Read § 119.
Commissioner v. Kowalski, 434 U.S. 77 (1977)
MR. JUSTICE BRENNAN delivered the opinion of the Court.
This case presents the question whether cash payments to state police troopers, designated as meal allowances, are included in gross income under § 61(a) of the Internal Revenue Code ..., 26 U.S.C. § 61(a), [footnote omitted] and, if so, are otherwise excludable under § 119 of the Code, 26 U.S.C. § 119. [footnote omitted]
... Respondent [footnote omitted] is a state police trooper employed by the Division of State Police of the Department of Law and Public Safety of the State of New Jersey. During 1970, the tax year in question, he received a base salary of $8,739.38, and an additional $1,697.54 [footnote omitted] designated as an allowance for meals.
... Under [the State’s cash allowance] system, troopers remain on call in their assigned patrol areas during their midshift break. Otherwise, troopers are not restricted in any way with respect to where they may eat in the patrol area and, indeed, may eat at home if it is located within that area. Troopers may also bring their midshift meal to the job and eat it in or near their patrol cars.
The meal allowance is paid biweekly in advance and is included, although separately stated, with the trooper’s salary. The meal allowance money is also separately accounted for in the State’s accounting system. Funds are never commingled between the salary and meal allowance accounts. Because of these characteristics of the meal allowance system, the Tax Court concluded that the “meal allowance was not intended to represent additional compensation.”
Notwithstanding this conclusion, it is not disputed that the meal allowance has many features inconsistent with its characterization as a simple reimbursement for meals that would otherwise have been taken at a meal station. For example, troopers are not required to spend their meal allowances on their midshift meals, nor are they required to account for the manner in which the money is spent. ... No reduction in the meal allowance is made for periods when a trooper is not on patrol because, for example, he is assigned to a headquarters building or is away from active duty on vacation, leave, or sick leave. In addition, the cash allowance for meals is described on a state police recruitment brochure as an item of salary to be received in addition to an officer’s base salary and the amount of the meal allowance is a subject of negotiations between the State and the police troopers’ union. Finally, the amount of an officer’s cash meal allowance varies with his rank, and is included in his gross pay for purposes of calculating pension benefits.
On his 1970 income tax return, respondent reported $9,066 in wages. That amount included his salary plus $326.45 which represented cash meal allowances reported by the State on respondent’s Wage and Tax Statement (Form W-2). [footnote omitted] The remaining amount of meal allowance, $1,371.09, was not reported. On audit, the Commissioner determined that this amount should have been included in respondent’s 1970 income, and assessed a deficiency.
Respondent sought review in the United States Tax Court, arguing that the cash meal allowance was not compensatory, but was furnished for the convenience of the employer, and hence was not “income” within the meaning of § 61(a), and that, in any case, the allowance could be excluded under § 119. ... [T]he Tax Court, with six dissents, [footnote omitted] held that the cash meal payments were income within the meaning of § 61 and, further, that such payments were not excludable under § 119. [footnote omitted]. The Court of Appeals for the Third Circuit, in a per curiam opinion, held that its earlier decision in Saunders v. Commissioner, 215 F.2d 768 (1954), which determined that cash payments under the New Jersey meal allowance program were not taxable, required reversal. We granted certiorari to resolve a conflict among the Courts of Appeals on the question. [footnote omitted. We reverse.
The starting point in the determination of the scope of “gross income” is the cardinal principle that Congress in creating the income tax intended “to use the full measure of its taxing power.” [citations omitted]. ... In the absence of a specific exemption, therefore, respondent’s meal allowance payments are income within the meaning of § 61 since, like the payments involved in Glenshaw Glass Co., the payments are “undeniabl[y] accessions to wealth, clearly realized, and over which the [respondent has] complete dominion.” Commissioner v. Glenshaw Glass Co., [348 U.S. 426, 431 (1955)]. [citations omitted].
Respondent contends, however, that § 119 can be construed to be a specific exemption covering the meal allowance payments to New Jersey troopers. Alternatively, respondent argues that notwithstanding § 119, a specific exemption may be found in a line of lower court cases and administrative rulings which recognize that benefits conferred by an employer on an employee “for the convenience of the employer” – at least when such benefits are not “compensatory” – are not income within the meaning of the Internal Revenue Code. In responding to these contentions, we turn first to § 119. Since we hold that § 119 does not cover cash payments of any kind, we then trace the development over several decades of the “convenience of the employer” doctrine as a determinant of the tax status of meals and lodging, turning finally to the question whether the doctrine as applied to meals and lodging survives the enactment of the Internal Revenue Code of 1954.
