8749 / What special rules apply when a taxpayer deducts business-related entertainment expenses and meals?

Editor’s Note: Congress lifted the 50 percent cap for 2021 and 2022, so that business meals were fully deductible under the 2020 year-end Consolidated Appropriations Act (CAA). This change was designed to support the restaurant industry during the COVID-19 recovery efforts, and, as such, the deduction was limited to food and beverages purchased in a restaurant. IRS guidance clarified that “restaurants” for this purpose include only businesses that prepare and sell food or beverages to customers for immediate consumption on the premises or off the premises. Pre-packaged meals and goods that are purchased for consumption at a later time, such as from a grocery store or convenience store, did not qualify. Meals provided through an employer-operated eating facility were not eligible for the 100 percent deduction even if the employer contracted with a third-party vendor to supply the meals. As is typically the case, the deduction was subject to the caveat that the meal expense was not lavish or extravagant.¹

Editor’s Note: Under the 2017 tax reform legislation, the previously existing 50 percent deduction for entertainment expenses that are directly connected with a business activity was suspended for 2018-2025. This applies to any activity considered entertainment, recreation or amusement, including membership dues with respect to any club organized for business, pleasure, recreational or social purposes.²

The 50 percent deduction for meal expenses remains in effect (including meals consumed while travelling for business). The 2017 tax reform legislation expanded the 50 percent deduction for meals to include expenses associated with providing meals through an eating facility meeting de minimis fringe benefit requirements ( Q 8910).³ The deduction for meals provided at the convenience of the employer expires after December 31, 2025.⁴

Special restrictions apply when a taxpayer deducts business meal and entertainment expenses. A taxpayer is generally entitled to deduct the cost of a business meal if (a) the meal is not lavish or extravagant (b) the taxpayer (or employee of the taxpayer) is present at the meal and (c) the food or beverages are provided to the taxpayer or a business associate.⁵ Entertainment expenses (prior to 2018) were typically only deductible if the taxpayer established that the activity was directly related to or associated with the taxpayer’s trade or business.⁶

Recently released IRS guidance has confirmed that the rules governing the deductibility of business meals prior to tax reform will continue to apply (i.e., the 50 percent deduction for business meals will continue in effect). However, if the food or beverage in question is purchased in connection with a simultaneous event that constitutes “entertainment,” the food and beverages must either be purchased separately, or must be separately stated on the receipt.⁷

Under the regulations, what amounts to “entertainment” is determined on an objective basis so that if an activity is generally considered to be entertainment, it will be treated as such even if it can be characterized as something else. However, the specific trade or business involved is taken into account.⁸

Example: A theatre critic attends a theatrical production that she will review. Even though attending a theatrical performance is usually considered entertainment, with respect to the theatre critic, it is business and, thus, the cost of the ticket would not be disallowed under the new rules. If a manufacturer had taken a client to attend the same production, the manufacturer would not be entitled to deduct the ticket costs.

Generally, the deduction for the ordinary and necessary cost of business meals (i.e., those expenses which are not lavish and extravagant), are reduced by half, so that only 50 percent of allowable costs are deductible.⁹ For certain taxpayers who are employed in the transportation industry, and are frequently required to have meals away from home (such as flight crews, interstate truck drivers, etc.), 80 percent of the cost of business meals is deductible for tax years beginning after 2007.¹⁰

In order to deduct the cost of business-related meals, taxpayers must also establish that the meal was either “directly related” or “associated with” the taxpayer’s business (i.e., the taxpayer must show that the expense was incurred directly before, during, or after a bona fide business discussion) in order to deduct the cost.¹¹

Under the final regulations, the food or beverages must be provided to a current or prospective business associate. The regulations define this to include a person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective. The final regulations clarify that employees are also included in the definition of business associate.¹²

The deduction for business entertainment expenses was also generally limited to 50 percent of otherwise allowable costs.¹³

If the amount of the allowable deduction is reduced because the expense is found to be lavish or extravagant, the 50 percent limitation is applied after the cost has been reduced by the portion that is deemed to be unacceptable.¹⁴

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Planning Point: Elimination of the deduction for business-related entertainment expenses while preserving the 50 percent deduction for business meals generated questions as to when a business meal becomes entertainment so as to be non-deductible under the tax reform law. Some speculated that this line is crossed when the meal becomes “lavish and extravagant”, a standard that existed pre-reform to deny the deduction for meal expenses that were essentially deemed unreasonable. The final regulations continue to reference the pre-existing “lavish and extravagant standard” (see Q 8751), which can help in determining whether the 50 percent deduction for business meals is permissible.

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If an employee is fully reimbursed for the expense of business meals and entertainment (prior to 2018), such expenses are fully deductible by the employer, although the 50 percent limitation will apply to the employer’s deduction.¹⁵ However, if the expenses are not reimbursed, the employee is subject to the 50 percent limitation described above. Furthermore, the unreimbursed expenses that are deductible after that limitation are then subject to the 2 percent floor on miscellaneous itemized deductions (all miscellaneous itemized deductions subject to the
2 percent floor were suspended from 2018-2025).¹⁶