The IRS Boozily Resurrects the 3-Martini Lunch
IRS and Treasury have recently been so overwhelmed by the volume of regulation needed to implement the 2017 tax legislation that it’s easy to understand if they just really need a drink. It’s still surprising, though, that one piece of their recent implementing guidance seems to bring back the days of Mad Men’s boozy lunches. In its recent Notice 2018–76, IRS seems to have proclaimed that business meals and beverages are now deductible to an extent we haven’t seen since 1962. They’ve had one martini too many: the Notice totally misreads the 2017 legislation.
Okay, if you haven’t taught or taken a Federal Income Tax class recently, you may need a reminder that for 50 years or so business meals have mostly not been deductible. Until the 2017 changes (herein SCTCJA, or so-called Tax Cut & Jobs Act), in order to “write off” your meal or other business “entertainment,” you had to conduct a concrete business transaction during or right before or after (unless you were traveling for work). While this was hardly an impossible standard to fake, it was a real speed bump, because genuine concrete transactions generate real documentation that can be audited.
SCTCJA deleted all of this language and replaced it with the phrase “no deduction shall be allowed for…activity which is of a type generally considered to constitute entertainment.” They left in place several pre-existing exceptions, including a provision that further bans deductions for meals that are “lavish or extravagant.”
Bizarrely, the new Notice reads this language as greatly expanding the kinds of business meals that can be deducted. Pointing to one sentence in the legislative history, the Notice declares that meals are still deductible. Indeed, meals now can be deducted any time they are shared with a “current or potential business customer, client, consultant, or similar business contact.”
It’s a standard that allows essentially anything to be deducted. “Hey, Chuck, let’s pretend that you might buy a tractor from me some day, ok? Great, now I can deduct these beers.”
But there is an enormous problem with the IRS’s reading of the legislative history. Here’s the Conference Report language they rely on (it’s page 407 of the linked document). See if you can spot the problem; I gave you a little hint about where it is.
“Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).” (emph. added)
Yeah, it’s that word “still.” Good spotting. How can you read the word “still” and think that it means “Congress says that we have to dramatically expand the deductibility of meals”? Martinis have to be involved. And, of course, there’s the whole issue that you really shouldn’t be reading legislative history to resolve the meaning of a statute that has no ambiguity. What part of “no deduction” didn’t they understand?
So in my view the Notice should be withdrawn, and hastily. If you’re interested, I’ve pasted in the full text of my comments on it (with lots more arguments for why it’s wrong) below.
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Dear Sir or Madam:
I write to offer brief comments on Notice 2018–76 and the proposed rulemaking to follow. The Notice would allow partial deductions for meal expenses, notwithstanding the unmistakably clear language of the revised statute prohibiting any deduction. I write to urge the IRS to follow the law as it was written by Congress, and to prohibit deductions for meal expenses other than those permitted by enacted law. That reading also avoids the unnecessary legal quagmires and economic distortions that the approach suggested in the Notice would entail.
First, the Notice’s position is unlawful. In defense of its position, the Notice states that “the legislative history of the Act clarifies that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business.” When a statute’s language is clear, it may not be amended through resort to legislative history. Wyeth v. Levine, 555 U.S. 555, 600 (2009). The amended § 274(a) states that “no deduction … shall be allowed for any item with respect to an activity which is of a type generally considered to constitute entertainment.” In case there were any doubt that this prohibition covers business meals, § 274(e)(1) states that it does not apply to certain “expenses for food and beverages.” Obviously, this exception would be sensible only if § 274(a) covered meals.
The Notice seems to imply that Congress’ failure to repeal § 274(k) permits a different result, but any such argument would be unpersuasive. Section 274(k) provides that “No deduction shall be allowed under this chapter for the expense of any food or beverages unless — (A) such expense is not lavish or extravagant under the circumstances, and (B) the taxpayer (or an employee of the taxpayer) is present at the furnishing of such food or beverages.” It further allows for exceptions in the case of “any expense described in paragraph (2), (3), (4), (7), (8), or (9) of subsection [274](e).”
Section 274(k) adds further requirements that taxpayers must satisfy in order to be able to deduct meals. Nothing in it lifts a barrier to deduction imposed by other portions of § 274. Its presence cannot authorize a deduction that would be prohibited by § 274(a).[1]
Perhaps the Notice drafters concluded that the continued existence of § 274(k) implies that Congress must have intended to preserve some deductions for business meals under § 274(a). It might be argued that § 274(k) would be useless surplusage if there would exist no meals limited by § 274(k) that were not already limited by § 274(a). But see Lamie v. U.S. Trustee, 540 U.S. 526, 534 (2004) (stating that preference for avoiding surplusage cannot make an otherwise clear statute unclear).
But this argument is unavailing because there are many potential meals restricted by § 274(k) and not § 274(a). For example, § 274(k) will still apply to any meal that falls into the exception under § 274(e)(1) and so is not barred by § 274(a). Section 274(e)(1) allows a deduction for meals “furnished on the business premises of the taxpayer primarily for his employees” (emph. added). It thus could permit an employer to deduct the cost of furnishing meals to some customers, or indeed to herself, even when there are no employees of the employer present (for instance, if the meal is furnished by contract caterers). Section 274(k) would prohibit this result. Admittedly, that is a narrow application. More important, though, is the other key limit of 274(k), which in the amended statute now serves as a bar on deductions for “lavish or extravagant” on-site meals. Narrow or not, none of the language of § 274(k) is surplus, and so § 274(k) offers no reason to read § 274(a) in any way other than its most natural and obvious meaning.
