Great article about how to handle taxing food and lodging provided by your employer.
Article by Alan D. Campbell, CPA, Ph.D., and Dena S. Mitchell, CPA on Journal of Accountancy
Gross income generally includes the fair market value (FMV) of meals and lodging received from one’s employer. However, Sec. 119 allows an employee to exclude from gross income the value of meals and lodging received from an employer under certain circumstances. In addition, some or all of the value of meals or lodging may be excluded from income under other exclusion provisions.
CONDITIONS FOR EXCLUSION OF MEALS BY AN EMPLOYEE
For an employee to exclude the value of meals received from an employer from gross income under the general exclusion in Sec. 119(a), the employer must furnish the meals on the employer’s business premises. The “employer’s business premises” generally means the employee’s place of employment. The business premises include the place where the employee performs significant duties or where the employer conducts a significant portion of its business. Places near the employer’s premises will not qualify, even though those places might be convenient. The business premises of the employer include any place on the grounds of the employer and not just the main structure. The meals must also be for the convenience of the employer, not the convenience of the employee.
NONCOMPENSATORY BUSINESS REASON REQUIREMENT
Under the convenience-of-the-employer condition, an employee may exclude from gross income the value of the meals provided free by an employer only if the employer does so for a substantial noncompensatory business reason. If the employer has a substantial noncompensatory business reason for providing the free meals, they will be treated as provided for the convenience of the employer even if the employer also has an additional, compensatory reason for providing the free meals. The employer’s statement alone is not sufficient evidence for the conclusion the employer provided the meals for a substantial noncompensatory reason. All the facts and circumstances are relevant to such a determination.
Where an employer requires an employee to accept lodging on the employer’s business premises as a condition of employment, Regs. Sec. 1.119-1(a)(2) deems any meal the employer provides free to the employee at the business premises to be for a substantial noncompensatory reason.
An employee may exclude from gross income the value of small food items and soft drinks as a de minimis fringe benefit. In addition, an employee may exclude from gross income occasional meals provided in kind or occasional cash received to buy dinner to allow the employee to work overtime. The same treatment may be extended to food and drinks provided by the employer to employees and their guests at picnics and parties.
MEALS BEFORE AND AFTER WORK
With some exceptions, Regs. Sec. 1.119-1(a)(2) treats meals provided before or after work as not provided for a substantial noncompensatory reason. Thus, the employee must include the value of those meals in gross income. Meals provided to restaurant employees are a common exception. A restaurant employee may exclude from gross income the value of free or discounted meals consumed immediately before work, during work, or immediately after work.
However, if a restaurant employee eats a meal free at the restaurant on a nonworking day, the employer must include the meal’s value in the employee’s wages and report it on Form W-2, Wage and Tax Statement. The employer must keep adequate records of the value of any meals included in the employee’s wages. The employer may treat the value of taxable noncash fringe benefits as paid on a per-pay-period, quarterly, semiannual, annual, or other basis. The employee would have to include the meal’s value in gross income.
However, a restaurant employee might be able to exclude from income the discount on discounted meals consumed on nonworking days as a qualified employee discount under Sec. 132. In that case, the discount cannot exceed the gross profit percentage of the price at which the meals are being offered by the employer to customers.
Example 1: G works as a bartender at a steakhouse. She may eat meals without charge immediately before her shift, while on break during her shift, and immediately after her shift. She excludes the value of these free meals under Sec. 119. On her nonworking days, G may eat meals at the restaurant for a 50% discount. Assume that the gross profit percentage at the steakhouse is 60%. Because the discount does not exceed the gross profit percentage, G may exclude all the discounts she receives as a qualified employee discount under Sec. 132.
If the employer would have provided a meal to an employee during working hours for a substantial noncompensatory business reason, but work duties prevented the employee from eating, the employee may exclude from gross income the value of a meal provided by the employer immediately after working hours.
