Travel Nursing Pay – Qualifying for Tax-Free Stipends: Part 4: The 3 Factor Threshold Test

In our previous blog post, we discussed how to qualify for factors 2 and 3 of the 3 Factor Threshold Test that the IRS uses when determining whether or not a tax payer qualifies to receive tax-free stipends. In this blog post, we’ll discuss factor 1. We chose to tackle factor 1 last because of its subjective nature. Unlike factors 2 and 3 which are straightforward and clear no matter the scenario, the method for satisfying factor 1 may vary depending on whether or not you’re aiming to qualify under 2 or 3 of the factors in the 3 Factor Threshold Test.

Remember, the 3 Factor Threshold Test will be employed by the IRS to determine if a tax-payer qualifies for tax free stipends in the majority of cases involving travel nurses. If a taxpayer meets all three criteria, then they are guaranteed to qualify. If the taxpayer meets only 1 factor, then they will not qualify. And if the taxpayer meets 2 of the factors, then the IRS will consider the facts and circumstances of the case to determine if the taxpayer qualifies.

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The 3 factors are as follows:

1. Whether the taxpayer performs a portion of their business within the vicinity of the declared tax home and uses the declared tax home for lodging purposes while performing business there.
2. Whether the taxpayer’s living expenses are duplicated as a result of their traveling for work.
3. Whether the taxpayer has not abandoned the declared tax home. This is typically determined by how frequently the taxpayer uses the declared tax home for their own personal lodging and personal business, and whether or not the taxpayer has direct family members living in the declared tax home (Blum and Coppage).

In our previous blog post, we pointed out that many travelers want to avoid factor 2, duplicated expenses. This means that they’d need to qualify for factors 1 and 3. Qualifying for factor 3 is fairly straightforward as described in our previous blog post.

Qualifying for Factor 1 when attempting to use factor 1 and 3 to qualify for tax-free stipends

Qualifying for factor 1 under the 2 factor qualification scenario requires that a significant portion of your income be derived at your tax home if you are not paying legitimate duplicate expenses. For travel nurses, this means that working some periodic PRN shifts at your tax home will most likely not suffice. Joseph Smith, a tax consultant specializing travel tax issues, offers two examples for qualifying for tax-free stipends using factors 1 and 3 on his website traveltax.com.

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In the first example, a young nurse working a permanent job and living at her parent’s home for free decides to take up travel nursing. She works out a deal with her current hospital employer to return and work there for three months each year during their busy winter season. She also maintains her personal ties to the tax home, returns there between travel nursing jobs, and conducts her personal business there. When she accepts travel jobs, she makes sure they’re in new locations and does not stay in any one location for more than one assignment.

In the second example, a traveling nurse continually returns to Phoenix, Arizona for assignments on an annual basis for several years. He then establishes Phoenix as his tax home by first paying taxes on all of the tax-free stipends he receives during a assignment there, and by second establishing personal and personal business ties in the Phoenix area. He then purchases an RV and takes assignments throughout the country making sure to not return to the same areas too often. He returns to Phoenix on an at least an annual basis to complete an assignment and pays full taxes on the income he earns there.

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There is a very important principle at play in both of these examples. These travelers are earning a significant percentage of their income at their tax home both as a percentage of their total annual income and relative to any one place that they travel to take an assignment. They also pay income taxes when they work at their tax home. By working 3 months out of the year at their tax home, they are earning approximately 25% of their annual income there. In addition, by never working more than one assignment in any given location they ensure that the income they earn at their tax home is very significant relative to any other location they work. If all of the assignments they take are 3 months or less, they ensure that the ratio between what they earn at home versus what they earn in any other single location is approximately 50/50.

This is important to ensure that the IRS does not rule that your tax home has shifted to another location because you perform a majority of your work at that location. Remember, in the scenario we’re discussing, you are not incurring duplicative expenses (factor 2). Therefore, if you do not ensure that a sizable portion of your income comes from your declared tax home, the IRS may determine that you’re maintaining your tax home for personal rather than business reasons.

Now, I have seen many travelers make the claim that “performing part of your business in the area” could be satisfied by activities other than work. For example, in their book “Travel Nurse Insights” Barry and Donna Padgett state, “Keep in mind that your ‘business’ activity is not just your work as a travel nurse. It is all aspects of your business life, such as banking, mortgage payments, doctor’s appointments, purchasing a car, paying insurance premiums, repairs of all kinds, etc.” They go on to recommend that travel nurses keep such as activities in the area of their declared tax home as a means to meeting the business requirement of the 3 factor threshold test.

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I have seen similar claims made on internet message boards and have spoken to travelers who claimed the same. I have been unable to determine where this information comes from as I have never seen a citation. Let me be clear, this information is not correct. These and other such activities do not constitute business activities as the IRS views them. Therefore, they will not count towards meeting the first factor of the three factor threshold test. Such activities would however be considered personal business and could be used to satisfy the third factor determining whether or not the taxpayer has abandoned the declared tax home.

