IRS Issues Proposed Regulations on Deductibility of Meals and Entertainment Expenses
March 02, 2020
By Richard Shapiro
On February 26, 2020, the IRS published in the Federal Register a notice of proposed rulemaking on the deductibility of meal and entertainment expenses, in keeping with provisions contained in the 2017 Tax Cuts and Jobs Act (TCJA) that limited such deductions. The notice requests comments and provides for a public hearing on April 7, 2020. The regulations are proposed to apply for taxable years beginning on or after the adoption of final regulations on this subject. However, pending the issuance of final regulations, taxpayers may rely on the proposed regulations for such expenses paid or incurred after December 31, 2017. In addition, taxpayers may rely on the guidance contained in Notice 2018-76, discussed below.
Background: State of the Law Post-TCJA
Business Meals and Entertainment. The Internal Revenue Code (IRC) post-TCJA disallows in full a deduction for any item with respect to entertainment, amusement, or recreation expenditures, subject to certain exceptions. These exceptions address, for example, (i) expenses directly related to business meetings of a taxpayer’s employees, stockholders, agents or directors and (ii) expenses directly related and necessary to attendance at a business meeting or convention of a business league, chamber of commerce, real estate board, board of trade or similar exempt organization.
Meanwhile, taxpayers may generally deduct 50% of the food and beverage expenses associated with operating their trade or business, including meals consumed by employees on work travel. This 50% deduction limitation is subject to a number of exceptions, including the following:
- Expenses treated as compensation
- Reimbursed expenses
- Recreational, social, or similar activity expenses for employees
- Expenses for goods, services and facilities made available by the taxpayer to the general public
- Entertainment sold by the taxpayer to customers in a bona fide transaction for an adequate consideration in money or money’s worth
- Expenses includible in income of persons who are not employees.
To summarize and clarify the tax treatment of business meal and entertainment expenses, the IRS issued Notice 2018-76 on October 15, 2018 to the following effect: Taxpayers may deduct 50% of an otherwise deductible business expense if: (i) the expense is an ordinary and necessary business expense paid or incurred during the taxable year in carrying on any trade or business; (ii) the expense is not lavish or extravagant under the circumstances; (iii) the taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages; (iv) the food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and (v) in the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts. Also, the entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
Travel Meals. Additional limitations apply in the case of travel meals. For example, no deduction is allowed for travel expenses paid or incurred with respect to a spouse, dependent, or other individual accompanying the taxpayer (or an officer or employee of the taxpayer) on business travel, unless (i) that other person is an employee of the taxpayer; (ii) the travel of the other person is for a bona fide business purpose; and (iii) such expenses would otherwise be deductible by such person.
Employer-Provided Meals. Under pre-TCJA law, employers were generally allowed to fully deduct an expense for food or beverages provided to their employees (and not be subject to the 50% deduction limitation) if the amount was excludible from the gross income of the employee as a de minimis fringe. The operation by an employer of any eating facility for employees is treated as a de minimis fringe if (i) the facility is located on or near the business premises of the employer and (ii) revenue derived from the facility normally equals or exceeds the direct operating costs of the facility. Since the TCJA repealed the special de minimis fringe rule just noted, food and beverages that are de minimis fringes, like other food or beverage expenses generally, are now subject to the 50% limitation unless one of the exceptions listed above applies.
The proposed regulations, together with their accompanying preamble, provide further detail to the tax treatment of meals and entertainment expenses post-TCJA. In particular, they provide guidance on a number of typical fact patterns. Highlights are provided below.
Entertainment Expenditures. Under the proposed regulations, “entertainment” is defined as any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at bars, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family, regardless of whether the expenditure for the activity is related to or associated with the active conduct of the taxpayer’s trade or business. Further, it may include an activity, the cost of which otherwise is a business expense of the taxpayer, which satisfies the personal, living, or family needs of any individual, such as a hotel suite or an automobile to a business customer or the customer’s family. However, a hotel room maintained by an employer for lodging of employees while in business travel status or an automobile used in the active conduct of a trade or business, even though used for routine personal purposes such as commuting to and from work, would not be considered entertainment. In contrast, the providing of a hotel room or an automobile by an employer to an employee who is on vacation would be considered entertainment of the employee and nondeductible.
The above notwithstanding, the taxpayer’s trade or business is to be taken into account. So, as described in the proposed regulations, although attending a theatrical performance generally would be considered entertainment, it would not be considered entertainment in the case of, say, a professional theater critic attending in a professional capacity. Similarly, for a manufacturer of dresses, conducting a fashion show for a group of store buyers would not be entertainment.
