Tax Court rules certain employer-provided meals fully deductible.

In a case of first impression, the Tax Court recently ruled in Boyd Gaming, 106 TC No. 19, that an employer could deduct 100% of the cost of meals it provided to employees in company cafeterias, even though the employees paid nothing for the meals. This decision may allow employers to avoid the 50% limitation on the deductibility of meals, under a broad interpretation of Regs. Sec. 1.132-7(a)(2) (relating to de minimis fringe benefits).

Sec. 274(n)(1) limits the deduction for"any expense for food or beverages" that is otherwise deductible to 50% of such expense (80% for tax years beginning after Dec. 31, 1986 and prior to Jan. 1, 1994). One of the exceptions is Sec. 274(n)(2)(B), which allows a 100% deduction for the cost of meals excludible from the recipients' gross incomes under Sec. 132(e).

Sec. 132(e) excludes employer-provided de minimis fringe benefits from employees' gross income. In general, de minimis fringe benefits are property or services whose value is "so small as to make accounting for it unreasonable or administratively impracticable" (Sec. 132(e)(1)). Sec. 132(e)(2) treats an eating facility operated by an employer for employees as a de minimis fringe benefit if it is located on or near the employer's business premises and the cafeteria's revenue equals or exceeds its direct operating costs. Direct operating costs include the costs of the meals and of the labor of the cafeteria workers. (Presumably, the rationale for this revenue/operating cost test is that any employer subsidy of a cafeteria in excess of this revenue target would be small on a per-employee basis.) The de minimis fringe benefit exception does not apply to highly compensated employees if the benefit is discriminatory in their favor.

In addition to these requirements, Regs. Sec. 1.132-7 (a) (2) requires the meals to be provided during, immediately before or immediately after the employees' workday. Also, this regulation contains the following important rule: the meals' revenues and costs can be disregarded for purposes of the revenue/operating cost test for all meals excludible from the employees' gross incomes under Sec. 119 if the employer can reasonably determine the number of meals so excluded.

Sec. 119(a) allows an exclusion from employees' gross incomes for the value of meals furnished to employees by the employer on the employer's business premises if the meals are provided for the employer's convenience. Sec. 119(b) specifies that whether employees pay for the meals is irrelevant for purposes of the "convenience of the employer" test. However, if a payment is required, employees must make it whether or not they accept the meals.

Regs. Sec. 119-l(a)(2) explains the "convenience of the employer" test. Meals are furnished for the convenience of an employer if the employer has a substantial noncompensatory business reason for furnishing them. Situations that qualify include:

* The employer needs to have the employees available for emergency call during the meal period.

* The employer's business requires a short meal period.

If the employer has both a substantial noncompensatory business reason and a compensatory reason for furnishing the meals, the "convenience of the employer" test is deemed to be satisfied.

Boyd and a related corporation owned Nevada resorts that consisted of casinos, hotels and restaurants. Each resort had an employee cafeteria on its premises separate from the public restaurants. Boyd provided free meals for its employees on a nondiscriminatory basis during their work shifts for "a variety of operational reasons." The employees were required to remain on the premises during their entire shift and were subject to discipline if they left the premises.

The IRS disallowed 20% of Boyd's deductions for meals for 1987 and 1988, claiming that the Sec. 274(n)(1) limitation applied. Boyd argued that the meals qualified as a de minimis fringe benefit under Sec. 132(e) and Regs. Sec. 1.132-7(a)(2). The Service conceded that Boyd satisfied all of the requirements of Sec. 132(e) and Regs. Sec. 1.132-7(a)(2) except for the revenue/operating cost test. The IRS argued that Boyd did not satisfy the test because Boyd earned no revenue from the employee meals. The Service maintained that the meals' revenues and costs can be disregarded only if the employees pay for their meals, some of which are excludible under Sec. 132(e) and the rest excludible under Sec. 119. Therefore, the cafeteria must make an Overall profit for the employer to deduct 100% of the meals' cost. The IRS based its analysis on excerpts from the congressional committee reports to Sec. 274(n)(1).

The Tax Court rejected the Service's analysis and ruled that the meals are fully deductible under the plain meaning of Regs. Sec. 1.132-7(a)(2). The court pointed out that the committee reports also contain the Sec. 132(e) exception to Sec. 274(n)(1) that applies to Boyd. In addition, the Tax Court emphasized that Congress enacted Sec. 274(n)(1) to reduce the deductibility of personal expenses by high-income taxpayers. Allowing a full deduction for Boyd did not violate this intent.

The Tax Court did not address the factual question of whether Boyd's employees qualified for the Sec. 119 exclusion; given the facts presented, it would appear they do. However, the IRS may appeal the Tax Court's ruling prior to the resolution of the Sec. 119 issue; such an appeal would be to the Ninth Circuit.

From Peter C. Barton, CPA, MBA, J.D., Professor of Accounting, University of Wisconsin-Whitewater, Whitewater, Wisc.