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In Chief Counsel Advice (AM 2018-004) (the CCA), the IRS clarified the standards it will apply in evaluating an employer's position that a substantial noncompensatory business reason exists for excluding employee meals from income.

Background

Section 119(a) excludes the value of any meal furnished in kind to an employee on the employer's business premises if the meal is furnished for the convenience of the employer. Treasury regulations provide that a meal is furnished for the convenience of the employer" if, taking into account all the facts and circumstances, it is furnished for a "substantial noncompensatory business reason" of the employer. The regulations list a number of examples in which a meal is provided for the convenience of the employer. The examples include meals provided to: an employee who must be available for emergency call during the meal period, an employee restricted to a short meal period, an employee who could not otherwise secure proper meals within a reasonable meal period, an on-shift restaurant employee, an employee whose duties prevented the employee from obtaining a meal during working hours.

Over the years (both before and following the addition of Section 119 to the Code), a number of cases have weighed in on the meaning of "convenience of the employer." The most significant of these cases is Kowalski v. Commissioner, 434 U.S. 77, 93, 95 (1977), in which the IRS challenged an income exclusion claimed by a New Jersey state police trooper for a cash payment designated as a meal allowance. The Supreme Court rejected the trooper's argument that the cash allowance was provided for the convenience of the employer. Noting at the outset that "[t]he convenience of the employer doctrine is not a tidy one," the court outlined the principles that underlie the exclusion. The Court explained that the doctrine is intended to exclude the value of food or lodging from income when those items are not intended to compensate the employee. That doctrine was codified in Section 119, albeit subject to narrower parameters than had been developed in jurisprudence. The court interpreted the now statutory "convenience of the employer" in light of the prior case law and the legislative history to incorporate a concept of business necessity, requiring that an employee must accept the employer-provided meals in order to properly perform the employee's duties. Congress responded to the Kowalski decision by, among other things, legislatively overruling a provision of the Section 119 regulations that disqualified any meal from exclusion if the employee bore a portion of the cost and had the option to decline.

More recently, the IRS challenged the exclusion of the value of meals provided to casino employees who were not permitted to leave the premises while on shift. In that decision, Boyd Gaming Corp. v. Commissioner, 177 F.3d 1096 (9th Cir. 1999), the Ninth Circuit sided with the employer, observing, "[g]iven the credible and uncontradicted evidence regarding the reasons underlying the 'stay-on-premises' policy, we find it inappropriate to second guess these reasons or to substitute a different business judgment for that of Boyd." The Ninth Circuit decision applied the business necessity standard articulated in Kowalski, holding that, under the circumstances of the case, the meals furnished by Boyd Gaming were "'indispensable to the proper discharge' of the employees' duties."

The IRS acquiesced to the Boyd Gaming decision, issuing an Action on Decision (AOD) stating that it "will not challenge whether meals provided to employees of … businesses similar to that operated by Boyd Gaming meet the [Section] 119 'convenience of the employer' test where the employer's business policies and practices would otherwise preclude employees from obtaining a proper meal within a reasonable meal period" and further "will not 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, 1999-2 C.B. 243, August 9, 1999.

Facts

The CCA responds to a request from Tax Exempt & Government Entities Division Counsel concerning relevant standards for evaluating a pattern of cases in which employers offer a variety of business reasons for providing free meals to their employees. The employers maintain that the meals are excludable from employee income and wages under Section 119. The employers assert a number of business reasons for providing the meals, such as facilitating innovation, collaboration, and productivity; enabling employees to work long days and overtime; protecting sensitive information; and promoting a healthier workforce.

Analysis

Has the Kowalski test been superseded by Section 119(b)(2)?

The first question posed by the CCA is whether the legislative addition of Section 119(b)(2) to the Code effectively overruled the Kowalski decision such that the business necessity analysis does not apply in determining whether a meal is provided for the convenience of the employer. The CCA reports that employers have claimed that Congress overturned Kowalski.

