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.
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.
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 be applied, 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 in IRS Publication 1542 or 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.
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.
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.
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.
The Tax Cuts and Jobs Act has eliminated employer deductions for entertainment, amusement, or recreation expenses, even if they serve a business purpose. The following applied to tax years before 2018.
Goodwill entertainment is entertainment that often accompanies a business discussion and is generally deductible if the main purpose and accomplishment of the meeting was to have a substantial, bona fide business discussion. Entertainment and business discussions must be within 1 day of each other unless a longer interval is reasonable. Entertainment costs for the spouses are generally deductible if the cost of the business associates is deductible, especially for out-of-town customers or potential clients. Home entertainment may also be deductible as long as it was primarily for business, and not social. The taxpayer should keep a record of the names of guests, and their business affiliation or relationship to indicate business motive, and a record of the entertainment costs to support deductibility.
There are many forms of entertainment, that because of their nature or because of the environment that they create, are not conducive to promoting business or where it is clear that there is not a primary business motive for providing the entertainment. Thus, ownership and maintenance of entertainment facilities or clubs are not deductible since they are not considered business facilities and would mostly be used for recreation. Meals at those facilities may be deductible, however.
Club dues, such as for country clubs and athletic clubs are generally not deductible, since dues cover an extended duration and the primary purpose of these clubs is for recreation. Hence, a primary business motive is unlikely. However, there are some exceptions, such as for:
- civic or public service organizations, such as Kiwanis or Rotary clubs
- professionals associations
- Chambers of commerce or trade associations or
- any other type of organization for a business whose main purpose is not to provide entertainment for members or guests.
The deductibility of tickets to entertainment events is limited to their face value, so any excess amounts paid to ticket agencies or scalpers are not deductible, unless the tickets are for a qualifying charitable sporting event.
Skybox rentals provide luxury seating areas at sports arenas. Their deductibility is subject to the 50% rule as are any separate charges for food or beverages. The rental of the skybox is limited to 50% of the rental if it is for only one game. However, if the rental covers more than 1 game on separate days or a series of games, then the deduction is limited to 50% of what the same number of regular seats would cost. So if a skybox had 10 seats, and regular seats would cost $100 per seat for a series of games, then the skybox deduction would be equal to 50% of the $1000 of the cost of the 10 regular seats.
Lodging, Entertainment, and Meals Provided as Part of Entertainment
Entertainment and meals provided as part of an entertainment setting are also subject to the 50% rule. Lodging charges are fully deductible but if they include meals, then the taxpayer must allocate a portion of the cost of meals to apply the 50% rule. An employee receiving a per diem allowance does not have to allocate expenses between meals and lodging if the employee is reimbursed from an accountable plan. However, expenses must be allocated if the employee wants to deduct any expenses exceeding reimbursement.
There are certain exceptions to the 50% rule:
- meals provided as compensation to employees or independent contractors;
- meals and entertainment provided to the public for advertising or the promotion of goodwill;
- meals and entertainment sold to the public as a business, such as a restaurant or a nightclub;
- meals provided to employees as a tax-free de minimis fringe benefit, but only if more than half of the employees are provided the meals as a convenience to the employer on the employer's premises;
- tickets to charitable sports events if:
- they benefit a tax exempt organization;
- the organization receives 100% of the proceeds; and
- volunteers do most of the work at the event.
There are 3 tests to determine the deductibility of dining and entertainment costs:
- generally related to business test;
- expenses incurred in a clear business setting; or
- expenses incurred for services performed.
If the tests are not satisfied, then they may qualify under the goodwill entertainment rules that require a business discussion either before or after the entertainment.
The generally related to business test requires a clear business motive, such as an expectation of getting future income or some other business benefit, but the taxpayer does not have to prove that it actually increased business, although it would certainly support the claim.
A clear business setting means that the people being entertained are not related to the taxpayer, and there is no motive other than to further the taxpayer's business. The clear business setting test is not met if:
- the taxpayer is not present during the entertainment;
- the event itself is too distracting to allow easy discussion; or
- the taxpayer meets with people other than those who can further the taxpayer's business, such as friends.
The services performed test is satisfied if the expense was directly or indirectly related to the benefit of an existing customer or an employee who received taxable compensation for the services or received a taxable prize or award. So the services performed test is satisfied if an insurance company rewards its top salespeople who meet sales quota by giving them a free trip to Aruba.
Under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, employer deductions are disallowed 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).