The IRS and Treasury have finalized regulations implementing amendments made by the Tax Cuts and Jobs Act (TCJA) to business related meals and entertainment deductions. The TCJA largely eliminated the deduction for entertainment expenses paid or incurred after December 31, 2017, but left intact certain exceptions. Notable changes were made to food and beverage expenses as well; however, the final regulations confirm that in general 50 percent deductions for business meals remain.
The final regulations largely follow proposed regulations issued in February of 2020 and Notice 2018-76, with a few modifications in response to comments. Guidance provided distinguishes entertainment from meals, reinforces exceptions that continue to allow a full deduction, and clarifies business meal deductibility.
Entertainment, In General
Business related entertainment expenses were previously allowed a 50 percent deduction. However, the TCJA changed §274 to generally disallow deductions related to entertainment, amusement, or recreation – even when business related. The regulations, however, provide an important reminder that exceptions under §274(e) were not changed by the TCJA and remain available to allow deductions for certain business related entertainment expenses.
The nine exceptions to the entertainment disallowance include:
1) On site food and beverages for employees, including expenses for related facilities
2) Expenses treated as compensation
3) Reimbursed expenses under an accountable plan
4) Expenses for recreational, social, or similar activities primarily for the benefit of employees
5) Expenses directly related to business meetings of employees, stockholders, agents, or directors
6) Expenses related to attending business league or chamber meetings
7) Items made available to the general public
8) Entertainment sold to customers
9) Expenses includable into income of persons who are not employees of the taxpayer
If these items above are related to otherwise deductible business meals, they may be 100 percent deductible, depending upon whether they meet a further exception discussed below.
Meals, In General
Section 274(n)(1) generally limits a deduction for business related food and beverage expense to 50 percent of the expenditure. Taxpayers may deduct 50 percent of business food and beverages if:
- The expense is an ordinary and necessary expense under §162(a),
- The expense is not lavish or extravagant under the circumstances,
- The taxpayer, or their employee, is present,
- The meal is provided to the taxpayer or a business associate (includes clients and employees), and
- Food and beverages are purchased separately or separately stated on a receipt if provided during an entertainment activity.
However, six of the nine exceptions under §274(e) allow for a full deduction of business related food and beverages including:
1) Expenses treated as compensation
2) Reimbursed expenses under an accountable plan
3) Expenses for recreational, social, or similar activities primarily for the benefit of employees,
4) Items made available to the general public
5) Entertainment sold to customers
6) Expenses includable into income of persons who are not employees of the taxpayer
Recall that before the TCJA, onsite business meals provided to employees were 100 percent deductible, but are now 50 percent deductible.
What follows is a discussion of the final treatment of several types of commonly incurred meal costs:
Coffee, donuts, and various snacks provided in office breakrooms used to be 100 percent deductible as well, but they got trimmed down too and are now considered to be meals, regardless of their de minimis fringe benefits status, and are deductible at 50 percent of cost. The regulations also make clear that despite fun may be had in the breakroom, it “is not a recreational, social, or similar activity primarily for the benefit of the employees” and the §274(e)(4) exception for social gatherings won’t apply just because employees may incidentally socialize where free food and drinks are available.
Employer M provides free coffee, soda, bottled water, chips, donuts, and other snacks in a breakroom available to all employees. A breakroom is not a recreational, social, or similar activity primarily for the benefit of the employees, even if some socializing related to the food and beverages provided occurs. Thus, the exception in section 274(e)(4) does not apply and unless another exception in section 274(n)(2) applies, M may deduct only 50 percent of the expenses for food and beverages provided in the breakroom. In addition, the limitations in section 274(k)(1) (which require expenses to not be lavish or extravagant and that the taxpayer or employees be present) apply because none of the exceptions in section 274(k)(2).
Employee Social Gatherings
Occasional social gatherings such as holiday parties, annual picnics, or summer outings for the benefit of employees remain fully deductible under §274(e)(4); this includes costs associated with entertainment and meals. This exception will not apply if the event is in favor of only highly-compensated employees.
Employer L invites all employees to a holiday party in a hotel ballroom that includes a buffet dinner and open bar. The costs of the party, including food and beverage, is not subject to the deduction limitations and may be 100 percent deductible.
Otherwise deductible business meals remain 50 percent deductible. This includes taking a client or coworker to lunch if business is discussed, as well as meals when travelling for work. The regulations provide the following examples; assume that the food or beverage expenses are otherwise deductible (ordinary and necessary expenses under §162(a) and are not lavish or extravagant under the circumstances).
