Dropping the Curtain on Entertainment Deductions
The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, significantly changed Sec. 274(a) by eliminating any deduction of expenses considered entertainment, amusement, or recreation. The TCJA also extended the 50% deduction limitation for expenses related to food and beverages to those provided by employers to employees in some instances.
Because the changes were unclear on whether food and beverage expenses could be deducted when combined with entertainment expenses, the IRS provided transition guidance through Notice 2018-76 and later through proposed regulations under Sec. 274 (REG-100814-19). In October 2020, the IRS issued final Regs. Secs. 1.274-11 and 1.274-12 (T.D. 9925). But then, at the end of 2020, Congress changed the rules yet again to temporarily allow a 100% deduction for certain business meals (see the sidebar, "On the Menu: A Temporary Full Deduction").
SEPARATING MEALS FROM ENTERTAINMENT
Regs. Sec. 1.274-11 disallows a deduction for entertainment, amusement, or recreation expenditures paid or incurred after Dec. 31, 2017. An objective test that considers the taxpayer's trade or business is used to determine whether an activity is entertainment. Any expenditure that is considered entertainment or in connection with an entertainment activity, including for a facility used in connection with an entertainment activity, is not deductible. Dues or fees to any social, athletic, or sporting club, or to any organization that has connections to such facilities, are nondeductible. In addition, no deductions are allowed for amounts paid for membership in any club organized for business, pleasure, recreation, or other social purpose.
However, under Regs. Sec. 1.274-11, entertainment does not include expenditures for food and beverages, as long as they are purchased separately from the entertainment or their cost is stated separately from that of the entertainment on bills, invoices, or receipts. If the food or beverages are not purchased separately from the entertainment, or their cost is not reasonably located on the invoice separately from the cost of entertainment, then the entire amount is nondeductible.
Example 1: Taxpayer X invites Y, a business associate, to a college basketball game to discuss business, and X purchases the tickets for them both. In addition, Taxpayer X buys Y dinner in the alumni tent before the game. The dinner is purchased separately from the cost of the tickets. The cost of the tickets is nondeductible entertainment. However, the cost of the dinner is not considered entertainment and is therefore deductible, but it is subject to the 50% limit under Sec. 162 and Regs. Sec. 1.274-12.
Example 2: Taxpayer X invites Y, a business associate, to a college basketball game and purchases two tickets for them to attend the game in a suite in the college's arena, which includes the cost of all food and beverages. The cost of the tickets is considered entertainment under Regs. Sec. 1.274-11(b)(1) and is not deductible. Likewise, since the food and beverages are not purchased separately from the tickets, their cost is also considered entertainment and nondeductible under Sec. 274(a)(1) and Regs. Sec. 1.274-11.
Example 3: Assume the same facts as in Example 2, except that the invoice X received separates the cost of the tickets from the cost of the food and beverages. Similarly to Example 2, the cost of the tickets is deemed to be nondeductible entertainment. However, the cost of the food and beverages, at the usual price charged by the college's concession stand if purchased separately, are not deemed to be entertainment expenditures disallowed under Regs. Sec. 1.274-11(b)(1); therefore, X may deduct 50% of the cost of the food and beverages if the expenses meet the Sec. 162 and Regs. Sec. 1.274-12 requirements.
Regs. Sec. 1.274-12 describes the limitation on deductions for certain food or beverage expenses paid or incurred after Dec. 31, 2017. The regulations do not change the provisions relating to the deductibility of business meals. Thus, taxpayers generally may continue to deduct 50% of the food and beverage expenses associated with operating their trade or business (again, apart from the new 100% deduction for food and beverages provided by a restaurant in 2021 and 2022), including meals consumed by employees on work travel (H.R. Rep't No. 115-466, at 407 (2017)). However, as before the TCJA, no deduction is allowed for the expense of any food or beverages unless (1) the expense is not lavish or extravagant under the circumstances, and (2) the taxpayer (or an employee of the taxpayer) is present when the food or beverages are furnished (Sec. 274(k)).
Regs. Sec. 1.274-12(a)(3) provides examples of deductible costs of meals provided to business clients and employees in restaurant lunches and during business meetings at a hotel.
Regs. Sec. 1.274-12 also incorporates the substantiation requirements in Sec. 274(d) for expenses of food or beverages paid or incurred while traveling away from home in pursuit of a trade or business and the limitations of Sec. 274(m)(3) for food and beverage expenses of spouses, dependents, or other individuals accompanying the taxpayer or officers or employees of the taxpayer on business travel.
MEALS AT SOCIAL AND RECREATIONAL ACTIVITIES
Food or beverage expenses paid or incurred by a taxpayer for a recreational, social, or similar activity primarily for the benefit of the taxpayer's employees are not subject to the 50% deduction limitation under Regs. Sec. 1.274-12(c)(2)(iii). This exception does not apply if the employee is highly compensated or if an employee (and/or a member of the employee's family) owns a 10% or greater interest in the taxpayer's trade or business. Any expense for food or beverages made under circumstances that discriminate in favor of highly compensated employees is not considered to be made primarily for the benefit of employees.
Example 4: Employer R holds a holiday party with a buffet dinner and open bar for all R's employees at a hotel ballroom. R may deduct 100% of the cost of the party.
However, snacks available to employees in a break room are subject to the 50% deduction limitation because this is not a recreational, social, or similar activity, "even if some socializing related to the food and beverages provided occurs" (Regs. Sec. 1.274-12(c)(2)(iii), Example (3)).
MEALS AS DE MINIMIS FRINGE BENEFITS
Before the TCJA, expenses for food or beverages that were excludable from employee income under Sec. 274(n)(2)(B) as Sec. 132(e) de minimis fringe benefits were not subject to the 50% deduction limitation and could be fully deducted. The TCJA repealed Sec. 274(n)(2)(B), so these food and beverage expenses are now subject to the 50% deduction limitation.
REGULATIONS BRING CLARITY
The TCJA eliminated the Sec. 274(a) deduction for expenses related to business entertainment, amusement, or recreational activities. These final regulations bring clarity for the business community on what food and beverage expenses are deductible that can be separated from entertainment, amusement, or recreational activities.
On the menu: A temporary full deduction
The Consolidated Appropriations Act, 2021, P.L. 116-260, temporarily provided a 100% business expense deduction (rather than 50%) for the cost of food or beverages provided by a restaurant, for expenses paid or incurred after Dec. 31, 2020, and before Jan. 1, 2023 (Sec. 274(n)(2)(D), added by Division EE, Taxpayer Certainty and Disaster Tax Relief Act of 2020, §210).
(Source: AICPA – CPA Letter Daily – Journal of Accountancy – March 6, 2021)