IRS Audit: Tax Treatment of Employee Meals and Deductions

This report, prepared for a senior partner, examines the tax implications of a client's provision of meals to employees. The client, operating a casino/bar/restaurant, requires employees to remain on-site during their shifts and provides meals in an employee cafeteria, for which the employees pay. The IRS is auditing the client, questioning the deductibility of the meal costs and the potential inclusion of the meal's value in employees' taxable wages. The report analyzes whether the client can deduct 100% of the meal costs, whether the meals constitute taxable income for the employees, and considers the application of Section 119(a) of the Internal Revenue Code, which addresses the exclusion of meals from gross income under certain conditions. The analysis concludes that the client cannot deduct 100% of the costs because the employees pay for the meals, and the meals are not taxable income for the employees as they are paying for their own meals, and the meals are considered business expenses. The report highlights the importance of aligning the provision of meals with the 'convenience of the employer' principle to avoid potential tax issues and employee relations concerns.

To: Senior Partner
From: [student name]
Date: July 28, 2019
Re: Meals Provided for Employees
Issue and Conclusion
This is in response to your request for a considered opinion regarding the tax treatment of
meals provided by our client for its employees. It is my view that the client is not entitled to
deduct 100% of cost incurred in providing meals to employees.
Facts
Our client is undergoing an IRS audit for the years 2016 and 2017. The client operates a
casino/bar/restaurant at a single location. In order to make sure that its on-duty employees are
available if there is a sudden influx of customers, employees are not allowed to leave the
premises during their shifts. Employees are allowed periodic breaks, and are provided with
meals at an employee cafeteria separate from the customer areas. The employees pay for their
meals. The IRS auditor has determined that the amounts the client charges the employees do not
cover the direct operating costs of providing the meals. The client agrees that this is the case.
The auditor is proposing to include the excess of the cost of the meals over the charges in the
employees’ taxable wages, and to require the client to pay withholding on those wages. In the
alternative, the auditor is proposing to disallow deduction of 50% of the client’s cost of the
meals.
Analysis

Employers and employees can both get significant tax benefits when the employer
provides meals for employees or pays for employees’ meals (Weathington, and Tetrick, 2010).
The employer would benefit from deducting the cost of providing the meals as a business
expense and consequently reducing taxable income. The employee on the other hand can benefit
if the meal is treated as a tax free fringe benefit. Meals provided by employers are ordinarily
treated as taxable benefit (Klonoski, 2016). However, there is an exception to this general rule;
meals provided by employers can be tax free if they are provided on the employer’s premises and
if the provision of the meals is for the convenience of the employer.
The first issue for consideration is whether the employees should include the meals
provided by the employer as income. Section 119(a) of the Internal Revenue Code allows
employees to exclude the value of meals provided by the employer if the provision of the meals
is “for the employer’s convenience” at the employer’s place of business (IRS Publication 463,
2006). While the meals provided by the employer in this case are for the employer’s
convenience, the fact that the employees pay for their own meals implies that the meals provided
by the employer are not a form of compensation (Weathington and Tetrick, 2010). The fact that
the employees pay for their own meals renders all other considerations that are typically made in
Section 119(a) with regard to the exclusion of the value of meals provided from income. As
such, the meals cannot be included by the employees as taxable wages.
The second issue for consideration is whether the client is entitled to deduct 100% of the
costs of the meals. The client cannot deduct the costs of the meals as employee compensation for
the same reason that the employees cannot include the meals as taxable wages; the meals are
paid for by the employees.

The next consideration is whether the client is entitled to deduct 100% of it costs of the
meals a costs of sales to employees. As the employees pay for the meals provided to them by the
employer, they are for all intents and purposes customers of the employer and as such the costs
incurred by the employer are business expenses and are 100% deductible. A further
consideration is whether the amount paid by the employees covers all the costs incurred by the
employer preparing the meals.
Going forward, the client needs to be clear why they are providing meals to employees.
The intention of providing meals to the employees is arguably to prevent them from leaving the
premises. In such situations, employers typically provide meals that overall are a benefit to the
employees (Steiner, 2012). The situation for the client however looks like a scheme to force
employees to take and pay for meals from the employer. The client could be accused by the
employees of curtailing their freedom. To avoid such accusations, the client should abide by
guidelines set out in section 119(a).
Authorities
Bruno, F. and Torgler, B. (2017). Tax morale and conditional cooperation. Journal of
Comparative Economics Vol. 136, No. 1.
IRS Publication 463 (2006). Travel, Entertainment, Gift, and Car Expenses.
Klonoski, R. (2016). Defining Employee Benefits: A Managerial Perspective". International
Journal of Human Resource Studies. Vol.6 (2): 52–72.
Steiner, T. L. (2012). Employee happiness and corporate financial performance. Financial
Practice & Education. Vol.10 (2): 47–52.

Weathington, B. and Tetrick, L. (2010). Compensation or right: An analysis of employee 'Fringe'
benefit perception. Employee Responsibilities and Rights Journal. Vol.12 (3): 141–162.