Meals and Entertainment Expenses Under Section 274, 26 CFR Part 1, 85 Fed. Reg. 64026 (Oct. 9, 2020)
The IRS has issued final regulations under Code § 274 addressing the effects of the Tax Cuts and Jobs Act (TCJA) on business expense deductions for meals and entertainment. Effective after 2017, the TCJA eliminated deductions for entertainment expenses and reduced the deduction for certain food and beverage expenses to 50% (see our Checkpoint article). After providing interim guidance on those changes, the IRS proposed two regulations incorporating the interim guidance—one addressing the disallowance of deductions for entertainment expenses, and another addressing the limited deduction for food and beverage expenses (see our Checkpoint article).
The final regulation regarding disallowance of entertainment deductions makes few changes to the proposed version. Entertainment is still defined objectively, based on whether the activity is of a type “generally considered” to constitute entertainment, amusement, or recreation, whether or not related to or associated with the active conduct of the taxpayer’s business, but taking that business into account (e.g., a theatrical performance is not entertainment to a professional critic who must view the show to write a review). And food and beverages provided at an entertainment activity must be treated as part of the nondeductible entertainment expense unless those expenses are separately purchased or their cost is separately stated.
The final regulation regarding food and beverage expense deductions clarifies that the limited deduction is available for food or beverages provided to employees and to the taxpayer (including taxpayers who are sole proprietors or other business owners). Examples illustrate application of the 50% limit to food and beverage expenses provided at an offsite business meeting and affirm that the statutory exception to disallowance for expenses “directly related to business meetings” does not apply to food and beverage expenses. Thus, other business meeting expenses may be fully deductible, but food and beverages for attendees are still subject to the 50% limit. Other changes clarify the six statutory exceptions under Code § 274(e) that can, if applicable, preserve an employer’s 100% deduction. Highlights of those other changes include—
Expenses treated as compensation. The final regulations add a provision regarding application of this exception to “specified individuals” (e.g., directors, officers, and more-than-10% owners). The regulations also replace the proposed “all or nothing” rule—which would have entirely denied this exception if an employer included less than the proper amount in an employee’s compensation and wages—with a “dollar-for-dollar” method. Under that method, if food and beverages are wholly or partially excluded from an employee’s income, or the amount included is less than the required amount, the exception will not apply to amounts greater than the sum of the amount treated as compensation and wages and the amount paid by the employee. This method conforms the outcomes for employees and specified individuals, and denies the exception for food and beverages that are completely excludable from an employee’s income and have not been paid for by the employee.
Recreational expenses. Revised examples illustrate that the exception for recreational expenses for employees does not apply if (1) the expenses are incurred for a holiday party to which only highly compensated employees are invited; (2) the expenses are for snacks and drinks available to all employees in a break room; (3) the food is furnished for the employer’s convenience (e.g., meals for on-call employees); or (4) a birthday celebration is incorporated into a business meal.
Available to the general public. Minor revisions have been made to the examples clarifying when the cost of food and beverages available to employees may be 100% deductible because the food or beverages are also provided to, and primarily consumed by, the general public. For example, snacks at a car dealer and meals for counselors at a summer camp are fully deductible, but meals at a company cafeteria that only occasionally allows visitors and others to eat without charge are subject to the 50% limit.
EBIA Comment: The final regulation on food and beverage deductions affirms the principle that, when expenses are reimbursed, the deduction limits under Code § 274(a) are only applied once. The deduction limits apply to the employee if the reimbursement is treated as income on the employer’s tax return and as wages for withholding purposes. Otherwise (setting aside certain independent contractor situations), the limit applies to the employer. (The final regulation on entertainment deductions does not discuss this or individually address the exceptions in Code § 274(e) because, as the preamble notes, the TCJA did not change how those exceptions apply to entertainment expenditures.) This consequence could play a part in an employer’s decision regarding whether to reimburse employees on a taxable or nontaxable basis for business expenses. From the employee’s perspective, application of these limits to taxable reimbursements may seem largely academic because miscellaneous itemized deductions have been suspended, thus preventing any deduction for business expenses regardless of the Code § 274 limits. The entertainment and food and beverage limits may become more meaningful in the future, however, assuming miscellaneous itemized deductions are restored after 2025, as the law now provides. For more information, see EBIA’s Fringe Benefits manual at Sections II.E (“Employee Business Expense Reimbursements”), XVI (“Employer-Provided Meals”), and XXI.B (“Deductible Business Travel Expenses”).
Contributing Editors: EBIA Staff.