Of the many changes to the tax law made by P.L. 115-97, known as the Tax Cuts and Jobs Act of 2017 (TCJA), few are more confusing to taxpayers and tax practitioners alike than the changes made to the meals and entertainment deduction. This article seeks to clarify some of the confusion.
Under pre-TCJA law, 50% of entertainment expenses were deductible under certain circumstances. The requirements included (1) that the expenditure be “directly related to” the active conduct of the taxpayer’s trade or business, or (2) that the expenditure be “associated with” the active conduct of the taxpayer’s trade or business, where the expenditure either “directly preceded or followed a substantial and bona fide business discussion (including business meetings at a convention or otherwise).” These requirements were outlined in former Sec. 274(a)(1).
Regulations issued by Treasury tracked the statutory language, broadly defining “entertainment” as “any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, 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” (Regs. Sec. 1.274-2(b)(1)(i)).
The regulations continue to provide that “the term entertainment may include an activity, the cost of which is claimed as a business expense by the taxpayer, which satisfies the personal, living, or family needs of any individual, such as providing food and beverages, a hotel suite, or an automobile to a business customer or his family” (Regs. Sec. 1.274-2(b)(1)(i)).
Under pre-TCJA law, most litigation focused on whether the “directly related to” or “associated with” prongs of the statute were satisfied. The phrase quoted in the paragraph directly above this paragraph, despite being included in a regulation that is presumably authoritative, has apparently never been quoted by any court in arriving at its decision. Yet, the regulation would appear to support the IRS in post-TCJA litigation more than it would in pre-TCJA litigation.
The TCJA removed the “directly related to” and “associated with” language in the statute — now, the statute simply reads, “No deduction otherwise allowable under this chapter shall be allowed for any item — with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation” (Sec. 274(a)(1)). While the contingency for deduction of expenses in the case of night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacations, and similar trips would appear to be clearly removed for post-TCJA expenses, the deduction for expenses for meals associated with business meetings are not so clearly determined.
A brief history of Sec. 274 and business meals
Sec. 274 is a disallowance provision and begins with the assumption that expenses are deductible under Sec. 162, as ordinary and necessary trade or business expenses, or Sec. 212, as expenses for the production of income. Sec. 274 does not provide for a deduction, but rather, limits the scope of otherwise allowable deductions and imposes additional qualifications.
In 1961, President John F. Kennedy proposed eliminating all income tax deductions for expenses for entertainment activities and facilities (see Joint Committee on Taxation, Tax Reduction and Reform Proposals—5: Business Expense Deductions (JCS-14-78), p. 8 (April 18, 1978)). In the Revenue Act of 1962, P.L. 87-834, Congress enacted Sec. 274, which included Sec. 274(a), containing the same language cited above from 1962 until 2017.
Against that backdrop, Treasury promulgated the regulations quoted in the introductory paragraphs, above. Those regulations were effective on June 25, 1963.
Shortly thereafter, the Service issued Rev. Rul. 63-144. In Q&A 7, the Service provides that “entertainment” includes “any expense for meals purchased for a business customer.” Read in its entirety, Rev. Rul. 63-144 supports claiming business meals as deductions, but the reasoning supporting business meals as deductions has been removed with the statutory changes in the TCJA. At this point, Rev. Rul. 63-144 is most authoritative for the conclusion that business meals are “entertainment” and included in the prohibition under Sec. 274(a)(1), unless an exception under Sec. 274(e) applies.
Sec. 274(e)(1), as originally enacted in the Revenue Act of 1962, initially contained an exception to Sec. 274(a)(1) for business meals. The statute originally read:
Expenses for food and beverages furnished to any individual under circumstances which (taking into account the surroundings in which furnished, the taxpayer’s trade, business, or income-producing activity and the relationship to such trade, business, or activity of the persons to whom the food and beverage are furnished) are of a type generally considered to be conducive to a business discussion.