Section 119 provides that an employee may exclude from income “the value of any meals ... furnished to him by his employer for the convenience of the employer, but only if ... the meals are furnished on the business premises of the employer ...” By its terms, § 119 covers meals furnished by the employer, and not cash reimbursements for meals. This is not a mere oversight. As we shall explain at greater length below, the form of § 119 1 which Congress enacted originated in the Senate and the Report accompanying the Senate bill is very clear: “Section 119 applies only to meals or lodging furnished in kind.” S. Rep. No. 1622, 83d Cong., 2d Sess., 190 (1954). See also Treas. Reg. § 1.119-1(c)(2) ... Accordingly, respondent’s meal allowance payments are not subject to exclusion under § 119.
The “convenience of the employer” doctrine is not a tidy one. The phrase “convenience of the employer” first appeared in O.D. 265, 1 Cum. Bull. 71 (1919), in a ruling exempting from the income tax board and lodging furnished seamen aboard ship. The following year, T.D. 2992, 2 Cum. Bull. 76 (1920), was issued, and added a “convenience of the employer” section to Treas. Regs. 45, Art. 33 ... While T.D. 2992 extended the “convenience of the employer” test as a general rule solely to items received in kind, O.D. 514, 2 Cum. Bull. 90 (1920), extended the “convenience of the employer” doctrine to cash payments for “supper money.” [footnote omitted]
The rationale of both T.D. 2992 and O.D. 514 appears to have been that benefits conferred by an employer on an employee in the designated circumstances were not compensation for services, and hence not income. Subsequent rulings equivocate on whether the noncompensatory character of a benefit could be inferred merely from its characterization by the employer, or whether there must be additional evidence that employees are granted a benefit solely because the employer’s business could not function properly unless an employee was furnished that benefit on the employer’s premises. O.D. 514, for example, focuses only on the employer’s characterization. [footnote omitted] Two rulings issued in 1921, however, dealing respectively with cannery workers [footnote omitted] and hospital employees, [footnote omitted] emphasize the necessity of the benefits to the functioning of the employer’s business, and this emphasis was made the authoritative interpretation of the “convenience of the employer” provisions of the regulations in Mim. 5023, 1940-1 Cum. Bull. 14. 2
Adding complexity, however, is Mim. 6472, 1950-1 Cum. Bull. 15, issued in 1950. This mimeograph states in relevant part:
The ‘convenience of the employer’ rule is simply an administrative test to be applied only in cases in which the compensatory character of ... benefits is not otherwise determinable. It follows that the rule should not be applied in any case in which it is evident from the other circumstances involved that the receipt of quarters or meals by the employee represents compensation for services rendered.Ibid
Mimeograph 6472 expressly modified all previous rulings which had suggested that meals and lodging could be excluded from income upon a simple finding that the furnishing of such benefits was necessary to allow an employee to perform his duties properly. [footnote omitted] However, the ruling apparently did not affect O.D. 514, which, as noted above, creates an exclusion from income based solely on an employer’s characterization of a payment as noncompensatory.
Coexisting with the regulations and administrative determinations of the Treasury, but independent of them, is a body of case law also applying the “convenience of the employer” test to exclude from an employee’s statutory income benefits conferred by his employer.
An early case is Jones v. United States, 60 Ct. Cl. 552 (1925). There, the Court of Claims ruled that neither the value of quarters provided an Army officer for nine months of a tax year nor payments in commutation of quarters paid the officer for the remainder of the year were includable in income. The decision appears to rest both on a conclusion that public quarters, by tradition and law, were not “compensation received as such” within the meaning of § 213 of the Revenue Act of 1921, 42 Stat. 237, and also on the proposition that “public quarters for the housing of ... officers is as much a military necessity as the procurement of implements of warfare or the training of troops.” 60 Ct. Cl. at 569; 565-568. ...
