In the recent movie, The Internship, the character played by Vince Vaughn is amazed when he begins working at Google and finds out he can graze on an array of free food and beverages all day long. (However, he is sternly told that he can’t take anything home from the office).
The practice of providing free meals and snacks is not unusual in the tech industry, and is a perk at other types of companies as well. But the tax benefits of this tradition might be in jeopardy. In a recent document released by the IRS, the tax agency indicated that it will be updating guidance related to employer-provided meals. This has caused speculation that IRS could be cracking down on the practice of providing unlimited free meals and snacks.
Tax Exclusion for Employer-Provided Meals
Under the tax code, meals are excludable from tax if they are furnished:
- To employees for the convenience of the employer; and
- On the business premises.
According to the regulations, the “convenience-of-the-employer test” is met only if the meals are furnished for a substantial non-compensatory business purpose. It doesn’t count if an employer is furnishing meals as a way of providing additional compensation to employees. Conversely, if the employer furnishes meals to employees for a substantial non-compensatory business reason, the meals will be regarded as furnished for the convenience of the employer, even though the meals are also furnished for a compensatory reason.
Although the finding of a substantial non-compensatory business purpose depends on the facts and circumstances, the regulations provide a number of acceptable circumstances, including:
- Meals are provided in order to keep employees available for emergency calls during the meal period. However, the regs add that such calls actually occur or can reasonably be expected to occur.
- The nature of the employer’s business means meal periods are short (for example, 30 to 45 minutes). However, it doesn’t qualify if a meal period is shortened in order to allow employees to leave early.
- Employees cannot otherwise secure proper meals within a reasonable meal period. As an example, the regulations state that meals qualify under this test if there aren’t enough eating facilities near the workplace.
Under Internal Revenue Code Section 119(b)(4), all meals furnished on the premises of an employer to its employees are treated as furnished for the convenience of the employer — and therefore excludable from the employee’s income — if more than 50 percent of the employees fed on the premises are furnished the meals for the convenience of the employer.
The Employer’s Deduction
As a general rule, a business may deduct only 50 percent of the otherwise-allowable cost of meals (and entertainment). However, meals provided to employees are fully deductible in circumstances including: Meals treated as compensation, and meals that are tax-free de minimis fringe benefits.
An employer-operated eating facility is a de minimis fringe if it is located on or near the employer’s business premises, and the facility’s revenue normally equals or exceeds its direct operating costs (the revenue test). Highly compensated employees get the exclusion only if access to the facility is provided on a non-discriminatory basis.
Note: Under the exception for meals that are tax-free de minimis fringe benefits, an employer can deduct 100 percent of the cost of providing the meals if its on-premises employer-operated eating facility meets the revenue test.
For purposes of determining if an eating facility’s revenue equals or exceeds its direct operating costs, the regs state that “if an employer can reasonably determine the number of meals that are excludable from income by the recipient employees,” then it can “disregard all costs and revenues attributable to such meals provided to such employees.”
For purposes of the revenue test for determining whether an employer-operated eating facility is a de minimis fringe, an employee who can exclude the value of a meal under Code Section 119 is treated as having paid an amount for the meal equal to the direct operating costs of the facility attributable to the meal.
Note: As explained above, all meals furnished to employees on an employer’s business premises are treated as furnished for the convenience of the employer if more than half the employees to whom on-premises meals are furnished are given the meals for the employer’s convenience. Thus, if the more-than-half exception is met, an employer may fully deduct the cost of all meals provided at its employer-operated eating facility.
This is a complex area of tax law but the 100 percent deduction is derived as follows:
- If more than half the meals provided at the on-premises eating facility are provided for the employer’s convenience, then the balance of the meals also are treated as provided for the employer’s convenience.
- If all the meals are deemed to have been provided for the employer’s convenience, they are all tax-free to the employees under Code Sec. 119.
- If all the meals are tax-free to the employees under Code Sec. 119, all the affected employees are treated under Code Sec. 132(e)(2) as having paid an amount for their meals equal to the direct operating costs of the facility attributable to the meal.
- If the employer-operated eating facility qualifies as a de minimis fringe under tax law, all the expenses in operating it will be deductible under the exception.
Tech Company Practices
It has been widely reported that technology companies sometimes compete with each other to offer extensive — and even elaborate — in-house meal options to employees. In some cases, the food is available all day long.
- The business reasons for the generous food perks include:
- They provide an incentive for employees to put in more hours;
- They cut down the time employees take for meal breaks;
- They keep employees on the premises collaborating with each other — not at public restaurants possibly talking about trade secrets.
- They provide an incentive to attract new employees and retain current staff members; and
- They project an image that the employer cares about its employees.
What Might Happen?
If the IRS shuts down the tech industry’s food practices, its line of attack might be that under existing guidance, most of the reasons cited above for providing meals don’t appear to support treating the perk as excludable from tax. In fact, regulations specifically state that meals “will be regarded as furnished for a compensatory business reason of the employer when the meals are furnished to the employee to promote the morale or goodwill of the employee, or to attract prospective employees.”
However, the first reason — that employees have an incentive to work longer hours — might be considered a non-compensatory business purpose.
If there’s no substantial non-compensatory business purpose, the employer wouldn’t be able to deduct the entire cost of providing the meals because they wouldn’t qualify as tax-free de minimis fringe benefits under the law. The employer could claim a 100 percent deduction if it treated the meals as compensation, but only if the cost was so treated on the taxpayer’s income tax return as originally filed.
It’s possible the IRS could allow a tech-industry exception from the generally applicable meal rules, but that may not go over well with other industries that would like to provide in-house meals to employees with favorable tax treatment. Stay tuned.