Entertainment, Meals, Gifts and Lodging — Deduction and Recordkeeping Requirements (Portfolio 520)

Tax Management Portfolio, Entertainment, Meals, Gifts and Lodging — Deduction and Recordkeeping Requirements, No. 520-2nd, explains the substantive and procedural rules for deducting the costs of business entertainment, gifts and meals, and for excluding from an employee's income the value of meals and lodging provided by the employer. 

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Tax Management Portfolio, Entertainment, Meals, Gifts and Lodging — Deduction and Recordkeeping Requirements, No. 520-2nd, explains the substantive and procedural rules for deducting the costs of business entertainment, gifts and meals, and for excluding from an employee's income the value of meals and lodging provided by the employer. This Portfolio contains an exhaustive analysis of the limitations imposed by §§162 and 274, as well as by other relevant statutory, regulatory, and case law limitations, on deductions for the costs of entertainment and gifts, as well as expenses for meals and unreimbursed employee business expenses. This Portfolio also analyzes the problems which arise in the context of determining whether a particular expense is a personal or business expenditure and whether an expense is deductible by the employer or by the employee incurring the cost. Additionally, this Portfolio discusses the impact of tax withholding on business expenses. Finally, because it is imperative that the taxpayer claiming the deduction of an expense be capable of substantiating the various elements of the expense, this Portfolio discusses in detail all relevant recordkeeping and reporting requirements.

A detailed examination is also made of §119, under which an employee may exclude from income certain meals or lodging provided by the employer. This discussion includes the requirements the employee must meet to qualify for the exclusion, and those the employer must meet to claim a business expense deduction for the cost of the meals or lodging, and the tax withholding requirements that pertain to those items. Finally, statutory and regulatory provisions other than §119 permitting the exclusion of meals and lodging are discussed. The information and analysis in this Portfolio will assist the practitioner or business person in ensuring that all the requirements for deductibility are met. This is vital because, unless strict attention is paid to the requirements of the statute and regulations, the employer and the employee may both lose the benefit of otherwise allowable deductions.

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Ira B. Stechel, B.A., magna cum laude, City College of New York (1969); J.D., Cornell Law School (1972); Note Editor, Cornell International Law Journal (1971–72); LL.M. (Taxation), New York University; member, Connecticut Bar, New York Bar; American Bar Association (Section of Taxation); New York State Bar Association (Tax Section), Committee on Corporations, Committee on Partners and Partnerships; author, 519 T.M., Travel and Transportation Expenses — Deduction and Recordkeeping Requirements; contributor, Journal of Taxation, Taxation for Lawyers, Taxation for Accountants, Tax Management Real Estate Journal, Tax Ideas; lecturer, N.Y.U. Institute on Federal Taxation, Midwest Tax Institute and Fordham Law School.


Detailed Analysis

I. Expenditures for Business Entertainment and Meals, Entertainment Facilities and Club Dues

A. Introduction

B. Overview of Requirements for Deductibility

1. Substantive Prerequisites

a. Threshold Characterization as “Ordinary and Necessary”

b. Limitations Imposed on Section 162 and Section 212 Deductions by Section 274

(1) Background to Enactment of Section 274

(2) Basic Pattern of Section 274

2. General Substantiation and Recordkeeping Requirements

3. Percentage Limitations and Other Restrictions on Deductibility of Costs

C. Satisfying the Substantive Requirements for Deductibility

1. Substantive Tests for Entertainment and Meal Costs

a. Statutory Pattern

b. Definition of “Entertainment” and “Meals”

(1) What Are “Entertainment” and “Meals”

(2) Distinguishing “Entertainment Facilities”

(3) Distinguishing Travel and Transportation Expenses

(4) Distinguishing “Gifts” from Entertainment and Meals

c. Who Qualifies as a Recipient

d. Meeting the “Directly Related” or “Associated With” Tests

(1) What Constitutes “Directly Related” Entertainment or Meals

(a) “Active Business Discussion” Test

(i) Proximity

(ii) Active Conduct of Business

(iii) Principal Aspect

(iv) Exclusion of Nonbusiness Guests

(b) “Clear Business Setting” Test

(c) Nonemployee Compensation

(d) Pre–1994 Club Dues Allocable to Business Meals

(2) What Constitutes “Associated With” Entertainment or Meals

(3) Combined “Directly Related” and “Associated With” Entertainment

2. Limitations Upon Deductions for Costs of Entertainment Facilities and Club Dues

a. Entertainment Facilities

(1) In General

(2) Costs “With Respect to” Entertainment Facilities

(3) Effect of Disallowance of Deduction

b. Club Dues

(1) Nondeductibility of Post–1993 Club Dues

(a) General Rules

(b) Exclusion as Working Condition Fringe Benefit

(2) Limited Deductibility of Pre–1994 Club Dues

(a) Applicability and Summary of Restrictions

(b) “Primary Use” Requirement

(c) Deduction Limited to “Directly Related” Percentage

(d) Personal Use of “Dwelling Unit”

