In Notice 2018-76, Treasury and the IRS announced their intent to issue proposed regulations on the deductibility of expenses for certain business meals. The notice also provides guidance taxpayers may rely on until the proposed regulations are effective.
Sec. 274(a), as modified by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, disallows any otherwise allowed deduction from income tax for an activity or facility that constitutes entertainment, amusement, or recreation. Sec. 274(k) disallows a deduction for any food or beverages unless: (1) the expense is not lavish or extravagant under the circumstances, and (2) the taxpayer (or employee of the taxpayer) is present at the furnishing of the food or beverages. Sec. 274(n)(1) limits the deduction for any expense for food or beverages to no more than 50% of the expense that otherwise would be allowable.
The TCJA repealed the exception from Sec. 274(a) that preserved a deduction for business entertainment if it is directly related to or associated with the active conduct of business. This change effectively eliminates business entertainment deductions. Treasury regulations define "entertainment" using an objective standard, including activity "of a type generally considered to constitute entertainment," such as "entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, [and] sporting events." Under the regulations, entertainment may include activities that satisfy "personal, living, or family needs" but does not include: (1) supper money an employer provides to an employee working overtime; (2) a hotel room maintained by an employer for lodging of employees while traveling for business; or (3) an automobile used for business, even though it is also used for routine personal purposes, such as commuting to and from work.
The notice clarifies that the TCJA did not change the definition of entertainment under Sec. 274(a)(1) and, therefore, the regulations defining entertainment continue to apply. In addition, the notice states that the TCJA did not address when the provision of food and beverages might constitute entertainment, observing that "the legislative history of the [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 notice, Treasury and the IRS intend to issue proposed regulations to clarify when business meal expenses are nondeductible entertainment expenses and when those expenses are 50% deductible. Until those regulations are effective, however, taxpayers may rely on the guidance in the notice.
Under the notice, taxpayers may deduct 50% of an otherwise allowable meal expense if:
1. The expense is an ordinary and necessary expense under Sec. 162(a) that is paid or incurred during the tax year in carrying on a trade or business;
2. The expense is not lavish or extravagant under the circumstances;
3. The taxpayer or the taxpayer's employee is present at the furnishing of the food or beverages;
4. The food and beverages are provided to current or potential business customers, clients, consultants, or similar business contacts; and
5. The food and beverages (for food and beverages provided during or at an entertainment activity) are purchased separately from the entertainment, or the cost of the food or beverages is stated separately from the entertainment cost on one or more bills, invoices, or receipts.
To illustrate the appropriate deduction for a food and beverage expense incurred at an entertainment event, the notice provides three examples demonstrating the treatment of business meals in connection with an entertainment activity:
Example 1. Business meals purchased separately from entertainment: In the first example, Taxpayer A takes B, a business contact, to a baseball game. A purchases the tickets and separately buys hot dogs and drinks for A and B at the game. The notice provides that the cost of the tickets is a nondeductible entertainment expense. However, the cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense. Accordingly, A may deduct 50% of the expense for the hot dogs and drinks.
Example 2. Cost for business meals commingled with entertainment, not separately stated or purchased: In the second example, Taxpayer C takes D, a business contact, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The ticket cost includes the costs of the food and beverages available in the suite, which are not separately stated on the invoice. The notice provides that the full cost is a nondeductible entertainment expense.
Example 3. Business meals separately stated from entertainment: The third example modifies the second example such that the invoice for the basketball game tickets separately states the cost of the food and beverages. The notice provides that the separately stated cost of the food and beverages is not an entertainment expense. Accordingly, C may deduct 50% of the food and beverage expense.
IRS seeking comments
Notice 2018-76 requested comments (that were due Dec. 2, 2018) on the following issues:
- What further guidance is needed to clarify the treatment of entertainment and business meal expenses;
- Whether the entertainment definition in Regs. Sec. 1.274-2(b)(1)(i) should be retained and, if so, whether and how it should be revised;
- Whether the objective test in Regs. Sec. 1.274-2(b)(1)(ii) should be retained and, if so, whether and how it should be revised; and
- What examples should be addressed in the guidance.
Notice 2018-76 generally allows a taxpayer a 50% business deduction for meals associated with an entertainment activity to the extent that the meals are purchased separately from the entertainment, or the cost is stated separately from the entertainment cost on the receipt. Companies that do not currently require receipts that separately identify food and beverages from an entertainment activity should immediately address their current expense system and implement modifications. Failure to do so will render all those food and beverage expenses nondeductible.
Companies should also assess their current inventory of licensing agreements with entertainment venues, social clubs, and other entertainment/recreation facilities to confirm expenses attributable to food and beverages are separately stated from other costs. The notice does not change or otherwise address income inclusion or what is included in federal taxable wages.
Michael Dell is a partner at Ernst & Young LLP in Washington.
For additional information about these items, contact Mr. Dell at 202-327-8788 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP. Ernst & Young previously published versions of these items as Tax Alerts.