Ex. 1: Taxpayer A takes client B out to lunch. Under section 274(k) and (n), A may deduct 50 percent of the food or beverage expenses.
Ex. 2: Taxpayer C takes employee D out to lunch. Under section 274(k) and (n), C may deduct 50 percent of the food or beverage expenses.
It's important to note that meals determined to be inherently personal are nondeductible both before and after tax reform, as noted in several Tax Court cases where the taxpayer failed to prove daily meals were directly related to the conduct of a business. For example, a physician's regular lunches with coworkers were found to be nondeductible personal expenses. In its decision, the Tax Court noted that occasional lunch meetings with other physicians to discuss current treatment techniques may be deductible as a business expense, but expenses for meals eaten three or four times a week, year-round, are nondeductible personal expenses [Hankenson, TC Memo 1984-200].
Entertaining Clients & Customers
While taking a client or customer to a concert or ballgame may now be nondeductible, otherwise deductible business meals during an entertainment event are still 50 percent deductible so long as receipts separately itemize their costs. If the costs are not separately stated, no allocation can be made and the entire expense becomes nondeductible entertainment. The regulations also warn that inflating meals to deduct an entertainment component is not allowed. Amounts charged for food or beverages on a bill, invoice, or receipt must reflect the venue’s usual selling costs for those items as if they were purchased separately from the entertainment component.
Taxpayer A invites B, a business associate, to a basketball game to discuss a proposed business deal. A purchases tickets for A and B to attend the game. A also buys nachos and drinks at the concession stand, which are purchased separately from the tickets. The baseball game is entertainment as defined in §1.274-11(b)(1) and thus, the cost of the game tickets is an entertainment expense not deductible by A. However, the cost of the hot dog and drinks purchased separately from the tickets are not entertainment expenditures and not subject to disallowance. Therefore, A may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game if the expenses are otherwise deductible.
The cost of business meetings may have several different components to consider for tax deductibility. The regulations provide two examples, below.
Ex. 1: Taxpayer E holds a business meeting at a hotel during which food and beverages are provided to attendees. Expenses for the business meeting, other than the cost of food and beverages, are not subject to the deduction limitations in section 274 and are deductible if they meet the requirements for deduction under section 162. E may deduct 50 percent of the food and beverage expenses.
Ex. 2: The facts are the same as example 1, except that all the attendees of the meeting are employees of E. Expenses for the business meeting, other than the cost of food and beverages, are not subject to the deduction limitations in section 274 and are deductible if they meet the requirements for deduction under section 162. E may deduct 50 percent of the food and beverage expenses. The exception in section 274(e)(5) [for business meetings of employees, et al] does not apply to food and beverage expenses under section 274(k) and (n).
The exception under §274(e)(3) is a little different than its statutory companions and therefore can be somewhat confusing. While the other eight exceptions are ways out of the limitations under §274, the reimbursement exception is more of an explanation that two taxpayers will not be subject to potential limitations on the same expense.
Limitations on deductions of food or beverage expenses paid or incurred by one person and reimbursed by another under a reimbursement plan or other expense allowance arrangement apply either to the person making the expense (the person receiving reimbursement) or to the ultimate payer of the expense (the person making a reimbursement), but not to both.
If reimbursement is included into a person’s compensation, the person making a reimbursement would be entitled to a full deduction under §274(e)(3) and the reimbursed individual would then apply potential limitations. However, if the reimbursement is excludable from income, the potential §274 limitations apply to the person paying the reimbursement.
F is a professional services firm, employing Z. Z takes a client out for a business lunch and submits the expense to F for reimbursement under an accountable plan where the expense is not included into Z’s taxable income. F must apply the 50 percent limitation on business meals for the expense. If instead, the reimbursement were included in Z’s taxable income as compensation, F would be entitled to a 100 percent deduction, but if Z were to try and deduct the payment as an unreimbursed employee expense (note: these are not allowed until 2026), Z would be subject to a 50 percent limitation on the deduction.
Before the TCJA, distinguishing between meals and entertainment was generally unnecessary or limited to separating out fully deductible expenses, but it’s imperative now to take it a step further. A best practice to maximize tax deductions and minimize headaches is to revise the chart of accounts to capture each type of meal or entertainment expense that may have different tax treatments on the front end, rather than having to sift through combined costs and recall the events after the fact.
Please contact your RubinBrown team with questions on any of the items discussed above.
Readers should not act upon information presented without individual professional consultation.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
All Tax Consulting News Tax Consulting Services