The IRS has released proposed regulations addressing the deductibility of meal and entertainment expenses in tax years beginning after December 31, 2017. Among other things, the proposed regs clear up lingering confusion regarding whether meals are considered entertainment and, therefore, generally nondeductible.
TCJA Rule Changes
Prior to the Tax Cuts and Jobs Act (TCJA), Section 274 of the Internal Revenue Code generally prohibited deductions for expenses related to entertainment, amusement or recreation (commonly referred to as “entertainment” expenses). The tax code granted exceptions, however, for entertainment expenses “directly related to” or “associated with” actively conducting business. Businesses generally could deduct 50% of such expenses.
The TCJA amended Sec. 274 to generally prohibit deductions for any expenses related to entertainment, regardless of whether they’re directly related to or associated with conducting business.
The tax code also previously limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was permitted only if 1) the expense wasn’t lavish or extravagant under the circumstances, and 2) the taxpayer (or an employee of the taxpayer) was present when the food or beverages were furnished. The amount of the deduction was limited to 50% of such expenses.
Some taxpayers wondered whether the TCJA amendment also banned deductions for business meal expenses.
The IRS responded to this question in fall 2018 with Notice 2018-76. The notice listed several circumstances under which businesses could continue to treat business meal expenses, including meals consumed by employees on work travel, as 50% deductible expenses until the IRS published its proposed regs explaining when business meal expenses are nondeductible entertainment expenses.
Applicability of the Proposed Regs
The proposed regs provide that the 50% deduction limitation rules generally apply to all food and beverages, whether characterized as meals, snacks or other. The deduction limitations apply even to food and beverages treated as de minimis fringe benefits.
The proposed regs define food or beverage expenses as the cost of food or beverages, including any delivery fees, tips and sales tax. But the deductible expenses for employer-provided meals at an eating facility don’t include operating expenses for the facility (for example, the salaries of employees preparing and serving meals and other overhead costs).
Food and Beverages at Entertainment Activities
Food or beverages provided during or at an entertainment activity aren’t considered nondeductible entertainment expenses under the proposed regs as long as they’re purchased separately from the entertainment, or their cost is stated separately from the entertainment cost on a bill, invoice or receipt. For example, let’s say you take a client to a football game. You buy food at the game and pay for it separately from the game tickets. The amount paid for the food will qualify for a 50% deduction, subject to certain other requirements. The amount paid for the tickets would be nondeductible.
The 2018 notice provided that taxpayers couldn’t circumvent this entertainment disallowance rule by inflating the amount charged for food and beverages. The proposed regs tackle this issue by requiring that the amount charged for food or beverages reflect 1) the venue’s usual selling cost for those items if purchased separately from the entertainment, or 2) the reasonable value of the items.
Business Meal Expenses
The proposed regs generally follow the lead of the 2018 guidance on the deductibility of business meal expenses, but also incorporate other statutory requirements taxpayers must meet to deduct 50% of the expense. Thus, businesses may deduct 50% of business meal expenses if:
- The expense isn’t lavish or extravagant under the circumstances,
- The taxpayer (or an employee of the taxpayer) is present at the furnishing of the food or beverages and
- The food and beverages are provided to a business associate.
The proposed regs also clarify the requirement in Notice 2018-76 that the food and beverages be provided to a “business contact.” The notice described such an individual as a current or potential business customer, client, consultant or similar business contact.
The proposed regs use the term “business associate,” defined as a person the taxpayer could reasonably expect to engage with in business, including a current or prospective customer, client, supplier, employee, agent, partner or professional advisor. The inclusion of employees makes the standard applicable to employer-provided meals and situations where a business provides meals to both employees and nonemployee business associates at the same event.
Travel Meal Expenses
Although the TCJA didn’t explicitly change the rules for travel expenses, the proposed regs are intended to provide comprehensive rules for food and beverage expenses. As a result, they apply the general rules for meal expenses to travel meals, meaning travel meals are also 50% deductible.
The proposed regs also incorporate statutory substantiation requirements for travel meal expenses — evidence of the amount, time and place, and business purpose of the meal. In addition, meal expenses for spouses, dependents or other individuals accompanying the taxpayer (or an employee of the taxpayer) on business travel generally aren’t deductible unless the individual is an employee of the taxpayer and traveling for a bona fide business purpose.
Other Food and Beverage Expenses
In addition, the proposed regs provide that business meal expenses and 50% deduction limits don’t apply to expenses that fall within one of the following exceptions:
- Expenses treated as compensation,
- Reimbursed food and beverage expenses,
- Expenses related to recreational, social or similar activities for employees, such as holiday parties, annual picnics and summer outings that don’t favor highly compensated employees (but not free food and beverages in break rooms or provided for the convenience of the employer, such as that provided for employees who must stay on call for emergencies),
- Items available to the public (if more than 50% of the actual or reasonably estimated consumption is by the general public, including customers, clients and visitors) and
- Goods and services sold to customers (for example, food or beverage items that are purchased as part of preparing and providing meals to a restaurant’s paying customers, which are also consumed at the worksite by employees).
These expenses all are fully deductible.
Final Regs on the Way
Comments on the proposed regs must be submitted by April 13, 2020 (date subject to change), and a public hearing may be held. In the meantime, you can rely on the proposed regs as well as the guidance in Notice 2018-76 until the IRS issues final regs.
What This Means for Taxpayers
These regulations are important for taxpayers to understand. To fully maximize deductions, it is important for taxpayers to have separately stated accounts for these various expenses. As discussed, some of these expenses are nondeductible, others are 50% deductible and still others are fully deductible. Separate ledger accounts documenting the varying deductibility will help maximize the allowable amount, in turn, minimizing taxes paid. It is important to keep substantiation as to the nature of the expense to support the tax treatment.
If you have questions on business-related meal and beverage expenses, please don’t hesitate to contact us.