Excerpt from FCICA Presents Tax, Insurance, and Cost Reduction Strategies for Small Businesses by Lance Wallach and Dr. Bart Basi. Published in Summer 2008.
The 1993 tax law changed the amount allowable as a deduction for business meals and entertainment expenses incurred after. In addition, some special rules were enacted into the tax law. The limitation for deducting such expenses incurred after December 31, 1993 is 50%. Accordingly, after the general rules and exceptions are applied to meals and entertainment expenses incurred and the total dollar amount is determined, the 50% rule must then be applied. Business people must keep current with such rules or face the wrath of the IRS. The purpose of this chapter is to explain the general rule, the exceptions, and the special rules that are in effect for all business meals and entertainment expenses.
The General Rule
For purposes of the application of the 50% rule, it should be remembered that generally the entertainment or meal expenses are first determined, and then 50% of such expenses are subtracted prior to the expenses actually being deducted by either the employer or the employee. For example: $100 expense is incurred for meals, tips included (it must first be determined that the expense is a legitimated entertainment expense).
$100 – 50% = $50 which is the deductible portion resulting from the application of the 50% rule.
If an individual is traveling away from home on business, 50% of the cost of his meals is allowed as a deduction. However, if any portion of the meal expenses incurred while away from home is considered to be lavish or extravagant, then this amount must be subtracted first and is not applicable to the deduction. Lavish or extravagant is based upon the circumstances and conditions existing at the time the expenses are incurred.
It is important to note that the deduction is allowable only in the case that the taxpayer or employee of the taxpayer is present at the furnishing of such food or beverages.
The above illustration is a general application of the 50% rule. However, there are numerous exceptions that apply to this rule. Following is a discussion of the exception (It should be noted that the exceptions will either increase or decrease the total amount deductible from the general rule which allows 50% of the expenses to be deducted.)
Exceptions to the 50% Rule
- If an employer reimburses employees 100% for the cost of meals and entertainment, the employer can deduct the entire 100% of the reimbursement as long as the employer considers the additional 50% as added compensation, subject to withholding taxes. In this case, the employer must add the additional 50% to the W-2 Form provided to the employees.
- If an employer provides samples or promotional food items to the general public, the employer can take a 100% deduction and not be limited by the 50% rule for such food items provided to employees as well as the general public.
- If there is a bona fide sale of goods to employees, then the employer is also allowed to deduct 100% of the expense. This is automatic since a sale is said to have taken place.
- If the employer incurs meal expenses as a result of social or recreational activities for the benefit of the employees, the meal expenses would be 100% deductible. For example, this would be true if the employer provided a Christmas party or a summer picnic for its employees each year. The 50% rule does not apply to these traditional social activities that benefit all employees and their families.
- If food and beverage expenses are provided to employees and are so small as to overshadow the costs involved in record keeping, the employer can deduct 100% of such expenses without charging the employee for the fair market value of the food and beverages. This would be true, for example, if the employer provided coffee and donuts for the employees on a daily basis. The cost of allocation of such expenses would be grater that the benefit derived from the record keeping.
- If an employer obtains tickets to a sporting activity that was organized to benefit a tax-exempt organization and volunteer substantially performed all of the work during the event, then 100% of the cost of such tickets would be deductible. This rule, however, does not apply to any athletic activities where the referees or coaches receive compensation. Consequently, high school or college football games do not come under this rule and are subject to the 50% rule.
- Fees paid for what is referred to as “sky boxes” at sports arenas are subject to a special rule. The deductible amount of the cost of a skybox is disallowed to the extent that it exceeds the cost of the highest priced non luxury box. The 50% rule then applies to the remaining amount of the expense; which results in a deduction that is less than 50% of the total expense incurred.
- If meals provided to employees by the employer on the employee’s premises are for the convenience of the employer, then the cost is considered a ‘de minimis’ fringe benefit. Therefore, the cost is 100% deductible to the employer and excluded from the employee’s wages.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He writes about 412(i), 419, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Pubic Radio’s All Things Considered, and others. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, firstname.lastname@example.org or visit www.taxaudit419.com.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.