IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance

Practical Law Legal Update w-016-8982 (Approx. 5 pages)

IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance

by Practical Law Employee Benefits & Executive Compensation

Entertainment and Business Meal Expenses Before and After the TCJA

As background, the Code permits a deduction for ordinary and necessary expenses paid or incurred in carrying out an employer's business (26 U.S.C. § 162(a)). However, the Code, as amended by the TCJA, generally disallows a deduction for any item regarding an activity that is considered to be entertainment, amusement, or recreation (26 U.S.C. § 274(a)(1)).

Entertainment Expenses

Even before the TCJA, the Code generally prohibited a deduction for activities considered to be entertainment, amusement, or recreation (that is, entertainment expenses) (26 U.S.C. § 274(a)(1)(A)). However, pre-TCJA law provided exceptions to this general prohibition if an employer could show that:

An item was directly related to the active conduct of the employer's business (the "directly related" exception).
For an item that directly preceded or followed a substantial and bona fide business discussion (for example, business meetings at a convention), the item was associated with the active conduct of the employer's business (the "business discussion" exception).

Before the TCJA, employers could deduct 50% of entertainment expenses that satisfied the directly related or business discussion exceptions. The TCJA repealed the two exceptions, however, so that the Code now disallows a deduction for any item regarding an activity that is considered entertainment, amusement, or recreation.

Meaning of Entertainment

Under the regulations' somewhat circular definitions, which continue to apply after the TCJA, entertainment means any activity of the type generally considered to constitute entertainment, amusement, or recreation. The definition includes entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, or sporting events, and on hunting, fishing, vacation, and similar trips – including activities relating solely to an individual or the individual's family (26 C.F.R. § 1.274-2(b)(1)(i)).

Entertainment may also include an activity, the cost of which is claimed as a business expense by the individual, which satisfies the individual's personal, living, or family needs. For example, this could include providing food and beverages, a hotel suite, or an automobile to a business customer or the customer's family.

Under the regulations, entertainment does not include activities which, although satisfying an individual's personal, living, or family needs, are clearly not considered to be entertainment. For example, this includes:

Employer-provided dinner money for an employee who is working overtime.
A hotel room maintained by an employer for lodging its employees who are traveling for business.
An automobile used for actively conducting business (even though the automobile is also used for routine personal purposes such as commuting to and from work).

However, if an employer provides a hotel room or automobile to an employee on vacation, this would be entertainment as to the employee.

Determining Whether an Activity Is Entertainment

An objective test is used to determine whether a given activity is entertainment (26 C.F.R. § 1.274-2(b)(1)(ii)). As a result, if an activity is generally considered entertainment, it will constitute entertainment for Code Section 274(a) purposes:

Even if the expense for the activity can also be described otherwise.
Although the expense relates to an individual alone.

An employer's business is considered in applying the objective test. For example, attending a theatrical performance:

Generally would be considered entertainment.
Would not be considered entertainment for a professional theater critic attending in a professional capacity.

Business Meal Expenses

The Code permits a deduction for a food or beverage expense if:

The expense is not lavish or extravagant under the circumstances.
The employer or an employee is present when the food or beverage is provided.

(26 U.S.C. § 274(k).)

The amount permitted for a food or beverage deduction cannot be more than 50% of the amount of the expense that otherwise would be allowable (26 U.S.C. § 274(k), (n)). In other words, employers may deduct 50% of allowable meal expenses.

Transitional Guidance on the Deductibility of Business Meal Expenses

The IRS indicated in Notice 2018-76 that it plans to issue proposed regulations addressing when business meal expenses are:

Nondeductible entertainment expenses.
50% deductible expenses.

Until those proposed regulations are effective, however, employers may rely on Notice 2018-76 concerning the treatment of business meal expenses for Code Section 274 purposes.

Under Notice 2018-76, an employer may deduct 50% of an otherwise allowable business meal expense if the following requirements are met:

The expense is an ordinary and necessary expense under Code Section 162(a) that is paid or incurred during the tax year in carrying on a business (26 U.S.C. § 162(a)).
The expense is not lavish or extravagant under the circumstances.
The employer or an employee 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.

An additional requirement applies for food and beverages provided during or at an entertainment activity. In this case, either:

The food and beverages must be purchased separately from the entertainment.
The cost of the food and beverages must be stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.

Also, the IRS warned that the TCJA's entertainment disallowance rule may not be avoided by inflating the amount charged for food and beverages.

The guidance includes several examples of how deduction rules work. One example applies the following assumptions:

The food and beverage expenses at issue are:
- ordinary and necessary expenses under Code Section 162(a) paid or incurred during the tax year in carrying on a business; and
- not lavish or extravagant under the circumstances.
The employer and its business contact are not engaged in a business that is related to the entertainment activity.

In the example, an employer:

Invites a business contact to a baseball game.
Buys tickets for the employer and business contact to attend the game.
Buys hot dogs and drinks for the employer and business contact while at the game.

The baseball game in this example is entertainment under the regulations and, as a result, the cost of the game tickets is an entertainment expense and is not deductible by the employer. However, the cost of the hot dogs and drinks, which were purchased separately from the game tickets, is not an entertainment expense and is not subject to the entertainment expense disallowance. As a result, the employer may deduct 50% of the expenses associated with the hot dogs and drinks purchased at the game.

Practical Impact

This guidance offers a first glimpse at how the IRS will interpret the treatment of business meal and entertainment expenses in light of the TCJA, and the IRS indicates in Notice 2018-76 that more guidance is to follow. For example, the IRS plans to issue separate guidance addressing the treatment of expenses for food and beverages provided primarily to employees on an employer's business premises. Notice 2018-76 also requests comments on issues in this space (due December 2, 2018), including, for example, whether:

The current definition of entertainment for Code Section 274 purposes should be retained.
Additional clarifying guidance is needed.

For additional IRS implementing guidance concerning tax reform, see the IRS TCJA webpage.

IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance | Practical Law