The 2017 law repealed the deduction for business entertainment expenses but continued the deduction for business meals. Since that time, an IRS notice and proposed regulations clarified that, when food or beverages are provided during an entertainment activity, the food and beverage expenses are still deductible at 50% if they are purchased separately or stated separately from the cost of the entertainment on bills, invoices, or receipts.
The rules may not be circumvented through inflating the amount charged for food and beverages, and the final regulations require that the amount charged for food or beverages 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.”
Entertainment, Exceptions Defined
The final regulations define entertainment in the usual sense with minor modifications to remove outdated language. The term “entertainment” means any activity of a type that constitutes entertainment, amusement, or recreation, such as entertaining at bars, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips, including activities of the taxpayer or the taxpayer’s family.
This definition applies regardless of whether the activity is related to the active conduct of the taxpayer’s business. Providing a hotel room or an automobile to an employee who is on vacation also would constitute entertainment of the employee under the final rules.
Meal Still Deductible, Employees Count
The final regulations incorporate other statutory requirements taxpayers must meet to deduct 50% of meal expenses. The expenses must not be lavish or extravagant under the circumstances, and the taxpayer, or an employee of the taxpayer, must be present at the furnishing of the food or beverages. The final regulations confirm that snacks and beverages provided to employees in areas like the pantry, break room or copy room are 50% deductible as are refreshments at real estate open houses and food provided to food service workers.
Deductible “food or beverage expenses” include delivery fees, tips, and sales tax but do not include indirect expenses, such as the cost of transportation to a meal, the rules explain.
The final rules also expand the list of people who can be considered business contacts to include employees. The regulations state that business contact are “person[s] 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.” Thus, meals provided to both employees and non-employee business associates at the same event may qualify for the deduction.
The final rules also answer one commenter’s question by confirming that sole proprietors qualify for the meal deduction as long as all requirements are met.
Commenters on the proposed regulations requested examples addressing the treatment of meal expenses provided to attendees at a business meeting, such as a conference for clients or a training seminar for employees.
These examples assume the food or beverage expenses are ordinary and necessary expenses paid in carrying on a trade or business and are not lavish or extravagant under the circumstances.
Example 1. Taxpayer A takes client B out to lunch. A may deduct 50% of the food or beverage expenses.
Example 2. Taxpayer C takes employee D out to lunch. C may deduct 50% of the food or beverage expenses.
Example 3. Taxpayer E holds a business meeting at a hotel during which food and beverages are provided to attendees. Expenses for the business meeting, other than the cost of food and beverages, are deductible as business expenses. E may deduct 50% of the food and beverage expenses.
Example 4. The facts are the same as in Example 3 above, except that all the attendees of the meeting are employees of E. Expenses for the business meeting, other than the cost of food and beverages, are deductible. E may deduct 50% of the food and beverage expenses.
Deduction not Denied for Incorrect Income Amounts
The lavish or extravagant ban and the 50% limitation on deductions for food or beverages do not apply to the extent an employer treats the expenses as compensation to the employee. This exception also applies to meal expenses provided to a non-employee to the extent the expenses are includible in the gross income of the recipient as compensation or as a prize or award.
The final regulations make an important change in the application of these rules. The proposed regulations imposed an “all or nothing” rule to disallow deductions if less than the full value of food or beverages was included in gross income of an employee or non-employee. The IRS and commenters note that this rule may lead to harsh results if there are good faith errors in determining the value of food and beverages. As a result, the IRS revised the rules to still allow a partial deduction under a “dollar-for-dollar” method that only denies the part of the deduction attributable to expenses that exceed the amount of compensation.
Employer G provides food and beverages to its employees without charge at a company cafeteria on its premises. Each employee pays $8 per day for the food and beverages. The fair market value of the food and beverages is $10 per day, per employee. G incurs $9 per day, per employee for the food and beverages. G treats the food and beverage expenses as determines the amount of the inclusion to be $2 per day, per employee ($10 fair market value−$8 reimbursed by the employee G may deduct 100% of the food and beverage expenses, or $9 per day, per employee.
All in all, the final regulations make positive changes to the meal deduction rules. Entertainment deductions are gone for now, but the meal expense deduction stays intact with some new flexibility in application of the rules. If you have questions about how to apply the meal expense deduction rules, please reach out to your Frazier & Deeter tax advisor.