Current developments in employee benefits.

• Author: Walker, Deborah
• Position: Part 2

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I, published in the November issue, focused on current developments affecting qualified retirement plans (excluding changes made by the Small Business job Protection Act of 1996 (SBJPA)). Part II, below, focuses on recent changes related to welfare benefits and executive compensation (excluding changes enacted by the SBJPA).

Employer-Provided Meals

In Boyd Gaming Corp.,(22) the Tax Court ruled that a casino can deduct 100% of the cost of meals provided free to employees if such meals meet the de minimis fringe benefit exception of Sec. 274(n)(2)(B).

Boyd Gaming Corp. and three related casinos (collectively, "taxpayers") operated casinos in Las Vegas. Each maintained and operated a cafeteria that provided free meals to employees on a nondiscriminatory basis. The cafeterias were separate from the public restaurant facilities located on the properties. The taxpayers provided their employees with free meals to remain competitive in the market and to keep employees on the business premises during their shifts.

For 1987 and 1998, the IRS disallowed 20% of the taxpayers, claimed deduction for the meals under Sec. (which currently disallows 50%); in Tax Court, it moved for partial summary judgment on this issue. The taxpayers argued in response that 100% of the cost was deductible under the Sec. 274(n)(2)(B) de minimis fringe benefit exception and that the applicability of said exception was a factual determination. They also sought partial summary judgment, contending that 100% of the cost was deductible under the Sec. 274(e)(8) bona fide sale exception.

The Tax Court first addressed the Sec. 274(n)(2)(B) de minimis fringe benefit exception. Employee meals provided on a nondiscriminatory basis satisfy the exception if the following conditions under Regs. Sec. 1.132-7(a) are met:

1. The eating facility is owned or leased by the employer. 2. The facility is operated by the employer. The facility is located on or near the employer's business premises. 4. The meals furnished at the facility are provided during, or immediately before or after, the employee's workday. 5. The annual revenue derived from the facility normally equals or exceeds the facility's direct operating costs (the revenue/operating cost test).

The parties' only dispute was whether the revenue/operating cost test was met. Regs. Sec. 1.132-7(a)(2) provides that an employer may disregard the cost and revenue of any employee meal that the employer reasonably determines is excludible from gross income under Sec. 119. Sec. 119(a)(1) allows an employee to exclude from income the value of meals furnished by an employer for the employer's convenience and on the employer's premises. Regs. Sec. 1.119-1(a)(2)(i) states that meals provided to employees without charge on the employers, premises are within Sec. 119 if the employer furnished the meals for a "substantial noncompensatory business reason" (the presence of which is a factual determination).

The IRS argued that the revenue/operating cost test was not met, because the taxpayers did not earn revenue from the employee meals; Regs. Sec. 1.132-7(a)(2) applies only when employees pay for meals, some of which are excludible from gross income under Sec. 132(e) and the rest under Sec. 119. The IRS further asserted that Congress intended to allow a full deduction for employee meals only when they are provided in a facility that normally makes an overall profit, and did not intend for Sec. 274(n)(2)(B) to apply to meals covered by Sec. 119.

The IRS cited as support the legislative history to Sec. 274(n)(1), which provides that "20% of an otherwise allowable deduction for food and beverages...is disallowed. Similarly, the cost of a meal furnished by an employer to employees on the employer's premises is subject to the rule."(23) "The bill generally reduces to 80% the amount of any deduction otherwise allowable for meal expenses, including meals...furnished on an employer's premises to its employees (whether or not such meals are excludible from the employee's gross income under Sec. 119)."(24)

The Tax Court rejected the Service's argument that the taxpayers could not qualify for the Sec. 274(n)(2)(B) de minimis fringe benefit exception merely because they did not charge their employees for the meals; according to the court, the taxpayers could deduct the cost of the meals if it could reasonably determine that the meals were excludible from the employees, incomes under Sec. 119.

