United States

Don’t overlook 100 percent deductions on some meals and entertainment


Most business meals and entertainment expenses are only 50 percent tax deductible and as a result, government contractors generally group these expenses together in their general ledgers so they are easily identified at tax time. What many of these companies fail to realize is that there are numerous exceptions to the 50 percent rule, and these exceptions can be particularly beneficial to government contractors.

The Internal Revenue Code says that, "in general," a taxpayer may only deduct 50 percent of meals and entertainment expenses. "Meals" are defined as food or beverages, and "entertainment" is defined as "any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such activity"1. These definitions are intentionally broad, but there are a few exceptions to the general rule and certain meals and entertainment expenses are 100 percent deductible, including:

  1. Expenses treated as compensation.2
  2. Reimbursed expenses.3
  3. Expenses for recreational, social, or similar activities primarily for the benefit of employees.4
  4. Expenses for goods, services, and facilities made available by the taxpayer to the general public.5
  5. Expenses for goods or services which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration.6
  6. Expenses includable in income of persons who are not employees.7

Government contractors with cost reimbursable-type contracts should pay particular attention to the "reimbursed expenses" exception of Code Section 274(e)(3). The regulations under section 274 state that, in the case of an expense for meals or entertainment of an independent contractor in performing services for a customer under a reimbursement arrangement, the 50 percent limitation applies to the party expressly identified in an agreement between the parties as subject to the limitation.8  If an agreement between the parties does not expressly identify the party subject to the limitations (as is generally the case), the 50 percent limitation applies either:

  1. To the independent contractor to the extent the independent contractor does not account for the expenses to the customer.9
  2. To the customer if the independent contractor accounts for the expenses to the customer.10

Under cost reimbursable-type contracts, contractors are reimbursed for expenses incurred, and they must be able to substantiate their costs to the government. The rules for reimbursement of government contractor's expenses under cost reimbursable-type contracts are contained within the Federal Acquisition Regulations (FAR). According to the FAR, costs for transportation, lodging, meals, and incidental expenses incurred by a contractor personnel on official company business are reimbursable, and reimbursement can be based on actual expenses or per diem rates, provided the method used results in a reasonable charge. Costs will be considered reasonable and allowable only to the extent that they do not exceed on a daily basis the maximum per diem rates in effect at the time.11 Government contractors typically use per diem rates to avoid running afoul of the reimbursement rules in the FAR.

To summarize, government contractors who incur meals and entertainment expenses that are reimbursed under cost reimbursement-type contracts are exempt from the 50 percent deduction limitation for the reimbursed expenses. Government contractors should incorporate these rules into their accounting policies and take care to segregate 50 percent deductible expenses from 100 percent deductible expenses to help minimize income taxes.

1 Code Sec. 274(n)(1)
2 Code Sec. 274(e)(2)
3 Code Sec. 274(e)(3)
4 Code Sec. 274(e)(4)
5 Code Sec. 274(e)(7)
6 Code Sec. 274(e)(8)
7 Code Sec. 274(e)(9)
8 Reg. Sec. 1.274-2(f)(2)(iv)(C)
9 Reg. Sec. 1.274-2(f)(2)(iv)(C)(1)
10 Reg. Sec. 1.274-2(f)(2)(iv)(C)(2)
11 FAR Sec. 31.205-46


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