Legal Advice Issued by Associate Chief Counsel 2018-004
In Legal Advice Issued by Associate Chief Counsel (Legal Advice), IRS has shed light on several issues involving the “for the convenience of the employer” requirement under Code Sec. 119‘s exclusion for meals provided by an employer.
Background. An individual’s gross income generally includes compensation for services, including fringe benefits, subject to certain exceptions. (Code Sec. 61(a)(1)) One such exception is the value of any meals furnished by or on behalf of an individual’s employer, which are excludable if the meals are furnished on the employer’s business premises for the convenience of the employer. (Code Sec. 119(a))
In ’78, Congress added Code Sec. 119(b)(2), which provides that, in determining whether meals are furnished for the convenience of the employer, the fact that a charge is made for such meals, and the fact that the employee may accept or decline such meals, is not taken into account.
Whether meals are furnished for the convenience of the employer is a question of fact to be determined based on the facts and circumstances of each case. (Reg § 1.119-1(a)(1)) Meals furnished by an employer without charge to the employee will be regarded as furnished for the convenience of the employer if such meals are furnished for a “substantial noncompensatory business reason” of the employer (Reg § 1.119-1(a)(2)(i)), such as because the employer’s business requires that the employee be restricted to a short meal period during which the employee couldn’t be expected to eat elsewhere (Reg § 1.119-1(a)(2)(ii)(b)) or the employees must be available for emergency calls during the meal period. (Reg § 1.119-1(a)(2)(ii)(a))
In Comm. v. Kowalski, (S Ct 1977) 40 AFTR 2d 77-6128, the test that the Supreme Court applied to determine “convenience of the employer” under Code Sec. 119 (the “Kowalski test”) provides that the Code Sec. 119 exclusion applies to employer-provided meals only if the meals are necessary for the employee to properly perform his or her duties.
In Boyd Gaming Corp (f/k/a The Boyd Group & Subsidiaries), (CA9 1999, CA9) 83 AFTR 2d 99-2354, the Ninth Circuit determined that a substantial noncompensatory business reason requires a business nexus under which the employee must accept the meals in order properly to perform his or her duties. However, this business nexus does not require a link to an employee’s specific duties. Thus, the taxpayer, an operator of several casino-hotels, had an adequate business nexus for requiring its employees to eat in on-premises cafeterias where it established that it had a policy of requiring its casino-hotel employees to remain on its premises throughout their work shifts—which effectively required them to eat in the cafeterias—and where it provided adequate evidence of legitimate business reasons for that policy. These included security and efficiency concerns, maintaining work force control, handling business emergencies and continuous customer demands, and the impracticality of obtaining meals elsewhere within a reasonable proximity. Under these circumstances, it was not necessary for taxpayer to demonstrate that the particular duties of each of its various categories of workers were such as to require them to remain on the taxpayer’s premises throughout their shifts. The Court also noted that it was “inappropriate” for IRS to second guess these reasons or to substitute a different business judgment.
Facts. In conducting employment tax examinations, IRS encountered a pattern of cases in which employers furnish meals to employees and do not include the value of these meals in the employees’ income, claiming that the meals are excluded from income under Code Sec. 119. In these cases, the meals were provided on the business premises of the employer, which generally include a room or rooms where meals are prepared and/or served to employees, so only the “convenience of the employer” requirement of Code Sec. 119 was at issue.
The employers offered a variety of business reasons for furnishing meals to their employees and claimed that such reasons were substantial noncompensatory business reasons. For example, many employers claimed that innovation and collaboration were a key aspect of their company’s business model and culture, and the meals the employer provides facilitated employee innovation, collaboration, and productivity. Many also claimed that meals were provided to enable employees to work long days and overtime. Some claimed that meals were provided to promote a healthier workforce, because the furnished meals were healthier than the meal options the employees might otherwise consume off the premises. Certain employers claimed that meals were provided to discourage employees from jeopardizing trade secrets by encouraging them to remain on business premises for meals, rather than leave the premises and possibly discuss sensitive information during meals in public places.
