IRS Clarifies Deductibility of Business Meal Expenses in Light of TCJA Changes

(Parker Tax Publishing October 2018)

The IRS issued guidance addressing practitioner questions about the deductibility of business meal expenses in light of the elimination of entertainment expense deduction in the Tax Cuts and Jobs Act of 2017. The guidance, which may be relied on before the issuance of regulations, provides that taxpayers may deduct 50 percent of an otherwise allowable business meal expense if five conditions are met. Notice 2018-76.

Last week, the IRS issued some much needed guidance in the area of business meal deductions. After the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), the tax treatment of such deductions was in question because of TCJA's elimination of entertainment expense deductions. Prior to TCJA, taxpayers could deduct 50 percent of qualified business entertainment and meal expenses. As amended by TCJA, Code Sec. 274 generally disallows a deduction for expenses with respect to entertainment, amusement, or recreation, but does not specifically address the deductibility of business meal expenses.

In Notice 2018-76, the IRS provides transitional guidance for the deduction of business meal expenses under Code Sec. 274. The guidance confirms what many practitioners thought but what was not clearly stated: not all business meals are nondeductible entertainment. The IRS plans to issue proposed regulations that will include guidance on the deductibility of business meal expenses. However, until the proposed regulations are effective, taxpayers may rely on the guidance in Notice 2018-76 for the treatment under Code Sec. 274 of expenses for certain business meals.

Background

Code Sec. 162(a) allows a deduction for ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. However, Code Sec. 274(a)(1), as amended by TCJA, generally disallows a deduction for any item with respect to an activity that is of a type generally considered to be entertainment, amusement, or recreation.

Under Code Sec. 274(k), no deduction is allowed for any food or beverage expenses unless (1) such expense is not lavish or extravagant under the circumstances, and (2) the taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages. Code Sec. 274(n)(1) generally provides that the amount allowable as a deduction for any expense for food or beverages cannot exceed 50 percent of the amount of the expense that otherwise would be allowable.

Before TCJA, Code Sec. 274(a)(1)(A) generally prohibited a deduction with respect to an activity of a type considered to be entertainment, amusement, or recreation (i.e., entertainment expenses). However, pre-TCJA Code Sec. 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).

Pre-TCJA Code Sec. 274(n)(1) generally limited the deduction of food and beverage (i.e., meal) expenses and entertainment expenses to 50 percent of the amount that otherwise would have been allowable. Thus, under prior law, taxpayers could deduct 50 percent of meal expenses and could deduct 50 percent of entertainment expenses that met the directly-related or business-discussion exceptions.

TCJA repealed the directly-related and business-discussion exceptions to the general prohibition on deducting entertainment expenses in pre-TCJA 274(a)(1)(A). Thus, entertainment expenses are no longer deductible. TCJA also amended the 50 percent limitation in pre-TCJA 274(n)(1) to remove the reference to entertainment expenses. Otherwise allowable meal expenses remain deductible, subject to the 50 percent limitation in Code Sec. 274(n)(1).

Reg. Sec. 1.274-2(b)(1)(i) provides that the term "entertainment" means any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips, including such activity relating solely to the taxpayer or the taxpayer's family. The term "entertainment" may include an activity, the cost of which is claimed as a business expense by the taxpayer, which satisfies the personal, living, or family needs of any individual, such as providing food and beverages, a hotel suite, or an automobile to a business customer or the customer's family. The term "entertainment" does not include activities which, although satisfying personal, living, or family needs of an individual, are clearly not regarded as constituting entertainment, such as (i) supper money provided by an employer to an employee working overtime, (ii) a hotel room maintained by an employer for lodging of employees while in business travel status, or (iii) an automobile used in the active conduct of trade or business even though also used for routine personal purposes such as commuting to and from work. On the other hand, the providing of a hotel room or an automobile by an employer to an employee who is on vacation does constitute entertainment of the employee.

Reg. Sec. 1.274-2(b)(1)(ii) provides that an objective test must be used to determine whether an activity is of a type generally considered to constitute entertainment. Thus, if an activity is generally considered to be entertainment, it will constitute entertainment for purposes of Code Sec. 274(a) and Reg. Sec. 1.274-2 regardless of whether the expenditure for the activity can also be described otherwise, and even though the expenditure relates to the taxpayer alone. This objective test precludes arguments that "entertainment" means only entertainment of others or that an expenditure for entertainment should be characterized as an expenditure for advertising or public relations. However, in applying this test the taxpayer's trade or business is considered. Thus, although attending a theatrical performance would generally be considered entertainment, it is not considered entertainment for a professional theater critic attending in a professional capacity. Similarly, if a manufacturer of dresses conducts a fashion show to introduce its products to a group of store buyers, the show generally is not considered entertainment. In contrast, if an appliance distributor conducts a fashion show for its retailers, the fashion show generally would be considered entertainment.

Code Sec. 274(e) enumerates the following nine specific exceptions to Code Sec. 274(a):

(1) food and beverages for employees;

(2) expenses treated as compensation;

(3) reimbursed expenses;

(4) recreational, etc., expenses for employees;

(5) employees, stockholder, etc., business meetings;

(6) meetings of business leagues, etc.

