February 26, 2020 Proposed regulations clarify deductions for IRC Section 274 entertainment and food and beverages expenses with few changes from previous guidance In proposed regulations (REG-100814-19), the Treasury Department and the IRS address changes made to business expense deductions under IRC Section 274 after the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the deduction for entertainment expenses. The proposed regulations address: (1) the elimination of the deduction for expenditures related to entertainment, amusement, and recreational activities and (2) the limitation on the deduction for food and beverages expenses. Comments on the proposed regulations should be submitted by April 13; a public hearing is scheduled for April 29, 2020. Background IRC Section 274(a), as modified by the TCJA, disallows any otherwise allowed income tax deduction for an activity or facility that qualifies as entertainment, amusement, or recreation. The TCJA repealed the exception from IRC Section 274(a) that preserved a deduction for business entertainment if directly related to or associated with the active conduct of business. This repeal effectively eliminated business entertainment deductions. Existing Treasury regulations define "entertainment" using an objective standard, including activity "of a type generally considered to constitute entertainment," such as "entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, [and] sporting events." IRC Section 274(k) disallows a deduction for any food or beverages unless: (1) the expense is not lavish or extravagant under the circumstances, and (2) the taxpayer (or employee of the taxpayer) is present at the furnishing of the food or beverages. IRC Section 274(n)(1) limits the deduction for any expense for food or beverages to no more than 50% of the expense that otherwise would be allowed. The TCJA repealed an exception to IRC Section 274(n) for de minimis fringe benefits, which includes employer-operated eating facilities. In October 2018, the Treasury Department and the IRS published Notice 2018-76, which provides guidance clarifying when meal expenses are nondeductible entertainment expenses and indicates the Treasury Department and IRS's intent to propose future regulations in line with the Notice (see Tax Alert 2018-1997). Proposed regulations The proposed regulations would not revise the regulations at Treas. Reg. Section 1.274-2, finalized in 1963, which interpret the limitation on entertainment deductions and the applicable exceptions as first enacted. Further, the Preamble explains that taxpayers may continue to rely on those existing rules to the extent applicable and not superseded by the TCJA. The proposed regulations would add two new regulatory sections: Treas. Reg. Section 1.274-11, addressing disallowed deductions for entertainment, amusement, or recreation expenditures paid or incurred after December 31, 2017; and Treas. Reg. Section 1.274-12, addressing the limitation on deductions for certain food or beverages expenses paid or incurred after December 31, 2017. The proposed regulations would apply to tax years beginning on or after the publication date of final regulations in the Federal Register. In the meantime, taxpayers may rely on the proposed regulations and Notice 2018-76. Non-food entertainment expenses The proposed regulations would define entertainment for purposes of the statutory disallowance in a manner that largely tracks the existing definition, updated to remove outdated references. The proposed regulations confirm that the IRC Section 274(e) exceptions continue to apply to entertainment expenditures. Food and beverages expenses Treatment of certain business meals as 50% deductible The proposed regulations follow Notice 2018-76 in treating food or beverages provided at an entertainment activity as nondeductible entertainment expenses unless the food or beverages are purchased separately from the entertainment, or the cost of the food or beverages is stated separately from the cost of the entertainment on bills, invoices, or receipts. The proposed regulations clarify that the receipt amount must reflect "the venue's usual selling cost for those items if they were to be purchased separately from the entertainment or must approximate the reasonable value of those items." If the food or beverages are not separately purchased or itemized, no allocation of the cost is permitted. Rather, the full cost will then be a nondeductible entertainment expense. The proposed regulations would further incorporate other statutory requirements for deductibility under IRC Sections 162 and 274(k) by requiring (1) the expense not to be lavish or extravagant under the circumstances; (2) the taxpayer, or the taxpayer's employee, to be present at the furnishing of the food or beverages; and (3) the food or beverages to be provided to a business associate. For these purposes, the proposed regulations would define a "business associate" as a "person with whom the taxpayer could reasonably expect to engage or deal in the active conduct of the taxpayer's trade or business such as the taxpayer's customer, client, supplier, employee, agent, partner, or professional adviser, whether established or prospective." This definition tracks the existing definition of "business associate" in Treas. Reg. Section 1.274-2(b)(2)(iii), which interpreted the now-repealed "active conduct of business" requirement. Notably, this definition treats an employee as a business associate, effectively opening up the Notice 2018-76 non-entertainment treatment of meals (as 50% deductible) at entertainment events to employer-provided meals, including meals provided to both employees and non-employee business associates at the same event. Travel meals The proposed regulations include specific rules concerning meal expenditures incurred while travelling for business. These rules were not amended by the TCJA, but the proposed regulations consolidate the rules in one place, clarifying that these meals and other travel expenses are subject to IRC Section 274(d)'s heightened substantiation requirements, as well as the limitation on deductibility of travel expenses of spouses, dependents, and other non-business companions. Exceptions The proposed regulations clarify that the deduction limitations do not apply to expenditures for business meals, travel meals, or other food or beverages that fall within certain IRC Section 274(e) exceptions that apply to IRC Section 274(n). 