In many of these cases, IRS has applied the Supreme Court’s “Kowalski test.” However, in response some employers maintained that Congress statutorily overturned Kowalski with the enactment of Code Sec. 119(b)(2) in ’78. In addition, some employers claimed to furnish meals for policy reasons that qualified for the Code Sec. 119 exclusion under various provisions of the regs, but these employers provided little to substantiate that they actually had—and enforced—these policies. Further, some employers claimed that IRS could not question or examine employers concerning their use of these policies, based on the Ninth Circuit’s decision in Boyd Gaming Corp.
Issues. The Legal Advice posed the following three issues:
(1) In determining whether business reasons are substantial noncompensatory business reasons, should IRS apply the Kowalski test or has this test been superseded by the enactment of Code Sec. 119(b)(2)?
(2) In light of certain holdings in Boyd Gaming Corp., that IRS may not supplant an employer’s business judgment with its own, may IRS question whether certain business needs and goals and employer policies offered by employers as reasons for furnishing meals to employees are substantial noncompensatory business reasons for furnishing meals under Reg § 1.119-1(a)(2)
(3) If an employer claims to have a business policy that, if such policy does exist and is enforced, qualifies as a substantial noncompensatory business reason, can IRS require substantiation that such employer actually has communicated the policy to employees and meaningfully enforces such a policy? If so, what substantiation must the employer provide?
Conclusions. In the Legal Advice, IRS determined that the Kowalski test continues to be the applicable standard for determining whether meals are furnished for the convenience of the employer. Accordingly, the test is relevant for determining whether a business reason for furnishing meals to employees is a substantial noncompensatory business reason.
The Legal Advice reasoned that, basing its finding on legislative history and pre-statute case law, the Supreme Court in Kowalski provided that the appropriate standard for determining convenience of the employer is the business-necessity theory, which means a situation where an employee must accept the employer-provided meals in order properly to perform his or her duties.
However, the Legal Advice further reasoned, the test does not demand that the employee must literally be required to accept and eat the meal to “properly perform duties.” Rather, the test means that the carrying out of the employee’s duties in compliance with employer policies for that employee’s position must require that the employer provide the employee meals in order for the employee to properly discharge such duties. If the employer’s particular business policies are such that employer-provided meals are necessary for the employee to properly discharge the duties of a particular job position, then meals provided to employees with such duties in that job position are provided for the convenience of the employer, even if certain individual employees in that position decline the meals.
Legislative history for Code Sec. 119(b)(2) indicates that the purpose of this addition was to overrule an IRS reg under Code Sec. 119 that had provided that the exclusion under Code Sec. 119 was not available to employers who charged for meals furnished to employees, and not to change the standard by which “convenience of the employer” is determined. The Kowalski test, as clarified by Boyd Gaming, and in keeping with Code Sec. 119(b)(2), provides that “convenience of the employer” means that the carrying out of the employee’s duties in compliance with employer policies for that employee’s position must require that the employer provide the employee meals in order for the employee to properly discharge such duties. If the employer’s particular business policies are such that employer-provided meals are necessary for the employee to properly discharge the duties of a particular job position, then meals provided to employees with such duties in that job position are provided for the convenience of the employer, even if certain individual employees in that position decline the meals. Accordingly, the Kowalski test is still applicable in determining whether a particular noncompensatory business reason for furnishing meals is substantial, as required by the regs under Code Sec. 119 for meeting the convenience of the employer standard.
In the Legal Advice, IRS concluded that while Boyd Gaming precludes IRS from substituting its judgment for the business decisions of a taxpayer as to its business needs and concerns and what specific business policies or practices are best suited to addressing these business needs and concerns, it does not preclude IRS from determining (i) whether an employer actually follows and enforces its stated business policies and practices, and (ii) whether these policies and practices, and the needs and concerns they address, necessitate the provision of meals so that there is a substantial noncompensatory business reason for furnishing meals to employees within the meaning of the Code Sec. 119regs and the applicable judicial guidance.