3. Statutory Exceptions to Limitations Upon Deductions for Costs of Entertainment, Meals and Entertainment Facilities

a. Overview

b. Specific Exceptions

(1) Food and Beverage for Employees

(2) Entertainment Expenses Treated as Compensation

(3) Reimbursed Expenses

(4) Recreational Activities for Employees

(5) Business Meetings

(6) Meetings of Business Leagues

(7) Items Available to the Public

(8) Entertainment Sold to Customers

(9) Expenses Includible in Income of Nonemployees

II. Substantiation, Reporting and Recordkeeping Requirements Relating to Expenses for Entertainment, Meals and Entertainment Facilities

A. Historical Background

B. Substantiation Under Section 274(d)

1. Elements of an Expenditure

a. Entertainment and Meals

b. Entertainment Facilities and Club Dues

c. Travel and Transportation

2. Separate Expenditures; Aggregation of Expenditures

C. Acceptable Methods of Substantiation

1. Background

2. “Adequate Records”

a. Diaries and Account Books

b. Documentary Evidence

c. Deemed Substantiation

(1) Standard Meal Allowance

(a) General rule

(b) Transportation Industry

(2) Daily Allowance in Lieu of Meals and Lodging

(a) High-Low Method

(b) Per Diem Method

(3) Mileage Allowance Methods

(4) Standard Meal and Snack Rate for Family Day Care Providers

d. Other Sufficient Evidence

e. Special Rules for Federal Employees

f. Relief Provisions

(1) Substantial Compliance

(2) Exceptional Circumstances

(3) Loss of Records

D. Reporting and Recordkeeping Requirements

1. Reporting of Reimbursements and Advances

a. Statutory Pattern

b. Requirements for Accountable Reimbursement Arrangements

(1) Business Connection

(2) Substantiation

(3) Returning Excess Amounts

c. Employer Reporting Requirements

d. Employee Reporting Requirements

(1) Accountable Plans

(a) General Rules

(b) Specific Applications

(i) Expenses Equal to Reimbursements

(ii) Expenses Less Than Reimbursements

(iii) Expenses Exceed Reimbursements

(2) Nonaccountable Plans

2. Bearing the Burden of the Recordkeeping Requirements

a. When upon Employer

b. When upon Employee

c. When upon Independent Contractor

3. Permissible Employee Business Expenses

4. Retention of Records

5. Withholding Requirements

E. Restrictions upon the Deductibility of Entertainment and Meal Expenses That Otherwise Conform to the Substantive and Recordkeeping Requirements

1. Subjective Restrictions on Personal Benefit

a. “Lavish or Extravagant” Expenses

b. Taxpayer's Personal Expenses

(1) Permissive Deductibility of Taxpayer's Individual Costs Incurred in Business Context

(2) Nondeductibility Limited to Instances of “Abuse”

(3) Specific Instances of Deductibility of Taxpayer's Individual Costs

(a) Meals with Co–Workers

(b) Substantial Employer–Imposed Restrictions

(c) Statutory Exclusions Under Sections 119 and 132

(i) Exclusion of Section 119 for Meals and Lodging

(ii) Exclusion of Section 132 for Fringe Benefits

(4) Costs Attributable to Spouse

(5) Entertainment or Meals in Taxpayer's Home

2. Objective and Fixed Limitations

a. 50% Cutback for Entertainment and Meal Costs

(1) Amount Subject to Cutback

(2) Meals in Travel Status

(3) Exceptions to Cutback Percentage

(4) Reimbursement and Per Diem Arrangements

(5) Interplay with Other Limitations

(6) Effective Dates

b. Cost of Skyboxes

c. Limitation of Deduction of Cost of Tickets to Face Value

d. Requirement of Taxpayer's Presence at Entertainment and Meals

(1) Meals

(2) Entertainment

e. 2% Floor for Unreimbursed Employee Business Expenses

(1) Summary of Limitations

(2) Categorization of Miscellaneous Itemized Deductions

(3) Application of 2% Floor to Pass–through Entities

(4) Limited Exceptions to Applicability of 2% Floor

f. 3% of AGI Reduction in Itemized Deductions

3. Expenditures Contrary to Public Policy

a. Background

b. Illegal Bribes and Kickbacks

c. Lobbying Expenses and Political Contributions

F. Effect of Expense Disallowance

1. Disallowance Under Section 162

a. Effect on Employer

b. Effect on Employee

2. Disallowance Under Section 274

a. Policy of Single Disallowance

b. Possibility of Double Disallowance

III. Business Gifts

A. Definition of “Gift” in Business Context

B. Statutory Limitations on Deductibility of Business Gifts

1. Restrictions of Section 274(b)

2. Gifts Not Falling Within Section 274(b)

3. Overlapping “Gift” and “Entertainment” Expenditures

4. Overlapping “Gift” and “Charitable Contribution” Expenditures

C. Exceptions to Statutory Restrictions for Certain Gifts to Employees

1. General Rule

2. Recognition of Employee Accomplishment

a. Employee Achievement Awards

b. Prizes and Awards Under Section 74

3. Gifts of Nominal Value

4. Union Benefits

5. Widow's Benefits

6. Pre–1987 Instances of Employer Generosity Motivated by Noncompensatory Purpose

D. Substantiation Requirements

IV. Meals or Lodging Furnished to an Employee

A. General

B. Background to Enactment of 119

C. Requirements for Exclusion

1. “Convenience” of the Employer

a. Meals

b. Lodging

c. Effect of Compensatory Purpose

2. “Condition of Employment”

