On February 26, 2020, the IRS issued proposed regulations relating to meals and entertainment expenses. On December 22, 2017, the President signed the Tax Cuts and Jobs Act (“TCJA”), which eliminated the deductibility of entertainment expenses and made adjustments to the deductibility of certain meal expenses. These proposed regulations provide further clarification after the publication of IRS Notice 2018-76 on October 3, 2018.
Under the TCJA, entertainment expenses paid or incurred after December 31, 2017, were no longer deductible. IRS regulations define entertainment expenses as:
Any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertainment at bars, theaters, country clubs, golf, and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips including such activities relating solely to the taxpayer or the taxpayer’s family.
Unlike previous guidance before TCJA, taxpayers may no longer consider whether the entertainment relates to the “active conduct of the taxpayer’s trade or business.” Instead, an objective test must be used to determine whether or not an activity is entertainment and therefore no longer deductible to the taxpayer.
However, it is important to note that the proposed regulations provide that if food and beverage costs associated with an entertainment expense are purchased separately or clearly stated separately from the entertainment expense then such expenses are still eligible for deductibility at 50%, unless another exception applies.
Food and Beverage Expenses
The proposed regulations confirm the guidance under IRS Notice 2018-76 that food and beverage expenses are still deductible. For these expenses to be deductible, they must satisfy the following conditions:
a) The expense is an ordinary and necessary expense under Section 162(a) or incurred in carrying on a trade or business;
b) The expense is not lavish or extravagant under the circumstances;
c) The taxpayer or employee is present at the providing of the food or beverage; and
d) The food or beverage is provided to an existing or prospective client, customer, supplier, employee, or professional advisor who the taxpayer has a reasonable expectation of engaging in the taxpayer’s trade or business.
Exceptions to the General Rule
The proposed regulations identify exceptions to the general rule of non-deductibility or 50% limitation of deductibility:
- Expenses Treated as Compensation
If a taxpayer includes an expense for food or beverage as compensation to the employee of the taxpayer or in gross income to a nonemployee for services rendered, then the taxpayer can receive 100% deductibility of that expense.
- Reimbursement for Food or Beverage Expenses
For food or beverage expenses incurred by one person in connection with the performance of services for another person, pursuant to a reimbursement or expense allowance plan, then either the person who incurs the expense or the person who actually bears the cost, but not both, may make use of the 50% deduction for meals.
- Food or Beverage Expense for Employer Social Activities
A taxpayer may receive a 100% deduction for food or beverage expenses paid or incurred by the taxpayer for recreational, social, or similar activities, primarily for the benefit of taxpayer’s employees. This exception is primarily associated with a company holiday party, picnic, or similar event. Just remember not to discriminate in favor of your highly compensated employees or the exception may not be applicable.
- Items available to the General Public
A taxpayer may be eligible for a 100% deduction for food or beverage expenses that are made available to the general public. This exception applies in situations where over 50% of the food or beverage is actually consumed or reasonably estimated to be consumed by the general public. If less than 50%, then only eligible for 100% deduction on the portion that was consumed by the general public. For example, a real estate agent provides refreshments at an open house to prospective buyers, and both the general public and employees of the real estate agent consumes the refreshments. As long as over 50% of the food or beverage is consumed by the general public, the full expense is deductible.
- Sale of Food or Beverage
Expenses for food or beverage that are sold to customers (including employees) in a bona fide transaction for adequate and full consideration in money are not subject to the deduction limitations. In addition, if an employer purchases food and prepares meals for its paying customers and such meals are also consumed by its employees, at the work location, such expense is still eligible for full deductibility.
These proposed regulations apply for taxable years after they become final. However, taxpayers may rely upon these proposed regulations and Notice 2018-76.
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