Subsequent judicial development of the “convenience of the employer” doctrine centered primarily in the Tax Court. In two reviewed cases decided more than a decade apart, Benaglia v. Commissioner, 36 B.T.A. 838 (1937), and Van Rosen v. Commissioner, 17 T.C. 834 (1951), that court settled on the business necessity rationale for excluding food and lodging from an employee’s income. 3 Van Rosen’s unanimous decision is of particular interest in interpreting the legislative history of the 1954 recodification of the Internal Revenue Code, since it predates that recodification by only three years. There, the Tax Court expressly rejected any reading of Jones, supra, that would make tax consequences turn on the intent of the employer, even though the employer in Van Rosen, as in Jones, was the United States, and, also as in Jones, the subsistence payments involved in the litigation were provided by military regulation. [footnote omitted]. In addition, Van Rosen refused to follow the Jones holding with respect to cash allowances, apparently on the theory that a civilian who receives cash allowances for expenses otherwise nondeductible has funds he can “take, appropriate, use and expend,” 17 T.C. at 838, in substantially the same manner as “any other civilian employee whose employment is such as to permit him to live at home while performing the duties of his employment.” Id. at 836 , 839-840. It is not clear from the opinion whether the last conclusion is based on notions of equity among taxpayers or is simply an evidentiary conclusion that, since Van Rosen was allowed to live at home while performing his duties, there was no business purpose for the furnishing of food and lodging.
Two years later, the Tax Court, in an unreviewed decision in Doran v. Commissioner, 21 T.C. 374 (1953), returned in part to the “employer’s characterization” rationale rejected by Van Rosen. In Doran, the taxpayer was furnished lodging in kind by a state school. State law required the value of the lodging to be included in the employee’s compensation. Although the court concluded that the lodging was furnished to allow the taxpayer to be on 24-hour call, a reason normally sufficient to justify a “convenience of the employer” exclusion, [footnote omitted] it required the value of the lodging to be included in income on the basis of the characterization of the lodging as compensation under state law. The approach taken in Doran is the same as that in Mim. 6472, supra. [footnote omitted] However, the Court of Appeals for the Second Circuit, in Diamond v. Sturr, 221 F.2d 264 (1955), on facts indistinguishable from Doran, reviewed the law prior to 1954 and held that the business necessity view of the “convenience of the employer”’ test, “having persisted through the interpretations of the Treasury and the Tax Court throughout years of reenactment of the Internal Revenue Code,” was the sole test to be applied. 221 F.2d at 268.
Even if we assume that respondent’s meal allowance payments could have been excluded from income under the 1939 Code pursuant to the doctrine we have just sketched, we must nonetheless inquire whether such an implied exclusion survives the 1954 recodification of the Internal Revenue Code. [citation omitted]. Two provisions of the 1954 Code are relevant to this inquiry: § 119 and § 120 [footnote omitted], now repealed [footnote omitted], which allowed police officers to exclude from income subsistence allowances of up to $5 per day.
In enacting § 119, the Congress was determined to “end the confusion as to the tax status of meals and lodging furnished an employee by his employer.” H.R. Rep. No. 1337, 83d Cong., 2d Sess., 18 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess., 19 (1954). However, the House and Senate initially differed on the significance that should be given the “convenience of the employer” doctrine for the purposes of § 119. As explained in its Report, the House proposed to exclude meals from gross income “if they [were] furnished at the place of employment and the employee [was] required to accept them at the place of employment as a condition of his employment.” H.R. Rep. No. 1337, supra, at 18; see H.R. 8300, 83d Cong., 2d Sess., § 119 (1954). Since no reference whatsoever was made to the concept, the House view apparently was that a statute “designed to end the confusion as to the tax status of meals and lodging furnished an employee by his employer” required complete disregard of the “convenience of the employer” doctrine.
The Senate, however, was of the view that the doctrine had at least a limited role to play. After noting the existence of the doctrine and the Tax Court’s reliance on state law to refuse to apply it in Doran v. Commissioner, supra, the Senate Report states:
Your committee believes that the House provision is ambiguous in providing that meals or lodging furnished on the employer’s premises, which the employee is required to accept as a condition of his employment, are excludable from income whether or not furnished as compensation. Your committee has provided that the basic test of exclusion is to be whether the meals or lodging are furnished primarily for the convenience of the employer (and thus excludable), or whether they were primarily for the convenience of the employee (and therefore taxable). However, in deciding whether they were furnished for the convenience of the employer, the fact that a State statute or an employment contract fixing the terms of the employment indicate the meals or lodging are intended as compensation is not to be determinative. This means that employees of State institutions who are required to live and eat on the premises will not be taxed on the value of the meals and lodging even though the State statute indicates the meals and lodging are part of the employee’s compensation.S. Rep. No. 1622, supra, at 19.
