Analysis of the Senate Tax Reform Bill – Part II: Changes to Deductions and Exclusions for Employee Meals and Other Fringe Benefits, Changes to Private Retirement Plan Benefits, and New Paid Leave Credit

Early Saturday morning, the Senate voted 51-49 to approve a modified version of the Tax Cuts and Jobs Act (the “Senate Bill”). The Senate Bill differs from the House bill (discussed in an earlier series of posts here) passed last month in several respects, and a final negotiated bill will need to pass both chambers before the President can sign it into law. Given the difficulty of moving legislation through the Senate, it seems likely that any enacted legislation would likely be similar to the version passed by the House.

This post is the second in a series of three posts analyzing provisions of the Senate Bill. (Part I analyzes the elimination of the penalty for failing to maintain minimum essential coverage under the ACA and changes to equity and executive compensation. Part III analyzes new reporting and withholding requirements and source rules.)  This post analyzes the following changes:

  • Fringe Benefits – (a) eliminate the deduction for entertainment expenses; (b) eliminate the deduction (after 2025) for meals provided for the employer’s convenience (that are not occasional overtime meals) and meals provided at employer-operated eating facilities; (c) impose a 50-percent limitation on deductions for occasional overtime meals and other de minimis meals; (d) eliminate the deduction for qualified transportation fringes; (e) eliminate the deduction for commuting expenses (except for the employee’s safety); (f) suspend the exclusion for qualified bicycle commuting reimbursement; (g) suspend the exclusion for qualified moving expense reimbursement; and (h) prohibit the use of cash or gift cards and other non-tangible personal property as employee achievement awards.
  • Private Retirement Benefits – (a) extend the rollover time period of certain outstanding plan loans; and (b) allow qualified distributions for victims of major disasters in 2016.
  • Employer Tax Credits – provide employer tax credits in 2018 and 2019 for paid family and medical leave.

These changes generally would be effective after 2017, except as otherwise noted below.

Fringe Benefits

Elimination of Deduction for Entertainment Expenses. Similar to the House bill, section 13304(a) of the Senate Bill would completely disallow employer deductions for (1) entertainment, amusement, or recreation (“entertainment expenses”); (2) membership dues for clubs organized for business, pleasure, recreation or other social purposes; and (3) facilities used in connection with any of these items.  This full disallowance would replace the existing 50‑percent limit for entertainment expenses directly related to the active conduct of the employer’s trade or business.

Unlike the House bill, however, the Senate Bill would not impose a separate deduction limitation on “amenities,” which the House bill defined as de minimis fringe benefits that are primarily personal in nature and that involve property or services not directly related to the taxpayer’s business. (See earlier coverage.) The Senate Bill would continue to permit deductions for such expenses to the extent currently permitted by law (as modified by the provisions relating to employer meals discussed below).

Elimination of Deduction for Meals Provided for Employer’s Convenience (that are not Occasional Overtime Meals) and Employer-Operated Eating Facilities After 2025. Under existing law, employers may generally deduct (1) 50 percent of expenses for meals provided for the employer’s convenience under Code section 119; and (2) all expenses for the operation of and meals provided through an employer-operated eating facility that constitute de minimis fringe benefits under Treasury Regulation § 1.132-7 (but as described below, a 50‑percent limitation would apply starting in 2018). These deductions would be repealed under section 13304(d) of the Senate Bill, effective after 2025. After the repeal, if an employer chooses to provide meals to employees under section 119 or through an employer‑operated eating facility, these meals would remain excludable from employees’ income and wages to the extent currently excludable under section 132, but the cost of providing them would not be deductible by the employer (except to the extent employees pay for the meals). The Senate Bill would not change the existing 50‑percent deduction for other meal expenses associated with operating the employer’s trade or business (e.g., meals consumed by employees on work-related travel).

The Senate Bill’s restrictive approach to meal deductions differs from the House bill’s approach of allowing full deductions for meals provide at employer‑operated eating facilities, meals provided for the employer’s convenience under section 119, and meals that otherwise qualify as de minimis fringe benefits, such as occasional overtime meals. Moreover, the Senate Bill’s deferred repeal at the end of the 10‑year budget window suggests that the repeal may have been part of an effort to ensure compliance with Senate reconciliation rules requiring that the Bill not increase the deficit outside of the budget window.

50-Percent Limitation on Deductions for Occasional Overtime Meals and Other De Minimis Meals. Currently, employers may generally deduct and employees may exclude from income meals that constitute de minimis fringe benefits under Code section 132(e). De minimis meals may include occasional overtime meals, cocktail parties, group meals, and picnics for employees and their guests, and year-end holiday parties, in addition to meals provided at employer‑operated eating facilities. Section 13304(b) of the Senate Bill would generally impose a 50‑percent limitation on deductions for de minimis meals starting in 2018. As described above, starting in 2026, employers would not be permitted to deduct any expenses for operating and providing meals through employer‑operated eating facilities (except to the extent the employees pay for the meals). But the other types of de minimis meals would continue to be deductible subject to the 50‑percent limitation.