The CCA explains that the Kowalski business necessity analysis continues to be the applicable standard for determining whether meals are furnished for the convenience of the employer. The CCA explains that the legislative response to Kowalski was not meant to overturn the Kowalski analysis but rather to address the treatment of subsidized meals that employees have the option to decline. Before this legislative change, the Section 119 regulations disqualified such meals from Section 119. (This provision in the regulations has not yet been updated to reflect Section 119(b)(2).)

The CCA notes that Boyd Gaming clarified "how the business-necessity rationale and [Section] 119(b)(2) are reconciled." In Boyd Gaming, the Court relied on the Kowalski business necessity rationale to hold that the meals at issue were properly excluded. The Ninth Circuit reasoned that Boyd Gaming's policies required it to furnish meals for the employees to properly perform their duties. The CCA explains, however, that the business necessity standard does not require an individual employee to actually eat the meal provided.

May the IRS question whether an employer's business reasons for providing meals are substantial noncompensatory business reasons?

The Boyd Gaming court declined to substitute its judgment for an employer's business decisions and, in its AOD, the IRS acquiesced to this approach. The CCA reports that a number of employers now advance a range of policies that are distinct from the Boyd Gaming scenario. The CCA states, "these employers provide little to substantiate that they actually have and enforce these policies. Further, some employers claim that the IRS cannot question or examine employers concerning their use of these policies, based on the Ninth Circuit's decision in Boyd Gaming Corp … "

The CCA pushes back on these positions, admonishing that neither Boyd Gaming nor the AOD provided full license to employers. Rather, the AOD stated that "the Service will consider whether the policies decided upon by the employer are reasonably related to the needs of the employer's business (apart from a desire to provide additional compensation to its employees) and whether these policies are in fact followed in the actual conduct of the business." Accordingly, the CCA explains that the IRS may determine whether policies related to an employer's business needs and goals have been adopted and whether those policies connect the employer's business needs and goals to the business necessity of providing meals to employees. In making this determination, the IRS will not find a substantial noncompensatory business reason if there is no: (1) related policy that governs how employees subject to the policy should carry out their jobs; and (2) substantiation of how the meals provided by the employer are necessary to allow the employees to perform their duties in accordance with the policy.

Can the IRS require substantiation that the employer communicated the policy to employees and enforces the policy?

The CCA goes on to make clear that the IRS is not required "to accept at face value an employer's claim that a general business goal relates to the provision of meals to employees." Rather, the IRS should seek substantiation for the business reasons that support the employer's claim of providing meals for the employer's convenience. An employer maintaining that it has substantial noncompensatory business reasons for providing meals must be able to substantiate that related policies exist by demonstrating that the policies are enforced.

Implications

The CCA states the IRS's position that the business necessity test of Kowalski provides the guiding principles for determining whether employee meals are excludable from income as furnished for the convenience of the employer.

Although the Tax Cuts and Jobs Act (TCJA) did not eliminate or otherwise change the employee income exclusion for meals provided for the convenience of the employer, the deductibility of these meals was modified when the meal furnished for the convenience of the employer was provided at an employer-operated eating facility. Before repealing the de minimis exception in Section 274(n)(2)(b), such a meal was fully excludable and fully deductible. Additionally, in 2026, Section 274(o) will eliminate any deduction for the costs of providing either a meal for the convenience of the employer or a meal at an employer-operated eating facility.

There has been some question whether free employee meals remain an IRS priority following these changes in deductibility. The CCA makes clear that the IRS continues to view employee meals as an enforcement concern. Additionally, since 2014, the Priority Guidance Plan of the Treasury Department and IRS has included a project to draft regulations under Section 119 and Section 132 regarding employer-provided meals. Although the Priority Guidance Plan was substantially reworked following the enactment of the TCJA, the meals project was not removed from the plan. Accordingly, taxpayers should expect that the IRS will continue to focus on employee meals. Taxpayers that furnish free meals to employees should evaluate whether their business policies support exclusion of the meals under the Kowalski business necessity standard and whether adequate substantiation of the policy is available.

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