In a technical appendix, the Senate Report further elaborated:
Section 119 applies only to meals or lodging furnished in kind. Therefore, any cash allowances for meals or lodging received by an employee will continue to be includible in gross income to the extent that such allowances constitute compensation.Id. at 190-91.
After conference, the House acquiesced in the Senate’s version of § 119. Because of this, respondent urges that § 119, as passed, did not discard the “convenience of the employer” doctrine, but indeed endorsed the doctrine shorn of the confusion created by Mim. 6472 and cases like Doran. Respondent further argues that, by negative implication, the technical appendix to the Senate Report creates a class of noncompensatory cash meal payments that are to be excluded from income. We disagree.
The Senate unquestionably intended to overrule Doran and rulings like Mim. 6472. Equally clearly, the Senate refused completely to abandon the “convenience of the employer” doctrine as the House wished to do. On the other hand, the Senate did not propose to leave undisturbed the convenience of the employer doctrine as it had evolved prior to the promulgation of Mim. 6472. The language of § 119 quite plainly rejects the reasoning behind rulings like O.D. 514, see n. 15, supra, which rest on the employer’s characterization of the nature of a payment. [footnote omitted]. This conclusion is buttressed by the Senate’s choice of a term of art, “convenience of the employer,” in describing one of the conditions for exclusion under § 119. In so choosing, the Senate obviously intended to adopt the meaning of that term as it had developed over time, except, of course, to the extent § 119 overrules decisions like Doran. As we have noted above, Van Rosen v. Commissioner, 17 T.C. 834 (1951), provided the controlling court definition at the time of the 1954 recodification, and it expressly rejected the Jones theory of “convenience of the employer” – and, by implication, the theory of O.D. 514 – and adopted as the exclusive rationale the business necessity theory. See 17 T.C. at 838-840. The business necessity theory was also the controlling administrative interpretation of “convenience of the employer” prior to Mim. 6472. Seesupra at 434 U.S. 85-86, and n 19. Finally, although the Senate Report did not expressly define “convenience of the employer,” it did describe those situations in which it wished to reverse the courts and create an exclusion as those where “an employee must accept ... meals or lodging in order properly to perform his duties.” S. Rep. No. 1622, supra, at 190.
As the last step in its restructuring of prior law, the Senate adopted an additional restriction, created by the House and not theretofore a part of the law, which required that meals subject to exclusion had to be taken on the business premises of the employer. Thus, § 119 comprehensively modified the prior law, both expanding and contracting the exclusion for meals and lodging previously provided, and it must therefore be construed as its draftsmen obviously intended it to be – as a replacement for the prior law, designed to “end [its] confusion.”
Because § 119 replaces prior law, respondent’s further argument – that the technical appendix in the Senate Report recognized the existence under § 61 of an exclusion for a class of noncompensatory cash payments – is without merit. If cash meal allowances could be excluded on the mere showing that such payments served the convenience of the employer, as respondent suggests, then cash would be more widely excluded from income than meals in kind, an extraordinary result given the presumptively compensatory nature of cash payments and the obvious intent of § 119 to narrow the circumstances in which meals could be excluded. Moreover, there is no reason to suppose that Congress would have wanted to recognize a class of excludable cash meal payments. The two precedents for the exclusion of cash – O.D. 514 and Jones v. United States – both rest on the proposition that the convenience of the employer can be inferred from the characterization given the cash payments by the employer, and the heart of this proposition is undercut by both the language of § 119 and the Senate Report. Finally, as petitioner suggests, it is much more reasonable to assume that the cryptic statement in the technical appendix – “cash allowances ... will continue to be includable in gross income to the extent that such allowances constitute compensation” – was meant to indicate only that meal payments otherwise deductible under § 162(a)(2) of the 1954 Code [footnote omitted] were not affected by § 119.
