Analysis of the Final 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

On December 15, the House-Senate Conference Committee released the joint explanatory statement and final legislative text (the “Final Bill”) resolving differences between the House- and Senate-passed versions of the Tax Cuts and Jobs Act (the “House Bill” and “Senate Bill,” respectively).  The provisions of the Final Bill related to health reform, equity and executive compensation, deductions and exclusions for employee meals and other fringe benefits, private retirement plan benefit, paid leave, and various reporting, withholding, and income sourcing rules, largely track the bill passed by the Senate.  Many of the changes included in the House Bill but not the Senate Bill were dropped from the Final Bill. (Our earlier coverage of the House and Senate bills can be seen in a series of posts here.)

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– The Final Bill will eliminate the deduction for entertainment expenses; 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; impose a 50-percent limitation on deductions for occasional overtime meals and other de minimis meals; eliminate the deduction for amounts excluded from an employee’s income as qualified transportation fringes; eliminate the deduction for commuting expenses (except for the employee’s safety); suspend the exclusion for qualified bicycle commuting reimbursement; suspend the exclusion for qualified moving expense reimbursement; and prohibit the use of cash or gift cards and other non-tangible personal property as employee achievement awards.  The Final Bill does not include the following provisions that were included in the House Bill: the disallowance of deductions for de minimis fringe benefits that are primarily personal in nature and not related to the employer’s trade or business; the disallowance of deductions for expenses related to on-site athletic facilities; the application to all employees of the deduction disallowance for specified individuals for the deduction of entertainment expenses treated as compensation in excess of the amount included in income; the elimination of the exclusion for employer-provided tuition assistance and qualified tuition reductions; the elimination of the exclusion for adoption assistance programs; the elimination of the exclusion for dependent care assistance; and the elimination of the exclusion for employee achievement awards.
  • Private Retirement Benefits– The Final Bill will extend the rollover time period of certain outstanding plan loan offsets treated as a distribution from a qualified retirement plan, a section 403(b) plan, or a section 457(b) plan solely on account of the termination of the plan or the failure to meet the repayment terms of the loan due to severance from employment.  The Final Bill will also 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 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; allows for the ratable inclusion in income of such distributions over a three-year period; and permits the repayment of such distributions into an eligible retirement plan during 2018.
  • Employer Tax Credits– The Final Bill includes the Senate Bill provision that would provide employer tax credits in 2018 and 2019 for paid family and medical leave.  The Final Bill does not adopt the changes included in the House Bill to the credits under Code section 42F for employer provided child care and Code section 45B for the employer share of Social Security taxes on certain employee tip income.  The Final Bill also does not change the Work Opportunity Tax Credit under Code section 51.

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

Fringe Benefits

Elimination of Deduction for Entertainment Expenses.  The Final Bill tracks the language of the Senate Bill and will 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.  The Final Bill does not include a provision from the House Bill that would have limited the exception for entertainment expenses treated as compensation to (or included in the gross income of) the recipient to the amount actually treated as compensation (or included in gross income of) the recipient as it is with employees that are “specified individuals” under current law.  (See earlier coverage.)

The Final Bill also does 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.)

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 Final Bill will generally impose a 50‑percent limitation on deductions for de minimis meals starting in 2018.  However, as described below, 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, other types of de minimis meals would continue to be deductible, subject to the 50‑percent limitation.

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).  The Final Bill repeals these deductions effective in 2026.  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).

Elimination of Deduction for Qualified Transportation Fringes Excluded From Income.   Section 13304(c) of the Final Bill would disallow the deduction for providing any qualified transportation fringe benefits.  Under Code section 132(f), qualified transportation 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.  The Final Bill also clarifies that the deduction for qualified bicycle commuting reimbursement would be preserved from 2018 through 2025 (since the corresponding exclusion would be suspended during this period, as discussed below).

Elimination of Deduction for other Commuting Expenses (Except for Employee’s Safety).  Section 13304(c) of the Final Bill includes the Senate proposal that will disallow deductions for providing transportation (or any payment or reimbursement for related expenses) for commuting between an employee’s residence and the place of employment, except as necessary to ensure the employee’s safety.  Although it is unclear how the IRS would interpret the provision, the Final 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.  As in the Senate Bill, section 11048 of the Final 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.  As expected, section 11048 of the Final Bill would largely suspend the exclusion from income and wages for a qualified moving expense reimbursement, which is employer-paid relocation assistance equal to the moving expenses that would have been deductible by the employee if he or she directly paid or incurred the cost.  As a result, employers who provide relocation assistance will either have to gross-up the amounts that would have been previously deductible or leave employees to pay more of the cost out-of-pocket.  The Final Bill would retain a narrow exclusion for members of U.S. Armed Forces on active duty who move pursuant to military orders.  In contrast to the permanent elimination in the House Bill, these changes would be effective from 2018 through 2025, as in the Senate Bill.

