IRS Updates Business Meals and Entertainment Guidance

On Feb. 21, the IRS released proposed regulations on the treatment of meals and entertainment expenses based on the modifications imposed when the Tax Cuts and Jobs Act (TCJA) was passed into law. The proposed regulations primarily serve to reinforce and clarify the rules previously established in the TCJA and IRS Notice 2018-76. This article addresses some of the key provisions and considers the impact on businesses.

Since implementation of the TCJA, taxpayers are no longer able to deduct any expense that is generally considered to be entertainment, or with respect to a facility used in connection with an entertainment activity. The proposed regulations provide additional clarification on food and beverages which are provided during or at an entertainment activity. As a general rule, food and beverages served during or at an entertainment activity will be considered an entertainment expense and will be nondeductible expenses to the taxpayer. However, food and beverages provided during or at an entertainment activity will not be considered an entertainment expense if:

• The food and beverage expenses are purchased separately from the entertainment, or are stated separately from the cost of the entertainment on the bill, invoice, or receipt; and
• The amount charged for the food and beverages reflect the venue’s usual selling cost for those items or must approximate the reasonable value of those items.

Any food and beverage expense which is not considered an entrainment expense may be deducted by the taxpayer up to 50% of the cost of such items, so long as:

• The expense is not lavish or extravagant under the circumstances;
• The taxpayer, or an employee of the taxpayer, is present when the food or beverages are furnished; and
• The food or beverages are provided to a business associate (i.e., a customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective).

In addition to the 50% deduction for food and beverages which aren’t considered entertainment expenses, Internal Revenue Code (IRC) § 274 provides nine specific exceptions to the general rule of disallowance:

1. Food and beverage for employees furnished on the business premises of the taxpayer primarily for employees.
2. With some exceptions, meals and entertainment expenses treated as compensation to an employee.
3. Employees and independent contractors are entitled to a full deduction for meals and entertainment expenses for which they were reimbursed by another person (whether or not such other person is the employer).
4. Expenses for recreational, social, or similar activities incurred primarily for the benefit of employees. This exception does not include expenses incurred for the benefit of highly compensated employees.
5. Expenses incurred by a taxpayer which are directly related to business meetings of employees, stockholders, agents, or directors.
6. Expenses which are directly related, and necessary, to attendance at a business meeting or convention of tax exempt business league or other organization described in IRC § 501(b)(6).
7. Expenses for goods, services, and facilities which the taxpayer makes available to the general public.
8. Expenses for goods and services which are sold by the taxpayer.
9. Expenses includible in the gross income of a recipient, who is not an employee of the taxpayer, as compensation for services rendered or as a prize or award.

Any expenses falling within the exceptions described in numbers 1, 5, or 6 will be deductible subject to the 50% limitation, and any expenses falling within the exceptions described in numbers 2, 3, 4, 7, 8, or 9 will be 100% deductible to the taxpayer.

The proposed regulations also provide explicit clarification regarding the treatment of some common expenses which had not been directly addressed previously.

The proposed regulations specifically address free food and drinks provided by an employer to their employees in a break room. These expenses  include such items as coffee, soda, bottled water, chips, donuts, and other snacks. Under the proposed regulations, the IRS clarifies that employers who provide these break room items to their employees will be subject to a 50% limitation for the cost of such items.

The proposed regulations also directly address shift meals. Shift meals are food and beverage items, purchased in connection with preparing and providing meals to paying customers, which are consumed at the worksite by employees who work in the employer’s restaurant or catering business. The IRS clarified that shift meals are considered goods or services which are sold by the taxpayer (exception #8 above), and are 100% deductible to the taxpayer.

It is important to note that proposed regulations are issued to provide the public access to the IRS’ position on the issues presented in the proposed regulations and provide feedback to the IRS on these positions. For this reason, taxpayers should continue to separate their entertainment expenses from food and beverage expenses on the general ledger to allow for greater ease in determining which expenses allow for a deduction going forward.

To assist in determining the deductibility of expenses related to entertainment and other food and beverages items, you can also consult KSM’s reference chart on the tax treatment of business meals and entertainment expenses.