IRS Business Meal and Entertainment Expense Proposed Rules Address TCJA Requirements, Holiday Parties, Breakroom Snacks, and More (Reliance Permitted)

Practical Law Legal Update w-024-1743 (Approx. 6 pages)

IRS Business Meal and Entertainment Expense Proposed Rules Address TCJA Requirements, Holiday Parties, Breakroom Snacks, and More (Reliance Permitted)

by Practical Law Employee Benefits & Executive Compensation

Deductibility of Entertainment Expenses Under Proposed Regulations

For background on the TCJA's changes regarding the deductibility of entertainment and business meal expenses, see Legal Update, IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance: Entertainment and Business Meal Expenses Before and After the TCJA. In general, prior to the TCJA, a deduction was permitted for 50% of business meal expenses and 50% of entertainment expenses for items that either:

Were directly related to the active conduct of the employer's business (the "directly related" exception).
Directly preceded or followed a substantial and bona fide business discussion (for example, meetings at a convention) (the "business discussion" exception).

The TCJA removed the directly related and business discussion exceptions as to deducting entertainment expenses (though certain other exceptions remain).

The proposed regulations add two new sections under Code Section 274 that address, respectively:

The disallowance of deductions for certain entertainment, amusement, or recreation expenses paid or incurred after December 31, 2017.
The limits on deductions for certain food or beverage expenses paid or incurred after December 31, 2017.

The proposed regulations on business meals also address travel meals and employer-provided meals.

Entertainment Expenses

The proposed regulations on entertainment expenses:

State the general disallowance of deductions for entertainment expenses (which are defined in the regulations).
Provide that this rule also applies to dues or fees for any social, athletic, or sporting club or organization.

The proposed regulations would also provide that a set of nine pre-TCJA exceptions (for example, expenses treated as compensation) continue to apply regarding entertainment expenses (26 U.S.C. § 274(e)).

Regarding business meals provided at or during entertainment, the proposed regulations would largely incorporate transition rules under Notice 2018-76 on how to distinguish between entertainment expenses and food or beverage expenses (see Legal Update, IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance: Transitional Guidance on Deductibility of Business Meal Expenses). Under Notice 2018-76, for example, the food or beverages would not be considered entertainment if either:

They are purchased separately from the entertainment.
The cost of the food or beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.

Importantly, however, the proposed regulations would apply the Notice 2018-76 guidance to all food and beverages (including travel meals and employer-provided meals) that are provided at or during an entertainment activity.

The proposed regulations include a clarification regarding a Notice 2018-76 requirement that the general entertainment disallowance may not be circumvented by inflating the amount charged for food and beverages in bills, invoices, or receipts. Under the proposed regulations, the amount charged for food or beverages in bills, invoices, or receipts must either:

Reflect a venue's typical selling cost for such items if they had been purchased separately from the entertainment.
Approximate the reasonable value of those items.

Deductibility of Business Meal Expenses Under Proposed Regulations

The proposed regulations on food or beverage expenses address business meal expenses, travel meal expenses, and other food or beverage expenses.

The proposed regulations on business meal expenses address Code Section 274 statutory requirements regarding deductibility—for example, that business meal expenses must not be lavish or extravagant under the circumstances. In addition, no deduction is allowed for a food or beverage expense unless it is provided to business associates (which is also a requirement under Notice 2018-76). For this purpose, business associates are defined as individuals with whom an employer could reasonably expect to engage or deal in the active conduct of its trade or business (for example, a customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective). By including employees as business associates, the proposed regulations make this standard applicable to:

Employer-provided meals.
Situations in which meals are provided both to employees and non-employee business associates at the same event.

Travel Meals; Other Food or Beverage Expenses

To provide comprehensive rules for food and beverage expenses, the proposed regulations would also apply the Notice 2018-76 rules for meal expenses, as revised under the proposed regulations, to travel expenses and other food or expenses generally – for example, breakroom snacks (see Legal Update, IRS Addresses Entertainment and Business Meal Expenses in Latest TCJA Guidance: Transitional Guidance on the Deductibility of Business Meal Expenses). Food or beverage expenses also would include any delivery fees, tips, and sales tax. The proposed regulations would also apply Code Section 274(d) substantiation requirements to travel meals.

