The Tax Cuts and Jobs Act (TCJA) permanently eliminated deductions for most business-related entertainment expenses paid or incurred after 2017. For example, taxpayers can no longer deduct any of the cost of taking clients out for a round of golf, to the theater or for a football game. Taxpayers responded to these changes by implementing changes to accounting systems and reimbursement policies to comply with new rules. But the TCJA didn’t specifically address the meals, beverages and snacks that often accompany entertainment activities, leaving some taxpayers with questions.
Adding to the complexity, the Consolidated Appropriations Act (CAA), which was signed into at law in December of 2020, temporarily increased the deduction for certain business-related meal expenses. As part of initiative designed to encourage purchases from restaurants hard hit by the COVID-19 pandemic, the IRS issued Notice 2021-25 which allows a temporary 100-percent deduction on business meals purchased during tax years 2021 and 2022 and provides further clarification on what is deductible.
If you’re like many business owners today, you may need some clarification on what you can deduct or how much you can deduct. Here’s what you need to know.
A 100% Deduction
The CAA allows taxpayers to deduct 100% of the cost of business-related food and beverage expenses incurred at restaurants in 2021 and 2022. In previous years, deductions for business meals at restaurants were limited to only 50% of the cost.
Under the new law, for 2021 and 2022, business meals provided by restaurants are 100% deductible, subject to the considerations identified in preexisting IRS regulations. IRS guidance in Notice 2021-25, released in April, defines “restaurants” for the purpose of this tax break to include businesses that prepare and sell food or beverages to retail customers for immediate on-premises and/or off-premises consumption.
However, restaurants don’t include businesses that primarily sell pre-packaged goods not for immediate consumption, such as grocery stores and convenience stores. Additionally, an employer may not treat certain employer-operated eating facilities as restaurants, even if these facilities are operated by a third party under contract with the employer.
In October 2020, the IRS issued final regulations which clarified that taxpayers could still deduct 50% of business-related meal expenses under the TCJA. These regs were written before the CAA change that allows 100% deductions for business-related restaurant meals provided in 2021 and 2022, but they still provide some useful guidance on the following issues:
- Definition of food and beverage costs: Food or beverages means all food and beverage items, regardless of whether they are characterized as meals, snacks or other types of food and beverages. Food or beverage costs mean the full cost of food or beverages, including any delivery fees, tips and sales tax.
- Treatment of food and beverages provided with entertainment: For purposes of the general disallowance rule for entertainment expenses, the term “entertainment” includes food or beverages only if the food or beverages are provided at or during an entertainment activity (such as a sporting event) and the costs of the food or beverages aren’t separately stated.
Specifically, to be deductible, amounts paid for food and beverages provided at or during an entertainment activity must be:
- Purchased separately from the entertainment, or
- Stated separately on a bill, invoice or receipt that reflects the venue’s usual selling price for such items if they were purchased separately from the entertainment or the approximate reasonable value of the items.
Otherwise, the entire cost is treated as a nondeductible entertainment expense; the taxpayer can’t attempt to allocate costs between the entertainment and the food or beverages.
An example the IRS provides is as follows: Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B. The baseball game is entertainment, and thus not deductible to the taxpayer. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense and thus the taxpayer may deduct 50% of the expenses associated with the hot dogs and drinks purchased at the game.
Note that if the meal and game had been purchased on the same ticket whichdid not separately state the amount for the meal, none of the expense would be deductible. If the food is separately stated and meets the criteria above, then it is deductible.
Treatment of Business Meals
Under the final regs, a deduction is allowed for business-related food or beverages only if:
- The expense isn’t lavish or extravagant under the circumstances,
- The taxpayer or an employee of the taxpayer is present at the furnishing of the food or beverages, and
- The food or beverages are provided to the taxpayer or a business associate.
A business associate means a person with whom the taxpayer could reasonably expect to engage or deal with in the active conduct of the taxpayer’s business such as a customer, client, supplier, employee, agent, partner or professional advisor — whether established or prospective.
Treatment of Meals While Traveling on Business
While there are instances when spouses or others may be included, te regulations reiterate the long-standing rule that no deductions are allowed for personal meal expenses incurred for spouses, dependents or other individuals accompanying the taxpayer on business travel (or accompanying an officer or employee of the taxpayer on business travel). One exception is where the expenses would otherwise be deductible by the spouse, dependent or other individual. For example, meal expenses for the taxpayer’s spouse would be deductible if the spouse works in the taxpayer’s unincorporated business and accompanies the taxpayer for business reasons.
Under the new law, for 2021 and 2022, meals provided by restaurants while traveling on business are 100% deductible, subject to the preceding considerations.
Taxpayers should be aware that state treatment for meals and entertainment may differ from the current federal treatment and may require an adjustment to state taxable income. For example, California has stated that California does not conform to the temporary elimination of the 50 percent limitation on the deduction of expenses for food or beverages provided by a restaurant that are paid or incurred after 12/31/2020, and before 1/1/2023. However, states such as Georgia which conform to the IRC through Jan 1, 2021 and which include conformity to the Consolidated Appropriates Act, will not require an addback. Since state laws and conformity differ, states must be looked at on an individual basis.
Taxpayers should revisit their internal policies and accounting for meals and entertainment in light of the recent changes made by the IRS. Taxpayers should ensure that they have appropriate documentation to claim deductions and should consider potential state differences in treatment. Taxpayers should consider separately paying for meals when incurred together with entertainment in order to maximize deductibility.