The Tax Cuts and Jobs Act (TCJA) was packed with goodies for businesses, but it also seemed to eliminate the popular meal expense deduction in some situations. While it works on proposed regulations in the interim, the IRS has issued transitional guidance that confirms the deduction remains allowable in certain circumstances and clarifies when businesses can claim it.
The need for guidance
Before the TCJA, Section 274 of the Internal Revenue Code generally prohibited deductions for expenses related to entertainment, amusement or recreation (commonly referred to as entertainment expenses). It provided exceptions for entertainment expenses “directly related” to or “associated” with conducting business.
Sec. 274(k) further limited deductions for food and beverage expenses that satisfied one of the exceptions. A deduction was allowed only if 1) the expense wasn’t lavish or extravagant under the circumstances, and 2) the taxpayer (or an employee of the taxpayer) was present when the food or beverages were furnished. Section 274(n)(1) limited the amount of the deduction to 50% of the expense.
The TCJA amends Sec. 274 to disallow a deduction for expenses related to entertainment expenses, regardless of whether they are directly related to or associated with conducting business. Some taxpayers interpreted the amendment to ban deductions for business meal expenses as though they were deemed to be entertainment expenses. According to the new guidance, the law does not specifically eliminate all of these expenses.
Rather, the law merely repeals the two exceptions and amends the 50% limitation to remove the reference to entertainment expenses. The TCJA doesn’t address the circumstances in which providing food and beverages might constitute nondeductible entertainment, the IRS says, but its legislative history “clarifies that taxpayers generally may continue to deduct 50% of the food and beverage expenses associated with operating their trade or business.”
Until the IRS publishes its proposed regulations explaining when business meal expenses are nondeductible entertainment expenses and when they’re 50% deductible expenses, businesses may deduct 50% of business meal amounts if:
- The expenses are ordinary and necessary expenditures paid or incurred to carry on business,
- The expenses aren’t lavish or extravagant under the circumstances,
- The taxpayer (or an employee of the taxpayer) is present at the furnishing of the food or beverages,
- The food and beverages are provided to current or potential customers, clients, consultants or similar business contacts, and
- For food and beverages provided during or at an entertainment activity, the entertainment is purchased separately from the food and beverages or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.
Recognizing that the fifth criterion above could create some confusion, the IRS guidance included the following illustrative examples:
A taxpayer invites a business contact to a baseball game, paying for both tickets. While at the game, the taxpayer also pays for hot dogs and drinks. The game is entertainment, so the cost of the tickets is a nondeductible entertainment expense. However, the cost of the hot dogs and drinks, purchased separately from the tickets, isn’t an entertainment expense. Therefore, the taxpayer can deduct 50% of the cost as a meal expense.
The second example employs a similar scenario, with the taxpayer inviting a contact to a basketball game. This time, the taxpayer buys tickets to watch the game from a suite with access to food and beverages included. The game again represents entertainment, and the cost of the tickets is nondeductible. The cost of the food and beverages isn’t stated separately on the invoice, rendering it a disallowed entertainment expense as well.
The final example uses the previous scenario, except that the cost of the food and beverages is stated separately on the invoice for the basketball game tickets. The cost of the tickets remains nondeductible, but the taxpayer can deduct 50% of the cost of the food and beverages.
The TCJA doesn’t change the definition of “entertainment.” Under the applicable regulations, the term continues to include, for example, entertaining at the following:
- Night clubs
- Cocktail lounges
- Country clubs
- Golf and athletic clubs
- Sporting events
Entertainment also includes hunting, fishing, vacation and similar trips. It may include providing food and beverages, a hotel suite or an automobile to a customer or the customer’s family.
Be aware that the determination of whether an activity is entertainment considers the taxpayer’s business. For example, a ticket to a theater performance normally would be deemed entertainment. If the taxpayer is a theater critic, it would not.