Meals, Entertainment, and Gift Deductions

Although meals and entertainment expenses related to business are deductible, the deduction is limited to 50% of its cost. Previous to the 2017 Tax Cuts and Jobs Act (TCJA), employees could also deduct meal and entertainment expenses, but the 50% deduction was further limited to the 2% AGI floor for miscellaneous itemized deductions, but the 2017 TCJA eliminated this deduction.

The expenses must be directly related for promoting business and they must be ordinary and necessary expenses, which are expenses that are usually incurred by a particular type of business or to promote a business, such as being a participant in a parade. Expenses for goodwill entertainment are also deductible if a bona fide business discussion either directly preceded or succeeded the entertainment.

The Tax Cuts and Jobs Act disallows employer deductions for the following, even if they serve a business purpose:

• expenses for entertainment, amusement, or recreation
• membership dues for clubs organized for business or social purposes, or expenses for a facility used for such purposes, even if the activity relates to trade or business
• expenses incurred by transportation fringe benefits or from providing transportation for commuting (except for employee safety).

Meal Expenses While Traveling

A taxpayer can deduct meal expenses as part of an entertainment setting for business associates or clients, even if the dining occurs in the taxpayer's tax home unless the taxpayer claims an excessive amount habitually, in which case a stricter Tax Court rule, known as the Sutter rule, will apply, allowing the taxpayer to only deduct meal costs that exceeded what would normally be spent.

However, meals eaten while traveling on business are deductible only if they are eaten away from the tax home and only if the business trip involves an overnight stay. Travel meals can be deducted either as ½ of actual costs, including taxes + tips, or ½ of the federal per diem rate allowed to federal employees while traveling. The per diem rate varies according to the location of travel, but ranges between $45 and $75. If the cost of the meals does not exceed ½ of the per diem rate, then the entire cost of the meals can be deducted by claiming the per diem rate. Indeed, if the meals are less than ½ of the per diem rate, then not only can the entire cost be deducted, but the taxpayer can even receive a small handout from the government by being able to claim more than 100% of the meal expense! If their per diem rate is chosen, then receipts of actual costs do not have to be kept but the taxpayer must substantiate the travel. Note, too, that if the per diem method is chosen, then it must be used to deduct all travel meals for the year and it can only be applied to deductible meals while traveling, not to meals eaten in an entertainment setting. Current per diem rates can be found by using the database at the US General Services Administration (GSA) Per Diem Rates, where rates for specific locales can be found by entering the city and state or the ZIP Code or by clicking on the map.

The 50% deduction limit does not apply to employers if they include the reimbursements as taxable compensation, since the employees will pay both ordinary and employment taxes on the compensation; otherwise, the 50% rule applies. The 50% rule also applies to sales taxes on meals and tips. Workers subject to the Department of Transportation's hours of service limits can deduct 80% of their meals.

Employee Meals

Meals provided to employees and their spouses or children are 100% deductible by the employer and not includible in the pay of the employees if they fall into the following categories:

• Employer convenience, where the business requires the employee's presence, such as for a business meeting or to work longer for the holidays. However, meals to owners, officers, and 10% shareholders are not deductible unless they are for a business meeting.
• Employer events, where the business provides a recreational or social activity, such as a holiday party. However the expenses must be reasonable.
• Nominal gifts of food, such as providing employees with a turkey at Thanksgiving.
• General provision of food that is not provided to any specific employee, such as snacks or soda set on the table for general consumption.
• Meals provided to employees of restaurants, non-luxury water vessels, and offshore or Alaskan oil rigs.

However, meals provided as a reward or incentive are considered compensation, so the expense is only deductible by including it in the employees' income. Furthermore, reimbursements or cash advances for food are not deductible under this provision.

Business Gifts

The deduction for business gifts, whether given directly or indirectly, is limited to $25 per business for each donee, even if the business is a partnership or a sole proprietorship where the spouses are co-proprietors. The $25 limitation does not apply to incidental expenses, such as wrapping, insuring, mailing, or delivering the gift unless the wrapping is ornamental and has substantial value over what it contains. Incidental expenses are those that do not add significant value to the gift. An indirect gift is not given directly to the business customer or client, but who, nonetheless, benefits from it, such as giving the gift to a spouse.

There is a higher limitation of deductibility for gifts to employees. If the award is for length of service or for safety and it is given under a qualified plan, which is a written plan or program that does not discriminate in favor of highly compensated employees and in which the average cost of all awards given to employees during the year does not exceed $400, then the deductibility limit is $1600 for the year. If the gift is not given under a qualified plan, then the deduction limit is $400. If an employee receives both qualified and nonqualified awards during the year, then the $1600 limit applies overall. However, any length-of-service award must be for at least 5 years of employment. Any amounts below the deductible limits are not taxable to the employee; otherwise, the excess is taxable to the employee as wages.

Recordkeeping Requirements

Generally, the IRS requires a record of the deductible expenses, including the

• time and place of the expenditure
• business purpose of the expense
• names of people involved in the transaction, such as those being entertained.

Credit card statements are adequate for simple expenditures, but not for expenditures where the payment may be for more than 1 thing, such as lodging, because it can also include phone calls or other hotel services. Therefore, the taxpayer must keep actual receipts for lodging.

The taxpayer must keep an account book or a computer log of expenditures. The log entries do not have to repeat the information on the receipts, but there should be some reference to the receipt in the account book or the computer records. Receipts for most expenditures of $75 or less do not have to be kept, but an adequate record of the expense should be maintained.

In certain cases, if the taxpayer incurs periodic expenses that do not vary significantly over time, then support for these deductions can be done through sampling a representative time period and then using that figure for the rest of the year.

If records are inadequate, then deductions may be disallowed. However, there are several exceptions where the IRS may allow the deductions even without adequate records:

• If there is substantial compliance with IRS rules, then the deductions will generally be acceptable, even if there is some information missing.
• If records are accidentally destroyed through no fault of the taxpayer, then the IRS will accept a reconstruction of the records.
• Additionally, if the taxpayer does not have the records because of what the IRS calls the inherent nature of the situation, then the IRS may accept the best evidence, such as testimony from people who benefited from the transaction or from other evidence. However, the IRS never defines this phrase, but it would seem reasonable to suppose that it means that records were not kept because none were attainable because of the nature of the transaction.

Historical Notes

For 2021 and 2022 only, the Consolidated Appropriations Act for 2021 (H.R. 133), signed into law on December 27, 2020, provides a 100% business deduction for food and beverage expenses, including carryout or delivered meals from a restaurant, but the expense may not be lavish or extravagant. After 2022, the deduction is reduced to the 50% deduction that applied previously. A restaurant is any business establishment that prepares food and beverages for immediate consumption, even if the victuals are catered, delivered, or sold as take-out. Restaurants do not include businesses that sell food and beverages packaged for later consumption, such as grocery stores, liquor stores, convenience stores, and vending machines.

According to Notice 2021-63, an individual may also treat the full meals portion of a per diem rate or allowance paid or incurred in 2021 or 2022 as being attributable to food or beverages provided by a restaurant. So employers and self-employed taxpayers may deduct 100%, rather than 50%, of the meals portion of the applicable per diem rate.