What constitutes entertainment expense, is a question we are often asked. If an activity is generally considered to be entertainment, it will constitute entertainment for purposes of Section 274 (a) and Section 1.274-2 regardless of whether the expenditure for the activity can also be described otherwise, and even though the expenditure relates to the taxpayer alone. This objective test precludes arguments such as that “entertainment” means only entertainment of others or that an expenditure for advertising or public relations.
What constitutes entertainment expense must be looked at carefully to avoid the pitfalls of incorrectly deducting taxable income. Section 274 (e) enumerates nine specific exceptions to section 274 (a). Expenses that are within one of the exceptions in section 274 (a), which may include certain meal expenses, are not disallowed under section 274 (a). However, those expenses may be subject to the 50 percent limit on deductibility under section 274 (a).
The Treasury Department and the IRS intend to publish proposed regulations under Section 274 clarifying when business meal expenses are nondeductible entertainment expenses and when they are 50 percent deductible expenses. Until the proposed regulations are effective, taxpayers may rely on the guidance in this notice for the treatment under Section 274 of expenses for certain business meals.
Under this notice, taxpayers may deduct 50 percent of an otherwise allowable business meal expense if, The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business. The expense is not lavish or extravagant. The taxpayer is present at the furnishing of food or beverages. The food or beverages are provided to current or potential business customers, or clients. In the case of food and beverages provided during an entertainment activity, the food and beverages are purchased separately from the entertainment. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.