Regarding other food or beverage expenses, the TCJA repealed a provision under which expenses for food or beverages that were excludable from employee income as a de minimis fringe benefit:

Were not subject to the 50% deduction limit for meals.
Could therefore be fully deductible.

(See Practice Note, Fringe Benefits Under Code Section 132: De Minimis Fringe Benefits.)

Post-TCJA, expenses for food or beverages that are excludable as a de minimis fringe benefit also are subject to the 50% deduction limit (unless another exception applies).

The proposed regulations also address several contexts involving the deductibility of food or beverage expenses, including:

Food or beverages provided to food service workers who consume the food or beverages while working in a restaurant or catering business.
Snacks available to employees in a pantry, break room, or copy room.
Refreshments provided by a real estate agent at an open house.
Food or beverages provided by a seasonal camp to camp counselors.
Food or beverages provided to employees at a company cafeteria.
Food or beverages provided at company holiday parties and picnics.

Recreational Expenses for Employees; Holiday Parties and Breakroom Snacks

Under the proposed regulations, any food or beverage expenses paid or incurred by an employer for a recreational, social, or similar activity—and primarily for the benefit of an employer's employees—would not be subject to deduction limits under which:

Meals must not be lavish or extravagant under the circumstances.
An employer (or an employee of the employer) must be present at the furnishing of the food or beverage.
Only 50% of a meal expense is allowed.

(26 U.S.C. § 274(e)(4).)

However, activities that discriminate in favor of highly compensated employees, officers, shareholders, or other individuals owning a 10% or greater interest in a business would not be considered paid or incurred primarily for employees' benefit.

Under the proposed regulations, the recreational expenses exception would apply to food or beverage expenses for company holiday parties, annual picnics, or summer outings that do not discriminate in favor of highly compensated employees.

However, the recreational expenses exception would not apply to free food or beverages provided in a breakroom. Regarding these items, the IRS reasoned that the mere provision or availability of food or beverages is not a recreational, social, or similar activity (even if employees may incidentally socialize while in the breakroom).

In addition, the recreational expenses exception would not apply to food or beverage expenses that are excludable as meals provided for the convenience of the employer (under Code Section 119) (26 U.S.C. § 119; see Practice Note, Fringe Benefits Under Code Section 132: Meals for the Employer's Convenience). According to the IRS, these food or beverages are, by definition, provided for the employer's convenience. As a result, they cannot also be primarily for employees' benefit (even if some social activity occurs while such food or beverages are provided).

Proposed Applicability Date; Reliance Permitted

The proposed regulations would apply for tax years beginning on or after the date the rules are published in final form in the Federal Register. Until the rules are finalized, employers may rely on the proposed regulations for entertainment expenditures and food or beverage expenses that are paid or incurred after December 31, 2017. Employers also may rely on Notice 2018-76 until the proposed regulations are finalized.

The IRS requested comments on all aspects of the proposed regulations, and noted some specific issues (for example, the definition of entertainment) for comment.

Practical Impact

In issuing the Notice 2018-76 transitional guidance in October 2018, the IRS indicated that it would eventually also publish proposed regulations on meals and entertainment expenses post-TCJA—including guidance on the deductibility of expenses for business meals. So in that respect the proposed regulations are not a surprise. But the proposals do include some notable provisions, including the IRS's decision to apply the Notice 2018-76 business meal guidance to food or beverage expenses generally. Elsewhere, the proposed regulations' rules on recreational expenses and items available to the public include several specific examples that are helpful in setting out the IRS's position on the deductibility of certain items, even if some of those positions may not be popular with employers (for example, the treatment of breakroom snacks under the recreational expenses proposals).

The comment period for the proposed regulations is relatively short—comments must be received by April 13, 2020.

IRS Business Meal and Entertainment Expense Proposed Rules Address TCJA Requirements, Holiday Parties, Breakroom Snacks, and More (Reliance Permitted) | Practical Law