Elimination of Deduction for Qualified Transportation Fringes. Like the House bill, section 13304(c) of the Senate Bill would disallow the deduction for providing any qualified transportation fringe benefits.  Under Code section 132(f), these fringe benefits permit employers to either pay for an employee’s public transportation, van pool, bicycle, or parking expenses related to commuting on a pre-tax basis or allow employees to elect to receive a portion of their compensation in the form of non-taxable commuting benefits. Although the Senate Bill does not change the existing income exclusion for commuting expenses (other than bicycle commuting expenses, discussed below) that constitutes de minimis fringe benefits, it would likely discourage employers from providing qualified transportation benefits to employees.

Elimination of Deduction for other Commuting Expenses (Except for Employee’s Safety). Unlike the House bill, section 13304(c) of the Senate Bill would further disallow deductions for providing transportation (or any payment or reimbursement for related expense) for commuting between an employee’s residence and the place of employment, except as necessary to ensure the employee’s safety. This deduction disallowance would appear to apply even to commuting benefits that are treated as taxable compensation to the employee. Although it is unclear how the IRS would interpret the provision, the Senate Bill could be read to disallow a deduction for transportation between an employee’s home and a temporary place of employment, which are currently fully deductible and excludable by the employee. Ultimately, the effect of this change will depend upon how broadly the IRS interprets “place of employment,” which could be interpreted to include even temporary work locations away from an employee’s tax home.

Suspension of Exclusion for Qualified Bicycle Commuting Reimbursement. Unlike the House bill, section 11048 of the Senate Bill would repeal the exclusion under Code section 132(f) for bicycle commuting expenses, making such benefits taxable to employees from 2018 through 2025.

Suspension of Exclusion for Qualified Moving Expense Reimbursement. Similar to the House bill, section 11049 of the Senate Bill would partially suspend the exclusion from income and wages for a qualified moving expense reimbursement, which is an employer-provided benefit capped at the amount deductible by the individual if he or she directly paid or incurred the cost.  The Bill would retain a narrow exclusion for members of U.S. Armed Forces on active duty who move pursuant to military orders. These changes would be effective from 2018 through 2025.

Prohibition on Use of Cash or Gift Cards and Other Non-Tangible Personal Property as Employee Achievement Awards.  Whereas the House bill would eliminate the exclusion and deduction limitation for employee achievement awards, section 13311 of the Senate Bill would retain the exclusion and deduction limitation but codify proposed regulations defining “tangible personal property” for purposes of employee achievement awards.  Under Code sections 74(c)(1) and 274(j), employee achievement awards are excludable from income and deductible by the employer.  Section 274(j)(3)(A) defines an “employee achievement award” as an item of “tangible personal property” that meets certain other requirements without defining this term.  Under Treasury Regulation § 1.274-3(b), tangible personal property does not include cash or any gift certificate other than a nonnegotiable gift certificate conferring only the right to receive tangible personal property.  Under Proposed Regulation § 1.274-8(c)(2), the IRS provided a more comprehensive list of items that do not constitute tangible personal property, but these regulations were never issued in final form.

The Senate Bill would basically codify the list in the proposed regulations, to make clear that the following items do not constitute tangible personal property: (a) cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than certificates conferring only the right to select and receive tangible personal property from a limited array of pre-selected items); (b) vacations, meals, lodging, tickets to theater or sporting events; and (c) stocks, bonds, other securities, and other similar items.  The restriction on gift certificates is more restrictive than the current language of Treasury Regulation § 1.274-3(b) and the proposed regulations, which would permit employee achievement awards that are nonnegotiable gift certificates that provide only the right to receive tangible personal property.  The requirement that the employee be permitted to choose from a limited array of pre-selected items would appear to bless many common employee achievement programs, but is still more restrictive than existing law and the proposed regulations.

Private Employer Retirement Benefits

Extension of Time Period for Rollover of Certain Outstanding Plan Loans.  Under Code section 402(c)(3), a participant whose plan or employment terminates while he or she has an outstanding plan loan balance generally must contribute the loan balance to an individual retirement account (IRA) within 60 days of receiving an offset distribution.  Otherwise, the loan is treated as an impermissible early withdrawal and is subject to the 10‑percent early withdrawal penalty.  Like the House bill, section 13613 of the Senate Bill would relax these rules by adding a new section 402(c)(3)(B) to give these employees until the due date for their individual tax return to contribute the outstanding loan balance to an IRA.  The 10‑percent penalty would only apply after that date.

