Hungry and bored? Proposed regulations clarify meals and entertainment expenses

The IRS issued two new proposed regulations under the meals and entertainment (M&E) rules that serve to describe, clarify and expand on the changes made to the M&E rules in the Tax Cuts and Jobs Act of 2017 (TCJA) and related subsequent guidance. Specifically, one of the proposed regulations focuses on entertainment expenses, with the other centered on food and beverage expenses. Generally, under the TCJA, entertainment expenses are not deductible and meals are 50% deductible. The proposed regulations further define what entertainment is and when meals are deductible. 

Entertainment expenses

The proposed regulations focus on two key concepts pertaining to entertainment expenses. First, entertainment is defined as “any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at bars, 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 IRS also provided that an objective test will be used to determine whether an activity is entertainment. Therefore, if an activity is generally considered to be entertainment, it will be treated as entertainment regardless of whether the expenditure can also be described as not being an entertainment expense. Amounts treated as entertainment expenses are nondeductible.

Second, the proposed regulations make it clear that food or beverage expenses must be plainly distinguished from entertainment expenses. Taxpayers can distinguish food or beverage expenses from entertainment expenses by either (1) purchasing the food or beverage separately or (2) ensuring the cost of the food or beverage is stated separately from the cost of the entertainment. Food or beverage expenses purchased or stated separately are 50% deductible. If food or beverage is not purchased or stated separately, then no allocation can be made, and the entire amount is a nondeductible entertainment expenditure.

Food or beverage expenses

The other proposed regulation addresses food and beverage expenses — specifically, (1) what expenses are included in the cost of food or beverage, (2) when are the expenses deductible, and (3) whether the expenses are subject to the general limitation of 50% or meet an exception to be fully deductible.

The M&E rules say no deduction is allowed for the expense of any food or beverages unless such expense is:

1. not lavish or extravagant under the circumstances (neither the statute nor the proposed regulations define “lavish” or “extravagant”; the determination is subjective, based on the facts and circumstances), and
2. the taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages. 

The new rules incorporate these two requirements and expand the law by adding a third requirement that food or beverages must be provided to a business associate for the cost to be deductible.

The new rule, however, shouldn’t cause taxpayers much concern, as “business associate” is loosely defined to be “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 question has also arisen concerning exactly what ancillary expenses should be included in the cost of food or beverage. The new rules define food or beverage expenses to mean the cost of food or beverages, including any delivery fees, tips and sales tax. The rules go on to say that in the case of employer-provided meals at an eating facility, food or beverage expenses do not include expenses for the operation of the eating facility such as salaries of employees preparing and serving meals, and other overhead costs.

As stated above, the general rule is food or beverage expenses are limited to 50%, unless they qualify for one of six exceptions. The new rules provide additional clarification on when these exceptions apply. The following provides a brief overview.

• Expenses treated as compensation are generally 100% deductible. However, this exception does not apply if the expenses for food or beverages have a value that is less than the amount included in the employee’s gross income or if the value required to be included is zero. In such a case, the deductible amount is limited to 50%.
• Expenses paid for food or beverages by a taxpayer for recreational, social or similar activities primarily for the benefit of employees are generally 100% deductible. The exception only applies to food or beverages provided primarily for the benefit of employees other than the highly compensated employees and shareholders who own a 10% or greater interest in the business. This exception applies also when the benefit is provided to a limited number of employees at a single time, e.g., one department. This exception does not apply to free food or beverages provided in the break room (subject to a 50% limit, unless de minimis).
• Food or beverages made available to the general public are generally 100% deductible. This exception applies to the entire amount of the expense for food or beverages provided to employees if similar food or beverages are provided by the employer to, and are primarily consumed by, the general public. For this purpose, “primarily consumed” means greater than 50% of actual or reasonably estimated consumption and “general public” includes customers, clients and visitors.
• Goods or services sold to customers are generally 100% deductible. The new rules address concerns from the food and beverage industry. They provide that a restaurant or catering business may continue to deduct 100% of its costs for food or beverage items, purchased in connection with preparing and providing meals to its paying customers, which are also consumed at the worksite by employees who work in the employer’s restaurant or catering business.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.