Deducting business meals as an expense on a tax return gets many small business owners into trouble, especially those who regularly eat in restaurants alone or with business associates. The rules are confusing and accompanied by a great deal of rumor and misinformation. In this article, we’ll discuss what business meals are deductible and, in the process, address some of the misconceptions surrounding deducible business meals. But first, let’s share a significant change that rocked the business-deduction world a few years ago.
Entertainment No Longer Deductible: For decades, the line for deductible meals on a sole proprietor’s tax return was called Meals and Entertainment. Businesses could deduct a variety of entertainment expenses such as golf outings and charter-fishing trips - even coliseum skyboxes if the activities were (somehow) related to business. The entertainment expense, however, was scratched in 2018 by the Tax Cuts and Jobs Act of 2017. Entertainment costs, with the possible exception of a staff holiday party or picnic, are no longer deductible.
We discuss travel meals in our article on Deductible Travel Expenses. Travel meals get reported on the same line as other deductible meals. They are also subject to the same 50% limitation (discussed below). Business owners can also claim a per diem amount for meals during business travel. Meal costs incurred on trips that do not qualify as deductible business trips remain deductible so long as they meet the definition of a business meal that follows.
When’s a Meal’s a Business Meal
Before we get into the technical definition of a deductible business meal, let’s share my common-sense definition. The simplest way to describe a deductible business meal is one that passes all five of the following tests:
- With a business associate or customer/client, that
- Involves your business,
- Requires some level of preparation,
- Is important enough to be your calendar, and
- You pay for their meal as well as your own.
Of course, this is not a full-proof explanation, and it does not mean that casual lunches cannot be for business, but it helps weed out meals many try to deduct but can’t.
OK – on to the IRS definition.
According to the IRS, a deductible meal meets one of two criteria, each of which has detailed requirements. The meal must either be: 1) Directly related to actively conducting business, or 2) Associated with actively conducting business. So, what meals fall under each condition? Let’s take a look at each.
Meals Directly Related to Business
To be directly related to the active conduct of business, the meal must pass three tests:
- Conducting Business with Others: The meal is a business meeting, and incidental to having that meeting. The meal is important enough to be on your calendar and has some type of agenda: formal or informal. Topics discussed are specific and not general in nature. It’s meeting with Rick to discuss contingencies on Wilk’s home. It’s not lunch with Judith and chatting about listings and clients.
FYI: Want an easy way to tell if a meal’s primary purpose is business? It wouldn’t occur if not for business. Also - a local business meal never happens alone (a virtual Zoom discussion while you eat is not a business meal).
- Business Happens During the Meal: Being on your calendar is not enough. Business activity must occur. Your meeting, however, does not have to be successful
- Expectation of Business Benefit: The meal/meeting must have potential, tangible business consequences for your business, such as obtaining a listing, a price change, or offsets for your client, receiving a viable referral. The key here is to make sure any business discussion is not general in nature. It is specific and potentially beneficial for your business.
Failing to pass all three tests means the meal is not related to actively conducting business. It is not a deductible business meal.
Meals Associated with Actively Conducting Business
The second way a meal is deductible as a business meal is to be associated with legitimate business activity. To be associated with actively conducting business, the meal must occur directly before or immediately following a business meeting. This meeting must be substantial, meaning it had a tangible business consequence. Such meetings are generally formal, require some level of preparation, and on your calendar.
An example would be taking a client out to dinner after they close on a new home. Of course, such a meal would have a secondary business function – establishing goodwill in the hope of generating referrals.
Additional Meal Deduction Facts
Business Meals Are Subject to 50% Reduction: Only 50% of business meals get deducted on your tax return, regardless of the number of business meal attendees.
Not Lavish or Extravagant Under the Circumstances: Here’s another IRS facts and circumstances definition. Make sure the meals are not over the top ridiculous and proportionate to the potential benefit received. A $300 meal with a prospect that might generate a single $75 sale might make an auditor smile as they scratch the deduction from your return. On the other hand, they might just as quickly nod if you can show the prospect generated $20,000 in business.
Only Business Participant’s Meals Count: If there is not a business purpose for a meal attendee, their meal is not a business meal. For example, you meet with Rick to discuss a new listing, and he brings his daughter along because she has a dentist’s appointment. If you pay for Rick and his daughter’s meal, only Ricks is deductible. There is, however, an exception to this rule. If your guest brings their spouse (or children) and your wife (or kids) attend, everyone’s meals get expensed - provided their attendance is conducive to your business purpose. Just be sure to document your business purpose.
Local Meals Alone Are Not Deductible: As mentioned earlier, meals you have alone are only deductible on business days during business travel. For more information on business meals, please see our article on Business Travel Expenses.
Meals with Significant Others: Proving a meal alone with your spouse or significant other has a bona fide business purpose is super-difficult. You see and eat with each other regularly, even daily. Proving a business purpose is tough even when your spouse is a business partner. If such meals occur, make sure they are rare, and you can show what made the meal so business-special.
Dutch Meals: Meals alone are never deductible, and sharing the cost doesn’t make your meal deductible. The premise behind deducting 50% of business meals is limiting the deduction to the other party’s food (which makes little sense when paying for a party of five, but it’s the rule). This rule, however, has a somewhat cumbersome silver lining. If you generally eat leftovers for lunch and the cost of your business meal is higher than your leftovers, you can deduct the difference, well 50% of it.
