Decisions — Eat, drink, deduct

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Image source: Theodoor Rombouts [Public domain], via Wikimedia Commons

Even if you don’t eat like a hockey player, you may be interested in the tax court’s take on the rules limiting deductions for meals.

Under current tax law, meal and entertainment expenses are not deductible unless the expenses are associated with the active conduct of a trade or business (internal revenue code section 274(a)(1)(A)). If you meet that hurdle, you can generally deduct 50% of meal and entertainment expenses…unless an exception applies and you can deduct 100%.

One exception is when a business maintains an “employer-operated eating facility.” Broadly speaking, that’s an identifiable location that is designated for the preparation and/or consumption of meals, whether owned or leased – an employee cafeteria, for example. The regulations provide rules that must be met for a facility to qualify for this exception (regulation 1.132-7).

The question in 148 T.C. No. 24 (Jacobs) was whether a hotel banquet room could be considered an employer-operated eating facility.

The taxpayer owned a sports franchise, and rented rooms in hotels for games away from the team’s local venue. The team stayed at hotels when visiting “away” cities and contracted with the hotels for pregame meals for players and team personnel. The taxpayer deducted the full cost of the meals.

While agreeing the meal expenses were associated with the taxpayer’s business, the IRS said the meals were only 50% deductible because the taxpayer did not meet any exception to allow 100% deductibility.

The taxpayer said the meals were fully deductible because they were provided at an “employer-operated eating facility.”

The court looked at five requirements necessary to qualify as an employer-operated eating facility (four from regulation 1.132-7 and one (#4) from code section 132(e)(2)(B)).

1. The eating facility is owned or leased by the employer

In this case, the contracts entered into between the taxpayer and the away city hotels were not specifically identified as “leases.” The taxpayer did not own the hotel meal rooms, but paid for “the right to use and occupy” them to conduct team business.

2. The eating facility is operated by the employer

If an employer contracts with another to operate an eating facility for its employees, the facility is considered to be operated by the employer.

In this case, the taxpayer contracted with the hotels to set up a private meal room and to provide meals and snacks that meet the team’s specific nutritional guidelines.

The IRS said that the taxpayer paid sales taxes on the meals, which meant that the contracts were not for services, but for meals served in a private setting. The IRS concluded that the meal rooms were not an employer-operated eating facility, but instead meal purchase orders for the purchase of a few meals on an individual day to be served in a private room.

3. The eating facility is located on or near the business premises of the employer

An employer’s “business premises” is a place where employees perform a significant portion of duties or where the employer conducts a significant portion of business. An eating facility doesn’t have to be located in an employer’s principal structure to be considered on the business premises.

In this case, the taxpayer says the hotels are essential to the team’s effective preparation for games, and the taxpayer uses the hotel to conduct business.

The IRS acknowledges that the taxpayer performs business activities at the hotels. However, the IRS argues that the activities at the hotels are insignificant. The IRS says the activities at the hotels are qualitatively less important than playing in the actual sports game and the team spends quantitatively less time at each hotel than at the team’s primary facilities.

4. The eating facility meets the revenue/operating cost test

Revenue derived from the employer-operated eating facility must equal or exceed the direct operating costs of the facility. The facility satisfies the revenue/operating cost test if the employer can reasonably determine that the meals are excludable to the employees (internal revenue code section 119). Meals are excludable to employees if they are furnished for the convenience of the employer and furnished on the business premises of the employer.

Meals furnished without charge to the employee are for the convenience of the employer if the meals are furnished “for a substantial noncompensatory business reason of the employer.”

In this case, the taxpayer says providing meals to traveling employees at away city hotels enables the team to effectively manage a hectic schedule by minimizing unproductive time and maximizing time dedicated to activities that help achieve the goal of winning games.

5. The meals must be furnished during, before, or after the employee’s workday

The IRS concedes the taxpayer has satisfied this requirement.

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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For the taxpayer.

1. The eating facility is owned or leased by the employer

For employee meals at an employer-operated eating facility to qualify as a de minimis fringe under sections 274(n)(2)(B) and 132(e), the regulations require that the employer-operated eating facility be “owned or leased by the employer.”

Although the contracts entered into are not specifically identified as “leases,” the substance of the contracts indicates that the taxpayer is paying consideration in exchange for “the right to use and occupy” the hotel meal rooms.

The taxpayer executes contracts to occupy meal rooms and determines what types of food are served. The taxpayer dictates several aspects regarding the setup of the meal rooms, such as the furnishings and the presence of audiovisual equipment or a whiteboard.

The evidence establishes that the taxpayer contracts with the hotels for the right to “use and occupy” meal rooms to conduct team business, and therefore these agreements are substantively leases.

 

2. The eating facility is operated by the employer

We find that by engaging in the process of creating contracts with the hotels, the taxpayer is “contract[ing] with another to operate an eating facility for its employees.”

 

3. The eating facility is located on or near the business premises of the employer

We conclude that the hotels were part of the taxpayer’s business premises for the years in issue. In arriving at this conclusion, we consider the traveling employees’ performance of significant business duties at the hotels along with the unique nature of the taxpayer’s business (a professional sports team).

An integral part of the professional sports business involves traveling to play games as dictated by the franchise schedule. Staying in hotels is indispensable to the team’s preparation, and the team uses the hotel to conduct business.

We thus conclude that away city hotels are vital to the business objective of winning sports games and are where a significant portion of the traveling employees’ responsibilities and the team’s business is conducted.

Accordingly, we hold that the hotels constituted part of the business premises for the years in issue.

 

4. The eating facility meets the revenue/operating cost test

The evidence establishes that the pregame meals at away city hotels are provided to the traveling employees for substantial noncompensatory business reasons. The pregame meals are provided to traveling employees first and foremost for nutritional and performance reasons. The meals are also provided because employees are subject to a busy schedule and have only limited time to prepare for an upcoming game.

The taxpayer has provided credible evidence establishing the business reasons for furnishing pregame meals to traveling employees at away city hotels, and we will not second-guess their business judgment.

Accordingly, we hold that the provision of meals at away city hotels is for the convenience of the employer under section 119 and therefore satisfies the revenue/operating cost test of section 132(e)(2)(B).

 

5. The meals must be furnished during, before, or after an employee’s workday

The IRS concedes the taxpayer has satisfied this requirement.

We conclude that the taxpayer’s provision of pregame meals and snacks to the traveling employees at away city hotels qualifies as a de minimis fringe pursuant to section 274(n)(2)(B).

Accordingly, the taxpayer is entitled to deduct the full cost of the meals without regard to the 50% limitation imposed by section 274(n)(1).

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