Meals and lodging exclusion for S shareholders.

Sec. 119 provides for the exclusion from gross income of meals and lodging furnished to employees for the convenience of an employer. Many farm and ranch operations are organized as S corporations, with the shareholders living in a corporate-owned home. The shareholder-managers are often compelled to live on the farm or ranch in order to be on the premises around the clock, particularly when livestock is involved. Care must be exercised when excluding the value of meals and lodging from the shareholder's income.

S shareholders are treated as partners for fringe benefit purposes (Sec. 1372). Partnerships generally are not allowed to deduct expenses incurred in providing fringe benefits to partners (Sec. 703(a)(2)(E)). However, a partner may be considered as acting in a capacity other than as a member of a partnership (Sec. 707(a)). A partner who is also an employee of the partnership should be allowed to exclude the value of meals and lodging provided to him under Sec. 119. This was the case in Armstrong v. Phinney, 5th Cir., 1968.

In Armstrong, a 5% partner served as manager of a 50,000-acre ranch. The partner received a share of the profits, as well as a fixed salary, for his services as manager. The partnership provided a home at the ranch and paid for some of his utilities and groceries. The value of the meals and lodging was excluded by the partner-manager, and the partnership deducted the costs incurred in furnishing the home and incidental expenses. In holding for the taxpayer, the Fifth Circuit said that a partner who is considered as "one who is not a partner" for purposes of Sec. 707 could also take advantage of the Sec. 119 exclusion for meals and lodging.

In contrast to Armstrong is the Dilts case, DC, 1994. In Dilts, an S corporation provided the shareholders with a home located on a ranch owned by the S corporation. Apparently, the shareholders were not paid a separate salary for management of the ranch and there was no written agreement that the shareholders would live on the ranch. The court found that the taxpayers were acting within the normal scope of shareholders of a closely held S corporation and not as ranch employees. Since the provision of meals and lodging did not stem from an employee relationship, the exclusion provided by Sec. 119 did not apply and the related deductions were disallowed at the corporate level.

In Dilts, the court also noted that Sec. 707 does not necessarily apply to an S corporation for purposes of the meals and lodging exclusion. Sec. 1372 refers specifically to "fringe benefit provisions." Sec. 707 is not per se a fringe benefit provision. Thus, there is a question as to whether Sec. 707 applies in an S corporation context. Resolution of this issue awaits further case law.

An ideal fact pattern for Sec. 119 exclusion would include shareholders who do not live in corporate-owned housing. This would enhance the argument for those shareholders who do live on the premises and who not only look out for their own shareholder interests but are accountable to the other shareholders as well.

In order to strengthen the argument that a home furnished to an S shareholder is excludible from income (and related expenses deductible by the corporation), the relationship between the shareholder and the corporation should be documented in writing. Sec. 119 requires that the employee be required to accept lodging on the business premises as a condition of employment. A written employment agreement between the corporation and the shareholder-employee, along with a reasonable salary, should greatly enhance the shareholder's ability to exclude the value of the use of the corporate-owned home.