Recent Guidance on Meals & Entertainment Expenses May Impact Your Bottom Line|
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One of the most notable changes to come out of the new tax law passed in 2017 was the significant limitations placed on tax breaks related to meal and entertainment (M&E) expenses; however, the IRS was slow to issue any further guidance or proposed rules. In fact, the first guidance from the IRS on changes to IRS Code Section 274 was issued more than a year ago in IRS Notice 2018-76, and the IRS just recently issued proposed regulations on Friday, Feb. 21, 2020 (REG-100814-19).
Taxpayers who pay or incur expenses for meals or entertainment in taxable years beginning after Dec. 31, 2017, should pay particularly close attention to the proposed regulations, which undertake some notable changes. Specifically, they address eliminating the deduction for business entertainment, which was previously deductible at 50 percent, and also clarify and reduce deductions that were historically deductible at 100 percent, such as break room snacks and internal working meals.
Although the new tax law completely eliminated deductions for entertainment expenses, Congress largely left the provisions for business meals deductions intact. Generally, taxpayers may continue to deduct 50 percent of food and beverage expenses associated with operating their trade or business, including meals consumed by employees on work travel or meals with clients, as long as they maintain proper substantiation. Notably, the same rules still apply, stating that the taxpayer must be present, and the meals may not be lavish or extravagant.
The primary purpose of the newly proposed regulations is to restate the statutory rules and incorporate the guidance previously issued by the IRS in 2018. The proposed rules also provide clarity on specific scenarios taxpayers were previously uncertain about.
Here are some of the key takeaways from the latest issuance by the IRS:
- Taxpayers can deduct the expense of meals incurred with fellow employees, clients, customers, or any external employee at 50 percent, providing that the taxpayer was present, and the meal was not lavish or extravagant.
- Taxpayers can also deduct 50 percent of the cost of meals that are purchased separately from the entertainment, even if the meal took place during a business entertainment activity. The proposed regulations clearly state that the term “entertainment” does not include food or beverages that were separately stated from the entertainment costs; however, a few additional limitations do apply. For instance, taxpayers may not allocate food and beverage expenses apart from entertainment expenses. Furthermore, the food and beverage must be purchased separately from the entertainment activity. At the very least, the cost of food and beverage must be separately stated from the cost of the entertainment on the bill, invoice or receipt.
- In order for the separately stated food and beverage portion to be 50 percent deductible, the taxpayer must be present, and attendees must include employees or non-employees “with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer’s trade or business such as the taxpayer’s customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective” as defined in Section 1.274-2(b)(iii).
- The 50 percent deduction now applies to meals once considered de minimis in nature or provided for the convenience of the employer. Under the old regulations, certain exceptions allowed companies to fully deduct expenses that were de minimis in nature, or, in other words, expenses that were minimal enough that any attempt to account for them would be administratively impractical.
Examples of expenses that were previously considered de minimis in nature include:
- Break room snacks;
- Overtime meals; and
- Meals that were provided for the convenience of the employer, such as when the eating facility was on or nearby work premises.
Due to the de minimis nature of these expenses, they were also excludable from employee income. Per the 2020 proposed regulations, these expenses are no longer fully deductible; they are now also subject to the 50 percent limitation. After the 2025 tax year, meals provided for the convenience of the employer will no longer be deductible at all.
Per the 2020 proposed regulations, certain exceptions still hold true relating to M&E expenses that are treated as compensation, reimbursed, recreational in nature, available to the public, included in the income of non-employees, or considered entertainment sold to customers. Since these exceptions still apply, clients may continue to fully deduct expenses for events like company holiday parties and picnics, assuming these events do not discriminate in favor of highly compensated employees.
- Entertainment expenses are no longer deductible.
- Companies may deduct food and beverage consumed at entertainment events at 50 percent, assuming there was a business purpose.
- Most M&E expenses that were previously 50 percent deductible (i.e. travel meals, general business meals with clients, etc.) remain 50 percent deductible, assuming proper substantiation and documentation is maintained.
- Internal working meals, break room snacks, and training meals may now only be deducted at 50 percent. They are no longer deductible at 100 percent.
- Meals provided for the convenience of the employer may no longer be deductible at 100 percent. They may now be deducted at 50 percent, but these expenses will be completely disallowed after the 2025 tax year.
- Recreational expenses may still be deducted at 100 percent. These expenses include holiday parties, team-building events, company picnics, etc.
- Food and beverage made available to the general public may still be deducted at 100 percent. These expenses include open houses, snacks in waiting rooms, etc.
Looking for guidance on how these M&E changes impact your business? Aprio’s Tax Credits & Incentives team is available to help. Contact Meredith Kowal, partner, at email@example.com.