The court found that the provisions of the legislative history relied on by the IRS were only the general rules, not the exceptions, and were taken out of context. Under the legislative history, the cost of a meal...is fully deductible if the full value...is excludable under Section 132, pursuant to either the subsidized eating facility exclusion or the exclusion for de minimis fringe benefits."(25)

The court stated that, taken in its entirety, the legislative history does not foreclose the complete deduction of employee meals in 100% of the cases. For example, the taxpayers' deduction for employee meals would not be limited by Sec. 274(n)(1) if Sec. 119 allows their employees to exclude the value of the meals from gross income. In such a case, the Secs. 132(e) and 274(n)(2)(B) de minimis fringe benefit exceptions allow the taxpayers to claim a complete deduction for the meals because the cafeterias' revenues and expenses will both be zero for purposes of the revenue/operating cost test.

The court concluded that Sec. 274(n)(2) allows the taxpayers to deduct the entire cost of the meals if they are a Sec. 132(e) de minimis fringe benefit. Thus, it denied the IRS's motion for partial summary judgment and set the case for trial to determine if the taxpayers qualified for the Sec. 274(n)(2)(B) de minimis fringe benefit exception.

The Tax Court then addressed the taxpayers' motion for summary judgment, which asserted that Sec. 274(n)(1)(B) does not limit the deduction, because the meals fall within the Sec. 274(n)(2)(A) exception, which cross-references Sec. 274(e)(8). Sec. 274(e)(8) provides an exception for expenses for goods or services sold by the taxpayer in a bona fide transaction for adequate and full consideration in money or money,s worth. The taxpayers argued that they sell the meals to their employees in consideration for the employees, services and their promise not to leave the business premises during breaks. In rejecting this argument, the court concluded that the taxpayers merely presented the meals to their employees in connection with their employment.

Boyd could prove extremely favorable for employers providing eating facilities to their employees. With the effective elimination of the revenue/operating cost test, the possibility of amending prior years' tax returns exists if employers meet the Sec. 119 requirements; however, the primary hurdle is that the meals must be provided for the convenience of the employer.

Split-Dollar Life Insurance

In Letter Ruling (TAM) 9604001,(26) the IRS ruled that a corporate officer whose life was insured under policies purchased through a split-dollar arrangement (SDA), is taxable on any cash surrender buildup in the policies that exceeds the amount returnable to the employer on discontinuance of the arrangement. This ruling could have a significant effect on insurance and estate planning techniques using SDAs.

Under a typical SDA, an employer and an employee join in purchasing a whole life insurance policy (or a similar type of policy - e.g., variable life or universal life, containing an investment element) on the employees life. The employer agrees to pay a portion of the insurance premium (often equal to the annual increase in cash surrender value); the employee pays the balance. If the employee dies, the employer receives an amount equal to the cash surrender value from the policy proceeds.

Under an equity SDA, the employer's interest is limited to a return of cumulative contributions (i.e., premium payments). The employee thus owns any equity build-up in excess of cumulative contributions. Prior to TAM 9604001, it was unclear how the IRS would treat the employee as to the excess of the cash surrender value over the employers cumulative contributions.

In the TAM, the taxpayer was chairman and CEO of Holding, of which he owned 51% Holding owned 98% of Subsidiary. In 1991, Subsidiary, two insurance companies, and Trust entered into the following transaction: (1) Subsidiary paid a premium to each of the insurance companies for two paid-up $500,000 life insurance policies on the taxpayers life (2) the insurance companies issued the life insurance policies to Trust as owner of the policies; (3) Trust entered into SDAs with Subsidiary; and (4) Trust's assigned the policies to Subsidiary as collateral for Trust's obligation under the SDAs to repay the premiums Subsidiary had paid to each insurance company.

Under the SDAs, Trust was the owner of the policies and the beneficiary, and possessed all incidents of policy ownership. Subsidiary had an unqualified right to receive a portion of the death benefits equal to the total premiums paid; no amount could be paid from the death benefit proceeds to the beneficiary until the full amount due Subsidiary has been paid.

The SDAs may be terminated for various reasons, including (1) Subsidiary's bankruptcy or cessation of operations; (2) termination of the taxpayers employment; and (3) written notice by Trust or the taxpayer. If the SDAs are terminated before the taxpayer's death, Trust must reimburse Subsidiary before the collateral will be returned to Trust. If the policies are canceled or surrendered, Subsidiary is to be reimbursed from the cash surrender proceeds.

The insurance documents indicated that in the policies, fourth year, the cash...