Few things say “thank you” like food. As the holidays and year-end crunch approach, many employers will bring pizza or donuts into the office, organize a holiday luncheon or provide their staff with free Thanksgiving turkeys. Employer provided meals offer an opportunity to thank employees for another year of service — or to entice them to stay late during the busy season. But many companies are unsure about the IRS rules for deducting employer provided meals, parties and gifts. In many cases, businesses may be able to legitimately deduct 100% of the costs of these items, if they abide by the IRS rules.
What about Meals Provided at the Company Cafeteria?
An employer-operated eating facility is usually a de minimis fringe benefit — and, therefore, the costs of providing meals there may be 100% deductible — if it’s located on or near the employer’s business premises. The facility’s revenue also must normally equal or exceed its direct operating costs (the “revenue test”). Highly compensated employees get the exclusion only if access to the facility is provided on a nondiscriminatory basis.
For purposes of the revenue test, 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.” This is a complex area of the tax code, so contact your tax adviser for more information.
General Tax Rules for Meals
As a general rule, a business may deduct only 50% of the cost of business meals and entertainment for federal tax purposes. However, meals provided to employees may be fully deductible in certain circumstances, such as when meals are provided as additional compensation (and thus included in the employees’ taxable income) and when they qualify as tax-free de minimis fringe benefits.
Meals also may be both deducted by the employer and excluded from employees’ income if they’re furnished 1) for the convenience of the employer, and 2) on the business premises. According to the regulations, the “convenience-of-the-employer test” is met only if meals are furnished for a substantial noncompensatory business purpose.
Although the finding of a substantial noncompensatory business purpose depends on the facts and circumstances, the regulations provide a number of acceptable circumstances, including when:
1. Meals are provided in order to keep employees available for emergency calls during the meal period. However, the regs add that such calls must actually occur or be reasonably expected to occur.
2. The nature of the employer’s business means meal periods are short (for example, 30 to 45 minutes). However, the furnishing of meals isn’t considered to be for a substantial noncompensatory business purpose if a meal period is shortened in order to allow employees to leave early.
3. 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.
Some companies offer in-house lunches every day. Besides keeping employees happy and fueled for the workday, business reasons for providing food perks include:
- Incentivizing employees to work longer hours,
- Cutting down on excess lunch breaks,
- Fostering collaboration on site, rather than at public restaurants where employees may inadvertently leak trade secrets or other confidential information, and
- Attracting new employees and demonstrating goodwill toward the existing staff.
Under the current tax rules, if more than 50% of the employees fed on the premises are furnished the meals for the convenience of the employer, then all meals furnished on the premises to employees are treated as furnished for the convenience of the employer — and, therefore, are excludable from all employees’ income, regardless of whether a particular employee meets the convenience-of-the-employer test.
Important note: Earlier this year, the IRS reiterated concerns it raised last year about certain employer provided meals. Eventually, the IRS concerns could possibly lead to new rules which would limit deductions for providing unlimited free meals and snacks all day long. This practice has become customary in the technology industry to attract and retain employees — and entice them to work longer hours.
Uncle Sam also may help subsidize your holiday party. The IRS allows some exceptions to the 50% deduction limit for meals and entertainment provided during holiday parties. Under the tax code, “occasional parties or picnics for employees and their guests” may qualify as de minimis benefits. This means that the cost of throwing a holiday party for your employees and their family members is generally 100% deductible for federal income tax purposes. It’s also not includable in the employees’ income.
Likewise, holiday parties for the general public are generally 100% deductible for federal income tax purposes. But expenses incurred for customers must meet the requirements for business meals and entertainment, and, even then, they’re only 50% deductible. Party expenses incurred for friends are not deductible, however.
To qualify as a business meal and entertainment expense, customer holiday parties must be for legitimate business purposes, cannot be extravagant, and require proper substantiation, including who, when and what was discussed and how much was spent.
To illustrate: Suppose your holiday party costs $2,000. Half of your 200 guests are employees, 50 are customers and 50 are friends. You allocate party costs based on the number of guests as follows:
- $1,000 to employee-related expenses,
- $500 to customer-related expenses, and
- $500 to friend-related expenses.
During the party, the owner announces the company’s plans to remodel and expand its showroom in 2016 and allows customers to preview the blueprints. How much of the party expenses can the company deduct?
With proper documentation — such as receipts, vendor contracts, a copy of the invitation, a signed guest book and a video of the owner’s speech — the company can probably deduct $1,250. That equals 100% of employee-related expenses and 50% of customer-related expenses. The cost of hosting your friends isn’t a legitimate business expense, so it’s not deductible.
Gifts of holiday turkeys, hams or fruitcakes are generally 100% deductible for employers and excluded from employees’ income. Why? They’re not worth much, and it would be “unreasonable or administratively impracticable” to account for these benefits.
But gift cards to local restaurants or the grocery store to pick out your own holiday turkey are a different story. The IRS considers these to be cash-equivalent fringe benefits. Their value is obvious and accounting for them isn’t unreasonable or impractical, so the IRS almost always requires employers to include gift cards as part of employees’ income.
For More Information
Many gray areas exist when it comes to deducting meals, parties and gifts. It’s always smart to consult a tax professional to make sure you get it right. Don’t let the confusing tax rules dissuade you from offering these perks, however. Showing your appreciation at year-end can pay dividends all year long.
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