As provided in Notice 2018-76, food or beverages provided during or at an entertainment activity are not considered entertainment if the food or beverages are purchased separately from the entertainment or the cost of the food or beverages is stated separately from the cost of the entertainment. The amount so charged for the food or beverages must reflect the venue’s usual selling cost for those items if they were to be purchased separately from the entertainment, or must approximate the reasonable value of those items. Importantly, unless the food or beverages are purchased separately from the entertainment or their cost is stated separately, no allocation can be made and the entire amount is a nondeductible entertainment expenditure.
Food or Beverages Expense. Under the proposed regulations, food or beverages expense (i.e., meals, snacks and other types of food or beverages) is the full cost of the food or beverages, including any delivery fees, tips and sales tax. In the case of employer-provided meals at an eating facility, food or beverages do not include expenses for the operation of the eating facility, such as the salaries of employees who prepare and serve meals and other overhead costs.
The proposed regulations, consistent with applicable statutory provisions, provide that the deduction limitations are not applicable to expenditures for business meals, travel meals or other food or beverages that fall within one of the six specified exceptions noted above. The proposed regulations address a number of specific scenarios in applying these exceptions.
- Business lunch. Taxpayer takes a client out to lunch and discusses client’s business activities. The taxpayer may deduct 50% of the food or beverage expenses. Similarly, if a taxpayer takes an employee out to lunch and discusses the employee’s performance review, 50% of the food or beverage expense is deductible.
- Food or beverages provided at no charge to food service workers who consume the food or beverages while working in a restaurant or catering business. These expenses are not subject to the 50% deduction limitation and are 100% deductible because the restaurant/catering business sells food and beverages to customers in a bona fide transaction for an adequate and full consideration in money or money’s worth.
- Snacks available to employees in a pantry, break room, or copy room. The break room is not considered a recreational, social, or similar activity primarily for the benefit of the employees (even though employees may incidentally socialize while there) and therefore the food and beverages are only 50% deductible.
- Refreshments provided by a real estate agent at an open house. These expenditures are not subject to the deduction limitation if over 50% of the food and beverages are primarily consumed by potential buyers and other real agents. If the food and beverages are not primarily consumed by the general public, only the costs attributable to the food and beverages provided to the general public are 100% deductible. The “general public” is described as customers, clients and visitors, but not employees, partners or independent contractors of the taxpayer or an exclusive list of guests.
- Food or beverages provided by a seasonal camp to camp counselors. The camp is open to the general public. The same type of meal is available to each counselor and camp attendee. If camp attendees consume more than 50% of the food and beverages, the expenses associated with the food and beverages are not subject to the deduction limitations because over 50% of the food and beverages are primarily consumed by camp attendees. Accordingly, the camp operator may deduct 100% of the food and beverage expenses.
- Food or beverages provided to employees at a company cafeteria. Food is provided to employees at a company cafeteria on its premises without charge. Occasionally, customers or other visitors also eat without charge in the cafeteria. The occasional consumption of food and beverages by customers and visitors is less than 50% of the total amount of food and beverages consumed at the cafeteria, and, therefore, only the costs attributable to the food and beverages provided to the general public are excepted from the 50% deduction limitation.
- Food or beverages provided at a company holiday party at a hotel or picnic open to all employees. The cost of the party/picnic, including food and beverage expenses, is not subject to the deduction limitation because the function is a recreational, social, or similar activity primarily for the benefit of non-highly compensated employees. Accordingly, 100% of the cost of the party/picnic is deductible. As a variation on the facts, assume that the employer invites only highly compensated employees to a holiday party and the invoice provided by the hotel lists the costs for food and beverages separately from the cost of the rental of the ballroom (representing the venue’s usual selling price for food or beverages). The recreational exception from the deduction limitation does not apply because only highly compensated employees are invited. However, the food and beverage expenses are not treated as entertainment; the employer may deduct 50% of the food and beverage costs that are separately stated on the invoice.
As a further variation, assume that the employer invites an employee and a client to dinner at a restaurant. The employer orders a special dessert because it is the birthday of the employee. Since this is a business meal and therefore not primarily for the benefit of the employee, the exception for recreational expenses for employees does not apply, even though an employee social activity (in the form of a birthday celebration) takes place during the meal. Accordingly, the meal is only 50% deductible.
The proposed regulations – particularly through its examples – give a clearer picture of the intended treatment post-TCJA of meals and entertainment expenses. Further clarity is likely to be forthcoming in the final regulations that will be issued after the April public hearing.