The IRS has released proposed regulations addressing the deductibility of meal and entertainment expenses in tax years beginning after December 31, 2017.
Among other topics, the proposed regulations clear up lingering confusion regarding whether meals are considered entertainment, which would generally make them nondeductible.
Tax Reform Rule Changes
Prior to the tax reform reconciliation act of 2017, or the Tax Cuts and Jobs Act (TCJA), Section 274 of the Internal Revenue Code (IRC) 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 that were “directly related to” or “associated with” actively conducting business. Businesses generally could deduct 50% of these expenses.
The tax code also limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was generally permitted only if:
- The expense wasn’t lavish or extravagant under the circumstances
- The taxpayer—or an employee of the taxpayer—was present when the food or beverages were furnished.
The deduction was limited to 50% for expenses that met either of the above criteria.
Revisions Following the TCJA
The TCJA amended Section 274 to generally prohibit deductions for any expenses related to entertainment, regardless of whether they’re 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 fall 2018 with Notice 2018-76. The notice listed several circumstances under which businesses could continue to treat business meal expenses as 50% deductible expenses, including meals consumed by employees traveling for work.
This remained the generally accepted approach for calculating business meal expenses until the IRS published its proposed regulations explaining when business meal expenses are nondeductible entertainment expenses.
Applying 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 even apply 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 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 regulations, as long as one of the following occurs:
- They’re purchased separately from the entertainment
- 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 you pay for the food may qualify for a deduction, if you meet certain other requirements.
The 2018 notice provided that taxpayers couldn’t 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 reflects one of the following:
- The venue’s usual selling cost for those items if purchased separately from the entertainment
- The reasonable value of the items
Business Meal Expenses
The proposed regulations generally follow 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. According to the proposed regulations, 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
- The food and beverages are provided to a business associate
Business Contact Clarification
The proposed regulations also clarify the requirement in Notice 2018-76 that food and beverages be provided to a business contact. The notice described business contacts as current or potential business customers, clients, consultants, or similar business contacts.
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 in the definition makes the standard applicable to employer-provided meals and situations during which 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 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, which require evidence of the amount, time and place, and business purpose of the meal.
Additionally, 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.
Fully Deductible Expenses
The proposed regulations provide that business meal expenses and 50% deduction limits don’t apply to expenses that fall within the following exceptions. These expenses all are fully deductible.
- 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 provided in break rooms or for the convenience of the employer, such as those 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
- 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
Next Steps
Final regulations are on the way. Comments on proposed regulations must be submitted by April 13, 2020, and a public hearing may be held.
In the meantime, businesses can rely on the proposed regulations as well as guidance in Notice 2018-76 until the IRS issues final regulations.
We’re Here to Help
If you have questions on business-related meal and beverage expenses, contact your Moss Adam professional.