While your business may not have accumulated many meal and entertainment (M&E) expenses over the last 18 months, it’s important to keep track of the latest IRS rule changes. Your tax advisor will be able to tell you exactly how IRS Notice 2021-25 affects your organization, but a general overview can be found below:
Ongoing Changes to M&E Deductions
The Tax Cut and Jobs Act (TCJA), signed into law at the end of 2017, eliminated most deductions for entertainment-related expenses for a taxpayer’s trade or business. There are a few exceptions—more about those in a moment—but most business-related entertainment expenses are no longer deductible.
On the other hand, the TCJA retained the 50 percent deduction for business-related food and beverage expenses. This meant that, after December 31, 2017, a taxpayer who took a client out for a round of golf and dinner could not deduct any expenses for the golf game but could deduct half the cost of the dinner.
After the COVID-19 pandemic ravaged the restaurant industry in 2020, Congress promoted increased business spending at restaurants by liberalizing the meals deduction. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, which was enacted as part of the Consolidated Appropriations Act for 2021, temporarily amended the M&E provisions to allow for a 100 percent deduction for any business-related food or beverages that are provided by a restaurant after December 31, 2020, and before January 1, 2023.
Currently, a taxpayer who takes a client out for a round of golf and dinner is still not permitted to deduct any expenses related to the game but can deduct the full cost of the dinner. Note, however, that the 100 percent meals deduction is effective only in 2021 and 2022 and is subject to other restrictions and limitations, as detailed in the recent IRS guidance.
Current IRS Guidance on Food and Beverage Expense
IRS Notice 2021-25 explains when the temporary 100 percent meals deduction applies versus the standard 50 percent limit. For example, the notice defines the term “restaurant” as a business that prepares and sells food or beverages to retail customers for immediate consumption regardless of whether the food or beverages are consumed on the business’s premises. Such purchases (including delivery fees and tips) are generally eligible for the temporary 100 percent deduction.
The notice specifically excludes businesses such as grocery stores, liquor stores, drug stores, convenience stores, newsstands, or kiosks, which primarily sell prepackaged food or beverages not for immediate consumption. Business-related food or beverages purchased from such non-restaurant establishments remain limited to the standard 50 percent deduction.
In addition, any food and beverage facility located on the business’s premises, such as an employee cafeteria, is also not considered a restaurant for purposes of the 100 percent deduction. So, for example, if an employer provides meals for a company meeting or employee training session, it could deduct 100 percent of the cost of those meals if they are brought in from a restaurant but only 50 percent if the meals are provided by the company cafeteria.
When a business is hosting clients or prospective clients, food and beverage costs are deductible only if the taxpayer or an employee is present at the meal and only if the expenses are “not lavish or extravagant under the circumstances.”
Deductible Entertainment Expenses
Although the TCJA effectively ended most entertainment deductions, there are still exceptions. For example, a business generally can deduct 100 percent of both meal and entertainment expenses for social events such as company picnics or holiday parties that are open to all employees. The same is true for events that are open to the general public, such as a grand opening or other promotional event.
Businesses can also deduct 100 percent of food, beverage, and entertainment expenses that are reported as taxable income to the recipients. Examples include employee performance incentives or contest prizes such as free trips or concert tickets as long as they are reported as income on either Form W2 for employees or Form 1099 for nonemployees.
IRS Notice 2021-25 has further complicated an already complex area of business tax rules. Your accountant and/or tax advisor will be able to answer any questions you may have to ensure your business is taking advantage of these new provisions while staying within the rules.
Minimizing your tax exposure, even though something as routine as M&E expenses, is a crucial part of your business’s tax strategy. If you aren’t working with an experienced tax advisor, now is the time to build that relationship. Contact Dembo Jones today.