and rejects Mr. Smith’s alternative loser argument that he could exclude housing allowance payments under §119. Details below the fold.
Law: The §119 Exclusion for Lodging Provided By Employer
Section 119 permits a taxpayer to exclude the value of lodging provided by their employer when that benefit meets three requirements: (a) a business premises requirement that the housing must be “on the business premises of [the] employer”; (b) a convenience of the employer requirement, and (c) a the a condition of employment requirement. I discussed the very interesting legal history of §119 in Classic Lesson From Tax Court: The Convenience Of The Employer Doctrine, TaxProf Blog (July 12, 2021). Today’s lesson focuses just on the “business premises” requirement.
The Tax Court has historically taken a very functional view of what satisfies the business premises requirement. Judge Toro tells us that the “business premises of the employer” generally means the physical space where the employee must be present to work for the employer, citing to Treas. Reg. 1.119-1(c)(1) (stating that lodging provided to domestic servants is excluded even though, obviously, their work place is the employer’s home and not their employer’s business premises). See McDonald v. Commissioner, 66 T.C. 223, 230 (1976) (“the business premises are not defined solely in terms of the employee's place of employment, but may include housing where the employee performs a significant portion of his duties or where the employer conducts a significant portion of its business.”)(citations omitted).
The strongest fact pattern for the exclusion is thus when both of two conditions are met: (1) the lodging is on the property of the employer’s business and (2) that is also where the employee performs services. The hotel manager cases are the quintessential example. The classic case, of course, is Benaglia v. Commissioner, 36 B.T.A. 838 (1937), where the taxpayer was a hotel manager whose employer required him (and his family) to live in a suite of rooms in very the hotel he managed (and the one next door).
When you start separating the physical location of the lodging from the physical location where the employee performs services, it is more difficult to establish entitlement to the exclusion. But not impossible. The Tax Court has permitted taxpayers to exclude housing that is not literally on the premises of their employer as long as the employee is providing substantial services from the lodging. Thus Lindeman v. Commissioner, 60 T.C. 609 (1973), is another hotel manager case where the taxpayer’s employer had moved him from lodging in the hotel to lodging in a house across the street from the hotel complex. That was close enough! The Court emphasized that the manager did a substantial amount of hotel work from the house, was required to be available 24 hours a day to attend to any issues arising in the hotel and in fact “often returns to the hotel building several times in an evening.” Id at 616.
Sadly, there is no tidy way to sum up the “business premises” rule. Like the Pirate Code in the Black Pearl movies, it’s more a series of guidelines than an actual rule. Judge Toro gives a great explanation and I particularly like this quote he uses from Vanicek v. Commissioner, 85 T.C. 731, 739 (1985): “The extent or boundaries of the business premises in each case is a factual question whose resolution follows a consideration of the employee's duties as well as the nature of the employer's business.”
In our legal system the essence of a “facts and circumstances” approach is to look at prior decisions to see which contained a fact pattern most like the current situation. That’s the game of precedent.
The upside of this approach is that it allows a wider variety of taxpayers to use the §119 exclusion than would a rigid rule. They just need to find a prior case that looks a lot like theirs. The downside of this approach is to make it easier for scurvy taxpayers—or tax advisors—to pretend eligibility by selective presentation of facts. That’s pretty much what I see in this case: the taxpayer relied upon a very selective set of facts to claim the exclusion. Let’s take a look.
The tax years in question are 2016 and 2017. During those years Mr. Smith was employed by Raytheon at the Pine Gap, a spy facility located in a remote part of Australia. Raytheon advised its employees that they would be provided housing in the nearby town of Alice Springs as part of their compensation. If an employee did not want that, Raytheon would pay the employee a stipulated housing allowance. Mr. Smith took the housing option and lived in Alice Springs, driving about 11 miles to perform services for Raytheon in his office at Pine Gap. Here’s a map showing their relationship between Alice Springs and Pine Gap.
Mr. Smith received very explicit information from Raytheon that either housing option would result in taxable income to him. He also received a 1099-MISC from the Air Force each year that reflected the income to him of the housing. I am not clear on why the Air Force was sending a 1099-MISC. I am guessing that the houses were owned by the Air Force and there was some side agreement with Raytheon to let its employees live in them? Otherwise I would expect the value of the housing to be reflected in a W-2 as compensation income. I welcome any comments on that.
Given these facts, any reasonable taxpayer would report the housing as income. And indeed Mr. Smith was a reasonable person and on his original returns (self-prepared) he duly reported the income. Only later was he suckered into submitting amended returns that excluded these amounts. Actually, he did not submit the amended returns. His return preparer submitted them without Mr. Smith’s signature, but by then Mr. Smith had apparently drunk the Koolaid and he ratified them. Op. at 5, Note 4. And, of course, the IRS quickly refunded the resulting claimed overpayment. Only later did the IRS audit the returns, issuing an NOD. That’s how Mr. Smith got to Tax Court.
Lesson: Offsite Home Did not Satisfy Business Premises Requirement
Remember that the Tax Court takes a facts-and-circumstances approach to whether housing is on the employer’s business premises. And remember that means the legal game is the game of precedent.
Mr. Smith’s lawyer was pretty bad at this game. Judge Toro explains how that Tax Court, in not just one but two previous cases had “considered nearly identical facts” and concluded that “off-base housing provided to contractors working at Pine Gap” did not satisfy the business premises requirement of §119. See Middleton v. Commissioner, T.C. Memo. 2008-150; Hargrove v. Commissioner, T.C. Memo. 2006-159.
Mr. Smith’s lawyer tried to play the game by arguing that the facts in Mr. Smith’s case made his circumstances different from the taxpayers in those prior cases. Her strongest argument was that Mr. Smith performed some work from his home whereas they had not. But all he did was complete some online training, fill in some time sheets, and write up some performance evaluations. Judge Toro concludes that such activity did not “constitute the requisite quantum or quality of activities to qualify” the housing as the employer’s premises. Op. at 10.
Nor did the fact that either Raytheon (or the Air Force, take your pick) owned and maintained the property make any difference. Remember, the business premises requirement is met only when (1) the lodging is on the property of the employer’s business or (2) that is where the employee performs their services. The Tax Court has long rejected the idea that the business premises requirement is simply a matter of who owned the property. See Benninghoff v. Commissioner, 71 T.C. 216, 221 (“To conclude that lodging is on the business premises of the employer merely because it is owned by the employer would make the [business premises] condition of section 119 meaningless. The property must bear an integral relationship to the business activities of the employer.”).
COVID Comment: I can see this issue getting some play for the two big COVID tax years of 2020 and 2021. That is, imagine that, because of COVID, Mr. Smith was required to perform all his duties from his employer-provided home in 2020 and/or in 2021. Playing the precedent game now would seem to favor a finding that the business premises requirement is met. Of course, as Judge Toro points out, the business premises requirement is only one of three requirements for the §119 exclusion. Still ... it’s something to think about.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.