The IRS is very clear that they intend “your business” to mean work, or something from which you derive income. Consider the following example taken straight from IRS Publication 463:

You are single and live in Boston in an apartment you rent. You have worked for your employer in Boston for a number of years. Your employer enrolls you in a 12-month executive training program. You do not expect to return to work in Boston after you complete your training.

During your training, you do not do any work in Boston. Instead, you receive classroom and on-the-job training throughout the United States. You keep your apartment in Boston and return to it frequently. You use your apartment to conduct your personal business. You also keep up your community contacts in Boston. When you complete your training, you are transferred to Los Angeles.

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You do not satisfy factor (1) because you did not work in Boston. You satisfy factor (2) because you had duplicate living expenses. You also satisfy factor (3) because you did not abandon your apartment in Boston as your main home, you kept your community contacts, and you frequently returned to live in your apartment. Therefore, you have a tax home in Boston.

You can see here that the IRS clearly states, “You do not satisfy factor (1) because you did not work in Boston.” Work is the key to satisfying factor 1. There have also been many court cases that have treated “business activity” as income deriving activity. For example, the Markey and Fisher cases both defined it as such (Blum and Coppage). In addition, note the IRS states that, “You use your apartment to conduct your personal business.” They are clearly differentiating between business and personal business.

One might argue that this is splitting hairs and taking it a bit too far. However, this is a very important distinction to make. Travel nurses must meet at least two of the criteria to qualify. If you are confused into thinking that activities such as where you locate your bank account are going to satisfy factor 1, then you could be in for big trouble. You may erroneously believe that you are satisfying both factors 1 and 3 when you are really only satisfying factor 3.

Qualifying for factor 1 when incurring duplicative expenses

As you can see, avoiding the duplicative expenses factor can be very tricky. However, if you do maintain legitimate duplicative expenses, then maintaining your tax home is much easier. Furthermore, if you are able to maintain duplicative expenses, then you should also maintain strong personal ties to your tax home. In other words, satisfy factors 2 and 3, and use factor 1 as a safeguard if you are able to do so. At the same time, make sure that you move around enough to ensure that your employment cannot be classified as indeterminate. This strategy is best for ensuring that you’re able to continue accepting tax-free money without penalty.

If you choose to qualify for factors 2 and 3 and want to use factor 1 to provide further credence to your case, then it is highly recommended that you maintain employment, whether permanent or PRN, in the vicinity of your declared tax home. This would allow you to occasionally return home and work in an effort to ensure that the requirement is met. Note that I said “effort”. These tests are subjective and in such cases the IRS is going to consider all the “facts and circumstances.”

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That said, in my opinion, the best option is for you to sign on as a PRN worker directly with the employer you’re leaving or some other employer in the area in order to take on assignments. They’ll typically have requirements for maintaining PRN status which usually involves working a specified number of shifts during a specified period of time. For example, they may require that you work at least 2 shifts every 6 weeks to maintain your PRN status.

The upside for travel nurses signing on directly with a hospital (or other healthcare provider) to work PRN is that they’ll be assured to get the work they need to meet the requirement. In a sense, the shifts are a sure thing. You’re on the schedule to work and the shifts are rarely cancelled. In addition, you’ll also be on that employer’s books as an employee. The downside is that you’ll have limited flexibility. You’ll need to meet the scheduling requirements in order to maintain your PRN status. This may require trips home in the middle of your assignments.

Another more flexible option would be to sign on with a local PRN staffing agency in the area of your designated tax home. In this scenario, you’ll give the agency advanced notice of the days that you’ll be available to work, and they’ll attempt to get you scheduled for shifts accordingly. You should give them ample notice to ensure the best results. You’ll also want to be sure to maintain your credentials with the agency so that you’re always in compliance. This will ensure that you’re able to quickly make yourself available to pick up shifts when you’re home between assignments. If you do not maintain your credentials, you may miss your chance to pick up shifts during your windows between assignments.

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The upside to working with a PRN agency is that you’ll have increased flexibility. Most agencies don’t have any scheduling requirements, and they’re happy to try to schedule you around your availability. The downside is that the shifts aren’t guaranteed, so you may not get any work at all. However, this may not be a deal breaker. Your concerted effort to obtain work in the area may be enough to qualify, and you should also be on the agency’s books as an employee as long as you keep your credentials current with them.

Conclusion:

Maintaining your tax home is important when travel nursing. Given the reduction in pay rates over the last 5 years, you need the benefit of tax-free money to increase the financial viability of travel nursing. Furthermore, you’ll be hard pressed to find travel nursing agencies that are willing to pay you any other way. Remember, the primary concern is to ensure that you maintain your temporary worker status so that your tax home doesn’t shift to your assignment location. Then, you can determine the best strategy for meeting the requirements of the 3 Factor Threshold Test.

It’s important to note that we are not tax advisers, Certified Public Accountants, or Lawyers. We are not in any way providing any tax advice. All information regarding taxes is informational and intended as a jumping off point. You must seek the help of professional tax advisers to gain a clear understanding of your unique circumstances. We recommend the folks at traveltax.com.