Recent Internal Revenue Service guidance clarifies the treatment of meal and entertainment expenses, but also instructive are recent IRS audits on this issue, a payroll operations expert said June 25.
“On the payroll side, we are definitely concerned with what is taxable to the employee and what isn’t, what actually flows through payroll and what doesn’t, what we can exclude, and how to make sure that you’re jumping through the hoops correctly,” Mindy Mayo, CPP, said at the American Payroll Association’s 2020 Virtual Congress.
“I will tell you that in the audits I’ve gone through in the past couple years, especially, the IRS has focused on this issue of meals and entertainment, and they are looking at how you are substantiating these from the company’s viewpoint,” said Mayo, an active member of the APA and national speaker’s bureau. “If you do not substantiate them correctly, the entire item that you’re providing to your employee could be considered a taxable event.”
Tax Reform Confusion
Before the federal tax cut overhaul toook efect Jan. 1, 2018, a business could deduct 50% of meal and entertainment expenses directly related to the active conduct of trade or business as long as it was immediately before or after a bona fide business discussion associated with the active conduct of a trade or business, said Mayo, who has 30 years’ experience in the payroll industry.
The new tax law eliminated the 50% deduction for expenses related to entertainment, amusement, or recreation, but did not address the deductibility of business-meal expenses, which caused confusion, Mayo said. “And so we were waiting for the IRS to provide a little bit of clarity, which they did.”
IRS issued proposed rules (REG-100814-19) in February that clarify that employers generally may continue to deduct 50% of an otherwise allowable business meal, including meals consumed by employees on work travel, if the meal is not lavish or extravagant under the circumstances, Mayo said.
Employers and employees must be present when the food and beverages are furnished, Mayo said. But the guidance does not cover food or beverage expenses that are excludable as meals provided for the employer’s convenience.
Defining De Minimis
Regarding de minimis costs, the tax law only addressed deductibility on the corporate side, Mayo said. “It has not changed at all the treatment on the employee side, and how you actually deal with meals and entertainment,” Mayo said.
Whether occasional meals qualify as being of such insignificant value that to account for them would be unreasonable or administratively impractical—or de minimis—“can be subjective and depend on an auditor’s views and how much they are liking you on a given day,” Mayo said. “As soon as the IRS believes items are no longer de minimis by their standards, de minimis goes right out the window.”
Generally, the value of de minimis meals can be excluded from an employee’s wages, IRS guidance said, but the same language around meals and entertainment has for years been in Publication 15-B, Employer’s Tax Guide to Fringe Benefits, may not have kept up with the times, Mayo said.
When the IRS publication talks about sodas and similar low-cost items being de minimis, “I think this was back in the days where maybe you have a staff meeting and all of a sudden the sodas come out” and not the typical well-stocked pantries that we see now where anybody can go and grab food, Mayo said. “What we see in practice going on right now versus what actually is in publications can be two different things.”
Before the tax law took effect, when the IRS was reviewing what meals and entertainment California employers actually were providing, the IRS took the position that the coffee, snacks, and granola bars that a company stocked in every break room were taxable because they were out all the time, not just occasionally, said Mayo, who at one time worked as a California tax auditor. The value of the items were divided among the employees and were taxable to each employee, she said, noting that this treatment would still take place today, despite tax reform.
Company-provided eating facilities are another issue that Mayo has seen the IRS address. If the eating facility’s annual revenue at least equals its direct operating cost, then that could be an expense excludable from employee compensation, if specific tests are met, Mayo said.
The IRS had no problem with a company cafeteria that provided meals at-cost to workers who otherwise could not get anywhere for meals, Mayo recalled. But the same company also provided an executive dining room with a full-time chef just to provide meals to the executive team that were substantially different from the cafeteria meals, so the IRS considered that value to be compensation to the executives, she said.
The business purpose around a company-provided cafeteria and whether meals are provided as a fringe benefit are the big issues, Mayo said, noting that providing meals to employees has become a sought-after hiring point and, for high-tech companies, “pretty much an expected occurrence.”
“When this happens, the IRS, of course, is taking exception with it,” Mayo said. The IRS believes that if there is no business purpose behind it, then it is considered compensatory to the employees, she said, noting that “the part that will catch you up is the ‘furnished for your convenience.’”
Many companies that Mayo has seen audited have been in metropolitan areas where restaurants abound. The IRS has taken the position that when employers are in a metropolitan area and have a cafeteria, the employers really have to say why their employees cannot leave the area they are in to get a meal, Mayo said.
“The tough part, I think, is when these items, the on-site cafeterias, are touted as a hiring perk” that read in human resources materials like an incentive, Mayo said, noting that IRS agents read all that material as well. “So, how do you display that--for recruitment purposes--it’s an incentive and then pull that statement back for tax purposes?” she said.