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Tax Rules for Providing Free Meals and/or Lodging to Employees

April 02, 20248 min read

“Tax-free” means no federal income tax for the employee and no federal payroll taxes withheld from the employee or owed by the employer (your business). Nice!

Your business can then deduct 50 percent of the cost of providing the free meals and the total cost of providing the free lodging.

Now for the bad news: the circumstances that allow tax-free treatment for free employer-provided meals and lodging are quite limited. But don’t give up hope.

Here are the basics you need to know in order to understand this issue.

 

Tax-Free Treatment Requires Passing Some Tests

For an employee of your business to be eligible for tax-free treatment for free meals and/or lodging, your business must pass the following tests.1

Business Premises Test 

Your business, as the employer, must provide the meals and/or lodging on the business premises.

For meals, the business premises would most likely be a break room in your company’s building or a company cafeteria.

But a business premises can also include a temporary jobsite where meals are furnished to employees. For instance, meals provided to cowhands while herding their employer’s cattle on leased land counted as meals provided on the employer’s business premises.2

Key point. To pass the business premises test, the employer’s business must own or lease the premises.3

 

Convenience of the Employer Test

Meals and/or lodging must be provided for the convenience of the employer.

Your business, as the employer, must have documentation to prove convenience. Specifically, you must prove to an IRS examiner that you provided the meals and/or lodging for a non-compensatory business reason.

In other words, you did not provide the goodies simply as a substitute for cash compensation or simply as additional compensation to lure or retain employees. You did it for a necessary reason related to your business operations.

More specifically, meals are considered provided for the convenience of the employer only if the meals are necessary for employees to properly perform their duties under the employer’s policies.4

Your business should be able to document its policy for providing meals and be able to show how the policy is related to its actual business practices and requirements. You should also be prepared to prove that the policy was communicated to employees and has been implemented and enforced.5

Finally, meals provided to all employees on the employer’s business premises are treated as provided for the convenience of the employer if meals are provided to more than half of the employees on the premises for the convenience of the employer. Under this favorable rule, tax-free meals can be provided to all employees, including those who just get them as an employer-provided goodie, as long as the more-than-half requirement is met.6

Key point. As the employer, your business can deduct only 50 percent of the cost of food and beverages (meals) that are provided for the convenience of your business and that are therefore treated as tax-free to recipient employees under Section 119 of the Internal Revenue Code.7

 

Tests for Lodging

For lodging to be tax-free to an employee, the lodging must be on your business premises, and the employee must be required to accept the lodging as a condition of employment. Also, the lodging arrangement must be for the convenience of your business.

Requiring the employee to accept the lodging as a condition of employment means that the lodging must be provided and accepted for the employee to properly perform his or her duties. Your business passes this test if8

  • the employee is required to be available for duty on the business premises at all times, or

  • the employee could not perform his or her required duties without the lodging.

Finally, the requirement that lodging must be furnished for the convenience of the employer (your business) is satisfied if the lodging is provided for a substantial non-compensatory business reason. For example, if the employee is required to be available for duty on the business premises at all times to deal with business emergencies that can be expected to occur more than rarely, that would constitute a substantial non-compensatory business reason.9

 

Applying the Lodging Tests

The condition of employment test requires the employer-provided lodging to be integrally related to the duties that the employee is required to perform and that require the employee to occupy the employer-provided lodging.

The convenience of the employer test requires the existence of a substantial non-compensatory business reason for the employer-provided lodging. 

Use the following two-question approach to apply both tests. 

Question 1. Must the employee be available for duty on the business premises at all times to properly fulfill the employee’s job duties? If yes, you pass both the condition and convenience tests.

Question 2. If the answer to Question 1 is no, is it necessary for the employee to occupy the employer-provided lodging in order to perform the employee’s required duties? If yes, the convenience of the employer test is passed. But answering this question may not be so easy. Facts and circumstances, baby! Be prepared to prove your case.

 

Provided-in-Kind Test

For the recipient employee, tax-free treatment is available only when the free meals and/or lodging are furnished in kind by your business as the employer—or in the case of meals, on behalf of your business. 

Cash reimbursements or allowances paid to an employee for meals or lodging do not qualify for tax-free treatment and count as taxable wages subject to Form W-2 reporting, federal payroll taxes, and federal income tax withholding. Similarly, if your business gives the employee the option to receive additional cash compensation in lieu of receiving free in-kind meals or lodging, the value of the meals and lodging counts as taxable wages.10

 

When Tax-Free Treatment Is Not Allowed

When your business does not pass the tests described above, the value of free employer-provided meals and lodging counts as additional taxable non-cash compensation given to the recipient employee. As such, the value must be reported on the employee’s Form W-2 and is subject to FICA tax, FUTA tax, and federal income tax withholding.11 

When the employee has the option to receive additional cash compensation instead of free meals or lodging, tax-free treatment is not available.12

Example. You give an employee the choice of being provided with free lodging on your business premises or receiving a cash allowance in addition to salary. 

Because the employee has this choice, the free lodging (if chosen) does not qualify for tax-free treatment. When tax-free treatment is not allowed, your business must count the value of the free lodging as taxable non-cash compensation. 

Thus, your business must treat that amount as taxable wages that are reported on the employee’s Form W-2 and subject to FICA tax, FUTA tax, and federal income tax withholding.13

 

Unfavorable Tax Treatment for Partners

For a partner, tax-free treatment is not allowed for free meals and lodging provided by the partnership. That’s because partners are not considered to be employees for purposes of how most fringe benefits are taxed.

The value of an affected fringe benefit provided to a partner is treated as a guaranteed payment to the partner. The guaranteed payment amount counts as taxable income for the partner and is income subject to self-employment tax. The only good news is that the partnership can deduct the guaranteed payment amount.

In the context of this analysis, unfavorable guaranteed payment treatment applies when free meals or lodging are provided to a partner without regard to partnership income and for services rendered to the partnership in the partner’s capacity as a partner.14

 

Unfavorable Tax Treatment for More Than 2 Percent S Corporation Shareholder-Employees

Weirdly enough, a more than 2 percent shareholder-employee of an S corporation is treated as a partner for purposes of how most fringe benefits are taxed.15 Therefore, if an S corporation provides free meals or lodging to a more than 2 percent shareholder-employee, the value is treated as additional taxable compensation that must be reported on the recipient’s Form W-2, and that value is subject to federal payroll taxes and federal income tax withholding.

The only good news is that the S corporation can deduct the amount treated as additional taxable compensation, assuming it constitutes reasonable compensation.

 

Takeaways

The federal tax treatment of free employer-provided meals and lodging is not a simple subject.

Applying the rules is more of an art than a science. If your business makes an honest attempt to apply the rules, you’ll probably avoid problems with the IRS if your business gets audited on the issue. (Most IRS auditors are probably no better at dealing with this art than you are.)

Be aware that after 2025, the 50 percent employer deduction for free employer-provided meals that is currently allowed under the Section 119 rules is scheduled to disappear unless Congress takes action.16 But free employer-provided meals that pass the tests explained in this analysis will still be tax-free for recipient employees.

This analysis does not address the federal tax issues when your business charges for meals or lodging provided to employees. That’s another subject, and it’s complicated.17

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Matt Bontrager

Matt Bontrager

Las Vegas CPABookkeeping Las VegasBookkeeping HendersonTax Services Las Vegas
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