As our Alert previously discussed, Congress provided a temporary exception to the 50% the business deduction for certain business meals under the Taxpayer Certainty and Disaster Relief Act of 2020 (the Act). The temporary exception under the Act allows a 100% deduction for business meals if the food or beverages are provided by restaurants after Dec. 31, 2020 and before Jan. 1, 2023
On April 8, 2021, the IRS issued guidance in Notice 2021-25 to further explain how to apply the temporary exception.
Under the general rules provided in section 274 and subsequent IRS guidance, taxpayers may deduct 50% of a business meal if:
- The expense is an ordinary and necessary expense under section 162(a) paid or incurred during the taxable year in carrying on any trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
The temporary change in the law allows business meal amounts to be tax deductible so long as the business owner (or an employee of the business) is present when the food or beverages are provided and the expense is not lavish or extravagant under the circumstance. However, it was not clear how the temporary change in the law defined the term ‘restaurant.’
Under the Notice, the term ‘restaurant’ is defined as a business that prepares and sells food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises. The Notice clarifies that grocery stores, specialty food stores, stores that sell alcohol, drug stores, convenience stores and vending machines may provide meals that can be eaten immediately, but they do not qualify as ‘restaurants’ because they primarily sell food that is pre-packaged and not for immediate consumption. The 50% deduction limitation under section 274 will continue to apply when a taxpayer purchases food or beverages from these locations.
Additionally, the Notice addresses the treatment of on-premises cafeterias. Some employers provide on-premises cafeterias for their employees. These cafeterias may provide meals that are tax-free to employees (under section 119) or may provide meals at direct cost (under section 132(e)(2)). Many such cafeterias are operated by contractors. There were open questions about whether these cafeterias could be treated as ‘restaurants’ for purposes of the temporary change in the deduction rules. The Notice provides that on-premises cafeterias operating under section 119 or section 132(e\)(2) may not be treated as restaurants, even if operated by contractors.
One item that seems to remain open is what ‘present’ means in the context of a taxpayer having to be present when the food or beverages are provided. It appears this will remain a facts and circumstances issue, especially as some companies continue to operate virtually.