1. Expenses treated as compensation IRC Section 274(e)(2) and (e)(9) provide an exception for meal and entertainment expenses treated as compensation of an employee or other service provider. Existing regulations except amounts to the extent that the expenditure is treated as employee compensation on the taxpayer's originally-filed income tax return and as wages to an employee for purposes of withholding. For a non-employee service provider, the expense is excepted if includible in the worker's income as compensation or a prize, provided that the income is reported if required. The proposed regulations track the existing rules in applying the IRC Section 274(e)(2) and (e)(9) exceptions to the 50% limitation on deductibility of food or beverages expenses but make a meaningful addition. This addition would deny the exception if the value included in income is less than the amount required to be included under the applicable valuation rules. Those rules generally require inclusion of the fair market value less any amount paid, but also allow a special valuation rule for meals provided at an employer-operated eating facility. If the amount required to be included in gross income is zero, the proposed regulations specify that the IRC Section 274(e)(2) and (e)(9) exceptions do not apply. The examples clarify that the expense of any meal provided for the convenience of the employer cannot qualify for the IRC Section 274(e)(2) exception because the amount required to be included in income is zero. 2. Reimbursed expenses IRC Section 274(e)(3) excepts food or beverage expenses incurred by one person for the performance of services for another person under a reimbursement or other expense allowance arrangement. This exception does not eliminate the 50% limitation but rather changes the taxpayer subject to the limitation depending on whether (1) the expense is substantiated to the ultimate payor or (2) the parties contractually agree upon the party to bear the limitation. The proposed regulations would apply this exception to the 50% limitation in a manner consistent with existing regulations. 3. Recreational expenses for employees IRC Section 274(e)(4) excepts the expenses of recreational, social, or similar activities for employees, if provided in a manner that does not discriminate in favor of highly-compensated employees. This exception has previously been interpreted as limited to "usual" events, such as holiday parties, annual picnics, or summer outings. The proposed regulations clarify that the exception does not apply to free food or beverages provided in a break room or to meals provided for the convenience of the employer. 4. Items available to the public IRC Section 274(e)(7) excepts expenses for goods, services, and facilities made available by the taxpayer to the general public. This exception generally applies to items given away to the public. For employee meals, the proposed regulations would allow this exception if similar food or beverages are made available to, and primarily consumed by, the public. Consistent with prior interpretation, the proposed regulations would treat customers, clients, and visitors as the general public if the food is not provided only to an exclusive list of guests. The proposed regulations state that "primarily consumed" means greater than 50% of actual or reasonably estimated consumption. It is not clear what is to be measured (for example, fair market value, gross receipts, allocable cost) or how consumption should be tracked. The examples make clear, however, that a taxpayer hosting an open event at which food is served at no charge could fully deduct the cost of the food even if some of it is furnished to employees. 5. Goods or services sold to customers IRC Section 274(e)(8) excepts expenses of goods or services sold by the taxpayer in a bona fide transaction for adequate and full consideration in money or money's worth. This exception generally allows a taxpayer in the business of selling food to customers to fully deduct its costs. Adopting an explanation provided in the Joint Committee on Taxation's Bluebook, the proposed regulations would allow a restaurant or catering business to fully deduct the costs for food or beverages, purchased in connection with preparing and providing meals to its paying customers, which are also consumed at the worksite by food service employees who work in the employer's restaurant or catering business. Implications For the most part, the proposed regulations are quite favorable to taxpayers, as was expected following the issuance of Notice 2018-76, which allowed virtually all otherwise deductible meals to escape the full disallowance applicable to entertainment expenses. The proposed regulations would add a condition to this rule, requiring the itemized food cost to be the usual selling cost at the venue. It is not clear whether this condition would be satisfied if, for example, a venue charges more for food in a luxury suite than in the stands. The proposed regulations would clarify that the non-entertainment treatment of meals at entertainment events includes employer-provided meals even if no customers or clients are present. This eliminates concerns that entertainment-related meals for employees that would not qualify for the exception for recreational expenses of employees might be nondeductible. Of course, if an expense qualifies for the employee recreation exception, this exception would allow the expense to be fully deductible rather than merely 50% deductible. The proposed regulations appear to interpret the compensation exceptions under IRC Section 274(e)(2) and (e)(9) in a novel manner, allowing the exceptions only if the full amount required to be included in income (whether under a special valuation rule or otherwise) is included in income. This rule appears to deny the exceptions when the value is fully excludable from income, whether because of a specific income exclusion or because the recipient paid some amount for the benefit. Additionally, the rule seems to require that the recipient must actually include the amount in income, rather than deeming the amount included if the taxpayer properly reported the amount. The proposed regulations provide welcome assurance to restaurants that the IRS will treat food served to food-service employees as fully deductible business expenses, in keeping with the interpretation stated by the Joint Committee on Taxation's Bluebook. The proposed regulations further clarify that this interpretation relies on the IRC Section 274(e)(8) exception, a point that was not clear from the Bluebook. ———————————————
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