On December 22, 2017, the President signed into law the legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “TCJA” or “Act”)[1]. The Act cut the top corporate tax rate from 35% to 21% and the top individual rate from 39.6% to 37%. In addition, the Act modified various provisions of the Internal Revenue Code (“IRC” or the “Code”), including Section 274, which disallows the deduction of certain expenses.
Prior to the Act, Section 274(a) denied an otherwise allowable deduction for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer established under Section 274(a)(1)(A) that either:
Additionally, Section 274(k)(1) provided that a deduction for the expense of food and beverages incurred during business meals would not be allowed unless:
Section 274(n)(1) limited the deduction for expenses paid or incurred for entertainment and/or food and beverages to 50%.[3] Therefore, under prior law, taxpayers could deduct 50% of entertainment expenses that met the “directly related or associated with” language of prior Section 274(a)(1)(A), as well as 50% of expenses paid or incurred for food and beverages in the course of customary business meals.
The Act modified Section 274(a)(1)(A) by eliminating the "directly related or associated with" language and amended Section 274(n)(1) to remove the reference to entertainment expenses. As a result, for tax years beginning after December 31, 2017, Section 274(a) denies a deduction for any expenses paid or incurred with respect to an activity considered to constitute entertainment, amusement, or recreation (collectively referred to as “entertainment expenses”).
The Act’s elimination of any deduction for entertainment expenses raised a critical question as to whether the modification also eliminated the deduction for food and beverages expenses incurred during customary business meals, which would include customary client business meals and customary business associate meals during which business is discussed. Newly released Notice 2018-76 (the “Notice”) provides updated guidance as to the deductibility of food and beverages for tax years beginning after December 31, 2017.
In the case of food and beverages provided during or at an entertainment activity, the food and beverages 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. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
The Notice clarifies the application of the provision with three examples, as described below.
In example 1, a taxpayer entertains a business contact at a baseball game and separately purchases food and beverages at the game. The cost of the food and beverages is 50% deductible, while the game tickets are not deductible.
In example 2, a taxpayer entertains a business contact at a basketball game in a stadium suite. The cost of the basketball tickets includes the cost of food and beverages, and the invoice for the suite does not separately state the cost of the food and beverages. The game tickets are non-deductible as they constitute an entertainment expense. Since the cost of food and beverages is included in the cost of the basketball tickets and not separately stated on the invoice, the cost of the food and beverages is also not deductible.
In example 3, a taxpayer again entertains a business contact at a basketball game in a stadium suite. However, the stadium suite invoice separately states the cost of food and beverages. As a result, the costs of the food and beverages is 50% deductible. The cost of the basketball tickets remains non-deductible as an entertainment expense.
While the Notice provides taxpayer favorable guidance, taxpayers need to remain diligent in their documentation of food and beverage expenses, as required by Section 274 and the related regulations.
Taxpayers who seek to deduct expenses paid or incurred for food and beverages during business entertainment will want to ensure that they receive documentation, e.g. invoice or receipts, that separately state the cost of the food and beverages. Moreover, unless otherwise changed in future regulations, the substantiation requirements under Treas. Reg. § 1.274-5T(b)(3) (business purpose and business relationship documentation) continue to be required. Finally, taxpayers will also want to ensure that their accounting systems properly segregate such costs from entertainment costs which remain non-deductible.
[2] IRC § 274(a)(1)(A), prior to the passage of the TCJA.
[3] In addition, the taxpayer had to meet the documentation substantiation requirement under IRC § 274(d).
[4] The Notice discusses Treas. Reg. § 1.274-2(b)(1) which clarifies the definition of “entertainment.” The Notice further clarifies that the Act did not change the definition of “entertainment” under Section 274(a)(1), and thus such regulations continue to apply. While the Act did not address the circumstances in which the food and beverages might constitute entertainment, the Notice asserts that the legislative history of the Act clarifies that taxpayers generally may continue to deduct 50% of food and beverage expenses associated with operating their trades or businesses.