The 2017 Tax Cuts Jobs Act (TCJA) essentially eliminated the business deduction for expenses related to entertainment, amusement, or recreational activities. On September 30, 2020, the IRS released its final regulations on these provisions. The final regulations primarily adopt the proposed regulations issued in February 2020 (Notice 2018-76), with some clarifications.
The final regulations are effective upon their publication and may be relied upon by taxpayers for expenses paid or incurred after Dec. 31, 2017.
Internal Revenue Code Section 274(a) generally disallows a deduction for expenses with respect to entertainment, amusement, or recreation. Prior to the TCJA, Section 274(a)(1)(A) provided exceptions to that prohibition if the taxpayer established that: (1) the item was directly related to the active conduct of the taxpayer’s trade or business (the directly-related exception), or (2) in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that the item was associated with the active conduct of the taxpayer’s trade or business (the business-discussion exception). Section 274(e) enumerates specific exceptions to Section 274(a), although those expenses may be subject to a 50% limit on deductibility. IRC Section 274 also allows a 50% deduction for food and beverage expenses when 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.
In other words, prior to the TCJA, taxpayers could deduct 50% of meal expenses and 50% of entertainment expenses that met the directly-related or business-discussion exceptions. The TCJA repealed the directly-related and business-discussion exceptions to the general prohibition on deducting entertainment expenses, meaning that entertainment expenses are no longer deductible.
The final regulations basically keep the definition of entertainment the same and clarify the distinction between entertainment expenses and deductible food or beverage expenses in the context of business meals provided during an entertainment activity. Due to the new regulations, businesses must separate their deductible meal expenses from nondeductible entertainment expenses. The regulations address this issue under a variety of circumstances.
Food and Beverage
Food and beverage are defined broadly, including meals, snacks, or other types of food, and includes delivery fees, tips, and sales tax. The definition excludes indirect expenses such as the cost of transportation to or from a meal.
Under Section 274(d), for certain expenses, taxpayers are required to be able to provide specific detailed information to substantiate the expenses. The final regulations incorporate the substantiation requirements in Section 274(d) to travel meals and also confirm that most meals for traveling employees are 50% deductible. The regulations apply limitations on expenses for spouses and other traveling companions, meaning that the nonemployee expenses are most likely nondeductible.
The final regulations also explain how the exceptions in Section 274(e) apply to food and beverage expenses and provide several examples.
- Expenses treated a compensation—If a meal is included in the employee’s (or self-employed individual’s) taxable compensation, its cost is deductible. The final regulations note that the taxpayer must apply the dollar-for-dollar methodology (deductible to the extent that the expenses are treated as taxable compensation). The regulations provide examples of the treatment of meals provided in employer-run cafeterias, including where companies use the “direct cost” method of charging employees for the meals.
- Reimbursement—If an employer’s customer must reimburse the employer for meals (usually travel meals) provided to the employees working on a customer contract, the 50% deduction limitations generally apply. The regulations provide examples involving independent contractors under similar arrangements.
- Recreation—The “social or recreational event” exception in Section 274(e)(4) applies to company holiday parties, annual picnics, or summer outings that are primarily for employees other than owners and highly compensated employees, and therefore do not discriminate in favor of the highly compensated or owners of the company.
- Items available to the public—As a general rule, if more than 50% of the food or beverage is likely to be consumed by the general public, the expenses are likely to be 100% deductible. The final regulations provide examples of who is or is not a member of the general public (it excludes employees, owners, contractors, or an invited guest list).
- Goods or services sold to customers—A restaurant or catering business may continue to deduct 100% of its costs for food or beverage items, purchased in connection with preparing and providing meals to its paying customers, which are also consumed at the worksite by employees who work in the employer’s restaurant or catering business.
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