Many of the expenses incurred by employees, and perks provided for employees, involve food.
Employees eat while traveling, while working, while taking breaks, and while entertaining. When employers provide or pay for these food costs, what are the real costs for both the employer and the employee?
The IRS basically refers to all food as meals, so there are actually two issues involved in answering this question:
Is the cost of providing or paying for employee meals a tax deductible expense?
Must the cost of a meal be added to the employee’s income?
IRS Publication 535, Business Expenses, states the following: “To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
It should be noted, however, that although an expense may qualify as a business expense, the deductible portion of the expense may be limited, which is often the case with meals.
The primary financial goal of a business is to make a profit. A profit is possible only if income exceeds tax deductible expenses. But making a profit is only part of the picture. The business must also have operating capital.
So what happens when a business incurs an expense that is not deductible? Three things:
The business’s working capital is reduced.
The business’s profit is increased in spite of the fact that it has incurred an expense.
The amount of income tax due on the profits will increase.
If a business continues to incur nondeductible expenses, then it may have a cascading effect. The business may have to borrow working capital to cover its expenses, and the interest on the borrowed funds will increase its expenses.
Psst... what are fringe benefits? Get up to speed here.
All meals must be treated either as a business expense or an employee fringe benefit. If it treated as a fringe benefit, then according to IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits, its must be treated as employee compensation except for:
Any amount that the law excludes from compensation; and
Any amount that the recipient pays for the benefit.
Suppose the employer pays for an employee’s lunch using a company credit card, and the total bill with tip was $30. If the cost of the meal cannot be excluded from wages, then the $30 would be added to the employee’s wages, and approximately $4.30 in additional taxes would be withheld as a cost to the employee. If the employer’s share of the taxes on the $30 is $3.60, then the employer can deduct a total of $33.60 as a business expense. On the other hand, if the $30 meal can be excluded from compensation, then the cost to the employee is zero, and the deductible cost to the employer is $30. Therefore, it is to the employer’s cost benefit if meals provided to employees can be excluded from employee compensation. Then, only the cost of providing the benefit will be incurred and the additional payroll taxes will be avoided.
Employers do have one other option. They can choose to provide meals to employees without treating them as a deductible expense. If they don’t deduct the expense in any form, then it does not have to be added to an employee’s compensation. In that case, the primary issue becomes one of cash flow and operating capital reserves.
So what meals are deductible business expenses, and what meals can be excluded from employee compensation?
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