Therefore, in examining whether meals are excludable under Code Sec. 119, it is appropriate for IRS to determine whether specific employer policies related to the employer’s stated business needs and goals (including general business goals such as promoting collaboration and healthier employees, keeping employees safe, or protecting sensitive information) have, in fact, been adopted, and if so, whether those specific employer policies connect the employer’s stated needs and goals to the business necessity of furnishing meals to employees. A general business goal, without a related policy that governs how employees subject to the policy carry out their employee duties and substantiation of how employer-provided meals are necessary to enable the employee to perform their duties in accordance with the policy, will not be a substantial noncompensatory business reason.
In the Legal Advice, IRS concluded that the taxpayers bear the burden of proving that they are entitled to exclusions. Employers who claim the exclusion from income and wages for meals furnished for the convenience of the employer must provide substantiation if requested concerning the business reasons supporting their claim of furnishing meals for the convenience of the employer. Employers who provide specific business policies as substantial noncompensatory business reasons for furnishing meals to employees must be able to substantiate that such policies exist in substance—not just in form—by showing they are enforced with respect to the specific employees for whom the employer claims these policies apply and must demonstrate how these policies relate to the furnishing of meals to employees. The form and quality of substantiation that is sufficient to demonstrate a particular business policy will vary according to the facts and circumstances of each case.
A written expression of an employer policy, for instance, in an employee manual or employment contracts, provided to the employees for whom this policy applies, generally provides adequate substantiation that the policy exists. But a written policy is not required by statute or regs, so other substantiation may also be provided. For example, disciplinary records showing that employees have been disciplined for violating a policy or a record of requests for waivers from a policy for special circumstances would also serve as substantiation of an employer policy. However, while a written policy is not necessary, a taxpayer must be able to provide enough substantiation to demonstrate that an actual policy, rather than a mere business goal or objective, actually exists. If a policy exists, the employer must also demonstrate how providing meals relates to the policy such that the meals are necessary for the employees to properly perform their duties.
The Legal Advice discussed how this would apply for meals provided because of a shortened meal period (see Reg § 1.119-1(a)(2)(ii)(b)). In addition to written documentation and disciplinary records, where the employees were required to check in and out for lunch, the employer could show these records to demonstrate short lunch periods. The employer could also provide evidence that, as the provision suggests, peak workloads for these employees occur during meal hours (such as a customer count for work days that shows peak customer visits during meal hours). A mere assertion by the employer that its business is of a nature that requires short meal periods is insufficient substantiation that the employer qualifies under Reg § 1.119-1(a)(2)(ii)(b). The employer must provide additional information that demonstrates that: employees indeed have shortened meal periods; employees are aware of the shortened meal period requirement, which the employer meaningfully enforces; and these shortened meal periods are linked to the nature of the employer’s business. Self-imposed limitations on meal periods on the part of employees (such as claims that employees take short meal periods due to the expectations of “corporate culture”) do not qualify as a situation in which an employer’s business requires a shortened meal period.
The Legal Advice also discussed how this would apply for meals provided because an employee must be on-call for an emergency (see Reg § 1.119-1(a)(2)(ii)(a)). It must be shown that emergencies have actually occurred or can reasonably be expected to occur. The Legal Advice noted that neither the regs nor case law provides a description of what qualifies as an “emergency” for purposes of Reg § 1.119-1(a)(2)(ii)(a). The example in the regs and the few court cases that reference Reg § 1.119-1(a)(2)(ii)(a) address employees who were responding to emergency situations that involved or had the potential to involve physical danger or harm to individuals and/or damage to property (fire, medical emergencies, dangerous motor vehicle situations, etc.). Employers have the knowledge and information to determine what occurrences or incidents constitute “emergencies” within the meaning of the Code Sec. 119 regs with respect to their own businesses, as long as they employ a reasonable application of this standard that does not result in classifying routine or non-exigent circumstances as “emergencies.”
References: For exclusion for meals and lodging furnished to employees, see FTC 2d/FIN ¶H-1750 et seq.; United States Tax Reporter ¶1194.01.
