On one of the first days of spring, we were eager to lunch at one of our favorite spots in town. With the sun shining, we felt comfortable eating outside, and my son was ready to ease back into something that felt “normal.”
I expected a crush of people thinking the same thing. But as we found ourselves on a nearly empty patio, it was clear that we weren’t heading back to normal any time soon.
Covid has impacted many industries across the country, but food service has been among the hardest hit. More than 8 million restaurant employees were laid off or furloughed, and the industry lost $280 billion in sales during the first 13 months of the pandemic, according to the National Restaurant Association.
Stimulus checks appeared to give a boost, with sales in March marking a healthy increase. But sales were still 5% below the pre-pandemic levels of February 2020.
Temporary 100% Deduction
To provide targeted relief, the Consolidated Appropriations Act of 2021 (Public Law 116-260) threw the industry a bone: a temporary 100% deduction for business meal expenses provided by restaurants.
The language modifying the deduction is short, weighing in at just under 100 words. Congress simply amended tax code Section 274 to remove the 50% cap for on such meals provided by a restaurant in 2021 and 2022.
Section 274 Basics
The tax code allows businesses to deduct expenses that are ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business, while a necessary expense is one that is helpful and appropriate for your trade or business. That includes business-related meals.
Using only those criteria would have consistently made those expenses fully deductible. So, Congress limited the deductibility. In addition to the ordinary and necessary qualifications, Section 274 makes clear that the expense can’t be lavish or extravagant under the circumstances, and the taxpayer (or an employee of the taxpayer) must be present for the food or beverages to be deductible. If those criteria are met, taxpayers could—until recently—deduct 50% of business-related meals, including meetings with potential clients, as well as travel meals.
Section 274 also allows taxpayers to deduct 100% of meal expenses for specific purposes, like a company picnic or party for the benefit of all employees, and food items made available to the public. (Notice 2018-76 confirmed that the 50% limitation under the 2017 tax law didn’t apply to those expenses, and they continue to be fully deductible.)
Tax Law Modifications
The tax overhaul tweaked Section 274. Beginning in 2018, taxpayers could continue to deduct 50% of business-related meals, but there were new restrictions. Specifically, deductions were disallowed for entertainment, amusement, and recreation—even when they were business-related.
Under the code section, the term “entertainment” includes activities like entertaining at nightclubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, as well as hunting, fishing, vacation, and similar trips. The tax law didn’t change that definition.
But since food and beverages are often tied to entertainment activities, the tax overhaul complicated matters. If, for example, you ordered food and drinks at a ballgame, did the fact that the meal was related to entertainment make it no longer deductible? Additional guidance was needed.
The IRS didn’t issue final regulations until late 2020. That would prove confusing for taxpayers when Congress changed the rules—again—just a few months later.
Those final rules (T.D. 9925) made clear that the costs of food and drinks purchased or stated separately from entertainment remain deductible. In other words, food and drinks provided during entertainment events will be treated as business meal expenses—not entertainment expenses—if they appear on a separate bill or invoice.
The guidance incorporated the substantiation requirements in Section 274(d) to travel meals. Additionally, they confirmed that travel expenses for meals for spouses, dependents, or others accompanying the taxpayer were only deductible if those persons were employees, the meals were for a legitimate business purpose, and the expenses would otherwise be deductible by the spouse, dependent, or another individual. So, a meal for your spouse who merely accompanies you on a trip isn’t deductible; but if your spouse works in your business and joins you on a business trip for business reasons, it is 100% deductible (provided you meet the other criteria). You would, however, need to keep good receipts.
The final regulations also defined food or beverage expenses to include delivery fees, tips, and sales tax. That would prove to be helpful in 2021 (read on).
Changing the Numbers
The CAA didn’t change any definitions. It simply removed the 50% cap for “any deduction otherwise allowable to a taxpayer under chapter 1 for any expense paid or incurred after December 31, 2020, and before January 1, 2023, for food or beverages provided by a restaurant.” Again, some clarity was needed.
The guidance confirms that the temporary 100% business meal expense deduction does not alter the rules related to entertainment expenses. Among other things, the rule that they should be separately stated from deductible meal expenses remains in place.
The guidance also confirms that the Section 274(k) rules—those disallowing lavish or extravagant meal expense deductions and requiring that the taxpayer (or an employee of the taxpayer) be present at meals—also survived the CAA. And, because it’s tax law, it won’t surprise you that the guidance makes clear that additional rules may apply “depending on the circumstances.”
What’s most helpful for taxpayers is the definition of “restaurant.” Confusingly, you won’t find restaurant defined in the tax code for purposes of Section 274, but the guidance makes clear that it means a business that prepares and sells food or beverages to retail customers for immediate consumption—including delivery and takeout.
It does not include a business that primarily sells pre-packaged food or drinks not for immediate consumption. Examples include grocery stores, liquor stores, drug stores, convenience stores, and kiosks.
The guidance also anticipates your tricks: An employer can’t treat an eating facility on the premises which provides tax-exempt meals for employees as a restaurant. Similarly, an employer-operated eating facility that is treated as a de minimis fringe benefit is not a restaurant. That remains true even if the employer contracts with a third party.
I wouldn’t be surprised to see more changes coming. It’s important to stay informed—and to keep excellent records. When substantiating your expenses, think about how to best categorize your records. Consider one bucket for 100% deductible meals, a second for 50% deductible meals, and a third for nondeductible expenses, like entertainment. That way, you can easily access and re-characterize costs, if needed, as the rules change.
And one more thing. The rationale behind increasing the deductibility of meals is to help out businesses and the restaurant industry. That meal that you were planning on having with prospective clients or your employee? Don’t put it off. So long as you can do it safely, there’s an incentive to do it now. And don’t forget to tip your driver or server—after all, it’s deductible.
This is a weekly column from Kelly Phillips Erb, the TaxGirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.