Moreover, even if we were to assume with respondent that cash meal payments made for the convenience of the employer could qualify for an exclusion notwithstanding the express limitations upon the doctrine embodied in § 119, there would still be no reason to allow the meal allowance here to be excluded. Under the pre-1954 “convenience of the employer” doctrine, respondent’s allowance is indistinguishable from that in Van Rosen v. Commissioner, supra, and hence it is income. ... In any case, to avoid the completely unwarranted result of creating a larger exclusion for cash than kind, the meal allowances here would have to be demonstrated to be necessary to allow respondent “properly to perform his duties.” There is not even a suggestion on this record of any such necessity.
Finally, respondent argues that it is unfair that members of the military may exclude their subsistence allowances from income, while respondent cannot. While this may be so, arguments of equity have little force in construing the boundaries of exclusions and deductions from income many of which, to be administrable, must be arbitrary. ...
MR. JUSTICE BLACKMUN, with whom THE CHIEF JUSTICE joins, dissenting.
I fear that state troopers the country over, not handsomely paid to begin with, will never understand today’s decision. And I doubt that their reading of the Court’s opinion – if, indeed, a layman can be expected to understand its technical wording – will convince them that the situation is as clear as the Court purports to find it.
Notes and Questions:
1. In the first sentence of its opinion, the Court set forth the issue it undertook resolve. How did it resolve that issue?
2. Whether meal money falls within an exclusion and whether it is gross income are separate questions. With regard to the second question, let’s review: What facts were particularly bad for Officer Kowalski and why? What strings were attached to the meal money that were different than the strings attached to any worker’s wages?
3. How important should the employer’s treatment of meal money – separate accounting, no commingling of funds – be in resolution of the question of whether cash-for-meals should be included in an employee’s gross income? Isn’t that a red herring in determining whether taxpayer Kowalski has enjoyed an accession to wealth? The Tax Court concluded that the meal money was not intended to be additional compensation, but was nevertheless includable in taxpayer’s gross income.
4. In the second footnote of the case, the Court quoted a case that quoted Benaglia. Taxpayer Benaglia was given accommodations at the Royal Hawaiian Hotel and ate his meals in the hotel dining room because otherwise he could not perform the services required of him as manager of that hotel and others. Moreover, Benaglia was denied the discretion to spend this accession to wealth in any manner that he saw fit.
- Have we seen the “deprivation of discretion” theme before?
- What conclusion did it suggest?
5. Surely even a taxpayer denied a choice in his/her purchase of meals or lodging and whose employment requires that any meal that s/he does eat be taken where and when the employer orders derives some consumption benefit that s/he would have paid something for if the employer had not provided it. Does it have to be all-or-nothing?
- Section 274(n)(1)(A) limits deductions for food or beverages to 50% of the amount spent. The other 50% in essence is treated as a personal expenditure and so is subject to federal income tax – but it is the one who pays for the meal who must pay the income tax, not the one who consumes it.
- However, § 274(n)(2)(B) excepts from the 50% limitation meals that § 132(e) excludes from an employee’s gross income. Section 132(e) treats employees as having paid the direct operating costs of their meal if it is excluded from their gross income under § 119.
- How important is administrative ease in this? How important is accuracy? If 50% isn’t the right figure (and neither is another figure), should we revert to all-or-nothing? Perhaps 50% is simply a “least-bad” figure.
6. Should “underpayment” of a class of workers provide any support whatsoever for a conclusion that § 119 encompasses the cash payments in this case – as Justice Blackmun suggests? How many people do not feel that they are “underpaid?”
- Were the view of Justice Blackmun to have prevailed, the consequences would have been highly unfortunate. How so and why? What economic distortions would have resulted?
7. What interest should the State of New Jersey, Officer Kowalski’s employer, have in the outcome of this case? If Officer Kowalski must pay income tax on his meal money, the State of New Jersey may find that it must increase the wages of its state troopers. It is entirely possible that the State of New Jersey captured all of the tax savings that Justice Blackmun feels all state troopers deserve.
8. Using the figures that the Court provided, Officer Kowalski received 13% ($1371 out of $10,437) tax-free. Naturally, this affects the amount of income tax that others must pay if the Government is to raise a certain amount of revenue. Moreover, other workers who might pay income tax on $9066 – the amount on which Officer Kowalski did pay income tax – who do not receive meal money that they may spend any way they wish probably would understand very well the system’s discriminatory treatment of two different taxpayers’ unequal accessions to wealth – contrary to Justice Blackmun’s inferential suggestion that this decision is difficult for lay people to understand.
