Taxable rent-free lodging ruling applies retroactively.

The IRS in Letter Ruling (TAM) 9609001 has refused a boarding school's request to limit the retroactive effect of a prior TAM's ruling that the school's rent-free lodging provided to several classes of employees would be taxable to the employees. Under Sec. 7805(b), the school sought a determination that the Service's earlier TAM would not be applied retroactively.

Background

Sec. 119 excludes from an employee's gross income the value of any lodging furnished to the employee, the employee's spouse, or any of the employee's dependents by or on behalf of the employer for the convenience of the employer, but only if the employee is required to accept such lodging on the employer's business premises as a condition of employment. Under Regs. Sec. 1.119-1(b), the value of lodging furnished to an employee by the employer is excludible if three tests are met:

1. The lodging is furnished on the employer's business premises; 2. The lodging is furnished for the employer's convenience; and 3. The employee is required to accept such lodging as a condition of employment.

In TAM 9404005, the National Office concluded that lodging provided by the taxpayer to its teaching, maintenance and administrative staffs did not meet the Sec. 119 (a) requirements for exclusion. Therefore, the value of lodging provided to these employees was wages for FICA and income tax withholding purposes. Apparently, these employees lived one to three miles from the center of the campus or did not perform duties after hours or in their residences. Conversely, the lodging provided by the taxpayer to the resident dormitory staff and the evening shift nurse was excludible under Sec. 119(a); its value was not considered wages.

Retroactive Effect of TAM

A TAM holding adverse to a taxpayer is applied retroactively, under Regs. Sec. 601.105(b) (5) (viii) (b), unless the Associate Chief Counsel of the Employee Benefits and Exempt Organizations Section exercises the discretionary authority under Sec. 7805 (b) to limit the holding's effect. The boarding school argued this discretionary authority was appropriate, based on three alternative theories: (1) receipt of a 1943 determination letter, (2) "standard industry practice" and (3) a prior examination. The Service rejected all three theories.

As to the school's argument that a 1943 determination letter establishing its status as a tax-exempt entity should prevent retroactive application of the lodging ruling, the IRS found there was no evidence the determination had authorized exclusion of the value of lodging from employees' taxable incomes. Further, the Service noted the law on the taxation of lodging had changed since the issuance of the determination letter, and that the change would preclude continued reliance on the determination letter.

Citing two court cases, the school argued that denial of retroactive relief would be an abuse of discretion if taxpayers who followed a "standard industry practice" were treated inconsistently. The IRS distinguished those cases on the grounds that they involved situations in which the taxpayer had relied on previous regulations or in which the Service's tolerance of the practice at issue was clear. In this case the IRS stated:

To our knowledge, the Service has not granted retroactive relief under section 7805(b) of the Code--either publicly or privately--to any taxpayer seeking to exclude the value of lodging from gross income pursuant to section 119 of the Code. The Taxpayer has failed to cite a regulation, revenue ruling, publication in the Internal Revenue Bulletin, private letter ruling, technical advice memorandum, or determination letter interpreting and: applying section 119 of the Code in a manner that is inconsistent with the analysis and conclusions set forth in the Technical Advice Memorandum.

Finally, the Service rejected the school's reliance on a 1976 "no change" report issued by the IRS after its examination, on the grounds that prior examination is not an appropriate basis for limiting the retroactive effect of the holding in a TAM, because a no-change report is not a ruling for Sec. 7805(b) purposes. The Service also noted that whether the lodging issue was addressed in the examination was unknown; and even if it had been addressed, the facts and circumstances of the current lodging arrangement might have changed since 1976.

Effect on Taxpayers

This TAM indicates the IRS is not inclined to be sympathetic toward errors by nonprofits regarding withholding and FICA tax issues for taxable employee benefits. Although taxpayers might have thought an earlier examination that did not raise the issue of taxation of off-campus rent-free lodging was tantamount to a finding that such lodging was tax free, that assumption clearly is not justified.

FROM PETER I. ELINSKY, CPA, J.D., LL.M., AND MARTHA PRIDDY PATTERSON, J.D., WASHINGTON, D. C;