3. “On the Business Premises” of the Employer

a. In General

b. Perimeter of or Adjacent to Business Premises

c. Functional “Business Premises”

d. Branch Offices

e. Business Premises of Policemen

f. Individuals Residing in Camps Abroad

g. Employees of Certain Educational Institutions

4. “Furnished” by the Employer

a. In Kind Requirement

b. Election to Take in Kind or in Cash

c. Furnished at a Charge

(1) Background

(2) Meals

(3) Lodging

d. Furnished by Party Other Than Employer

5. Employment Relationship

a. Who Qualifies as an “Employee”

(1) General Tests for Exclusion

(2) Members of Employee's Family

b. Who Qualifies as an “Employer”

6. Exclusion for Items Related to Use of Meals or Lodging

a. Uncooked Food and Groceries

b. Nonfood Items

D. Business Expense Deduction for Cost of Meals or Lodging

1. By Employee

2. By Employer

E. Employment Tax Requirements

F. Provisions Other than Section 119 Relating to Meals and Lodging

1. Meals

a. Supper Money

b. Employer–Operated Eating Facilities

c. On-Duty Meals

d. Police Subsistence Allowance

e. Pre-Section 132 Administrative Exemptions

2. Exclusionary Provisions for Lodging

a. Parsonage Allowance

b. Faculty Housing

c. Pre–Section 132 Administrative Exemption

d. Section 1400P Temporary Relief for Employer-Provided Lodging Resulting from Hurricane Katrina and Midwestern Disasters

3. Exclusionary Provisions for Living Costs

a. Military Personnel

b. U.S. Employees Abroad

c. Casualty Loss Living Expenses

d. Pre–Section 132 Administrative Exemptions


Working Papers

Table of Worksheets

Worksheet 1 Excerpts from House Ways and Means Committee Report (H.R. Rep. No. 1447, 87th Cong., 2d Sess. (1962)) and Senate Finance Committee Report (S. Rep. No. 1881, 87th Cong., 2d Sess. (1962)) to accompany Revenue Act of 1962, P.L. 87–834.

Worksheet 2 Excerpts from Senate Finance Committee Report (S. Rep. No. 1263, 95th Cong., 2d Sess. (1978)) and Conference Committee Report (H.R. Rep. No. 1800, 95th Cong., 2d Sess. (1978)) to accompany Revenue Act of 1978, P.L. 95–600.

Worksheet 3 Excerpts from “Blue Book” of Tax Reform Act of 1986, P.L. 99–514 (Staff of Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (1987)).

Worksheet 4 Excerpts from Conference Committee Report (H.R. Rep. No. 998, 100th Cong., 2d Sess. (1988)) to accompany Family Support Act of 1988, P.L. 100–485.

Worksheet 5 [Reserved]

Worksheet 6 Reporting of Employee Business Expenses and Reimbursements for Travel, Transportation, Meals, Entertainment and Business Gifts.

Worksheet 7 Sample Documentation Evidencing Employer Policy Requiring Unreimbursed Business Expenses.

Worksheet 8 Sample Diary Reflecting Business Travel Expenses Incurred by Outside Salesman.

Worksheet 9 Sample Recordkeeping for Costs of Meals, Entertainment, and Entertainment Facilities

Worksheet 10 Elements to Prove Certain Business Expenses (Source: Publication 463)

Worksheet 10A Supplement to IRS Pub. 463 (Reflecting Amendments Made by the 2002 Job Creation and Worker Assistance Act)

Worksheet 11 IRS Pub. 1542, Per Diem Rates

Worksheet 12 Rev. Rul. 63–144, 1963–2 C.B. 129 (Questions and answers on business expense deductions)

Worksheet 13 [Reserved]

Worksheet 14 Rev. Proc. 2008–59 (Per Diem Allowances beginning on or after October 1, 2008)

Worksheet 14A Rev. Proc. 2007-63 (Per Diem Allowances beginning on or after October 1, 2007, and on or before September 30, 2008)

Worksheet 15 Ann. 98–77, 1998–34 I.R.B. 30, Training Materials for Application of Section 119 to Hospitality Industry Employee Meals

Worksheet 16 Rev. Proc. 2004-29, 2004-20 I.R.B. 918 Use of Statistical Sampling To Determine Deductible Business Meal and Entertainment Expenses






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