IRS updates guidance on business expense deductions for meals and entertainment
The IRS has proposed reliance regs that provide rules for deducting certain meal and travel expenses, in light of the Tax Cuts and Jobs Act’s elimination the deduction for entertainment, amusement, or recreation expenses and new limitations on the deduction for food and beverage expenses.
Background. Generally the tax law allows a deduction for ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.
Before it was amended by the Tax Cuts and Jobs Act (TCJA), the tax law generally prohibited a deduction for expenses related to an activity of a type considered to constitute entertainment, amusement, or recreation (i.e., entertainment expenses). However, the tax law provided exceptions to that prohibition. The TCJA repealed those exceptions.
The tax law defines the term “entertainment.”
The tax law generally disallows a deduction for entertainment expenses (i.e., the entertainment expense disallowance rule).
The tax law generally provides that no deduction is allowed for any food or beverages expense unless
- Such expense is not lavish or extravagant under the circumstances, and
- The taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages.
The tax law provides, subject to exceptions, that the amount allowable as a deduction for any expense for food or beverages may not exceed 50% of the amount of the expense that otherwise would be allowable (i.e., the deduction limitation).
The tax law enumerates specific exceptions to the entertainment expense disallowance rule. Expenses that are within one of the exceptions, which may include certain meal expenses, are not disallowed expenses but may be subject to the 50% deduction limitation.
The tax law provides substantiation requirements for traveling expenses, including food and beverage expenses incurred while on business travel away from home. The tax law also provides additional limitations on deductions for travel expenses.
The TCJA repealed parts of the prior tax law regarding “de minimis fringe benefits”, meaning that expenses for food or beverages that were “de minimis fringe benefits” are no longer excepted from the deduction limitation. As a result, these expenses, like other food or beverage expenses generally are subject to the 50% deduction limitation unless certain exceptions apply.
In October 2018, the IRS issued transitional guidance on the deductibility of expenses for certain business meals purchased in an entertainment context. This guidance provides that the entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
Entertainment expenses. To implement the TCJA’s disallowance of entertainment expenditures the IRS has provided rules for entertainment expenditures paid or incurred after December 31, 2017.
Entertainment expenses—generally. The new rules substantially incorporate the existing definition of “entertainment” in the tax law, with minor modifications to remove outdated language.
For purposes of the new tax law the term “entertainment” does not include food or beverages unless the food or beverages are:
- Provided at or during an entertainment, and
- The costs of the food or beverages are not separately stated from the entertainment costs.
Entertainment expenses—separately stated food and beverages are not an “entertainment activity.” The proposed tax law clarifies the rules applicable to food or beverages provided at or during an entertainment.
To be deductible, amounts for food or beverages provided during an “entertainment” must be
- Purchased separately from the entertainment, or
- Be separately stated on a bill, invoice or receipt that reflects the venue’s usual selling cost for such items as if they were purchased separately from the entertainment or provides the approximate reasonable value of the food and beverages.
Further, the proposed rules provide that unless expenses for food or beverages provided at or during an entertainment comply with the rule in the paragraph above, the taxpayer may not allocate the expenses; the entire amount is a nondeductible entertainment expenditure.
The proposed rules provide an “objective test” to determine whether an activity is of a type generally considered to be entertainment. This objective test precludes arguments that entertainment means only entertainment of others or that an expenditure for entertainment should be characterized as an expenditure for advertising or public relations.
The proposed rules clarify that the entertainment expense disallowance rule applies regardless of whether the expenditure for the activity is related to, or associated with, the active conduct of the taxpayer’s trade or business.
Food and beverage expenses. The IRS has added new proposed rules to address food or beverage expenses paid or incurred after December 31, 2017. The proposed rules specifically address expenses for business meals, as well as expenses for other meals including travel meals and employer-provided meals.
Food or beverage expenses—business meals. The proposed rules substantially incorporate the guidance discussed above that addresses business meals provided during or at an entertainment.
The proposed rules provide the expense 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.
In addition, to be a deductible expense, the food or beverages must be provided to a “business associate.”
A “business associate” means 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.
The proposed rules include employees as a type of business associate, making the rule in the above paragraph applicable to employer-provided meals as well as to situations where a taxpayer provides meals to both employees and nonemployee business associates at the same event.
Food or beverage expenses—travel meals. In the proposed rules, the IRS applies the general rules for meal expenses to travel meals. In addition, the proposed rules apply a substantiation requirements to travel meals.
The proposed rules \ also provide that no deduction is allowed for food or beverage expenses paid or incurred while traveling by spouses, dependents, or other individuals accompanying the taxpayer (or an officer or employee of the taxpayer) on business travel, unless the expense would otherwise be deductible by the spouse, dependent or other individual.
Food or beverages—definitions. The proposed rules define food or beverage expenses as the cost of food or beverages, including any delivery fees, tips, and sales tax.
In the case of employer-provided meals at an eating facility, food or beverage expenses do not include expenses for the operation of the eating facility, such as salaries of employees preparing and serving meals, and other overhead costs.
Under the proposed ruels, the deduction limitations do not apply to expenditures for business meals, travel meals, or other food or beverages that fall within one of the exceptions below.
For example, the deduction limitations do not apply to food or beverage expense deductions if the taxpayer treats the expenses as employee compensation on the taxpayer’s income tax return and as wages to the employee.
- Reimbursed food or beverage expenses. The proposed rules apply the deduction limitations to independent contractors unless, under a reimbursement or other expense allowance arrangement, the contractor accounts to the client or customer with substantiation that satisfies the requirements.
- Recreational expenses for employees. The proposed rules confirm the deduction limitation exception applies to food or beverage expenses for company holiday parties, annual picnics, or summer outings that do not discriminate in favor of highly compensated employees. However, there is no exception for free food or beverages provided in a break room because the mere provision or availability of food or beverages is not a recreational, social, or similar activity, despite the fact that employees may incidentally socialize while they are in the break room.
- Items available to the public. The proposed rules provide that a taxpayer’s food or beverage expense is not subject to the deduction limitations to the extent the food or beverages are made available to the general public. This exception applies to the entire amount of the expense for food or beverages provided to employees if similar food or beverages are provided by the employer to, and are primarily consumed by, the general public.
Under the proposed rules the term “general public” includes, but is not limited to customers, clients, and visitors but does not include employees, partners, or independent contractors of the taxpayer. Further, an exclusive list of guests also is not considered the general public.
The term “customer” includes anyone who purchases food or beverages in a bona fide transaction for an adequate and full consideration in money or money’s worth. However, money or money’s worth does not include payment through services provided. For example, a taxpayer’s employees are customers when they purchase food or beverages from the taxpayer in a bona fide transaction for arm’s length, fair market value prices.
Source: Checkpoint Newsstand 2/25/20