MEALS DURING WORKING HOURS
Under Regs. Sec. 1.119-1(a)(2)(ii), an employee may exclude from gross income the value of meals furnished by an employer during working hours if the reason is to have the employee available for emergency calls during the meal period. Likewise, an employee may exclude the value of meals furnished by an employer during working hours if the reason is that the employer allows only a short meal period, such as 30 to 45 minutes, and the employee could not be expected to eat elsewhere in that time. Such a circumstance may arise when the employee’s peak workload occurs during normal meal hours.
However, meals provided by the employer do not qualify for the exclusion if they are not provided for the employer’s convenience (e.g., if the purpose of the short meal period is to allow employees to leave earlier in the day).
An employee may exclude from gross income the value of meals furnished by an employer during working hours if the employee could not otherwise obtain proper meals within a reasonable meal period. This situation could occur if eating facilities near the employer’s location are insufficient.
OTHER FACTORS
If an employer provides meals to substantially all of its employees for a substantial noncompensatory business reason, then Regs. Sec. 1.119-1(a)(2)(ii)(e) treats the meals provided to other employees as provided for a substantial noncompensatory business reason.
Example 2: A large hospital has an on-site cafeteria where all of its 250 employees may eat free during working hours. Of the 250 employees, 234 are provided the meals because they must be available for emergencies. Because substantially all of the hospital’s employees must eat at the cafeteria, all of the employees may exclude the value of the meals from gross income.
If the employer provides meals for a price and the employee may or may not purchase the meals, Regs. Sec. 1.119-1(a)(3) does not treat such meals as provided for the convenience of the employer. Thus, if the meals’ FMV exceeds the cost paid by the employee, the employee must include the difference in gross income, unless the discounted meals qualify for exclusion as a qualified employee discount under Sec. 132.
Example 3: A company provides a cafeteria where employees may purchase meals at a discount of 40% from the meals’ FMV. Employees do not have to eat in the cafeteria. The company allows family and friends of employees to eat with them in the company cafeteria, but the family and friends must pay full price. Thus, the receipt for employees shows the full price, the 40% discount, and the net price paid. The company’s accounting system tracks the cumulative discounts received by employees and reports them on each employee’s Form W-2. One employee ate 250 meals at the company cafeteria during the year. She received an average discount of $4 per meal. Her gross income will include $1,000 (250 × $4) for the value of the meal discounts she received.
If an employer deducts a fixed amount from the employee’s compensation for the cost of meals the employer provides, the employer does not include such a reduction in pay in the employee’s gross income—it is a tax-free reduction in compensation. The employee determines whether the exclusion for the meals under Sec. 119 applies by using the rules of Regs. Sec. 1.119-1(a)(2).
Example 4: G works for an oil pipeline company on a project in a remote area of Alaska. His employer provides meals and lodging to the pipeline workers at a camp because no other facilities are available. G pays $75 per week to the employer through a payroll reduction for the meals and lodging. G determines that the meals are furnished for the convenience of his employer in accordance with the rules of Regs. Sec. 1.119-1(a)(2). He does not include the $75 per week withheld from his paycheck in gross income. G also excludes from gross income the value of the meals and lodging provided by the employer.
Sec. 119 applies to meals provided by an employer in kind. It does not apply to a cash meal allowance. An employee must include a cash meal allowance in gross income to the extent that such an allowance is compensation.
If an employee may choose to receive additional cash compensation in lieu of meals and the employee chooses the meals, he or she must include the meals’ value in gross income. However, if an employee refuses to accept free meals provided in kind by the employer, he or she does not necessarily have to include the value of the refused meals in gross income.
CONDITIONS FOR EXCLUSION OF LODGING BY AN EMPLOYEE
When an employer provides housing or lodging for an employee, the employee may be able to exclude the value of the lodging from gross income. The lodging must meet three tests under Regs. Sec. 1.119-1(b): (1) The lodging must be on the employer’s business premises; (2) the employer must provide the lodging for the employer’s convenience rather than for the employee’s convenience; and (3) the employer must require the employee to accept the lodging as a condition of employment. Thus, the employee must need to live in the lodging to be able to perform the duties of the employment.
