Prior to tax reform legislation in 2017, commonly referred to as the Tax Cuts and Jobs Act (TCJA), entertainment expenses were generally disallowed—unless the expense was related to the active conduct of a taxpayer’s trade or business. In those cases, the expense would generally be 50% deductible.
The TCJA typically disallows all entertainment expenses paid or incurred after 2017, even if they relate to an activity that’s directly related to the conduct of the taxpayer’s trade or business. However, the new law doesn’t contemplate certain circumstances in which food and beverages might be considered entertainment.
To help address this, the IRS recently issued Notice 2018-76, which concludes that business meal expenses remain deductible in some circumstances and clarifies when businesses can claim it. Proposed regulations that would align with the items discussed in the notice are expected in the future.
Background
The new tax law didn’t change the definition of entertainment. Current regulations define entertainment as any activity generally constituting entertainment, amusement, or recreation. This includes entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, as well as entertaining during hunting or fishing vacations or similar trips.
There are specific exceptions to the nondeductibility of entertainment expenses under Internal Revenue Code (IRC) Section 274(e). The following are the most common scenarios when entertainment is still partially or completely deductible:
- Food or beverages are provided on the business premises for employees
- Expenses are treated as compensation
- Social and recreational expenses for employees (holiday parties and company picnics, for example) as long as nondiscriminatory rules are satisfied
- Employee or stockholder business meetings
- Items available to the public
- Entertainment sold to customers
The Objective Test
The objective test in Treasury Regulation Section 1.274-2 states that if an activity is generally considered to be entertainment, it will be considered entertainment for purposes of IRC Section 274(a). This means a taxpayer can’t argue that an activity wasn’t entertaining to them, but was entertainment for others and therefore deductible.
When applying the objective test, the trade or business of the taxpayer should be considered. For example, if a professional theater critic attends a theatrical performance, the event wouldn’t be considered entertainment for the critic. Alternatively, if the CEO of a manufacturing company took customers to attend a theatrical performance, it would be considered entertainment because the business and event are unrelated to the taxpayer’s trade or business.
Business Meal Expenses
The IRS’s Notice 2018-76 provides some clarity on the deductibility of business meals. Taxpayers may rely on the guidance for the treatment of certain business meals under IRC Section 274.
However, the US Treasury Department and IRS intend to publish additional proposed regulations under IRC Section 274 to clarify the following:
- When business meals are considered nondeductible entertainment expenses
- When business meals are 50% deductible expenses
Deduction Requirements
Under the notice, taxpayers may deduct 50% of business meals otherwise allowable under the IRC, if the expense is ordinary and necessary under Section 162(a), it isn’t lavish or extravagant, and the following requirements are satisfied:
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages.
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact.
- Food and beverages, if provided during or at an entertainment activity, 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. The entertainment disallowance rule can’t be circumvented through inflating the amount charged for good and beverages.
Examples
The notice provides examples illustrating how the rules are applied to business meals in an entertainment setting.
Example One
The taxpayer, Joe, invites a business contact, Leslie, to a baseball game. Joe purchases tickets for himself and Leslie to attend the game.
While at the game, Joe buys hotdogs and drinks for the two of them. The baseball game is considered entertainment and the cost of the tickets are nondeductible. The cost of the hotdogs and drinks, which were purchased separately from the game tickets, isn’t considered an entertainment expense, so Joe can take a 50% deduction for the expenses associated with the hot dogs and drinks purchased at the game.
Example Two
A taxpayer, Samantha, invites a client to attend a basketball game. Samantha purchases tickets for herself and the client to attend the game in a suite, which gives them access to food and drinks.
The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages. Since the basketball game is considered entertainment and the cost of the food and beverages wasn’t purchased separately from the game tickets, the entire expense of the basketball game, including food and beverages, is nondeductible for Samantha.
However, if the food and beverages were separately stated on an invoice apart from the cost of the basketball tickets, the cost of the food and beverages wouldn’t be an entertainment expense, and Samantha could deduct 50% of the expenses associated with food and beverage.
We’re Here to Help
The Treasury Department and the IRS intend to issue separate guidance addressing the treatment of expenses for food and beverages furnished primarily to employees on the employer’s business premises.
To learn more about how the new guidance could affect you or your business, contact your Moss Adams professional.