The Tax Cuts and Jobs Act eliminated some of the deductions for business-related meal and entertainment expenses. New guidance from the IRS, in the form of proposed regulations, address meal and entertainment expenses.
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 regulations clear up lingering confusion regarding whether meals are considered entertainment and, therefore, generally nondeductible.
Tax Cuts and Jobs Act 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 tax code also limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was permitted only if 1) the expense was not 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.
The TCJA amended Sec. 274 to generally prohibit deductions for any expenses related to entertainment, regardless of whether they are directly related to or associated with conducting business. Some taxpayers wondered if the amendment also banned deductions for business meal expenses.
The IRS responded to this question in the fall of 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 regulations explaining when business meal expenses are nondeductible entertainment expenses.
Applicability of the Proposed Regulations
The proposed regulations provide that the deduction limitation rules generally apply to all food and beverages, whether characterized as meals, snacks or other types of food or beverage items. The deduction limitations apply even to food and beverages treated as de minimis fringe benefits.
The proposed regulations 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 do not 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 are not considered nondeductible entertainment expenses under the proposed regulations, as long as they are 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 baseball game to discuss a proposed business deal. You buy hot dogs and drinks at the game and pay for it separately from the game tickets. The cost of the hot dogs and drinks would qualify as a 50% deductible expense, but the cost of the ticket is nondeductible.
The 2018 notice provided that taxpayers could not circumvent this entertainment disallowance rule by inflating the amount charged for food and beverages. The proposed regulations 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 regulations 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 is not 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 regulations 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 regulations 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 did not explicitly change the rules for travel expenses, the proposed regulations 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.
The proposed regulations 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 are not 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 regulations provide that business meal expenses and 50% deduction limits do not apply to expenses that fall within one of the following exceptions:
- Expenses treated as compensation;
- Expenses related to recreational, social or similar activities for employees, such as holiday parties, annual picnics and summer outings that do not 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 (as long as 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 are fully deductible.
Final Regulations are on the Way
Comments on the proposed regulations must be submitted by April 13, 2020, and a public hearing may be held. In the meantime, you can rely on the proposed regulations, as well as the guidance in Notice 2018-76, until the IRS issues final regulations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.