In general, when meal and entertainment expenses are incurred in the context of an employer-employee or customer–independent contractor relationship, one party will be subject to a 50% limitation on the deduction. But which party? Last year, the IRS finalized regulations that address this question.
In the employer-employee setting:
- If the employer reimburses the employee for meal or entertainment expenses and treats the reimbursement as compensation, the employee reports the entire amount as taxable income. The employer deducts the payment as compensation, and the employee may be able to claim a business expense deduction, subject to the 50% limit.
- If the employer doesn’t treat the reimbursement as compensation, the employee excludes the entire amount from taxable income and the employer deducts the expense, subject to the 50% limit.
In a customer–independent contractor setting, the final regulations allow the parties to agree as to who will be subject to the 50% limit. If there isn’t an agreement, then:
- If the contractor accounts to the customer for meal and entertainment expenses reimbursed by the customer (i.e., properly substantiates the expenses), the 50% limit applies to the customer.
- If the contractor doesn’t, the limit applies to the contractor.
The rules surrounding meal and entertainment expense deductions are complex. Please contact us to ensure you’re making the most of the deductions available to you but not putting yourself at risk for back taxes, interest and penalties.