On-Premises Fringe Benefits, Part I: Is There Such a Thing as a Free Lunch?

It is no secret that many Silicon Valley employers serve free gourmet meals to their employees—the Wall Street Journal, Bon Appétit magazine, Time, Forbes, and other media sources have reported on this benefit. In addition, the number and variety of cafés and foods provided by these employers, the healthfulness of the meals served, the positive culinary reviews, famous executive chefs involved, cleanliness of the facilities, and the favorable benefit cost-estimates have been the subject of news stories for years.

News sources have recently reported that the Internal Revenue Service (IRS) has begun to examine the tax treatment of employer-provided free meals, though the agency has yet to officially comment on its findings. Depending on the value of the meals, the number provided per day, and the number of employees receiving the benefit, this could be a fairly big-ticket item in an employer’s tax audit if the IRS determines (1) that the value of the benefit should have been included in employee income, resulting in employer liability for the income and employment taxes, interest, and penalties and (2) that the value of the meals was not fully deductible.

It is also no secret that the U.S. Department of Treasury and IRS intend to provide additional guidance on the taxation of employer-provided meals under Internal Revenue Code sections 119 and 132. On August 26, 2014, the Treasury Department and the IRS released the “2014-2015 Priority Guidance Plan,” the federal government’s annual prioritization of tax issues and projects to be “addressed through regulations, revenue rulings, revenue procedures, notices, and other published administrative guidance.”Among the plan’s priorities is an entry entitled “Guidance under §§119 and 132 regarding employer-provided meals,” which appeared as the third item in the “Executive Compensation, Health Care and Other Benefits, and Employment Taxes” section. Odds are that this new guidance is related to the IRS’s audit experiences and to the free gourmet meals regularly provided by Silicon Valley companies to their employees.

The question remains: Is there such a thing as a free lunch? The answer is yes. The Code contains two provisions that allow employers to provide meals to their employees on a tax-free basis:

1. section 119, which applies to meals provided on the employer’s premises, if the meals are provided “for the convenience of the employer”; and
2. section 132(e)(2), which applies to meals provided at an employer-operated eating facility, such as a company cafeteria or café.

In addition, other Code provisions allow employers to provide or pay for employee meals on a tax-free basis. Two of these exceptions are the “accountable plan” rules (which apply to business travel and entertainment) and the “de minimis” rule. The de minimis rule covers employer-provided company picnics, occasional meals, coffee, donuts, and meal money necessitated by overtime work.

The requirements for the section 119 and section 132(e)(2) exclusions are generally described below and in part two of this series. If the requirements for either of the sections’ exclusions are not satisfied, then the meals technically are not free. Rather, the value of the meals is includible in employees’ wages and subject to income and employment taxes. Taxing employees poses obvious administrative difficulties. For example, an employer would have to keep track of the value of what each employee ate on a particular day. Of course, administrative difficulties aside, an employer could pay the taxes on the employees’ behalf and provide a tax gross-up for any additional taxes owed as a result, which is another, albeit more expensive, way to provide tax-free lunches to employees.

Code Section 119—“Convenience of the Employer” Test

To qualify for tax-exempt treatment under section 119, an employer-provided meal must be furnished

1. to an employee, or employee’s spouse or tax dependent;
2. by or on behalf of the employer;
3. on the business premises of the employer;
4. for the convenience of the employer.

“On the business premises of the employer” generally means the employee’s place of employment. The regulations give two examples of this term of art: meals furnished in an employer’s home to a domestic worker and meals furnished to cowhands while herding their employer’s cattle on leased land.

“For the convenience of the employer” generally means that free meals will be considered to have been furnished for the convenience of the employer, if the meals were furnished for a substantial noncompensatory business reason (though that reason need not have been the only reason for the provision of the meal). Whether an employer has a substantial noncompensatory business reason is determined based upon an examination of all the facts and circumstances. The regulations provide the following circumstances in which meals may be regarded as having been furnished for a substantial noncompensatory business reason of an employer:

1. Emergencies. Meals provided during working hours to maintain the employee’s availability for emergency calls during his or her meal period may be considered to have been provided for a substantial noncompensatory business reason. It must be shown that emergencies have occurred or can be reasonably expected to occur and that as a result of such emergencies, the employer called on the employee during the employee’s meal period.
2. Short meal periods. If an employer’s business requires a short meal period (such as 30 or 45 minutes) and the employee cannot be expected to eat elsewhere within such a short time, a meal furnished by the employer may be considered to have been provided for a substantial noncompensatory business reason. The meal period, however, cannot be kept short so that the employee may go home early.
3. No alternatives. Meals provided when insufficient eating facilities exist in the vicinity of the employer’s premises such that an employee cannot otherwise secure proper meals within a reasonable meal period may be considered to have been provided for a substantial noncompensatory business reason.
4. Restaurant work. Meals furnished to a restaurant or other food service employee for work he or she performs during a meal period will be regarded as furnished for a substantial noncompensatory business reason of the employer.

In part two of this two-part series, I will discuss the seminal case on employer-provided meals and the Internal Revenue Code income exclusion for certain employee meals provided at a company cafeteria.