Meals & Entertainment: What Can Your Construction Company Deduct?

The Internal Revenue Service (IRS) generally limits the deductibility of food and beverage expenses associated with operating a trade or business to 50%. Activities that constitute entertainment, amusement, or recreation, even if business-related, are generally nondeductible in full. Pretty straightforward, right? Not so fast. What may appear to be a surefire deductible business expense may instead be personal and nondeductible under the Internal Revenue Code (IRC), and there are several exceptions to the general rules noted above. With the rising costs of meals, alcoholic beverages, and various avenues of entertainment, it’s paramount to understand what your business is permitted to write off to avoid potential tax issues.

One might ask, “Is alcohol considered a beverage or a form of amusement in the eyes of the IRS?” They are certainly beverages under the Webster’s Dictionary definition, but could one argue that the purpose of drinking alcoholic beverages is for the amusing intoxicating effects? Does it matter if it’s a 4.1% ABV beer, which is more comparable to a bottle of water than a 40% ABV dirty martini? Are the drinks being ordered at a cocktail lounge or nightclub rather than a restaurant? In general, the IRS classifies beverages, irrespective of their alcohol content, as 50% deductible “food and beverage” rather than nondeductible entertainment. This classification is one example of the many counterintuitive provisions of the ever-changing politically constructed IRC.

The first requirement for an expense to be tax deductible is that it must be “ordinary and necessary” in carrying on your trade or business. Meal expenses are not deductible if the primary motivation for the meal is social and personal. For instance, deductions have been disallowed for daily business lunches attended by a law firm’s partners and employees, as they were viewed by the Tax Court as personal expenses due to their frequency. Alternatively, occasional lunch meetings held by a group of physicians to discuss treatment techniques were allowed as deductible meals. This highlights the importance of considering the facts and circumstances of each situation must first be considered to determine if a meal is ordinary and necessary to a taxpayer’s business and therefore deductible.

Furthermore, to be deductible, meals cannot be “lavish or extravagant” under the circumstances. The taxpayer or an employee of the taxpayer must be present when the meals are furnished, and a current or potential client, consultant or business associate must also be present. The question arises: Would ordering Beluga caviar and Dom Perignon during a meeting with a potential client be “lavish or extravagant” and therefore not deductible? It boils down to the circumstances. Would engaging the potential client result in millions of dollars in added income? Does ordering these expensive items help impress and improve the chances of landing the client, therefore making it ordinary and necessary?

Food and beverages that are provided during an entertainment activity are also non-deductible unless they are purchased separately from the entertainment itself or their cost is separately stated on the invoice. Think box suites for sporting events where the taxpayer regularly invites associates to form or better their business connections. The sporting venue will usually charge an annual or monthly fee. Accordingly, it’s important to request they separately state the portion of the fee that represents meals and beverages. This portion would then be 50% deductible, while the remainder of the fee would be classified as nondeductible entertainment.

Like many provisions of the IRC, there are exceptions, and even exceptions to those exceptions, when it comes to meals and entertainment. There is a list of exceptions that permit the deductibility in full for both meals and entertainment. For example, expenses for recreational, social, or similar activities primarily for the benefit of employees are deductible in full. So, if your company holds an annual golf outing where all the employees are invited, both the golf and any food or beverages incurred at the outing are 100% deductible. On the other hand, holding an annual ski trip for the owners and some highly compensated employees of a company, albeit recreational, is not for the primary benefit of the company’s employees and is therefore considered nondeductible entertainment.

Finally, there are many cases of recreational activities that have interweaving advertising components. For instance, a company may sponsor another organization’s golf outing and have its company name and logo displayed throughout the course. However, the owners may also receive the benefit of playing in the outing. Therefore, it’s essential to bifurcate the expenses related to the fully deductible advertising versus the nondeductible golf. The important factor here is demonstrating a legitimate link between recreational activities and a bona fide business purpose of expanding the potential customer base. In one tax court case, it was determined that an auto dealer that raced Chevrolet Corvettes was a legitimate deductible advertising expense. This is because the driver placed high in the race which resulted in local newspapers drawing attention to his dealership, increasing their revenue.

Given the complexities and fluid nature of the IRC related to meals, entertainment and other similar expenditures, it’s crucial to have a basic understanding of the law. However, this is not enough. To ensure you are correctly applying the rules and maximizing your deductions, it’s highly recommended to work with a trusted CPA who can navigate through your specific expenditures and provide tailored advice.

Contributing author: Anthony J. Cerchia, CPA, is a tax manager at Dannible & McKee, LLP. Anthony has over eight years of experience providing tax planning and ownership transition analysis to a wide range of clients, specifically within the construction, manufacturing, automotive, architecture and healthcare industries. For more information on this topic, you may contact Anthony at acerchia@dmcpas.com or (315) 472-9127.