Example 5: J is an employee of an apartment building, performing maintenance and repairs. His employer requires him to live in the apartments to be able to provide emergency repair services 24 hours per day and therefore provides J with free lodging there.
J meets all three tests: (1) The lodging is on the employer’s premises; (2) it is for the employer’s convenience; and (3) J must live there to be on call 24 hours a day as a condition of his employment. Therefore, he may exclude the value of the free lodging from gross income.
FOR THE EMPLOYER’S CONVENIENCE
Sec. 119(b) specifies that the terms of an employment contract or state statutes that describe terms of employment are not determinative of whether meals or lodging are for the employer’s convenience. If a state statute or employment contract treats employer-provided lodging as compensation, the employee may still exclude the value of the lodging from gross income for federal income tax purposes if the lodging meets the three tests. The employee must determine whether he or she may exclude the value of lodging from gross income by an objective analysis of all relevant facts and circumstances.
An employer’s subjective intent is not conclusive of whether an employee may exclude the value of lodging furnished by an employer from the employee’s gross income.
Example 6: S is a state employee. The state institution where she works requires her to be available for duty at all times. The state furnishes S with free meals and lodging at the institution. The applicable state statute considers the meals and lodging as compensation and includible in gross income for state income tax purposes.
Despite the state statute, S may nevertheless be able to exclude the value of the meals and lodging from gross income for federal income tax purposes. She must carefully examine all the facts and circumstances in determining whether the tests of Sec. 119 are met for the meals and lodging.
If an employer allows the employee to choose between free lodging or additional cash compensation and the employee chooses the free lodging, the employee must include the value of the free lodging in gross income.
If the lodging does not satisfy the three tests, the employee must include the FMV of the lodging in gross income, regardless of any amount the employer deducts from the employee’s pay for the lodging. Absent evidence to the contrary, Regs. Sec. 1.119-1(b) deems the FMV of the lodging to be the amount deducted from the employee’s pay for lodging.
EMPLOYER’S BUSINESS PREMISES
The requirement for the lodging to be on the business premises of the employer generally means at the place of employment. This could include the employer’s home, for a domestic servant, or property leased by the employer for the business purpose. It could mean other property owned by the employer where the employee performs a significant portion of his or her duties.
In Lindeman, 60 T.C. 609 (1973), acq., 1973-2 C.B. 2, a hotel manager lived in a house within the perimeter of the hotel property. The manager performed a significant portion of his duties in the house. He was on call 24 hours a day. Under these facts and circumstances, the Tax Court allowed the exclusion for lodging.
However, in Anderson, 371 F.2d 59 (6th Cir. 1966), a motel manager lived in a house owned by the employer. The house was two blocks from the motel. The employer provided the home free, paid for its utilities, and provided staple grocery items. The employer did so to avoid any loss of revenue that would result from the manager’s occupying a motel room. The manager was on call 24 hours a day. However, because the manager did not perform a significant portion of his duties in the house and because the house was not a significant place of business for the employer, the Sixth Circuit did not allow the exclusion for meals and lodging. Thus, the manager had to include the value of the lodging in gross income.
The employer of an engineer on the Trans-Alaska Pipeline built permanent homes and modular homes in the construction area because there was insufficient housing available elsewhere. The employer provided the housing free to employees. The employer then included the value of the lodging in the employees’ wages and withheld tax on it. The engineer employee deducted the value of the housing included in his wages as employee business expenses. The Tax Court found the employer provided the housing for the employer’s convenience, and the employee had to accept the lodging as a condition of employment.
