Many employers are struggling to hire and retain employees during the COVID-19 pandemic and the resulting “great resignation.”
If you’re one of those employers (or about to become one), examine your use of tax-free fringe benefits. It’s one of the proven ways to help keep good employees. Such benefits are deductible by you, the employer, but tax-free to the employee.
Common examples of tax-free benefits are health insurance and paid vacation. But there is another potential employee fringe benefit: free meals (usually, lunch). Free meals not only make your employees happy but keep them on the premises and generally make them more productive as well.
But not all employee meals are a tax-free fringe benefit. Employee meals qualify for tax-free treatment only if they are for the employer’s convenience. For decades, employers have been able to pass the convenience test with relative ease. But with on-demand meal delivery available to most workplaces today, is this about to change?
Requirements for Tax-Free Employee Meals
The general rule is that anything an employer gives an employee, including fringe benefits, is taxable compensation. But there are more important exceptions for certain fringe benefits.
One such exception is for certain employer-provided meals. They are tax-free if their main purpose is to benefit the employer, not to compensate the employee with free meals. Meals qualify for tax-free treatment if they are furnished:
- in kind,
- on the employer’s business premises, and
- for the convenience of the employer.
In kind – The in-kind requirement means that the employees may not be given the option of choosing a free meal or additional money. It’s a free meal or nothing. And under these free-meal rules, you can’t reimburse the employees for meals they buy themselves.
Business premises – The employer’s premises requirements means the meal must be eaten at the employees’ place of employment. This must be a place the employer owns or leases. It can’t include the employee’s home.
Employer’s convenience – The convenience test is where employers can run into problems with the IRS. Employee meals are furnished for the employer’s convenience only if they are furnished for a substantial non-compensatory business reason. That is, some reason other than rewarding employees for their work. IRS regulations provide 4 examples of employer’s convenience:
- The employees can’t obtain meals on their own within a reasonable time – for example, because there are insufficient eating facilities near the employer’s premises. (This is the most common way to pass the convenience test.)
- The employees need to be available on the employer’s premises for emergency calls during the meal period.
- The nature of the employer’s business restricts employees to shot meal periods- for example, 30 – 45 minutes because the business’s peak workload occurs during normal lunch hours.
- The employer is in the foodservice business and furnished meals to its food service workers immediately before or immediately after working hours.
These four examples are not the only ways to establish a non-compensatory purpose for free employee meals. For example, an employer could have a non-compensatory purpose for providing meals at mandatory employee meetings. This could be the case, for example, if certain employees must collaborate on a project and having a meeting that includes meals helps the project move forward.
But meals furnished to employees to promote morale or goodwill, or to attract prospective employees, are considered furnished for a compensatory business reason. Such meals don’t qualify for tax-free treatment unless the substantial non-compensatory business reason is also present.
Impact of On-Demand Food Delivery on the Employer Convenience Test
The IRC Section 119 regulations were adopted long before the widespread use of meal delivery services such as Grubhub, Uber Eats, and DoorDash. In 2019 technical advice, the IRS noted that today “employees have an array of meal options that can be delivered to their place of work with just a phone call, through a website, or via smartphone application.
In that technical advice, the IRS says that the new meal delivery service could defeat the “not enough time” reason for employer-provided meals, and if so, such meals are not tax-free to the employee. The technical advice seems to put a damper on the most widely used way for an employer to pass the Section 119 convenience test: lack of eating facilities nearby.
But Wait a Minute…
The IRS’s views expressed in technical advice are not the rule of law. And an employer could have good non-compensatory reasons to discourage or prohibit its employees from using meal delivery services and to provide its own free meals.
For example, the use of meal delivery services before and during the lunch period could be disruptive. Imagine if 50 employees all leave their desks at once to pick up their food in the lobby. Furthermore, there are security concerns about having meal delivery people wandering in and out of the workplace every day. Meal delivery services also may be unreliable, not to mention costly. Employers who seek to pass the convenience test on the grounds that their employees can’t get their own meals within a reasonable time should enact a company-wide policy barring the use of meal delivery services by employees. The policy should be in writing. It should be communicated to all employees and enforced by the employer. Also, employers should document the reasons the meal delivery option is not viable.
Employer Deduction for Convenience Meals Ends in 2026
Meals an employer provides to its employees are tax-deductible business expenses through 2025. But starting January 1, 2026, employers may no longer claim a tax deduction for such meals. That’s the bad news. The good news is that the meals will remain tax-free to the employee if the requirements for the employer’s convenience are met.
Deductible Now, but Weird Rules Prevail
Until 2026, the tax code limits the employer’s deduction for tax-free convenience meals to 50% of the food beverages expenses. Food or beverage expenses include the full cost of such items as delivery fees, tips, and sales taxes. But during 2021 and 202, the employer can deduct 100% of the cost of business-related restaurant meals. Thus, the employer that pays for business meals delivered by a restaurant may deduct 100% of the costs during 2021-2022.
But get ready for this, the employer that prepares meals in an employer-operated eating facility is not considered to be operating a restaurant and remains subject to the 50% deduction limitation.
If the employer fails to meet the Section 119 exclusion requirements, the employer must report the fair market value of the meals as W-2 income to the employee. Of course, this is bad news for the employee but not necessarily for the employer, because the employer now deducts 100% of the meal costs as W-2 employee compensation.
For purposes of Section 119, “meals” include breakfast, lunch, dinner, or their equivalent. Meals do not include snacks the employer provides its employees in a designated snack area, such as the office kitchen. Free snacks are tax-free. The costs of such snacks are 50% deductible by the employer. But if they are ordered from a restaurant during 2021-2022, they are 100% deductible.
Information via Bradford Tax Institute