Final regs. provide guidance on TCJA changes to entertainment deduction rules

Editor: Greg A. Fairbanks, J.D., LL.M.

The IRS issued final regulations (T.D. 9925) clarifying amendments to the deductibility of certain business meals and entertainment expenses under the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, enacted in December 2017. These final regulations apply to tax years beginning on or after Oct. 9, 2020.

Amendments under the TCJA eliminated the ability for taxpayers to partially deduct certain entertainment, amusement, or recreation expenses unless certain narrow exceptions are met. The TCJA also repealed the exception to the 50% limit for food or beverages excludable from employee income as a de minimis fringe benefit under Sec. 132(e). However, the TCJA continued to allow taxpayers to deduct food and beverage expenses, generally subject to a 50% limitation. Certain narrow exceptions to the 50% limitation allow taxpayers a 100% deduction for qualifying food and beverage expenses. (Note that the Consolidated Appropriations Act, 2021, P.L. 116-260, temporarily (for 2020 and 2021) allows a 100% business expense deduction for meals as long as the expense is for food or beverages provided by a restaurant.)

The repeal of the deduction for entertainment expenses, along with the retention of the deduction for meals, created uncertainty about the extent to which meal expenses incurred during an entertainment event were deductible. As a result, proposed regulations (REG-100814-19) were issued in February 2020 to provide additional guidance. These proposed regulations are now finalized. Guidance in the final regulations provides clarifying language and additional examples for determining the extent to which meals and entertainment expenditures may be deductible. The final regulations also retain a number of exceptions to the meal and entertainment expense limitations. These regulations refer to those exceptions and enlarge the exceptions that relate to food and beverages.

Entertainment expenditures

The final regulations reiterate the statutory provisions under Sec. 274 that no deduction is allowed for entertainment expenditures or for a facility that is used in connection with an entertainment activity. Entertainment means any activity that constitutes entertainment, amusement, or recreation, including entertaining at theaters, bars, country clubs, golf and athletic clubs, and sporting events, and on hunting, fishing, vacation, and similar trips. Likewise, dues or fees paid to any social, athletic, or sporting club or organization are not deductible. The regulations apply an objective test to determine whether an activity is considered entertainment.

The regulations provide that, if an activity is generally considered entertainment, it will be treated as entertainment for the purposes of the limitation. However, in applying the test, the taxpayer’s trade or business is considered. For example, attending a theatrical performance generally would be considered entertainment. However, a theater critic attending a performance in a professional capacity would not be considered entertainment (see Regs. Secs. 1.274-11(a) and (b)).

If food and beverages are provided during the entertainment activity, they will not be subject to the 100% limitation as long as either: (1) the food and beverages are purchased separately from the entertainment or (2) the cost of the food and beverages is separately stated from the price of the entertainment. However, they would be subject to the 50% limitation for food and beverages as discussed below (see Regs. Sec. 1.274-11(b)(1)(ii)). Taxpayers will want to take care in how they purchase food and beverages, and document those purchases, at or during an entertainment activity. Differences in the acquisition or substantiation of those purchases could result in the loss of an otherwise valid deduction.

Food and beverage expenditures

The final regulations provide taxpayers may deduct 50% of their expenditures for food and beverages if all of the following criteria are met:

• The expense is not lavish or extravagant under the circumstances;
• The taxpayer, or an employee of the taxpayer, is present at the furnishing of such food or beverages; and
• The food or beverages are provided to the taxpayer or a business associate.

The term “food or beverages” means all food and beverage items, whether they are characterized as meals, snacks, or other types of food and beverages and regardless of whether the food and beverages are treated as de minimis fringes under Sec. 132(e). The term “food or beverage expenses” means the full cost of food or beverages, including any delivery fees, tips, and sales tax. In the case of employer-provided meals furnished at an employer’s eating facility, the food or beverage expenses do not include the indirect expenses for the operation of the facility such as salaries of employees preparing and serving meals or other costs (e.g., crockery, glassware, and silverware) (see Regs. Sec. 1.274-12(b)).

The final regulations also revise Regs. Sec. 1.274-12(a)(1)(iii), referring to food or beverages provided “to the taxpayer or a business associate.” The purpose of the revision was to add “taxpayer” to the phrase and make clear that the 50% limitation also applies to food and beverages provided to a sole proprietor or other business owner. The term “business associate” is also defined broadly in the final regulations. The term includes any person the taxpayer could reasonably expect to engage or deal in the active conduct of the trade or business such as a customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective (see Regs. Sec. 1.274-12(b)(3)).

In addition, the final regulations contain special rules for travel meals. In general, food or beverage expenses paid or incurred while traveling for business are subject to the 50% limitation as well as the substantiation requirements described in Sec. 274(d). The final regulations also make clear that a deduction will not be allowed for travel meal expenses for a spouse, dependent, or others that accompany the taxpayer or employee of the taxpayer on business travel unless: (1) the person is an employee of the taxpayer; (2) it is for a bona fide business purpose of the taxpayer; and (3) the expenses would otherwise be deductible by the spouse, dependent, or other individual (see Regs. Sec. 1.274-12(a)(4)).

