Q: What exactly is the law on taxation ofcancellation and attrition fees — and whois obligated to pay?

A: Not surprisingly , the answer is notalways entirely clear and, more often thannot, is simply “it depends.”

But, ther e is some guidance to be had.Whether hotels can tax cancellation fees isa state law issue, so the answer variesdepending on which state has jurisdiction.In most cases, that will be the state wher ethe hotel is located. It may not seem obvi -ous why taxes should be paid on canceledrooms. The state would ar gue that it countson taxes from the sales of those sleepingrooms: if a room isn’t sold, but there is apayment anyway for the sale of that roomfrom a cancellation or attrition charge, we,the state, are still entitled to our tax rev-enue. While some states have speci�callyaddressed this issue, many have not.

One of the leading court decisions is inVermont, whose Supreme Court held in1985 that cancellation deposits were sub-ject to tax. The court ruled that any feesretained by the taxpayer resort for thecancellation of rented condominium unitswere fair game for room tax. Other stateshave taken a more direct, legislativeapproach to the subject. For example,Maryland amended its tax regulations onroom rentals in 2001 (apparently in reac-tion to industry fallout from high post-9/11 cancellations). In Maryland, taxesapply not only to cancellation fees, butalso to all no-show deposits and attritionfees paid to the hotel.

The same is true in Illinois. When a con-tracting party becomes irrevocably liableto pay for rooms, any guaranteed hotelroom charges and early departure feescharged to mitigate losses related tothose rooms are subject to taxes, regard-less of whether they are called attrition,no-show or cancellation fees. In the Dis-trict of Columbia, once an organizationhas the right to occupy the rooms, and isobligated to pay attrition or cancellationfees whether or not the hotel rooms are

used, those fees are taxable.The rule in Texas is that if the cancella-

tion charges are equal to the reservedroom rate, they are taxable. However, notax is due on fees that are less than thestated room rate. Oklahoma taxes cancel-lation charges, regardless of the rate ofthe room, but maintains that forfeiteddeposits are not subject to tax. North andSouth Carolina allow for taxation onlywhen the canceled room in question hasnot actually been re-rented to a newguest. Therefore, if the hotel can re-rentthe room, even if the canceling guest paidthe entire room rate as a cancellation fee,the fee is not subject to tax. Of course,many would argue that if a hotel can re-rent the room, no cancellation chargeshould be imposed in the �rst place.

In Florida, no tax is applied unless the

guest retains the right to occupy the room.Florida classi�es liquidated damage feesas “penalty charges,” and clearly statesthat they are not subject to tax. While can-celing rooms or failing to �ll a room blockin a Florida hotel may result in a “penalty,”it generally won’t require a tax on top. But,Florida is one of the few states where sucha clear “no-tax” decision results. For mostother states, it is not clear. As one canimagine, pressure is increasing on allstates to �nd additional revenue sources.Moreover, some cities, counties andmunicipalities separately tax cancellationfees. For example, San Francisco City andCounty apply taxes to all deposits and no-show fees whether or not the room is used.

Several lessons may be lear ned. Firstand foremost, be mindful that cancella-tion fees and attrition charges may besubject to tax. Second, negotiate up fr ontwho pays the tax. Like anything else in ahotel contract, the par ty responsible forpaying the tax on liquidated damages canbe negotiated. Thir d, organizations andhotels should work together to minimizethe potential for tax being imposed.

By reviewing existing state and localregulations and case law, creative contractdrafters can �nd ways to minimize thelikelihood liquidated damages will besubject to tax. After all, it is in their bestinterests to do so. None of those tax dol-lars are likely to bene�t them directly. Inaddition, organizations may start allowingthe existence of a tax on cancellation orattrition fees to in�uence the locations inwhich they are willing to book meetings.

Finally, organizations should not pay atax unless absolutely certain that it is dueand owing, and that it is going to thestate, not to the hotel itself. If in doubt,make two payments: one to the hotel forthe amount of the liquidated damagesand the second to the taxing body for theamount of the tax.

The answers provided here should not be construed

as legal advice or a legal opinion. You are urged to

consult a lawyer concerning any speci�c situations or

legal questions you may have.

Taxing Cancellation and Attrition Fees

By reviewing existing state

and local regulations and

case law, creative contract

drafters can �nd ways to

minimize the likelihood

liquidated damages will be

subject to tax.

LAW REVIEW

This Law Review was written by Jed Mandel. Jed serves as General Counsel for the Association Forum and practices law at Chicago Law Partners, LLC.