Qualified 2016 Disaster Distribution (for 2016 and 2017). Unlike the House bill, the Senate Bill would provide additional disaster relief.  Section 11029 of the Senate Bill, would waive the 10‑percent early withdrawal tax on distributions of up to $100,000 to an individual whose principal place of abode at any time during 2016 or 2017 was located in a “2016 disaster area” as declared by the President, and who suffered economic loss due to the storm, flooding, or other disaster that occurred in the area during 2016.  This relief is broader than that contained in the Senate Finance Committee language, which provided relief only to flooding and storm victims in the “Mississippi River Delta flood disaster area” during March 2016 (earlier coverage). The distribution must be made during 2016 or 2017 to be exempt from the early withdrawal tax.  Additionally, any distribution required to be included in income as a result of this special distribution rule is included in income ratably over a three-year period, beginning with the year of distribution.  During this three-year period, amounts received may be re‑contributed to the plan and treated as a rollover, thus allowing the individual to file an amended return.  (For more information regarding special tax relief for victims of natural disasters, see our discussions of: (1) leave-based donation programs, leave-sharing programs, and relaxed plan loans and hardship withdrawal rules for victims of Hurricane Harvey and Irma; and (2) qualified disaster relief payments under Code section 139.)

Employer Tax Credits

Employer Tax Credit for Paid FMLA Leave for 2018 and 2019.  Section 13403 of the Senate Bill would allow eligible employers to claim a general business credit equal to 12.5 percent of wages paid to a qualifying employee while on FMLA leave, plus 0.25 percent of wages (capped at 25 percent) for each percentage point by which the FMLA pay exceeds 50 percent of the employee’s normal pay.   An “eligible employer” is one that institutes a FMLA‑leave policy that: (a) allows all qualifying full-time employees not less than two weeks of annual paid family and medical leave (not counting leave paid by State or local government); (b) allows less-than-full-time employees a commensurate amount of leave on a pro rata basis; and (c) provide leave pay at a rate that is at least 50 percent of the employee’s normal pay. A “qualifying employee” is an employee under the Fair Labor Standards Act who has been employed by the employer for at least one year, and whose preceding‑year compensation did not exceed 60 percent of the compensation threshold for highly compensated employees ($120,000 for 2017).

The Senate Bill would also allow eligible employers to take this credit for paid family and medical leave provided to qualifying employees that are not covered by Title I of the FMLA, provided the employer will not interfere with rights provided under the policy and will not discharge or discriminate against any individual for opposing practices prohibited by the policy. This is a change from the credit as proposed in the Senate Finance Committee language (earlier coverage).

For each employee, the credit that the employer may claim is limited to 12 weeks of paid FMLA leave. Moreover, the employer may not deduct any portion of wages for which the employer claims the credit, but the employer can elect not to have the credit apply and deduct the paid leave instead. Finally, as the credit is part of a pilot program, the credit would only be available in 2018 and 2019.

Tax Reform Proposals Advance in the House and Senate

Yesterday, the full House passed its tax reform proposal, the Tax Cuts and Jobs Act (H.R. 1), on a party-line vote, 227-205.  In addition to the headline changes to the corporate and individual tax systems, the bill would make numerous changes to various fringe benefit exclusions, employer deductions for fringe benefits and executive compensation, cross-border withholding and sourcing, and employee retirement plans  (discussed here, here, here, herehere, here, and here).  Meanwhile, the Senate Finance Committee advanced its tax reform proposal, also on a party-line vote (14-12), with similar changes (discussed here and here).

Before advancing the proposal to the floor, the Senate Finance Committee adopted additional modifications to its existing proposal.  The new modifications included a change to the transition rule for the modified deduction limitation for executive compensation, a delay in the effective date of the new deduction disallowance for meals provided at the convenience of the employer and excluded from employee’s income under Code section 119 or 132(e)(6), and a definition of Mississippi River Delta flood disaster area and Mississippi River Delta flooding distribution for purposes of the retirement plan relief provided in the existing proposal:

  • The new transition relief for the deduction limitation under Code section 162(m) would apply the changes made in the proposal only to contracts entered into after November 2, 2017, and contracts materially modified after that date. The relief provided in the first modification to the chairman’s mark would have applied only if the compensation was no longer subject to a substantial risk of forfeiture before 2017.
  • The modification would delay the effective date for the deduction disallowance for meals provided for the employer’s convenience and meals provided at employer-operated eating facilities until 2026.
  • The modification defines “Mississippi River Delta flood disaster area” as an area subject to a Presidential major disaster declaration before March 31, 2016, by reason of severe storms and flooding occurring in Louisiana, Texas, and Mississippi during March 2016. A “Mississippi River Delta flooding distribution” is a distribution from an eligible retirement plan made on or after March 1, 2016, and before January 1, 2018, to an individual whose principal residence on March 1, 2016, was located in the Mississippi River Delta flood disaster area and who sustained an economic loss by reason of the severe storms and flooding that resulted in the Presidential disaster declarations.  (The modification also provides for an enhanced ability to claim a casualty loss deduction as a result of such storms and flooding.)