Mary Bernard
Mary Bernard

Travel & Entertainment Expenses

Are all business meals and entertainment costs subject to the 50-percent limitation?

June 23, 2011
by Mary Bernard, CPA

The long-established requirement that expense is ordinary, necessary and reasonable governs the deduction of business meals and entertainment expenses. The need to distinguish the difference between business-related and personal meals and entertainment expenses has been a challenge in the courts. Over the years, Internal Revenue Code Section 274 has been modified several times to arrive at its current version, whereby 50 percent of the meals and entertainment expenses are disallowed as a deduction. The most recent change to this section (in 1993) also introduced the disallowance of membership dues in clubs organized for business, pleasure, recreation or other social purpose.

Fifty Percent Disallowance for Entertainment and Meal Costs

Section 274(n) requires that the amount of an otherwise allowable deduction for the cost of business entertainment and meals generally be reduced by 50 percent. Thus, only 50 percent of the cost of any item with respect to an activity generally considered to constitute entertainment, amusement or recreation and only 50 percent of the cost for food and beverage, may be deducted, subject to the various exceptions.

While the general rule requiring the 50-percent reduction in the otherwise deductible meal and entertainment expenses relates to “the amount allowable as a deduction under this chapter,” the 50-percent limitation apparently does not apply to all deductions for meals, because the reduction is limited to only meals consumed in connection with the taxpayer's trade or business or in connection with an income-producing activity. Therefore, meals consumed while traveling for medical purposes or while performing charitable services away from home should not be subject to the 50 percent limitation, because medical treatment or charitable contributions are not part of the taxpayer's trade or business. Accordingly, the costs of meals consumed in connection with either (provided that the meals are otherwise deductible as medical expenses or charitable contributions) are arguably fully deductible.

Exceptions to the Disallowance

Ostensibly, the rationale for cutting back the deductibility of meal and entertainment costs was to limit the tax subsidy of the personal consumption element that Congress considered to be intertwined with costs of this nature. Nevertheless, there are several exceptions to the general reduction rule. The presumption is that each exception involves insufficient personal benefit to justify the disallowance. Thus, meal and entertainment expenses that meet any one of the following criteria remain 100 percent deductible and exempt from the 50 percent disallowance that is otherwise mandated:

  • The cost of a meal or an entertainment activity is fully deductible if such expense is treated as compensation to the recipient. When an employer provides meals or expenses to an employee, the employer's expenses are not subject to the percentage reduction rule if such amounts are reported as compensation and treated as wages for income-tax withholding purposes. Similarly, if an independent contractor has rendered services to a taxpayer, the taxpayer is not subject to the 50 percent disallowance if the expenses are includible in the independent contractor's gross income as compensation and the taxpayer reports such expenses on Form 1099 (unless the aggregate amount paid to the recipient is less than $600 and therefore not required to be reported).
  • Reimbursed expenses are excludible in their entirety to the party receiving the reimbursement. This may apply in the case of a salesperson who pays for a business lunch with a customer and then is reimbursed under an accountable reimbursement or other expense allowance arrangement with his or her employer; in this case, while the reimbursement is not treated as income to the employee, the employer can deduct only 50 percent of the reimbursement.
  • Expenses for recreational, social or similar activities for employees, such as Christmas parties or summer outings, remain fully deductible.
  • Expenses for goods, services or facilities that taxpayers make are available to the general public (e.g., promotional tickets or samples provided to customers) are exempt from the disallowance. In the instance in which the owner of a retail store runs a promotion offering tickets to a sports event to the first 50 people who visit the store on a particular date, the full amount of the face value of the tickets is deductible by the owner. If a wine merchant offers samples to members of the public who are potential customers, he may deduct in full the cost of the wine used as a sample, along with reasonable costs that are associated with the winetasting (e.g., food that is provided with the wine to demonstrate food pairings).
  • Expenses for goods, services or the use of facilities sold to customers in transactions for adequate consideration are not subject to the 50 percent disallowance. Thus, for example, a restaurant or dinner theater may deduct the full amount of its ordinary and necessary expenses in providing meals or entertainment to paying customers. This may seem self-evident, but it is addressed in this code section. Likewise, if an employer not otherwise in the restaurant or catering business provides meals on the premises to its employees for which the employer can establish that it charges arm's length, fair market value prices, the employer in this case is treated, in effect, like a restaurant and can deduct the entire cost of providing the meals.

Meals to Employees

Providing meals to employees can also be fully deductible in which the meals are excludable from an employee’s income under Section 119 and are also considered a de minimus fringe benefit under Section 132. If more than one-half the employees are furnished meals for the convenience of the employer, all meals provided on the premises are treated as furnished for the convenience of the employer. The employer can fully deduct the meals without the 50-percent disallowance and are excludable from the employee’s income.

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Mary F. Bernard, CPA, is director — income/franchise tax, at the Dallas, Texas-headquartered tax services firm of Ryan. Bernard formerly worked as principal, director of State & Local Tax Services, at Providence, RI-based Kahn, Litwin, Renza & Co., Ltd.