Exceptions to the 50% limitation for food and beverage expenses

Expenses treated as compensation: The final regulations generally allow a 100% deduction for expenditures for food or beverages provided to an employee if the employer treats those expenses as compensation to that employee. For this exception to apply, the employer must treat those expenses as: (1) compensation to an employee and as wages to the employee for purposes of withholding and (2) as compensation to the employee in the context of fringe benefits. If these provisions are met, a full deduction may be allowed, regardless of how the employee may treat the compensation on his or her return (see Regs. Sec. 1.274-12(c)(2)(i)).

If, however, the employer includes less than the amount required under Regs. Sec. 1.61-21 in the employee’s income or if the amount is excluded from income of the employee (other than by reason of reimbursement), the 100% deduction may be curtailed. In those instances, the 100% deduction is the lesser of: (1) the expense for the food and beverages provided to the employee or (2) the amount treated as compensation plus the amount of any reimbursement by the employee. The remainder, if any, is subject to the 50% limitation (see Regs. Sec. 1.274-12(c)(2)(i)(D)). This is a more favorable result than the all-or-nothing provision in the proposed regulations.

Similar rules also apply to nonemployees for expenses that are includible in the gross income of the recipient as either compensation or as a prize or award.

Reimbursed food or beverage expenses: In instances where one party is performing services for another, the final regulations provide the 50% limitation for food and beverage expenses applies either to the person who makes the expenditure or to the person who actually bears the expense, but not to both. In the case of a reimbursement arrangement between an employee and employer, the limitation will apply to the employee to the extent the employer treats the expense as compensation on its originally filed income tax return and as wages to the employee for the purposes of withholding. Otherwise, the limitation will apply to the employer (see Regs. 1.274-12(c)(2)(ii)(B)).

In arrangements involving an independent contractor, the parties may specify which party is subject to the limitation. In those instances, the government will respect the agreement between the parties. If the agreement does not specify the party subject to the limitation, the limitation will apply to the independent contractor unless the independent contractor provides an accounting to its client/customer that meets the substantiation requirements of Sec. 274(d). The client/customer will be subject to the limitation to the extent such an accounting is made. If there is no reimbursement arrangement in place, the independent contractor may not shift or avoid the limitation merely by providing an accounting to its client/customer (see Regs. Sec. 1.274-12(c)(2)(ii)(C)).

Recreational expenses for employees: A 100% deduction is allowed for food or beverage expenses incurred by the taxpayer for a recreational, social, or similar activity such as holiday parties, annual picnics, and summer outings. The exception does not apply to activities that discriminate in favor of highly compensated employees, officers, shareholders, or others with a 10% or greater interest in the business. However, a 50% deduction may still be available (see Regs. Sec. 1.274-12(c)(2)(iii)).

The final regulations appear to take a narrow view of this exception. In one example, the regulations conclude that expenses for food and beverages made available in a break room to all employees does not meet the exception even though some socializing may occur. The reason provided is that the break room is not a recreational, social, or similar activity. In another example, meals are provided to employees in a cafeteria where socializing may also take place. The value of the meals is excluded from employees’ income under Sec. 119 because the meals are provided for the employer’s convenience. The regulations conclude the exception is not met because the meals cannot be provided for both the convenience of the employer and also primarily for the employees’ benefit.

Items available to the public: A full deduction may be taken for food or beverage expenses to the extent the food or beverages are made available to the general public. If the food or beverages are consumed by the general public as well as by employees, a full deduction will be allowed for the expenses of all food and beverages provided if more than half the food and beverages are actually or reasonably estimated to be consumed by the general public. Should the employees consume more than half the food and beverages provided, a full deduction may still be taken to the extent they are consumed by the general public. The remainder would be subject to the 50% limitation. The term “general public” includes, but is not limited to, customers, clients, and visitors (see Regs. Sec. 1.274-12(c)(iv)).

Goods and services sold to customers: The final regulations provide that a full deduction is allowed for an expense for food or beverages that are sold to customers in a bona fide transaction where full consideration in terms of money or money’s worth is provided in exchange for the goods. However, the term “money or money’s worth” does not include payment through services provided. The final regulations also allow a restaurant or catering business a 100% deduction on the cost of its food or beverages that it acquires to provide meals to its paying customers, even though the food or beverages may also be consumed at the worksite by the employees of the business (see Regs. Sec. 1.274-12(c)(2)(v)).

As a result of the amendments to Sec. 274 enacted in the TCJA, as clarified and expanded upon by the final regulations, the analysis of meals and entertainment expenses has become more complex for many taxpayers. Under the TCJA and the final regulations, entertainment expenses are generally nondeductible, whereas food and beverage expenses are generally subject to a 50% limitation. However, the TCJA and the final regulations retain a number of the exceptions to the general rules for meal and entertainment expenses. When making and documenting meal and entertainment expenditures, taxpayers should consider these final regulations, including the exceptions to the general rules, to determine the deductibility of those expenses.

EditorNotes

Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington.

For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.

Contributors are members of or associated with Grant Thornton LLP.