(7) items available to public;

(8) entertainment sold to customers; and

(9) expenses includible in income of persons who are not employees.

Expenses that are within one of the exceptions in Code Sec. 274(e), which may include certain meal expenses, are not disallowed under Code Sec. 274(a). However, those expenses may be subject to the 50 percent limit on deductibility under Code Sec. 274(n).

Observation: The IRS said it intends to issue separate guidance addressing the treatment under Code Sec. 274(e)(1) and Code Sec. 274(n) of expenses for food and beverages furnished primarily to employees on the employer's business premises.

Interim Guidance

In Notice 2018-76, the IRS notes that TCJA did not change the definition of entertainment under Code Sec. 274(a)(1) and, therefore, the regulations under Code Sec. 274(a)(1) that define entertainment continue to apply. The IRS observed that, while TCJA did not address the circumstances in which the provision of food and beverages might constitute entertainment, the legislative history of TCJA clarifies that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business. According to the IRS, future proposed regulations under Code Sec. 274 will clarify when business meal expenses are nondeductible entertainment expenses and when they are 50 percent deductible expenses. The IRS said that, until the proposed regulations are effective, taxpayers may rely on the interim guidance in Notice 2018-76 for the treatment under Code Sec. 274 of expenses for certain business meals.

In Notice 2018-76, the IRS states that taxpayers may deduct 50 percent of an otherwise allowable business meal expense if the following conditions are met:

(1) the expense is an ordinary and necessary expense under Code Sec. 162(a) paid or incurred during the tax year in carrying on any trade or business;

(2) the expense is not lavish or extravagant under the circumstances;

(3) the taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;

(4) the food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and

(5) in the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, 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 and the entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.

The IRS also provides examples of what does and does not constitute deductible meal expenses. For each of the following examples, the food and beverage expenses are assumed to be ordinary and necessary expenses under Code Sec. 162(a) that are paid or incurred during the tax year in carrying on a trade or business and such expenses are not lavish or extravagant under the circumstances. Additionally, each example assumes that the taxpayer and the business contact are not engaged in a trade or business that has any relation to the entertainment activity.

Example: John invites Bob, a business contact, to a baseball game. John purchases tickets for himself and Bob to attend the game. While at the game, John buys hot dogs and drinks for himself and Bob. The baseball game is considered entertainment under Reg. Sec. 1.274-2(b)(1)(i) and, thus, the cost of the game tickets is an entertainment expense and is not deductible by John. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense and is not subject to the general disallowance rule. Therefore, John may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game.

Example: Carrie invites Doug, a business contact, to a basketball game. Carrie purchases tickets for herself and Doug to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages. The basketball game is considered entertainment and, thus, the cost of the game tickets is an entertainment expense and is not deductible by Carrie. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages is also an entertainment expense that is subject to the general disallowance rule. Therefore, Carrie may not deduct any of the expenses associated with the basketball game.

Example: Assume the same facts as the above example, except that the invoice for the basketball game tickets separately states the cost of the food and beverages. As in the above example, the basketball game is entertainment and, thus, the cost of the game tickets, other than the cost of the food and beverages, is an entertainment expense and is not deductible by Carrie. However, the cost of the food and beverages, which is stated separately on the invoice for the game tickets, is not an entertainment expense and is not subject to the general disallowance rule. Therefore, Carrie may deduct 50 percent of the expenses associated with the food and beverages provided at the game.

Observation: Neither the guidance in Notice 2018-76 nor the examples in the notice mention a requirement that there be a business discussion in order for the meal expense to be deductible.

IRS Requests Comments

The IRS is requesting comments for future guidance to further clarify the treatment of business meal expenses and entertainment expenses under Code Sec. 274. In particular, comments are requested concerning the following issues:

(1) whether and what further guidance is needed to clarify the treatment of (i) entertainment expenses under Code Sec. 274(a)(1)(A), and (ii) business meal expenses;

(2) whether the definition of entertainment in Reg. Sec. 1.274-2(b)(1)(i) should be retained and, if so, whether and how it should be revised;

(3) whether the objective test in Reg. Sec. 1.274-2(b)(1)(ii) should be retained and, if so, whether and how it should be revised; and

(4) whether and what additional examples should be addressed in guidance.

Comments must be submitted by December 2, 2018, and should be sent by one of the following methods to the applicable address: (1) by mail to: Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2018-76), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044; (2) by hand or courier delivery for delivery Monday through Friday between the hours of 8 a.m. and 4 p.m. to: Courier's Desk, Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2018-76), 1111 Constitution Avenue, NW, Washington, DC 20224; or (3) electronically to: Notice.Comments@irscounsel.treas.gov, with "Notice 2018-76" in the subject line.

All submissions will be available for public inspection and copying in Room 1621, 1111 Constitution Avenue, NW, Washington, DC, from 9 a.m. to 4 p.m.

For a discussion of the deductibility of business meal and entertainment expenses, see Parker Tax ¶91,115.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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