Still confused about the business expense deduction for meals and entertainment under the Tax Cuts and Jobs Act (TCJA)? In the months following the new law, taxpayers and tax professionals alike weren’t sure what the new limits and restrictions would mean for businesses. In October of 2018, the Internal Revenue Service (IRS) offered transitional guidance on the rules. At the time, the IRS indicated that it would provide additional guidance, and now it has issued proposed regulations on the business expense deduction for meals and entertainment.
Under prior law, the rule was that you could deduct 50% of entertainment, amusement, or recreation expenses directly related to your trade or business. Under the TCJA, the meals deduction remained but there is no deduction for any item generally considered to constitute entertainment, amusement, or recreation.
The TCJA did not change the definition of entertainment. Where things get tricky, though, is whether providing food and beverages might constitute entertainment, especially if they were tied to an activity considered to be entertainment.
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Under the transitional guidance issued in Notice 2018-76 (downloads as a PDF), taxpayers may deduct 50% of meals so long as the expense is ordinary and necessary to carry on a trade or business. Just as before, the costs may not be lavish or extravagant under the circumstances (context matters). And, the taxpayer or an employee of the taxpayer must be present when the food or beverages are served (you can’t just offer up a smorgasbord and walk away).
The proposed regulations largely incorporate the guidance in Notice 2018-76 with a few additional clarifications.
For example, the proposed regulations make clear that the 50% deduction for food and beverages remains in place. They also make clear that entertainment expenses are not deductible, even if the two are mixed and even if the expense is related to or associated with the active conduct of a trade or business. To help you sort it out, the proposed regulations include the following examples:
- Taxpayer A invites B, a business associate, to a baseball game to discuss a proposed business deal. A purchases tickets for A and B to attend the game. The baseball game is entertainment, and thus, the cost of the tickets is an entertainment expenditure and is not deductible by A.
- Assume the same facts as above except that A also buys hot dogs and drinks for A and B. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expenditure. Therefore, A may deduct 50% of the expenses associated with the hot dogs and drinks purchased at the game if they otherwise meet the deductibility requirements.
The proposed regulations also provide that the amount charged for food or beverages on a bill, invoice, or receipt 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. And as before, unless food or beverages provided at or during an entertainment activity are purchased or stated separately, the entire amount is a nondeductible entertainment expenditure. Yep, that means that you may not, on your own, decide on an allocation.
Again, some examples:
- Taxpayer C invites D, a business associate, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food or drinks. The basketball game is entertainment, and the cost of the game tickets is a nondeductible entertainment expense. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the value of the food and drink is considered entertainment. C may not deduct the cost of the tickets or the food and drinks associated with the basketball game.
- Assume the same facts as above except that the invoice for the basketball game tickets separately states the cost of the food and beverages and reflects the venue’s usual selling price if purchased separately. The basketball game is still entertainment, and the value of the game tickets, other than the cost of the food and beverages, is a nondeductible entertainment expense. However, the cost of the food and beverages, stated separately on the invoice for the game tickets, is not an entertainment expenditure, and C may deduct 50% of the expenses associated with the food and beverages provided at the game if they meet the other deductibility requirements.
One change in the proposed regulations involves the requirement in Notice 2018-76 that the food and beverages be provided to a business contact, which was described in the notice as a “current or potential business customer, client, consultant, or similar business contact.” The proposed regulations make clear that the food or beverages must be provided to a “person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective.” Since employees are included in the list, that means the 50% deductibility rule applies to employer-provided meals as well as to situations in which a taxpayer provides meals to both employees and non-employee business associates at the same event.
That’s a big change. Under prior law, expenses for food or beverages that were excludable from employee income as de minimis fringe benefits were not subject to the 50% deduction limitation: they could be fully deducted. Following the TCJA, expenses for food or beverages excludable from employee income are also subject to the 50% deduction limitation unless another exception applies.
Some meals continue to be deductible in full as exceptions to the 50% rule. They include:
- Expenses for food and beverages if the costs are treated as compensation to the recipient;
- Expenses for food and drinks if the costs are treated as income to a person other than an employee as compensation for services;
- Expenses incurred by a taxpayer in connection with the performance of services for another person (whether or not the other person is an employer) under a reimbursement or other expense allowance arrangement;
- Expenses for food or beverage paid or incurred for recreational, social, or similar activities primarily for the benefit of employees like company parties or annual picnics (but events that discriminate in favor of highly compensated employees, officers, shareholders or others who own a 10% or greater interest in the business are not considered paid or incurred primarily for the benefit of employees).
- Expenses for food and beverages made available to the general public (general public includes customers, clients, and visitors, but does not include employees, partners, or independent contractors); and
- Expenses for food and beverages that are sold to customers in a bona fide transaction for adequate and full consideration in money or money’s worth (customer includes anyone who is sold food or beverages in a bona fide sale, including employees if they pay fair market value prices).
The proposed regulations apply to taxable years that begin on or after the date of publication of a Treasury decision adopting these rules as final regulations in the Federal Register. Until then, you can rely on the proposed regulations for entertainment expenditures and food or beverage expenses paid or incurred after December 31, 2017. In addition, you can rely on the guidance in Notice 2018-76 until these proposed regulations are finalized.
The IRS will hold a public hearing on the proposed regulations on April 7, 2020.