Monday, March 9, 2020
Many farming and ranching operations provide meals for employees and receive a tax-break for doing so. But, the late 2017 tax law – the Tax Cuts and Jobs act (TCJA) modified the rules. In 2018, the IRS provided guidance on changed rules and how to distinguish between deductible meals and entertainment expense which is no longer deductible under the TCJA. That guidance was issued as a precursor to formal regulations on the issue. Now the Treasury Department has issued proposed regulations addressing the TCJA changes and where the lines are to be drawn.
Meal and entertainment expense tax treatment – that’s the topic of today’s post.
Line-Drawing – The TCJA
Meals. As noted above, the TCJA changed the rules on deductible meals and entertainment. For farming and operations, the tax rules governing meals often comes into play at harvest. An example would be for part-time workers that are employed at times of planting and harvest. These part-time employees may be fed lunches on the farm. Before 2018, meals were normally deductible to an employer at 50 percent of the cost of the meals. But, where the meals are provided on the employer’s premises (i.e., at the farm) and for the convenience of the employer, the meals are 100 percent deductible by the employer and the employees do not have to report any of the amount of the meals as income. The 100 percent deduction is because farm workers generally work in remote areas where eating facilities are not near, and the farm employer finds it a more productive use of time to supply meals at the farm.
Under the TCJA, the 50 percent rule still generally applies to allow an employer to deduct 50 percent of the (non-extravagant) food and beverage expenses associated with operating the business (e.g., meals consumed by employees on work travel). I.R.C. §274(k). But, for amounts incurred and paid after Dec. 31, 2017, and until Dec. 31, 2025, the TCJA expands the 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. I.R.C. §274(n)(1). That means that the 100 percent deduction for the meals provided the part-time farm employees in the above example is reduced to 50 percent. The 50 percent limitation remains in place through 2025 for meals (food and beverages) that aren’t “lavish or extravagant” and the taxpayer or employee of the taxpayer is present when the meal is furnished. I.R.C. §274(k)(2). Of course, the 50 percent cut-down can be avoided by treating the food and beverages as compensation to the employee (i.e., wages for withholding purposes).
After 2025, none of the cost of meals is deductible.
Entertainment. Through 2017, deductions for entertainment were generally disallowed unless they were directly related to the taxpayer’s business or directly preceded or followed a substantial bona fide business discussion. In those instances, entertainment expenses were deductible at the 50 percent level. Under the TCJA, effective for tax years after 2017, no deduction is allowed for any activity that is generally considered to be entertainment, amusement, or recreation that is purchased as a business expense. Likewise, no deduction is allowed for membership dues for any club organized for business, pleasure, recreation, or other social purposes. Similarly, no deduction is allowed associated with a facility or portion thereof used in connection with the provision of entertainment, amusement or recreation.
But what if meals and entertainment are interconnected in a business context? As noted, before 2018, 50 percent of the cost of business meals and entertainment purchased for business purposes was deductible. Now, entertainment expenses are not deductible even if they are incurred in a business context, unless they can satisfy an exception contained in I.R.C. §274(e). This creates an issue of how to distinguish between deductible meals and non-deductible entertainment when they are provided together. Clearly, taxpayers have an incentive under the TCJA for categorize expenses as “meals” rather than “entertainment.”
In 2018, the IRS issued Notice 2018-76, 2018-42 IRB to assist taxpayers in determining where the line was between deductible meals and nondeductible entertainment. The guidance in the Notice can be relied on until final regulations are issued.
The notice clarifies that taxpayers may deduct 50 percent of a business meal expense that meets these five requirements:
- The expense must be an ordinary and necessary expense business expenses as defined by I.R.C. §162(a);
- The expense must not be “lavish or extravagant” based on the particular situation;
- The taxpayer, or an employee of the taxpayer, must be present at the “meal”;
- The meal must be provided to a current or potential business customer, client, consultant, or similar business contact; and
- If the meal is provided in conjunction with entertainment, the meal expenses must be “stated separately” from the entertainment expenses.
Based on the Notice, it’s clear that meals expenses should not be inflated to make up for the loss of entertainment-related deductions. Separately purchasing meals and entertainment is important. The deduction for meals can be lost if the meals and entertainment are purchased together unless the “stated separately” requirement is satisfied.
On February 21, 2020, the IRS issued proposed regulations on the deductible meal/nondeductible entertainment issue. REG-100814-19. The proposed regulations generally follow Notice 2018-76, which can be relied upon until the regulations are finalized. Under the proposed regulations, taxpayers may deduct 50% of an otherwise allowable business meal expense if:
- The expense is an ordinary and necessary business expense under Sec. 162(a) paid or incurred during the tax year when carrying on any trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer or an employee of the taxpayer is present when the food and beverages are furnished;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- For food and beverages provided during or at an entertainment activity, they are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
“Food or beverage” expense is defined as “…all food and beverage items, regardless of whether characterized as meals, snacks or other types of food and beverages, and regardless of whether the food and beverages are treated as de minimis fringes under section 132(e). Prop. Treas. Reg. §1.274-12(b)(1). When food and beverages are provided to a potential business contact, the food and beverages must be provided to a “person 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.” Prop. Treas. Reg. §1.274-12(b)(3). The proposed regulations also apply this standard to employer-provided meals and when meals are provided to employees and nonemployee business associates at the same event.
To provide a means for IRS to determined that food and beverage costs have not been inflated, the proposed regulations require that the venue’s typical selling cost for items the food and beverages sold must be listed if they were purchased apart from any entertainment. Prop. Treas. Reg. §1.274-11(b)(1)(ii). If the typical selling price is not listed, the reasonable approximate value must be provided. However, the proposed regulations also state that if a single invoice is used for food and beverage costs and entertainment, the amount for food and beverages must be billed separately to be eligible for any deduction. Id.
So what is nondeductible “entertainment” under the proposed regulations? It’s “any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at bars, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family.” Prop. Treas. Reg. §1.274-11(b)(1)(i). It doesn’t matter that expenses for such activities is associated with the taxpayer’s trade or business – it’s still “entertainment.” “Entertainment” can also include activities that fall within the definition that are engaged in to satisfy personal living needs of the taxpayer and the taxpayer’s family. Thus, for example, the expenses associated with the spring fishing trip on Lake Michigan to provide salmon for the family for the next year could now be nondeductible entertainment expenses. But what about the cost of the two-week pack trip into the Teton Wilderness Area with clients and potential clients? Is that cost now fully nondeductible?
TCJA changed the rules for deducting meals and entertainment. Of course, substantiating meal expenses is key, and some meals remain 100 percent deductible under specific exceptions contained in I.R.C. §274(e). See I.R.C. §274(d). The proposed regulations are voluminous, contain many examples and are now subject to a public comment period. The IRS will hold a public hearing on comments received on April 7, 2020 in Washington, D.C. After the hearing, the proposed rules could become finalized. The proposed regulations apply to tax years beginning on or after the date they are published in the Federal Register as final regulations. Before that time, however, they can be relied on for expenses incurred after 2017. Also, taxpayers can continue to rely on Notice 2018-76 until the proposed regulations are finalized.