While the Tax Cuts and Jobs Act clearly changed entertainment expense to make it 100% not deductible, Congress did not actually change as much on the rules revolving around meals (that have a business benefit), yet. There has been little guidance and much speculation, but in October 2020, the IRS finally gave us some final regulations to provide some insight.
There is concern that if a meal is provided solely for the purpose of entertainment, it would become nondeductible as well. I would argue that meeting the IRS’ minimum standards for a meal still allows the deduction. The standards include the following:
- The meal is not lavish/extravagant.
- A substantial business discussion took place before, during, or after the meal
- There was a business purpose for the meal.
- The cost of the meal was not included in an entertainment-type ticket.
- An owner of the business attended the meal.
Therefore, meals can be deducted as a business expense if they are directly related or associated with the active conduct of a trade or business (with a valid purpose and documentation). Once this test is established, the expense falls into two categories: 50 percent deductible or 100 percent deductible. There is an additional caveat that if a meal is considered “lavish and extravagant” under the circumstances, the extra portion attributable to extravagance is not deductible at all. Meals with employees or business partners are only deductible if there is a direct or indirect business purpose. I’ve listed out common items that fall into each category to press down your taxable income!
100 percent deductible meals (no change):
- Meal expenses for a social or recreational event such as company picnic, holiday party, employee recognition, or career development. This is for the employee’s benefit only and is not on the company’s premise, so the employees work more. If there is any benefit for the employer, it becomes limited to 50% as stated below.
- Food made available to the public for free, usually as part of a promotional campaign.
- If the meal’s expense is included as taxable compensation to the employee and included on the W-2, then the expense is fully deductible to the employer.
- If a professional firm bills actual meal expenses separately when invoicing the client and is reimbursed by the client, the actual meal expenses for that engagement are fully deductible. However, if the meal’s expense is included in the invoice, but is not separately stated at actual cost, then those meal expenses are only 50 percent deductible.
- Meals and food that are part of a charity sporting event are fully deductible. To qualify, the event must be organized for the primary purpose of benefiting a 501(c)(3) organization (nonprofit), contribute 100 percent of net proceeds to the organization, and use volunteers for substantially all the work performed in carrying out the event.
- At an entertainment venue where food or beverages are provided to the public, not just employees, for advertising purposes or a sales presentation.
- If the business sells food, employers can still deduct 100% of meals given to employees between, before, or after shifts.
Potentially limited to 50 Percent, per October 2020 final IRS regulations (formerly 100% deductible):
- Office Snacks, including coffee, soft drinks, bottled water, donuts, and similar snacks or beverages provided to employees on the business premises.
- Any meals provided on the employer’s premises for the convenience of the employer. For example, if you are providing meals to employees in order to keep them working late, in your break room, working weekends, or being on call, it is for your convenience to have them at work and the meal is a means of enticement.
50 percent deductible meals (no change):
- Meal expenses for a business meeting of employees, stockholders, agents, and directors. Office meetings and partner meetings fall into this category. If there is no business function to the meal, it is completely nondeductible for tax purposes.
- Generally, any meals during business travel. If a portion of a business trip can be considered personal and not related to the business function of the trip, then a portion of the meals expense should also be considered personal and not deductible.
- Meals at a convention, seminar, or any type of meeting, even if the cost of the meals is not separately stated from the cost of the event. If not separately stated, it must be calculated by the taxpayer based on reasonableness, or per diem rates for that location.
- Meals with people related to the business, such as clients, customers, and vendors, provided that there is a business purpose or some benefit to the business will result.
- Meal expenses by an employee during a business trip, and reimbursed to that employee, are still only deductible at 50 percent, even though the employee was reimbursed 100 percent for the cost of the meals.
- Reimbursements using per diem rates are always only 50 percent deductible. However, if you are reimbursing an independent contractor, it will be added to their 1099 income; therefore, they will be fully deductible and should fall under the general ledger account of Contract Services instead of Meals and Entertainment.
- At an entertainment venue, if a meal was separately charged from any activity that could be considered an entertaining expense (a sporting event, for example), the amount charged for food or beverages on a bill, invoice, or receipt must reflect the venue’s usual selling cost for those items if they were to be purchased separately from the entertainment, or must approximate the reasonable value of those items.
Insider tip from Jackie: It is best to set up three General Ledger accounts for Meals and Entertainment: one for 50 percent deductible meals, one for 100 percent deductible meals, and one for nondeductible entertainment. Focus on industries that can benefit the most from 100% deductions, including food services, ones that provide many public events, or provide social activities that do not benefit the employer.
If this list seems daunting, use this handy flowchart we created at TaxPlanIQ to help guide you and your business clients (subject to change at any time!). In addition, let’s continue the discussion in my Accounting Firm Influencers‘ Facebook group.
Editor’s note: This article was updated with new information on Dec. 2, 2020.