IRS issues final regulations on meals and entertainment deductions
TAX ALERT |
On Sept. 30, 2020, the IRS issued final regulations that provide guidance for meal and entertainment deductions under section 274 of the Internal Revenue Code (Code). We previously summarized the proposed regulations and the related IRS Notice 2018-76 here. This alert summarizes the changes made by the final regulations.
The final regulations generally keep the existing definition of entertainment. Similarly, the final regulations confirm that the nine exceptions to entertainment expenses under section 274(e) remain the same.
The final regulations generally apply the guidance in Notice 2018-76 and the proposed regulations to all food or beverages, including travel meals and employer-provided meals, as well as food and beverages provided at or during an entertainment activity. In particular, the final regulations keep, but clarify the distinction between entertainment expenditures and food or beverage expenses in the context of business meals provided at or during an entertainment activity. For example, the final regulation adds a requirement that the amount separately invoiced or separately charged for food or beverage on the bill for an entertainment event must reflect the venue’s usual selling cost if they were purchased separately from the entertainment, so as to avoid inflating the food and beverage expenses to take advantage of the potential deduction. The final regulations provide examples showing the difference in deduction treatment between situations in which the cost of food and beverages provided as part of an entertainment activity were stated separately or were not stated separately on the invoices for the event.
Food and Beverage Expenses
Generally, the final regulations apply the guidance in the proposed regulations to food and beverage expenses. This includes keeping the conditions a taxpayer must satisfy to qualify for a 50% deduction.
The final regulations also provide some helpful definitions. First, the deduction limitation rules generally apply to all food and beverage, whether characterized as meals, snacks or other type of food. Additionally, a food and beverage expense includes any delivery fees, tips, and sales tax. However, it does not include indirect expenses such as the cost of transportation to a meal.
1. Business meal
The final regulations modified and added to examples provided in section 1.274-11 and 1.274-12 to clarify how certain expenses may satisfy the conditions to deduct a business meal. Additionally, for the purpose of better understanding the conditions, the final regulations include employees in the definition of “business associate.”
2. Travel meal
In addition to applying the general rules for meal expenses from proposed regulations, the final regulations incorporate the substantiation requirements in section 274(d) to travel meals and confirm that most meals (food and beverage) while an employee is on travel are 50% deductible. However, the final regulations apply the limitations in section 274(m)(3) to expenses for food or beverages incurred while on travel for spouses, dependents or other individuals accompanying the taxpayer (or an officer or employee of the taxpayer) on business travel. Thus, if an employee and the employee’s spouse (or a self-employed individual and spouse) travel together for the employee’s business, the cost of a meal for the spouse is almost always nondeductible.
The final regulations explain how the six exceptions in section 274(e) apply to food and beverage expense. Much of the application remained the same but the regulations add some helpful examples.
Expenses treated a compensation under section 274(e)(2) or (e)(9)
Section 274(e) provides that if a meal is included in the employee’s (or self-employed individuals) taxable compensation, the cost of the meal can be deducted. The final regulations note that including an amount that is too low will limit the tax deduction. Where a taxpayer includes less than the proper value of the meal in compensation, the final regulations provide that the taxpayer must apply the dollar-for-dollar methodology. Under that dollar-for-dollar methodology, the taxpayer may deduct meal expenses to the extent that the expenses do not exceed the amount of the expenses that are treated as taxable compensation. The regulations provide examples of the treatment of meals provided in employer-run cafeterias, including where companies use the “direct cost” method of charging employees for the meals.
Reimbursement under section 274(e)(3)
The final regulations address reimbursements arrangements between an employer and its customer where the customer is obligated to reimburse the employer for meals (usually travel meals) provided to the employees working on a customer contract. As in current regulations, the 50% deduction limitations apply to employer unless, under a reimbursement arrangement, the employer accounts to its customer with substantiation that satisfies the requirements of section 274(d) (in which case the customer bears the 50% loss of deduction. The regulations provide examples further addressing these fact patterns and fact patterns involving independent contractors under similar arrangements.
Recreation under section 274(e)(4)
The final regulations confirm that the “social or recreational event” exception in section 274(e)(4) applies to food or beverage expenses for company holiday parties, annual picnics, or summer outings that are primarily for employees other than owners and highly compensated employees and thus do not discriminate in favor of the highly compensated or owners of the company.
Items available to the public under section 274(e)(7)
The final regulations generally retain the guidance provided in the proposed regulations, along with the examples of what constitutes offering items to the general public. As a general rule, if more than 50% of the food or beverage is likely to be consumed by the general public, the expenses are likely to be 100% deductible. The regulations and examples add some clarity to who is or is not a member of the general public. The general public does not include employees, owners or contractors. In addition, if there is a specifically invited guest list, the invited list is not treated as members of the general public.
Goods or services sold to customers under section 274(e)(8)
The final regulations adopt the interpretations 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. The regulations retain the examples on the application of this rule, including meals for camp counselors eating with campers, real estate agents providing food during open houses and auto service centers providing food to customers waiting for their cars to be serviced.