January 23, 2020

IRS Issues Final Regulations Regarding Deductions of Meals and Entertainment Expenses

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Final regulations regarding the treatment of business meals and entertainment expenses were published in the Federal Register on October 9, 2020.¹ These regulations provide much-needed guidance on Internal Revenue Code (IRC) §274—the IRC section which was modified in 2017 such that the deductibility of both entertainment and meal costs was curbed by entirely disallowing deductions for business entertainment expenses.²

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Background

For many years, taxpayers have benefitted from being able to deduct 50% of the ordinary and necessary expenses incurred for meals associated with the pursuit of a trade or business. Moreover, taxpayers have been accustomed to taking 50% of entertainment expenses incurred during pursuit of business as a deductible expense.

However, in 2017, the Tax Cuts and Jobs Act (TCJA) amended IRC §274 so that for amounts paid or incurred after December 31, 2017, deductions are disallowed for entertainment, amusement, or recreation—and that’s even if the activity is directly associated with the active conduct of a trade or business.³ And although TCJA preserved the 50% deduction for qualifying business meal expenses, it simultaneously expanded the number of meals subject to the 50% limitation (for example, after December 31, 2017, even meals qualifying as de minimis fringe benefits are subject to the limitation). However, there remained considerable concern that meal expenses would be ultimately be classified as “entertainment expenses” and, thus, completed disallowed under the new rules.

On October 3, 2018, in Notice 2018-76, the IRS announced that it would publish proposed regulations clarifying when meal expenses are deductible.⁴ Subsequently, in February 2020, the IRS released proposed regulations clarifying when meal expenses are deductible, and when IRC §274 limitations are still applicable.⁵

Thereafter, on September 30, 2020, the IRS released final regulations on the matter, T.D. 9925, wherein the IRS states that it “adopts the proposed regulations with modifications in response to certain comments, as described in the Summary of Comments and Explanation of Revisions section.”⁶

The 50% Rule

In the final regulations, the IRS states that “prior to the TCJA, neither section 274 nor the regulations under section 274 attempted to define meal expenses or to distinguish meal expenses from entertainment expenses.”⁷ The IRS then explained that it believes that a plain reading of post-TCJA IRC §274 dictates different treatment for meal expenses and entertainment expenses.⁸ Thus, the IRS clarified that the final regulations maintain the proposed regulations’ position that business meals generally remain 50% deductible.

In other words, for food and beverage expenses–even those incurred at an entertainment activity—generally, taxpayers are still allowed a 50% deduction of the cost of a business meal if:

  • the expense is ordinary and necessary (per IRC §162(a)) and paid or incurred during the tax year in carrying on any trade or business,
  • the expense is neither lavish nor extravagant (consider the circumstances),
  • the taxpayer, or the taxpayer’s employee, is present when food or beverages are provided,
  • the food or beverages are provided to a business associate, and the cost of food or beverages is stated independently from entertainment costs on one or more bills or receipts.

Example: Taxpayer holds business meeting at a hotel and food and beverages are served to attendees. Taxpayer may deduct 50% of the food and beverages expenses. The other business meeting expenses are deductible under IRC §162, because they are not subject to the deduction limitations in IRC §274.

*Note: For purposes of defining “business associate,” the final regulations adopt the definition found in the current regulations, Regs. §1.274-12(b)(3). Thus, “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.’”⁹ Significantly, the final regulations clarify that this definition applies “to employer-provided food or beverage expenses by considering employees as a type of business associate as well as to the deduction for expenses for meals provided by a taxpayer to both employees and non-employee business associates at the same event.”¹

The “All or Nothing Rule”

Again, food and beverages are not deemed “entertainment expenses” unless the food or beverages are provided during an entertainment activity. However, in Notice 2018-76, the IRS clarified that taxpayers may continue to deduct 50% of an otherwise allowable business expense provided that the food and beverages are purchased separately from the entertainment activity. The final regulations further indicate that:

If the food or beverages are not purchased separately from the entertainment, or the cost of the food or beverages is not stated separately from the cost of the entertainment on one or more bills, invoices, or receipts, no allocation between entertainment and food or beverage expenses may be made and, except as further provided in this section and section 274(e), the entire amount is a nondeductible entertainment expenditure under this section and section 274(a).¹¹“

In other words, it’s “all or nothing” such that unless the costs of food or beverage are stated separately, the entire amount is considered a nondeductible entertainment expenditure.

Example: Taxpayer invites a business associate to a football game. Taxpayer buys the tickets for himself and the business associate. The tickets provide them with a suite where food and beverages are available. The invoice for the tickets separately states the cost of the food and beverages. Thus, Taxpayer is permitted to deduct 50% of the food and beverage expenses (assuming all other qualifications discussed above are met).

The Definition of “Entertainment”

The final regulations provide a definition for “entertainment.” According to the final regulations:

the term entertainment means any activity which is of a type generally considered to constitute 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 such activity relating solely to the taxpayer or the taxpayer’s family.  These activities are treated as entertainment under this section, subject to the objective test, regardless of whether the expenditure for the activity is related to or associated with the active conduct of the taxpayer’s trade or business.¹²“

In other words, subject to an “objective test,” entertainment is defined as any activity generally considered to constitute entertainment. This objective test is described in Reg. §1.274-11(b)(1)(iii), and consists of four parts:

  • An activity which is generally considered entertainment, will be treated as entertainment.
  • Such activity will be treated as entertainment regardless of whether the activity can also be described otherwise, and even though the activity relates to the taxpayer alone.
  • Entertainment does not only refer to the entertainment of others.
  • An entertainment expenditure should not be characterized as expenditure for advertising or public relations.

Conclusion

Businesses now have final regulations to help them determine the appropriate tax treatment of business meals and entertainment expenses. Most importantly, the final regulations clarify that: (1) 50% of food or beverage expenditures are still deductible, even during an entertainment activity; (2) food and beverages provided during an entertainment activity must appear separately from the entertainment on invoices—because it’s “all or nothing;” and (3) so long as an activity is generally considered entertainment, then it will be treated as entertainment.

If you have any tax questions, don’t hesitate to contact our tax team at 410-862-4220 or fill out our online form.

Footnotes

  1. T.D. 9925, 85 Fed. Reg. __ (Oct. 9, 2020).
  2. See §274(a), as amended by the TCJA, §13304.
  3. Id.
  4. 2018-42 I.R.B. 599.
  5. Prop. Reg. §1.274-11, Prop. Reg. §1.274-12, REG- 100814- 19, 85 Fed. Reg. 11,020 (Feb. 26, 2020).
  6. 85 Fed. Reg. __ (Oct. 9, 2020).
  7. Preamble to T.D. 9925 at 15.
  8. Id.
  9. Id. at 14, citing Regs. §1.274-12(b)(3).
  10. Id.
  11. Reg. §1.274-11(b)(1)(ii).
  12. Reg. §1.274-11(b)(1)(i).
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