Networking and Similar Meals: If you are a member of a business network or organization and meet regularly, meals purchased for yourself gets treated as a dutch meal. Let’s say you’re a member of a formal network group (or Rotary or Chamber of Commerce), and you meet each Wednesday at 8 AM at a local restaurant. You generally buy the breakfast buffet and eat as members take turns promoting their business and exchanging leads. Is the meal deductible? Yea, but only by the amount it exceeds the cost of your regular breakfast.
Note: The rules I share concerning Dutch meals and buying your meals at meetings and events arise from a 1953 tax court case referred to as the Sutter Case. It is still invoked by the IRS, especially when one’s business meal deduction is substantial. Are you in danger of losing a meal deduction for an occasional business meeting where you buy your meal or coffee? Probably not. But, if you want to be on firmer ground, take turns buying your guest’s cappuccino as well as your own & document a substantial business discussion!
Meals at Entertainment Events: Entertainment expenses are no longer deductible due to the Tax Cuts and Jobs Act. Meals at such events, on the other hand, are still deductible if billed separately. For example, Rick takes a client to a baseball game at the game and buys his client’s lunch. Since Rick purchased the meals separately, he can deduct 50% of the meal cost, including his. The baseball tickets are not deductible.
If deducting meals associated with entertainment, please make sure it occurs close time-wise to a substantial business discussion. You or your employee must also be present for the meal, and only business attendees’ food is deductible.
Meals for Employees: The Tax Cuts and Jobs Act kept the deduction for employee meals provided for the convenience of the employer but reduced it from 100% to 50%. Such meals arise when the employer wants to keep the employees close to work or on the job (for example, buying pizza for tax office employees when working late).
Office Coffee and Snacks: Break-room coffee and snacks provided by an employer are also limited to 50% (thanks TCJA!). This change is somewhat ridiculous for smaller businesses due to the de minimis nature of the expense. For many, the hassle of separately tracking such a minor cost, just to cut it in half, is not worth the effort.
Food Not Subject to 50% Limitation
Notice that I use the word food and not meals? I did this because some food is not considered a meal and is 100% deductible. When the food purchased is not for a business meal, ask yourself why you bought the food. If the answer is an ordinary and necessary business expense, you may have a 100% deduction. Here are some examples:
Promo-Related Food: Refreshments offered at an Open House or similar event are not a business meal. If the event is open to the public, it is an advertising expense – the food is helping you promote a listing. Similarly, snacks and treats offered to attendees at your trade-show exhibit are there to draw interest and referrals. It’s advertising.
Event Food: If you’re holding a training or other business event that includes refreshments or even a light lunch, this food can be 100% deductible when included in the cost of attendance.
Annual Picnic or Holiday Party: The cost of food or meals provided at an event held infrequently for employees remains 100% deductible so long as the event is open to all employees and not extraordinarily lavish in nature.
Coffee & Snacks for the Public: Want to get a 100% snack deduction? Move the break room to the office lobby (I’m kidding). Coffee and snacks offered in a waiting room or office lobby for clients and customers as they wait may be considered a promotional expense and 100% deductible.
Income to Recipient: When the cost of meals and food provided to an employee or contractor gets included on their W2 or 1099, the expense is 100% deductible as salaries and wages, contract labor, or other appropriate expense.
Substantiating Business Meals
There are two essential points to make before we discuss substantiating business meals. First: The most common reason a meal deduction gets denied is that attendees, purpose, or cost cannot be verified. Second: The main reason business owners fail to deduct meals is that they don’t record them and forget they occurred.
Here are three steps to help you remember your business meals and keep your deduction when the IRS visits.
Step One - Document Attendees: For a meal to be deductible, you must share it with at least one person with whom you have a business relationship. Document attendees by recording them in a calendar or journal you can easily refer to when needed. Additionally, write their name and a quick discussion summary on the establishment’s receipt. No need to be extravagant. The note can be as simple as “Samantha Jones / Mayhew Home Inspection.”
Step Two - Document Business Purpose: This can be as easy a few words on your calendar or the receipt. When using your business debit or credit card to pay (as you should), grab your datebook and jot attendees and meeting purpose by the statement charges.
Step Three: Document Date, Place, and Cost: There is no better way to document the date, place, and cost of the meal than a receipt from the place of business. But, I’m also a big fan of the debit/credit methodology mentioned above.
For more information tracking and proving meal expenses, check out our Easy Recordkeeping Article.
Summary and Invite: We hope this article has helped and encouraged you to track, prove, and – most importantly – maximize your business meal deduction. If you’d like some assistance in cutting a Real Estate Agent’s highest cost - taxes, please download our Real Estate Agent Tax Organizer. To seriously minimize your tax-obligation, purchase our Real Estate Agent Tax-Cut Library. It contains over eight hours of tax-cut information broken into twenty-nine searchable volumes. It’s tax-deductible and covers every possible deduction a Real Estate Agent can take. The library pays for itself with the taxes you save, and our Broker Version will help your entire agencies cut their most considerable expense-TAXES!