Five Things Small Businesses Should Know About Meals & Entertainment Expenses

Thoughtware Article Published: Oct 22, 2021
Group around a table

In recent years, several changes have been made to how businesses must account for their meals and entertainment expenses for tax purposes. Small businesses should be aware of these rules and update policies to properly record their expenses throughout the year.

Nondeductible Entertainment

Business entertainment generally is nondeductible. Entertainment includes any activity that is considered to constitute entertainment, amusement, or recreation, including:

  • Activities at night clubs, cocktail lounges, and theaters
  • Activities at country clubs, golf courses, and athletic clubs
  • Activities at sporting events
  • Activities while hunting, fishing, or on vacation

Some business expenses for activities that satisfy the personal, living, or family needs of any individual, such as providing a hotel to a business customer, also may be nondeductible.

If food or beverages are purchased during an entertainment activity on a separate bill or they are stated on the invoice separately from the cost of the entertainment, they will be considered meals eligible for 50 percent or 100 percent deductibility. However, if the cost is not stated separately, no allocation can be made between entertainment and food and beverages and the entire amount is disallowed as nondeductible entertainment.

100 Percent Deductible Entertainment

There are some exceptions to the general rule above. Fully deductible entertainment includes entertainment that is:

  • Treated as compensation to an employee
  • Reimbursed by a third party
  • For recreational or social activities primarily for the benefit of employees, other than highly compensated employees
  • Incurred during employee or stockholder business meetings
  • Directly related to attendance at business meetings of an Internal Revenue Code (IRC) Section 501(c)(3) organization, such as chambers of commerce, real estate boards, or business leagues exempt from taxation under §501(a)
  • Provided to the general public
  • Sold to customers
  • Includible in the income of a person who is not an employee

Example 1: Employer A invites all employees to a holiday party in a hotel ballroom that includes a buffet dinner and an open bar. The cost of the party, including food and beverage expenses, is not subject to deduction limitations because the holiday party is a recreational, social, or similar activity primarily for the benefit of non-highly compensated employees. Thus, Employer A may deduct 100 percent of the cost of the party.

50 Percent Deductible Meals

For meal expenses paid or incurred prior to December 31, 2020, the business deduction is limited to 50 percent of the amount paid for food and beverages that are not lavish or extravagant, for which the taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages that are provided to the taxpayer or a business associate. Food and beverage expenses are defined to include the full cost of food or beverages (meals, snacks, or drinks), including delivery fees, tips, and sales tax. It does not include expenses for the operation of an employer-owned eating facility on the employer’s business premises. Meals that are 50 percent deductible include food and beverages that are:

  • Incurred during employee or stockholder business meetings
  • Directly related to attendance at business meetings of an IRC §501(c)(3) organization, exempt from taxation under §501(a)
  • Purchased during client business meals
  • Incurred during business travel away from home for the employer or employees
  • Provided to employees as a de minimis fringe benefit, where the value is so small as to make accounting for it unreasonable or administratively impracticable1
  • Provided on the premises of the employer primarily for the benefit of the employees, but not for a recreational or entertainment purpose
  • Provided to employees for the convenience of the employer at the employer’s business location1

Example 2: Employer B provides free coffee, soda, bottled water, chips, donuts, and other snacks in a break room available to all employees. A break room is not a recreational, social, or similar activity primarily for the benefit of the employees, even if some socializing related to the food and beverages provided occurs. Thus, Employer B may deduct only 50 percent of the expenses for food and beverages provided in the break room.

Certain individuals who are subject to the “hours of service” limits under federal regulations and who work in the air transportation industry, as interstate truck or bus drivers, as certain railroad employees, or merchant mariners may deduct 80 percent of their meals when away from their home and if the meals take place during a period subject to the “hours of service” limits. 

100 Percent Deductible Meals

For amounts paid or incurred prior to December 31, 2020, for food and beverages, the following categories are fully deductible as meals expenses:

  • Treated as compensation to an employee
  • Reimbursed by a third party
  • For recreational or social activities primarily for the benefit of employees, other than highly compensated employees
  • Provided to the general public
  • Sold to customers
  • Includible in the income of a person who is not an employee

Temporary 100 Percent Deductible Meals from Restaurants

Most recently, the 2021 Consolidated Appropriations Act allowed a temporary 100 percent deduction for food or beverages provided by a restaurant, effective for amounts paid or incurred after December 31, 2020, and before January 1, 2023. A restaurant is defined to mean a business that prepares and sells food or beverages to retail customers for immediate consumption, whether or not the consumption occurs on the restaurant’s premises. The other restrictions related to the deductibility remain: 

  • The food or beverages are not lavish or extravagant 
  • The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages
  • The food or beverage is provided to the taxpayer or a business associate

Businesses that primarily sell prepackaged food or beverages not for immediate consumption, such as grocery stores, liquor stores, or convenience stores, are not considered restaurants. Also excluded from the definition of a restaurant for purposes of the temporary 100 percent deduction are eating facilities located on the employer’s business premises for which meals are provided to employees and excluded from their gross income and de minimis fringe employer-operated eating facilities.

Proper accounting for meals and entertainment expenses requires analysis of the people involved, environment, and activities surrounding them to apply the applicable percentage deduction allowed for federal and state tax purposes. For more information, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below. Learn how we can help your business by exploring our Outsourced Accounting Services.

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No deduction for these meals will be allowed for amounts paid or incurred after December 31, 2025. 
 

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