In part one of this two-part series, “On-Premises Fringe Benefits, Part I: Is There Such a Thing as a Free Lunch?,” I discussed the Internal Revenue Code’s provisions on tax-free employer-provided meals in addition to the code’s “convenience of the employer” test. In this part, I will discuss a pivotal case on free lunches: Boyd Gaming Corporation v. Commissioner of Internal Revenue and the income exclusion for certain employee meals provided at a company cafeteria.

The Boyd Gaming Case

The seminal case involving the “convenience for the employer” test is Boyd Gaming Corporation v. Commissioner of Internal Revenue, 177 F.3d 1096 (9th Cir. 1999). In Boyd Gaming, a casino furnished free meals on its business premises to all of its employees, most of whom were required to stay on the premises during their working hours because of the casino’s security concerns. The Ninth Circuit Court of Appeals held that it was inappropriate to second-guess an employer’s business reasons or to substitute a different business judgment for the employer’s. The court found that the employer’s security and business concerns provided sufficient justification for its policy of requiring employees to stay on the premises to satisfy the “convenience of the employer” test.

In light of Boyd, in 1999, the Internal Revenue Service (IRS) announced that in applying Section 119, it would no longer “attempt to substitute its judgment for the business decisions of an employer as to what specific business policies and practices are best suited to addressing the employer’s business concerns.” (Announcement 99-77, 1999-32 I.R.B. 243; Action on Decision 1990-010, 1999-32 I.R.B. 243 (August 30, 1999).) However, the IRS will consider whether an employer’s policies are reasonably related to its business needs and whether the policies were in fact followed.

More on the Convenience of the Employer Test

If more than half of the employees receive an on-premise meal that is, in fact, for the convenience of the employer, then pursuant to section 119(b)(4), all meals furnished on the business premises of that employer may be treated as furnished “for the convenience of the employer.”

Whether the employer charges for a meal or whether the employee can decline such a meal does not affect the analysis. However, the meal must be in-kind and cannot be a cash allowance or additional compensation in lieu of the meal. According to the regulations, meals furnished to employees solely to promote goodwill or employee morale or to attract prospective employees do not meet the convenience of the employer test.

Code Section 132—De Minimis Exclusion for Subsidized Company Cafeterias

Employee meals at a company cafeteria are excludable from income as “de minimis” fringes if the facility does not operate at a loss (that is, the revenue from employees must at least equal the facility’s direct operating costs).

To qualify as a de minimis fringe benefit the employer-provided meal must meet the following requirements.

• Ownership: The eating facility must be owned or leased by the employer.
• Operation: The eating facility must be operated by the employer (that is, operated by employees or by a food services business under contract to the employer).
• Location: The eating facility must be located on or near the employer’s business premises.
• Revenue: The eating facility must generate revenues that on an annual basis equal or exceed the facility’s “direct operating costs.” For purposes of this requirement, direct operating costs are the cost of food, beverages, and the cost of labor of personnel whose services relate to the facility and are performed primarily on the premises (such as cooks, waiters, and waitresses). The direct operating costs test can be applied separately to each eating facility or to all eating facilities in the aggregate.
• When: The eating facility must provide meals either during, or immediately before or after, the employees’ workday.
• Nondiscrimination: Meals provided to highly compensated employees (HCE) at an employer-operated eating facility for employees must be taxed to those HCEs unless certain nondiscrimination rules are satisfied.

If the above requirements are not met, the discounts on meals provided at the facility must be valued and included in employees’ wages. Under the general valuation rule, any income imputation must be based on the fair market value of the meals, minus any amounts paid for the meals or excluded under other code sections (such as section 119). (Note that an alternative valuation method exists as well.)

Conclusion

Employers may prefer to rely on the de minimis exclusion for subsidized company cafeterias described above rather than the exclusion under section 119 because the rules are more straightforward and mechanical, assuming that the facility generates some revenue. In contrast, the exclusion under section 119 depends on whether the employer can satisfy the subjective “convenience of the employer” test.

Employers also prefer the de minimis exclusion because all meals provided to employees that are tax-free de minimis fringe benefits are fully deductible (and are not subject to the 50 percent deduction limit under section 274(n)(1)). However, it is possible, given the interaction of the section 119 rules with the revenue test for determining whether an employer-operated eating facility is a de minimis fringe, that if more than half of the employees to whom the meals are furnished on the employer’s premises are furnished for the employer’s convenience, an employer may fully deduct the cost of all meals provided at its eating facility.

It appears that employers that are providing free meals to employees and not including the value of those meals in wages are doing so for their own convenience under section 119 and the employers may be deducting the entire cost of providing the meals as a tax-free de minimis benefit due to the interaction of the section 119 rules with the de minimis rules. If the IRS determines that there is no substantial compensatory business purpose and that the value of the meals should have been included in employee wages, the employer would not be able to deduct the entire cost of providing the meals and the employer could be liable for the income and employment taxes, interest and penalties. It will be interesting to see how the case law and IRS guidance in this area develop.