The Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated generally the federal income tax business deduction for entertainment expenses in § 274 of the Internal Revenue Code (“IRC”) for years beginning after December 31, 2017. It did, however, leave as an exception to the elimination certain categories of expenses. One of those is the client-related food and beverages deduction as provided in IRC § 274(k).
Even so, these exceptions are limited to 50% by IRC § 274(n) and may not be deducted in full. As businesses begin their holiday hosting and entertaining of potential and existing business customers, they must be aware of the categorization of expenses in order to deduct only what is proper. Entertainment expenses are no longer allowed to be deducted, and the definition of what counts as entertainment can be quite broad.
Entertainment is defined in Treas. Reg. 1.274-2(b)(ii) as:
[A]ny 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. 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 the customer’s family.
Entertainment does not include:
[A]ctivities which, although satisfying personal, living, or family needs of an individual, are clearly not regarded as constituting entertainment, such as (a) supper money provided by an employer to an employee working overtime, (b) a hotel room maintained by an employer for lodging of employees while in business travel status, or (c) an automobile used in the active conduct of trade or business even though also used for routine personal purposes such as commuting to and from work. On the other hand, the providing of a hotel room or an automobile by an employer to an employee who is on vacation would constitute entertainment of the employee.
Client-related food and beverage deductions are sometimes challenging to classify correctly. IRS Notice 2018-76 provides five tests for guidance in the interim before Regulations are written concerning what remains as deductible client-related food and beverage expenses. Client-related food and beverage deductions are allowed if:
- The expense is an ordinary and necessary expense under § 162(a) paid or incurred during the taxable year in 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 at the furnishing of the food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- 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.
IRS Notice 2018-76 provided some examples to elucidate the intricacies of the deduction. For instance, let’s assume that person A invites person B, a business acquaintance, to a sports game the tickets for which person A pays. While they are at the game, person A buys food and beverages for them both. In this situation, the sports game is an entertainment expense and therefore not deductible, however, the food and drinks are purchased separately from the entertainment and is eligible for the 50% client-related food and beverage deduction.
If the hypo is changed to where person A buys sports game tickets for a suite for person B and himself or herself that include food and beverages in the price of the ticket, none of the price is deductible. If, however, person A buys tickets to a sports game suite for person B and himself or herself, but the food and beverage cost is broken out and billed separately, then the food and beverage cost would again be 50% deductible as separate from the entertainment expense.
The business entertainment expense deduction may be gone, but the client-related food and beverage expense deduction is still viable for up to 50% of the cost of providing food and drink to business contacts, so long as the expense is separated from entertainment costs. This categorization should prove useful to business owners hosting holiday gatherings for business customers and clients to ensure you get the most out of any potential deductions for the ongoing costs of doing business.