8750 / When is a business-related entertainment or meal expense “ordinary and necessary” so that it may be deducted?

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 is 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.¹ The 50 percent deduction for meal expenses remains in effect (including meals consumed while travelling for business). The 2017 tax reform legislation also 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).² The deduction for meals provided at the convenience of the employer expires after December 31, 2025.³

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Planning Point: Post-tax reform, employees are permitted to exclude the cost of employer-provided meals furnished to employees on the premises and for the employer’s convenience. The IRS guidance clarifies that the previously applicable standard, which requires that the meals are deemed to be provided for the employer’s convenience only if they are necessary for employees to properly perform their duties, will continue to apply even post-reform. Employers who wish to provide meals under this “convenience of the employer” provision must be able to substantiate that they have policies in place reflecting the need, and must be able to show that those policies connect the employer’s stated needs and goals to the necessity of providing employee meals. Sufficient substantiation will depend on the facts and circumstances of each case.

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Whether a business-related entertainment (prior to 2018) or meal expense is ordinary and necessary is generally a question of fact. The courts have recognized that the taxpayer is entitled to exercise a certain degree of discretion in determining whether an expense is ordinary and necessary in the taxpayer’s particular business.⁴

Expenditures are generally found to be sufficiently necessary if, based on all the facts and circumstances, they are “appropriate and helpful” to the taxpayer’s business.⁵ Expenditures are generally found to be sufficiently ordinary if they are made for “sound and normal” business expenses of a nature and amount determined by general commercial standards.⁶

The Tax Court has allowed a deduction for entertainment expenses incurred by a bank that paid for private dinner parties at a country club (hosted by the bank’s officers) for its significant customers (“key people” from among the bank’s top five hundred clients and prospective clients in the upper echelon of the financial community).⁷ The court noted that, in this case, there was evidence that these customers were not being reached by more direct methods, so it was not unreasonable for the bank to resort to private entertainment in order to entice their business. Note that country club dues would no longer be deductible under the 2017 tax reform legislation.

On the other hand, when a public defender who supervised several attorneys attempted to deduct the cost of taking those attorneys to lunches at the public defender’s country club, the Tax Court denied the deduction on the grounds that such expenses were not ordinary and necessary for a taxpayer who is engaged in the business of being a public defender. This was the case even though the court recognized that the lunches tended to boost morale and encourage efficient work. Also important was the Tax Court’s recognition that these expenses might have been found to be ordinary and necessary were they incurred by a partner operating in a private law firm.⁸