However, for the taxpayer’s lodging to be considered as within the employer’s business premises, those premises would have to encompass the entire town, an overly broad view of the term, the court said. Because the taxpayer did not perform a substantial amount of his duties in the home but rather at the employer’s oil pipeline terminal, the Tax Court found the lodging was not on the employer’s business premises. Consequently, the taxpayer had to include the value of the lodging in gross income and could not deduct it as a business expense. In the case of an employee who receives lodging from an employer in a camp in a foreign country, the law will treat the camp as the business premises of the employer, if the requirements in Regs. Secs. 1.119-1(c) and (d) are met.
CAMPUS HOUSING
In general, and as stated above, for an employee to exclude from gross income the value of lodging provided by the employer, the employer must require the employee to accept the lodging on the employer’s business premises as a condition of employment. Some educational institutions furnish lodging to their employees. Educational institutions generally do not require their employees to accept such lodging as a condition of employment. Thus, an employee of an educational institution who receives subsidized housing is usually unable to meet the requirements for exclusion.
However, Sec. 119(d) provides that employees of an educational institution may exclude from gross income the value of qualified campus lodging that the educational institution provides them. Qualified campus lodging is lodging on or close to campus that is provided by the educational institution as a residence for the employee and the employee’s spouse and dependents.
The exclusion does not apply when an employee pays inadequate rent for such housing. In that case, the employee would include in gross income all or a portion of the value of the housing provided, based on the inadequate-rent calculation.
Inadequate rent is the lesser of (1) 5% of the appraised value of qualified campus housing, or (2) the average rent paid by individuals for similar housing provided by the institution, minus the rent paid by the employee for the housing during the calendar year. The educational institution must determine the appraised value as of the close of the calendar year in which the tax year begins or, in the case of a rental period not greater than one year, any time during the calendar year in which the rental period begins.
Example 7: A large state university owns a house on campus it rents to Professor T. The house is currently appraised at $180,000, and similar properties rent for $1,400 per month. The university charges Professor T $600 per month in rent.
Professor T must include in gross income the lesser of (1) 5% of $180,000 or (2) $1,400 per month, minus the $600 monthly rent that he pays. The calculation is: 5% × $180,000 = $9,000 per year; $9,000 ÷ 12 months = $750 per month. Because $750 per month is less than $1,400 per month, the calculation is $750 − $600 = $150 per month; $150 per month × 12 months = $1,800. Professor T must include $1,800 per year in gross income as a result of the bargain rental from the university.
An educational institution is an educational organization that maintains a faculty and curriculum and normally has a body of enrolled students at the place where its educational activities occur.
The term “educational institution” includes not only a college or university but also an academic health center. An academic health center is an entity that carries on medical care, medical education, and/or medical research. To qualify as an academic health center, the entity must also receive payments under Section 1886 of the Social Security Act relating to graduate medical education. It must have as one of its principal purposes or functions providing and teaching basic and clinical medical science and research with its own faculty.
TAX-FREE HOUSING TO A PARTNER FROM A PARTNERSHIP
Sec. 119 does not address lodging provided by a partnership to a partner on the partnership’s business premises for the partnership’s convenience. Nevertheless, in some situations a partnership may view its transactions with a partner as being with someone who is not a partner. In Armstrong v. Phinney, 394 F.2d 661 (5th Cir. 1968), the Fifth Circuit ruled that a partner could act in a capacity other than as a partner under Sec. 707(a) for purposes of the exclusion for meals and lodging under Sec. 119.
However, taxpayers have lost similar cases (see, e.g., Doak, 234 F.2d 704 (4th Cir. 1956); Moran, T.C. Memo. 1958-5, rehearing on remand, 236 F.2d 595 (8th Cir. 1956); and Robinson, 273 F.2d 503 (3d Cir. 1959), cert. denied, 363 U.S. 810 (1960)).
About the authors
Alan D. Campbell (alancampbell@elmore.rr.com) is an associate professor of accounting at Troy University in Montgomery, Ala., and Dena S. Mitchell (dsmitchell@troy.edu) is an assistant professor of accounting at Troy University in Troy, Ala.
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Editor’s note:
This is an abridged version of a feature that appeared in the April 2015 issue of The Tax Adviser.
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