When the Tax Cuts and Jobs Act (TCJA) was released, the rules around the deductibility of meals and entertainment expenses were complicated and unclear. The IRS has now released proposed regulations that help better distinguish which meals and entertainment expenses are deductible for expenses incurred in tax years beginning after December 31, 2017. The proposed regs shed light on the types of meal-related expenses that are regarded as entertainment and are, thereby, ineligible for deduction.
How the TCJA Changed the Meals and Entertainment Expenses Rules
Before the Tax Cuts and Jobs Act changed the rules around meals and entertainment expenses, the IRS rules generally disallowed the deduction of expenses related to entertainment, recreation, or amusement unless those expenses could be shown to have been incurred while actively conducting business. In that case, businesses were mainly allowed to deduct 50% of the entertainment expenses.
Similarly, 50% of food and beverage expenses acquired in the course of doing business could be deducted only in the event that the expenses weren’t considered unduly extravagant and either the taxpayer or one or more of their employees was there at the time when the food or beverages were being provided.
The TCJA amended the prior rule by abolishing the ability for a taxpayer to deduct any entertainment expenses, regardless of whether they were directly related to conducting business. However, the TCJA did not clearly detail whether the amendment also pertained to deductions related to business meal expenses.
In an attempt to more clearly define the rules around the deductibility of business meal expenses, the IRS issued an explanatory notice in the fall of 2018 which detailed various situations under which business meal expenses would continue to be permitted to be deductible at the 50% rate. This included business meals for employees who were traveling for work.
How the Proposed Regs Further Change Meals and Entertainment Expense Deductions
Rules surrounding the treatment of meals and entertainment expense deductions were further addressed in the recently proposed IRS regs. In these proposed regs, an explanation was given as to when business meal expenses were to be treated as nondeductible entertainment expenses.
Mainly, deduction limitation rules pertain to all food and beverage items regardless of whether they are characterized as a meal, snack, or as a different type of food or beverage-related item. This includes those deemed as de minimis fringe benefits (or low-value perks offered to employees by an employer).
As per the proposed regs, food and beverage costs pertain to both the costs of the actual items (including sales tax) and any fees associated with their delivery (including tips). However, operating costs associated with meal expenses provided by an employer, such as salaries that go towards food preparers and servers or eating facility costs, are nondeductible.
Deductions for Food and Beverage Expenses During Entertainment Activities
Under the meals and entertainment expenses proposed regs, there is a fine line of distinction between what items qualify for a deduction when food or beverages are provided during an entertainment activity. Food and beverages are generally deductible provided they are purchased separately from the entertainment expense. It is important that the cost for a meal-related expense is listed separately from the cost of the entertainment activity on any bills or receipts a taxpayer receives.
For example, if a professional takes a client to a sporting event and that professional purchases food or beverages at the event, he or she must show documentation that the food and beverages were paid for separately from the payment for the sporting event tickets. In this instance, the food and beverage items purchased may qualify for a deduction if certain other requirements are met. All food and beverage charges must be in line with the entertainment venue’s normal selling costs for those items to prevent taxpayers from inflating the costs of these items.
Treatment of Business and Travel Meal Expenses
When it comes to business meals, the proposed regs generally remain unchanged, though they do incorporate a few other statutory requirements taxpayers must meet in order to deduct 50% of the expense. The 50% deduction is allowed if the expense isn’t deemed to be unnecessarily extravagant, either the employer or employee is present when the meal is provided, or the food or beverage is provided to a business associate.
The proposed regs take the language used in the earlier explanatory notice a step further, clearly defining a business associate as any individual with whom the taxpayer could reasonably expect to conduct business, including a current or prospective customer. A business associate could also mean an employee, client, vendor, agent, partner, or advisor. As employees are included in the definition, employer-provided meals and situations where an employer provides meals to both employees and nonemployee business associates at the same event are also eligible for the deduction.
Generally, the rules for meal expenses are also applicable to travel meal expenses. The proposed meals and entertainment expenses regs also incorporate a few additional substantiation requirements for expenses related to travel meals. The business traveler must provide details regarding the cost of the meal purchased, the time and location of the purchase, and the business purpose related to the travel meal. For the most part, however, travel meal expenses apply only to the taxpayer or an employee of that taxpayer and do not extend to a spouse, dependent, or any other individuals traveling with the employee. The exception is that travel meal expenses may be deductible if the accompanying individual is also an employee of the taxpayer and traveling for a legitimate business purpose.
Fully Deductible Food and Beverage Expenses
According to the proposed regs, there are a few business meal expenses that are fully deductible. These fall under one of the following exceptions:
- Expenses treated as compensation,
- Food and beverage expenses that are reimbursed,
- Expenses related to employee activities which are social or recreational (i.e. summer outings and corporate holiday parties open to all employees (note: this does not include free food and beverages in on-site kitchen areas or those an employer provides for their own convenience such as for employees who stay for emergencies),
- Items available to the public (if more than 50% of the actual or reasonably estimated consumption is by the general public, including clients, customers, and visitors), and
- Goods and services mainly meant to be sold to customers (such as food or beverage items purchased and prepared and provided as meals to a restaurant’s paying customers, which are also consumed employees at their workplace).
Final Regs Are Coming Soon
Though final comments on the proposed regs for meals and entertainment expense deductions are due by April 13, 2020, with final regs to follow, taxpayers can use the proposed regs until the final regs are released by the IRS. If you have questions on whether your meals and entertainment expenses qualify for a deduction, please contact your Untracht Early advisor.