In IRS Notice 2018-76, the IRS has provided guidance on the deductibility of expenses for business meals that are purchased in an entertainment context. The notice also announces the IRS intends to publish proposed regulations on the subject. Until those proposed regulations are effective, taxpayers may rely on the guidance in the notice.

Applicable Limitations. In general, only 50 percent of expenses incurred for meal expenses are deductible. The deduction for entertainment expense is not deductible effective for expenditures on or after January 1, 2018.

The recent Tax Reform Act did not address the circumstances in which the provision of food and beverages might constitute entertainment. However, the notice provides that taxpayers may deduct 50% of an otherwise allowable business meal expense if:

1. The expense is an ordinary and necessary expense paid or incurred during the tax year in carrying on any trade or business;
2. The expense is not lavish or extravagant under the circumstances;
3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
5. 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 provides three examples. For each example, assume that the food and beverage expenses are ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business and are not lavish or extravagant under the circumstances. Also assume that the taxpayer and the business contact are not engaged in a trade or business that has any relation to the entertainment activity.

Example 1. Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B.

The baseball game is entertainment, thus, the cost of the game tickets is an entertainment expense and is not deductible by A. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense and is not subject to the disallowance. Therefore, A may deduct 50% of the expenses associated with the hot dogs and drinks purchased at the game.

Example 2. Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages.

The basketball game is entertainment, thus, the cost of the game tickets is an entertainment expense and is not deductible by C. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages also is an entertainment expense that is subject to the disallowance.

Therefore, C may not deduct any of the expenses associated with the basketball game.

Example 3. Assume the same facts as in Example 2, except that the invoice for the basketball game tickets separately states the cost of the food and beverages.

As in Example 2, the basketball game is entertainment and, thus, the cost of the game tickets, other than the cost of the food and beverages, is an entertainment expense and is not deductible by C. However, the cost of the food and beverages, which is stated separately on the invoice for the game tickets, is not an entertainment expense and is not subject to the disallowance.

Therefore, C may deduct 50% of the expenses associated with the food and beverages provided at the game.

Note: Please reach out to your Somerset contact for further clarification on the meal and entertainment deductibility issue. Somerset believes that the recent IRS Notice is good news for taxpayers. It also provides for the importance of asking for food and beverages to be broken out separately from any entertainment item in order to obtain the 50% deduction related to the food and beverage.