9. In a sense, the Kowalski case presents the tip of an iceberg. Peruse the topics that §§ 105, 106, 107, 125, 127, 129, 132, 137 cover. All of these code provisions provide for some benefit that an employer can provide employees that are not subject to income tax to either the employer or the employee. These provisions assure that like taxpayers who work for different employers are not taxed alike.
Deadweight loss is someone’s loss and no one’s gain. The value of a good or service to a person is what the person is willing to pay for it. Everyone seeks to maximize value to himself/herself through purchasing choices within the limits of his/her after-tax income. Do exclusions from gross income cause deadweight loss? Yes.
Consider: Taxpayer pays income taxes at a marginal rate of 25%. Taxpayer is willing to pay $90 for a particular benefit and no more. Taxpayer would have to earn $120 in order to pay tax on the income necessary to purchase the benefit for $90. Naturally, taxpayer would be willing to pay less. The market price of the benefit is $100. Taxpayer is rational and makes no purchases for more money than the value s/he places on an item. Producers in turn strive to provide taxpayer goods and services at a cost to them that is less than the price taxpayer (and others) are willing to pay. All producers make a profit, so the markets are “sustainable.” Taxpayer does not purchase this benefit, but spends his/her after-tax income in ways that maximize his/her own consumer surplus. The economy works with allocative efficiency.
Now suppose that the Code excludes the benefit from taxpayer’s gross income if his/her employer provides it. Taxpayer’s employer offers to provide the benefit to taxpayer if taxpayer will accept a $100 reduction in pay. Should taxpayer accept the offer?
From taxpayer’s perspective, s/he can choose to keep the $100 in wages; this nets taxpayer $75 after taxes. Taxpayer can now rationally choose to accept the benefit because taxpayer essentially “pays” $75 for something s/he values at $90. That’s $15 of consumer surplus.
Unfortunately, the producers of the things taxpayer would have bought with his/her $75 of after-tax income lose the sales. The surplus value that they and taxpayer would have created by entering value-increasing bargains is lost – and replaced by a transaction that most assuredly does not increase after-tax value. No one captures the net loss in surplus value. It is deadweight loss.
All exclusions from gross income imply some deadweight loss. Assume that you had access to any information you wanted. How would you determine whether the nation should incur such deadweight losses?
10. Presumably, the accessions to wealth that employers offer employees that employees may in turn exclude from their gross income empower employers to customize the type of workforce they want. Maybe that is good. Airlines can pay less-than-market wages to persons who like to travel. Retailers can give employee discounts to persons who would (enthusiastically) shop at their establishments anyway. And so on.
- Consider this proposition: instead of aspiring to horizontal equality, aspire to horizontal equity by permitting a fixed ceiling on the value of excludable benefits that employers may provide employees. See William P. Kratzke, The (Im)Balance of Externalities in Employment-Based Exclusions from Gross Income, 60 Tax Law. 1, 3-8 (2006) (effective rate of federal income and employment taxes would be more progressive).
11. Read Reg. § 1.119-1(a)(2)(ii)(d).
- Do you think that someone lobbied to have this provision included in the regulations? Who?
12a. Fishing Expeditions, Inc. provides flight services, accommodations, and guides to remote places for fishing aficionados to fish in very remote places. Its employees are small airplane pilots, guides, and cooks. The company flies fishing parties to remote cabins that it owns in Alaska. Obviously while servicing a fishing party, the employees must reside at a remote cabin and take meals there also. The employees must pay Fishing Expeditions, Inc. $200 per week, which Fishing Expeditions deducts from their paychecks. The employees must include the $200 in their gross income.
- True or false.
12b. Cicely is an employee of the Hanford Nuclear Works. The HNR is located 60 miles from the nearest structure and 70 miles from the nearest town. HNR maintains some barracks-style housing for free onsite that it provides various workers, who are typically in their 20s and single. The value of this housing is $500 per month. To be fair to the other workers, HNR pays a housing stipend of $500 per month to employees who elect to live in the nearest town and commute to the jobsite.
- Tax consequences to the workers who live onsite?
- Tax consequences to the workers who live in town?