Even if it were permissible to resort to legislative history in interpreting the statute, the history cannot bear the weight the Notice gives it. The Notice’s summary of the legislative history omits a key phrase from the Conference Report. The full language of the report is: “Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).” H.R. Rep. №115- 466, at 407 (2017) (Conf. Rep.) (emphasis added). The legislative history thus merely recognizes the longstanding understanding that meals deductible under § 162(a)(2) are not considered entertainment. Certainly, there is nothing in this one brief sentence to suggest that Congress intended to redefine the scope of “entertainment” in §274(a) to exclude meals, and to thereby make section § 274(e)(1) meaningless.
It might be argued that the meaning of the legislative history cannot be as simple as I suggest, because the Conference Report prefaces the “meals consumed” language with an “e.g.,” and so must have more than one case in mind. That is so, but there are many other instances of deductible meals that Congress could have been referring to. Among others, Congress could have had in mind meals deductible under § 274(e)(1), e(5), and e(6), all of which are exempt from § 274(a) but subject to the 50% reduction of 274(n). Therefore, the Conference Report gives no reason to ignore the statute’s plain language.
Further, the IRS should avoid interpretations that result in unreviewable giveaways of taxpayer money, as the Notice does. Supreme Court precedent denies standing to this commentator, or anyone else, to challenge the IRS’s decision to grant deductions or other tax benefits unauthorized by law. Allen v. Wright, 468 U.S. 1250 (1984). In contrast, interpretations that may tend to increase taxes payable by any taxpayer can and likely will be subject to review both by IRS internal appellate procedures and in federal court. Errors in taxpayers’ favor require correction by Congress. Moreover, this asymmetric potential for error correction short of legislative override is nearly unique to the tax system. Other regimes, such as those for securities and environmental regulation, allow interested private parties a path into court to challenge agency failures to protect the public’s interest. While this dichotomy has been in place for over 30 years, it was never intended by Congress, which instead declared that final administrative action is presumptively subject to judicial review. 5 U.S.C. § 702. IRS should accordingly make every assumption against outcomes that would produce unreviewable benefits at the expense of the public fisc.
Lastly, the Notice is bad tax policy. By creating a new disparity in the treatment of meals and entertainment, the Notice obliges the IRS and taxpayers to attempt to distinguish between the two even though there is no principled basis in policy for doing so. Inevitably, this will lead to arbitrary and economically inefficient outcomes. Indeed, even the simple examples offered in the Notice demonstrate that the Notice will treat differently two taxpayers who differ only in how their expenses are stated. Sensible vendors will price their goods in a way that generates tax benefits for customers at minimal cost to the merchant, rather than the way that optimizes the business alone.
The Notice will also prove unadministrable. It declares that “[t]he entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages” with no suggestion about how such a rule could be enforced. The IRS will now develop, presumably, an expertise in hot dog pricing. But no expertise will resolve such nice questions as “When a restaurant charges twice as much as its ordinary price for a New Year’s Eve meal, or for a special event such as a wedding or key corporate function, what fraction of the price paid represents entertainment?”
Worse still, the Notice appears to replace the important role the former § 274(a) played in limiting abusive deductions with a vague “current or potential business” requirement. That language evidently would allow deductions even for expenditures that create substantial value beyond the current tax year. Equally troubling, it does nothing to cabin the almost unlimited potential for hiding consumption inside the forgiving language of § 162 and key decisions implementing it. Who isn’t a “potential…business contact?” Moreover, with the repeal of the former § 274(a) language, it is unclear what the statutory source of authority for this proposed limit might be, and so the provision is unlikely to survive legal challenge. That would leave nothing but the bare language of § 162 and its judicial constructions. As the IRS should know well, there are few meal expenses that cannot be defended as “common and accepted” at some level of generality.
This gap, ultimately, may be the strongest interpretive argument against the Notice’s reading of § 274. In essence, the Notice takes the position that, at the same time Congress withdrew any deduction at all for a wide array of entertainment expense, it simultaneously removed the most important existing constraint on taxpayers’ ability to deduct meals. But that cannot be what Congress intended. Indeed, the legislative history relied on by the Notice states that “[t]axpayers may still generally deduct …food and beverage expenses” (emph. added). “Still.” The Conference Report is flatly inconsistent with an interpretation that would allow deductions for meals that would not have been deductible under prior law. Yet that is precisely what the Notice permits.
In sum, the Notice lacks any basis in statutory language or legislative intent. It will undermine horizontal equity, encourage manipulative pricing, and waste scarce governmental and private resources in pursuit of a non-existent distinction between different kinds of entertainment. The Notice should be withdrawn, and replaced with guidance consistent with the statute.
Thank you for taking the time to consider these remarks. I am happy to answer any follow-up questions from you or your colleagues.
Respectfully submitted,
Brian Galle
Professor of Law
Georgetown University Law Center
[1] For similar reasons, that portion of § 274(k) exempting “any other expense to the extent provided in regulations” does not authorize the IRS to waive any aspect of § 274(a). That phrase is preceded by the clause “Paragraph (1) [of §274(k)] shall not apply to….” Thus, it is clear from context that IRS is authorized to create exceptions to the limits of 274(k)(1), not from § 274 generally.
