Virtually every business incurs some type of meal-related expenses. A question arises as to whether such meals are deductible and to what extent. This article provides a general overview of this topic; remember, though, that the deductibility of meals is highly fact-dependent and this article only provides an educational background to this issue, NOT a legal advice.
Generally, expenses incurred with respect to the entertainment-related meals are not deductible, unless the taxpayer is able to establish that the expense is directly related to the active conduct of a business or trade.
However, if a meal expense directly precedes or follows a bona fide business discussion (including a convention meeting), then it is deductible if it is established that the expense was associated with the active conduct of a trade or business. The taxpayers needs to be able to establish that this is the case.
Restrictions on the General Rule
The Internal Revenue Code (IRC) places two broad restrictions on the general rule. First, if neither the taxpayer nor the taxpayer’s employee is present at the meal, then, generally, meal expenses are not deductible.
Second, a meals deduction is not allowed where the expense is lavish or extravagant under the circumstances. This topic has been the subject of controversy for some time now as large corporations have engaged in entertaining their important guests in a manner that the IRS may sometime classify as “lavish.”
It is important to point out that these restriction would not apply to certain exceptions to the general rule.
Exceptions to the General Rule
IRC Section 274(e) specifically provides that some exceptions are not subject to the general rule described above and are deductible as ordinary and necessary expenses (as long as they are properly substantiated). The exceptions are:
a. Food and beverages furnished on the business premises primarily to the taxpayer’s employees;
b. Expenses for services, goods, and facilities that are treated as compensation or wages for withholding tax purposes. If the recipient is a specified individual, then the employer’s deduction cannot exceed the amount of compensation reported. IRC Section 274(e)(2)(B) defines who is a “specified individual”; here, it is sufficient to state that it generally means an officer, director, ten-percent shareholder or a related person;
c. Reimbursed expenses: “expenses paid or incurred by the taxpayer, in connection with the performance by him of services for another person (whether or not such other person is his employer), under a reimbursement or other expense allowance arrangement with such other person”. IRC Section 274(e)(3). However, this exception applies only if: (1) services are performed for an employer and the employer has not treated such expenses as wages subject to withholding; or (2) where the services are performed for a person other than an employer and the taxpayer accounts to such person;
d. Expenses for recreational, social, or similar activities (including facilities therefor) primarily for the benefit of employees (other than employees who are highly compensated employees (within the meaning of section 414(q)). See IRC Section 274(e)(4) for further details on treatment of shareholders. The most common example of this exception are company picnics;
e. Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors. IRC Section 274(e)(5);
f. Expenses directly related and necessary to attendance at a business meeting or convention of any organization described in section 501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and boards of trade) and exempt from taxation under section 501(a). IRC Section 274(e)(6);
g. Expenses for goods, services, and facilities made available by the taxpayer to the general public. IRC Section 274(e)(7);
h. Expenses for goods or services (including the use of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration in money or money’s worth. IRC Section 274(e)(8); and
i. Expenses paid or incurred by the taxpayer for goods, services, and facilities furnished to non-employees as entertainment, amusement, or recreation to the extent that the expenses are includible in the gross income of a recipient and reported on a Form 1099-MISC by the taxpayer.
It is very important to note that exceptions a, e, and f maybe subject to the “50-Percent Limitation” rule.
50-Percent Limitation Rule
Generally, a taxpayer can only deduct 50 percent of the allowable meal and entertainment expenses, including such expenses incurred in the course of travel. The process in calculating the 50-percent limitation involves, first, the calculation of the allowable deductions through the process of exclusion of non-allowable deductions (e.g. lavish portion of the meal) and addition of related expenses (e.g. taxes, tips, room rental, and parking fees) and, then, the 50-percent rule applies. Note that the allowable deductions for transportation costs to and form a business meal are not reduced.
The 50-percent rule maybe subject to various statutory modifications based on profession or the nature of activity. For example, the transportation workers may deduct 80 percent. There are also complications with respect to a leasing company and independent contractors.
Exceptions to the 50-Percent Limitation Rule
The 50-Percent Limitation rule is riddled with exceptions.
First, exceptions b, c, d, g, h and i described above (see Exceptions to General Rule section) are not subject to the 50-Percent Limitation rule.
Second, the food expenses classified as de minimis fringe benefits and excludable from the recipient’s gross income are also not subject to the 50-Percent limitation rule.
Third, there are somewhat complicated exceptions related to the tickets to a sporting events.
Fourth, employee’s meal expenses incurred while moving are not subject to the 50-Percent Limitations rule if they are reimbursed by the employer and includible in the employee’s gross income.
There are various other exceptions to the 50-Percent Limitations rule such as food and beverages provided to employees on certain vessels, oil or gas platforms, drilling rigs, and so on.
This article provides a general review of the rules regarding deductibility of meal on Schedule C. However, this is only an educational article and it does NOT offer a tax or legal advice. You should see a tax professional regarding your specific facts.