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50 PERCENT LIMIT ON
MEAL AND ENTERTAINMENT EXPENSES

(a) APPLICATION OF THE 50 PERCENT LIMIT

The Code Section 274 disallowance rule generally determines whether expenses incurred for entertainment are deductible. After it has been determined that an expense is deductible, Code Section 274(n) limits the amount of the expense that may be deducted. The amount allowable as a
deduction for food and beverages and for other entertainment expenses is limited to 50 percent of the deductible expense. For example, if a taxpayer takes a client to lunch at a cost of $50, only $25 would be deductible, even though the lunch would qualify as directly related entertainment because the taxpayer and the client discuss business throughout the lunch.

This limitation applies to all meals and entertainment unless one of the exceptions discussed in Section 28.9 applies. Thus, it applies to the cost of meals that are deductible because the taxpayer is away from home on business or moving, to out-of-pocket expenses in the service of a
charitable organization, to meals excluded from employees' income under Code Section 119 because they are provided on the employer's business premises for the convenience of the employer, and to an employer's reimbursement of expenses incurred by its employees in entertaining
customers in a restaurant operated by the employer. FSA 199947005. It also applies to meals and entertainment furnished as part of events held in connection with horse races (and presumably other sporting events). Churchill Downs, Inc. v. Commissioner, 115 T.C. 279 (2000).

This limitation is applied after determining the amount of the otherwise allowable deduction under Code Section 162, and after applying the other provisions of Code Section 274. The 50 percent limitation is applied before the application of the 2 percent floor on miscellaneous itemized deductions. Reg. Section 1.67-1T(a)(2).

COMPLIANCE TIP: The 50 percent limitation is applied after determining the amount of the otherwise allowable deduction. An employee may elect to determine that amount using the Federal meal and incidental expense (M&IE) rate for the appropriate locality of travel in lieu of using actual expenses. There is no formal election; an electing taxpayer calculates the deduction using the M&IE rate and
reports it on the appropriate form.

EXAMPLE 3: Michele takes a taxi to a restaurant at a cost of $9. She pays for lunch for her client, which costs $41 for food, $20 for drinks, $4 in taxes, and $10 for the tip. If the lunch is deductible, the taxi ride is not subject to the 50 percent limitation, but the $75 total of food, drink, taxes, and tip is limited to a deduction of $37.50.

In cases where the 50 percent limitation applies on the employer level, there may be a question as to which party is the employer -- for example, in an employee leasing arrangement, is the employer the lessor or the lessee? In such cases, the determination of which party is the employer is
made by applying common law principles regarding the employer-employee relationship. Beech Trucking Co., Inc. v. Commissioner, 118 T.C. No. 27 (2002). See Section 101.5 for a discussion of the factors considered in determining the existence of a common law employment relationship.

(b) ALLOCATION OF SINGLE SUM EXPENDITURES

If a taxpayer makes one payment for a package of goods and services consisting of food and beverages, entertainment, and other services, such as lodging or transportation, the expenses allocated to meals and entertainment are subject to the 50 percent limitation but the lodging and transportation expenses are not subject to the limitation. For example, a hotel may include one or more meals in its room charge, or a
company may provide its employees with one per diem amount to cover both lodging and meal expenses. In these cases, the expenses must be allocated on a reasonable basis between the expenditures for food, beverages, and entertainment and the expenditures for other services in order to apply the 50 percent limitation to the entertainment expenditures.