Prohibition on Use of Cash or Gift Cards and Other Non-Tangible Personal Property as Employee Achievement Awards.  The Final Bill retains the exclusion and deduction limitation for employee achievement awards but codifies 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.  The House Bill would have eliminated the exclusion for employee achievement awards.

An “employee achievement award” is as an item of “tangible personal property” that meets certain other requirements without defining this term.  Treasury Regulations specify that 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.  In proposed regulations, 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.  Section 13310 of the Final Bill would generally 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 appears 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.  The Conference Summary stated, however, that “[n]o inference is intended that this is a change from present law and guidance.”

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 Senate Bill and similar to the House Bill, section 13613 of the Final Bill would relax these rules by adding a new section 402(c)(3)(C) to give these employees until the due date for their individual tax return to contribute the outstanding loan balance to an IRA.  This new rule would only apply to loan offset amounts treated as distributed solely by reason of the termination of the plan or the failure to repay the loan because of the employee’s severance from employment.  The 10‑percent penalty would only apply after that date.

Qualified 2016 Disaster Distribution (for 2016 and 2017).  Like the Senate Bill, the Final Bill would provide disaster relief.  Section 11028 of the Final 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 Final Bill includes a new section of the Code that will 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 Final Bill specified that the policy must be put in writing.

For each employee, the credit that the employer may claim is limited to 12 weeks of paid FMLA leave (including paid family and medical leave provided to qualifying employees that are not covered by Title I of the FMLA, provided the employer does not interfere with rights provided under the policy and does not discharge or discriminate against any individual for opposing practices prohibited by the policy).  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 Court Expands Section 119 Exclusion in Boston Bruins Decision

In a much anticipated decision, the U.S. Tax Court ruled yesterday that “the business premises of the employer” can include an off-premises facility leased by the employer when its employees are on the road.  The decision in Jacobs v. Commissioner addressed whether the employer (in this case, the professional hockey team, the Boston Bruins) was entitled to a full deduction for the meals provided to the team and staff while on the road for away games.  The debate arose after the IRS challenged the full deduction and asserted that the employer should have applied the 50% deduction disallowance applicable to meals by section 274(n) of the Code.

Under section 162 of the Code, an employer may deduct all ordinary and necessary business expenses.  However, in recognition that the cost of meals is inherently personal, the Code limits the deductions for most business meal expenses to 50% of the actual expense under section 274(n), subject to certain exceptions.  The exception at issue in Jacobs allows an employer to deduct the full cost of meals that qualify as de minimis fringe benefits under section 132(e) of the Code.  In general, this includes occasional group meals, but would not typically include frequently scheduled meals for employees travelling away from home.  (For this purpose, home is the employee’s tax home, which is typically the general area around the employee’s principal place of employment.)  However, under Treasury Regulation § 1.132-7, an employer-operated eating facility may qualify as a de minimis fringe benefit if, on an annual basis, the revenue from the facility is at least as much as the direct operating cost of the facility.  In other words, an employer may subsidize the cost of food provided in a company cafeteria, provided the cafeteria covers its own direct costs on an annual basis and meets other criteria (owned or leased by the employer, operated by the employer, located on or near the business premises of the employer, and provides meals immediately before, during, or immediately after an employee’s workday).

The Bruins’ owners argued that they were entitled to a full deduction because the banquet rooms in which employees were provided free meals qualified as an employer-operated eating facility.  That may leave some of our readers wondering, “How can a facility that is free have revenue that covers its direct operating cost?”  The key to answering that question lies in the magic found in the interface of sections 132(e)(2)(B) and section 119(b)(4) of the Code.  Under section 132(e)(2)(B), an employee is deemed to have paid an amount for the meal equal to the direct operating cost attributable to the meal if the value of the meal is excludable from the employee’s income under section 119 (meals furnished for the “convenience of the employer”) for purposes of determining whether an employer-operated eating facility covers its direct operating cost.  In turn, section 119(b)(4) provides that if more than half of the employees who are furnished meals for the convenience of the employer, all of the employees are treated as having been provided for the convenience of the employer.  Working together, if more than half the employees are provided meals for the convenience of the employer at an employer-operated eating facility, the employer may treat the eating facility as a de minimis fringe benefit, and deduct the full cost of such facility.