All the provisions found in Sec. 274(e) are exceptions to Sec. 274(a). If Sec. 274(e) applies, then under pre-TCJA law, the taxpayer does not need to meet the Sec. 274(a)(1) requirements. Against this backdrop, taxpayers were successful in litigating business meal expenses even where there was no proof of any business discussion carried on by the taxpayer and his or her guests (see Steel, 437 F.2d 71 (2d Cir. 1971); Howard, T.C. Memo. 1981-250).
Concerned about abuses of the deduction, in the Tax Reform Act of 1986, P.L. 99-514, Congress removed Sec. 274(e)(1)’s “business meals” exception from the list of provisions exempt from Sec. 274(a)(1). The Conference Report to the Tax Reform Act of 1986 recognized that “deductions for meals are subject to the same business-connection requirement as applies under present law for other entertainment expenses.” This reflects the congressional view that business meals are deductible only under Sec. 274(a)(1) because they constitute “entertainment.”
Accordingly, Sec. 274(e)(1) relating to business meals was removed in 1986, and business meals became subject solely to Sec. 274(a)(1) as “entertainment.” Unless another exception in Sec. 274(e) applies, business meals are no longer deductible under the pre-TCJA version of the statute.
Do any other Sec. 274(e) provisions apply to avoid the Sec. 274(a) nondeductibility provisions if the expense involves a client or customer meal?
First, Sec. 274(e)(1) excludes from Sec. 274(a) those expenses incurred for “food and beverages (and facilities used in connection therewith) furnished on the business premises of the taxpayer primarily for his employees.” Seizing upon the word “primarily,” the regulations proceed to recite the statutory language that “the exception applies even though guests are occasionally served in the cafeteria or dining room” (Regs. Sec. 1.274-2(f)(2)(ii)).
Therefore, meals provided to guests — even business guests — would qualify as a deduction despite the passage of the TCJA, as long as they are furnished on the business premises, and so long as the costs incurred (as a whole) are primarily for employees. There is no need to segregate expenses for food and beverages provided to guests.
Sec. 274(e)(5) also provides an exception to nondeductibility for “employee, stockholder, etc., business meetings.” Once again, the regulation contains and expands upon the language of the statute:
Any expenditure by a taxpayer for entertainment which is directly related to bona fide business meetings of the taxpayer’s employees, stockholders, agents, or directors held principally for discussion of trade or business is not subject to the limitations on allowability of deductions provided for in paragraphs (a) through (e) of this section… For example, an expenditure by a taxpayer to furnish refreshments to his employees at a bona fide meeting, sponsored by the taxpayer for the principal purpose of instructing them with respect to a new procedure for conducting his business, would be within the provisions of this exception. A similar expenditure made at a bona fide meeting of stockholders of the taxpayer for the election of directors and discussion of corporate affairs would also be within the provisions of this exception… A meeting under circumstances where there was little or no possibility of engaging in the active conduct of trade or business (as described in paragraph (c)(7) of this section) generally will not be considered a business meeting for purposes of this subdivision. [Regs. Sec. 1.274-2(f)(2)(vi)]
The regulation expands the class to include those individuals who are “employees, stockholders, agents, or directors.” As such, so long as those individuals are meeting for business purposes, the expenses are allowable.
The statute and regulations do not address whether third parties may be present at such a meeting. Presumably, so long as the meeting withstands scrutiny as a “bona fide business meeting,” expenses related to the employee are allowable. Where a single employee meets with a business client, however, it would appear very difficult to conclude that the meeting was a “bona fide business meeting … of the taxpayer’s employees, stockholders, agents, or directors.” Where multiple employees are involved, there at least exists the mathematical possibility.
Can business meals still be deducted post-TCJA?
Overlooked by many commentators are the new provisions in the TCJA, which disallow expenses for business meals. The occasional business meal on the employer’s premises may still be deductible. A meal accompanying a business meeting of employees may be deductible — but, given the fact that business meals were specifically removed from the Code in 1986 due to perceived abuses, taxpayers should tread lightly when invoking this exception.