The IRS objected to the owners’ treatment of the banquet rooms as their employer-operated eating facilities and disallowed 50% of the meal costs.  The Tax Court succinctly explained that the Bruins’ banquet contracts constituted a lease of the rooms provided for meals and that the contracts also meant that the Bruins operated the facilities under Treasury Regulation § 1.132-7(a)(3).  In doing so, the Tax Court summarily dismissed the IRS’s argument that the payment of sales taxes meant that the contracts were not contracts for the operation of an eating facility but instead the purchase of meals served in a private setting.

Having determined that the first two criteria were satisfied, the Tax Court turned to the question of whether the hotel banquet rooms constituted the “business premises of the employer.”  The court looked to a series of cases indicating that the question was one of function rather than space.  Relying on those cases, the court determined that the hotels were the business premises of the employer because the team’s employees conducted substantial business activities there.   The court seemed to put significant weight on the fact that the team was required to participate in away games, necessitating it travel and operation of its business away from Boston.  The Tax Court was unpersuaded by the IRS’s quantitative argument that the team spent more time working at its facility in Boston than at any individual hotel and its qualitative argument that the playing of the away game was more important than the preparation for the game that took place at the hotel.

Having determined that the hotel banquet rooms were an employer-operated eating facility, the Tax Court next addressed whether it qualified as a de minimis fringe benefit because more than half of the employees who were furnished meals in the banquet rooms were able to exclude the value of such meals from income under section 119 of the Code.  The court determined that this requirement was satisfied because the meals were provided to the team and staff for substantial noncompensatory business reasons.  The business reasons included: ensuring the employees’ nutritional needs were met so that they could perform at peak levels; ensuring that consistent meals were provided to avoid gastric issues during the game; and the limited time to prepare for a game in each city given the “hectic” hockey season schedule.  Relying on the Ninth Circuit’s decision in Boyd Gaming v. Commissioner from the late 1990s, the court declined, once again, to second guess the team’s business judgment by substituting the government’s own determination.

Although the decision focuses on the specific facts and the exigencies of a traveling hockey team, the decision is of interest for other taxpayers as well.  This is especially true given the IRS’s recent increased interest in both meal deductions and the imposition of payroll tax liabilities with respect to free or discounted meals provided to employees, particularly in company cafeteria settings.  The decision expands the scope of the section 119 exclusion to meals further than the IRS’s current limited view that it applies only to remote work sites, such as oil rigs, schooners,  and camps in Alaska.   To date, the most expansive application of the exclusion in the company cafeteria setting occurred in Boyd Gaming, where a casino successfully established that its policy requiring employees to eat lunch on-site was based on security concerns and the attendant screening procedures made it necessary to provide employees with meals during their shifts.

Jacobs seems to take the analysis one step further, because many of the business reasons for providing meals to Bruins employees could be echoed by other taxpayers.  No doubt, all employers are concerned with the performance of their employees.  To that end, it could be argued that ensuring that they eat well-balanced nutritionally appropriate meals can increase performance even if the employer is more concerned with brains rather than brawn.  Indeed, given the large health insurance costs borne by many employers, employers have a legitimate interest in providing healthy meals that may reduce the incidence of obesity, diabetes, heart disease, and other chronic ailments that raise their costs.  Moreover, many employees have hectic schedules during the work day with frequent appointments, meetings, and other activities that make it necessary to maximize the time available for work during the day.   Given the Tax Court’s implicit admonition of the IRS’s attempt to substitute its own judgment regarding the employer’s business reasoning in Jacobs and the court’s refusal to substitutes its own judgment as well, the IRS likely has a more difficult road ahead if it attempts to challenge the purported business reasons that an employer provides for furnishing meals to its employees.  It remains to be seen how the IRS will react to the decision and whether it will appeal the case, which seems likely.  For now, however, the case is a positive development for employers who have made a business decision to provide meals on a free or discounted basis to their employees to increase productivity and improve their health.